Coyle Chapter 9 Managing Inventory in Teh Supply Chain

7/21/2019 Coyle Chapter 9 Managing Inventory in Teh Supply Chain

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Chapter 9 Managing Inventory in the Supply Chain

Learning Objectives

After reading this chapter, you should be able to do the

following:

Appreciate the role and importance of inventory in the economy.

List the major reasons for carrying inventory.

Discuss the major types of inventory, their costs, and their

relationships to inventory decisions.

Understand the fundamental differences among approaches to

managing inventory.

Describe the rationale and logic behind the economic order

quantity (EOQ) approach to inventory decision making, and be

able to solve some problems of a simple nature.


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Learning Objectives (cont.)After reading this chapter, you should be able to do the

following:

Understand alternative approaches to managing inventoryjust-

in-time (JIT), materials requirement planning (MRP), distributionrequirements planning (DRP), and vendor-managed inventory

(VMI).

Explain how inventory items can be classified.

Know how inventory will vary as the number of stocking points

changes. Make needed adjustments to the basic EOQ approach to

respond to several special types of applications.


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Introduction

Inventory is an asset on the balance sheet and a variable expense on

the income statement.

Inventories also have an impact on return on investment (ROI) for thefirm.

Inventories also have an impact on return on investment (ROI) for an

organization.


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GDP versus Inventory

Nominal GDP grew by 127.2 percent between 1990 and 2006.

The value of inventory increased by 78.4 percent during the

same time period.

Inventory costs as a percent of GDP declined from 17.9 percent

in 1990 to 14.1 percent in 2006.

The absolute value of inventory increased during this time

period, but it decreased as a percentage of GDP.


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Batching economies or cycle stocks

arises from three sources

procurement

production

transportation

Scale economies are often associated with all three, whichcan result in the accumulation of inventory that will not be

used or sold immediately


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Uncertainty/Safety Stocks

All organizations are faced with uncertainty.

On the demand side, there is usually uncertainty in how much

customers will buy and when they will buy it.

On the supply side, there might be uncertainty about obtaining

what is needed from suppliers and how long it will take for the

fulfillment of the order.


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Time/In-Transit and Work-in-Process Stocks

The time associated with transportation means that even while goods

are in motion, an inventory cost is associated with the time period. The

longer the time, the higher the cost.

WIP inventories, associated with manufacturing, can be significant while

the length of time the inventory sits in a manufacturing facility waiting

and should be carefully evaluated in relationship to scheduling

techniques and the actual manufacturing/assembly technology.


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Seasonal Stocks

Seasonality can occur in the supply of raw materials, in thedemand for finished product, or in both.

Those faced with seasonality issues are constantly challenged

when determining how much inventory to accumulate.

Seasonality can impact transportation.

Anticipatory Stocks

A fifth reason to hold inventory arises when an organizationanticipates that an unusual event might occur that will negativelyimpact its source of supply.


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The Importance of Inventory in Other Functional Areas

Logistics interfaces with an organizations other functional areas

Finance

Marketing

Manufacturing


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Inventory Costs

Inventory Carrying Costs

Capital Cost (interest or opportunity cost)

cost of capital tied up in inventory and the resulting lost

opportunity from investing that capital elsewhere

hurdle rate

weighted average cost of capital (WACC).


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Storage Space Cost includes handling costs associated with moving products into

and out of inventory, as well as such costs as rent, heat, and

light

Can be variable

Inventory Service Cost includes insurance and taxes

Inventory Risk Cost reflects the possibility that inventory value might decline for

reasons beyond firms control


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Calculating the Cost of Carrying Inventory

Calculating the cost to carry (or hold) a particular item in

inventory involves three steps.

First, determine the value of the item stored in inventory.

Second, determine the cost of each individual carrying cost

component to determine the total direct costs consumed by the item

while being held in inventory.

Third, divide the total costs calculated in Step 2 by the value of the

item determined in Step 1.


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Nature of Carrying Cost

Ordering Cost or Setup Cost refers to the expense of placing an order for additional inventory,

not including product cost

Order Cost Cost of placing order which may have both fixed and variable

components

Setup Costs expenses incurred each time an organization modifies a production

or assembly line to produce a different item for inventory


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Expected Stockout Cost

several consequences might occur:

Back order, which results in the vendor incurring incremental

variable costs associated with processing and making the extrashipment

Customer might decide to purchase a competitors product resulting

in a direct loss for the supplier.

Customer might decide to permanently switch to a competitors

product with loss of income.


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Safety Stock

Cost calculation Formula


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In-Transit Inventory Carrying Cost

Owner of product while it is in transit will incur

resulting carrying costs.

In-transit inventory carrying cost becomes especiallyimportant on global moves since both distance andtime from the shipping location both increase.

Owner should consider its delivery time part of itsinventory carrying cost.


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Determining the Cost of In-Transit Inventories

The capital cost of carrying inventory in transit generally equals carrying

inventory

storage space cost not relevant to inventory in transit

insurance needs requires special analysis

obsolescence or deterioration costs are lesser risks for inventory in

transit


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Dependent versus Independent Demand

independent when such demand is unrelated to the demand for other

items

dependent when it is directly related, or derives from, the demand for

another inventory item or product

Pull versus Push The pull approach relies on customer orders to move product through

a logistics system, while the push approach uses inventory

replenishment techniques in anticipation of demand to move products.


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Principle Approaches -Techniques for InventoryManagement

Fixed order quantity model involves ordering a fixed amount ofproduct each time reordering takes place

Simple EOQ Model The following are the basic assumptions of the simple EOQ model:

1. A continuous, constant, and known rate of demand

2. A constant and known replenishment or lead time

3. All demand is satisfied

4. A constant price or cost that is independent of the order quantity

(i.e., no quantity discounts) 5. No inventory in transit

6. One item of inventory or no interaction between items

7. Infinite planning horizon

8. Unlimited capital


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The EOQ model can be developed in standard mathematical form,using the following variables:


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Determining Q can be accomplished by differentiating the

TAC function with respect to Q, as shown in Formula 9-5


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Total cost model formulas:


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The Just-in-Time Approach

Four major elements

zero inventories

short, consistent lead times

small, frequent replenishment quantities

high quality, or zero defects


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Materials Requirements Planning:

deals specifically with supplying materials and component parts

whose demand depends on the demand for a specific end

product

consists of a set of logically related procedures, decision rules,

and records designed to translate a master production schedule

into time-phased net inventory requirements and the planned

coverage of such requirements for each component item neededto implement this plan


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MRP system uses the following elements:

Master production schedule (MPS)

Bill of materials file (BOM)

Inventory status file (ISF)

MRP program

Outputs and reports


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Distribution Requirements Planning: Purpose is to more accurately forecast demand and to explode

that information back to develop production schedules.

Firm can minimize inbound inventory in conjunction with

production schedules.

Outbound (finished goods) inventory is minimized

DRP develops a projection for each SKU requiring the following:

Forecast of demand for each SKU

Current inventory level of the SKU (balance on hand, BOH)

Target safety stock Recommended replenishment quantity

Lead time for replenishment


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Vendor-Managed Inventory

The basic principles: The supplier and its customer agree on which products are to

be managed using in the customers distribution centers.

An agreement is made on reorder points and economic orderquantities for each of these products.

As these products are shipped from the customers

distribution center, the customer notifies the supplier, by

SKU, of the volumes shipped on a real-time basis.

This notification is also called pull data


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ABC Analysis: Assigns inventory items to one of three groups according to the

relative impact or value of the items

A items are considered to be the most important

B items being of lesser importance

C items being the least important

Paretos Law, or the 8020 Rule

many situations were dominated by a relatively few vital elements


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Inventory at Multiple LocationsThe Square-Root Rule:The square-root rule states that total safety stock inventories in a

future number of facilities can be approximated by multiplying the

total amount of inventory in existing facilities by the square root of

the number of future facilities divided by the number of existing

facilities.


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Summary

Inventory as a percent of overall business activity continues to decline. Explanatoryfactors include greater expertise in managing inventory, innovations in information

technology, greater competitiveness in markets for transportation services, andemphasis on reducing cost through the elimination of non-value-adding activities.

As product lines proliferate and the number of SKUs increases, the cost of carryinginventory becomes a significant expense of doing business.

There are a number of principle reasons for carrying inventories. Types of inventory

include cycle stock, work-in-process, inventory in transit, safety stock, seasonalstock, and anticipatory stock.

Principle types of inventory cost are inventory carrying cost, order/setup cost,expected stockout cost, and in-transit inventory carrying cost.

Inventory carrying cost is composed of capital cost, storage space cost, inventory

service cost, and inventory risk cost. There are precise methods to calculate each ofthese costs.

Choosing the appropriate inventory model or technique should include an analysis ofkey differences that affect the inventory decision. These differences are determinedby the following questions: (1) Is the demand for the item independent or dependent?(2) Is the distribution system based upon a push or pull approach? (3) Do theinventory decisions apply to one facility or to multiple facilities?


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Summary (cont.)

Traditionally, inventory managers focused on two important questions to improveefficiency, namely, how much to reorder from suppliers and when to reorder.

The two aforementioned questions were frequently answered using the EOQ model,trading inventory carrying cost against ordering costs, and then calculating a reorderpoint based on demand or usage rates.

The two basic forms of the EOQ model are the fixed quantity model and the fixedinterval model. The former is the most widely used. Essentially, the relevant costs areanalyzed (traded off), and an optimum quantity is decided. This reorder quantity willremain fixed unless costs change, but the intervals between orders will varydepending on demand.

The basic EOQ model can be varied or adapted to focus more specifically ondecisions that are impacted by inventory-related costs, such as shipment quantities

where price discounts are involved.

Just-in-time inventory management captured the attention of many U.S. organizationsduring the 1970s, especially the automobile industry. As the name implies, the basicgoal is to minimize inventory levels with an emphasis on frequent deliveries of smallerquantities and alliances with suppliers or customers. To be most effective, JIT shouldalso include quality management


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Summary (cont.)

Materials requirements planning and distribution requirements planning are typicallyused in conjunction with each other. In addition, a master production schedule isutilized to help balance demand and supply of inventory. DRP is used on theoutbound side of a logistics system. Demand forecasts of individual SKUs aredeveloped to drive the DRP model. Then, an MPS schedule is developed to meet thescheduled demand replenishment requirements.

VMI is used to manage an organizations inventories in its customers distributioncenters. Using pull data, suppliers monitor inventory levels and create orders to shipproduct to bring inventory levels up to an economic order quantity in the customersdistribution centers.

ABC analysis is a useful tool to improve the effectiveness of inventory management.Another useful tool is the quadrant model.

When organizations are adding warehouses to their logistics networks, a frequentlyasked question is, How much additional inventory will be required? The square rootrule is a technique that can be used to help answer this question.

Coyle Chapter 9 Managing Inventory in Teh Supply Chain

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