Ch7: Inventory Management
Strategic Stock
Additional inventory beyond cycle and safety stock used for a very specific purpose or future event for a defined period of time Also called anticipation stock, build stock, seasonal stock
Assumptions of Reactive (Pull) Inventory Logic
All customers, market areas, and products contribute equally to profits Infinite capacity exists at production facility Supply cycle time can be predicted and cycle lengths are independent Customer demand patterns are relatively stable and consistent Each distribution warehouse's timing and quantity of replenishment orders are determined independently of all other sites, including the supply source Supply cycle length cannot be correlated with demand
Replenishment Programs
Designed to streamline the flow of goods within the supply chain Intent is to reduce reliance on forecasting and position inventory using actual demand on a just in time basis
Planning Safety Stock
Determine likelihood of a stockout using a probability distribution- forecast accuracy/error Estimate the demand during a potential stockout period Establish the desired level of stockout protection- desired service level
Individual Item Purchase Price Discounts
Discounts for ordering larger quantities If volume discount is sufficient to offset the added cost from carrying additional inventory, then ordering larger volume is desirable
Time Buckets
Discrete increments of time used to facilitate planning activities
Total Cost
Driven by inventory planning decisions which establish when/how much to order = Purchase Cost + Ordering Cost + Holding Cost
Performance Cycle
Elapsed time between release of a purchase order by the buyer to the receipt of shipment
Carrying Costs
Expense associated with maintaining inventory
Inventory Carrying Cost
Expense associated with maintaining inventory = Actual inventory carrying cost % x Avg inventory value
Profile Replenishment
Extends quick response and vendor managed inventory by giving suppliers the right to anticipate future requirements according to their knowledge of a product category
MRP: Bill of Materials
GO OVER EXAMPLE IN POWERPOINT
Product/Market Classification
Groups products, markets, or customers with similar characteristics to facilitate inventory management Classify by sales, profit contribution, inventory value, usage rate, item category
Reasons a Company Decides to Carry Strategic Stock
Hedge currency fluctuations Take advantage of a price discount Protect against short term disruptive event in supply Take advantage of a business opportunity For life cycle changes- seasonal demand, new product launch, transition protection
External Inventory
Held external to company by downstream supply chain trading partners Pipeline inventory
Multiple item Purchase Price Discounts
If you purchase a combination of items from a supplier you may be able to take advantage of a volume discount based on the total volume discount
Transportation
Item being ordered and transported may require specialized or dedicated transportation, impacting the quantity per order
Inventory Policy
Key customers/stakeholders- manufacturers, wholesalers, distributors, retailers, consumers Level of service required- differs by customer, what's important to them? what value do they create? what risks do they take? Inventory positioning/ ABC classification- how do the inventory decisions you make impact service levels to your customers, "total costs" to serve?
Transportation Freight Rate Discounts
Ordering a larger quantity may mean that you can take advantage of these discounts which will lower the per unit costs
Common Measures of Service Level
Performance cycle Order fill Case fill rate Line fill rate
Supply Uncertainty
Performance cycle How long will it take to replenish inventory with our customers?
Supply Chain Network
Plant warehouse to western and eastern distribution centers to their specific west/east customers
Calculating Safety Stock
Probability theory enables the calculation of safety stock for a target service level Service level is equal to 100% minus probability % of stockout Most common probability distribution for demand is the normal distribution- bell curve
Pull- Make to Order
Producing stock in response to actual demand
Inventory Management Practices
Product/market classification Segmentation strategy Policies and parameters
Fair Share Allocation
Provides each distribution facility with an equitable distribution of available inventory Limited ability to manage multistage inventories
Economic Order Quantity
Quantitative decision model based on the trade off between the annual ordering costs and the annual inventory holding costs Sum of the annual ordering costs and the annual inventory holding costs is minimized Model makes many assumptions Used as a baseline for further modification before determining the actual quantity to order
Categories of Inventory
Raw materials Work in process (WIP) Finished goods Maintenance, repair, and operating supplies Individual items within these categories can be current or obsolete
Safety Stock with Combined Uncertainty
Requires combining 2 independent variables Joint impact of the probability of both demand and supply variation must be determined Direct method- combine standard deviations using a convolution formula
Safety Time
Safety lead time Ordering an item earlier than necessary based on lead time to ensure timely arrival
Lead Time
Time required to replenish the finished goods inventory Expressed in months- period of forecast interval Fully replenish inventory including all manufacturing, assembly, packaging, quality control Must also consider how long it will take to respond once a stock out occurs
Standard Mathematical Solution for EOQ
sqrt of √(2 x Order Cost x Annual Demand Volume)/ (Annual Carrying Cost % x Unit Cost) Don't need to memorize, need to know how to calculate
1.25 MAD
Approximation of the standard deviation of the forecast error Approximate up to 25% more than the Mead Absolute Deviation Anything beyond this is abnormal demand not covered by safety stock
Safety Stock
Buffer stock Inventory that is above/beyond what is actually needed to meet anticipated demand Quantity of stock planned to be n inventory to protect against fluctuations in demand/supply Make to stock companies maintain some safety stock
Inventory Management Models
Classified as independent demand and dependent demand
ABC System
Classifies inventory based on degree of importance Determine which inventories should be counted and managed more closely than others
Perpetual Review
Continuously monitors inventory levels to determine inventory replenishment needs
Inventory Deployment Planning Approaches
Coordinate inventory requirements across multiple locations in the supply chain Fair share allocation Requirements planning
Inventory Carrying Cost Components
Cost of capital Taxes on inventory held in warehouse Insurance- based on estimated risk or loss over time Obsolescence- deterioration of product during storage Storage- expense to holding product rather than product handling
K
Customer service level target (safety factor) Derived from the normal distribution using the desired product availability or customer service level target Sample values: 2.33 for 99%, 2.03 for 98%, 1.64 for 95%
Fair Share Allocation Formula
DS= AQ + Sum Inventory for each warehouse / sum of daily demand for each warehouse DS= common days supply for warehouse inventory AQ= inventory units to be allocated from plant warehouse
Inventory Control Using Reactive Approaches
Defines how often inventory levels are reviewed to determine when and how much to order Periodic review Perpetual review
Reorder Points
Defines when a replenishment order is initiated
Independent Demand
Demand for final product Has a demand pattern affected by trends, seasonal patterns, and general market conditions Forecasted demand Ex: pick up truck
Dependent Demand Replenishment
Dependent demand inventory requirements are a function of known events that are not random Does not require forecasting because there is no uncertainty No specific safety stock is needed to support time phased procurement programs No safety stock assumes procurement replenishment is predictable and constant and vendors/suppliers maintain adequate inventories to satisfy 100% of purchase requirements
Steps for ABC System
Determine annual usage or sales for each item Determine % of total usage or sales that each item represents Rank items from high to low % Classify items into groups- highest value, moderate value, least value
A Items
Given highest priority "80/20 rule" Account for 20% of the total number of items, but 80% of total inventory cost
Ordering Costs
Incurred each time an order is placed Order preparation costs, order transportation costs, order receipt
Practical Considerations of EOQ- Volume Economies of Scale
Individual item purchase price discounts Multiple item purchase price discounts Transportation freight rate discounts
Requirements Planning
Integrates across the supply chain taking into consideration unique requirements MRP- Materials requirements planning, driven by a production schedule DRP- Distribution requirements planning, driven by supply chain demand
Dependent Demand
Internal demand for parts based on demand of the final product in which parts are used Determined/calculated demand Order quantities computed with MRP- material requirements planning Relationship between independent and dependent demand shown in BOM- bill of materials Ex: sub assemblies, components, and raw materials Ex: pick up truck engine
Cycle Stock
Inventory a company builds to satisfy its immediate demand Depletes gradually as customer orders are received, replenished cyclically when supply orders are received Amount held is dependent on actual demand in immediate time period, supply replenishment lead time, and order quantities
Pipeline Inventory
Inventory in transportation network and distribution system Already out in market being held by wholesalers, distributors, retailers, and consumers Ownership of this has been transferred to trading partners, but may still influence decisions the company makes regarding how they manage and control their internal inventory and how much safety/strategic stock to hold You no longer own it, owned by someone else
Inventory Inputs
Inventory policy Service levels Demand Performance cycle lead time
Demand Uncertainty
Involves variation in sales during the lead time necessary to replenish inventory
Practical Considerations of EOQ- Constraints
Limited capital Storage capacity Transportation Obsolescence Production lot size Unitization
Safety Stock Policy
Long production lead time necessitates de-coupling Provides maximum flexibility by centrally locating safety stock Influenced by batch/lot/campaign size Remember- long term stability in bulk storage? expiry concerns? Able to have rapid response to increases in customer demand, maintain closest to end customer
Fill Rate
Magnitude of a backorder or stockout Case by case fill rate, line fill rate, etc
Inventory Control
Managerial procedure for implementing an inventory policy
Maintenance Repair and Operating Supplies
Materials you need to run manufacturing operation and business. but does not end up as part of finished product Consumed during process of converting raw material to finished goods (oil for equipment) Used to facilitate operation (cleaning supplies) Facilitate company's administrative activities- office supplies
MAD
Mean Absolute Deviation Of monthly demand Absolute forecast error expressed as a unit quantity Measurement of the size of the average absolute forecast error over a given period of time Normally calculated based on past 12 months actual sales vs lead time offset forecast for those months
Limited Captial
Model may generate an order quantity which the company does not have sufficient available funds to purchase at one time
Storage Capacity
Model may generate an order quantity which the company does not have sufficient storage capacity to handle at the time
Obsolescence in EOQ
Model may generate an order quantity which would create spoilage or obsolescence
Assumptions of EOQ
Model must be calculated for one product at a time Demand must be known and constant throughout the year Delivery replenishment lead time is known and doesn't fluctuate Replenishment is instantaneous Purchase price is constant and no discounts or price breaks are factored into model Carrying costs and order cost are known and constant Stockouts not allowed
Vendor Managed Inventory
Modified quick response program that eliminates the need for replenishment orders Transfers the responsibility for managing the inventory located at a customer's facility back to the vendor/manufacturer of that inventory
Periodic Review
Monitors inventory status of an item at regular intervals, weekly/monthly
Policies and Parameters
Must be defined at a detailed level Data requirements, software applications, performance objectives, and decision guidelines
DC
Number of distribution centers at which safety stock is maintained
B and C Items
Other 80% of the total number of items, but only 20% of the total inventory cost B- require closer management since they re relatively more expensive per unit, require more effort to purchase/make, and ma be more prone to obsolescence C- have lowest value and lowest priority
Case Fill Rate
Percent of cases ordered that are shipped as requested
Order Fill
Percent of customer orders filled completely as requested
Line Fill Rate
Percent of order lines (items) that were filled completely as requested
Supply
Performance cycle Uncertainty involves variation in the time and/or quantity necessary to replenish inventory
Service Level
Performance target specified by management and defines inventory performance objectives Higher the service level target, higher the amount of inventory you will need to assure the target is achieved
Push- Make to Stock
Producing stock on the basis of anticipated demand Basis of forecasted demand and product availability
Collaborative Inventory Replenishment Programs
Quick response Vendor managed inventory Profile replenishment
Perpetual Review Formula
ROP= D * T + SS ROP= reorder point in units D= avg daily demand in units T= avg performance cycle length in days SS= safety/buffer stock in units
Periodic Review Formula
ROP= D(T + P/2) + SS ROP= reorder point D= avg daily demand T= avg performance cycle length P= review period in days SS= safety stock
Segmentation Strategy
Specifies all aspects of inventory management process for each segment of inventory Service objectives, forecasting method, management technique, and review cycle
Responsibilities of a Vendor in VMI
Stock inventory Place replenishment orders Arrange display Typically owns inventory until purchased Required to work closely with customer
Obsolete Inventory
Stock that is expired, out of date, or no longer needed Met obsolescence criteria established by company Will never be used or sold at full value Writing if off may reduce company's profit Takes up space and costs money to maintain, better to write it off Cost associated with actual disposal May donate it to non-profits if any value remains- avoids disposal costs
Unitization
Supplier may require the company to order an item in full pack, case, or pallet configurations
Production Lot Size
Supplier may require the company to order an item in full production lot sizes
Quick Response
Technology driven cooperative effort between retailers and suppliers to improve inventory velocity while matching supply to consumer buying patterns
Functions of Inventory: Why hold inventory?
To meet customer demands- cycle stock To buffer against uncertainty in demand/supply- safety stock To decouple supply from demand- strategic stock To decouple dependencies in the supply chain
Safety Stock to Plan for Uncertainty
Trying to account for 2 types of uncertainty with safety stock Demand uncertainty Supply uncertainty Variations must be considered in both areas to make effective inventory planning decisions
Common Metrics for Inventory
Units- number of units available Dollars- amount of dollars tied up in inventory Weeks of supply- avg on hand Inventory / avg wekly usage Inventory turns- COGS/avg inventory value Inventory carrying cost
Review Period
Used in periodic review calculation of ROP that is not used in perpetual review
Hybrid
Uses a combination of push and pull Facilitated by manufacturing postponement strategy
Demand Uncertainty- Safety Stock
When and how much product will our customers order? Add safety stock to base inventory to protect against a potential stockout when demand uncertainty exists Ex: demand exceeds forecast
Formula for Calculating Safety Stock
k * [ sqrt√(lead time * dc) ] * (1.25 * MAD)
Safety Stock in Dependent Demand Situations
3 approaches to introduce safety stock into dependent demand situations if necessary
Inventory Stock Levels
3 levels of internal inventory Strategic stock Safety Stock Cycle stock Also: obsolete inventory
Introducing Safety Stock in Dependent Demand Situations Approaches
1. Put a safety time into requirements plan- order a component earlier than needed to ensure timely arrival 2. Increase replenishment order by a quantity specified by some estimate of expected plan error- over planning 3. Utilize statistical techniques to set safety stocks directly for a component rather than to the item of top level demand