SCM301: Chapter 7 Inventory Management
Periodic Review Systems
-(nQ, s, R) periodic review policy: if at the time of inventory review, the physical inventory is equal to or less than the reorder point, s, the quantity, nQ, is ordered to bring the inventory up to the level between s and (s+Q). -(S,R) periodic review policy: at each review time, a sufficient quantity is ordered to bring the inventory up to a pre-determined maximum inventory level, S. -(s,S,R) policy: if at the time of inventory review, the physical inventory is equal to or less than the reorder point, s, a sufficient quantity is ordered to bring the inventory level up to the maximum inventory level, S.
Continuous Review System
-(s, Q) continuous review policy: orders the same quantity, Q, when physical inventory reaches the reorder point, s. -(s, S) continuous review policy: when current inventory reaches or falls below the reorder point, s, sufficient units re ordered to bring the inventory up to a pre-determined level, S.
How Much Effort To Put Into Managing Inventory?
-ABC Inventory Analysis -Inventory Turnover Analysis
Simple EOQ Model
-Assumptions: demand known and constant, order lead time known and constant, full replenishment (order delivered at one time), price is constant (no quantity or price discounts), order cost is known and constant, no stockiest, no limits on capital availability -EOQ= lowest point where Annual Holding Cost and Annual Order Cost are equal.
Variability and Average Inventory
-Average inventory impacts TAIC. -Since safety stock on average is not consumed, the average inventory level including safety stock can be found by: average inventory=Q/2+SS
ABC Inventory Control System
-Determines which inventories should be counted and managed more closely than others. -Groups inventory as A, B, and C items. -A items: given highest priority with larger safety stocks. A items account for approximately 20% of the total items and about 80% of total inventory cost. -B items: account for the other about 40% of total items and 15% of total inventory cost. -C items: lowest value and hence lowest priority. They account for the remaining 40% of total items and 5% of total inventory cost.
Inventory Investment
-Firms should diligently measure inventory investment to ensure that it does not adversely affect competitiveness. -Measures include: absolute value of inventory (balance sheet), inventory turnover
Periodic Review (P) System
-Fixed-time period model: time triggered (monthly sales call by sales rep). -Assume demand is random. -Order up to the 'target' level at a specified time.
Maintaining Inventory Level
-If both demand and lead time are constant: ROP= average demand *Lead time
Inventory-Related Costs
-Item cost: direct costs traceable to each unit for material and labor. -Ordering or setup costs -Carrying (holding) costs: risk costs (obsolescence, inventory shrinkage), storage space costs (variable storage and handling costs), service costs (insurance, taxes), capital or finance (interest charges, opportunity cost). -Stockout Costs: cost of not having inventory on hand when demand occurs.
Simple Inventory Management Systems
-Maintain two bins of item in stock. Use one until it is gone. Start using second and order a new one. Size of bins should be equal to reorder point. Fixed order quantity system. -Advantage: simple, requires no monitoring, good for cheap and common items. -Critical decision: what should bin size be?
Inventory Models
-Order quantity and ROP assume that physical inventory is precisely know at every point in time. -Reality shows that stock records and actual quantity are different and requires continuous review of inventory to determine when to reorder. -A continuous review system is costly to conduct but requires less safety stock than periodic review. -Periodic Review System: reviews physical inventory at specific points in time and required higher level of safety stock.
When Should Orders Be Placed?
-Periodic Review -Continuous Review
Cycle Counting
-Physical inventory-taking technique in which inventory is counted on a frequent basis rather than once or twice a year. -Checks inventory accuracy
Economic Order Quality (EOQ) Model
-Quantitive decision model based on the trade-off between annual inventory holding costs and annual order costs. -Seeks to determine an optimal order quantity, where the sum of annual order cost and the annual inventory cost and the annual inventory holding cost is minimized. -Order cost is the direct variable cost associated with placing an order, setup cost. -Holding cost is the cost incurred for holding inventory in storage, carrying cost. -Used for independent demand items, widely used and robust, answers "how much do I order?"
What Inventory Level Should Be Maintained?
-Reorder Point -Safety Stock
Why Inventory Management?
-Right product, right point in time, right place to meet customer demand. -What, where, when, how many? -$$$-Inventory is significant portion of working capital. -Ex-Walmart: large amount of inventory
How Much Do I Order?
-Simple bin systems, EOQ -Price Break Model (Quantity Discounts): large quantities from costco cheaper than one unit at hy-vee.
How Much to (Re)Order
-Summary and Evaluation of EOQ Approach -EOQ is popular inventory model, does not handle multiple locations well, doesn't do well when demand is not constant, minor adjustments can be made to basic model, newer techniques take the place of EOQ, understanding EOQ is necessary to understand more complex models.
Where Is Inventory Required?
-Suppliers: raw materials, sub assemblies (WIP, MRO), finished goods. -Manufacturing: raw materials, sub assemblies (WIP, MRO), finished goods. -Distribution/Retail: finished goods -Consumers
Why Inventory Exists?
-To maintain independence of operations, to meet variation in product demand, to allow flexibility in production scheduling, to provide a safeguard for variation in raw material delivery time, to take advantage of economic purchase order size.
Inventory Turnover
-Turnover Ratio -How many times inventory "turns" in an accounting period. -Faster is better =Cost of Revenue/Average Inventory =COGS/Average Aggregate Inventory Level
Demand and Lead-time Uncertainty
-Uncertainty is a normal condition: demand often affected by exogenous factors- weather, forgetfulness. lead times often vary regardless of carrier intentions. -Reorder point: becomes the average demand during lead time plus safety stock (buffer against uncertainty)
Continuous Review (Q) System
-When should orders be placed? -Fixed-order quantity model: event triggered (running out of stock). -Allows for random demand -Stock position is monitored continuously
Functions of Inventory
1. Buffer uncertainty in marketplace: satisfy customer demand, meet independent demand (set by market conditions, independent of operations, 'replenishment philosophy'). 2. Decouple dependencies in the supply chain: facilitate demand, meet dependent demand (components and assemblies for creating good or service, demand is dependent on the factory or service schedule, demand comes in clumps, 'requirements philosophy"
Price Break
Company has chance to reduce their inventory costs by placing larger quantity orders using the price-break order quantity. -What should optimal order quantity be?
EOQ Model Formula
EOQ= square root (2*Annual Demand*Order or Setup Cost)/Holding Cost = square root(2RS/kC)
ROP and Safety Stock Calculation
ROP=average demand *average lead-time+Safety Stock= d*LT+SS SS= z* square root (standard deviation of LT^2*d^2+ standard deviation of demand^2*LT)
Inventory Accuracy
Refers to how well the inventory records agree with physical count. -Problem if not accurate
Total Annual Inventory Cost Formula
TAIC= Annual Purchase Cost (APC) + Annual Order Cost (AOC) + Annual Holding Cost (AHC) =Annual Demand (R) * Cost per unit (C) + # of orders per year (R/Q) * ordering cost per order (S) + average inventory (Q/2) * annual holding cost per unit (k*C) =RC+ (R/Q)S+(Q/2)(kC)
Inventory
The stock of any item or resource used in an organization. -4 categories: finished goods, raw materials (will become part of product), work in progress, maintenance repair and operating (MRO)