15

Inventory Concepts

INVENTORY IS A

LARGE AND COSTLY

INVESTMENT

“Every management mistake ends up in inventory.”

Michael C. Bergerac Former Chief Executive Revlon, Inc.

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

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

Customer Service, i.e., Stock Availability

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.

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 demand

3. It enables specialization in manufacturing

4. It provides protection from uncertainties in demand and order cycle

5. 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

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

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

Inventory

Orderplaced

Orderarriva l

Averagec

ycle

inventory

Days 10 20 30 40 50 60

0

100

200

B . Order quantity of 200 units

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

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

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

46

Demand:20 units

A . W ith variable demand

Average Inventory Investment Under Conditions of Uncertainty

Inventory

Averagecyc le

inventory

Ss(

a fe tytock

50)

yAve ra geinve n to r(150 )

200

100

8 10 20 30 40

Days{{

411

Demand:2025 units

Average Inventory Investment Under Conditions of Uncertainty

B . W ith variab le lead tim e

Inventory

Averagecyc le

inventory

yAve ra geinve n to r(140 )

200

100

10 12{ 20 30 40

Day

Ss(

a fe tytock

40) s{

412

If orders arrive 2 days late

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

Inventory

Averagecyc le

inventory

yAve ra geinve n to r(200 )

200

100

10 12{ 20 30 40

DayyS

s(

a fe t

0tock

10 )s{ 8

Average Inventory Investment Under Conditions of Uncertainty

413

Factors Influencing Safety Stocks

Forecast error

Exposure to stockout

Lead time

Service level requirement

4 14

Impact of Demand Patterns on Inventory Management

• INDEPENDENT versus DEPENDENT DEMAND - Whether the demand for an item depends on

demand for something else-dependent demand� - demand for an item depends on demand for something

else

•Just-in-time (production philosophy)

-Attempts to synchronize stock flows so as to just meet demand as it occurs-Minimizes the need for inventory

• Pull strategy

production and distribution are demand driven so that they are coordinated with actual customer orders, rather than forecasted demand.

• Draws inventory into the stocking location

• Each stocking location is considered independent

• Maximizes local control of inventories

•Push Strategy

Products are pushed through the channel, from the production side up to the retailer.

The manufacturer sets production at a level in accord with historical ordering patterns of retailers.

It takes longer for a push-based supply chain to respond to changes in demand, which can result in overstocking or bottlenecks and delays (the bullwhip effect), unacceptable service levels and product obsolescence.� - Allocates production to stocking locations based on

overall demand� - Encourages economies of scale in production

•Push-Pull Boundary

the interface between the push-based stages and the pull-based stages is known as the push-pull boundary.

Dell- Inventory levels of individual components are determined by forecasting general demand, but final assembly is in response to a specific customer request. The push-pull boundary would then be at the beginning of the assembly line.

Inventory Carrying Cost

Inventory carrying costs are those costs associated with the amount of inventory stored.

Inventory carrying costs are made up of a number of

different costs.

Unfortunately, many companies have never calculated inventory carrying costs, even though these costs are both real and substantial.

Benchmarking the percentage of inventory carrying

costs-Avon /Revlon

InventoryCarrying

Costs

Inventory Investment

Insurance

Taxes

Obsolescence

Pilferage

Normative Model of Inventory Carrying Cost Methodology

Storagespace costs

Capitalcosts

Inventoryservicecosts

Inventoryrisk costs

Plant warehouses

Public warehouses

Rented warehouses

Company-owned warehouses

Damage

Relocation costs

5 3

MAIN AIMS OF INVENTORY MANAGEMENT

To improve cash flows

To improve return on investment (ROI)

Inventory and Least Total Cost Logistics

Inventory carrying cost is related with the decision of

logistics system design, customer service levels, number and location of DCs, transportation modes, inventory levels production schedules.

Inventory turnover as a Measure Of Inventory Management Effectiveness

Inventory turnover= Total cost of goods sold /Average inventory at cost

Average inventory at cost = beginning inventory (cost) + ending inventory (cost) / 2

Inventory Turns (Inventory Turnover): The number of times that a company’s inventory cycles or turns over per year.

It is one of the  most commonly used Supply Chain Metrics showing how fast a company is selling through its inventory and efficiently managing its resources

  Coca-ColaBalance Sheet

 

  2000 1999

Inventories $1,066,000,000 $1,076,000,000

     

  Income Statement

 

Cost of Goods Sold

$6,204,000,000  

5.79 times each year

123456789

101112131415

$750,000375,000250,000187,500150,000125,000107,14393,75083,33375,00068,18262,50057,69253,57150,000

$300,000150,000100,00075,00060,00050,00042,85737,50033,33330,00027,27325,00023,07721,42820,000

-$150,000

50,00025,00015,00010,0007,1435,3574,1673,3332,7272,2731,9231,6491,428

InventoryTurns

AverageInventory

Carrying Costat 40 Percent

Carrying CostSavings

The Impact of Inventory Turns on Inventory Carrying Costs

58

Relationship between Inventory Turns and Inventory Carrying Costs

Inventory Turns

$300,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

$250,000

$200,000

$175,000

$150,000

$125,000

$100,000

$75,000

$50,000$37,500$25,000

0

Inventory carrying costs

$225,00

$275,000

0

59

Annual Inventory Carrying Costs Compared to Inventory Turnovers

Variable Manufacturing CostCarrying Cost %Annual Cost to Carry in InventoryMonthly Cost (1/12)

$100x 30%$30

$2.50

Inventory Turns

Inventory carrying costs (per unit)

1 2 3 4 5 6 7 8 9 10 11 1 2

15.00

12.50

10.00

7.50

5.003.752.50

0

$30.00

6.00

510

ABC Analysis-Pareto

80/20 concept is useful in distribution and inventory management.

The top 20 %-A ~ wide geographic distribution through many warehouses with high levels of stock availability

The next 30 %- B The remainder 50 %- C~distributed from a

single, central stocking point

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

Annual cost(dollars)

Lowest to ta l cos t(EOQ )

Total cost

Inventorycarryingcost

Ordering cost

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

48

OrderQuantity

Numberof Orders(D/Q)

OrderingCost

PX (D/Q)

InventoryCarryingCost

1/2 Q X C X V

TotalCost

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

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

49

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

Symptoms of Poor Inventory Management

Increasing numbers of back orders. Increasing investment in inventory with back orders remaining

constant. High customer turnover rate. Increasing number of orders canceled. Periodic lack of sufficient storage space. Wide variance in turnover of major inventory items between

distribution centers. Deteriorating relationship with intermediaries, as typified by

dealer cancellations and declining orders. Large quantities of obsolete items.

Methods for Reducing Inventory

Multiechelon inventory planning.(ABC analysis) Lead time analysis. Delivery time analysis. Elimination of low turnover and/or obsolete items. Analysis of pack size and discount structure. Examination of procedures for returned goods. Encouragement/automation of product substitution. Installation of formal reorder review systems. Measurement of fill rates by storekeeping units.

Methods for Reducing Inventory (Cont’d)

Analysis of customer demand characteristics. Development of a formal sales plan and emend forecast by

predetermined logic. Expand view of inventory to include inventory management and

information sharing at various levels in the SC. Reengineering inventory management practices to realize

improvements in product flow.