CHAPTER 7 INVENTORY MANAGEMENT Principles of Supply Chain Management: A Balanced Approach Prepared by Daniel A. Glaser-Segura, PhD

CHAPTER 7INVENTORY MANAGEMENT

Principles of Supply Chain Management: A Balanced Approach

Prepared by Daniel A. Glaser-Segura, PhD

© 2009 South-Western, a division of Cengage Learning 2

Learning Objectives

You should be able to:– Distinguish dependent from independent

demand inventories.– Describe the four basic types of

inventories & their functions.– Understand the costs of inventory &

inventory turnovers.– Understand ABC classification, ABC

inventory matrix & cycle counting.


Learning Objectives (Cont.)

– Know RFID & how it can be used in inventory management.

– Understand the EOQ model & its underlying assumptions.

– Understand the Quantity Discounts & the EMQ Models & their relationships with the basic EOQ model.

– Understand & able to distinguish among the various statistical ROP models.

– Describe the continuous review & periodic review systems.


Chapter Seven Outline

• Dependent Demand & Independent Demand• Concepts & Tools of Inventory Management

– The Functions & Basic Types of Inventory– Inventory Costs– Inventory Investment– The ABC Inventory Control System– Radio Frequency Identification


Chapter Seven Outline (Cont.)

• Inventory Models– The Economic Order Quantity Model

The Quantity Discount Model– The Economic Manufacturing Quantity

Model– The Statistical Reorder Point

• The Continuous Review System versus the Periodic Review System– The Continuous Review System– The Periodic Review System


Introduction• Inventory can be one of the most expensive

assets of an organization • Inventory may account for more than 10% of

total revenue or 20% of total assets• Management must reduce inventory levels

yet avoid stockouts and other problems This chapter will discuss:

– Dependent & independent demand– Tools for managing inventory– Basic types of inventories– Various inventory management

approaches


Matching Supply & Demand

• Suppliers must accurately forecast demand so they can produce & deliver the right quantities at the right time at the right cost.

• Suppliers must find ways to better match supply & demand to achieve optimal levels of cost, quality, & customer service to enable them to compete with other supply chains.

• Problems that affect product & delivery will have ramifications throughout the chain.


Dependent & Independent Demand

• Inventory management models are generally classified as dependent demand and independent demand models.

• Dependent Demand Describes the internal demand for parts based on the demand of the final product in which the parts are used. Subassemblies, components, & raw materials are examples of dependent demand items.

• Independent DemandThe demand for final products & has a demand pattern affected by trends, seasonal patterns, & general market conditions.


Concepts and Tools of Inventory Management

Functions and Basic Types of Inventory

• The primary functions of inventory are to: – Buffer uncertainty in the marketplace & – Decouple dependencies in the supply chain (e.g.,

safety stock)

• Four broad categories of inventories– Raw materials- unprocessed purchase inputs.– Work-in-process (WIP)- partially processed

materials not yet ready for sales.– Finished goods- products ready for shipment.– Maintenance, repair & operating (MRO)- materials

used in production (e.g., cleaners & brooms).


Concepts and Tools of Inventory Management (Cont.)• Inventory Costs

– Direct costs- directly traceable to unit produced (e.g., labor)

– Indirect costs- cannot be traced directly to the unit produced (e.g., overhead)

– Fixed costs- independent of the output quantity (e.g, buildings, equipment, & plant security)

– Variable costs- vary with output level (e.g., materials)

– Order costs- direct variable costs for making an order. In mfg, setup costs are related to machine setups

– Holding or carrying costs- incurred for holding inventory in storage


Concepts and Tools of Inventory Management (Cont.)• Inventory Investment

– Firms should diligently measure inventory investment to ensure that it does not adversely affect competitiveness. Measures include:• Absolute value of inventory (found on

balance sheet)• Inventory turnover or turnover ratio- how

many times inventory “turns” in an accounting period. Faster is better!

Inventory Average

Revenue ofCost

Inventory Average

Revenue ofCost

Inventory Average

Revenue ofCost

Inventory Average

Revenue ofCost

Cost of Revenue

Average InventoryInventory Turnover Ratio =


Concepts and Tools of Inventory Management (Cont.)• ABC Inventory Control System

Determines which inventories should be counted & managed more closely than others

Groups inventory as A, B, & C Items– A items are given the highest priority with larger safety

stocks. A items, which account for approximately 20 % of the total items, are about 80 % of the total inventory cost

– B & C account for the other 80% of total items & only 20% of costs. The B items require closer management since they are relatively more expensive (per unit), require more effort to purchase/make, & may be more prone to obsolescence

– C items have the lowest priority


Concepts and Tools of Inventory Management (Cont.)

The ABC Inventory Matrix (Fig. 7.1)

InventoryMatches

Sales

AB

C A

nal

ysis

of

Inve

nto

ry U

sage

($)

ABC Analysis of Physical Inventory ($)

C Items B Items A Items

C I

tem

sB

Ite

ms

A I

tem

s

Understo

ckin

g

A and B

item

s.

Overs

tock

ing B

and C

item

s, sig

n of ex

cessi

ve

obso

lete s

tock

s

InventoryMatches

Sales

AB

C A

nal

ysis

of

Inve

nto

ry U

sage

($)

ABC Analysis of Physical Inventory ($)

C Items B Items A Items

C I

tem

sB

Ite

ms

A I

tem

s

Understo

ckin

g

A and B

item

s.

Overs

tock

ing B

and C

item

s, sig

n of ex

cessi

ve

obso

lete s

tock

s


Concepts and Tools of Inventory Management (Cont.)Radio Frequency Identification (RFID)

Successor to the barcode for tracking individual unit of goods. RFID does not require direct line of sight to read a tag and information on the tag is updatable.

(See Fig. 7.4)

RFID Tags (Transponders) Readers Information Infrastructure (Local/ERP Servers)

Hand Held ReadersShelf Readers

Fixed Portal Readers

RFID MiddlewareLocal / ERP Server

Database

Item

PalletCrate

Box

RFID Tags (Transponders) Readers Information Infrastructure (Local/ERP Servers)




Database

Item

PalletCrate

Box

RFID Tags (Transponders) Readers Information Infrastructure (Local/ERP Servers)RFID Tags (Transponders) Readers Information Infrastructure (Local/ERP Servers)




Database

Item

PalletCrate

Box



RFID MiddlewareLocal / ERP ServerRFID Middleware

Local / ERP Server

DatabaseDatabase

ItemItem

PalletCratePalletCrate

BoxBox


Inventory Models

• The Economic Order Quantity (EOQ) ModelA quantitative decision model based on the trade-off between annual inventory holding costs & annual order costs.

The EOQ model seeks to determine an optimal order quantity, where the sum of the annual order cost & the annual inventory holding cost is minimized.

• Order Cost is the direct variable cost associated with placing an order.

• Holding Cost or carrying cost is the cost incurred for holding inventory in storage.


Inventory Models (Cont.)

• Assumptions of the EOQ Model– Demand must be known & constant.– Delivery time is known & constant.– Replenishment is instantaneous.– Price is constant.– Holding cost is known & constant.– Ordering cost is known & constant.– Stock-outs are not allowed.



EOQ Model (Fig. 7.5)


Inventory Models (Cont.)Physical inventory & relationships of EOQ, average inventory, lead time, reorder point, & order cycle (Fig. 7.6)



• The Quantity Discount Model or price-break model

– Relaxes the constant price assumption by allowing purchase quantity discounts.

– Considers the tradeoff between purchasing in large quantity to take advantage of the price discount and issuing fewer orders, against holding higher inventory.

– Due to the step-wise shape of the total inventory cost curve, the optimal order quantity lies on either one of the feasible EOQs or at the price break point.



First price break

Order Size (Q)

Total Costs ($)

201 5010

EOQC=$5.00 = 483 (Infeasible EOQ)


EOQC=$4.00 = 540 (Feasible EOQ)

Second price break

Total Annual Inventory Cost

C

A

B

Optimal Order Quantity

First price break

Order Size (Q)

Total Costs ($)

201 5010




Second price break


C

A

B


First price break

Order Size (Q)

Total Costs ($)

201 5010




Second price break


C

A

B


Quantity Discount Model (Fig. 7.7)


Inventory Models (Cont.)• The Economic Manufacturing Quantity Model or Production Order Quantity Model

– Relaxes the instantaneous replenishment assumption by allowing usage during production or partial delivery.

– The EMQ model is especially appropriate for a manufacturing environment with simultaneous manufacture and consumption

– Inventory builds up gradually during the production period rather than at once as in the EOQ model.


Inventory Models (Cont.)The EMQ Model (Fig. 7.9)

Demand Only

Time

Inventory On-hand

Q

Qm

TP TC

Production& Demand

Demand Only

Time

Inventory On-hand

Q

Qm

TP TC

Production& Demand

Demand Only

Time

Inventory On-hand

Q

Qm

TP TC

Production& Demand



• The Statistical Reorder Point (ROP)

– The lowest inventory level at which a new order must be placed to avoid a stockout.

– Demand and delivery lead time are never certain and require safety stock.

• The models used under uncertainty are:

– Statistical ROP with Probabilistic Demand and Constant Lead Time

– The Statistical ROP with Constant Demand and Probabilistic Lead Time

– The Statistical ROP when Demand and Lead Time are both Probabilistic



• The Continuous Review System versus The Periodic Review System

– Order quantity & ROP models assume that the physical inventory is precisely known at every point in time

– Reality shows that stock records and actual quantity are different & requires continuous review of inventory to determine when to reorder

– A Continuous Review System is costly to conduct but requires less safety stock than the

– The Periodic Review System, which reviews physical inventory at specific points in time and requires higher level of safety stock

Documents

CHAPTER 7 INVENTORY MANAGEMENT Principles of Supply Chain Management: A Balanced Approach Prepared by Daniel A. Glaser-Segura, PhD