Managing Inventory Flow on Supply Chains and Inventory decision making
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Transcript of Managing Inventory Flow on Supply Chains and Inventory decision making
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1Session 5 & 6: Managing Inventory Flow on Supply Chains and Inventory
decision making
Chapter 6&7
Objectives:
Understanding the importance of coordinated flows of inventory through supply chains
Appreciate the role of inventory and understand the reasons for carrying/ holding inventory
Assess the types of inventory related costs
Understand how companies can manage inventory using simple tools and techniques
Inventory - Definition
The number of units and/or value of the stock of goods held by a company
Types of Inventory
Raw material Work-in-process Finished goods Support parts MROs (maintenance,
repairs & operating supplies)
In-transit Stock Regular Or Cycle Stock Safety Stock Obsolete, Dead Or
Shrinkage Seasonal Stock Speculative Stock Promotional Stock
A stock (fast-moving stock) B stock C stock (slow-moving stock)
In The Pipeline
Called in-transit stock
Regular Or Cyclical Stock
Inventories required to meet average demand between replenishments.
Dependant upon: sales demand or production lot size replenishment lead times price-quantity discount schedules economical
shipment quantities storage space limitations
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2Safety Stock
Hedge against variability in supply, demand and replenishment lead time
Added to regular stock Calculated by statistical procedures Accurate forecasting is essential If demand and lead time 100% correct, no
need for safety stock
Obsolete, Dead, Shrinkage Stock
Includes out of date, lost or stolen stock.
Where products expensive or easily stolen-must have special precautions.
Seasonal Stock
Inventories held in advance of production or sales requirements
Speculative Stock
Inventories built up in anticipation of future price increases
Promotional Stocks
For marketing promotion purposes Trial product Sampling Free gift
Reasons for holding inventory
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3enables firms to achieve economics of scale
A firm can realiseeconomics of scale in purchasing, manufacturing, distribution.
Purchasing in large volumes
Realising lot quantity discounts
Transport can move large quantities, reducing freight costs per unit through better vehicle utilisation
Manufacturing long production runs
helps balance supply and demand
helps balance supply and demand when demand or supply is seasonal
Raw materials supply may be available only at certain times during the year.
Demand may be seasonal By manufacturing to stock,
production can be kept level throughout the year. This reduces idle capacity and maintains a relatively stable workforce.
allows for production specialisation
Inventory allows firms with subsidiaries to specialise -focused factories
Instead of producing a variety of products, each plant can manufacture a product and then ship the finished products to field warehouses where they are mixed to fill customer orders.
protects against uncertainties
A primary reason to hold inventory is to offset uncertainties in demand and supply.
Supply shortage in raw materials -production shuts down.
Customer orders outstrip finished goods supply, stockouts occurs-lose customers.
acts as a buffer
Inventory can buffer key interfaces, creating time and place utility
Key interfaces:Supplier-procurementprocurement-productionproduction-marketingmarketing-distributiondistribution-intermediary intermediary-customer
Conflicting objectives of functional areas
Marketing wants high inventories over broad range of products to allow quick response to customer demands
Production wants high inventories to support long production runs and to realise economics of scale through the reduction of per unit fixed costs
Finance normally prefers low inventories to increase inventory turns
MarketingMarketing ProductionProduction FinanceFinance
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4Total cost concept
Order processing &information costs
Lot quantitycost
Inventorycarrying costs
Warehousingcosts
Transportationcosts
Customerservice
Inventory covers problems
Sea of inventory
Quality
problems
Machinebreakdown Lineimbalance
Long transportationLong
set-up
time
Lack ofhouse-keeping
Vendor delivery
Poor
schedulin
g
Finish product to customer
Rawmaterial
Commun
ication
problem
Absenteeism
Cost of inventory
Does it cost to carry/hold inventory?
inventory costs categories
Carrying costcosts associated with physically storing a product. Includes only those costs that vary with the quantity of inventory. Usually expressed as a % of product value.
Ordering cost costs of placing an
order. Setup cost
refers to modifying the production process to make different goods.
Two types of costs are associated with inventory
Inventory carrying costs
Carryingcost
Carryingcost
Service cost
Service cost
Capital/opportunity cost
Capital/opportunity cost
insuranceinsurance
Inventory investmentInventory investment
TaxesTaxes
Plant warehousesPlant warehouses
Public warehousesPublic warehouses
Rented warehousesRented warehouses
Company warehousesCompany warehouses
ObsolescenceObsolescence
DamageDamage
RelocationRelocation
TheftTheft
Storage cost
Storage cost
Inventoryrisk cost
Inventoryrisk cost
Calculating Inventory Carrying Cost an Example
10247
23%
CapitalStorage spaceInventory serviceInventory risk costTotal
% of product valueCost
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5Ordering/setup costs
Orderingcost
Orderingcost
selecting suppliersselecting suppliers
processing order requestprocessing
order request
preparing payment
preparing payment
Reviewinginventory level
Reviewinginventory level
Setupcost
Setupcost Capital
equipment costCapital
equipment cost
Personnelcost
Personnelcost
stock checking
Inventory Costs: Expected Stock-out Cost
Cost of not having product available when a customer wants it.
Includes : backorder costs (special order). Losing one item profit by substituting a competing firms
product. Losing a customer permanently if customer finds they
prefer the substituted product and/or company.
STOCKOUT COSTS CALCULATION
COST POSSIBILITY
Wait until normal replenishment $0 10%Back order $10 40%Lost of sales $50 30%Lost of customer $100 20%
Total :$0*10% + $10x40% + $50x30% + 100x20% =$39
Trade-off: carrying costs vs ordering cost
Ordering costOrdering cost
InventoryInventorycarrying costcarrying costA
nnua
l cos
t ($)
Ann
ual c
ost (
$)
Size of orderSize of order
ABC Analysis
Single-Criterion ABC Analysis: Based on the notion: 'Vital few, trivial many' Separating inventory items into three groupings
according to their annual cost volume usage. A items having high dollar usage B items having an intermediate dollar usage C items having a low dollar usage.
The Pareto (80-20) effect
% of items
% o
f tot
al s
ales
20
20
100
100
80
80
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620% of customers,products, parts
80% of thecompany's revenueand inventoryinvestment
These are called"A" customers, "A"products, "A" parts
30% of customers,products, parts
15% of thecompany's revenueand inventoryinvestment
These are called"B" customers, "B"products, "B" parts
50% of customers,products, parts
5% of thecompany's revenueand inventoryinvestment
These are called"C" customers, "C"products, "C" parts
A-B-C analysis: An Example
SKU Annual Quantity % of total Annual $ % of total Used Item Purchases Purchases
1 1023 9.4 3600000 11.82 574 5.3 6200000 20.43 3906 36 1100000 3.64 521 4.8 15400000 50.75 1145 10.5 2300000 7.66 3754 34 1800000 5.9
Total 10923 100 30400000 100
Highest
Lowest
A-B-C Analysis (Contd)
SKU Annual Quantity % of total Annual $ % of total Used Item Purchases Purchases
4 521 4.8 15400000 50.72 574 5.3 6200000 20.41 1023 9.4 3600000 11.85 1145 10.5 2300000 7.66 3754 34 1800000 5.93 3906 36 1100000 3.6
Total 10923 100 30400000 100
71.1% of purchases10.1% of items
Pareto analysis (Example)
% o
f tot
al s
ales
10.1
100
100
71.1
90.5
30
A
B
C
10.1%
19.9%
70%
9.5%
19.5%
71.1%
A = 2, 4
B = 1, 5
C = 3, 6
Inventory management policy
The purpose of classifying items into categories is to establish the appropriate degree of control over each item.
A category items: must be frequently reviewed and should be
ordered more frequently. Attempt must be made to reduce the average lot
size For C category items:
much looser control is appropriate higher lot size and higher inventory is tolerated
For B category items
Basic approaches to managing inventory
Basic questions:
How much to order? When to order? Balance cost with service
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7Differences among approaches
Push and pull system
Dependent and independent demand
System-wide and single-facility solution
Key Differences among Approaches to Managing
Inventory
Pull versus Push Pull approach is a reactive system, relying on
customer demand to pull product through a logistics system. MacDonalds is an example.
Push approach is a proactive system, and uses inventory replenishment to anticipate future demand. Catering businesses are examples of push
systems.
PUSH MODEL
EOQ Economic Order Quantity MRPI Material Requirements Planning MRPII Manufacturing Resource Planning DRP Distribution Requirements Planning ERP Enterprise Resource Planning
PULL MODEL JIT
Key Differences among Approaches to Managing
Inventory
Dependent versus Independent Demand Dependent demand is directly related to the
demand for another product. For many manufacturing processes, demand is dependent. JIT, MRPI and MRPII are generally associated with items
having dependent demand.
Independent demand is unrelated to the demand for another product.
For many end-use items, demand is independent. EOQ & DRP models are generally associated with items
exhibiting independent demand.
Economic order quantity (EOQ)
Based on some unrealistic assumptions: Demand is known and constant Lead time is known and constant Receipt of inventory is instantaneous No stock-out Quantity discount is not allowed.
Economic order quantity (EOQ)
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8EOQ Formula-how many to buy?
LetA = cost of placing an order (or setup
cost) ($ per order)R = annual demand (units)W = annual inventory carrying cost (as
a % of product cost)V = value or cost of one unit of
inventory ($).Q = quantity ordered lot size (units).
R/Q = number of orders(R/Q)*A = annual ordering (setup) cost.Q/2 = average inventory(Q/2)*W*V = annual inventory carrying
cost
Note that optimal total cost occurs at a point where annual carrying cost is equal to annual ordering (setup) cost.
Therefore,(R/Q)*A = (Q/2)*W*V (i)
From expression (i) we can calculate Economic Order Quantity (EOQ):
Q = EOQ = (2RA/WV)
Re-order point: When to buy?
Reordering point - ROP = d x L
Where d = demand rate; L = average lead time
ROP = (R /12 )x L (when L expressed in months) ROP = (R /52) x L (when L expressed in weeks) ROP=? (When L expressed in days)
Classroom Exercise
The Williams Manufacturing Company Purchases 8000 units of a product each year at a unit cost of $10.00. The order cost is $30.00 per order, and the holding cost per unit peryear is $3.00. What are the:
(1) EOQ, (2) total annual inventory
expenses(3) number of orders to place in
one year(4) ROP when the lead time is 2
weeks?
Q* = 2RA/WV = (2 x 30 x 8000)/3 = 400 units
TIC = VR + RA/Q* + WVQ*/2= 10 x 8000 + 30 x 8000/400
+ 3 x 400/2= $81200.00
N = R/Q* = 8000/400 = 20 orders /year
ROP = R x L /52 = (8000/52)x2 = 307.7 = 308 units
Graph
Q* = 400
ROP = 308
LT = 2 Wks
Q* = 400
d = 8000/52=308/2 = 154 units
Two important insights of EOQ
An optimal policy balances between inventory holding cost and ordering or setup cost.
Total inventory cost is insensitive to order quantities within certain range, that is, changes in order quantities have relatively small impact on annual setup costs and carrying costs. 1.00 1.200.60 0.80 1.40
10.0
5.0
0.00
15.0
20.0
When Q < 40% Q* total variable cost increases by 14%When Q > 40% Q* total variable cost increases by about 6%
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9Inventory under uncertainty
Demand varies Lead time varies
2 127
Demand distribution
Lead timeVaries between 3 and 5Average lead time = 4
Example: sales data (Demand)
Day Sales Day Sales1 100 14 802 80 15 903 70 16 904 60 17 1005 80 18 1406 90 19 1107 120 20 1208 110 21 709 100 22 10010 110 23 13011 130 24 11012 120 25 9013 100
Minimum sales
Maximum sales
Standard deviation of sales = 20 units
Average sales = 100 units
Example: lead time data
# Lead time # Lead time1 9 14 122 8 15 113 9 16 114 13 17 135 11 18 126 7 19 87 12 20 98 11 21 99 9 22 1010 9 23 1011 8 24 912 9 25 1113 10
Minimum lead time
Maximum lead time
Lead time = 7 - 13 days
Average Lead time = 10 days
Standard deviation of LT=1.63
Inventory under uncertainty
) Safety stock =(AvgLT*s2d + Avgd2*sLT2) z= (10*400 + 10000* (1.63)2)z
84.13% = 1 x standard deviation; z=1; safety stock = 175
97.72% = 2 x standard deviation; z=2; safety stock = 350
99.87% = 3 x standard deviation; z=3; safety stock = 525
Probability Distribution
Total sales=840 average sales=840/12=70
80116056012606
601040470910039087021007501
salesperiodsalesperiod
-
10
1800fd2=4000
900302N=12
100
40040020190
10010010180
000270
400100-10460
400400-20150
900900-30140
fd2Deviation squared
d2
Deviation from
average
Frequency(f)
sales
19112
40001
2
===nfd
S
Average lead time=118/158
18
fd2=46932
n=151156
442110
21129
00028
51-157
84-226
99-315
fd2Deviation squared
(d2)
Deviation from
average
Frequency(f)
Lead time in days
8.1115
461
2
===nfd
LT
) Safety stock =(AvgLT*s2d + Avgd2*sLT2) *z= (8*192 + 702* (1.8)2) *z=137* z
MRPI
Material Requirements Planning
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11
61
The McGraw-Hill Companies, Inc., 2004
Firm orders from knowncustomers
Forecastsof demand
from randomcustomers
Aggregateproduct
plan
Bill ofmaterial
file
Engineeringdesign
changes
Inventoryrecord file
Inventorytransactions
Master productionSchedule (MPS)
Primary reportsSecondary reports
Planned order schedule for inventory and production control
Exception reportsPlanning reportsReports for performance control
Materialplanning(MRP
computer program)
MRPII (Closed Loop MRP)
Master Production Scheduling
Realistic?No
Feedback
Execute
Yes
Feedback
Manufacturing Resource Planning (MRP II)
Goal: Plan and monitor all resources of a manufacturing firm : manufacturing marketing finance engineering
DRP
Distribution Requirements Planning
Distribution Requirements Planning
Market Market Market
Regional warehouse
Regional warehouse
FactoryCentral warehouse
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12
Distribution Requirements Planning
Inventory planning What to distribute How much to distribute
Transport planning Time & Frequency Vehicle & Driver Route
Warehouse planning Space Receiving Processing Dispatch
Customer order planning Order cycle management
Etc.
Just In Time (JIT)
Produces and delivers finished goods just in time to be sold
Produces sub-assemblies just in time to be assembled into finished goods
Produces fabricated parts produced just in time to make sub-assemblies
Purchases raw materials just in time to make fabricated parts
JIT is a Pull model
JIT pulls materials and products through production plant and distribution channels in response to customer or downstream demands.
PullPullflexible manufacturing demand responseShorter production runs
lower inventory levels
Inventory at Multiple Locations The Square Root Law (SQL)
Used to reduce inventory at multiple locations.
As locations increase, inventory also increases, but not in the same ratio as the growth in facilities.
Inventory at Multiple Locations The Square Root Law
X2= (X1) * (n2/n1) Where:
n1 = number of existing facilitiesn2 = number of future facilitiesX1 = total inventory in existing facilitiesX2 = total inventory in future facilities
Square Root Law Example
Current distribution 40,000 units Eight facilities shrinking to two Using the square root law:
X2 = (40,000) *(2/8)X2 = 20,000 units