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Chapter 6: Managing Inventory Flows in the Supply Chain.

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Presentation on theme: "Chapter 6: Managing Inventory Flows in the Supply Chain."— Presentation transcript:

1 Chapter 6: Managing Inventory Flows in the Supply Chain

2 Chapter 6Management of Business Logistics, 7 th Ed.2 Learning Objectives - After reading this chapter, you should be able to do the following: Understand the importance of coordinated flows of inventory through supply chains. Understand the impact of effective inventory management upon the return on assets (ROA) for a company. Appreciate the role and importance of inventory in the economy and why inventory levels have declined relative to Gross Domestic Product (GDP).

3 Chapter 6Management of Business Logistics, 7 th Ed.3 Learning Objectives Understand the major reasons for carrying inventory. Explain the role of inventory to major functional areas in the company. Discuss the major types of inventory-related costs and their relationships to inventory decisions.

4 Chapter 6Management of Business Logistics, 7 th Ed.4 Learning Objectives Understand how inventory items (stock- keeping units) can be designed to maximize the efficiency of managing inventory. Appreciate the importance and value of inventory visibility to increasing supply chain effectiveness. Understand how companies can evaluate the effectiveness of their inventory management techniques.

5 Chapter 6Management of Business Logistics, 7 th Ed.5 Logistics Profile: Micros and More Inventory, inventory, inventory….I am sick and tired of hearing complaints about our inventory levels and the costs associated with carrying inventory, muttered the COO. What is the role of inventory? What are the important trade-offs in the management of inventory? What are the relevant inventory costs? Can the supply chain help control inventory?

6 Chapter 6Management of Business Logistics, 7 th Ed.6 Management of Inventory Flows in the Supply Chain: Introduction Inventory as an asset has taken on increased significance as companies struggle to reduce investment in fixed assets that accommodate inventory (plants, warehouses, etc.). Changes in inventory affect return on assets (ROA), an important internal and external metric. Ultimate challenge is to balance supply and demand for inventory.

7 Chapter 6Management of Business Logistics, 7 th Ed.7 Inventory in the Economy Inventory in the Economy has decreased. As a percentage of the GDP, from 1985 to 2000, inventory levels have decreased from 5.4% to about 3.8% Examine Table 6-1.

8 Chapter 6Management of Business Logistics, 7 th Ed.8 Table 6-1: Macro Inventory Cost in Relation to U.S. Gross Domestic Product

9 Chapter 6Management of Business Logistics, 7 th Ed.9 On the Line: Inventory Turns Think of inventory turns as a measure of how well a companys products are doing in the market and how well its inventory is managed. There is a continuing move away from traditional build-to-forecast manufacturing models to more flexible build-to-demand systems. Increasing emphasis on fully integrated supply chain means inventories barely spend any time sitting idle. Ideally, zero inventory will maximize cash flow. Inventory turnover potential is 30 to 40 times/year.

10 Chapter 6Management of Business Logistics, 7 th Ed.10 Inventory in the Firm: Rationale for Inventory Product Line Proliferation Depth & breath of product lines trending up. Results in larger inventories. Examine Table 6-2 Total Logistics Costs Inventory carrying costs of $332 billion approach 35 percent of total logistics costs for companies.

11 Chapter 6Management of Business Logistics, 7 th Ed.11 Table 6-2 Total Logistics Costs

12 Chapter 6Management of Business Logistics, 7 th Ed.12 Inventory in the Firm: Batching Economies/Cycle Stocks Price discounts Result in trade-offs between large purchases qualifying for quantity discounts and costs of storing inventory. Because physical supply inventory is often raw materials, storage costs are often less than savings from buying in bulk, so supplies are stockpiled.

13 Chapter 6Management of Business Logistics, 7 th Ed.13 Inventory in the Firm: Batching Economies/Cycle Stocks Transportation rate discounts Large quantities often result in carload freight rates. Largest shipments may qualify for even lower multiple truckload, carload or trainload rates. Lower freight rates are often reflected in lower consumer prices.

14 Chapter 6Management of Business Logistics, 7 th Ed.14 Inventory in the Firm: Batching Economies/Cycle Stocks Production economics favor long production runs. Results in cycle stock that must be stored. Cycle stocks can be beneficial as long as the appropriate analysis is done to cost justify the inventory.

15 Chapter 6Management of Business Logistics, 7 th Ed.15 Inventory in the Firm: Uncertainty/Safety Stocks Reasons for uncertainty are commonplace. Net results are the same: companies accumulate safety stock to buffer themselves against uncertainty. Safety stock more challenging and complex to manage for many firms.

16 Chapter 6Management of Business Logistics, 7 th Ed.16 Inventory in the Firm: Uncertainty/Safety Stocks Impact of information on uncertainty Trade-off analysis appropriate to assess risk and measure inventory cost. Information technology can be used in the supply chain to reduce inventory. Collaborative planning and forecasting requirements (CPFR) is an example. Bar coding, EDI, the Internet have enabled companies to reduce uncertainty.

17 Chapter 6Management of Business Logistics, 7 th Ed.17 Inventory in the Firm: Time/In- Transit and Work-In-Process Stocks Time-related trade-offs from using slower to faster transport modes Faster modes cost more but may save a larger amount in inventory carrying costs. Work-In-Process inventory should be examined for possible trade-offs especially in the production of high value goods. Scheduling and actual production times can be closely examined to reduce inventory.

18 Chapter 6Management of Business Logistics, 7 th Ed.18 Inventory in the Firm: Seasonal Stocks Seasonality can occur on the inbound and/or outbound side of the firms logistics systems. Perishable supply in agricultural products or seasonal-related transportation problems. Seasonal demand compressing selling seasons in some industries results in smaller plants producing for stock.

19 Chapter 6Management of Business Logistics, 7 th Ed.19 Inventory in the Firm: Anticipatory Stocks In some cases, companies anticipate that some forecasted event will negatively impact the production cycle. For example, labor strikes, shortage of supplies due to weather or political event, or significant price increases may prompt the firm to build inventory levels higher than normal. Risk assessment is important in these cases.

20 Chapter 6Management of Business Logistics, 7 th Ed.20 Inventory in the Firm: The Importance of Inventory in Other Functional Areas Marketing uses inventory to provide strong customer service. Manufacturing uses inventory to schedule longer production runs. Finance wants inventory turnover ratios to be kept high so that risk of inventory loss is reduced and rate of return on assets kept competitively high.

21 Chapter 6Management of Business Logistics, 7 th Ed.21 Inventory Costs: Why are they so important? First, inventory costs are a significant portion of total logistics costs for many firms. Second, inventory levels affect customer service levels. Third, inventory cost trade-off decisions affect inventory carrying costs.

22 Chapter 6Management of Business Logistics, 7 th Ed.22 Inventory Costs: Inventory Carrying Cost Capital Cost Opportunity cost associated with investing in inventory, or any asset. What is the implicit value of having capital tied up in inventory, instead of some other worthwhile project? Minimum ROR expected from any asset. Debate on inventory valuation at fully allocated or variable costs only.

23 Chapter 6Management of Business Logistics, 7 th Ed.23 Inventory Costs: Inventory Carrying Cost Storage Space Cost Handling costs, rents, utilities. Logistics develops a cost formula for storage space costs based on cost behaviors. Public space mostly variable. Private space a mix of fixed and variable.

24 Chapter 6Management of Business Logistics, 7 th Ed.24 Inventory Costs: Inventory Carrying Cost Inventory Service Cost Insurance and taxes on stored goods. Varies according to the value of the goods. Inventory Risk Cost Largely beyond the control of the firm. Due to obsolescence, damage, theft, employee pilferage.

25 Chapter 6Management of Business Logistics, 7 th Ed.25 Table 6-3 Example of Carrying Cost Components for Computer Hard Disks CostPercentage of Product Value Capital 12 % Storage space2 Inventory service3 Inventory8 Total 25 %

26 Chapter 6Management of Business Logistics, 7 th Ed.26 Inventory Costs: Calculating the Cost of Carrying Inventory Step 1 - Identify the value of the item stored in inventory (e.g. $100). Step 2 - Measure each individual carrying cost component as a percentage of product value (e.g. 25%). Step 3 - Multiply overall carrying cost (as a percentage) times the dollar value of the product (e.g. $100 times 25% = $25 inventory carrying cost per year.

27 Chapter 6Management of Business Logistics, 7 th Ed.27 Inventory Costs: Nature of Carrying Cost Items with basically similar carrying costs should use the same estimate of carrying cost per dollar. There are exceptions for items that are subject to special consideration for purposes of quick obsolescence or high degree of theft, etc.

28 Chapter 6Management of Business Logistics, 7 th Ed.28 Table 6-4 Inventory and Carrying Cost Information for Computer Hard Disks

29 Chapter 6Management of Business Logistics, 7 th Ed.29 Inventory Costs: Order/Setup Costs Order costs MIS costs for inventory stock level tracking. Preparing and processing purchase orders and receiving reports. Inspecting and preparing inventory for sale. Setup Costs Incurred when production changes over from one product to another.

30 Chapter 6Management of Business Logistics, 7 th Ed.30 Table 6-5 Order Frequency and Order Cost for Computer Hard Disks

31 Chapter 6Management of Business Logistics, 7 th Ed.31 Inventory Costs: Carrying Cost versus Order Cost Examine Table 6-6. Order costs and carrying costs respond in opposite ways to increases in volume. This reinforces the logisticians need to be able to separate costs by how they behave in relation to changes in volume. Assistance from managerial accountants is available for cost-volume-profit analysis.

32 Chapter 6Management of Business Logistics, 7 th Ed.32 Table 6-6 Summary of Inventory and Cost Information

33 Chapter 6Management of Business Logistics, 7 th Ed.33 Figure 6-1 Inventory Costs

34 Chapter 6Management of Business Logistics, 7 th Ed.34 Inventory Costs: Expected Stockout Cost Cost of not having product available when a customer wants it. Includes backorder costs (special order). Losing one item profit by substituting a competing firms product. Losing a customer permanently if customer finds they prefer the substituted product and/or company.

35 Chapter 6Management of Business Logistics, 7 th Ed.35 Inventory Costs: Expected Stockout Cost Possible to handle this by adding safety stock. In a manufacturing firm, a stockout may result in lost hours of production until the item is restocked.

36 Chapter 6Management of Business Logistics, 7 th Ed.36 Inventory Costs: Inventory in Transit Carrying Cost Any product inbound to the firm using F.O.B. origin should be counted. Any product outbound from the firm using F.O.B. destination should be counted. In transit carrying cost is generally less than for regular inventory because some cost components are not present. No storage costs, no taxes, and reduced risk of obsolescence.

37 Chapter 6Management of Business Logistics, 7 th Ed.37 Classifying Inventory: ABC Analysis Ranking system Developed in 1951 by H. Ford Dicky of General Electric 3. Suggested that GE classify items according to relative sales volume, cash flows, lead time, or stockout cost. Most important inventory put in Group A. Lesser impact goods put in Groups B and C respectively.

38 Chapter 6Management of Business Logistics, 7 th Ed.38 Classifying Inventory: ABC Analysis Paretos Rule (80-20 Rule) Based on a nineteenth century mathematicians observation that many situations were dominated by a very few elements. Conversely, most elements had very little influence in most situations. Separates the trivial many from the vital few.

39 Chapter 6Management of Business Logistics, 7 th Ed.39 Classifying Inventory: ABC Analysis Rule 80% of sales will come from 20% of the inventory SKUs. 20% of sales will come from 80% of the inventory SKUs. The Rule has been found to explain many phenomena that interest managers. For example, 80% of sales come from 20% of customers; and vice versa.

40 Chapter 6Management of Business Logistics, 7 th Ed.40 Figure 6-2 ABC Inventory Analysis

41 Chapter 6Management of Business Logistics, 7 th Ed.41 Table 6-7 ABC Analysis for Big Orange Products, Inc.

42 Chapter 6Management of Business Logistics, 7 th Ed.42 Inventory Visibility The ability of the firm to see inventory on a real-time basis throughout the supply chain system requires: Tracking and tracing inventory SKUs for all inbound and outbound orders. Providing summary and detailed reports of shipments, orders, products, transportation equipment, location, and trade lane activity. Notification of failures in inventory flow.

43 Chapter 6Management of Business Logistics, 7 th Ed.43 Inventory Visibility: General Benefits Improved customer service Decreased cost-of-sales Improved vendor relations and cost Increased Return on Assets Improved cash flow Improved response time and service recovery Improved performance metrics

44 Chapter 6Management of Business Logistics, 7 th Ed.44 Evaluating the Effectiveness of a Companys Approach to Inventory Management Are customers satisfied with the current level of customer service? If standards have been set in consultation with the customer, this question can be answered objectively.

45 Chapter 6Management of Business Logistics, 7 th Ed.45 Evaluating the Effectiveness of a Companys Approach to Inventory Management How frequently does backordering and/or expediting occur? If records of these events are kept, the answer to this question can point out the need for a modification or adoption of new inventory strategies.

46 Chapter 6Management of Business Logistics, 7 th Ed.46 Evaluating the Effectiveness of a Companys Approach to Inventory Management Is the company calculating an Inventory Turnover ratio for each product SKU? This ratio can provide good information on whether the inventory is being effectively and efficiently managed. Examine Table 6-8, Figure 6-3 and Figure 6-4.

47 Chapter 6Management of Business Logistics, 7 th Ed.47 Table 6-8 The Relationship among Inventory Turnover, Average Inventory, and Inventory Carrying Costs

48 Chapter 6Management of Business Logistics, 7 th Ed.48 Figure 6-3 Saving Inventory Dollars by Inventory Turns

49 Chapter 6Management of Business Logistics, 7 th Ed.49 Figure 6-4 Past and Projected Inventory Turnover of Finished Goods

50 Chapter 6Management of Business Logistics, 7 th Ed.50 Evaluating the Effectiveness of a Companys Approach to Inventory Management How does inventory level behave as sales rise or fall? From sales records, the firm can determine if inventory levels rise as much as sales, less than sales, or stay about the same regardless of sales levels.


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