3 Functions of Inventory Meet customer demands, provide selectionDe-couple production from distributionDecrease costs (all types)De-couple production processesManage input demand (services, backlogs)Uncertainty protection
4 Disadvantages of Inventory (All measured by increased cost) Increased costs for storage, handling, tracking, and protectionHides production problemsRisk of deterioration or obsolescenceRisk of lost business (demand inventory)
5 Types of Inventory – Where Did It Come From? Cycle inventory –> result of lot size = (Q/2)+SSRaw –> fixed order sizesWIP and FG –> fixed production batch sizesSafety stock –> just in case something goes wrong – all typesDemand/Backorders -> insufficient capacityAnticipation inventory –> all typesPipeline –> demand rate times transit time = d×LVendor Managed Inventory (VMI)Maintenance/Repair/Operating Supplies
6 Inventory Notation and Definitions IP = inventory position = OH + SR – BOT = target inventory positionOH = on-hand inventorySR = scheduled receipts (open orders)BO = back orders (delayed delivery)ROP = reorder point (inventory level when order is placed)Q = order quantityTBO = time between orders for continuous reviewP = fixed time between orders for periodic reviewL = lead time from order until deliveryProtection interval = P + LADDLT = average demand during lead timeSO = stock out (no material to satisfy demand)SS = safety stock (cushion to prevent stock out)
7 Physical Inventory Classifications Process stageNumber and ValueDemand TypeOtherRaw MaterialWIPFinished GoodsA Items B Items C ItemsIndependent DependentMaintenance Operating
9 Pressures on inventory Pressure for lower inventoryInventory investmentInventory holding costPressure for higher inventoryCustomer serviceOther costs related to inventory
10 ABC Analysis Enables effective focus, prioritization Divides on-hand inventory into 3 classesA class, B class, C classBasis is usually annual dollar volume (investment)$ volume = Annual demand x Unit costPolicies based on ABC analysisDevelop class A suppliers moreEstablish tighter physical control of A itemsForecast A items more carefullyIt might be helpful here to discuss some of the differences in the ways we would manage items in the three different levels. What actions would we actually take in managing A versus in managing C?
11 ABC Analysis Class % $Vol % Items A 80 20 B 15 30 C 5 50 102030405060708090100Percentage of itemsPercentage of dollar value100 —90 —80 —70 —60 —50 —40 —30 —20 —10 —0 —Class CClass BClass AClass% $Vol% ItemsA8020B1530C550
12 Inventory CostsHolding costs - associated with holding or “carrying” inventory over timeOrdering costs - associated with costs of placing order and receiving goodsSetup costs - cost to prepare a machine or process for manufacturing an orderTransportation costs – associated with distribution (pipeline inventory).
13 Holding (Carrying) Costs ObsolescenceInsuranceExtra staffing for handling, managementInterestPilferageDamageWarehousingTaxesTrackingIBM Tracking RFIDEtc.You might ask students if they can identify an industry for which the cost of obsolescence is particularly important. Is the number of such industries likely to grow or decline?The same question could be asked regarding pilferage.The question could be asked in a more general manner: Are there industries for which one or another of the areas listed is of particular or unusual importance?
14 Inventory Holding Costs (Approximate Ranges) CategoryHousing costs (building rent, depreciation, operating cost, taxes, insurance)Material handling costs (equipment, lease or depreciation, power, operating cost)Labor cost from extra handlingInvestment costs (borrowing costs, taxes, and insurance on inventory)Pilferage, scrap, and obsolescenceOverall carrying costCost as a% of Inventory Value6%(3 - 10%)3%( %)(3 - 5%)11%(6 - 24%)(2 - 5%)26%Note that this slide suggest holding costs are, on average, about 26% of the inventory value
15 Ordering Costs Supplies Forms Order placement (submitting, tracking, receiving)Clerical supportPackaging waste disposalEtc.
17 Inventory ManagementEffective inventory management requires information about:Expected demand (accurate forecasting)Amounts on handAmounts on orderAppropriate timing and size of the reorder quantitiesAcquisition and holding costs