Introduction to Supply Chain management(Lesson 5)

Edited By JQuek

Define the meaning of inventory management Be able to list and describe the inventory list Compare & contrast holding inventory against

having zero inventory

Objectives for today’s lesson

Definition of Inventory & Inventory System

Inventory- A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state.

Inventory System- A set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be

Inventory consists of....

Raw Materials Works-in-Process Finished Goods Maintenance, Repair and Operating (MRO)

Inventory is expensive stuff! The average carrying cost of inventory across all

manufacturing plants.. in the U.S. is 30-35% of its value.

What does that mean? Savings from reduced inventory result in increased profit.

Zero Inventory? Reducing amounts of raw materials and

purchased parts and sub-assemblies by having suppliers deliver them directly.

Reducing the amount of works-in process by using just-in-time production.

Reducing the amount of finished goods by shipping to markets as soon as possible.

Inventory Positions in the Supply Chain

RawMaterials

WorksinProcess

FinishedGoods

Finished Goodsin Field

Reasons for Inventories

Improve customer service Economies of purchasing Economies of production Transportation savings Hedge against future Unplanned shocks (labor strikes, natural

disasters, surges in demand, etc.) To maintain independence of supply chain

The link between Inventory and Value

Remember this?◦Quality◦Speed◦ Flexibility◦Cost

Nature of Inventory: Adding Value through Inventory

Quality - inventory can be a “buffer” against poor quality; conversely, low inventory levels may force high quality

Speed - location of inventory has large effect on speed Flexibility - location, level of anticipatory inventory both

have effects Cost - direct: purchasing, delivery, manufacturing

indirect: holding, stock-out.

Nature of Inventory:Functional Roles of Inventory

Transit : En-route goods or materials which are in the ownership of the firm but in the possession of the carrier.

Seasonal : inventory built up to counter predictable variability in demand

Decoupling: This is a term used sometimes instead of safety stock to establish a buffer between product demand and product supply.

Speculative : refers to inventory that a business obtains and holds in anticipation of future demand, rather than to meet current demand.

Nature of Inventory:Functional Roles of Inventory

Lot Sizing : Inventory that results whenever quantity price discounts, shipping costs, setup costs, or similar considerations make it more economical to purchase or produce in larger lots than are needed for immediate purposes.

Mistakes : Incorrect unit count, unit measure, incorrect part number etc. Inventory is then added back to the original order.

Design of Inventory Management Systems: Macro Issues

Need for Finished Goods Inventories◦Need to satisfy internal or external customers?◦Can someone else in the value chain carry the

inventory? Ownership of Inventories Specific Contents of Inventories Locations of Inventories Tracking

Inventory Measurement The Dilemma: closely monitor and control

inventories to keep them as low as possible while providing acceptable customer service.

Average Aggregate Inventory ValueHow much of the company’s total assets

are invested in inventory?Value($) Wks of Supply Turnover

Ford: 6.825 bil. 3.5 14.8Sears: 4.039 bil. 9.2 5.7G.M 8.0Toyota 35.0

Reasons Against keeping Inventory

Non-value added costs (If you are not going to sell them off immediately, why keep them?)

Opportunity cost (If you didn’t keep these items, what would you have done that might be better off?)

Complacency (Keeping inventory means you are lazy and consistently less competitive)

Inventory deteriorates, becomes obsolete, lost, stolen, etc.

Types of Inventory Costs Procurement costs (Order processing, Shipping, Handling, Purchasing costs, Manufacturing cost)

Carrying costs (Capital (opportunity) costs, Inventory risk costs Space costs, Inventory service costs)

Out-of-stock costs (Lost sales costs, Back-order costs)

Independent Demand & Dependent demand

Independent demand items are finished products or parts that are shipped as end items to customers. Forecasting plays a critical role. Due to uncertainty, extra units must be carried in inventory

Dependent demand items are raw materials, component parts, or sub-assemblies that are used to produce a finished product.

Design of Inventory Management Systems: Micro Issues

Order QuantityEconomic Order Quantity (EOQ)

is the number of units that a company should add to inventory with each order to minimize the total costs of inventory—such as holding costs, order costs, and shortage costs.

Order Timing Reorder Point (The level in which an inventory

reaches where it signals that a replenishment is due)

Key Objectives of Inventory Control

1. Maximize the level of customer service by avoiding under-stocking.

2. Promote efficiency in production and purchasing by minimizing the cost of providing an adequate level of customer service.

Balance in Inventory Levels:Questions to ask

When should the company replenish its inventory, or when should the company place an order or manufacture a new lot?

How much should the company order or produce?

Models for Inventory Management:EOQ

EOQ minimizes the sum of holding and setup costs

Q = √2DCo/Ch

Where:

D = annual demandCo = ordering/setup costs

Ch = cost of holding one unit of inventory

Example of a company: Seatide

EOQ = √2DCo / Ch

Where: D = annual demand = 6,000

Co = ordering/setup costs = $60

Ch = cost of holding one unit of inventory

$3.00 x 24% = 0.72

2 x 6,000 x 60 ═ .72

720,000.72

1,000═

Reorder Point

Quantity to which inventory is allowed to drop before replenishment order is made

Need to order EOQ at the Reorder Point:

ROP = D X LTD = Demand rate per periodLT = lead time in periods

The number of days from when a company buys the production inputs it needs to when those items arrive at the manufacturing plant. Order lead time can have a significant impact on a company's bottom line. It is a key component of delivery cycle time, along with the time it takes to make the product and the time it takes to deliver the product.

What is order lead time?

level of inventory average

inventory

units

Q

t time

The Sawtooth Model

based on reorder point - When inventory is depleted to ROP, order replenishment of quantity EOQ.

Q - System Inventory Control

Planning for Uncertainty changing lead times changing demand Uncertainty creeps in:◦Plug in safety stock. Safety stock - allows manager to

determine the probability of stock levels - based on desired customer service levels

Inventory Model Under Uncertainty

reorder Qm

point

safety stock time

an alternative to ROP/Q-system control is periodic review method

Q-system - each stock item reordered at different times - complex, no economies of scope or common product/transport runs

P-system - inventory levels for multiple stock items reviewed at same time - can be reordered together

higher carrying costs - not optimum, but more practical

P-SystemPeriodic Review Method

Classifying Inventory Items ABC Classification (Pareto Principle) A Items: very tight control, complete and

accurate records, frequent review B Items: less tightly controlled, good records,

regular review C Items: simplest controls possible, minimal

records, large inventories, periodic review and reorder

NOTE: The HIGHER the VALUE of the Inventory, the TIGHTER the control

Planning Supply Chain Activities

Anticipatory - allocate supply to each warehouse based on the forecast

Response-based - replenish inventory with order sizes based on specific needs of each warehouse

determine requirements by forecasting demand for the next production run or purchase

establish current on-hand quantities add appropriate safety stock based on desired

stock availability levels and uncertainty demand levels

determine how much new production or purchase needed (total needed - on-hand)

Anticipatory Inventory Control

replenishment, production, or purchases of stock are made only when it has been signaled that there is a need for product downstream

requires shorter order cycle time, often more frequent, lower volume orders

determine stock requirements to meet only most immediate planning period (usually about 3 weeks)

Response-Based System