51
Inventory Concepts
INVENTORY IS A
LARGE AND COSTLY
INVESTMENT
What are Inventories?
•Finished product held for sale
•Goods in warehouses
•Work in process
•Goods in transit
•Any owned or financially controlled
raw material, work in process, and/or
finished good or service held in
anticipation of a sale but not yet sold
CR (2004) Prentice Hall, Inc.
Where are Inventories?
Inbound
transportation
Production
Outbound
transportation
Finished goods
warehousing
Customers
Receiving
Material
sources
Production
materials
Finished goods
Shipping
Inventories
in-process
Inventory
locations
CR (2004) Prentice Hall, Inc.
9-4
1
4
Inventory Pipeline
Raw & In-Process
Mfg.
In-Transit Plant
Whse
Process
to
Vendor
Mfr.
Plant.
Whse
Finished Goods
InTransit
to DCs
Field Pick & In-Transit
Whse Load
Customer
to
Custmr
Location Strategy
• Location decisions
• The network planning process
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
IMPLEMENTING
ORGANIZING
Inventory Decisions in
Strategy
Inventory Management Objectives
Good inventory management is a careful balancing act
between stock availability and the cost of holding
inventory.
,
Stock out probability
Inventory Holding costs
(inventory Carrying 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
economical replenishment quantities and timing
CR (2004) Prentice Hall, Inc.
MAIN AIMS OF INVENTORY
MANAGEMENT
To improve cash flows
 To improve return on investment (ROI,

the benefit (return) of an investment is divided by the cost
of the investments)




ROI= Gains from investment – Cost of investment
Cost of Investment
$700,000 - $500,000 = 40%
$500,000
MEASURES OF INVENTORY
MANAGEMENT EFFECTIVENESS
The impact that inventory has on corporate
profitability
 Measures to decrease inventory-related
costs include;

reducing the number of backorders or
expedited shipments, purging obsolete or dead
stock from the system, or improving the
accuracy of forecasts.
MEASURES OF INVENTORY
MANAGEMENT EFFECTIVENESS
(Cont.)

Fill rate is a common measure of the customer service
performance of inventory.

Product fill rate: fraction of product demand satisfied
from product in inventory (single item) computer

Order fill rate: percentage of units available when
multiproduct order is received. Computer+mouse

A 96% fill rate means that 4% of requested units were
unavailable when ordered by customer.

Cycle service level: if the store doesn’t run out of stock in
6 out of 10 replenishment cycles, the store achieves a CSL
of 60 percent
MEASURES OF INVENTORY
MANAGEMENT EFFECTIVENESS
(Cont.)
•inventory turnover ratio would be calculated as units sold
divided by units on hand.
Inventory Turnover Comparisons
4
3
Inventory Management Answers
Four Important Questions

How to order?

When to order?

What to order?

How much to order?
42
Why Hold Inventory?
1.
2.
3.
4.
5.
It enables the firm to achieve economies of
scale
It balances supply and demand
It enables specialization in manufacturing
It provides protection from uncertainties in
demand and order cycle
It acts as a buffer between critical interfaces
within the channel of distribution
Economies of Scale

Inventory is required if an organization is to
realize economies of scale in purchasing,
transportation, or manufacturing.

Per unit price reductions!

The cost of maintaining this inventory must
be “traded off” against the production
savings realized.
Balancing Supply and
Demand
Seasonal supply or demand may make it
necessary for a firm to hold inventory. (finished
goods)
 Demand for a product may be relatively stable
throughout the year, but raw materials may be
available only at certain times during the year.
 Ex: Canned fruits and vegetables

Specialization




Inventory makes it possible for each of a firm’s
plants to specialize in the products that it
manufactures.
The finished products can be shipped to field
warehouses where they are mixed to fill customer
orders.
Whirlpool Co.- cost savings through specializing
manufacturing by plant location and the
consolidation of warehouse operations
Focused Factories-specialization by facility
Protection From
Uncertainties

Inventory is held as protection from
uncertainties; that is, to prevent a stock out
in the case of variability in demand or
variability in the replenishment cycle.

Inventory planning is critical to successful
manufacturing operations to protect from
uncertainties.
Inventory As A Buffer

Inventory is held throughout the supply chain
to act as a buffer for the following critical
interfaces:
–
–
–
–
–
–
* supplier-procurement
* procurement-production
* production-marketing
* marketing-distribution
* distribution-intermediary
* intermediary-customer/user
THE LOGISTICS FLOW
Raw
materials
inventory
Work-in-process
inventory
Finished goods
inventory at
plant location
Finished goods
inventory at
field locations
Supplier
inventory
Consumer
inventory
Retail
inventory
Reworking or
repackaging
of product
Forward
logistics flow
Waste and
by-products
Waste
disposal
Reverse
logistics
flow
TYPES OF INVENTORIES
Inventories can be classified based on the reasons
for which they are accumulated.






In-transit inventories
Speculative stock
Seasonal stock
Dead stock
Cycle stock
Safety or buffer stock
In-transit Inventories

In-transit inventories are items that are en
route from one location to another

For calculating inventory carrying costs,intransit inventory should be considered as
inventory at the place of shipment origin
since the items are not available for use,
sale,etc.
Speculative Stock

Speculative stock is inventory held for reasons
other than satisfying current demand

Materials may be purchased in volumes larger
than necessary:
to receive quantity discounts,
because of a forecasted price increase
materials shortage,
to protect against the possibility of a strike.




Seasonal Stock

Seasonal stock is a form of speculative
stock that involves the accumulation of
inventory before a seasonal period begins

This often occurs with agricultural products
and seasonal items.

Ex: back-to-school
Dead Stock

Dead stock refers to items for which no demand has been
registered for some specified period of time.

Dead stock might be obsolete throughout a company or
only at one stock keeping (SKU) location.

J.C. Whitney Company-sells auto parts that are no longer
produced

Transshipment of dead stock-Asia markets
Cycle Stock

Cycle stock is inventory that results from
replenishment of inventory sold or used in production.

It is required in order to meet demand under
conditions of certainty; that is, when the firm can
predict demand and replenishment times (lead times).

Orders are scheduled to arrive just as the last unit is
sold-no extra inventory beyond the cycle stock is
required.
Cycle Stock
Lot or batch size: The quantity that a stage of supply
chain either produces or purchases at a given time

Q: quantity in a lot or batch size

Cycle stock: Q / 2
Safety or Buffer Stock


Safety or buffer stock is held in excess of cycle stock
because of uncertainty in demand or lead time.
Average inventory at a stock keeping location that
experiences demand or lead time variability = half the
order quantity (cycle stock)+ the safety stock
Inventory
level
time
4 14
Factors Influencing
Safety Stocks

Forecast error

Exposure to stockout

Lead time

Service level
requirement
Under certainty
Demand per day:20 units
 Order quantity: 400 units
 Lead time: 10 days

44
The Effect of Reorder Quantity on
Average Inventory Investment with
Constant Demand and Lead Time
Demand:20
units
A. Orderquantity of 400 units
Inventory
Order
arrival
400
Order
placed
Order
arrival
Order
placed
Average
cycle
inventory
200
0
Days
10
20
30
40
50
60
4
5
The Effect of Reorder Quantity on
Average Inventory Investment with
Constant Demand and Lead Time
Demand:20
units
B. Order quantity of 200 units
Inventory
Order
arrival
Order
placed
200
Average
c cleo
invent
y ry
100
0
Days
10
20
30
40
50
60
4
6
The Effect of Reorder Quantity on
Average Inventory Investment with
Constant Demand and Lead Time
Demand:20
units Inventory
C. Order quantity of 600 units
600
Order
arrival
Average
cycle
inventory
Order
placed
300
0
Days
10
20
30
40
50
60
With variable demand

Demand fluctuates between 15 and 25
units per day
 Lead time is constant
11
4
Average Inventory Investment
Under Conditions of Uncertainty
Demand:2025 units
A. With variable demand
Inventory
200
Average
cycle
inventory
100
{{
Ave ra ge
inve ntory
(150)
S afety
s tock
(50)
8
10
20
30
Days
40
Variable lead time
Lead time fluctuates between 8 and 12
days
 Demand per day is constant

12
4
Average Inventory Investment
Under Conditions of Uncertainty
If orders arrive 2 days late
B. With variable lead time
Inventory
200
Average
cycle
inventory
100
{{
Ave ra ge
inve ntory
(140)
S afety
s tock
(40)
10
12
20
30
Days
40
With variable demand and
lead time
Lead time fluctuates between 8 and 12
 Demand per day fluctuates between 15
and 25

13
4
Average Inventory Investment
Under Conditions of Uncertainty
C. With variable demand and lead time
Inventory
200
Average
cycle
inventory
100
{{
Ave ra ge
inve ntory
(200)
S afety
s tock
(10 0)
8
10
12
20
30
Days
40
4
The EOQ Model
7
EOQ =
2PD
CV
where:
P = The ordering cost (dollars per order)
D = Annual demand or usage of the product
(number of units)
C = Annual inventory carrying cost (as a percentage
of product cost or value)
V = Average cost or value of one unit of inventory
8
4
Cost Trade-offs Required to Determine
the Most Economic Order Quantity
Total cost
Annual cost
(dollars)
Lowest total cost
(EOQ)
Inventory
carrying
cost
Ordering cost
Size of order (Q)
9
4
Cost Trade-offs Required to Determine the Most
Economic Order Quantity
D = 4800 units per year C = $1 per unit
P = $40 per order
V= $25 per unit
Number
of Orders
Order
Quantity (Q) (D/Q)
Ordering
Cost
PX (D/Q)
40
60
80
100
120
140
160
200
300
400
$ 4,800
3,200
2,400
1,920
1,600
1,400
1,200
960
720
480
120
80
60
48
40
35
30
24
18
12
Inventory
Carrying
Cost
1/2 Q X C X V
$ 500
750
1,000
1,250
1,500
1,750
2,000
2,500
3,750
5,000
Total
Cost
$ 5,300
3,950
3,400
3,170
3,100
3,150
3,200
4,460
4,470
5,480
10
Assumptions of the Simple
EOQ Model
4









A continuous, constant, and known rate of
demand.
A constant and known replenishment cycle or
lead time.
A constant purchase price that is independent of
the order quantity or time.
A constant transporation cost that is independent
of the order quantity or time.
The satisfaction of all demand (no stockouts are
permitted).
No inventory in transit.
Only one item in inventory, or at least no
interaction among items.
An infinite planning horizon.
No limit on capital availability.
Fixed order point-Fixed order
interval policy
Fixed order point policy: EOQ-an order is placed
when inventory on hand reaches a predetermined
min. level necessary to satisfy demand during order
cycle
Fixed order interval policy: Inventory levels are
reviewed at a certain –set time interval like every
week