Chapter 7: Inventory Management

Formula #1 - Calculating Safety Stock

(Max. Daily Usage X Max. LT in Days) - (Avg. Daily Usage X Avg. LT in Days) 1. Multiply maximum daily usage by maximum replenishment lead time in days. 2. Multiply average daily usage by average replenishment lead time in days. 3. The difference between the two is the calculated Safety Stock. *Divide by Average Daily Usage = # of Days of Safety Stock Coverage

Inventory

*A key decision in any product-based supply chain is how much inventory to keep on hand. ▪ Inventory is usually one of the company's largest assets, so careful management of that asset is an essential business requirement. ▪ Maintaining adequate finished product inventory allows a company to fill customer orders immediately ▪ Maintaining adequate materials inventory allows a company to support manufacturing operations and the production plan while avoiding delays. ▪ Failing to manage inventory adequately can lead to significant issues and inefficiencies throughout the supply chain, including dissatisfied customers, lost sales and revenue, and higher costs

Segmentation Strategy: ABC Classification

*Classifies inventory based the degree of importance: Steps: 1. Determine annual usage or sales for each item 2. Determine % of the total that each item represents 3. Rank items from highest to lowest % 4. Classify items into groups: A: Highest Value B: Moderate Value C: Least Valuable

Product Classification by Sales

- Product identification - Annual Sales (in 000s) - Percent Total Sales - Accumulated Sales (%) - Products (%) - Classification Category

Benefits of a Segmentation Strategy such as ABC pt. 1

1. End of Life Management: With the ABC analysis, inventory planners can forecast the declining demand and manage the stock levels accordingly; reducing inventory levels to minimize carrying costs and avoid obsolescence. 2. Supplier Negotiation: The company can prioritize and focus on negotiating with suppliers of the class A category items since they represent 70% - 80% of the money spent. The negotiation needs to be win-win. The supplier needs to make a reasonable profit from the deal while helping the company get the desired quality product and services at the lowest price. 3. Inventory Optimization: ABC analysis allows inventory planners to organize high priority items aligned to customer requirements. Inventory levels can be set to satisfy to high demand items while also carrying low stock for undesirable items.

3 Ways to Calculate Safety Stock #1

1. Fixed safety stock quantity Companies can set a fixed level of safety stock for their goods. ▪ This number may be based on the judgment of the operations manager or on assumed stock level calculations. ▪ It's often set on an aggregated level and not on the individual item. ▪ This method may lead to high inventory costs or stock-outs since demand is not always constant or similar for all the items in the group for which the aggregation is done. Example: 100 units of safety stock for A Products 500 units of safety stock for B Products 800 units of safety stock for C Products

Functions of Inventory - Why hold inventory?

1. To Meet Customer Demand (cycle stock): ▪ Immediately fill customer orders ▪ Deploy the product/material near where it will be used 2. To Buffer Against Uncertainty in Demand and/or Supply (safety stock): ▪ Uncertainty in demand: sales or usage above expectations ▪ Uncertainty in supply: shortages, delays, disruptions *OR BOTH 3. To Decouple Supply from Demand (strategic stock): ▪ Supply pattern is different from demand pattern: - Achieve economies of scale in purchasing; take advantage of volume price breaks/discounts - Speculative buying in anticipation of a price increase - Economical order size, lot size, production output - Seasonal products/demand *Decouple = Separate 4. To Decouple Dependencies in the Supply Chain (strategic stock): ▪ Separating operations in a process ▪ Smoothing production and reducing peak period capacity needs

3 Ways to Calculate Safety Stock #2

2. Time-based calculation Time-based safety stock level is used to calculate the stock required over a fixed period. ▪ In addition to the cycle stock, usually a percentage or a week's average sales is added. ▪ This method also has a drawback, particularly when items are slow moving, as there is no connection to lead-time. ▪ It can result in a large amount of unnecessary capital tied up in safety stock, which becomes excess stock sitting in warehouses. Example: 2 weeks of safety stock for A Products 4 weeks of safety stock for B Products 8 weeks of safety stock for C Products

3 Ways to Calculate Safety Stock #3

3. Statistical calculation The mathematical approach, which uses mathematical theories of probability, imposes order and regularity on aggregates of more or less distinct elements. ▪ Different statistical calculations are presented in literature and they will provide better results than the fixed and time-based safety stock calculations. ▪ Keep in mind that different mathematical methods are more or less difficult to implement, both manually and in your software solution. Examples (shown on the next few slides): Formula #1 (Max. Daily Usage * Max. LT in Days) - (Avg. Daily Usage * Avg. LT in Days) Formula #2 k * Sqrt (lead time * dc) * (1.25 * MAD)

Benefits of a Segmentation Strategy such as ABC pt. 2

4. Strategic Pricing: ABC analysis helps in setting the prices strategically for products which bring more value to the company. Prices for highly desirable products can be increased which will have a significant impact on profits. 5. Resource Allocation: Resource allocation is a continuous process requiring periodic tracking of class A items. If a class A item is no longer desired by the customers or has lower demand, the item can to be moved to a lower classification. 6. Customer Service Levels: ABC analysis allows planners to set customer service levels based on the product classification, which improves the overall supply chain performance by carrying less safety stock. The customer service level is set by product and depends on multiple factors such as the item cost, demand, and margin.

ABC Classification

A Items: ▪ Very tight control ▪ Complete and accurate records ▪ Frequent review via EOQ model. B Items: ▪ Less tightly controlled ▪ Good records ▪ Regular review C Items: ▪ Simplest controls possible ▪ Minimal records ▪ Large inventories ▪ Periodic review and reorder

Segmentation Strategy: ABC Classification (continued) This allows different inventory management techniques to be applied to different segments of the inventory in order to increase revenue and decrease costs.

A items are given the highest priority. "80/20 rule" Generally, A items account for approximately 20% of the total number of items, but about 80% of the total inventory cost. B & C items account for the other 80% of the total number of items, but only 20% of the total inventory cost. - B items require closer management since they are relatively more expensive (per unit), require more effort to purchase/make, & may be more prone to obsolescence. - C items have the lowest value, and hence the lowest priority

Other Inventory Management Programs Safety Stock Policy

Active Ingredients, Safety Stock: ✓ Long production lead time necessitates de-coupling ✓ Provides maximum flexibility by centrally locating safety stock ✓ Influenced by batch/lot/campaign size Dosage Forms: × Long term stability in bulk storage × Expiry concerns Finished Goods, Stafety Stock (Geographically Dispersed): ✓ Rapid response to increases in customer demand ✓ Maintained closest to end customer *Safety Stock to cover for variability in both Demand and Supply

Strategic Stock

Additional inventory beyond cycle and safety stock, generally used for a very specific purpose or future event, and for a defined period of time. A company may decide to carry strategic stock to: ▪ hedge currency fluctuations ▪ take advantage of a price discount ▪ protect against a short-term disruptive event in supply ▪ take advantage of a business opportunity ▪ for life cycle changes: seasonal demand, new product launch, transition protection Also called anticipation stock, build stock, or seasonal stock

Safety Stock: Decoupling Dependencies in the Supply Chain

Cumulative Lead Time WITHOUT Safety Stock = 15 months Cumulative Lead Time WITH Safety Stock to Decouple AI and FG Lead Times = 2 months

Fair Share Allocation

DS = Common days supply for warehouse inventories AQ = Inventory units to be allocated from plant warehouse = 500 Ij = Inventory in units for warehouse J Dj = Daily demand for warehouse J DS = AQ + Sum inventory for each warehouse / Sum of daily demand for each warehouse Formula for amount allocated = (DS * D) - I

Safety Stock to Plan for Uncertainty

Demand Uncertainty — when and how much product will our customers order? Supply Uncertainty — how long will it take to replenish inventory with our customers? ▪ Variations must be considered in each area to make effective inventory planning decisions Planning for both demand and supply uncertainty requires combining two independent variables as the joint impact of the probability of both demand and supply variations must be determined. ▪ The method for determining this is to combine standard deviations using a convolution formula. ▪ The calculations for the convolution formula are beyond the scope of this course but you should understand that there is a method for addressing this situation.

Dependent Demand Items

Dependent demand inventory requirements are a function of known events that are not random ▪ Dependent demand does not require forecasting because there is no uncertainty ▪ Generally, no specific safety stock is needed to support time-phased procurement programs (e.g., MRP) No safety stock assumes: - Procurement replenishment is predictable and constant - Vendors and suppliers maintain adequate inventories to satisfy 100% of purchase requirements ▪ However, these assumptions do not always hold true . . .

Distribution Requirements Planning (DRP) Manufacturing Plant Warehouse >> 1. Western Distribution Center- Western Customers 2. Eastern Distribution Center- Eastern Customers

Distribution Requirements Planning (DRP) A time-phased finished good inventory replenishment plan in a distribution network. The function of determining the need to replenish inventory at branch warehouses. ▪ DRP is a logical extension of the MRP system and ties physical distribution to the manufacturing planning and control system

Calculating EOQ

EOQ = Sqrt [(2 * Order Cost * Annual Demand Volume) / (Annual Carrying Cost % * Unit Cost)] * % is expressed as a decimal Proof: Annual Order Cost = (Annual Demand Volume / EOQ * Order Cost) Annual Carrying Cost = [EOQ/2 * (Unit Value @ Cost aka Purchase Price * Annual Inventory Carrying Cost)]

What is Finished Goods Inventory Deployment?

Finished Goods Inventory Deployment is determining where to stock each item and evaluating alternative deployment and fulfillment strategies from a total network, logistics, and cost to serve perspective. ▪ Must factor in transportation, distribution, and inventory dynamics in a single holistic approach. ▪ Model and evaluate slow-mover stocking consolidation, postponement and delayed differentiation, hub and spoke fulfillment, and other advanced stocking strategies. ▪ Quantify the business benefits of adoption before you make operational changes.

Inventory Management Flow Chart

Finished Goods: - Master Production Schedule - Production Requirements - Manufacturing Strategy, Process, Facility Layout - Finished Goods (FG) Inventory Receipt - FG Inventory Deployment Materials & Components: - Material Requirements Plan - Purchase Requirements - Procurement Strategy - Material Delivery & Inventory Receipt - Material Inventory Allocation

Inventory Management Practices - Product Classification - Segmentation Strategy - Policies and Parameters

I. Product/Market Classification groups products, markets, or customers with similar characteristics together to facilitate inventory management - e.g., classify by sales, profit contribution, inventory value, usage rate or item category. ABC Classification System II. Segmentation Strategy specifies all aspects of inventory management for each segment of inventory - e.g., service objectives, forecasting method, management technique, and review cycle by segment III. Policies and Parameters defined at the detail level - e.g., data requirements, software applications, performance objectives, and decision guidelines

Inventory Management Policy VED Analysis: V- Vital E- Essential D- Desirable

In addition to an ABC segmentation, companies using Lean Inventory Management to further control inventory may also opt to implement a VED Analysis which attempts to classify the items used into three broad categories based on their criticality for the company. Vital: Those items without which the production activities or any other activity of the company, would come to a halt, or at least be drastically affected Essential: Those items whose stock-out cost is very high for the company Desirable: Those items whose stock-out or shortage causes only a minor disruption for a short duration in the production schedule. The cost incurred is very nominal

Requirement Planning - Integrated MRP/DRP System

Integrated planning approach for raw materials, work-in-process, and finished goods MRP System: Dependent Demand Driven DRP System: Independent Demand Driven

Inventory Carrying Cost Components

Inventory Carrying Cost is the expense associated with maintaining inventory Cost Components: ▪ Cost of capital - specified by senior management ▪ Taxes - on inventory held in warehouses ▪ Insurance - based on estimated risk or loss over time and facility characteristics ▪ Obsolescence - deterioration of product during storage, and shelf-life - e.g., food and pharmaceutical sell-by dates ▪ Storage - facility expense related to product holding rather than product handling *Typically expressed as a percentage of inventory value

Pipeline Inventory

Inventory in the transportation network and the distribution system. Inventory that is already out in the market being held by wholesalers, distributors, retailers, and even consumers. The ownership of this inventory has been transferred to the trading partners, but may still influence decisions the company makes regarding how they manage and control their internal inventory, and how much safety stock and/or strategic stock to hold.

Obsolete Inventory

Inventory items that have met the obsolescence criteria established by the company. Obsolete inventory is stock that is expired, damaged, or no longer needed. Obsolete inventory will never be used or sold at full value. ▪ Writing obsolete inventory off of the books and disposing of it may be a difficult decision to make as all or part of the obsolete product's value may be lost and it may reduce a company's profit. ▪ Unusable inventory takes up space and costs money to maintain, so it may be better to absorb the loss as soon as an item has met the obsolescence criteria rather than delay and continue to lose money on storage and related fees. ▪ There may be a cost associated with the actual disposal of the inventory. ▪ Some companies may donate this inventory to a non-profit organization if it has any remaining value, which not only helps the non-profit but also avoids disposal costs and may result in a tax benefit for the company.

Cycle Stock

Inventory that a company builds to satisfy its immediate demand. Cycle stock depletes gradually as customer orders are received, and is replenished cyclically when supply orders are received. The amount of cycle stock that a company holds is dependent on actual demand in the immediate time period, supply replenishment lead time, and order quantities.

Constraints on the Practical use of EOQ

Limited Capital: The model may generate an order quantity which the company does not have sufficient available funds to purchase at one time. Storage Capacity: The model may generate an order quantity which the company does not have sufficient storage capacity to handle at one time. Transportation: The item being ordered and transported may require specialized or dedicated transportation, impacting the quantity per order. Obsolescence: The model may generate an order quantity which would create spoilage or obsolescence. Production Lot Size: The supplier may require the company to order an item in full production lot sizes. Unitization: The supplier may require the company to order an item in full pack, case, or pallet configurations.

Managing Finished Goods Inventory Deployment

Managing inventory deployment might be as important as determining the inventory levels. ▪ Positioning of products is important for minimizing the number of moves and the amount of time spent loading transportation vehicles. ▪ Becomes even more important when customers are only accepting delivery within a specific time window. ▪ Traditionally customer orders use to be fulfilled completely from a single location, now customer orders can be split and fulfilled from different locations creating additional complexity. ▪ An inefficient pairing of items and locations might result in a waste of money and resources.

Inventory Ordering Cost Components Purchase Cost + Ordering Cost + Holding Cost = Total Cost

Ordering Costs - are incurred each time an order is placed ▪ Order preparation costs ▪ Order transportation costs ▪ Order receipt processing costs ▪ Material handling costs Total cost is driven by inventory planning decisions which establish when and how much to order

Safety Stock for Independent Demand Uncertainty Add safety stock to base inventory to protect against a potential stockout when demand uncertainty exists, i.e., demand exceeds forecast Safety stock determinations are not intended to eliminate all stockouts — just the majority of them.

Planning safety stock requires three steps: 1. Determine the likelihood of a stockout using a probability distribution, i.e., forecast accuracy/error 2. Estimate the demand during a potential stockout period 3. Establish the desired level of stockout protection, i.e., the desired service level

Collaborative Inventory Replenishment Programs

Replenishment Programs are 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 1. Quick Response (QR) is a technology-driven cooperative effort between retailers and suppliers to improve inventory velocity while matching supply to consumer buying patterns. ✓ The intention is to shorten lead times from order receipt to delivery and minimize unsold inventory by holding minimum inventory levels. 2. Vendor Managed Inventory (VMI) is a modified QR that eliminates the need for replenishment orders 3. Profile Replenishment (PR) extends QR and VMI by giving suppliers the right to anticipate future requirements according to their knowledge of a product category (JIT II)

Review Frequency & Reorder Point Formulas ROP = Demand during lead time + safety stock Reorder Point: Defines when a replenishment order is initiated. Methods: 1. Periodic Review 2. Perpetual Review Both methods compare the item's on-hand and on-order inventory to the Reorder Point. If the total is ≤ Reorder Point, then a replenishment order is initiated

Review Frequency: Defines how often inventory levels are reviewed Periodic Review: monitor inventory status of an item at regular intervals such as weekly or monthly ROP = (D X (T + P/2)) + SS where: ROP = Reorder Point D = Average Daily Demand T = Average Lead Time in Days P = Review Period in Days SS = Safety Stock Perpetual Review: monitor inventory status of an item continuously ROP = (D X T) + SS where: ROP = Reorder Point D = Average Daily Demand T = Average Lead Time in Days SS = Safety Stock

What does safety stock cover? No Safety Stock Needed: 95% probability of no stock out

Safety Stock covers for actual demand exceeding forecasted demand but only up to a point EXAMPLE: With a customer service target of 95% availability, the company must be willing to accept a 5% probability of a stock out

Safety Stock

Safety stock, also known as "buffer stock," is inventory that is above and beyond what is actually needed to meet anticipated demand. A quantity of stock planned to be in inventory to protect against fluctuations in demand or supply. Companies operating in a make-to-stock environment will generally maintain some amount of safety stock whether based on a management decision, or based on a safety stock determination formula.

Service Level - Probability that demand will not exceed supply during lead time

Service Level is a performance target specified by management and defines inventory performance objectives ▪ Generally, the higher the service level target, the higher the amount of inventory you will need to assure the target is achieved. - e.g., 90% of orders filled complete within 3 business days - e.g., 99.5% of line items filled within 24 hours of order date Common measures of service level include: ▪ Performance Cycle (i.e., lead time) - the elapsed time between release of a purchase order by the buyer to the receipt of shipment ▪ Order Fill - the percent of customer orders filled completely as requested ▪ Case Fill Rate - the percent of cases ordered that are shipped as requested ▪ Line Fill Rate - the percent of order lines (items) that were filled completely as requested

Single-Stage versus Multi-Echelon Optimization

Single-Stage Optimization: - Warehouses optimized seperately Multi-Echelon: - All warehouses in network optimized simultaneously

Inventory Carrying Cost Policy

The carrying cost percent used by a firm is a managerial policy. It is typically around 24% (i.e., ≈2% per month) ▪ Inventory carrying cost is an imputed cost. It doesn't appear in the financial statement. ▪ Companies also determine the cost of capital they want to use which is typically the return they expect on investments.

Categories of Inventory

There are four main categories of inventory: ▪ Raw Materials (RM) ▪ Work-in-Process (WIP) sometimes called Work-in-Progress ▪ Finished Goods (FG) ▪ Maintenance, Repair and Operating supplies (MRO) ▪ Individual items within each of these inventory categories can be current or obsolete

Inventory Stock Levels Maintenance, Repair and Operating (MRO) supplies ▪ Not directly related to product creation

There are three levels of internal inventory which may be held by companies to: ▪ Meet customer demand ▪ Buffer against uncertainty in demand and/or supply ▪ Decouple supply from demand ▪ Decouple dependencies in the supply chain Internal Inventory: - Strategic Stock - Safety Stock - Cycle Stock There may also be inventory which is held external to the company by downstream supply chain trading partners External Inventory: - Pipeline Inventory ▪ Inventory in transit. ▪ Inventory held/owned by suppliers, or by wholesalers, distributors, retailers, and customers.

Maintenance, Repair & Operating (MRO) supplies

These are materials that you need to run the manufacturing operation and the business, but do not end up as part of the finished product. ▪ Some MRO items are consumed during the process of converting raw materials into finished goods, e.g., oil for the manufacturing equipment. ▪ Other MRO items are used to facilitate the manufacturing operation, e.g., cleaning supplies, spare parts, etc. ▪ While still other MRO items may be used to facilitate the company's administrative activities, e.g., office supplies, coffee for the break room, etc. ▪ MRO inventory is separate from production inventory, but it is just as important. ▪ Frequently these items are expensed at the time they are purchased, and there may be a separate function, group, or individual who plans and orders these MRO items, from those who plan and order production items.

Safety Stock in Dependent Demand Situations

Three approaches to introduce safety stock into dependent demand situations if necessary 1. Add Safety Time into the requirements plan. - Safety Time (aka, Safety Lead Time) is ordering an item earlier than necessary based on the lead time, to ensure timely arrival. 2. Increase the replenishment order by a quantity specified by some estimate of expected plan error, i.e., over-planning / top-level demand. (Frequently used if there is a history of quality issues.) - e.g. order an additional 5% 3. Utilize statistical techniques to set safety stocks directly for a component rather than to the item of top-level demand

Maintaining Accurate Inventory Records

Two approaches to counting inventory in an effort to maintain accurate inventory records: ▪ Perpetual Inventory System - A system that keeps track of withdrawals from inventory on a continuous basis. ▪ Periodic Inventory System - A system that physically counts items at periodic intervals ✓ Cycle Counting: Physically counting a defined portion of the total inventory items on a regular/cyclical basis ✓ Often used with ABC classification

Inventory Deployment Planning Approaches: Across Multiple Locations

Two planning approaches to coordinate inventory requirements across multiple locations in the supply chain ▪ Fair Share Allocation determines a fair share % of the available supply which is then allocated to each competing demand. - Provides each distribution facility with an equitable distribution of available inventory ▪ Requirements Planning integrates across the supply chain taking into consideration unique requirements 1. Materials Requirements Planning (MRP) is driven by the MasterProduction Schedule 2. Distribution Requirements Planning (DRP) is driven by customer demand

Vendor Managed Inventory (VMI)

VMI arrangements transfer the responsible for managing the inventory located at a customer's facility back to the vendor/manufacturer of that inventory. The vendor/manufacturer: ▪ Stocks inventory ▪ Places replenishment orders ▪ Arranges the display ▪ Typically owns inventory until purchased ▪ Is required to work closely with customer

Inventory Management

Who are your key customers? ▪ Manufacturers (internal/external), Wholesalers, Distributors, Retailers, Consumers ─ What level of service do they required? Does it differ by customer? ─ What is important to them? ─ What value do they create? ─ What risks do they take? How do the inventory decisions you make: ─ Impact service levels to your customers? ─ Impact the total cost to serve?

Formula #2 - Calculating Safety Stock

k * (Sqrt(lead time * dc)) * (1.25 * MAD) K = Customer Service Level Target (safety factor). Derived from the normal distribution using the desired product availability or customer service level target. Sample values for k are: 2.33 for 99%, 2.03 for 98%, 1.64 for 95%, etc. Lead Time = The time required to fully replenish the finished good inventory. The lead time must also consider how long it will take to respond once a stockout occurs. DC = Number of distribution centers at which safety stock is maintained. 1.25 = The value "1.25 MAD" is an approximation of the standard deviation of the forecast error, which is assumed to be normally distributed (i.e. "bell shaped curve"). This is to approximate up to 25% more than the Mean Absolute Deviation (forecast error). Anything beyond this would be considered "abnormal demand" and not covered by safety stock MAD = Mean Absolute Deviation of the monthly demand. The absolute forecast error expressed as a unit quantity. The MAD is a measurement of the size of the average absolute forecast error over a given period of time. *Safety Stock = # Units

Value of Inventory Counting Systems

▪ Eliminates shutdown and interruption of production necessary for an annual physical inventories ▪ Eliminates annual inventory adjustments ▪ Provides trained personnel to audit the accuracy of inventory ▪ Allows the cause of errors to be identified and remedial action to be taken ▪ Maintains accurate inventory records.

Independent & Dependent Demand Inventory management models are generally classified as: - Independent Demand - Dependent Demand

▪ Independent Demand - The demand for the final product. Demand pattern affected by trends, seasonal patterns, & market conditions. Forecasted Demand Example: Automobile *Potential need for safety stock ▪ Dependent Demand - Internal demand for parts and materials based on the demand for the final product in which the parts and materials are used. Calculated Demand - Order quantities computed with Material Requirements Planning (MRP). - Relationship between independent and dependent demand shown in Bill of Materials (BOM). - Subassemblies, components, & raw materials are examples of dependent demand items. Example: Automobile Engine *Generally, no need for safety stock

Volume Economies of Scale The EOQ calculation will be impacted by volume economies of scale such as the following: - Individual Item Purchase Price Discounts - Multiple-Item Purchase Price Discounts - Transportation Freight-Rate Discounts

▪ Individual Item Purchase Price Discounts ➢ Discounts for ordering larger quantities. If the volume discount is sufficient to offset the added cost from carrying additional inventory, then ordering a larger volume may be desirable. ▪ 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 across all the items purchased rather than just an individual item's volume. ▪ Transportation Freight-Rate Discounts ➢ Ordering a larger quantity may mean that you can take advantage of Transportation Freight-Rate Discounts which will lower the per unit costs.

Inventory Metrics

▪ Inventory Carrying Cost - Measures how much it costs a company to store inventory over a given period of time. Inventory Carrying Rate x Average Inventory Value The inventory carrying cost metric helps a company to understand how much profit they can make with their current inventory; it is also useful in helping suppliers determine their production cycles. Generally, carrying costs equal approximately 20 - 30% of a company's inventory value, making this metric a significant cost factor. ▪ Inventory Accuracy - The variance between perpetual inventory and physical inventory. An important metric because misleading inventory levels may make it seem that a company has more inventory than it actually does, which leads the company to sell stock that is not available which results in dissatisfied customers. Inaccurate inventory data may also obscure inventory that is actually available, which can lead to stock remaining in a warehouse and ultimately becoming obsolete.

Inventory Metrics (continued)

▪ Inventory Days of Supply - The number of days it would take to run out of supply if it was not replenished. Inventory On Hand / Average Daily Usage SCM seeks to minimize inventory days of supply in order to reduce the risks of excess and obsolete inventory. Excess inventory tends to tie up operational cash flow, so there is a financial benefits to minimizing this metric. ▪ Days of Supply (DOS) - The most common KPI used by managers in measuring the efficiency in supply chain. Average Inventory / Monthly Demand x 30 It is calculated by dividing the average inventory on hand (as value) by the average monthly demand (as value) and then multiplying it by thirty, when measuring on a monthly basis.

Inventory Metrics ...Continued

▪ Inventory Turnover - The number of times that a company's inventory cycles per year. Cost of Goods Sold / Average Inventory The inventory turnover ratio is a key metric for determining how efficiently a company manages its' inventory and generate sales from it. It measures the number of opportunities to earn profit that a company experiences each year from the working capital invested in inventory. A higher inventory turnover means lower inventory levels and indicates an efficient supply chain. There is no specific benchmark for Inventory Turnover, however generally: ✓ Product Leaders in the Market: 3 - 4 Turns per Year ✓ Wholesalers/Distributors: 5 - 7 Turns per Year ✓ Operational Excellence Oriented Organizations: 8 - 9 Turns per Year Every unit/dollar of inventory that a company can reduce drops right to the bottom line as pure savings

Key Customer Service and Inventory Metrics: Customer Service Level Metrics

▪ Perfect Order Measurement - The percentage of orders that are error-free. A Perfect Order is delivered complete, on time, at the right location, in perfect condition, with complete and accurate documentation ((Total Orders - Error Orders) / Total Orders) x 100 This is often broken down by stage: ✓ Procurement: 99.99% - perfect ✓ Production: 99.12% - perfect ✓ Transportation: 99.02% - perfect ✓ Warehousing: 99.98% - perfect ▪ Fill Rate - The percentage of a customer's order that is filled on the first shipment. This can be represented as the percentage of items, SKUs or order value that is included with the first shipment. (1 - ((Total Items - Shipped Items) / Total Items)) x 100 *Fill rate can be important to customer satisfaction and has implications for transportation efficiency.

Limitations to Inventory Deployment Planning Approaches

▪ Requires accurate and coordinated forecasts for each warehouse ▪ Requires consistent and reliable product movement between warehouse facilities ▪ Subject to frequent rescheduling because of production breakdowns or delivery delays

Calculating Safety Stock Probability theory enables the calculation of safety stock for a target service level

▪ Service level is equal to 100% minus the probability % of stockout - e.g., a service level of 99% results in a stockout probability of 1% ▪ The most common probability distribution for demand is the normal distribution, i.e., "bell curve" - From analysis of historical demand data the safety stock required to ensure a stockout only 1% of the time is possible - A one-tailed normal distribution is used because only demand that is greater than the forecast can create a stockout. - Is the forecast error bias on the over-forecast or under-forecast side of the bell curve? ✓ Safety stock is only needed for under-forecast error (i.e., when actual demand exceeds forecasted demand)

Practical use of EOQ

▪ The experienced supply chain practitioner will check each application of EOQ to be sure that it is valid for the practical situation at hand. ▪ In the real world, EOQ is generally used as a baseline. ▪ With a thorough understanding of EOQ, the technique can be used to yield some benefits by its modification based on experience » Supply chain practitioners will frequently apply overrides due to variability in the assumptions previously outlined.

Order Quantity Determination: EOQ Economic Order Quantity - A quantitative decision model based on the trade-off between the annual ordering costs and the annual carrying costs *The sum of the Annual Ordering Costs and the Annual Carrying Costs is minimized

▪ The intersection of the Annual Ordering Costs and the Annual Inventory Carrying Cost will yield the lowest Annual Total Cost. ▪ This model involves many assumptions (outlined on slide 30) ▪ Generally used as a baseline for further modification before determining the actual quantity to order.

Assumptions of the EOQ Model *In the "real world" these assumptions do not hold true over time *Supply Chain Managers must make adjustments to the basic EOQ

▪ The model must be calculated for one product at a time. ▪ The demand must be known and constant throughout the year. ▪ The delivery replenishment lead time is known and does not fluctuate. ▪ Replenishment is instantaneous. — There is no delay in the replenishment of the stock, and the order is delivered in the quantity that was demanded, i.e. in one whole delivery. ▪ The purchase price (i.e., unit cost) is constant and no discounts or price breaks are factored into the model. ▪ Carrying cost is known and constant. ▪ Order cost is known and constant. ▪ Stockouts are not allowed

Calculating Safety Stock - Considerations

▪ There are numerous other deterministic safety stock formulas than those that are covered here. Some models can be quite complex. ▪ A company will have to determine which of the many formulas is the most appropriate for their products. ▪ Many companies calculate safety stock based on demand uncertainty alone and rely on that to at least partially cover for supply uncertainty as well. » If an item has a known supply uncertainty, an additional quantity of safety stock may be added to compensate.