Inventory Models: Planning and Managing Inventories in a

Inventory Models: Planning and

Managing Inventories in a Supply Chain

SCM centers around INVENTORY.

Where to keep, how much, how to ship?

How to reduce it, trade it off?

Inventory models provide foundation for

understanding SCM concepts.

Read: 4th ed.: 3.1-3.5; 10.1 upto p273 (+ optional:

10.6); 12.1 -12.2. 3rd: 3.1-3.5; 10.1 upto

p281(+optional 10.5); 12.1 -12.2.

What Is Inventory?What Is Inventory?

• Stock to be sold or transformed into a more

valuable state

• Stock in transit/storage - all materials in

transit or in storage

Previously, inventory is flow unit!

What Is Inventory?What Is Inventory?

• Stock in transit/storage - all materials in

transit or in storage

• Examples

Companies hold inventories for

the following reasons:

1. Pipeline inventory

2. Seasonal inventory

3. Cycle inventory

4. Decoupling inventory/buffers

5. Safety inventory

Pipeline inventory

• An item (a flow unit) that has to spend in the

process in order to be transformed from input

to output

• Pipeline inventory also refers to as an item in

the up-stream supply chain that is designated

to coming to you E.g., you order today, then it takes 1 wk for order preparation,

then 3 wks shipping =4 wks

Zero inventory?

• If one states “we need to achieve zero

inventory in our process”, how will you

respond?

• By Little’s Law, Inv = flow rate * flow

time

Reasons against Holding

Inventory

• Interest/Opportunity costs

• Holding (or carrying) cost

• Building lease, insurance, etc.

• Depreciation of inventory value

• Damages while in-hold

• Hides production/operations problems

Lowering Inventory Reduces

Waste

Lowering Inventory Reduces

Waste

ScrapScrapUnreliable Unreliable

VendorsVendors

Capacity Capacity

ImbalancesImbalances

Lowering Inventory Reduces

Waste

Lowering Inventory Reduces

Waste

ScrapScrap

Reducing inventory revealsReducing inventory reveals

problems so they can be solved.problems so they can be solved.

Unreliable Unreliable

VendorsVendors

Capacity Capacity

ImbalancesImbalances

WIPWIP

Therefore, quality is pre-requisite for low inventory. The

core of JIT is of low inventory. Then, Total quality mgmt

& JIT are interdependent.

SKUSKU

• Managerial decisions regarding inventories ultimately

made at the level of an individual item or product

– SKU - specific unit of stock - item of stock that is

completely defined as to function, style, size, &

colour.

The Diversity of Stock-Keeping UnitsThe Diversity of Stock-Keeping Units

• Facts

– Large retailers carry about 100,00 SKUs

– A typical medium-sized MNC mfg concern keeps in

inventory about 10,000 types of raw materials, parts, and

finished goods

– Some large mfg companies & defence org. stock

more than 500,000 distinct items

– May be perishable -- deterioration, obsolescence

– Goods also arrive by diff. transport. modes & in

quant.

SKU: an item of stock that is completely specified

as to function, style, size, colour.

The ABC ClassificationThe ABC Classification

• Close examination of multi-SKU inventory systems

reveals a statistical regularity in the usage rate of diff

items ($)

– A class, B class, C class: 80/20 rule

• Policies based on ABC analysis

– Develop class A suppliers more ...

– Give tighter physical control of A items

– Forecast A items more carefully

13

累积存货单元数

总销量 $

20%

80％

40%

90％

100%

ABC Classification Solution*ABC Classification Solution*

Stock # Vol. Cost $ Vol. % ABC

Z-206 13,000 $ 22 $286,000 79.1 A

Z-019

W-105

1,700

75

25

200

42,500

15,000

11.8

4.1

B

B

P-144 12,000 1 12,000 3.3 C

K-207 3,000 2 6,000 1.7 C

Total $361,500 100.0

Note: Example is for illustration only; too few items.Note: Example is for illustration only; too few items.

More about 80/20 PrincipleMore about 80/20 Principle

• The 80/20 principle asserts that a minority of causes, inputs or effort usually lead to a majority of the results, outputs or rewards.

• In business: 20% products - 80% revenue *

• In society, 20% criminals - 80% value; 20% motorists -80% accidents *

• In home, 20% clothes - worn 80% time

• In bars, 20% drinkers – 80% sales

• IBM found 80% computer time spent executing about 20% of routines/codes

• Winner takes all: 5% families - 75% equity

More about 80/20 PrincipleMore about 80/20 Principle

Input Output Causes Consequences

Effort Results

65/35, 75/25, 80/20, 90/10, 95/5, 85/10

More about 80/20 PrincipleMore about 80/20 Principle

• “50/50 fallacy” - effort and results are not generally

equally balanced

• Resources that have weak effects in any

particular use are not used, or are used sparingly

– If course grades depend entirely on Finals ?

– 80% of work done by 20% workers

– 80% total beer was drunk by 28% drinkers

18

The Long Tail

• Originated from Statistics: dinosaur’s long

tail

– <Wired>magazine editor, Chris Anderson,

2004 coined it: so long as storage and channel

are big enough, the sales of low demand items

all together can match those of the hit products

• 80-20： minority vs. majority

• Long tail look at the 80% of trivial items

Amazon.com found among millions of books

that it sold online, hundreds count for a half

of its revenue, the other half from the rest of

millions.

Inventory

Process

Stage

Demand

Type

Number

& ValueOther

Raw Mat'l

WIP

Fin. Goods

Independent

Dependent

A Items

B Items

C Items

Mainten.

Repair

Operating

Inventory ClassificationsInventory Classifications

Inventories are typically measured in

three ways

Average aggregate inventory value: used to used to

accumulate total value of all items held in inventory on the accumulate total value of all items held in inventory on the

average, over some time period.average, over some time period.

Weeks (months) of supply: computed by dividing computed by dividing

average aggregate inventory held, by sales per week average aggregate inventory held, by sales per week

(month) at cost.(month) at cost.

Inventory turns: computed by dividing annual sales at computed by dividing annual sales at

cost, by average aggregate inventory value maintained cost, by average aggregate inventory value maintained

during the year.during the year.

The last two are essentially equivalent: The last two are essentially equivalent:

Annual Inventory turns = 1 / years of supply

Flow time /cycle time:T

is the time it takes a “unit of

flow” (a job) to traverse

the system

Flow/Throughput rate: R

Average number of jobs that

pass thru the system per unit

of time

Inventory: I

The number of jobs within

the system boundaries at a

particular point in time

Little’s Law

I = R * T

Little’s law

Inventory (I) = Flow Rate (R) * Flow Time (T)

Examples

Berger King

• R: Throughput: 5000kg/week

• I: Inventory: 2500kg

T = I/R = 0.5 week

Berger King

• R: Throughput: 1500

customers/day (15 hrs)

• I: Inventory: 25 customers

T = I/R = 1/60 days = 15 min

Travel Insurance

• Processes 10,000 claims per yr

• Average process time = 3 wks

• How many in processing/wait?

(50 wks per yr)

Cash flow

• Nokia sells 300M$ worth phones

per yr

• Average receivables = 45M$

More examples

• Inventory turns: compute right from financial data

Cost of Goods sold:

25,263 mill $/year

Inventory: 2,003 mill $

Cost of Goods sold:

20,000 mill $/year

Inventory: 391 mill $

T = 391*365/20000 = 5.4 days

Inv. Turns: 65.5 times/yr

T=2003*395/25263

= 29 days

Inv. Turns: 12.6 times/yr

More on Inv. Turns

• Inventory x Turns = Cost of goods sold (COGS, “turnover” at cost)

• Inventory = (1 /Turns) x COGS

• Earnings = Margin x COGS

An example:

– Margin = 12%

– Turns = 10, or (1/Turns) = 10%

– Holding cost rate = 30%

– Net margin rate = 9% ( =12 - 30/10 )

Two PC Makers

• PC Industry (U.S.):

– Margin rate = 8%

– Inventory costs = 50%

• Dell: Turns = 50, Net

margin = 7% (= 8 - 50/50)

• Compaq: Turns = 10, Net

margin = 3% (= 8 - 50/10)

• Dell has more cash

• 2Q/2000, Dell & Compaq: the same revenue. Thus, Dell earnings is at least Compaq’s 2.33 times (7/3)

• Suppose that the two companies’ P/E ratios the same. Then Dell’s market capitalization was about Compaq’s 2.33

– In fact, at the time, Dell = US$76B, Cpq = US$19B

Hutchison-Whampoa’s Retailing: Cost of goods sold: US$mil 9484,

Inventory: 2692, Turns= 3.52. (2007)

Park n Shop, AS Watson, 3, …