Intro to Supply Chain Management Chapter 7: Inventory Management

Primary Functions of Inventory

*Buffer*, from uncertainty in the market place. *Decoupl,* dependencies in the supply chai, for example safety stock.

The Statistical Reorder Point (ROP)

*Reorder Point* ROP is the lowest inventory level at which a new order must be placed to avoid a stockout.

Assumptions of EOQ Model

1. Demand must be known and constant. 2. Delivery Time is known and constant. 3. Replenishment is instantaneous. 4. Price is constant. 5. Holding cost is known & constant. 6. Ordering cost is known and constant. 7. Stock-Outs are not allowed.

Statistical ROP w/ Demand and Lead Time Probabilistic

Both demand and lead time of a product are unknown.

Economic Order Quantity (EOQ) Model

Classic independent demand inventory system. EOQ model seek to determine an *optimal order quantity,* where the *sum* of the *annual order cost* & the *annual inventory cost* is minimized.

Finished Goods

Completed products ready for shipment.

RFID Steps to Automate Supply Chain

1. Materials Management - Goods are automatically counted and logged as they enter the supply warehouse. 2. Manufacturing - Assembly instructions encoded on RFID tag provide information to computer controlled assembly devices. 3. Distribution Center - Reader picks up signals from the tags to alert the RFID software and ERP system to update the inventory automatically and initiate a replenishment order and notification for delivery tracking. 4. Retail Store - RFID reader placed on the store shelf to trigger automatic replenishments when an item reaches its reorder point. No check out lines as scanners link RFIP tagged goods in shopping cart with buyers credit card.

Categories of Inventory

1. Raw materials 2. Work-in-process 3. Finished Goods 4. MRO

ABC Inventory Matrix

A items, based on current inventory should match the A items based on annual inventory dollar usage. The B and C items should match when comparing the two ABC analyses. Inventory Usage on Y axis. Cost of Inventory on X axis. If Inventory matches sale (in the middle) then there shouldn't be an under stocking of A(left side) and B items nor an overstocking of B and C items (right side, sign of obsolete stocks).

Radio Frequency Identification (RFID)

A successor to the barcode for tracking individual units of goods. RFID does not require direct line of sight to read a tag and information on the tag is updatable. This automates the supply chain. Barcode cannot do this because it requires direct line of sight and the information stored on it is static and non updatable.

A Items (High-Priority)

Approximately 20 percent of the items make up 80 percent of the total annual dollar usage and require greater attention, these are classified as the A items. Requires higher safety stocks.

Fixed Order Quantity Models

Assume demand, delivery lead time and other parameters already determined, using fixed parameters to derive optimum order quantity and minimize total inventory costs. This includes: - EOQ Model - Quantity Discount Model - EMQ Model These are the most widely used fixed order quantity models.

Statistical ROP w/ Constant Demand and Probabilistic Lead Time

Assumes demand of a product is constant and the lead time is unknown.

Direct Costs

Cost that are directly traceable to the unit produced, such as the amount of materials and labor used to produce a unit of the finished good.

Holding or Carrying Costs

Costs incurred for holding inventory in storage. Examples include handling charges, warehousing expenses, insurance, pilferage, shrinkage, taxes and the cost of capital.

Fixed Costs

Costs that are independent of the output quantity. Examples are buildings, equipment, plant security, heating, and lighting.

Indirect Costs

Costs that cannot be traced directly to the unit produced and they are synonymous with manufacturing overhead. Examples include MRO supplies, heating, lighting, buildings, equipment, and plant security.

Variable Costs

Costs that change as a function of the output level. Examples include direct materials and labors costs.

Sunk Costs

Costs that have been already incurred and cannot be recovered or reversed.

Independent Demand

Deamnd for a firm's end procyst and has a demand pattern affected by trends, seasonal patterns and general market conditions. While batteries, headlights, seals and gaskets for an Independent Demand product such as an ATV are considered dependent demand. Any replacement parts for the same product are considered independent demand. Independent demand items cannot be derived using the MRP softwares indications for demand, thus they must be forecasted based on market conditions.

Statistical ROP w/ Probabilisitic Demand and Constant Lead Time

Demand and delivery lead time are never quite certain and require safety stock.

Inventory Costs

Include: 1. Direct Costs 2. Indirect Costs 3. Variable Costs 4. Fixed Costs 5. Order Cost/Setup Costs 6. Holding/Carrying Cost

Dependent Demand

Internal demand for parts based on the demand of the final product for which the parts are used. This includes subassemblies, components and raw materials. MRP software is often used to compute exact material requirements.

Maintenance, Repair, Operating (MRO)

Materials and supplies used when producing the products but are not parts of the products.

Work-in-process (WIP)

Materials that are partially processed but not yet ready for sales.

Inventory Turnover Ratio

Measurement that determines how efficiently a firm is using its inventory to generate revenue. It shows how many times a company turns over it inventory in an accounting period. Faster turnovers indiciate a positive trend because it shows the company is capable of generating more revenue per dollar in inventory investment. This allows the company to increase cash flow and reduce warehousing and carrying costs. Slower or low inventory turnover ratios point to overstocking or deficiencies in the product line or marketing effort. Inventory Turnover Ratio = Cost of Revenue/Average Inventory

Roles of Inventory

One of the most expensive assets of an organizations. May account for more than 10% of total revenue or 20% of total assets. Management must reduce inventory levels, yet avoid stock outs and other problems.

Inventory Models, Continuous vs. Periodic Review Systems

Order Quantity & ROP models assume that the physical inventory is precisely known at every point in time. Reality shows that stock record and actual quantity are different & require continuous review of inventory to determine when to reorder.

Order Costs/Setup Costs

Order costs are direct variable costs associated with placing an order with the supplier. Examples of order costs include managerial and clerical costs for preparing the purchase, as well as other incidental expenses that can be traced directly to the purchase. Setup Costs are used in place of order costs to describe the costs associated with setting up machines and equipment to produce a batch of product. Order costs and setup costs are often used interchangeably.

ABC Inventory Control System

Prioritizes inventory items into Group A, B and C. A items are given the highest priority, while C items have the lowest priority and are typically the most numerous. Priority is determined by product shelf life, sales volume, whether the materials are critical components and annual dollar usage.

Raw Materials

Unprocessed purchased input or materials for manufacturing the finished goods.

Quantity Discount Model or Price-Break Model

Variation of the classical EOQ model that *relaxes constant price assumptions* by allowing purchase quantity discounts. A price break point is the minimum quantity required to get a price discount.

Economic Manufacturing Quantity (EMQ) Model or Production Order Quantity (POQ) Model

Variation of the classical EOQ model that *relaxes instantaneous replenishment assumption* by allowing usage or partial delivery during production.

B Items (Middle-Priority)

Make up roughly 40 percent of the items and account for about 15 percent of the total annual dollar usage. Require closer management since they are relatively more expensive per unit. They require more effort to purchase or make and may be more prone to obsolescence.

C Items (Low-Priority)

Make up the remaining 40 percent of the items and account for about 5 percent of total annual dollar usage. Lowest priority and lowest value.

Continuous Review System

Reviews inventory constantly. This is costly to conduct but requires less safety stock.

Periodic Review System

Reviews inventory periodically. This is less costly to conduct, but requires higher level of safety stock.

80/20 Rule or Pareto Analysis

Suggest that 80 percent of the objective can be achieved by doing 20 percent of the task, but the remaining 20 percent of the objective will take up 80 percent of the task. Recommends that tasks falling into the first category be assigned the highest priority.