Inventory Management

Inventory management is a core operations management activity. Good inventory management is important for the successful operation of most businesses and their supply chains. Operations marketing, and finance have interests in good inventory management.

Introduction

A stock or store of goods. Firms typically stock hundreds or even thousands of items in inventory, ranging from small things such as pencils, paper clips, screws, nuts, and bolts to large items such as machines, trucks, construction equipment, and airplanes,

Inventory

Independent-demand items - Items that are ready to be sold or used. Example: computers

Dependent-demand items- these are components of finished products, rather than the finished products themselves. Example: Computer components

Independent vs. Dependent Demand Inventory

Inventories are a vital part of business. Not only are necessary for operations, but they also contribute to customer satisfaction.

Inventory decisions in service organizations can be especially critical. Hospitals, for example, carry an array of drugs and blood supplies that might be needed on short notice.

Nature and Importance of Inventories

Raw materials and purchased parts Partially completed goods, called work-in-

process (WIP) Example: Body parts of cars. Finished-goods inventories (manufacturing

firms) or merchandise (retail stores) Tools and supplies Maintenance and repairs (MRO) inventory Goods-in-transit to warehouses, distributors,

or customers (pipeline inventory)

Different kinds of inventories

1. To meet anticipated customer demand. 2. To smooth production requirements. 3. To decouple operations. 4. To protect against stockouts. (safety

stocks)5. To take advantage of order cycles. (to

minimize purchasing and inventory costs)6. To hedge against price increases. 7. To permit operations. 8. To take advantage of quantity discounts.

Functions of Inventory

1. Level of customer service, that is, to have the right goods, in sufficient quantities, in the right place, at the right time.

2. Cost of ordering and carrying inventories.

Two Main Concerns of Inventory Management

To achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds.

Measures of performance managers can use to judge the effectiveness of inventory management: ◦ Customer satisfaction◦ Inventory turnover ( ratio of annual cost of goods

sold to average inventory investment)

Objectives of inventory control

1. A system to keep track of the inventory on hand and on order.

2. A reliable forecast of demand that includes an indication of possible forecast error.

3. Knowledge of lead time variability. 4. Reasonable estimates of inventory holding

costs, and shortage costs. 5. A classification system for inventory items.

Requirements for effective inventory management

1. Periodic Inventory System – a physical count of items in inventory is made at periodic intervals (e.g. Weekly, monthly) in order to decide how much to order of each item.

2. Perpetual Inventory System – (also known as a continual system) keeps track if removals from inventory on a continuous basis, so the system cam provide information on the current level of inventory for each item.

Inventory Counting Systems

This system can range from very simple to very sophisticated. ◦ A two-bin system, a very elementary system,

which uses two containers for inventory. ◦ Batch or online

Batch systems, inventory records are collected periodically and entered into the system.

Online systems, the transactions are recorded immediately.

Perpetual Inventory systems

Supermarkets, discount stores, and department stores have always been major users of periodic counting systems.◦ Universal product code (UPC) or bar code –

bar code printed on a label that has information about the item to which is attached.

◦ RFID (Radio frequency identification tags) are also used to keep track of inventory in certain applications

Periodic Inventory Systems

1. Holding, or carrying cost 2. Ordering costs 3. Shortage costs

Inventory Costs

1. Holding, or carrying cost – Cost to carry an item in inventory for a length of time, usually a year.

Costs include interest, insurance, taxes, depreciation, obsolescence, deterioration, spoilage, pilferage, breakage, and warehousing costs (heat, light, rent, security), opportunity costs.

Holding Costs

Ordering costs – Costs of ordering and receiving inventory.

They are the costs that vary with the actual placement of an order. Besides shipping costs, they include determining how much is needed, preparing invoices, inspecting goods upon arrival for quality and quantity, and moving the goods to temporary storage.

Ordering Costs

Shortage costs – Costs resulting when demand exceeds the supply of inventory; often unrealized profit per unit.

These costs can include the opportunity cost of not making a sale, loss of customer goodwill, late charges, and similar costs. Furthermore, if the shortage occurs in an item carried for internal use (e.g., to supply an assembly line), the cost of lost production or downtime is considered shortage cost.

Shortage costs

1. The basic economic order quantity model2. The economic production quantity model3. The quantity discount model

How much to order: Economic Order Quantity Models

This is the simplest of the three models. It is used to identify fixed order size that will minimize the sum of the annual costs of holding inventory and ordering inventory.

Basic Economic Order Quantity (EOQ) Model

1. Only one product is involved. 2. Annual demand requirements are known.3. Demand is spread evenly throughout the

year so that the demand rate is reasonably constant.

4. Lead time does not vary. 5. Each order is received in a single delivery 6. There are no quantity discounts.

Assumptions of the basic EOQ model

Assumptions of EPQ model: 1. Only one item is involved. 2. Annual demand is known. 3. The usage rate is constant. 4. Usage occurs continually, but production

occurs periodically. 5. The production rate is constant. 6. Lead time does not vary. 7. There are no quantity discounts.

Economic Production Quantity (EPQ)

These are price reductions for large orders offered to customers to induce them to buy in large quantities.

Quantity Discounts

There are four determinants of the reorder point quantity:

1. The rate of demand (usually based on a forecast)

2. The lead time 3. The extent of demand and/or lead time

variability. 4. The degree of stockout risk acceptable to

management.

When to reorder with EOQ ordering

Reorder point – When the quantity on hand of an item drops to this amount, the item is reordered.

Safety stock – stock that is held in excess of expected demand due to variable demand and/or lead time.

Lead time – time interval between ordering and receiving the order.

Point-of-sale (POS) systems- record items at time of sale.

Definition of terms