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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, …
