1. Inventory Management Professor Stephen R. Lawrence Leeds School of Business University of Colorado Boulder, CO 80309-0419

2. Inventory Management Outline Inventory Management What is inventory? Why is it held? Why materials management is important Conflicting organizational objectives ABC inventory analysis Independent vs dependent demand systems Deterministic inventory models Economic Order Quantity (EOQ) Stochastic inventory models “Newsvendor” single-period models Independent demand multi-period models

3. Inventory Management What is inventory? Purposes of inventory?

4. Where Inventory is Held INPUTSTRANSFORMATIONSOUTPUTS Purchasing Vendors Receiving Raw Materials FGI WIP Shipping Distributors Customers Conversion Processes Warehouse Inventory

5. Why Inventories are Held Cycle Stock inventory resulting from batch (rather than unit) ordering or production. Safety (Buffer) Stock buffer against uncertain demand. Anticipation Stock accumulation in anticipation of peak demand. Pipeline (WIP) Stock goods in transit and in-between stages of production. Decoupling Stock inventory used to seperate decision making at different production echelons (e.g. factory and warehouse).

6. Why Inventory is Important Recent inventory write-offs (2000): Cisco – $2.5 billion Agere Systems -- $270 million Micron Technology -- $260 million Vitesse Semiconductor – $50.6 million Xilinx, Nortel, Lucent, Corning, JDS Uniphase, … Where Inventories are Held (USA): Manufacturing 40% Wholesalers 21% Retailers 20% Farm 9% Others 10%

7. Greater leverage with materials Consider a company with Materials = 50% cost of sales Labor = 20% cost of sales Profit margin = 10% of sales To raise profits by 1% Increase sales by 10%; Decrease labor costs by 5%; or Reduce material costs by 2%

8. Conflicting Objectives Marketing/sales I can't keep our customers if we continue to stockout and there is not sufficient product variety. I can't sell from an empty wagon! Production If I can produce larger lot sizes, I can reduce per unit cost and function efficiently! Purchasing I can reduce our per unit cost if I buy large quantities in bulk! Finance Where am I going to get the funds to pay for inventory? The levels should be lower! Distribution (warehousing) I am out of space. I can't fit anything else in the building!

9. Relevant Inventory Costs Costs of Holding Inventory opportunity costs of capital; storage, handling, insurance; obsolescence, shrinkage; Costs of Procuring Materials per unit cost of material; ordering/setup costs; tracking costs; volume discounts; Costs of Backlogs & Stockouts lost sales; backorder costs; lost future sales (goodwill). Rule of thumb Annual inventory carrying costs are about 25-30% of the value of inventory!

10. ABC Analysis Observation: 20% of SKU's account for 80% of total inventory costs (Pareto principal). Idea: Manage most important (costly) inventory items most closely. Use: First analysis to undertake when attacking inventories! 1.0 Fraction of Total Items 0.00.20.5 0.6 0.9 1.0 Fraction of $ Annual Use

11. ABC Item Classification Class A Items: 20% of items which account for approximately 60-80% of annual $ usage Tight control, keep inventories as low as possible; Monitor continuously (continuous review); Purchase/manufacture in small, frequent batches. Class B Items: 30% of items which account for approximately 20-30% of annual $ usage Moderate control; Good records, monitor periodically (periodic review); Purchase/manufacture in medium size batches. Class C Items: balance of SKU's whcich account for remaining 5-15% of annual $ usage Minimal control; Simple manual records, occasional review; Purchase/manufacture in large, infrequent batches.

12. ABC Example Annual $ Annual $ Cumul $Cumul ItemQuantity Cost Usage Usage Percent Class G2195,000 112,145,000 2,145,000 39.75 M3240,000 71,680,000 3,825,000 70.89 M1100,000 5 500,000 4,325,000 80.15 P1 80,000 6 480,000 4,805,000 89.05 G1 40,000 7 280,000 5,085,000 94.24 M4 16,000 8 128,000 5,213,000 96.61 P2 10,000 7 70,000 5,283,000 97.91 P3 5,000 9 45,000 5,328,000 98.74 G3 4,000 10 40,000 5,368,000 99.48 M2 2,000 14 28,000 5,396,000100.00 ------------- 5,396,000

13. Independent Demand Independent Demand Items Finished goods, end products purchased by customers Raw material commodity stocks, common to many products Demand rate and pattern determined outside of the firm Demand is independent of demand for other products or items We will focus on Independent Demand Items here

14. Dependent Demand Items Materials, parts, and subassemblies used in end products Items traceable to specific end products Demand is dependent on the number of end items manufactured To produce 100 bicycles in March, then need 200 wheels in February and 7200 spokes in January Dependent demand items are controlled using Materials Resource Planning (MRP) systems

15. Independent vs Dependent Demand Bicycle Hardware Wheels Frame RimHubSpokesTire Independent Demand Dependent Demand

16. Inventory Management Systems Establish amount of inventory Monitor inventory levels Determine when to replenish inventories Calculate order or production quantities

17. Inventory System Design Repetition Single-order (one-time buy) Multiple orders Supply source External supply (purchase) Internal supply (produce) Certainty of demand Deterministic Stochastic Pattern of demand Constant demand Time-varying demand Dependent demand Knowledge of leadtime Constant (certain) Stochastic (random) Inventory Review Continuous (perpetual) Periodic

18. Inventory System Taxonomy