Ch7: Inventory Management

Strategic Stock

Additional inventory beyond cycle and safety stock used for a very specific purpose or future event for a defined period of time Also called anticipation stock, build stock, seasonal stock

Assumptions of Reactive (Pull) Inventory Logic

All customers, market areas, and products contribute equally to profits Infinite capacity exists at production facility Supply cycle time can be predicted and cycle lengths are independent Customer demand patterns are relatively stable and consistent Each distribution warehouse's timing and quantity of replenishment orders are determined independently of all other sites, including the supply source Supply cycle length cannot be correlated with demand

Replenishment Programs

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

Planning Safety Stock

Determine likelihood of a stockout using a probability distribution- forecast accuracy/error Estimate the demand during a potential stockout period Establish the desired level of stockout protection- desired service level

Individual Item Purchase Price Discounts

Discounts for ordering larger quantities If volume discount is sufficient to offset the added cost from carrying additional inventory, then ordering larger volume is desirable

Time Buckets

Discrete increments of time used to facilitate planning activities

Total Cost

Driven by inventory planning decisions which establish when/how much to order = Purchase Cost + Ordering Cost + Holding Cost

Performance Cycle

Elapsed time between release of a purchase order by the buyer to the receipt of shipment

Carrying Costs

Expense associated with maintaining inventory

Inventory Carrying Cost

Expense associated with maintaining inventory = Actual inventory carrying cost % x Avg inventory value

Profile Replenishment

Extends quick response and vendor managed inventory by giving suppliers the right to anticipate future requirements according to their knowledge of a product category

MRP: Bill of Materials

GO OVER EXAMPLE IN POWERPOINT

Product/Market Classification

Groups products, markets, or customers with similar characteristics to facilitate inventory management Classify by sales, profit contribution, inventory value, usage rate, item category

Reasons a Company Decides to Carry Strategic Stock

Hedge currency fluctuations Take advantage of a price discount Protect against short term disruptive event in supply Take advantage of a business opportunity For life cycle changes- seasonal demand, new product launch, transition protection

External Inventory

Held external to company by downstream supply chain trading partners Pipeline inventory

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 discount

Transportation

Item being ordered and transported may require specialized or dedicated transportation, impacting the quantity per order

Inventory Policy

Key customers/stakeholders- manufacturers, wholesalers, distributors, retailers, consumers Level of service required- differs by customer, what's important to them? what value do they create? what risks do they take? Inventory positioning/ ABC classification- how do the inventory decisions you make impact service levels to your customers, "total costs" to serve?

Transportation Freight Rate Discounts

Ordering a larger quantity may mean that you can take advantage of these discounts which will lower the per unit costs

Common Measures of Service Level

Performance cycle Order fill Case fill rate Line fill rate

Supply Uncertainty

Performance cycle How long will it take to replenish inventory with our customers?

Supply Chain Network

Plant warehouse to western and eastern distribution centers to their specific west/east customers

Calculating Safety Stock

Probability theory enables the calculation of safety stock for a target service level Service level is equal to 100% minus probability % of stockout Most common probability distribution for demand is the normal distribution- bell curve

Pull- Make to Order

Producing stock in response to actual demand

Inventory Management Practices

Product/market classification Segmentation strategy Policies and parameters

Fair Share Allocation

Provides each distribution facility with an equitable distribution of available inventory Limited ability to manage multistage inventories

Economic Order Quantity

Quantitative decision model based on the trade off between the annual ordering costs and the annual inventory holding costs Sum of the annual ordering costs and the annual inventory holding costs is minimized Model makes many assumptions Used as a baseline for further modification before determining the actual quantity to order

Categories of Inventory

Raw materials Work in process (WIP) Finished goods Maintenance, repair, and operating supplies Individual items within these categories can be current or obsolete

Safety Stock with Combined Uncertainty

Requires combining 2 independent variables Joint impact of the probability of both demand and supply variation must be determined Direct method- combine standard deviations using a convolution formula

Safety Time

Safety lead time Ordering an item earlier than necessary based on lead time to ensure timely arrival

Lead Time

Time required to replenish the finished goods inventory Expressed in months- period of forecast interval Fully replenish inventory including all manufacturing, assembly, packaging, quality control Must also consider how long it will take to respond once a stock out occurs

Standard Mathematical Solution for EOQ

sqrt of √(2 x Order Cost x Annual Demand Volume)/ (Annual Carrying Cost % x Unit Cost) Don't need to memorize, need to know how to calculate

1.25 MAD

Approximation of the standard deviation of the forecast error Approximate up to 25% more than the Mead Absolute Deviation Anything beyond this is abnormal demand not covered by safety stock

Safety Stock

Buffer stock Inventory that is above/beyond what is actually needed to meet anticipated demand Quantity of stock planned to be n inventory to protect against fluctuations in demand/supply Make to stock companies maintain some safety stock

Inventory Management Models

Classified as independent demand and dependent demand

ABC System

Classifies inventory based on degree of importance Determine which inventories should be counted and managed more closely than others

Perpetual Review

Continuously monitors inventory levels to determine inventory replenishment needs

Inventory Deployment Planning Approaches

Coordinate inventory requirements across multiple locations in the supply chain Fair share allocation Requirements planning

Inventory Carrying Cost Components

Cost of capital Taxes on inventory held in warehouse Insurance- based on estimated risk or loss over time Obsolescence- deterioration of product during storage Storage- expense to holding product rather than product handling

K

Customer service level target (safety factor) Derived from the normal distribution using the desired product availability or customer service level target Sample values: 2.33 for 99%, 2.03 for 98%, 1.64 for 95%

Fair Share Allocation Formula

DS= AQ + Sum Inventory for each warehouse / sum of daily demand for each warehouse DS= common days supply for warehouse inventory AQ= inventory units to be allocated from plant warehouse

Inventory Control Using Reactive Approaches

Defines how often inventory levels are reviewed to determine when and how much to order Periodic review Perpetual review

Reorder Points

Defines when a replenishment order is initiated

Independent Demand

Demand for final product Has a demand pattern affected by trends, seasonal patterns, and general market conditions Forecasted demand Ex: pick up truck

Dependent Demand Replenishment

Dependent demand inventory requirements are a function of known events that are not random Does not require forecasting because there is no uncertainty No specific safety stock is needed to support time phased procurement programs No safety stock assumes procurement replenishment is predictable and constant and vendors/suppliers maintain adequate inventories to satisfy 100% of purchase requirements

Steps for ABC System

Determine annual usage or sales for each item Determine % of total usage or sales that each item represents Rank items from high to low % Classify items into groups- highest value, moderate value, least value

A Items

Given highest priority "80/20 rule" Account for 20% of the total number of items, but 80% of total inventory cost

Ordering Costs

Incurred each time an order is placed Order preparation costs, order transportation costs, order receipt

Practical Considerations of EOQ- Volume Economies of Scale

Individual item purchase price discounts Multiple item purchase price discounts Transportation freight rate discounts

Requirements Planning

Integrates across the supply chain taking into consideration unique requirements MRP- Materials requirements planning, driven by a production schedule DRP- Distribution requirements planning, driven by supply chain demand

Dependent Demand

Internal demand for parts based on demand of the final product in which parts are used Determined/calculated demand Order quantities computed with MRP- material requirements planning Relationship between independent and dependent demand shown in BOM- bill of materials Ex: sub assemblies, components, and raw materials Ex: pick up truck engine

Cycle Stock

Inventory a company builds to satisfy its immediate demand Depletes gradually as customer orders are received, replenished cyclically when supply orders are received Amount held is dependent on actual demand in immediate time period, supply replenishment lead time, and order quantities

Pipeline Inventory

Inventory in transportation network and distribution system Already out in market being held by wholesalers, distributors, retailers, and consumers Ownership of this has been transferred to trading partners, but may still influence decisions the company makes regarding how they manage and control their internal inventory and how much safety/strategic stock to hold You no longer own it, owned by someone else

Inventory Inputs

Inventory policy Service levels Demand Performance cycle lead time

Demand Uncertainty

Involves variation in sales during the lead time necessary to replenish inventory

Practical Considerations of EOQ- Constraints

Limited capital Storage capacity Transportation Obsolescence Production lot size Unitization

Safety Stock Policy

Long production lead time necessitates de-coupling Provides maximum flexibility by centrally locating safety stock Influenced by batch/lot/campaign size Remember- long term stability in bulk storage? expiry concerns? Able to have rapid response to increases in customer demand, maintain closest to end customer

Fill Rate

Magnitude of a backorder or stockout Case by case fill rate, line fill rate, etc

Inventory Control

Managerial procedure for implementing an inventory policy

Maintenance Repair and Operating Supplies

Materials you need to run manufacturing operation and business. but does not end up as part of finished product Consumed during process of converting raw material to finished goods (oil for equipment) Used to facilitate operation (cleaning supplies) Facilitate company's administrative activities- office supplies

MAD

Mean Absolute Deviation Of monthly demand Absolute forecast error expressed as a unit quantity Measurement of the size of the average absolute forecast error over a given period of time Normally calculated based on past 12 months actual sales vs lead time offset forecast for those months

Limited Captial

Model may generate an order quantity which the company does not have sufficient available funds to purchase at one time

Storage Capacity

Model may generate an order quantity which the company does not have sufficient storage capacity to handle at the time

Obsolescence in EOQ

Model may generate an order quantity which would create spoilage or obsolescence

Assumptions of EOQ

Model must be calculated for one product at a time Demand must be known and constant throughout the year Delivery replenishment lead time is known and doesn't fluctuate Replenishment is instantaneous Purchase price is constant and no discounts or price breaks are factored into model Carrying costs and order cost are known and constant Stockouts not allowed

Vendor Managed Inventory

Modified quick response program that eliminates the need for replenishment orders Transfers the responsibility for managing the inventory located at a customer's facility back to the vendor/manufacturer of that inventory

Periodic Review

Monitors inventory status of an item at regular intervals, weekly/monthly

Policies and Parameters

Must be defined at a detailed level Data requirements, software applications, performance objectives, and decision guidelines

DC

Number of distribution centers at which safety stock is maintained

B and C Items

Other 80% of the total number of items, but only 20% of the total inventory cost B- require closer management since they re relatively more expensive per unit, require more effort to purchase/make, and ma be more prone to obsolescence C- have lowest value and lowest priority

Case Fill Rate

Percent of cases ordered that are shipped as requested

Order Fill

Percent of customer orders filled completely as requested

Line Fill Rate

Percent of order lines (items) that were filled completely as requested

Supply

Performance cycle Uncertainty involves variation in the time and/or quantity necessary to replenish inventory

Service Level

Performance target specified by management and defines inventory performance objectives Higher the service level target, higher the amount of inventory you will need to assure the target is achieved

Push- Make to Stock

Producing stock on the basis of anticipated demand Basis of forecasted demand and product availability

Collaborative Inventory Replenishment Programs

Quick response Vendor managed inventory Profile replenishment

Perpetual Review Formula

ROP= D * T + SS ROP= reorder point in units D= avg daily demand in units T= avg performance cycle length in days SS= safety/buffer stock in units

Periodic Review Formula

ROP= D(T + P/2) + SS ROP= reorder point D= avg daily demand T= avg performance cycle length P= review period in days SS= safety stock

Segmentation Strategy

Specifies all aspects of inventory management process for each segment of inventory Service objectives, forecasting method, management technique, and review cycle

Responsibilities of a Vendor in VMI

Stock inventory Place replenishment orders Arrange display Typically owns inventory until purchased Required to work closely with customer

Obsolete Inventory

Stock that is expired, out of date, or no longer needed Met obsolescence criteria established by company Will never be used or sold at full value Writing if off may reduce company's profit Takes up space and costs money to maintain, better to write it off Cost associated with actual disposal May donate it to non-profits if any value remains- avoids disposal costs

Unitization

Supplier may require the company to order an item in full pack, case, or pallet configurations

Production Lot Size

Supplier may require the company to order an item in full production lot sizes

Quick Response

Technology driven cooperative effort between retailers and suppliers to improve inventory velocity while matching supply to consumer buying patterns

Functions of Inventory: Why hold inventory?

To meet customer demands- cycle stock To buffer against uncertainty in demand/supply- safety stock To decouple supply from demand- strategic stock To decouple dependencies in the supply chain

Safety Stock to Plan for Uncertainty

Trying to account for 2 types of uncertainty with safety stock Demand uncertainty Supply uncertainty Variations must be considered in both areas to make effective inventory planning decisions

Common Metrics for Inventory

Units- number of units available Dollars- amount of dollars tied up in inventory Weeks of supply- avg on hand Inventory / avg wekly usage Inventory turns- COGS/avg inventory value Inventory carrying cost

Review Period

Used in periodic review calculation of ROP that is not used in perpetual review

Hybrid

Uses a combination of push and pull Facilitated by manufacturing postponement strategy

Demand Uncertainty- Safety Stock

When and how much product will our customers order? Add safety stock to base inventory to protect against a potential stockout when demand uncertainty exists Ex: demand exceeds forecast

Formula for Calculating Safety Stock

k * [ sqrt√(lead time * dc) ] * (1.25 * MAD)

Safety Stock in Dependent Demand Situations

3 approaches to introduce safety stock into dependent demand situations if necessary

Inventory Stock Levels

3 levels of internal inventory Strategic stock Safety Stock Cycle stock Also: obsolete inventory

Introducing Safety Stock in Dependent Demand Situations Approaches

1. Put a safety time into requirements plan- order a component earlier than needed to ensure timely arrival 2. Increase replenishment order by a quantity specified by some estimate of expected plan error- over planning 3. Utilize statistical techniques to set safety stocks directly for a component rather than to the item of top level demand