MRI 2315
Warehousing and Distribution
Voon N. L.
4. Inventory and Materials Management
4.1 Basic concepts of inventory management.
Inventory serves 5 purposes:
• 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 supply chain
Economies of Scale
• Purchase contracts are being negotiated based on annual volumes
• Enjoy lower transportation cost per unit
• Manufacturing economies where plant capacity is greater, and perunit manufacturing costs are lower with few production run
changes
• Manufacturing in small quantities leads to short production runs
and high changeover costs
Balancing Supply and Demand
• Seasonal supply and/or demand may make it necessary for a
firm to hold inventory
• Raw materials may be available only at certain times during the
year
• The cost of establishing production capacity to handle the
volume at these peak periods would be substantial
• To maintain a relatively stable workforce, and produce at a
constant level throughout the year to lower total cost
Specialization
• Finished products can be shipped to large mixing warehouses,
from which customer orders and products for field
warehouses can be shipped
• Specialized facilities are known as “focused factories”
Protection from Uncertainties
• Raw materials inventory
• Speculative purchase, e.g. future price increase or strike
• Seasonal availability
• Work-in-Process inventory
• Eliminate manufacturing bottlenecks
• Excessive inventories can increase costs and reduce profitability
• Finished goods inventory
• Improve customer service levels by reducing the likelihood of a stockout
due to an-unanticipated demand or variability in lead time
A Buffer throughout the Supply Chain
• Acts as a buffer for the following critical interfaces:
• Supplier – procurement (purchasing)
• Procurement – production
• Production – marketing
• Marketing – distribution
• Distribution – intermediary
• Intermediary – consumer/use
• Forward logistics flow & reverse logistics flow
Components of Logistics Management
4. Inventory and Materials Management
4.2 Calculate safety stocks.
Cycle Stock
• Cycle stock is inventory that results from the replenishment
process and is required in order to meet demand under
conditions of certainty, i.e. when the firm can predict demand and
replenishment times (lead times) perfectly.
• Example : Average cycle stock (page 232)
Safety or Buffer Stock
• Safety or buffer stock is held in excess of cycle stock because of
uncertainty in demand or lead time.
• Example: Demand varies and lead time constant
• Example: Demand constant and lead time varies
• Example: Demand and lead time vary
4. Inventory and Materials Management
4.3 Production policies influence inventory levels.
Production Policies Influence Inventory Levels
• Production Rate ↑
• Total Production Cost ↓

Inventory Level ↑
Reverse is true
• Inventory Levels ↓

Production Rate ↓

Total Production Cost ↑ significantly
4. Inventory and Materials Management
4.4 Interrelated within Inventories and customer service levels.
Service Level
• Service level measures the performance of a system. Certain
goals are defined and the service level gives the percentage to
which those goals should be achieved.
• Examples of service level:
• Percentage of calls answered in a call center.
• Percentage of customers waiting less than a given fixed time.
• Percentage of customers that do not experience a stockout.
Relationship between inventory investment and customer
service levels
• Service Level ↑

Inventory Investment ↑
To improve service level
• Increase inventory Investment (easy but astronomical)
• Substitution Transportation Cost for Inventory Carrying Cost
• Associate each product on demand levels and demand variation
and set inventory levels accordingly
• Decentralization of products (e.g. stock highest volume at retail
locations; high- and moderate-volume items at field warehouse
locations; slow-moving items at centralized locations)
4. Inventory and Materials Management
4.5 Financial aspects of inventory strategy.
Financial Aspects of Inventory Strategy
Inventory and Corporate Profitability
• Excessive Inventories Can Lower Profitability
• Net profit is reduced by out-of-pocket costs associated
with holding inventory, such as insurance, taxes, storage,
obsolescence, damage, and interest expense, if the firm
borrows money specifically to finance inventories
• Total assets are increased by the amount of the inventory
investment, which decreases asset turnover. The result is
a reduction in return on assets and return on net worth
Financial Aspects of Inventory Strategy (con’t)
Inventory and Corporate Profitability (con’t)
• Capital Rationing Raises the Cost of Carrying Inventory
• If the company does not have enough money to invest
in all of the new projects available, then the
management has to decide where to invest the money
from the inventory reduction and at what rate of return
• Inventory cut; Production Efficiency Improvement
•
6
 Inventory level
Cost of goods sold
Financial Aspects of Inventory Strategy
Cost Tradeoffs Required in Marketing and Logistics
Marketing Objective:
• Allocate resources to the marketing mix in such a manner as to
maximize the long-term profitability of the firm.
Logistics Objective:
• Minimize Total costs given the customer service objective where total
costs = Transportation Costs + Warehousing Costs + Order Processing
and Information Costs + Lot Quantity Costs + Inventory Carrying Costs
Components of Inventory Carrying Costs
• Capital Costs
• interest bearing debt from banks, and opportunity costs of capital
• Inventory service costs
• insurance, taxes
• Storage space costs
• plant warehouses, public warehouses, rental warehouses, company-owned
warehouses
• Inventory risk costs
• obsolescence, damage, shrinkage, relocation costs
Inventory and Least Total Cost Logistics
• Least total cost logistics is achieved by minimizing the total
costs for a specified level of customer service.
• Given the same customer service level, low inventory carrying
costs lead to multiple warehouses and a slower mode of
transportation, such as rail roads.
• High inventory carrying costs resulted in limited number of
stock locations and a faster means of transportation, such as
motor or air carriers, in order to minimize total totals.
4. Inventory and Materials Management
4.6 Ways to recognize poor inventory management and improvement
methods.
The following symptoms may be associated with poor
inventory management:
• Increasing numbers of back orders
• Increasing dollar investment in inventory with back orders
remaining constant
• High customer turnover rate
• Increasing number of orders being canceled
The following symptoms may be associated with poor
inventory management: (con’t)
• Periodic lack of sufficient storage space
• Wide variance in inventory turnover among distribution
among distribution centers and among major inventory items
• Deteriorating relationships with intermediaries, as typified by
dealer cancellations and declining orders
• Large quantities of items
In many instances inventory levels can be reduced by one
or more of the following steps:
• Multi-echelon inventory planning. ABC analysis is an example of such
planning
• Lead time analysis
• Delivery-time analysis. This may lead to a change in carriers or
negotiation with existing carriers
• Elimination of low turnover and/or obsolete items
• Analysis of pack size and discount structure
In many instances inventory levels can be reduced by one
or more of the following steps: (con’t)
• Examination of returned goods procedures
• Encouragement/automation of product substitution
• Installation of formal reorder review systems
• Measurement of fill rates by stock-keeping unit (SKU)
• Analysis of customer demand characteristics
• Development of a formal sales plan and source demand by a predetermined logic.
Improving Inventory Management Techniques:
• ABC analysis
• Forecasting
• Enterprise Resource Planning (ERP) Systems
• Advanced Order processing systems
ABC analysis
Forecasting
• buyer intentions by mail questionnaires, telephone interviews, or
personal interviews
• Data to develop into a sales forecast
• Disadvantages
• Costly
• Accuracy
• Opinions of sales people or experts in the field (judgment
sampling)
• Disadvantage
• Personal biases of individuals
• Past sales data
• Forecasting for groupings of Stock-Keeping Units (SKUs) increases
forecast accuracy
Enterprise Resource Planning (ERP)
• Financial Modules: Financial Accounting (FI), Controlling (CO), Investment
Management (IM), Treasury (TR), Enterprise Control (EC).
• Logistics Modules: Material management (MM), Sales & distribution (SD),
Production, Planning & Control (PP), Product Data Management (PDM), Quality
Management (QM), Plant maintenance (PM), Service management(SM), Project
systems (PS)
• Human resource management Module: Personnel Management, Organizational
Management, Payroll Accounting, Time Management, Personnel Development,
Training & Event Management
• Cross Application Module: Workflow (WF), SAP Office.
Enterprise Resource Planning (ERP)
• Real-time
• Information-directed
• Video on ERP
Common Types of ERP
• SAP (German firm SAP AG)
• Oracle (America, California)
• Microsoft (America, Washington State)
Advanced Order Processing Systems
• Specialized order processing software package
• Linking members of the supply chain with timely and accurate
product usage information
• An order processing system captures order data from customer
service employees or from customers directly, stores the data in a
central database and sends order information to the accounting
and shipping departments, if applicable. Order processing systems
provide tracking data on orders and inventory for every step of the
way.