Inventory Policy Decisions Lecturer: Arsalan Siddiqui 9-1 CR (2004) Prentice Hall, Inc. CONTROLLING Customer service goals • The product • Logistics service • Ord. proc. & info. sys. Transport Strategy • Transport fundamentals • Transport decisions PLANNING Inventory Strategy • Forecasting • Inventory decisions • Purchasing and supply scheduling decisions • Storage fundamentals • Storage decisions ORGANIZING Inventory Decisions in Strategy Location Strategy • Location decisions • The network planning process 9-2 CR (2004) Prentice Hall, Inc. Nature of Demand •Perpetual demand -Continues well into the foreseeable future •Seasonal demand -Varies with regular peaks and valleys throughout the year Accurately forecasting demand is singly the •Lumpy demand most important factor -Highly variable (3 Mean) in good inventory •Regular demand management -Not highly variable (3 < Mean) •Terminating demand -Demand goes to 0 in foreseeable future •Derived demand -Demand is determined from the demand of another9-3 item of which it is a part Inventory Management Philosophies •Pull -Draws inventory into the stocking location -Each stocking location is considered independent -Maximizes local control of inventories •Push -Allocates production to stocking locations based on overall demand -Encourages economies of scale in production •Just-in-time -Attempts to synchronize stock flows so as to just meet demand as it occurs 9-4 -Minimizes the need for inventory CR (2004) Prentice Hall, Inc. Inventory Management Philosophies (Cont’d) •Supply-Driven -Supply quantities and timing are unknown -All supply must be accepted and processed -Inventories are controlled through demand •Aggregate Control -Classification of items: ›Groups items according to their sales level based on the 80-20 principle ›Allows different control policies for 3 or more 9-5 broad product groups CR (2004) Prentice Hall, Inc. Pull vs. Push Inventory Philosophies PUSH - Allocate supply to each warehouse based on the forecast for each warehouse PULL - Replenish inventory with order sizes based on specific needs of each warehouse Demand forecast Warehouse #1 Q1 A1 A2 Q2 Plant Warehouse #2 A3 Demand forecast Q3 A = Allocation quantity to each warehouse Q = Requested replenishment quantity by each warehouse CR (2004) Prentice Hall, Inc. Warehouse #3 Demand forecast 9-11 Costs Relevant to Inventory Management •Carrying costs -Cost for holding the inventory over time -The primary cost is the cost of money tied up in inventory, but also includes obsolescence, insurance, personal property taxes, and storage costs -Typically, costs range from the cost of short term capital to about 40%/year. The average is about 25%/year of the item value in inventory. 9-7 CR (2004) Prentice Hall, Inc. Relevant Costs (Cont’d) •Procurement costs -Cost of preparing the order -Cost of order transmission -Cost of production setup if appropriate -Cost of materials handling or processing at the receiving dock -Price of the goods 9-8 CR (2004) Prentice Hall, Inc. Relevant Costs (Cont’d) •Out-of-stock costs -Lost sales cost ›Profit immediately foregone ›Future profits foregone through loss of goodwill -Backorder cost ›Costs of extra order handling ›Additional transportation and handling costs ›Possibly additional setup costs 9-9 CR (2004) Prentice Hall, Inc. Inventory Management Objectives Good inventory management is a careful balancing act between stock availability and the cost of holding inventory. Customer Service, i.e., Stock Availability Inventory Holding costs •Service objectives -Setting stocking levels so that there is only a specified probability of running out of stock •Cost objectives -Balancing conflicting costs to find the most 9-10 economical replenishment quantities and timing CR (2004) Prentice Hall, Inc. Inventory’s Conflicting Cost Patterns Minimum cost reorder quantity Cost Total cost Procurement cost Stockout cost CR (2004) Prentice Hall, Inc. Replenishment quantity 9-16 FUNCTIONS OF LOGISTICS Procurement or purchasing Inward transport Receiving Material Handling Warehousing Inventory control 9-12 FUNCTIONS OF LOGISTICS (CONT) Order picking Outward transport Physical distribution Recycling, returns and waste disposal Location Communication 9-13 PROCUREMENT OR PURCHASING Procurement or purchasing which usually initiates the flow of materials through an organization by sending a purchase order to a supplier This means that procurement has to find suitable suppliers, negotiate terms, set conditions, organize delivery, arrange insurance, authorize payment, and do everything needed to get materials into the organization. In the past, this has been a largely clerical job centered on order processing, but now it is recognized as being responsible for major expenditure and giving a critical link with supplier 9-14 CONTINUED Inward transport or traffic which actually moves materials from suppliers to the organization’s receiving area Important decisions concern the mode of transport (road, rail, air, etc.), policies for outsourcing, choice of transport operator, route, safety and legal requirements, timing of deliveries, costs, etc. Receiving makes sure that materials delivered correspond to the order, acknowledges receipt, unloads delivery vehicles, inspects materials for damage, and sorts them. 9-15 MATERIAL HANDLING Material handling moves materials from receiving and puts them into stores It is responsible for all movements of materials within an organization, so it also removes materials from stores, takes them to the place they are needed, and generally moves materials between operations 9-16 CONTINUED Warehousing or stores takes care of materials held in stock until they are needed. Warehousing makes sure that materials have the right conditions, treatment and packaging to keep them in good condition, and are available quickly when needed. Stock or inventory control sets the overall policies for stock, considering the materials to store, investment, customer service, stock levels, order sizes, order timing and so on. 9-17 CONTINUED Order picking finds and removes materials from stores. Typically materials for a customer order are located, identified, checked, removed from racks, consolidated into a single load, wrapped and moved to a departure area for loading onto delivery vehicles. Outward transport takes materials from the departure area and delivers them to customers (with concerns that are similar to inward transport). 9-18 CONTINUED Physical distribution is a general term for the activities that deliver finished goods to customers. It is often aligned with marketing and forms an important link with downstream activities. 9-19 RECYCLING, RETURNS AND WASTE DISPOSAL There are sometimes problems with delivered materials – perhaps faults, the wrong materials or too much delivered – and logistics has to collect them and bring them back to the supplier This reverse logistics also collects associated materials such as pallets, delivery boxes, cable reels and containers (the standard 20-foot-long metal boxes that are used to move goods). Some materials are brought back for recycling (such as metals, glass, paper, plastics and oils) while others are brought back for safe disposal (such as dangerous chemicals). 9-20 CONTINUED Location finds the best site for those activities that can be in different places. Stocks of finished goods, for example, can be held at the end of production, moved to nearby warehouses, sent to large centralized facilities, put into stores near to customers, passed on to be managed by other organizations, or a range of alternatives. Communication Alongside the physical flow of materials is the associated flow of information This links all parts of the supply chain, passing information about products, customer demand, materials moved, timing, stock levels and etc. 9-21 INVENTORY AND LOGISTICS These Functions reinforces the point that all logistics activities have a direct impact on the stocks To take one example, we can look at the mode of transport, which describes the type of delivery vehicle used. The alternative modes are road, rail, air, inland waterway, ocean shipping or pipeline – and the choice is determined by locations, infrastructure, weight and volume carried, value of goods, customer service offered, urgency and a series of other factors. But this choice has a direct effect on stocks. Air travel is fastest and most expensive while shipping is slowest and cheapest – so the choice affects lead times and delivery costs. It also affects the amount of pipeline stocks (which are the materials in transit between locations), with airfreight having little stock on short journeys and shipping having weeks of stock out at sea. 9-22 Top Mgt. --------STRATEGIC Mid-Mgt. ------------TACTICAL First-Line Mgt. -------------------OPERATIONAL LEVEL OF DECISIONS Strategic decisions are most important, have effects over the long term, use many resources and are the most risky. These set the overall direction for operations. (Customer service is a strategic issue when designing the supply chain) Tactical decisions are concerned with implementing the strategies over the medium term; they look at more detail, involve fewer resources and some risk. (a tactical issue when organizing transport for delivery) Operational decisions are concerned with implementing the tactics over the short term; they are the most detailed, involve few resources and little risk. (an operational issue when scheduling the next delivery) 9-24 Copyright © 2013 Dorling Kindersley (India) Pvt. Ltd. Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra • Role in competitive strategy Form, location, and quantity of inventory allow a supply chain to range from being very low cost to very responsive Objective is to have right form, location, and quantity of inventory that provides the right level of responsiveness at the lowest possible cost Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra Copyright © 2013 Dorling Kindersley (India) Pvt. Ltd. Inventory Single Order Purchasing Make a one-time purchase of an item. How much to order? Procedure: Balance incremental profit against incremental loss. Profit = Price per unit Cost per unit Loss = Cost per unit Salvage value per unit If CPn is probability of n units being sold, then CPn x Loss = (1 CPn) x Profit or CPn = Profit/(Profit + Loss) Daily stocking of newspapers in vending machines is a good example Now, increase order quantity until CPn just matches cumulative probability of selling additional units. CR (2004) Prentice Hall, Inc. 9-18 Single Order Purchasing (Cont’d) Example A clothing item is purchased for a seasonal sale. It costs $35, but it has a sale price of $50. After the season is over, it is marked down by 50% to clear the merchandise. The estimated quantities to be sold are: Probability of Number of selling exactly n items, n items 10 0.15 15 0.20 20 0.30 25 0.20 30 0.10 35 0.05 1.00 CR (2004) Prentice Hall, Inc. Cumulative probability 0.15 0.35 0.65 0.85 0.95 1.00 9-19 Single Order Purchasing (Cont’d) Solution Profit = $50 35 = $15 Loss = $35 (0.5)(50) = $10 CPn = 15/(15 + 10) = 0.60 CPn is between 15 and 20 items, round up and order 20 items. 9-30 CR (2004) Prentice Hall, Inc. Turnover Ratio Annual sales Turnover ratio Average inventory A fruit grower stocks its dried fruit products in 12 warehouses around the country. What is the turnover ratio for the distribution system? Warehouse no. 1 2 3 4 5 6 Annual Average warehouse inventory throughput, $ level, $ 21,136,032 2,217,790 16,174,988 2,196,364 78,559,012 9,510,027 17,102,486 2,085,246 88,228,672 11,443,489 40,884,400 5,293,539 TO ratio $425,295,236 9.7 $43,701,344 CR (2004) Prentice Hall, Inc. Warehouse no. 7 8 9 10 11 12 Totals Annual warehouse throughput, $ 43,105,917 47,136,632 24,745,328 57,789,509 16,483,970 26,368,290 425,295,236 $ are at cost Average inventory level, $ 6,542,079 5,722,640 2,641,138 6,403,076 1,991,016 2,719,330 43,701,344 9-31 9-32 9-33 Virtual Inventories •Stockouts are filled from other stocking locations in the distribution network • Customers assigned to a primary stocking location • Backup locations are usually determined by “zoning” rules • Expectation is that lower system-wide inventories can be achieved while maintaining or improving stock availability levels • Total distribution costs should be lower to support the cross filling of customer demand 9-34 CR (2004) Prentice Hall, Inc. ABC INVENTORY CLASSIFICATION ABC classification is a method for determining level of control and frequency of review of inventory items A Pareto analysis can be done to segment items into value categories depending on annual dollar volume A Items – typically 20% of the items accounting for 80% of the inventory value-use B Items – typically an additional 30% of the items accounting for 15% of the inventory value-use C Items – Typically the remaining 50% of the items accounting for only 5% of the inventory value © Wile y 201 0 ABC ANALYSIS A items are the few most expensive ones that need special care. B items are ordinary ones that need standard care C items are the large number of cheap items that need little care. 36 © Wiley 2010 37 © Wiley 2010 38 © Wiley 2010 CONCLUSION 39 © Wiley 2010 ANALYSIS ON ITS ENTIRE INVENTORY BUT HAS DECIDED TO TEST THE TECHNIQUE ON A SMALL SAMPLE OF 15 OF ITS SKU’S. THE ANNUAL USAGE AND UNIT COST OF EACH ITEM IS SHOWN BELOW 40 © Wile y 201 0 (A) FIRST CALCULATE THE ANNUAL DOLLAR VOLUME FOR EACH ITEM 41 B) LIST THE ITEMS IN DESCENDING ORDER BASED ON ANNUAL DOLLAR VOLUME. (C) CALCULATE THE CUMULATIVE ANNUAL DOLLAR VOLUME AS A PERCENTAGE OF TOTAL DOLLARS. (D) CLASSIFY THE ITEMS INTO GROUPS 42 GRAPHICAL SOLUTION FOR AAU CORP SHOWING THE ABC CLASSIFICATION OF MATERIALS © Wiley 2010 The A items (106 and 110) account for 60.5% of the value and 13.3% of the items The B items (115,105,111,and 104) account for 25% of the value and 26.7% of the items The C items make up the last 14.5% of the value and 60% of the items How might you control each item classification? Different ordering rules for each? 43 PRACTICE PROBLEM A company manufactures a line of ten items. The usage and unit cost are shown in the following table, along with the annual dollar usage. The latter is obtained by multiplying the unit usage by the unit cost. a. Calculate the annual dollar usage for each item. , b. List the items according to their annual dollar usage. c. Calculate the cumulative annual dollar usage and the cumulative percentage of items. d. Group items into an A, B, C classification , , ,