SCM Lecture 4: Inventory Management

Assumptions of EOQ Model

(not all always hold true -> adjustments are made) -Demand must be known and constant. -Delivery time is known and constant. -Replenishment is instantaneous. -Price is constant. -Holding/Carrying cost is known and constant. -Ordering cost is known and constant. -Stock-outs are not allowed.

Fixed Time Period System / Periodic Review System

- inventory levels are checked in fixed time periods (T) -A target inventory level (R) is established (R) = restored when each new order is received -Quantity ordered (Q) varies (Q = R - IP) = (order quantity = target inventory - inventory position)

Matching Demand & Supply

- must make an accurate forecast demand --> produce & deliver right quantities, at the right time, and at the right cost (imbalances will affect all of SC) - find ways to match demand & supply to achieve optimal cost, quality, and customer service --> to compete w/ others' supply chains

Safety Stock

-Inventory carried in addition to demand during lead time. -Common to carry safety stock when demand (d) or lead time (L) are not constant.

Inventory Management Model: Independent & Dependent Demand

-Order quantities computed with Material Requirements Planning (MRP) -Relationship between independent and dependent demand shown in Bill of Materials (BOM)

Inventory Investment

-to ensure firm doesn't adversely affect competitiveness Measure: -absolute value of inventory (on Balance sheet) -inventory turnover/ turnover ratio (the more turns the better) --> ratio= (cost of revenue (aka COGS) / Avg Inventory @ cost) for any accting period

Primary functions of inventory

1. Buffering against uncertainty in the marketplace (in demand/ supply) 2.Decoupling dependencies in the supply chain (--> To achieve economies of scale in purchasing, manufacturing, transportation, etc.) 3. Balancing demand and supply (Product supply pattern = different from demand) 4. Geography (To locate the product / material near where it will be used)

Inventory Systems

1. Fixed-Order Quantity System:- Order a fixed quantity (Q), when inventory drops to a pre-established reorder point (ROP) 2. Fixed-Time Period System: Inventory checked in fixed time periods (T), quantity ordered varies.

Practical Considerations of EOQ

1. Lumpy Demand (can use Periodic Order Quantity (POQ) when demand is not uniform 2. EOQ Adjustments (total cost changes little on either side of the EOQ. Managers can adjust to accommodate needs) 3. Capacity Constraints (storage capacity and costs should be considered when order large quantities)

Vendor Managed Inventory (VMI) Responsibilities

1. Stocks inventory 2. Places replenishment orders 3. Arranges the display 4. Typically owns inventory until purchased 5. Is required to work closely with customer

Measuring Inventory Performance

1. Units - the number of units available 2. Dollars - the amount of dollars tied up in inventory 3. Weeks of Supply - (avg. on-hand inventory) / (avg. weekly usage) 4. Inventory Turns - (cost of good sold) / (avg. inventory value)

Typical Adjustments to EOQ

1. Volume transportation rates offer a freight-rate discount for larger shipments. 2. Quantity discounts offer a lower per unit cost when larger quantities are purchased 3. Production lot size 4. Multiple-item purchase 5. limited capital 6. dedicated trucking 7. unitization (ie buying in full pack, case, pallet configurations)

Fixed- Order Quantity System: variables & some assumptions

2 main variables: Order Quantity (Q), Reorder Point (ROP) Assumptions: a constant demand (d) rate, inventory position (IP) reduced by (d), etc

Manufacturing Inventory

4 broad categories: 1. raw materials- unprocessed 2. work-in-process (WIP) partially process materials not yet ready for sale 3. finished goods - ready for shipment 4. maintenance, repair & operating (MRO) - materials used/ consumed in production but don't become part of the finished product

ABC Inventory Classification

= classifies inventory based the degree of importance: Steps: 1. Determine annual usage or sales for each item. 2. Determine % of total usage or sales 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

Fixed- Order Quantity System: Reorder Point

= lowest inventory level at which a new order during lead time (L) must be placed to avoid a stockout ROP = Demand during Lead Time (dL)

ABC Inventory Control System Criterion

A items: highest priority "80/20 rule" A = 20% total # of items, but about 80% of total inventory cost B&C items= account for other 80% total number of items, but only 20% of total inventory cost (B = req. closer management since are more expensive per unit, require more effort to purchase/ make, & may be more prone to obsolescence) (C = have lowest value, and therefore lowest priority)

Inventory Policy

Addresses: 1. When to order 2. how much to order

Total US Inventory Pipeline

Average~ 12weeks 6 weeks: Internal (finished pack inventory) 6 weeks: External (wholesaler, pharmacy, patient)

Inventory Models: Continuous Review System vs Periodic

Continuous= used when stock records and actual quantity are routinely different - costly but requires less safety stock than periodic review system ( which reviews at specific points and req. higher safety stock)

Inventory Management Model: Dependent Demand

Determined / Calculated Demand (Describes the internal demand for parts which is dependent on the demand of the final product in which the parts are used) ie) pick- up truck engine

Inventory Costs: Direct & Indirect

Direct Costs - directly traceable to unit produced (e.g. labor) Indirect Costs- cant be ^ (e.g. equipment, MRP items)

Inventory Costs: Fixed & Variable

Fixed Costs/ Sunk - independent of the output quantity (e.g., buildings) Variable Costs - vary with output level (e.g., materials and labor

RFID and the Supply Chain

How the RFID automates the supply chain: 1. Materials Management (goods 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 (shipment leaving DC automatically updates ERP to trigger a replenishment order and notify customer for delivery tracking) 4. Retail Store (no check out lines as scanners link RFID tagged goods in shopping cart with buyers credit card)

Inventory Costs: Order & Holding/Carrying

Order Costs - direct variable costs associated with placing an order Holding / Carrying Costs - incurred for holding inventory in storage

Total Cost Formula

Total Cost = Purchase Cost + Ordering Cost + Holding Cost

Total Inventory

Total Inventory = External Inventory ("channel" stock/ Pipeline inventory) + Internal Inventory (Cycle & Safety Stock) + Excess Inventory

Vendor Managed Inventory (VMI)

VMI arrangements transfer the responsibility for managing the inventory located at a customer's facility back to the vendor of that inventory.

ABC Inventory Control System

a method to determine which inventories should be counted & managed more closely than others (groups inventory as A, B, or C)

Stock Levels

balance by costs & driven by the degree of reliability 1. Cycle 2. Safety 3. Anticipation /Strategic Stock

Order Cost

costs that are incurred each time an order is placed

Holding/ Carrying Cost

costs that are incurred for holding inventory in storage

Target Inventory

covers: - Cycle Stock (including) (demand during lead time (L), demand during review period (T)) -Safety Stock

Economic Order Quantity (EOQ) Model & formula

determines optimal order quantity (where sum of annual order costs & annual inventory holding cost is minimized) EOQ= sq. root of [(2 x Ordering Cost x Annual Volume)/ (Carrying Cost % x Unit Cost)

Inventory Management Model: Independent Demand

forecasted demand (The demand for the final product. Has a demand pattern affected by trends, seasonal patterns, & general market conditions. ) ie) pick-up truck

Ordering Costs examples

incurred each time an order is placed 1. Order preparation costs 2. Order transportation costs 3. Order receipt processing costs 4. Material handling costs

Holding/ Carrying Costs Examples

incurred for holding inventory 1. Cost of capital - specified by senior management 2. Taxes - on inventory held in warehouses 3. Insurance - based on estimated risk or loss over time and facility characteristics 4. Obsolescence - deterioration of product during storage, and shelf-life 5. Storage - facility expense related to product holding rather than product handling

Service Inventory

involves activities carried out in advance of the customer's arrival

Radio Frequency Identification (RFID)

successor to the barcode for tracking individual unit of goods (doesn't require seeing the tag, and the info on the tag is updatable)

Inventory Management

the effort to minimize inventory levels while avoiding stockouts and other problems