INVENTORY Introduction

8/7/2019 INVENTORY Introduction

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formed from four steel bars, and a leg assembly consisting of four legs, rolled from sheet

steel, each with a caster attached. An example of this cart's product structure tree is

presented in Figure 1.

Generally, raw materials are used in the manufacture of components. These components

are then incorporated into the final product or become part of a subassembly.Subassemblies are then used to manufacture or assemble the final product. A part that

goes into making another part is known as a component, while the part it goes into isknown as its parent. Any item that does not have a component is regarded as a raw

material or purchased item. From the product structure tree it is apparent that the rolling

cart's raw materials are steel, bars, wheels, ball bearings, axles, and caster frames.

WORK-IN-PROCESS

Work-in-process (WIP) is made up of all the materials, parts (components), assemblies,

and subassemblies that are being processed or are waiting to be processed within the

system. This generally includes all materialfrom raw material that has been releasedfor initial processing up to material that has been completely processed and is awaiting

final inspection and acceptance before inclusion in finished goods.

Any item that has a parent but is not a raw material is considered to be work-in-process.

A glance at the rolling cart product structure tree example reveals that work-in-process inthis situation consists of tops, leg assemblies, frames, legs, and casters. Actually, the leg

assembly and casters are labeled as subassemblies because the leg assembly consists of

legs and casters and the casters are assembled from wheels, ball bearings, axles, andcaster frames.

FINISHED GOODS

A finished good is a completed part that is ready for a customer order. Therefore, finished

goods inventory is the stock of completed products. These goods have been inspected andhave passed final inspection requirements so that they can be transferred out of work-in-

process and into finished goods inventory. From this point, finished goods can be sold

directly to their final user, sold to retailers, sold to wholesalers, sent to distributioncenters, or held in anticipation of a customer order.

Any item that does not have a parent can be classified as a finished good. By looking at

the rolling cart product structure tree example one can determine that the finished good inthis case is a cart.

Inventories can be further classified according to the purpose they serve. These typesinclude transit inventory, buffer inventory, anticipation inventory, decoupling inventory,

cycle inventory, and MRO goods inventory. Some of these also are know by other names,

such as speculative inventory, safety inventory, and seasonal inventory. We already have


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briefly discussed some of the implications of a few of these inventory types, but will now

discuss each in more detail.

MRO GOODS INVENTORY

Maintenance, repair, and operating supplies, or MRO goods, are items that are used tosupport and maintain the production process and its infrastructure. These goods are

usually consumed as a result of the production process but are not directly a part of the

finished product. Examples of MRO goods include oils, lubricants, coolants, janitorialsupplies, uniforms, gloves, packing material, tools, nuts, bolts, screws, shim stock, and

key stock. Even office supplies such as staples, pens and pencils, copier paper, and toner

are considered part of MRO goods inventory.

TRANSIT INVENTORY

Transit inventories result from the need to transport items or material from one locationto another, and from the fact that there is some transportation time involved in getting

from one location to another. Sometimes this is referred to as pipeline inventory.Merchandise shipped by truck or rail can sometimes take days or even weeks to go from

a regional warehouse to a retail facility. Some large firms, such as automobile

manufacturers, employ freight consolidators to pool their transit inventories coming fromvarious locations into one shipping source in order to take advantage of economies of

scale. Of course, this can greatly increase the transit time for these inventories, hence an

increase in the size of the inventory in transit.

ANTICIPATION INVENTORY

Oftentimes, firms will purchase and hold inventory that is in excess of their current need

in anticipation of a possible future event. Such events may include a price increase, a

seasonal increase in demand, or even an impending labor strike. This tactic is commonlyused by retailers, who routinely build up inventory months before the demand for their

products will be unusually high (i.e., at Halloween, Christmas, or the back-to-school

season). For manufacturers, anticipation inventory allows them to build up inventory

when demand is low (also keeping workers busy during slack times) so that whendemand picks up the increased inventory will be slowly depleted and the firm does not

have to react by increasing production time (along with the subsequent increase in hiring,

training, and other associated labor costs). Therefore, the firm has avoided both excessive

overtime due to increased demand and hiring costs due to increased demand. It also hasavoided layoff costs associated with production cut-backs, or worse, the idling or shutting

down of facilities. This process is sometimes called "smoothing" because it smoothes thepeaks and valleys in demand, allowing the firm to maintain a constant level of output and

a stable workforce.

CYCLE INVENTORY


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Those who are familiar with the concept of economic order quantity (EOQ) know that the

EOQ is an attempt to balance inventory holding or carrying costs with the costs incurred

from ordering or setting up machinery. When large quantities are ordered or produced,inventory holding costs are increased, but ordering/setup costs decrease. Conversely,

when lot sizes decrease, inventory holding/carrying costs decrease, but the cost of

ordering/setup increases since more orders/setups are required to meet demand. When thetwo costs are equal (holding/carrying costs and ordering/setup costs) the total cost (the

sum of the two costs) is minimized. Cycle inventories, sometimes called lot-size

inventories, result from this process. Usually, excess material is ordered and,consequently, held in inventory in an effort to reach this minimization point. Hence, cycle

inventory results from ordering in batches or lot sizes rather than ordering material

strictly as needed.

DECOUPLING INVENTORY

Very rarely, if ever, will one see a production facility where every machine in the process

produces at exactly the same rate. In fact, one machine may process parts several timesfaster than the machines in front of or behind it. Yet, if one walks through the plant it

may seem that all machines are running smoothly at the same time. It also could bepossible that while passing through the plant, one notices several machines are under

repair or are undergoing some form of preventive maintenance. Even so, this does not

seem to interrupt the flow of work-in-process through the system. The reason for this isthe existence of an inventory of parts between machines, a decoupling inventory that

serves as a shock absorber, cushioning the system against production irregularities. As

such it "decouples" or disengages the plant's dependence upon the sequentialrequirements of the system (i.e., one machine feeds parts to the next machine).

The more inventories a firm carries as a decoupling inventory between the various stagesin its manufacturing system (or even distribution system), the less coordination is needed

to keep the system running smoothly. Naturally, logic would dictate that an infiniteamount of decoupling inventory would not keep the system running in peak form. A

balance can be reached that will allow the plant to run relatively smoothly without

maintaining an absurd level of inventory. The cost of efficiency must be weighed againstthe cost of carrying excess inventory so that there is an optimum balance between

inventory level and coordination within the system.

BUFFER INVENTORY

As previously stated, inventory is sometimes used to protect against the uncertainties ofsupply and demand, as well as unpredictable events such as poor delivery reliability or

poor quality of a supplier's products. These inventory cushions are often referred to as

safety stock. Safety stock or buffer inventory is any amount held on hand that is over and

above that currently needed to meet demand. Generally, the higher the level of bufferinventory, the better the firm's customer service. This occurs because the firm suffers

fewer "stock-outs" (when a customer's order cannot be immediately filled from existing


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inventory) and has less need to backorder the item, make the customer wait until the next

order cycle, or even worse, cause the customer to leave empty-handed to find another

supplier. Obviously, the better the customer service the greater the likelihood of customersatisfaction.

THEORETICAL INVENTORY

In their bookManaging Business Process Flows: Principles of Operations Management,

Anupindi, Chopra, Deshmukh, Van Mieghem, and Zemel discuss a final type ofinventory known as theoretical inventory. They describe theoretical inventory as the

average inventory for a given throughput assuming that no WIP item had to wait in a

buffer. This would obviously be an ideal situation where inflow, processing, and outflowrates were all equal at any point in time. Unless one has a single process system, there

always will be some inventory within the system. Theoretical inventory is a measure of

this inventory (i.e., it represents the minimum inventory needed for goods to flow throughthe system without waiting). The authors formally define it as the minimum amount of

inventory necessary to maintain a process throughput ofR, expressed as:Theoretical Inventory = Throughput Theoretical Flow Time

Ith = R Tth

In this equation, theoretical flow time equals the sum of all activity times (not wait time)

required to process one unit. Therefore, WIP will equal theoretical inventory whenever

actual process flow time equals theoretical flow time.

Inventory exists in various categories as a result of its position in the production process(raw material, work-in-process, and finished goods) and according to the function it

serves within the system (transit inventory, buffer inventory, anticipation inventory,

decoupling inventory, cycle inventory, and MRO goods inventory). As such, the purpose

of each seems to be that of maintaining a high level of customer service or part of anattempt to minimize overall costs.

USES OF INVENTORY

(REASONS FOR MAINTAINING INVENTORY)

Anticipation Inventory or Seasonal Inventory: Inventory are often built in anticipation

of future demand, planned promotional programs, seasonal demand fluctuations, plantshutdowns, vacations, etc.

Fluctuation Inventory or Safety Stock: Inventory is sometimes carried to protectagainst unpredictable or unexpected variations in demand.

Lot-Size Inventory or Cycle Stock: Inventory is frequently bought or produced inexcess of what is immediately needed in order to take advantage of lower unit costs or

quantity discounts.

Transportation or Pipeline Inventory: Inventory is used to fill the pipeline as products

are in transit in the distribution network.


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Speculative or Hedge Inventory: Inventory can be carried to protect against some

future event, such as a scarcity in supply, price increase, disruption in supply, strike, etc.

Maintenance, Repair, and Operating (MRO) Inventory: Inventories of some items

(such as maintenance supplies, spare parts, lubricants, cleaning compounds, and officesupplies) are used to support general operations and maintenance.

The Purpose/importance of InventorySo why do you need inventory?

As discussed in a just-in-time Manufacturing environment, inventory is considered waste.

However, in environments where an organization suffers from poor cash flow or lacks strong

control over (i) electronic information transfer among all departments and all significantsuppliers, (ii) lead times, and (iii) quality of materials received, inventory plays important

roles. Some of the more important reasons for obtaining and holding inventory are:

Predictability:In order to engage in capacity planning and production scheduling, you need to control how

much raw material, parts, and subassemblies you process at a given time. Inventory bufferswhat you need from what you process.

Fluctuations in demand:A supply of inventory on hand is protection: You dont always know how much you arelikely to need at any given time, but you still need to satisfy customer or production demand

on time. If you can see how customers are acting in the supply chain, surprises in fluctuations

in demand are held to a minimum.

Unreliability of supply:Inventory protects you from unreliable suppliers or when an item is scarce and it is difficultto ensure a steady supply. Whenever possible unreliable suppliers should be rehabilitated

through discussions or they should be replaced. Rehabilitation can be accomplished through

master purchase orders with timed product releases, price or term penalties for

nonperformance, better verbal and electronic communications between the parties, etc. Thiswill result in a lowering of your on-hand inventory needs.

Price protection:

Buying quantities of inventory at appropriate times helps avoid the impact of cost inflation.Note that contracting to assure a price does not require actually taking delivery at the time of

purchase. Many suppliers prefer to deliver periodically rather than to ship an entire years

supply of a particular stock keeping unit (SKU) at one time. (Note: The acronym SKU,standing for stock keeping unit, is a common term in the inventory world. It generallystands for a specific identifying numeric or alpha-numeric identifier for a specific item.)

Quantity discounts:Often bulk discounts are available if you buy in large rather than in small quantities.

Lower ordering costs:


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If you buy a larger quantity of an item less frequently, the ordering costs are less than buyingsmaller quantities over and over again. (The costs of holding the item for a longer period of

time, however, will be greater.). In order to hold down ordering costs and to lock in favorablepricing, many organizations issue blanket purchase orders coupled with periodic release and

receiving dates of the SKUs called for.

OBJECTIVES OF INVENTORY MANAGEMENT

The primary function of inventory is to make supplies available when needed tomaintain continuous operation. The primary objectives of inventory are:

1. To have a stock of goods when needed by production and by sale.

2. To keep capital investment at the lowest level possible

3. To institute controls for the protection and distribution of inventory.

Inventory Management: Improving Profit Performance

A truly effective inventory management system will minimize the complexitiesinvolved in planning, executing and controlling a supply chain network which iscritical to business success. The opportunities available by improving a companys

inventory management can significantly improve bottom line business performance.

From a financial perspective, inventory management is no small matter. Oftentimes,

inventory is the largest asset item on a manufacturers or distributors balance sheet. As aresult, there is a lot of management emphasis on keeping inventories down so they do not

consume too much cash. The objectives of inventory reduction and minimization are

more easily accomplished with modern inventory management processes that areworking effectively.

Inventory Management and Its Effects on Customer Satisfaction

Customer satisfaction is the way the customer thinks about the company and deals with

the meeting or exceeding of expectation over the lifetime of the products and/or services.


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Organizations using modern inventory management processes are utilizing new and more

refined techniques. These techniques help to optimize inventories, which decrease

inventory and lower costs, and to maximize customer service. With these improvements

in inventory management, organizations are becoming more competitive in the delivery

of high level customer service and value

E.g.: Wal-Mart, Dell.

Excess Inventory- A Roadblock to World-Class Manufacturing

The most unrecognized adverse effect of inventory is its encouragement of bad qualityand sloppy workmanship. The mere sight of abundant supply and stocks make most

workers very careless in handling parts and products because it makes them think thatthere is a second or another chance to undo, rework, hide, or cover up first-time mistakes.

Inventories, looked upon as buffer or back-up, make it very difficult for employees to doit right the first time.

Results of excess inventory

Increased labor cost

Increased fuel cost

Cost of interest on working capital

Increased space cost

Increased maintenance cost Material scrap and rework

Material aging

Risk of material obsolescence

More transactions = wasted time

Measures against excess inventory

Production only of the number of items required by the subsequent process

Layout: from functional to cellular

Seamless flow between work centers

Disposal of obsolete materials

Very important: excess inventory hides problems, because it generates an alternative to

investigating the root cause of the problem.


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In JIT companies, the output of one station immediately becomes the input of the next,

and not thrown into a heap of buffer of work-in-process. With little stocks (ideally one

piece), between them, JIT work stations are effectively coupled; defects are easily spottedand solved since the receiving station rejects them right away and returns them to issuing

station that just produced them. This instantaneous feedback on quality is not possible

under the conventional JIC (Just-in-case) systems in which molehills of buffer separate ordecouple work stations that tend to mind their own business until disaster suddenly

strikes and the problem goes beyond control. Since the entire JIT production line would

stop if any work station stops, the workers and managers make sure no problem occursanywhere in the line.

EXCUSES FOR HIGH INVENTORY

There is an inventory of excuses which a typical manager uses to maintain the status quo

of high inventory. Using the output-process-input framework, we can classify these into

the following elements.

1. Output instability

Unreliable demand

Unsteady demand

Poor forecasting

Lack of market information

2. Process instability

Long production lead time

Long setup times

Frequent machine breakdown

High defect rate

Labor unrest

High absenteeism/employee turnover

Equipment capacity imbalance

3. Input instability

Unreliable suppliers


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Long lead time

Unstable prices

We could add a fourth, very fashionable group of excuses:

4. Environment instability

Bad roads

Bad traffic

Bad government

A typical manager who makes use of these excuses admits his own helplessness and

incompetence in dealing directly with these problems, without actually solving or

eliminating their roots. What is management for if its solution to practically all problemsis to build up inventory? To incompetent managers, inventory is the easiest way to paper

over problems, especially if the company has adequate financial resources at its disposal.

High inventory is often a symptom of mismanagement or no management at all.

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INVENTORY Introduction