MRI 2315 Warehousing and Distribution Voon N. L.

4. Inventory and Materials Management 4.1 Basic concepts of inventory management.

Inventory serves 5 purposes: It enables the firm to achieve economies of scale It balances supply and demand It enables specialization in manufacturing It provides protection from uncertainties in demand and order cycle It acts as a buffer between critical interfaces within the supply chain

Economies of Scale Purchase contracts are being negotiated based on annual volumes Enjoy lower transportation cost per unit Manufacturing economies where plant capacity is greater, and per- unit manufacturing costs are lower with few production run changes Manufacturing in small quantities leads to short production runs and high changeover costs

Balancing Supply and Demand Seasonal supply and/or demand may make it necessary for a firm to hold inventory Raw materials may be available only at certain times during the year The cost of establishing production capacity to handle the volume at these peak periods would be substantial To maintain a relatively stable workforce, and produce at a constant level throughout the year to lower total cost

Specialization Finished products can be shipped to large mixing warehouses, from which customer orders and products for field warehouses can be shipped Specialized facilities are known as “focused factories”

Protection from Uncertainties Raw materials inventory Speculative purchase, e.g. future price increase or strike Seasonal availability Work-in-Process inventory Eliminate manufacturing bottlenecks Excessive inventories can increase costs and reduce profitability Finished goods inventory Improve customer service levels by reducing the likelihood of a stockout due to an-unanticipated demand or variability in lead time

A Buffer throughout the Supply Chain Acts as a buffer for the following critical interfaces: Supplier – procurement (purchasing) Procurement – production Production – marketing Marketing – distribution Distribution – intermediary Intermediary – consumer/use Forward logistics flow & reverse logistics flow

Components of Logistics Management

4. Inventory and Materials Management 4.2 Calculate safety stocks.

Cycle Stock Cycle stock is inventory that results from the replenishment process and is required in order to meet demand under conditions of certainty, i.e. when the firm can predict demand and replenishment times (lead times) perfectly. Example : Average cycle stock (page 232)

Safety or Buffer Stock Safety or buffer stock is held in excess of cycle stock because of uncertainty in demand or lead time. Example: Demand varies and lead time constant Example: Demand constant and lead time varies Example: Demand and lead time vary

4. Inventory and Materials Management 4.3 Production policies influence inventory levels.

Production Policies Influence Inventory Levels Production Rate ↑ Total Production Cost ↓  Inventory Level ↑ Reverse is true Inventory Levels ↓  Production Rate ↓  Total Production Cost ↑ significantly

4. Inventory and Materials Management 4.4 Interrelated within Inventories and customer service levels.

Service Level Service level measures the performance of a system. Certain goals are defined and the service level gives the percentage to which those goals should be achieved. Examples of service level: Percentage of calls answered in a call center. Percentage of customers waiting less than a given fixed time. Percentage of customers that do not experience a stockout.

Relationship between inventory investment and customer service levels Service Level ↑  Inventory Investment ↑

To improve service level Increase inventory Investment (easy but astronomical) Substitution Transportation Cost for Inventory Carrying Cost Associate each product on demand levels and demand variation and set inventory levels accordingly Decentralization of products (e.g. stock highest volume at retail locations; high- and moderate-volume items at field warehouse locations; slow-moving items at centralized locations)

4. Inventory and Materials Management 4.5 Financial aspects of inventory strategy.

Financial Aspects of Inventory Strategy Inventory and Corporate Profitability Excessive Inventories Can Lower Profitability Net profit is reduced by out-of-pocket costs associated with holding inventory, such as insurance, taxes, storage, obsolescence, damage, and interest expense, if the firm borrows money specifically to finance inventories Total assets are increased by the amount of the inventory investment, which decreases asset turnover. The result is a reduction in return on assets and return on net worth

Financial Aspects of Inventory Strategy (con’t) Inventory and Corporate Profitability (con’t) Capital Rationing Raises the Cost of Carrying Inventory If the company does not have enough money to invest in all of the new projects available, then the management has to decide where to invest the money from the inventory reduction and at what rate of return Inventory cut; Production Efficiency Improvement 6  Inventory level Cost of goods sold

Financial Aspects of Inventory Strategy

Cost Tradeoffs Required in Marketing and Logistics Marketing Objective: Allocate resources to the marketing mix in such a manner as to maximize the long-term profitability of the firm. Logistics Objective: Minimize Total costs given the customer service objective where total costs = Transportation Costs + Warehousing Costs + Order Processing and Information Costs + Lot Quantity Costs + Inventory Carrying Costs

Components of Inventory Carrying Costs Capital Costs interest bearing debt from banks, and opportunity costs of capital Inventory service costs insurance, taxes Storage space costs plant warehouses, public warehouses, rental warehouses, company-owned warehouses Inventory risk costs obsolescence, damage, shrinkage, relocation costs

Inventory and Least Total Cost Logistics Least total cost logistics is achieved by minimizing the total costs for a specified level of customer service. Given the same customer service level, low inventory carrying costs lead to multiple warehouses and a slower mode of transportation, such as rail roads. High inventory carrying costs resulted in limited number of stock locations and a faster means of transportation, such as motor or air carriers, in order to minimize total totals.

4. Inventory and Materials Management 4.6 Ways to recognize poor inventory management and improvement methods.

The following symptoms may be associated with poor inventory management: Increasing numbers of back orders Increasing dollar investment in inventory with back orders remaining constant High customer turnover rate Increasing number of orders being canceled

The following symptoms may be associated with poor inventory management: (con’t) Periodic lack of sufficient storage space Wide variance in inventory turnover among distribution among distribution centers and among major inventory items Deteriorating relationships with intermediaries, as typified by dealer cancellations and declining orders Large quantities of items

In many instances inventory levels can be reduced by one or more of the following steps: Multi-echelon inventory planning. ABC analysis is an example of such planning Lead time analysis Delivery-time analysis. This may lead to a change in carriers or negotiation with existing carriers Elimination of low turnover and/or obsolete items Analysis of pack size and discount structure

In many instances inventory levels can be reduced by one or more of the following steps: (con’t) Examination of returned goods procedures Encouragement/automation of product substitution Installation of formal reorder review systems Measurement of fill rates by stock-keeping unit (SKU) Analysis of customer demand characteristics Development of a formal sales plan and source demand by a pre- determined logic.

Improving Inventory Management Techniques: ABC analysis Forecasting Enterprise Resource Planning (ERP) Systems Advanced Order processing systems

ABC analysis

Forecasting buyer intentions by mail questionnaires, telephone interviews, or personal interviews Data to develop into a sales forecast Disadvantages Costly Accuracy Opinions of sales people or experts in the field (judgment sampling) Disadvantage Personal biases of individuals Past sales data Forecasting for groupings of Stock-Keeping Units (SKUs) increases forecast accuracy

Enterprise Resource Planning (ERP) Financial Modules: Financial Accounting (FI), Controlling (CO), Investment Management (IM), Treasury (TR), Enterprise Control (EC). Logistics Modules: Material management (MM), Sales & distribution (SD), Production, Planning & Control (PP), Product Data Management (PDM), Quality Management (QM), Plant maintenance (PM), Service management(SM), Project systems (PS) Human resource management Module: Personnel Management, Organizational Management, Payroll Accounting, Time Management, Personnel Development, Training & Event Management Cross Application Module: Workflow (WF), SAP Office.

Enterprise Resource Planning (ERP) Real-time Information-directed Video on ERP Common Types of ERP SAP (German firm SAP AG) Oracle (America, California) Microsoft (America, Washington State)

Advanced Order Processing Systems Specialized order processing software package Linking members of the supply chain with timely and accurate product usage information An order processing system captures order data from customer service employees or from customers directly, stores the data in a central database and sends order information to the accounting and shipping departments, if applicable. Order processing systems provide tracking data on orders and inventory for every step of the way.