SCM Ch. 4

Work in Process (WIP)

"Black hole" of inventory. A good or goods in various stages of completion throughout the plant, including all materials from raw material that has been released for initial processing up to completely processed material awaiting final inspection and acceptance as finished goods.

Goal of Inventory Management

(1) reduce the amount of inventory held in stock, and (2) ensure there is enough inventory to satisfy customer demand. Effective inventory management balances these two considerations to achieve the stated goals of lowering costs and increasing sales.

Planning for safety stock

1. Determine the likelihood of a stockout using a probability distribution (e.g., forecast accuracy/ error). 2. Estimate demand during a potential stockout period. 3. Decide on a policy concerning the desired level of stockout protection (i.e., desired service level).

Concerns address by inventory policies

1. When to review inventory? 2. When to order replenishment inventory? 3. How much inventory to order?

Single-echelon inventory optimization

A distribution site is treated essentially as an island that holds needed inventory to meet the needs of its customers, separate from upstream components.

Order Fill Rate

A measure of delivery performance of finished goods, usually expressed as a percentage.

Make-to-stock

A product is produced prior to receipt of a customer order. A forecast and demand plan are created for the finished goods based on anticipated demand.

Safety stock (buffer stock)

A quantity of stock planned to be in inventory to protect against fluctuations in demand or supply. Inventory that is above and beyond what is actually needed to meet anticipated demand. Unexpected disruptions in supply can create a shortage, which leads to unfulfilled demand and/or interrupted production plans and schedules. Companies operating in a make-to-stock environment.

Reorder point

A set inventory level where, if the total stock on hand plus [the stock] on order falls to or below that point, an action is taken to replenish the stock. It's normally calculated as forecasted usage during the replenishment lead time plus safety stock. It's set at the level of remaining inventory that is sufficient to cover all of the demand that is projected to occur during the lead time necessary to receive the replenishment supply.

Inventory policy

A statement of a company's goals and approach to the management of inventories. Establish target inventory levels for all products and materials and the methods and systems used to achieve and maintain target goals.

Radio frequency identification (RFID)

A system using electronic tags to store data about items. Accessing these data is accomplished through a specific radio frequency and does not require close proximity or line-of-sight access for data retrieval.

Economic Order Quantity (EOQ)

A type of fixed order quantity model that determines the amount of an item to be purchased or manufactured at one time. The intent is to minimize the combined costs of acquiring and carrying inventory. It's quantitative decision model based on the trade-off between the inventory carrying costs and the order costs. The objective of this model is to find the point of intersection of these two costs in order to find the order quantity that bears the lowest total cost to meet projected demand.

Bin system

A type of inventory system that uses either one or two bins to hold a quantity of the item being inventoried. It is mainly used for small or low value items. When the inventory in the first bin has been depleted, an order is placed to refill or replace the inventory. The second bin is set up to hold enough inventory to cover demand during the replenishment lead time so as to last until the replacement order arrive.

ABC system

A type of inventory system that utilizes some measure of importance to classify inventory items and allocate control efforts accordingly. This system takes advantage of what is commonly called the 80/20 rule, which holds that 20% of the items usually account for 80% of the value.

Target stock level (TSL)

A type of periodic inventory review system. It is the level of inventory that is needed to satisfy all demand for a product or item over a specific time period. It is also known as an order-up-to-inventory level

Strategic stock (anticipation stock)

Additional inventory above and beyond cycle stock and safety stock. It's used for a very specific purpose or future event and for a defined period of time (i.e., neither continuous nor ongoing). Potential reasons: hedging a currency exchange, taking advantage of a price discount, protecting against a major short-term disruptive event in supply, taking advantage of a major business opportunity, and/or providing for lifecycle changes (seasonal demand, new product launch, transition protection or bridging, etc.). Companies do not routinely carry this kind of stock, and many companies never carry it.

Transportation Freight-Rate Discounts

Carriers generally offer a rate discount for larger volume shipments. These adjustments will vary the order cost at different order quantities, which is not accounted for in the standard EOQ model.

Requirements philosophy

Dependent demand items are typically managed using this philosophy. Only ordered as needed based on higher level components or products

Order Costs

Direct labor cost incurred when a purchaser places an order. They are used in calculating order quantities, and are the costs that increase as the number of orders placed increases. It includes costs related to the clerical work of preparing, releasing, monitoring, and receiving orders, the physical handling of goods, inspections, and setup costs, as applicable.

Multiple-Item Purchase Price Discounts

EOQ is calculated for one product at a time and does not consider any discounts for multiple item purchases, which would lower the unit cost of an item. 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 across all the items purchased rather than just an individual item's volume.

Direct Costs

Expenditures that are directly traceable to the volume of units produced. Ex: labor, materials, and expenses specifically related to the production of a product.

Indirect Costs

Expenditures that cannot be traced directly to the volume of units produced. Ex: depreciation, administrative expenses, overhead, MRO items, buildings, equipment, and utilities. They may be either fixed or variable and are typically allocated to a cost object as defined by individual company policy.

Fixed Costs

Expenditures that do not vary with the volume of units produced. Examples are rent, property tax, and salaries of certain personnel, all of which are independent from the output. They are frequently time related (i.e., paid on a weekly, monthly, or annual basis). They are generally referred to as overhead costs.

Variable Costs

Expenditures that vary directly with a change of even one unit in the volume produced. Examples are direct labor and materials consumed, sales commissions, and allocated overhead. They rise as production increases and fall as production decreases.

Hidden costs

Having too much or too little inventory on hand can create this kind of cost that will negatively impact a company. Financial resources tied up in too much inventory are not available for other purposes. Excess inventory makes meeting customer demand easier, but it might also be masking underlying problems with the supply chain. Too little inventory, on the contrary, leads to production disruptions due to unavailability of materials.

Barcode systems

Help businesses and organizations track products, prices, and stock levels for centralized management in a computer software system allowing for incredible increases in productivity and efficiency.

Individual item purchase price discount

If the volume discount is sufficient to offset the added cost from carrying additional inventory, then ordering a larger volume may be a desirable option, assuming obsolescence will not be an issue. To facilitate this decision, enterprise resource planning (ERP) systems must be programmed with quantity discount logic to work with the EOQ formula to determine optimum order quantities.

Continuous Review

In this method, inventory levels are continuously reviewed. As soon as the inventory/stock falls below a predetermined level (i.e., reorder point), a replenishment order is triggered. This system is more costly to conduct than a periodic review system, but it potentially requires less safety stock because inventory is constantly monitored and replenishment actions are taken more quickly.

Periodic Review

In this method, inventory levels are reviewed at a set frequency (weekly, monthly, etc.). At the time of review, if the stock levels are below the predetermined level (i.e., reorder point), then an order for replenishment is placed, otherwise, no action is taken until the next cycle. It is less expensive to implement and operate than a continuous review system. However, since inventory items are only reviewed periodically, there is a greater risk of inventory dropping well below the reorder point trigger between review points and there is a corresponding greater potential need for safety stock.

Facilitating products

Inventories companies in the service industry can maintain. They are those items that are used to help facilitate the service being provided. Restaurants can inventory the food, tableware, and other elements of the dining operation as these are facilitating products necessary to provide the dining service.

Decouple Dependencies in the Supply Chain

Inventory can be held between dependent operations in manufacturing. If some inventory of materials or work in process is maintained between operations, then operations downstream from the disruption may be able to continue the manufacturing process for some period of time, perhaps even until the disruption is resolved. The company can build up inventory when demand is low, keeping workers busy during slack times so that when demand picks up, the increased inventory can be slowly depleted through normal in-season sales and the company does not have to react by increasing production.

Obsolete Inventory

Inventory items that have met the obsolescence criteria established by the organization.

Multi-echelon inventory optimization (MEIO)

Inventory needs are established across various sites and levels of the supply chain, upstream and downstream, to meet the needs of the entire system's customers.

Service Level

It is a measure (usually expressed as a percentage) of satisfying demand through inventory or by the current production schedule in time to satisfy the customers' requested delivery dates and quantities.

"Single-period" inventory model

It is a type of inventory system in which inventory is only ordered for a one-time stocking. The objective is to maximize profit. This model is used by vendors preparing for a very small sales window

Cycle stock

It is the inventory that a company builds to satisfy its immediate demand. The amount of cycle stock that a company holds is dependent on various factors, including anticipated and actual demand in the immediate time period, supply replenishment lead time, and supply replenishment order quantities. It depletes gradually as customer orders are received and is replenished cyclically when supply orders are received.

Base stock level systems

It's a type of inventory system that triggers a replenishment order whenever a withdrawal is made from inventory. Replenishment order quantity is equal to the quantity withdrawn from inventory.

Pipeline inventory

It's inventory that is in-transit, either out to the distribution channels or already out in the market being held by wholesalers, distributors, retailers, and even consumers. The ownership of this inventory has been transferred to the company's downstream trading partners/customers, but it may still influence decisions the company makes regarding how it manages and controls its internal inventory.

Finished Goods

Items on which all manufacturing operations, including final testing, have been completed. These products are available for sale and/or shipment to the customer as either end items or repair parts. Worth much more than raw materials or WIP, because all of the material, labor, and overhead costs are fully applied.

Maintenance, Repair and Operating (MRO) supplies

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.

Fixed-Time Period Quantity

Measures actual inventory levels at regular intervals of time; either an order is placed every time, or a check of inventory levels is made and an order placed if needed. Often the quantity ordered varies from period to period as inventory is restored to a predetermined level. Q = R - IP Where: Q = order quantity R = target inventory level IP = inventory position

Decouple Supply from Demand (Economies of scale in purchasing, manufacturing, and/or transportation)

One reason to hold inventory. If the price break, discount, or lower per unit transportation cost is sufficient to offset the extra holding cost incurred as a result of the additional inventory, then the decision to buy the larger quantity is justified. Inventory can also be used as a hedge against price increases.

Raw materials

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

Inventory

Represents the quantities of goods and materials that are held in stock. Those stocks or items used to support production (raw materials and work-in-process items), supporting activities (maintenance, repair, and operating supplies), and customer service (finished goods and spare parts)

Utilization

Similar to production lot size, the supplier may require the company to order an item in full pack, case, or pallet configurations, particularly if the supplier does not have any other customers for that item.

Pipeline inventory

Stock that is external to the company and may have an impact on decisions that companies make about how to manage and control their inventory resources.

Collaborative Planning, Forecasting and Replenishment (CPFR)

Supply chain trading partners can jointly plan key supply chain activities from production and delivery of raw materials to production and delivery of final products to end customers.

Inventory Management

The branch of business management concerned with planning and controlling inventories. It helps a company be more profitable by lowering the cost of goods sold and/or by increasing sales.

Responsive capabilities model

The company can choose to maintain a somewhat higher level of inventory held at multiple decentralized locations which may potentially be closer to the customer(s). This strategy increases the overall inventory costs but reduces the risk of a customer service issue occurring.

Efficient capabilities model

The company can choose to maintain a somewhat more reduced level of inventory held at a centralized location, which may potentially be more remote from the customer(s). This strategy decreases the overall inventory costs but increases the risk of a customer service issue.

Carrying Costs

The cost of holding inventory, usually defined as a percentage of the dollar value of inventory per unit of time (generally one year). They depend mainly on the cost of capital invested as well as the costs of maintaining the inventory, taxes, and insurance, obsolescence, spoilage, and space occupied.

Independent Demand

The demand for an item that is unrelated to the demand for other items. Demand for finished goods, parts required for destructive testing, and service parts requirements are examples of independent demand.

Dependent Demand

The demand that is directly related to or derived from the bill of material structure for other items or end products. Such demands are therefore calculated and need not and should not be forecast. A given inventory item may have both dependent and independent demand at any given time.

Make-to-order

The finished goods are not produced until a customer order is received, and the raw materials may not even be ordered from the supplier(s) in advance.

Inventory Turnover

The number of times that an inventory cycles, or 'turns over,' during the year. A frequently used method to compute this is to divide the average inventory level into the annual cost of sales. It measures the speed with which inventory passes through an organization or supply chain.

Annual Demand Volume

The projected cumulative quantity of the item to be consumed/ sold over the course of a year.

Fixed-Order Quantity

The same order quantity is used from order to order. The time between orders (i.e., order period) then varies from order to order. When the inventory position drops to a predetermined reorder point, the same predetermined quantity order is placed.

Production lot sizes

The supplier may require the company to order an item this way, particularly if the supplier does not have any other customers for that item.

Cycle stock, Safety stock, and Strategic stock

The three main inventory stocking levels.

Line Item Fill Rate

The total number of line items filled divided by the total number of line items ordered. This metric applies to products or orders that contain multiple products.

Absolute Inventory Value

The value of the inventory at either its cost or its market value. It is the cost of all finished goods and materials a company has on hand. Computed on (1) a FIFO, i.e., first in first out basis, meaning that the oldest inventory is used/sold first, (2) a LIFO, i.e., last in first out basis, meaning the newest inventory is used/sold first, or (3) a standard cost basis, to establish the cost of goods sold.

Unit Cost

Total expenditure incurred by a company to produce, store, and sell one unit of a particular product or service. They include all fixed costs, or overhead costs, and all variable costs, or direct material costs and direct labor costs, involved in the production.

Measurements specifically for analyzing inventory

Units: the number of units available Dollars: the number of dollars tied up in inventory Days/Weeks/Months of Supply: (Avg. on-hand inventory) / (Avg. usage) Inventory Turns: (Cost of goods sold) / (Average inventory at cost)

Replenishment philosophy

Used with independent demand. Reordered when the current inventory diminishes to a predefined level

Reorder Point without Safety Stock

When inventory drops down to 50 units, a replenishment order is triggered for delivery in 10 days: 5 units of demand per day x 10 days of lead time needed for replenishment = reorder point of 50 units of remaining inventory. In this example the replenishment order will be delivered to the company just as the inventory drops to zero but not faster, avoiding a stockout.

Reorder Point with Safety Stock

When inventory drops down to 75 units, a replenishment order is triggered for delivery in 10 days: 5 units of demand per day x 10 days of lead time needed for replenishment + safety stock of 25 units = reorder point of 75 units of remaining inventory. In this example, the replenishment order will be delivered to the company 10 days after the order is placed when there are still 25 units remaining in inventory.