Managing Inventory throughout the Supply Chain Chapter 11

Chapter Objectives Be able to: Describe the various roles of inventory, including the different types of inventory and inventory drivers. Distinguish between independent demand and dependent demand inventory. Calculate the restocking level for a periodic review system. Calculate the economic order quantity (EOQ) and reorder point (ROP) for a continuous review system. Determine the best order quantity when volume discounts are available. Calculate the target service level and target stocking point for a single-period inventory system. Describe how inventory decisions affect other areas of the supply chain. In particular, describe the bullwhip effect, inventory positioning issues, and the impacts of transportation, packaging, and material handling considerations.

Introduction: A Balancing Act for Management Both the presence and absence of inventory contribute to value and to costs. Too much inventory is an investment that will provide no return. Too little inventory results in missed or late sales and deliveries. Carrying the correct amount of inventory is a difficult balancing act.

1. Define Inventory.

Inventory Management Inventory – Those stocks or items used to support production (raw materials and work-in-process items), supporting activities (maintenance, repair, and operating supplies) and customer service (finished goods and spare parts). © 2010 APICS Dictionary

2. Why should businesses carry inventory?

Why Should Businesses Carry Inventory? Decoupling: Reducing the direct dependency of a process step on its predecessor. This could be in a process or in the supply chain. Decouple customer from supplier and machine from machine Disruptions, if decoupled, don’t have as serious of an impact Decoupling enhances reliability and response time

Why Should Businesses Carry Inventory? Decoupling Meeting Demand Emergency Situations

3. Why should business avoid carry too much inventory?

Why Should Businesses Avoid Carrying Too Much Inventory? No Financial returns - Inventory is an investment that should provide a financial return; excess inventory is an investment that provides no return. Associated costs - In addition to the cost of purchasing it, inventory also has other “carrying” costs: Cost of storage, Cost of insurance, Reduction in flexibility

Why Should Businesses Avoid Carrying Too Much Inventory? Reduces management’s ability to make quick decisions (reduces flexibility) Less adaptability to changing market conditions

4. What are the six types of inventory?

Inventory Types Cycle stock Safety stock Anticipation inventory Hedge inventory Transportation inventory Smoothing inventory

Types of Inventory Cycle stock – Components or products that are received in bulk by a downstream partner, gradually used up, and then replenished again in bulk by an upstream partner. Safety stock – Extra inventory that a company holds to protect itself against uncertainties in either demand or replenishment time.

Types of Inventory Anticipation inventory – Inventory that is held in anticipation of customer demand. Hedge inventory – A form of inventory buildup to buffer against some event that may not happen. © 2010 APICS Dictionary

Types of Inventory Transportation inventory – Inventory that is moving from one link in the supply chain to another. Smoothing inventory – Inventory that is used to smooth out differences between upstream production levels and downstream demand.

5. What are the five kinds of inventory costs?

Costs and Benefits Order cost: The fixed cost associated with ordering inventory. Changeover (setup) cost: The cost of changing equipment from producing one product or service to another. Analogous to order cost. Carrying cost: Costs associated with carrying inventory. Insurance, storage, opportunity cost of money tied up in inventory. Stockout cost: Costs associated with not having inventory when a customer wants it. Purchasing cost: Cost of purchasing the actual inventory. Sometimes quantity discounts lower this cost, but this comes at the expense of raising carrying costs. Buying in Bulk (discounted)…..

Inventory Drivers Inventory drivers – Business conditions that force companies to hold inventory. Table 11.2

6. Distinguish between independent and dependent demand inventories.

Independent vs. Dependent Demand Inventory Independent demand inventory – Inventory items whose demand levels are beyond a company’s complete control. Dependent demand inventory – Inventory items whose demand levels are tied directly to a company’s planned production of another item.

Independent vs. Dependent Demand Inventory Example: Independent demand: Kitchen table – Need 500 tables five weeks from now Dependent demand: Kitchen table legs – Need 4 per table or 2,000 legs Calculation of dependent demand (Chapter 12)

7. What are the two general approaches to managing independent demand inventory?

Inventory Control Systems Continuous Review System – An inventory system used to manage independent demand inventory where the inventory level for an item is constantly monitored and when the reorder point is reached, an order is released. Periodic Review System – An inventory system that is used to manage independent demand inventory where the inventory level for an item is checked at regular intervals and restocked to some predetermined level.

Continuous Review System Key features: Inventory levels are monitored constantly, and a replenishment order is issued only when the reorder point is reached. The size of a replenishment order is typically based on the trade-off between holding costs and ordering costs. The reorder point is based on both demand and supply considerations, as well as on how much safety stock managers want to hold.

Continuous Review System Assumptions: Constant demand and lead time Holding and Ordering cost known and fixed Price of each unit is fixed.

Continuous Review System When the demand rate and lead time are constant: Reorder point = demand x lead time R = dL Figure 11.7

Economic Order Quantity Economic Order Quantity (EOQ) – The order quantity that minimizes annual holding and ordering costs for an item. Holding costs (H)– The cost to hold a single unit in inventory for a year. Ordering costs (S) – The cost of placing an order regardless of the order quantity.

Re-Order Point (ROP): The impact of varying demand rates and lead time Figure 11.10

Causes of Variability The variability of demand The variability of lead time The average length of lead time The desired service level

ROP Problem For men’s size XL Trevecca T-shirts at the bookstore, the average weekly demand is 7, with a standard deviation of 3. the replenishment lead time is 1 week. What should the re-order point be to maintain a 99% confidence of satisfying the demand during the lead time?

Quantity Discounts Quantity Discounts – Price reductions for ordering larger quantities.

Quantity Discounts Two-step process: Calculate the EOQ. If the EOQ represents a quantity that can be purchased for the lowest price, stop – we have found the lowest cost order quantity. Otherwise, go to Step 2. Compare total holding, ordering, and item costs at the EOQ quantity with total costs at each price break above the EOQ. There is no reason to look at quantities below the EOQ, as these would result in higher holding and ordering costs, as well as higher item costs.

Example 11.4 – Hal’s Magic Shop Demand (D) = 1,000 masks Ordering cost (S) = $20 Holding cost (H) = $3 Solve for EOQ:

Example 11.4 – Hal’s Magic Shop Because 115 is not eligible for the lowest price, calculate total cost at 115:

Example 11.4 – Hal’s Magic Shop And compare to total cost at next price break or 201. Price is cheaper at the 201 price break.

Periodic Review System Calculating the order quantity (Q) Q = R-I where R = restocking level I = inventory level at the time of review. Figure 11.6

Periodic Review System Calculating the restocking level (R)

Calculating Service Level Service Level – A term used to indicate the amount of demand to be met under conditions of demand and supply uncertainty. Assumes that the demand during the reorder period and the order lead time is normally distributed.

Single-Period Inventory System When excess inventory cannot be held in the future, firms must weigh the cost of being short against the cost of holding excess units. Examples: Fresh fish, magazines, newspapers, Christmas trees

Single-Period Inventory System Single-period inventory system – A system used when demand occurs in only a single point in time. Goals: Determine a target service level (SLT) that strikes the best balance between shortage costs and excess costs. Use the target service level to determine the target stocking point (TS) for the item.

Single-Period Inventory System Target service level – The service level at which the expected cost of a shortage equals the expected cost of having excess units. Target stocking point – The stocking point at which the expected cost of a shortage equals the expected cost of having excess units.

Target Service Level OR

Target Service Level The target service level (SLT) is the p value at which holds true

Target Stocking Point

8. What are the ramifications of inventory decisions for the rest of the supply chain?

Inventory in the Supply Chain Bullwhip Effect An extreme change in the supply position upstream in a supply chain generated by a small change in demand downstream in the supply chain. Inventory Positioning Cost and value increases and flexibility decreases down the supply chain. Transportation, Packaging, Material Handling Physical size and quantity of lot, how it is packaged, material handling equipment needed, and disposal of packaging are all factors in choosing appropriate supplier and distribution process. © 2010 APICS Dictionary

Demand vs. Order Size The Bullwhip Effect Figure 11.12

Managing Inventory Case Study Northcutt Bikes: The Service Department

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