Chapter 7 - Discussion Questions - Answers
1.
It has been said that customer service and inventory investment are two measurements that cannot be considered separate from one another. Explain.
Answer:
For a manufacturer or distributor, competitiveness is measured in its ability to
provide the products customers want. This requirement means having products
in the right variety, volume, place, price, and time that matches as closely as
possible to customers’ needs and wants. The more customers’ expectations are
fulfilled as to product availability, the closer customers will be tied to their
supplier. Measuring this expectation is termed inventory serviceability and can
be expressed several ways, such as the number of orders shipped complete and
on time; the number of order lines shipped complete and on time; perceived
quality divided by customer needs, wants and expectations, etc.
Seeking higher levels of customer responsiveness is directly related to the
commitment the firm is willing to make as to inventory investment. Basically,
the more investment companies are willing to make in inventory, the higher
customer service levels will rise. But companies must be careful not to expand
the cost of inventories to a point that they exceed their targeted ROI.
2.
What is meant by cost/benefit trade-offs relating to inventory? How can this
management technique be applied to the first question?
Answer:
Cost/benefit trade-off analysis is essentially a financial decision whereby the
benefit resulting from an action outweighs the costs associated with its performance. In the first question the inventory trade-off centered on how to achieve
high customer responsiveness while conversely achieving high levels of inventory efficiency. These two objectives are essentially contradictory. High levels
of responsiveness mean responding to a wide range of product variety and
quantities, meeting shorter delivery times, and reducing supply uncertainty.
High levels of inventory efficiency center on reducing the amount of inventory,
storage aggregation, and making and delivering a product to the customer.
When costs are increased efficiencies are lowered. Conversely for every decision to increase responsiveness, there are additional costs that decrease efficiencies. The solution to the problem is for managers to identify how to operate
on the lowest level of efficiency for a given level of responsiveness. Increasing
the level of responsiveness without lowering efficiencies can be accomplished
only by improving processes and deploying technologies that will lower costs.
3.
What are some problems that can arise when each stage of a supply chain focuses solely on its own profits when making decisions? Identify some actions
that can help a retailer and a manufacturer work together to improve their
strategic fit.
2
Answer:
High inventories, poor quality, low customer service, and increased returns are
just four common problems that occur when each stage of a supply chain focuses solely on its own profits. The trucking company requires full truck loads
for delivery forcing the retailer to carry more inventory than wanted or needed.
The supplier offers discounts to their buyers to maximize production but forcing the buyers to purchase in larger quantities than desired. This concept was
prevalent during the 1950s and 1960s as companies aimed to minimize local
costs and maximize their own profits. Today, retailers and manufacturers have
the opportunity to plan promotions jointly, such as Wal-Mart and P&G are doing. They can share sales information to determine customer trends. Joint product development opportunities are being explored throughout the supply chain
among retailers, manufacturers, and raw material suppliers.
4.
Why do businesses carry inventory?
Answer:
There are many reasons why companies elect to stock inventories. To begin
with, inventory provides insurance against demand and supply uncertainty. Regardless of how good the forecast or reliable the supplier, there will always be
unexpected fluctuations in demand and delivery that risks stock out. Second,
inventory can counteract a lack of process flexibility by providing buffers permitting producers to optimize the cost of processing by having enough materials available to build larger than demand lots. Third, inventory enables firms to
take advantage of volume or variety discounts by buying or building product in
larger than needed lots sizes. Fourth, inventory enables companies to such as a
promotion or seasonal demand. Fifth, ordering inventory in larger than demand
quantities may actually reduce aggregate costs involved in reducing the number
of replenishment orders released along with the associated costs of material
handling and administration. Sixth, inventory can increase in value. And finally, inventory provides supply chain buffers so that businesses can be more
responsive to customer demand occurring anywhere in the supply channel.
5.
Describe the five general functions of inventory.
Answer:
The fundamental function of inventory is to act a buffer shielding the organization from the uncertainties of forecasts, customer demand, and supplier delivery. Inventory also enables the decoupling of productive processes from each
other so that each process can operate at maximum efficiency without being
constrained by the slowest preceding process. The five general functions of inventory are:
 Cycle (lot size) inventory. This function is the result of ordering requirements that force planners to purchase, manufacture, and transport inven-
3




tories in batches that exceed the originating demand quantity. Cycle inventories exist principally because of economies realized by trading-off
the cost of ordering or producing and the cost of carrying inventory.
Safety inventory. This function seeks to have an amount of excess inventory on hand to cover unplanned fluctuations in customer demand and
uncertainties in supply.
Anticipation inventory. In some environments inventory will be purchased or built in advance of demand to enable effective response to seasonal sales, a marketing promotional campaign, or expected problems in
supply.
Transportation inventory. The function of this inventory is to enable the
movement of items by ship, railcar, pipeline, airplane, or truck from point
of origin to point of consumption. Transportation inventory exists because time is required to move stock through the channel.
Hedge inventory. The final function of inventory is to provide planners
with the opportunity to purchase or build large quantities of product to
take advantage of temporary low prices, the possibility of a strike, or
other uncommon events. The utility of hedge stocks is measured by the
resulting percent of profit or return on investment.
6.
What are the different models by which inventory can be valued?
Answer:
In a simple world, the value of inventory could be easily calculated as the unit
cost times the inventory balance at a point in time. But, determining just what
the unit cost is at any time can be tricky. The unit cost often changes through
time. During inflationary times, acquisition prices will go up. The price of some
items will swing wildly based on market conditions. How are new receipts of
an item at one price to be costed with old receipts at a different price? How is
the cost of inventory to be reported to shareholders? The five costing models
permit inventory managers to effectively respond to different needs to value
differently by item type, the kinds of acquisition processes (manufacture or
purchase) used by the business, marketplace variability, and financial realities
such as inflation or deflation.
7.
What are the objectives of inventory management?
Answer:
The objective of inventory management is making informed, conscious tradeoff decisions between the cost of acquiring and stocking inventories and the
ability to meet or exceed a targeted level of customer responsiveness. Even as
the level of customer responsiveness increases, the objective of managers is to
explore how to continuously reduce the inventory/cost portion of the trade-off.
Simply to accept a certain level of inventory based on a pre-determined ratio of
cost to sales revenue is insufficient to meeting this overarching objective.
Among the subsets of this trade-off decision process can be found these
other objectives:
3
4




8.
Inventories provide protection against stock outs. One role of the inventory manager is to investigate and resolve issues causing demand and
supply variability stemming from such things as poor forecasts, materials
and component shortages, inadequate shop floor scheduling, high scrap,
poor communications, and faulty processes. The effect of uncertainties
caused by these and other factors is higher inventory levels.
Since inventories are a major capital cost, a critical objective of inventory managers is continuous cost reduction without accompanying reduction in customer service levels. This is a complex objective to achieve, involving decisions such as make-or-buy alternatives, determining
inventory levels for different stocked products, number of channel locations, role of supply chain partners, lead times and process cycles, consignment stocking policies, scrap, and others.
Effective inventory management permits the efficient application of
equipment and workforce to meet customer responsiveness targets.
Proper inventory availability enables optimization of productive resources, agility to make quick changeovers, and scalability of resources
to be activated or deactivated based on demand. At the same time, effective inventory management reduces overtime costs, cycles of employee
layoff and rehire, and premium purchase order and transportation costs.
Effective inventory control enables companies to realize not only inventory objectives, but also a range of linked departmental budget objectives. Inventory expenditures can be matched to the capital expense plan
periodically to obtain ROI measurements, analyze variances, and provide
a basis for corrective action. In addition, as inventory stock out declines,
sales personnel will be able to make its revenue numbers, finance will
more effectively plan for cash flow, and operations will reduce the costs
associated with overtime, expediting, and uncertainty.
Describe the utilization of trade-off decisions in the management of inventories.
Answer:
Resolving the conflicting objectives of sales, operations, and finance rests with
the effective execution of inventory trade-off decisions. These decisions basically revolve around balancing the opposing objectives of customer responsiveness and operations efficiencies. Striking a balance between these two opposing objectives requires answers to six major questions:
 What is the optimal balance between inventory and customer service?
The larger the variety and volume of stocked quantities the higher the
customer service level; however, the higher the inventory the higher the
cost.
 What is the level of control inventory managers should establish over inventories? Large organizations often choose to exercise wide control
over inventory processes in an effort to remove channel redundancies,
leverage economies of scale, and maintain specific performance levels,
5




9.
while smaller organization will outsource non-core competencies to supply channel partners.
Under what circumstances should control over inventories be changed?
Changes in markets, products, technologies, channel direction, government regulation, and the status of supply chain partners will require close
review to determine if the present equilibrium between channel demand
and supply is still viable.
What is the optimum balance between inventory investment and associated carrying costs? Alterations in product variety and volumes will impact inventory costs proportionately. Inventory managers must be careful
to ensure that costs arising from decisions increasing inventory costs do
not nullify anticipated sales profits.
What is the optimum balance between inventory investment and replenishment costs? As a rule, as replenishment lot sizes decrease, so will inventory carrying costs. However, decreased lot sizes will increase ordering costs. The appropriate lot size will be the one that reduces risk of
stock out while maintaining the lowest cost.
What is the optimum balance between inventory investment and transportation costs? As a rule, as customer responsiveness increases so do transportation costs. In general, for products with high value-to-weight ratios,
a faster transportation mode is favorable. Correspondingly, for products
with low value-to-weight, a cheaper mode of transportation is preferable.
By aggregating inventories in a central warehouse, companies can reduce
inventory and inbound logistics costs, but will incur increased outbound
costs as the size of shipping lot sizes declines and faster delivery transportation modes are used.
Describe the seven classes of inventory.
Answer:
The seven classes of inventory are as follows:
 Raw materials: products normally extracted from nature–wood, grains,
cloth, steel, chemicals, and other unfinished commodities. Although these
products can be sold as received, normally they are not useful until they
have been fabricated into semifinished items or finished goods ready for
sale.
 Work in process (WIP): raw materials, components, and subassemblies
that are in the process of being transformed or are waiting to be transformed, into assemblies or finished goods. This classification also applies
to completed products awaiting final inspection.
 Finished goods: purchased items or manufactured assemblies requiring
no more processing and are ready for shipment to the customer
 Distribution: inventory located in the distribution system that is separate
from manufacturing inventory. This inventory includes items in transit
and in storage at a channel warehouse that are awaiting delivery to a customer.
5
6



Maintenance, repair, and operating supplies (MRO): items used to support general operations and maintenance, such as spare parts and goods
expended in production or supporting operations. In terms of financial
value and quantity, this inventory is considered relatively minor.
Service parts: modules, assemblies, kits, components, and individual
parts used to replace originals without modification. Service parts are frequently part of the distribution inventory. Many manufacturers of mechanical finished goods will keep a spare parts inventory for customers
who experience product breakdowns.
Damaged and obsolete: raw materials, components, subassemblies, and
finished goods that are no longer sold or cannot be sold because of damage. While constituting relatively small financial value and quantity, this
class of inventory must be closely managed to determine whether it can
be repaired and returned to stock or discarded.
10. Discuss the role of inventory in the financial life of the typical business. Is
inventory an asset or a liability? Explain your answer.
Answer:
Inventory provides value to a company in many ways as described in the following points:
 Lowest cost for revenue value received. Efficiently managed inventory
enables companies to continuously shrink costs while increasing customer service levels. As the variance widens between what the final product is worth to the customer and the costs the business incurs in filling the
customer’s request, businesses can expect to increase profits. The basis of
all trade-off decisions is determined by how proper inventory management can decrease cost for revenue value received.
 Improved channel efficiencies. By driving demand from the customer to
the producer, channel companies can ensure that the inventory balances
they stock support channel demand. Improper management of inventories
can cause two major sources of financial risk. The first is stock out anywhere in the supply chain. Stock out risks the loss of the customer’s order
and causes channel partners to undertake expedited actions to rush production and inventories through the supply chain, reducing the gap between costs and profit. The second source of financial loss is the unnecessary build-up in channel inventories due to poor planning and channel
visibility. This is known as the “‘bullwhip’ effect.”
 Improved quality. As inventory quantities shrink everywhere in the supply chain, businesses simply cannot afford poor quality. Defects cannot
be solved by simply replacing it by taking another item. Quality must be
resolved at the source if an organization is to reduce costs and expand
customer responsiveness. Finally, quality makes it possible for companies to reduce the occurrence of surplus and obsolete inventories.
 Supply network simplification. Efficient inventory management enables
companies to increase the speed of inventory flow through the supply
7
chain pipeline. Properly stocked inventory permits companies to expand
manufacturing and delivery flexibility and agility.
 Improved channel fulfillment information. Besides assisting companies to
reduce costs and accelerate inventory flows, financial value can be enhanced through reductions in stock out costs. Stock outs risk lost sales
and reduction in customer goodwill. An effective way to measure the impact of lost sales on financial value is by determining the difference between the revenue that would have arisen from the transaction and the direct cost of making, selling, and delivering the product. As the fulfillment
channel is cleared of obstacles and the flow of goods accelerates, the
value of inventory grows in proportion.
Inventory becomes a liability when it is poorly managed. Poor management
results in excess inventory build-up, increased carrying costs, obsolescence,
and damage.
7