Chapter 4- Inventory Management

annual ordering costs

(D/Q)*S Where D = annual demand, Q = order quantity (units), and S = ordering costs (per order)

EOQ

(Economic Order Quantity) a quantitative decision model based on the trade-off b/t annual inventory carrying costs and annual order costs sq[(2*D*S)/H)] Where D = annual demand, Q = order quantity (units), and S = ordering costs (per order)

Reorder Point

(ROP) the lowest inventory level at which a new order must be placed to avoid a stockout - set at a level that provides enough inventory so demand is covered during the lead time (L) needed to replenish inventory

inventory costs

- direct costs - indirect costs - fixed costs - variable costs - order costs - carrying costs

Common Inventory Ordering System Categories

Fixed-Order Quantity System Fixed-Time Period System

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

storage capacity

company doesn't have sufficient storage capacity to handle at one time

Individual Item Purchase Price Discounts

discounts for ordering purchase price discounts; if volume discount is sufficient to offset the added cost from carrying additional inventory, then order a larger volume may be desirable

Inventory policy

establishing target inventory levels for all products and materials 1. When to review? 2. When to order? 3. How much to order?

effects of having too much inventory

financial resources tied up in inventory underlying problems being hidden rather than being exposed and solved no incentive for process improvements

Transportation Freight-Rate Discounts

ordering a larger quantity may mean that you can take advantage of Transportation Freight Rate Discounts which will lower per unit costs

effects of having too little inventory

production disruptions longer delivery replenishment lead times reduced responsiveness

raw materials

purchased items or extracted materials that are converted via the manufacturing process into components and products

4 categories of inventory

raw materials work-in-progress (WIP) finished goods maintenance, repair, and operating (MRO) supplies

unitization

supplier may require 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

Annual carrying costs

(Q/2)*H Where Q = order quantity and H = holding costs (per unit)

MRO

(maintenance, repair, and operating) items used in support of general operations and maintenance such as maintenance supplies, spare parts, and consumables used in the manufacturing process and supporting operations

Multiple-Item Purchase Price Discounts

based on total volume across all the items purchased rather than just an individual item's volume

Bin System

inventory system that uses either one or two bins to hold quantity of the item being inventoried; mainly used for small or low value items

cycle stock

inventory that a company builds to satisfy its immediate demand; gradually depletes as customer orders are received

safety stock

inventory that is above and beyond what is actually needed to meet anticipated demand

obsolete inventory

inventory that is expired, damaged, or no longer needed; will never be used or sold at full value

order costs

labor costs associated with placing an order for inventory and the cost of receiving the order; incurred each time an order is placed

inventory turnover

the # of times that an inventory cycles or "turns over", during the year *the more the better ratio = COGS/Average Inventory @ Cost

units

the # of units available

dollars

the amount of dollars tied up in inventory

Fixed-Time Period System

inventory is checked in fixed time periods against a target inventory level - if inventory is less than target, a quantity necessary to bring inventory back up to the target level is ordered Q = R - IP where Q = order quantity, R = target inventory level, and IP = inventory position

continuous reiew system

inventory levels are continuously reviewed; as soon as inventory falls below a pre-determined level, a replenishment order is triggered

periodic review system

inventory levels are reviewed at a set frequency; at the time of review, if the stock levels are below the pre-determined level, an order for replenishment is placed, other wise no action is taken until the next cycle

pipeline inventory

inventory that is already out in the market held by wholesalers, distributors, retailers, and even consumers; also in-transit

Absolute Inventory Value

the value of the inventory at either its cost or its market value

indirect costs

cannot be traced directly to the unit produced

weeks of supply

(avg. on-hand inventory)/(avg weekly usage)

Other Types of inventory Systems

- ABC System - Bin System - Base Stock Level System - "Single-Period" Inventory Model

inventory turns

(COGS)/(avg. inventory value)

2 Models for Determining When to Review

1. Continuous Review System 2. Periodic Review System

3 Levels of Internal Inventory

1. Cycle Stock 2. Safety Stock 3. Strategic Stock

Why hold inventory?

1. to meet customer demand (cycle stock) 2. to buffer against uncertainty in demand and/or supply (safety stock) 3. to decouple supply from demand (strategic stock) 4. to decouple dependencies in the supply chain

measures of inventory investment

Absolute inventory Value Inventory Turnover

Volume Economies of Scale

Individual Item Purchase Price Discounts Multiple-Item Purchase Price Discounts Transportation Freight-Rate Discounts

What is the right amount of inventory?

It depends on the supply chain strategy and set up, the types of products, etc

Constraints

Limited Capital storage capacity transportation obsolescence production lot size unitization

Total Cost

Purchase Cost + Order Cost + Carrying Cost

Inventory Management

The function of planning and controlling inventories Goal is to help a company be more profitable by lowering COGs and/or by increasing sales

Practical Considerations of EOQ

Volume Economies of Scale Constraints

Fixed-Order Quantity System

a continuous inventory review system in which the same order quantity is used from order to order - when inventory position drops to a predetermined reorder point, a predetermined fixed order quantity is placed

work-in-process

a good or goods in various stages of completion throughout the plant, spanning from raw material that has been released for initial processing up to fully processed material awaiting final inspection and acceptance as finished goods

single-period model

a type of inventory system is only ordered for one-time stocking - goal is to maximize profits Ex) Newspaper stands

Base Stock Level System

a type of inventory system that issues an order whenever a withdrawal is made from inventory

service inventory

activities carried out in advance of the customer's arrival

ABC system

classifies inventory based on the degree of importance A: Highest Value B: Moderate Value C: Least Valuable

Limited Capital

company doesn't have sufficient available funds to purchase at one time

carrying costs

costs for physically having inventory on-site and for maintaining the infrastructure needed to store the inventory and to secure and insure it over time; incurred for holding inventory

variable costs

dependent on the unit volume

direct costs

directly traceable to unit produced

barcode systems

help businesses track products and stock levels for inventory management Types: Linear 1D, 2D, barcode reader

fixed costs

independent of hte unit volume produced

transportation

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

finished goods

items on which all manufacturing operations, including final testing, have been completed. These items are available for sale and/or shipment to the customer

inventory

the quantities of goods and materials that are held in stock

common metrics for inventory

units, dollars, weeks of supply, inventory turns