Chapter 11: Strategic Leadership Chapter 10 Inventory management

Chapter 11: Strategic Leadership Overview FunctionsTypesCosts PLANNING Optimum levels CONTROL Maintain appropriate levels MODELS

Chapter 11: Strategic Leadership Outcomes Understand why businesses keep stock Differentiate between the various types of inventory Identify inventory-ordering costs and inventory- carrying costs Determine a suitable carrying cost percentage Set optimum inventory levels Perform effective inventory control

Chapter 11: Strategic Leadership Geographical specialisation – Location economies – Consolidation – Economic specialisation Decoupling – WIP – Economic lot sizes greater than demand – Large shipments at lower transport costs – Lower cost of purchasing Functions of inventories

Chapter 11: Strategic Leadership Balancing supply and demand – Seasonal production, but year-round consumption – Seasonal consumption: provide for peaks Buffer uncertainties – Demand uncertainty – Lead-time uncertainty Prevent cost of stockout Functions of inventories (continued)

Chapter 11: Strategic Leadership Types of inventory Based on position in supply chain: – Raw material – Work-in-process (WIP) – Packaging material – Finished goods Based on purpose: – Cycle stock – Transit inventory – Safety stock – Speculative stock

Chapter 11: Strategic Leadership Important inventory concepts Availability – Definition – Measurements Average inventory – half order quantity + safety stock Inventory turnover

Chapter 11: Strategic Leadership Average inventory and order quantity

Chapter 11: Strategic Leadership Inventory costs Ordering costs Carrying costs

Chapter 11: Strategic Leadership Inventory-ordering costs Consist of: – Administration costs – Handling costs Depend on where stock is replenished – Outside supplier – Restocking own field warehouse

Chapter 11: Strategic Leadership Carrying-cost percentage Used to calculate carrying costs Expressed as annual % value Applied to average inventory ICC = average inventory x % Example: R x 20% = R Assign factor to each cost element

Chapter 11: Strategic Leadership Determine carrying-cost percentage Cost elementDeterminantsExam- ple Capital investment- Prime interest rate - Return on investment17% Insurance- Direct levy based on risk or exposure - % of insurance costs on average inventory value - Preventative measures 2% Obsolescence- Problematic to quantify - Deterioration of product while stored - Difference in price 0,5% DamageNet amount after claims0,5% ShrinkageDirect loss related to inventory storage1% Storage Space- Allocated to specific products - Type of warehouse 5% Total26%

Chapter 11: Strategic Leadership Setting optimum inventory levels How much to order – Simple EOQ – EOQ extensions When to order – Reorder point Safety stock

Chapter 11: Strategic Leadership Simple EOQ: the concept Trade-off between ordering and carrying costs Remember: – Average inventory = half order size Therefore, high OQ results in: – high average inventory and – high carrying costs Graph Formula

Chapter 11: Strategic Leadership Simple EOQ: trade-off

Chapter 11: Strategic Leadership Simple EOQ: formula EOQ= Where P=ordering costs ($ per order) D=annual demand or sales volume in units C=carrying-cost percentage V=cost or value per unit

Chapter 11: Strategic Leadership EOQ adjustments Volume transport rates Quantity discounts Production lot size Multiple-item purchases Limited capital Own transport Unitisation

Chapter 11: Strategic Leadership Determining order point When to order Expressed in SKU units or days of supply Formula: R = D x T + SS Where R=reorder point in units D=average daily demand T=average lead time SS=safety stock

Chapter 11: Strategic Leadership Target-level replenishment Fixed order interval Short interval periodic review Order quantities vary Quantity to meet target level Review period added to lead time to arrive at targeted reorder point (ROP)

Chapter 11: Strategic Leadership Target-level replenishment (continued) TSL=D (T + P) + SS Where D =average daily demand T=average lead time P=review period (days) SS=safety stock Now order to reach target Q=TSL - I – Where Q=quantity to be ordered TSL=target level I=inventory status =quantity on order QoQo QoQo

Chapter 11: Strategic Leadership Demand uncertainty Safety stock added to base inventory Average inventory = half order quantity + SS Normal distribution Only consider when demand is greater than 50% in normal distribution Calculate: – Mean – Standard deviation

Chapter 11: Strategic Leadership Normal distribution theory

Chapter 11: Strategic Leadership Normal distribution theory (continued)

Chapter 11: Strategic Leadership Demand uncertainty Mean – Average of all values in series – Formula: μ= ∑ x i /n Standard deviation – Formula: √ (1/n x ∑ (x i -μ) 2

Chapter 11: Strategic Leadership Lead-time uncertainty Lead time a combination of: – Order communication time – Processing time – Transport time Calculation: – Same as demand uncertainty (i.e. calculate standard deviation)

Chapter 11: Strategic Leadership Combined standard deviation Formula: s=√ TS s 2 + D 2 S t 2 Where s=combined standard deviation T=average lead time S s =sales standard deviation D=average sales S t =lead time standard deviation

Chapter 11: Strategic Leadership Fill rate Normal distribution theory gives indication of probability of stockout. Percentage, not indication of availability levels. Fill rate gives indication of magnitude of stockout rather than probability. Fill rate = desired customer service objective. Fill rate = percentage of units out of stock relative to demand.

Chapter 11: Strategic Leadership Fill rate and order size Fill rate influenced by: – Probability of stockout – Replenishment order size The larger the order quantity, the lower the magnitude of potential stockouts. Example: 20-day period – OQ sufficient for 10 days, stockouts can occur twice – OQ sufficient for 20 days, stock-outs will occur once

Chapter 11: Strategic Leadership Fill rate formula Formula for SL: SL=1-[(s/EOQ) x f(k)] Where f(k)= function of right tail Or f(k)=(1-SL) x (Q/s) s= combined standard deviation

Chapter 11: Strategic Leadership Safety stock for given fill rate Formula for SS: First calculate f(k) SS=k x s Where k= safety factor for corresponding f(k) s= combined standard deviation k can also be calculated: k=SS/s

Chapter 11: Strategic Leadership Calculating safety stock: example Information – EOQ = 300 – S= 13 – Desired FL= 99% Solution First calculate f(k) f(k)= (1-0,99) x (300/13) = 0,01 x 23,08 = 0,2308 k= 0,4 (corresponding factor for f(k) of 0,2308) SS= 0,4 x 13 = 5,2 units

Chapter 11: Strategic Leadership Calculating fill rate: example Information – EOQ = 200 – s= 13 – SS= 8 First calculate k k=8/13=0,6154 Therefore f(k)=0,16 (roughly) Fill rate SL=1-[(s/OQ) x f(k)] =1-[(13/200) x 0,16] =1-[0,0650 x 0,16] =1-0,0104 =0,99 or 99%

Chapter 11: Strategic Leadership Logistics requirements planning (LRP)

Chapter 11: Strategic Leadership Procedure for LRP Plan weekly Start with independent demand Demand forecasting Calculate how long stocks will last Deduct safety stock Add stock in transit Calculate date when safety stock is reached

Chapter 11: Strategic Leadership Procedure for LRP (continued) Calculate date of shipment (allow lead time) Plan production Calculate delivery date of materials Calculate shipment allowing for lead time

Chapter 11: Strategic Leadership Just in time (JIT): approach We have items when they are needed and none when they are not needed. Demand for one item triggers demand for another.

Chapter 11: Strategic Leadership Conventional vs JIT systems Push system Satisfied with status quo Fixed lead time Product range is a sales issue Stock in case of demand Convenient purchase batch size Pull system Continuous improvement Reducing lead time Product range reduc- tion: inventory issue Purchase to meet demand Buy single or small quantities

Chapter 11: Strategic Leadership JIT application possibilities Typical features of ideal company: – Narrow product range – Manufacturer – High volume – Stable market – Influential – Good quality management – Local suppliers of goods and services – Dependent and reliable suppliers – Fast-cycle processes – Personal commitment

Chapter 11: Strategic Leadership JIT requirements Short lead time Long-term agreements Close co-operation Local suppliers Customers must smooth forecasts Good estimate of long-term demand Frequent deliveries

Chapter 11: Strategic Leadership Collaborative inventory initiatives Collaborative planning, forecasting and replenishment (CPFR) Quick response (QR) Vendor-managed inventory (VMI) Profile replenishment (PR)

Chapter 11: Strategic Leadership Pareto analysis Pareto principle: – Villefredo Pareto: 18 th century – 20% of people control 80% of wealth – True in everyday life – 80% of effect is provided by 20% of cause

Chapter 11: Strategic Leadership ABC analysis using Pareto Purpose – Facilitate control – Minimise effort – Provide service with least cost and effort Procedure – Rank items/lines according to annual turnover – Annual turnover = annual usage x unit costs Classification – A = 10% of lines giving 65% turnover – B = 20% of lines giving 25% turnover – C = 70% of lines giving 10% of turnover

Chapter 11: Strategic Leadership 80 ABC analysis based on the Pareto principle

Chapter 11: Strategic Leadership Different service levels for inventory categories CLASSTURNOVER VALUE (%) LOS (%) WEIGHTED LOS (%) A66,89865,5 B23,29020,9 C10858,5 OVERALL SERVICE LEVEL94,9

Chapter 11: Strategic Leadership Stock cover Time in which stock will run out Tool for measuring total inventory Monitor performance of each item Formula: current stock x 52 forecast usage Result: weeks in hand SC =

Chapter 11: Strategic Leadership Stock turnover Measures inventory management effectiveness Formula: Stock turnover = Value of annual usage Value of stock in store Shows number of times that stock will be used up during the year

Chapter 11: Strategic Leadership Setting stock targets Based on ABC ‘A’ class: tighter control and lower stock cover Target for each class Acceptable ranges: – A1 to 4 weeks – B2 to 8 weeks – C3 to 20 weeks