Inventory Concepts

15Inventory Concepts

INVENTORY IS A

LARGE AND COSTLY

INVESTMENT

CR (2004) Prentice Hall, Inc.

What are Inventories?•Finished product held for sale•Goods in warehouses•Work in process•Goods in transit•Any owned or financially controlled

raw material, work in process, and/or finished good or service held in

anticipation of a sale but not yet sold


Where are Inventories?Materialsources

Inboundtransportation

Production Outboundtransportation

Finished goodswarehousing

Customers

Inventory locations

Finished goods Shi

ppin

g

Inventoriesin-process

Rec

eivi

ng

Productionmaterials

9-4

Inventory Pipeline

Raw & In-Process Finished Goods

VendorIn-Transit

toMfr.

PlantWhse

Mfg.Process

Plant.Whse

In-Transit

to DCs

FieldWhse

Pick &Load

In-Transitto

CustmrCustomer

41

Inventory Decisions in Strategy


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Transport Strategy• Transport fundamentals• Transport decisionsCustomer

service goals• The product• Logistics service• Ord. proc. & info. sys.

Inventory Strategy• Forecasting• Inventory decisions• Purchasing and supply

scheduling decisions• Storage fundamentals• Storage decisions

Location Strategy• Location decisions• The network planning process

PLA

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IMPL

EMEN

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Transport Strategy• Transport fundamentals• Transport decisionsCustomer

service goals• The product• Logistics service• Ord. proc. & info. sys.

Inventory Strategy• Forecasting• Inventory decisions• Purchasing and supply

scheduling decisions• Storage fundamentals• Storage decisions

Location Strategy• Location decisions• The network planning process

Inventory Management ObjectivesGood inventory management is a careful balancing act between stock availability and the cost of holding inventory.

, Stock out probability

Inventory Holding costs (inventory Carrying Costs)

•Service objectives- Setting stocking levels so that there is only a

specified probability of running out of stock•Cost objectives- Balancing conflicting costs to find the most

economical replenishment quantities and timingCR (2004) Prentice Hall, Inc.

MAIN AIMS OF INVENTORY MANAGEMENT

To improve cash flows To improve return on investment (ROI,

the benefit (return) of an investment is divided by the cost of the investments)

ROI= Gains from investment – Cost of investment Cost of Investment

$700,000 - $500,000 = 40% $500,000

MEASURES OF INVENTORY MANAGEMENT EFFECTIVENESS

The impact that inventory has on corporate profitability

Measures to decrease inventory-related costs include; reducing the number of backorders or

expedited shipments, purging obsolete or dead stock from the system, or improving the accuracy of forecasts.


(Cont.) Fill rate is a common measure of the customer service

performance of inventory.

Product fill rate: fraction of product demand satisfied from product in inventory (single item) computer

Order fill rate: percentage of units available when multiproduct order is received. Computer+mouse

A 96% fill rate means that 4% of requested units were unavailable when ordered by customer.

Cycle service level: if the store doesn’t run out of stock in 6 out of 10 replenishment cycles, the store achieves a CSL of 60 percent


(Cont.)

• inventory turnover ratio would be calculated as units sold divided by units on hand.

Inventory Turnover Comparisons

How to order?

When to order?

What to order?

How much to order?

Inventory Management Answers Four Important Questions

4 3

4 2 Why Hold Inventory?

1. It enables the firm to achieve economies of scale

2. It balances supply and demand3. It enables specialization in manufacturing4. It provides protection from uncertainties in

demand and order cycle5. It acts as a buffer between critical interfaces

within the channel of distribution

Economies of Scale Inventory is required if an organization is to

realize economies of scale in purchasing, transportation, or manufacturing.

Per unit price reductions!

The cost of maintaining this inventory must be “traded off” against the production savings realized.

Balancing Supply and Demand

Seasonal supply or demand may make it necessary for a firm to hold inventory. (finished goods)

Demand for a product may be relatively stable throughout the year, but raw materials may be available only at certain times during the year.

Ex: Canned fruits and vegetables

Specialization Inventory makes it possible for each of a firm’s

plants to specialize in the products that it manufactures.

The finished products can be shipped to field warehouses where they are mixed to fill customer orders.

Whirlpool Co.- cost savings through specializing manufacturing by plant location and the consolidation of warehouse operations

Focused Factories-specialization by facility

Protection From Uncertainties

Inventory is held as protection from uncertainties; that is, to prevent a stock out in the case of variability in demand or variability in the replenishment cycle.

Inventory planning is critical to successful manufacturing operations to protect from uncertainties.

Inventory As A Buffer

Inventory is held throughout the supply chain to act as a buffer for the following critical interfaces:� * supplier-procurement� * procurement-production� * production-marketing� * marketing-distribution� * distribution-intermediary� * intermediary-customer/user

Raw materialsinventory

Work-in-process inventory

Finished goods inventory at plant location

Supplier inventory

Finished goods inventory at

field locations

Consumer inventory

Retail inventory

Waste and by-products

Waste disposal

Reworking or repackaging

of product

THE LOGISTICS FLOW

Forward logistics flow

Reverse logistics flow

TYPES OF INVENTORIESInventories can be classified based on the reasons

for which they are accumulated.

In-transit inventories Speculative stock Seasonal stock Dead stock Cycle stock Safety or buffer stock

In-transit Inventories

In-transit inventories are items that are en route from one location to another

For calculating inventory carrying costs,in-transit inventory should be considered as inventory at the place of shipment origin since the items are not available for use, sale,etc.

Speculative Stock Speculative stock is inventory held for reasons

other than satisfying current demand

Materials may be purchased in volumes larger than necessary:

to receive quantity discounts, because of a forecasted price increase materials shortage, to protect against the possibility of a strike.

Seasonal Stock Seasonal stock is a form of speculative

stock that involves the accumulation of inventory before a seasonal period begins

This often occurs with agricultural products and seasonal items.

Ex: back-to-school

Dead Stock Dead stock refers to items for which no demand has been

registered for some specified period of time.

Dead stock might be obsolete throughout a company or only at one stock keeping (SKU) location.

J.C. Whitney Company-sells auto parts that are no longer produced

Transshipment of dead stock-Asia markets

Cycle Stock Cycle stock is inventory that results from

replenishment of inventory sold or used in production.

It is required in order to meet demand under conditions of certainty; that is, when the firm can predict demand and replenishment times (lead times).

Orders are scheduled to arrive just as the last unit is sold-no extra inventory beyond the cycle stock is required.

Lot or batch size: The quantity that a stage of supply chain either produces or purchases at a given time

Q: quantity in a lot or batch size

Cycle stock: Q / 2

Cycle Stock

Safety or Buffer Stock Safety or buffer stock is held in excess of cycle stock

because of uncertainty in demand or lead time. Average inventory at a stock keeping location that

experiences demand or lead time variability = half the order quantity (cycle stock)+ the safety stock

time

Inventory level

Factors Influencing Safety Stocks

Forecast error

Exposure to stockout

Lead time

Service level requirement

4 14

Under certainty

Demand per day:20 units Order quantity: 400 units Lead time: 10 days

200

400

0

Days 10 20 30 40 50 60

Inventory

Orderplaced

Orderarrival

Orderplaced Average

cycleinventory

A. Order quantity of 400 units

Orderarrival

The Effect of Reorder Quantity on Average Inventory Investment with Constant Demand and Lead Time

4 4

Demand:20 units

InventoryOrderplaced

Orderarriva l

Averagec

ycle

inventory

Days 10 20 30 40 50 600

100

200

B . Order quantity of 200 units


45

Demand:20 units

Averagecycle

inventory

Orderarriva l

Orderplaced

C . Order quantity of 600 units

Days 10 20 30 40 50 60

Inventory

0

300

600


46

Demand:20 units

With variable demand

Demand fluctuates between 15 and 25 units per day

Lead time is constant

A . W ith variab le demand

Average Inventory Investment Under Conditions of Uncertainty

Inventory

Averagecyc le

inventory

Ss(

a fe tytock

50)

yAve ra geinven to r(150 )

200

100

8 10 20 30 40Days{{

411

Demand:2025 units

Variable lead time

Lead time fluctuates between 8 and 12 days

Demand per day is constant


B . W ith variab le lead tim e

Inventory

Averagecyc le

inventory


200

100

10 12{ 20 30 40Day

Ss(

a fe tytock

40) s{

412

If orders arrive 2 days late

With variable demand and lead time

Lead time fluctuates between 8 and 12 Demand per day fluctuates between 15

and 25

C . W ith variab le dem and and lead tim e

Inventory

Averagecyc le

inventory


200

100

10 12{ 20 30 40Day

ySs(

a fe t

0tock

10 ) s{ 8


413

EOQ = 2PDCV

where:

P = The ordering cost (dollars per order)D = Annual demand or usage of the product

(number of units)C = Annual inventory carrying cost (as a percentage

of product cost or value)V = Average cost or value of one unit of inventory

The EOQ Model47

Size of order (Q)

Annual cost(dollars)

Lowest tota l cos t(EOQ )

Total cost

Inventorycarryingcost

Ordering cost

Cost Trade-offs Required to Determine the Most Economic Order Quantity

48

OrderQuantity (Q)

Numberof Orders(D/Q)

OrderingCost

PX (D/Q)

InventoryCarryingCost

1/2 Q X C X VTotalCost

406080

100120140160200300400

120806048403530241812

$ 4,800 3,200 2,400 1,920 1,600 1,400 1,200 960 720 480

$ 500 750

1,000 1,250 1,500 1,750 2,000 2,500 3,750 5,000

$ 5,300 3,950 3,400 3,170 3,100 3,150 3,200 4,460 4,470 5,480

49 Cost Trade-offs Required to Determine the Most Economic Order Quantity

D = 4800 units per yearP = $40 per order

C = $1 per unitV= $25 per unit

Assumptions of the Simple EOQ Model

A continuous, constant, and known rate of demand.

A constant and known replenishment cycle or lead time.

A constant purchase price that is independent of the order quantity or time.

A constant transporation cost that is independent of the order quantity or time.

The satisfaction of all demand (no stockouts are permitted).

No inventory in transit. Only one item in inventory, or at least no

interaction among items. An infinite planning horizon. No limit on capital availability.

410

Fixed order point policy: EOQ-an order is placed when inventory on hand reaches a predetermined min. level necessary to satisfy demand during order cycle

Fixed order interval policy: Inventory levels are reviewed at a certain –set time interval like every week

Fixed order point-Fixed order interval policy

Inventory Concepts

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