Chapter 7
INVENTORY
MANAGEMENT
Prepared by Mark A. Jacobs, PhD
©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.
LEARNING OBJECTIVES
You should be able to:
 Distinguish dependent from independent demand
inventories
 Describe the four basic types of inventories & their
functions
 Understand the costs of inventory & inventory
turnovers
 Understand ABC classification, ABC inventory matrix &
cycle counting
©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
2
LEARNING OBJECTIVES
(Continued)
 Know RFID & how it can be used in inventory
management
 Understand the EOQ model & its underlying
assumptions
 Understand the Quantity Discounts & the EMQ Models &
their relationships with the basic EOQ model
 Understand & able to distinguish among the various
statistical ROP models
 Describe the continuous review & periodic review
systems
©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
3
CHAPTER OUTLINE
•
•
•
•
Introduction
Dependent and Independent Demand
Concepts and Tools of Inventory Management
Inventory Models
©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
4
Introduction
 Inventory can be one of the most expensive assets of an
organization
 Inventory may account for more than 10% of total revenue
or 20% of total assets
 Management must reduce inventory levels yet avoid
stockouts and other problems
This chapter will discuss:
 Dependent & independent demand
 Tools for managing inventory
 Basic types of inventories
 Various inventory management approaches
Matching Supply & Demand
 Suppliers must accurately forecast demand so they
can produce & deliver the right quantities at the right
time at the right cost
 Suppliers must find ways to better match supply &
demand to achieve optimal levels of cost, quality, &
customer service to enable them to compete with other
supply chains
 Problems that affect product & delivery will have
ramifications throughout the chain
Dependent & Independent
Demand
Inventory management models –
Generally classified as dependent demand and
independent demand models
 Dependent Demand –
Describes the internal demand for parts based on the
demand of the final product in which the parts are used.
Subassemblies, components, & raw materials are
examples of dependent demand items.
 Independent Demand –
The demand for final products & has a demand pattern
affected by trends, seasonal patterns, & general market
conditions.
Concepts and Tools of
Inventory Management
Functions and Basic Types of Inventory
 The primary functions of inventory are to –
 Buffer from uncertainty in the marketplace &
 Decouple dependencies in the supply chain (e.g., safety
stock)
 Four broad categories of inventories
 Raw materials- unprocessed purchase inputs.
 Work-in-process (WIP)- partially processed materials not
yet ready for sales.
 Finished goods- products ready for shipment.
 Maintenance, repair & operating (MRO)- materials used in
production (e.g., cleaners & brooms).
Concepts and Tools of Inventory
Management
(Continued)
Inventory Costs
 Direct costs- directly traceable to unit produced (e.g.,
labor)
 Indirect costs- cannot be traced directly to the unit
produced (e.g., overhead)
 Fixed costs- independent of the output quantity (e.g,
buildings, equipment, & plant security)
 Variable costs- vary with output level (e.g., materials)
 Order costs- direct variable costs for making an order. In
mfg, setup costs are related to machine setups
 Holding or carrying costs- incurred for holding inventory
in storage
Concepts and Tools of Inventory
Management
(Continued)
Inventory Investment
 Firms should diligently measure inventory investment to
ensure that it does not adversely affect competitiveness.
Measures include:
 Absolute value of inventory (found on balance sheet)
 Inventory turnover or turnover ratio- how many times
inventory “turns” in an accounting period. More is
better because its faster!
Inventory Turnover Ratio =
Cost of Revenue
Average Inventory
Concepts and Tools of Inventory
Management
(Continued)
ABC Inventory Control System
Determines which inventories should be counted &
managed more closely than others
 Groups inventory as A, B, & C Items
 A items are given the highest priority with larger safety stocks.
A items, which account for approximately 20% of the total
items, are about 80% of the total inventory cost
 B & C items account for the other 80% of total items & only
20% of costs. The B items require closer management since
they are relatively more expensive (per unit), require more
effort to purchase/make, & may be more prone to
obsolescence
 C items have the lowest value and hence lowest priority
Concepts and Tools of Inventory
Management
(Continued)
Radio Frequency Identification (RFID)
Successor to the barcode for tracking individual unit of
goods. RFID does not require direct line of sight to read a
tag and information on the tag is updatable.
(Fig. 7.4)
Concepts and Tools of Inventory
Management
(Continued)
RFID
 Automates the supply chain:
 Materials Management – goods automatically counted and
logged as they enter the supply warehouse
 Manufacturing – assembly instructions encoded on RFID tag
provide information to computer controlled assembly devices
 Distribution Center – shipment leaving DC automatically
updates ERP to trigger a replenishment order and notify
customer for delivery tracking
 Retail Store – no check out lines as scanners link RFID tagged
goods in shopping cart with buyers credit card
Inventory Models
 The Economic Order Quantity (EOQ) Model –
A quantitative decision model based on the trade-off
between annual inventory holding costs & annual order
costs
The EOQ model seeks to determine an optimal order
quantity, where the sum of the annual order cost &
the annual inventory holding cost is minimized.
• Order Cost is the direct variable cost associated
with placing an order.
• Holding Cost or carrying cost is the cost incurred
for holding inventory in storage.
Inventory Models
(Continued)
 Assumptions of the EOQ Model
 Demand must be known & constant.
 Delivery time is known & constant.
 Replenishment is instantaneous.
 Price is constant.
 Holding cost is known & constant.
 Ordering cost is known & constant.
 Stock-outs are not allowed.
Inventory Models
EOQ Model
(Fig. 7.5)
(Continued)
Inventory Models
(Continued)
Illustration
Inventory on hand & relationships to – EOQ, average
inventory, lead time, reorder point, & order cycle
(Fig. 7.6)
Inventory Models
(Continued)
 The Statistical Reorder Point (ROP)
 The lowest inventory level at which a new order must be placed
to avoid a stockout.
 Demand and delivery lead time are never certain and require
safety stock.
 The models used under uncertainty are –
 Statistical ROP with Probabilistic Demand and Constant Lead
Time
 The Statistical ROP with Constant Demand and Probabilistic
Lead Time
 The Statistical ROP when Demand and Lead Time are both
Probabilistic
Inventory Models
(Continued)
 The Continuous Review System versus The Periodic
Review System
 Order quantity & ROP models assume that the physical
inventory is precisely known at every point in time
 Reality shows that stock records and actual quantity are different
& requires continuous review of inventory to determine when to
reorder
 A Continuous Review System is costly to conduct but requires
less safety stock than the
 The Periodic Review System, which reviews physical inventory
at specific points in time and requires higher level of safety stock