Chapter 11 Managing Inventory

bullwhip effect

"an extreme change in the supply position upstream in a supply chain generated by a small change in demand downstream in the supply chain." may actually increase overall supply chain costs

inventory

"those stocks or items used to support production (raw materials and work-in-process items), supporting activities (maintenance, repair, and operating supplies) and customer service (finished goods and spare parts)."

Three basic approaches are used to manage independent demand inventory items

1. periodic review systems 2. continuous review systems 3. single-period inventory systems

Inventory ties up space and capital

A dollar invested in inventory is a dollar that cannot be used somewhere else. Likewise, the space used to store inventory can often be put to more productive use. Inventory also poses a significant risk of obsolescence, particularly in supply chains with short product life cycles. Consider what happens when Samsung announces its next generation of cell phones. Would you want to be stuck holding the old-generation cell phones when the new ones hit the market?

Restocking Levels

In general, R should be high enough to meet all but the most extreme demand levels during the reorder period (RP) and the time it takes for the order to come in (L).

supply uncertainty

In managing inventory, organizations face uncertainty throughout the supply chain. On the upstream (supplier) end, they face supply uncertainty, or the risk of interruptions in the flow of components they need for their internal operations. In assessing supply uncertainty, managers need to answer questions such as these: How consistent is the quality of the goods being purchased? How reliable are the supplier's delivery estimates? Are the goods subject to unexpected price increases or shortages? Problems in any of these areas can drive up supply uncertainty, forcing an organization to hold safety stock or hedging inventories.

Another common inventory driver is the mismatch between demand and the most efficient production or shipment volumes.

Let's start with a simple example—facial tissue. When you blow your nose, how many tissues do you use? Most people would say 1, yet tissues typically come in boxes of 200 or more. Clearly, a mismatch exists between the number of tissues you need at any one time and the number you need to purchase. The reason, of course, is that packaging, shipping, and selling facial tissues one at a time would be highly inefficient, especially because the cost of holding a cycle stock of facial tissues is trivial. On an organizational scale, mismatches between demand and efficient production or shipment volumes are the main drivers of cycle stocks.

Inventory Positioning

Managers must decide where in the supply chain to hold inventory. In general, the decision about where to position inventory is based on two general truths: 1. The cost and value of inventory increase as materials move down the supply chain. 2. The flexibility of inventory decreases as materials move down the supply chain. That is, as materials work their way through the supply chain, they are transformed, packaged, and moved closer to their final destination. All these activities add both cost and value. Take breakfast cereal, for example. By the time it reaches the stores, cereal has gone through such a significant transformation and repackaging that it appears to have little in common with the basic materials that went into it. But the value added goes beyond transformation and packaging; it includes location as well. A product that is in stock and available immediately is always worth more to the customer than the same product available later. What keeps organizations from pushing inventory as far down the supply chain as possible? Cost, for one thing. By delaying the transformation and movement of materials, organizations can postpone the related costs. Another reason for holding inventory back in the supply chain is flexibility. Once materials have been transformed, packaged, and transported down the chain, reversing the process becomes very difficult, if not impossible. Wheat that has been used to make a breakfast cereal cannot be changed into flour that is suitable for making a cake. Likewise, repackaging shampoo into a different-sized container is impractical once it has been bottled. The same goes for transportation: Repositioning goods from one location to another can be quite expensive, especially compared to the cost of delaying their movement until demand has become more certain. This loss of flexibility is a major reason materials are often held back in the supply chain. In short, supply chain managers are constantly trying to strike a balance between costs on the one hand and flexibility on the other in deciding where to position inventory.

How can businesses reduce the need to hold anticipation inventory?

Often they do so both by shrinking their own lead time and by persuading customers to wait longer. It's hard to believe now, but personal computers once took many weeks to work their way through the supply chain. As a result, manufacturers were forced to hold anticipation inventories to meet customer demand. Today manufacturers assemble and ship a customized laptop or tablet directly to the customer's front door in just a few days. Customers get fast and convenient delivery of a product that meets their exact needs. At the same time, the manufacturer can greatly reduce or even eliminate anticipation inventory.

demand uncertainty

On the downstream (customer) side, organizations face demand uncertainty, or the risk of significant and unpredictable fluctuations in the demand for their products. For example, many suppliers of automobile components complain that the big automobile manufacturers' forecasts are unreliable and that order sizes are always changing, often at the last minute. Under such conditions, suppliers are forced to hold extra safety stock to meet unexpected jumps in demand or changes in order size.

periodic review system

One of the simplest approaches to managing independent demand inventory is based on a periodic review of inventory levels. In a periodic review system, a company checks the inventory level of an item at regular intervals and restocks to some predetermined level, R. As you might imagine, a periodic review system is best suited to items for which periodic restocking is economical and the cost of a high restocking level (and hence a large safety stock) is not prohibitive. A classic example is a snack food display at a grocery store. Constantly monitoring inventory levels for low-value items such as pretzels or potato chips makes no economic sense. Rather, a vendor will stop by a store regularly and top off the supply of all the items, usually with more than enough to meet demand until the next replenishment date. While the periodic review system is straightforward, it is not well suited to managing critical and/or expensive inventory items.

there is a trade-off between yearly holding costs and ordering costs

Reducing the order quantity, Q, will decrease holding costs, but force the organization to order more often. Conversely, increasing Q will reduce the number of times an order must be placed but result in higher average inventory levels.

In general, the decision of how much safety stock to hold depends on five factors:

The variability of demand The variability of lead time The average length of lead time The desired service level The average demand Let's talk about each of these factors. First, the more the demand level and the lead time vary, the more likely it is that inventory will run out. Therefore, higher variability in demand and lead time will tend to force a company to hold more safety stock. Furthermore, a longer average lead time exposes a firm to this variability for a longer period. When lead times are extremely short, as they are in just-in-time (JIT) environments (see Chapter 13), safety stocks can be very small. The service level is a managerial decision. Service levels are usually expressed in statistical terms, such as "During the reorder period, we should have stock available 90% of the time." While the idea that management might agree to accept even a small percentage of stockouts may seem strange, in reality, whenever demand or lead time varies, the possibility exists that a firm will run out of an item, no matter how large the safety stock. The higher the desired service level, the less willing management is to tolerate a stockout, and the more safety stock is needed.

mismatch between the timing of the customer's demand and the supply chain's lead time

When you go to the grocery store, you expect to find fresh produce ready to buy; your expected waiting time is zero. But produce can come from almost anywhere in the world, depending on the season. To make sure that bananas and lettuce will be ready and waiting for you at your local store, someone has to initiate their movement through the supply chain days or even weeks ahead of time and determine how much anticipation inventory to hold. Whenever the customer's maximum waiting time is shorter than the supply chain's lead time, companies must have transportation and anticipation inventories to ensure that the product will be available when the customer wants it.

Scholastic, the book​ publisher, has their​ suppliers, book​ printers, manufacture millions of Harry Potter books ahead of time so customers can have instant availability on the launch date. This type of inventory is

anticipation

​"An extreme change in the supply position upstream in a supply chain generated by a small change in demand downstream in the supply​ chain" is the definition of

bullwhip effect

inventory drivers

business conditions that force companies to hold inventory see figure 11.2 on pptx

mismatches between overall demand levels and production capacity

can force companies to hold smoothing inventories

A company makes​ tools, such as hammer and tape measures. One of their primary raw materials is steel and if they run out of steel they cannot make tools. The inventory level for steel is constantly monitored and when the reorder point is​ reached, an order is released for the economic order quantity. The tool company uses which of the following independent demand inventory systems for​ steel?

continuous review system

A computer manufacturer receives​ 20,000 computer mice in bulk from an upstream​ supplier, gradually uses them up over​ time, then receives another bulk shipment of​ 20,000 computer mice. This type of inventory is

cycle stock

The type of demand which is tied to the production of another item​ (table legs are an​ example) is

dependent

A company which produces​ electricity, like Progress​ Energy, is considering buying extra coal to hold in inventory. They want to buffer against a potential strike at a major coal producer which would likely result in a significant price increase. This type of inventory is

hedging

The type of demand which comes from outside the​ organization, is​ unpredictable, and usually forecasted is

independent

service level

indicates what percentage of the time inventory levels will be high enough to meet demand during the reorder period. For example, setting would make R large enough to meet expected demand 90% of the time (i.e., provide a 90% service level), while setting would provide a 99% service level.

​"Any idle resource held for future use - those stocks or items used to support production​ (raw materials), supporting activities​ (drill bits) and customer service​ (finished goods, spare​ parts)" is the definition of

inventory

"Inventory is the root of all evil."

inventory is both a valuable resource and a potential source of waste.

The cost and value of inventory increase as materials move down the supply chain. One way operations and supply chain managers counteract the negative aspect of this fact is by

inventory pooling

​_______________ is holding a safety stock in a single location instead of multiple locations. Several locations then share these inventories to lower overall holding costs.

inventory pooling

Hedge inventory

is "a form of inventory buildup to buffer against some event that may not happen. Hedge inventory planning involves speculation related to potential labor strikes, price increases, unsettled governments, and events that could severely impair the company's strategic initiatives." In this sense, hedge inventories can be thought of as a special form of safety stock. WolfByte has stockpiled a hedge inventory of two months' worth of hard drives because managers have heard that Supplier 2 may experience a temporary shutdown over the next two months.

Safety stock

is extra inventory that companies hold to protect themselves against uncertainties in either demand levels or replenishment time. Companies do not plan on using their safety stock any more than you plan on using a fire extinguisher; it is there just in case. Figure 11.4 (pg.335)

Anticipation inventory

is inventory that is held in anticipation of customer demand. Anticipation inventory allows instant availability of items when customers want them.

single-period inventory system

is to establish a stocking level that strikes the best balance between expected shortage costs and expected excess costs. Developing a single-period system for an item is a two-step process: Determine a target service level (SLT) that strikes the best balance between shortage costs and excess costs. Use the target service level to determine the target stocking point (TS) for the item.

smoothing inventory

is used to smooth out differences between upstream production levels and downstream demand. Suppose management has determined that WolfByte's assembly plant is most productive when it produces 3,000 laptops a day. Unfortunately, demand from retailers and customers will almost certainly vary from day to day. As a result, WolfByte's managers may decide to produce a constant 3,000 laptops per day, building up finished goods inventory during periods of slow demand and drawing it down during periods of high demand. (Figure 11.5 illustrates this approach, pg.336.) Smoothing inventories allow individual links in the supply chain to stabilize their production at the most efficient level and to avoid the costs and headaches associated with constantly changing workforce levels and/or production rates. If you think you may have heard of this idea before, you have: It's part of the rationale for following a level production strategy in developing a sales and operations plan.

The owner of a vending machine company has weekly stops to check the soda machine at NC State. She checks the inventory levels and fills the machine back up to its full restocking level. She is using which of the following types of independent demand inventory​ systems?

periodic review system

Cycle stock

refers to components or products that are received in bulk by a downstream partner, gradually used up, and then replenished again in bulk by the upstream partner. For example, suppose Supplier 3 ships 20,000 keyboards at a time to WolfByte. Of course, WolfByte can't use all those components at once. More likely, workers pull them out of inventory as needed. Eventually, the inventory runs down, and WolfByte places another order for keyboards. When the new order arrives, the inventory level rises and the cycle is repeated. Figure 11.3 (pg. 334) shows the classic sawtooth pattern associated with cycle stock inventories. Cycle stock is often thought of as active inventory because companies are constantly using it up, and their suppliers constantly replenishing it.

independent demand inventory

refers to inventory items whose demand levels are beyond a company's complete control A simple example of an independent demand inventory item is a kitchen table. While a furniture manufacturer may use forecasting models to predict the demand for kitchen tables and may try to use pricing and promotions to manipulate demand, the exact demand for kitchen tables is unpredictable. The fact is that customers determine the demand for these items, so finished tables clearly fit the definition of independent demand inventory.

Dependent demand inventory

refers to inventory items whose demand levels are tied directly to the company's planned production of another item. Because the required quantities and timing of dependent demand inventory items can be predicted with great accuracy, they are under a company's complete control. Ex. The components that are used to make the tables, such as legs? Suppose that a manufacturer has decided to produce 500 tables five weeks from now. With this information, a manager can quickly calculate exactly how many legs will be needed: 500 tables x 4 legs per table = 2000 legs Furthermore, the manager can determine exactly when the legs will be needed, based on the company's production schedule. Because the timing and quantity of the demand for table legs are completely predictable and under the manager's total control, the legs fit the definition of dependent demand items. Dependent demand items require an entirely different approach to managing than do independent demand items.

Transportation inventory

represents inventory that is "in the pipeline," moving from one link in the supply chain to another. When the physical distance between supply chain partners is long, transportation inventory can represent a considerable investment.

The bullwhip effect says that

the farther upstream the supply​ chain, the greater the impact of a small disturbance downstream.

continuous review system

the inventory level for an item is constantly monitored, and when the reorder point is reached, an order is released. A continuous review system has several key features: 1. Inventory levels are monitored constantly, and a replenishment order is issued only when a preestablished reorder point has been reached. 2. The size of a replenishment order is typically based on the trade-off between holding costs and ordering costs. 3. The reorder point is based on both demand and supply considerations, as well as on how much safety stock managers want to hold.

Economic Order Quantity (EOQ)

the particular order quantity (Q) that minimizes holding costs and ordering costs for an item. This special order quantity is found by setting yearly holding costs equal to yearly ordering costs and solving for Q

inventory velocity

the speed at which goods move through a supply chain

A company which sources raw materials and components from overseas will hold extra inventory of these items due to a mismatch between the timing of customer demand and supply chain lead times. This type of inventory is

transportation