Module 2
Managing Material flow
5
Inventory Management
Content…….
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Introduction
Type of inventory
Inventory related costs
Managing cycle stock
Managing saftey stock
Managing seasonal stock
Analysing impact of supply chain redesign on the
inventory
• Managing inventory for short life cycle products
• Multiple item, multiple location inventory
management
Sector-wise Inventory Performance
10
inventory turnover ratio
9
1991
1996
2001
2006
8
7
6
5
4
3
2
1
0
chemical
textile
machinery
non metallic mineral
years
transport
metal and metal
products
food and beverages
Sector-wise Performance on
Inventory Turnover Ratio in India
Types of Inventory
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Cycle Stock : Economies of scale
Safety Stock
Decoupling stocks
Anticipation Stock
– Seasonal Stock
– Speculative Stock
• Pipeline Inventory
• Dead stock
Cycle Stock
• The inventory
resulting
from
the
production or purchase in batches is called
cycle stocks.
Safety Stock
• Stocks which are maintained as a
safeguard against uncertainties of demand
and supply is called safety stock.
Decoupling Stock
• In most organization internal supply chain
is divided into three decision units,
materials, manufacturing and distributions
which take care of the buy, make and
deliver functions, respectively. Some
organizations
hold
inventories
at
organizational as well as departmental
boundaries, this is called decoupling
stocks.
Anticipation Stock
• Anticipation inventories consists of stock
accumulated in advance of expected peak
in sales or that which takes care of some
special event that does not occur on a
regular basis.
– Seasonal stock
– Speculation stock
Pipeline Inventory
• Production and transportation activities
take certain finite time, firms need to carry
pipeline or in-transit stock.
• Pipeline inventory consists of materials
actually being worked or being moved
from one location to another in the chain
Dead stock
• Dead stock refers to that part of the nomoving inventory that is unlikely to be of
any further use in supply chain operations
or markets.
• Dead stock essentially includes items tat
have become obsolete because of
changes in customer taste, design or
production processes.
Drivers of Inventory
Type of Inventory
Driver ( Logic)
Cycle Stock
Economies of Scale
Safety Stock
Uncertainty in demand & Supply
Seasonal stock
Mismatch between demand and
supply rate
Speculation Stock
Uncertainty in price of material
Pipeline Stock
Lead-time in
production/transportation process
Dead Stock
Judgmental error/ Change in
economic or technological
environment
Inventory Management: Key
Decisions
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How much to order?
When to order?
Where to hold inventory?
When to review?
– Continuous review systems ( Fixed order
quantity)
– Periodic review systems
Inventory in Chain
• Supply chain consists of series of stock points
connected by processes ( conversion processes and
transportation processes)
• Each stock point has demand process and supply
process
• Inventory at stock point : cycle stock, safety stock,
seasonal stock
• Inventory within conversion and transportation
processes: pipeline inventory
Inventory Management: Relevant
Cost
• Ordering cost/setup cost
• Inventory carrying cost
• Stockout cost
– Lost sale cost
– Backorder cost
Ordering cost/setup cost
• It include all fixed cost associated with
placing an order
– Administration costs involved in placing the
order
– Transportation cost
– Receiving cost
Inventory carrying cost
• It capture all the actual and opportunity
costs that are incurred because of holding
inventory
– Financing cost
– Storage and handing cost
– Inventory risk
Stockout cost
• It captures the economical consequences
of running out of stock
– Lost sale cost
– Backorder cost
Cycle-stock Inventory
Fixed Order Quality Model ( Cont. Review Model)
Q=Order Quantity, Reorder point= L*d
Average cycle stock = Q/2
Optimal Order Quantity Trade-offs
Inventory Models: Cycle Stock
__________
Q =2AD/i C
A = Ordering Cost / Cost of setup
D = Annual Demand
i = Inventory carry cost
C = cost of item
Q= Optimum order quantity
Optimum Order Quantity
Daily Demand = 100
Working days in year=300
Ordering cost = 256 Rs.
Cost of item = 30 Rs.
Inventory-carrying cost = 0.2 Rs./Rs./Year
Supplier LT = 15 Days
Optimum order Qty. =
_______________________
 (2*256*100*300/(30*0.20 ) = 1600
Average cycle stock= 0.5* 1600 = 800
units
Reorder point= 15*100 =1500
Insight from cycle stock inventory
model
• Fast vs. slow moving products
• Importance of volume
• Focus on reduction in ordering cost/set up
cost
Safety Stock
R= reorder point
Distribution of Demand During Lead Time
Safety Stock
Basic Demand and Lead-time Data
Demand
Data
d1
Demand 115
Lead-time
data
L1
Lead12
time
d2 d3
d4
d5 d6 d7
95 150 125 28 90 93
d8
115
d 9 d10
93 96
L2 L3
15 4
L8
18
L 9 L10
19 20
L4
21
L5 L6 L7
18 11 12
Ordering Policy in Case of
Demand and Supply Uncertainty
Order quantity = Q* = Optimum order
quantity
Reorder point= D * L + K Lead Time Demand
K = Safety factor
Safety stock= K Lead Time Demand
Impact of Safety Factor on
Service Level
Safety factor (K)
Service level
0
0.500
0.5
1.0
1.5
2.0
2.5
3.0
0.690
0.841
0.933
0.977
0.994
0.998
Impact of Service Level On Safety Stock
Safety Stock: Demand Uncertainty
Only
S.S = K Lead Time Demand
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Lead Time Demand =  L D2
D = average Demand ,D = S.D. of Demand ,
L = Lead-time, K
= Safety Factor
Safety Stock : Demand and
Supply Uncertainty
S.S = K Lead Time Demand
____________
Lead Time Demand =  L D2 + D2 L2
D = average Demand ,D = S.D. of Demand ,
L = Average Lead-time, L = S.D. of Lead-time
K = Safety Factor
Inventory Profile at Stock Point:
Cycle Stock + Safety Stock
Inventor
y
Average
Inventory
Cycle Inventory
Safety Inventory
Time
Inventory Management
Cycle and Safety Stock
Daily Demand: Mean = 100 , SD = 30
Ordering cost = 256 Rs.
Cost of item = 30 Rs.
Inventory-carrying cost = 0.2 Rs./Year
Supplier Performance
Mean = 15 Days , SD = 5
Service Level = 98%
• Service level is the probability that all
orders will be filled from stock during the
replenishment lead time or during the
reorder cycle. This is also known as cycle
service level
Impact of Change in Demand and
Supply Parameters
Average
Demand
Standard
deviation
of demand
Average Standard Safety
leaddeviation stock
time
of lead- - units
time
Safety
Remark
stock in
days of
inventory
100
30
15
5
1026
10.3
Base case
100
30
15
0
232
2.3
100
0
15
5
1000
10
100
15
15
5
1006
10
100
30
15
2.5
526
5.3
100
30
7.5
5
1003
10
No supply
uncertainty,
No demand
uncertainty
Reduce demand
uncertainty
Reduce supply
uncertainty
Reduction in
lead-time
Managing Seasonal Stock
• Capacity versus inventory tradeoff in
seasonal demand/supply situation
• Two basic approaches in aggregate
planning
(Sales
and
operations
Planning)
– Chase Option : Produce as per demand
– Level Option: produce at the same level
– Mix approaches
Illustration: Managing Seasonal Stock
Demand
Level option
Production
Hiring Cost
Inv. C. Cost
Chase option
Production
Hiring Cost
Inv. C. Cst
Q1
8000
Q2
8000
Q3
8000
Q4
12000
9000
0
3000
9000
0
6000
9000
0
9000
9000
0
0
8000
0
0
8000
0
0
8000
0
0
12000
48000
0
Cost: level option= 18,000
Chase option= 48000
Centralized Versus Decentralized
Systems
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Inventory
– Safety Stock
– Cycle stock
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Service Level
Overhead Costs
Customer Lead Time
Transportation Cost
Centralized Versus Decentralized
Systems: Illustration
Demand distribution at each region ( 16 regions)
Daily Demand: Mean = 100 , SD = 30
Ordering cost = 256 Rs.
Cost of item = 30 Rs.
Inventory Carrying cost = 0.2 Rs./Rs./Year
Plant Lead time:= 15 Days ( No supply Uncertainty)
Transportation:
Decentralized- Rs. 1 per unit
Centralized case: - 10% higher
Decentralised
system
–16
stock points
Centralised
system
–1
stock point
Cycle stock/stock
point = Q*/2
800
3200
Safety Stock per
stock point
232
928
Total Inv. in units
for the system
(232+800)  16
= 16512
928+3200
= 4128
Total Inv. carrying
cost
16512  6
= 99072
4128  6
= 24768
Incremental
Transportation
cost
300100160.
1
=48,000
Inventory for Short life-cycle Products
• Short life cycle products is a special
category of items where demand takes
place during a sort period of item, and
good are kept ready in stock to take care
of demand.
• Two kinds of products
– Style goods (fashion goods)
– Perishable goods (news papers)
Newsboy model or Single Period Model
Balancing cost of under-stocking versus cost of
overstocking
CU = Cost of under-stocking
CO = Cost of overstocking
Optimum service level = (CU *100/ (CU + CO )
Optimum Order size= Mean demand
+ K * Std. Dev. Demand
K= optimum service level
Optimum Order for a New Music
CD
CD purchase price = Rs. 200
CD sales price = Rs. 300
CD sales price after first weeks = Rs. 62.
Demand: Average 100 and Standard Deviation 30
- What is optimum order quantity
- If manufacturer offers buyback scheme , would your
decision change?
- Cost of administering return- Rs. 53
Selective Inventory Control
techniques
• ABC classification
• FSN Classification
• VED Classification
ABC Classification
Class
Percentage
of Percentage
of
items
Total sales Value
A
5-15
55-75
B
20-30
20-30
C
55-75
5-15
• ABC categorization has been used with
success in following areas:
– Allocation of managerial time
– Improvement efforts
– Setting up of service levels
– Stocking decision in the distribution system
ABC Classification: Kurlon
Case
48
Improving Inventory Turns
Type of Inventory Driver ( Logic)
Improvement focus
Cycle Stock
Economies of Scale
Reduce ordering/setup cost
Safety Stock
Uncertainty in demand & Supply
Reduce demand & supply
uncertainty & Reduce LT,
supply chain redesign
Seasonal stock
Mismatch between demand and
supply rate
Reduce Seasonality in
demand, Create flexible
capacity
Speculation Stock
Uncertainty in price of material
Risk management
Pipeline Stock
Lead-time in
production/transportation process
Reduce Lead Time
Dead Stock
Judgmental error/ Change in
economic or technological
environment
Anticipate changes in
demand structure