MIDTERM 4

Inventory ManagementInventory refers to stocks of goods and materials that are held for many purposes, one of which is to fulfill normal demand patterns.

Inventory turnover measures how fast is the inventory sold. The formula is: Inventory Turnover = average costs of goods sold/average inventories. A low figure indicates that it is taking longer for that company to sell their inventory, while a higher figure will mean the inventory is selling fast (and that the levels of inventory are low which can lead to stockouts).

Inventory classifications:         Cycle (base) stock: stock held to fulfill normal customer demands during an order cycle         Safety (buffer) stock: stock held in addition to cycle stock in case of uncertainties in demand or lead time (transport delays)         Pipeline (in-transit) stock: the stock that is on its way         Speculative stock: stock held because of seasonal demand, potential shortages of the said product, and possible price increases of the product.         Companies prefer to keep lower levels of inventory as its carrying cost increases

Inventory related costs:         Inventory carrying costs are determined by many factors. Perishable items lose their value much faster over time, while a  box of pencils losses value much slower. But in general, almost all products lose value over time (perishable: after they expire they have no value, pencils: if kept in inventory for to long, new type of pencils might come out making the pencils in inventory obsolete)         Inventory shrinkage: more items are entering a facility then leaving it. Could be caused by damage, loss, or theft         Storage costs: costs related with the space taken by items in the facility. Some items have special storage requirements         Handling costs: hiring people to receive, store and move inventory. Machinery is also needed for this.         Inventory insurance costs: insure inventory against fire, flood, theft and other issues.         Taxes on inventory

         Special cases: some types of inventory (i.e. live stock) have special needs, and may cause extra costs.

Stockout Costs         In order to calculate stockout costs we can divide customers in three categories

o    Brand loyal customers: if a goods is not available to purchase at the moment, the customer will come back when the item arriveso    Switches and comes back: in cases of stockouts, the customer will change their place of purchase but only temporaryo    Lost customer: customer is forever losto    There are tradeoffs between carrying costs and stockout costs

         A firm should keep safety stock in order to avoid stockouts.  The monetary value of stockout should be  equal or bigger than the additional carrying costs incurred from keeping this safety stock on inventory.

When to order         Fixed order quantity system:  the time of the order may fluctuate, but the same quantity is always ordered.         Fixed order interval system: time interval fixed, quantity ordered fluctuates

o    Reorder (trigger) point (ROP): the level of inventory at which a new order is placed. The ROP is calculated:

         ROP=DDxRC, where DD is daily demand for the product and RC is the replenishment cycle. This formula tells you at what level must the inventory fall, in order to reorder that item. This formula is used in fixed order quantity system.         When you consider safety stock as well, formula becomes: ROP=(DDxRC)+SS ,  where SS stands for safety stock.         Its disadvantage is that it requires constant monitoring of the inventory in order to see when the inventory equals ROP so to know when to reorder.

How much to reorder         Economic order quantity (EOQ) deals with calculating the size of the order with respect to costs of carrying the inventory and costs of ordering the inventory.         If there were no costs of carrying inventory, companies would not care how much inventory they keep         Similarly, if there were not costs associated with ordering goods, companies would not worry about the

frequency of sending orders, and as a result they will keep low or no inventories. Instead, they would just order whenever needed.         The EOQ determines the point at which carrying costs and ordering costs are at minimum         EOQ=SQR ROOT of  2AB/C , where A is the annual value of goods used (items sold or ordered), B costs per order, C carrying costs of inventory. The result of this formula tells you the optimum quantity of goods (in terms of $ ) to be ordered.      EOQ=SQR ROOT of 2DB/IC   , where D is annual demand, B costs per order, C carrying costs (expressed as percentage), I dollar value of the inventory (per unit). The result is expressed as the optimum quantity to be ordered (in terms of units).

Contemporary methods to managing inventory1. The ABC analysis claims that inventories of a company are not of equal importance.  Items sold by a

company might be categorized in 3 categories: A items are of essential importance to the business, B items are less important than A items, and C items are slightly important.  A way that these categories could be classified is as follows: if 90% of the revenues come from 30% of items than those items contained in that 30% can be categorized as A items, if 5% of revenues come from 32% of items than those items contained in that 35% are B items, if 5% of revenues come from 38% of items than those items contained in that 38% can be categorized as C items. Since different item groups have different importance to the company (example: importance could be measured with revenues), than that company should treat each item or item group differently depending on its importance.

2. Just in time approach (JIT) tries to reduce (or completely remove) safety stock, and have the required materials arrive exactly when they are needed at the production facility. This approach views inventory as waste. In order for this approach to work, the shipment of materials from suppliers to the production facility must be free from defects cause otherwise the production will fail (or be delayed, causing JIT to fail). Since under JIT inventory levels are low or zero, orders will be send very often to suppliers. This requires that suppliers have their ordering systems capable of receiving frequent orders from the customer in an error free fashion. Lastly, in order for JIT to work, the suppliers of the company should be placed close to the  facility of the customer. This avoids the possible delays that could be caused by long distance travelling. Since JIT requires frequent smaller shipments, and close supplier location, this type of inventory management requires trucking service in order to function properly.

3. Vendor-management Inventory (VMI) in this type of method, the manufacturer is responsible with taking care of the size and timing of replenishment orders.

4. Inventory tracking latest technological advances have made it more easier to keep track of inventory. One of these advantages is the RFID chips. RFID contains more data about a product than a barcode, which makes it possible to monitor inventory without opening the package of a good. The high cost of RFID, prevents it from having  mass adoption.

Inventory management: Special concerns         Complementary products: some goods only go with some other goods. Example: for razors to sell, you need to also keep razor blades         Dead inventory: items that do not sell         Deals: suppliers might make unsellable items attractive to retailers, like lowering the price. These types of good are a burden to the retailer. (Stock keeping unit ): SKUs must be defined similarly between supply chain members, otherwise problems may arise. If the suppliers defines a SKU as 12pcs of cola and the retailer defines it as 24pcs of cola, than we can imagine the problems this will cause.         Informal agreements outside the distribution channel         Repair and replacement parts: these items are of critical importance to customers. Although they do not sell much or often, when they are needed they are really needed. This represents a problem for companies; they find it difficult to know what quantity of these items should be kept, and at how many facilities to keep them.         Reverse logistics : items flying back from the customer to the producer/retailer. These include returned items, refurbished items         Substitute products: example: when cola is missing, it is important to have a close substitute such as Pepsi in order to avoid customer dissatisfaction