Reasons for Inventory
• To create a buffer against uncertainties in supply
& demand
• To take advantage of lower purchasing and
transportation cost associated with high volume
• To take advantage of economies of scale
associated with manufacturing products in
batches
• To build up seasonal demand for promotional
sales
• To accommodate product flowing from one
location to another (work in process or in transit)
• To exploit speculative opportunities for buying
and selling commodities and other products
Goals: Reduce Cost, Improve Service
• By effectively managing inventory:
– Xerox eliminated $700 million inventory from
its supply chain
– Wal-Mart became the largest retail company
utilizing efficient inventory management
– GM has reduced parts inventory and
transportation costs by 26% annually
Goal: Reduce Cost, Improve Service
• By not managing inventory successfully
– In 1994, “IBM continues to struggle with shortages in
their ThinkPad line” (WSJ, Oct 7, 1994)
– In 1993, “Liz Claiborne said its unexpected earning
decline is the consequence of higher than anticipated
excess inventory” (WSJ, July 15, 1993)
– In 1993, “Dell Computers predicts a loss; Stock plunges.
Dell acknowledged that the company was sharply off in
its forecast of demand, resulting in inventory write
downs” (WSJ, August 1993)
Inventory
• Where do we hold inventory?
– Suppliers and manufacturers
– warehouses and distribution centers
– retailers
• Types of Inventory
– WIP
– raw materials
– finished goods
• Why do we hold inventory?
– Economies of scale
– Uncertainty in supply and demand
Why Inventory Reduction
•Business processes
reduce or eliminate
inventories mainly by
reducing or
eliminating
uncertainties that
make them
necessary
• Better
communication and
coordination of
activities across
company functions
and between the
company and its
vendors and
customers can
greatly reduce
uncertainties.
Ways to Reduce
Uncertainties
• Improving the accuracy of forecasts by
developing better forecasting methods
• Promoting better communication between supply
chain managers and marketing and sales
managers
• Sharing supply chain information with vendors
and other third party providers
• Consolidating number of locations where
products are held
• Reducing product variety
• Postponing product customization to downstream
stage of the supply chain
Role of Inventory in the
Supply Chain
Improve Matching of Supply
and Demand
Improved Forecasting
Reduce Material Flow Time
Reduce Waiting Time
Reduce Buffer Inventory
Economies of Scale
Supply / Demand
Variability
Seasonal
Variability
Cycle Inventory
Safety Inventory
Seasonal Inventory
Figure Error! No text of
Inventory Policy
Match Supply & Demand
Reduce Buffer Inventory
Economies of Scale
Supply / Demand
Variability
Cycle Inventory
Safety Inventory
•Reduce fixed cost
•Aggregate across
products
•Volume discounts
•EDLP
•Promotion on Sell
thru
Seasonal
Variability
Seasonal Inventory
•Quick Response measures
•Reduce Info Uncertainty
•Reduce lead time
•Reduce supply
uncertainty
•Accurate Response measures
•Aggregation
•Component commonality
and postponement
8
Role of Inventory in the
Supply Chain
• Overstocking: Amount available
exceeds demand
– Liquidation, Obsolescence, Holding
• Understocking: Demand exceeds
amount available
– Lost margin and future sales
Goal: Matching supply and demand
Understanding Inventory
• The inventory policy is affected by:
–
–
–
–
Demand Characteristics
Lead Time
Number of Products
Objectives
• Service level
• Minimize costs
– Cost Structure
Cost Structure
• Order costs
– Fixed
– Variable
• Holding Costs
–
–
–
–
–
Insurance
Maintenance and Handling
Taxes
Opportunity Costs
Obsolescence
EOQ: A View of Inventory*
Note:
• No Stockouts
• Order when no inventory
• Order Size determines policy
Inventory
Order
Size
Avg. Inventory
Time
EOQ:Total Cost*
160
140
Total Cost
120
Cost
100
Holding Cost
80
60
Order Cost
40
20
0
0
500
1000
Order Quantity
1500
EOQ: Calculating Total
Cost*
• Purchase Cost Constant
• Holding Cost: (Avg. Inven) * (Holding
Cost)
• Ordering (Setup Cost):
Number of Orders * Order Cost
• Goal: Find the Order Quantity that
Minimizes These Costs:
Fixed costs: Optimal Lot Size and
Reorder Interval (EOQ)
R:
S:
C:
h:
H:
Q:
T:
Annual demand
Setup or Order
Cost
Cost per unit
Holding cost per
year as a
fraction of
product cost
Holding cost per
unit per year
Lot Size
Reorder interval
H  hC
2 RS
Q
H
2S
T
RH
Example
Demand, R = 12,000 computers
per year
Unit cost, C = $500
Holding cost, h = 0.2
Fixed cost, S = $4,000/order
Q = 980 computers
Cycle inventory = Q/2 = 490
Flow time = Q/2R = 0.49 month
Reorder interval, T = 0.98 month
EOQ: Another Example
• Book Store Mug Sales
– Demand is constant, at 20 units a week
– Fixed order cost of $12.00, no lead time
– Holding cost of 25% of inventory value
annually
– Mugs cost $1.00, sell for $5.00
• Question
– How many, when to order?