Chapter 7 - Inventory Management

Dependent Demand

- Describes the internal demand for parts based on the demand of the final product in which the parts are used. DETERMINED / CALCULATED DEMAND (Example: Pick-up Truck Engine)

Independent Demand

- The demand for the final product. Has a demand pattern affected by trends, seasonal patterns, & general market conditions. FORECASTED DEMAND (Example: Pick-up Truck)

Inventory Carrying Cost Components

-Cost of capital - specified by senior management -Taxes - on inventory held in warehouses -Insurance - based on estimated risk or loss over time and facility characteristics -Obsolescence - deterioration of product during storage, and shelf-life e.g., food and pharmaceutical sell-by dates -Storage - facility expense related to product holding rather than product handling is the expense associated with maintaining inventory Annual inventory carrying cost percent times average inventory value

A company may decide to carry strategic stock to:

-Hedge currency fluctuations -Take advantage of a price discount -Protect against a short-term disruptive event in supply -Take advantage of a business opportunity -For life cycle changes; seasonal, new product launch, transition protection. (Also called anticipation stock, build stock, or seasonal stock).

Service Level is

A performance target specified by management and defines inventory performance objectives -Generally, the higher the service level target, the higher the amount of inventory you will need to assure the target is achieved. --e.g. 90% of orders filled complete in 3 order cycle days.

B & C items

Account for the other 80% of the total number of items, but only 20% of total inventory cost. -B items require closer management since they are relatively more expensive (per unit), require more effort to purchase / make, & may be more prone to obsolescence. -C items have the lowest value, and hence the lowest priority

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.

Independent and Dependent Demand: INVENTORY MANAGEMENT MODELS:

Are generally classified as INDEPENDENT demand and DEPENDENT demand

Maintenance, Repair, and Operations (MRO)

Are materials that you need to run the manufacturing firm operations, but do not end up as part of the finished product.

Common Metrics for Inventory:

CUSTOMER SERVICE LEVE - measured as "fill rate" UNITS - the number of units available DOLLARS - the amount of dollars tied up in inventory WEEKS OF SUPPLY - (avg. on-hand inventory) / (avg. weekly usage) INVENTORY TURNS - (cost of good sold) / (avg. inventory value) INVENTORY CARRYING COST - (discussed with EOQ)

Perpetual review =

D X T + SS D=Average daily demand T = Average performance cycle length SS = safety stock

Segment Strategy

Definition specifies all aspects of inventory management process for each segment of inventory -e.g., service objectives, forecasting method, management technique, and review cycle

Determining How Much to Order

Economic Order Quantity - A quantitative decision model based on the trade-off between the annual ordering costs and the annual inventory holding costs

Profile Replenishment (PR)

Extends QR and VMI by giving suppliers the right to anticipate future requirements according to their knowledge of a product category (JIT II)

A items are

Given the highest priority. "80/20 rule" Generally, A items account for approximately 20% of the total number of items, but about 80% of the total inventory cost.

Product/Market Classification

Groups products, markets, or customers with similar characteristics to facilitate inventory management -e.g., classify by sales, profit contribution, inventory value, usage rate or item category

Requirements Planning

Integrates across the supply chain taking into consideration unique requirements -Materials Requirements Planning (MRP) is driven by a production schedule -Distribution Requirements Planning (DRP) is driven by supply chain demand

Inventory Carrying Cost Policy

Inventory carrying cost is an imputed cost. It doesn't appear in the financial statement. Companies determine the cost of capital they want to use which is typically the return they expect on investments. Final carrying cost percent used by a firm is a managerial policy

Policies and Parameters

Must be defined at a detailed level -e.g., data requirements, software applications, performance objectives, and decision guidelines

Inventory Ordering Cost Components

ORDERING COSTS - are incurred each time an order is placed -Order preparation costs -Order transportation costs -Order receipt processing costs -Material handling costs

Common measures of service level include:

PERFORMANCE CYCLE: -- the elapsed time between release of a purchase order by the buyer to the receipt of shipment ORDER FILL: -- the percent of customer orders filled completely as requested CASE FILL RATE: -- the percent of cases ordered that are shipped as requested LINE FILL RATE: -- the percent of order lines (items) that were filled completely as requested

INVENTORY CONTROL USING REACTIVE APPROACHES: Inventory control defines how often inventory levels are reviewed to determine when and how much to order

PERIODIC REVIEW monitors inventory status of an item at regular intervals such as weekly or monthly PERPETUAL REVIEW continuously monitors inventory levels to determine inventory replenishment needs

Approaches to implementing inventory management policies:

PUSH (Make-to-Stock) -Producing stock on the basis of anticipated demand. Proactively allocates inventory on the basis of forecasted demand and product availability PULL (Make-to-Order) -Producing stock in response to actual demand Responds to actual customer demand to pull the product through the distribution channel Hybrid approach uses a combination of push and pull

Safety Stock with Combined Uncertainty

Planning for both demand and supply uncertainty requires combining two independent variables The joint impact of the probability of both demand and supply variation must be determined -Direct method is to combine standard deviations using a convolution formula --The calculations are beyond the scope of this course but you should understand that the concept exists and there is a method for addressing this situation.

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 --e.g., a service level of 99% results in a stockout probability of 1% -The most common probability distribution for demand is the normal distribution, i.e., "bell curve" --From analysis of historical demand data the safety stock required to ensure a stockout only 1% of the time is possible --A one-tailed normal distribution is used because only demand that is greater than the forecast can create a stockout. ---Is the forecast error bias on the over-forecast or under-forecast side of the bell curve? (Safety stock is only needed for under-forecast).

Collaborative Inventory Replenishment Programs

REPLENISHMENT PROGRAMS are 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

Periodic review =

ROP = D(T + P/2) + SS D=Average daily demand T = Average performance cycle length P = review period in days SS = safety stock PERPETUAL DOESN'T USE P VARIABLE

When is safety stock needed

Safety stock is only needed for under-forecast (demand exceeds forecast) error!

Vendor Managed Inventory detail (VMI)

VMI arrangements transfer the responsible for managing the inventory located at a customer's facility back to the vendor/manufacturer of that inventory. The vendor/manufacturer: -Stocks inventory -Places replenishment orders -Arranges the display -Typically owns inventory until purchased -Is required to work closely with customer

EOQ ='s

Where the sum of the annual ordering costs and the annual inventory holding costs is minimized SQRT of (2XCost per orderXAnnual sales volume/Inventory carry cost*Cost p/unit)

Fair Share Allocation

provides each distribution facility with an equitable distribution of available inventory -Limited ability to manage multistage inventories DS=AQ+Sum Inventory for each whse /sum of daily demand for each whose Amount allocated = (DS * D) - I DS = Common days supply for warehouse inventories AQ = Inventory units to be allocated from plant warehouse = 500 Ij = Inventory in units for warehouse J Dj = Daily demand for warehouse J

Other Important Inventory Related Definitions

-INVENTORY CONTROL is the managerial procedure for implementing an inventory policy -DEMAND UNCERTAINTY involves the variation in sales during the lead time necessary to replenish inventory -SUPPLY (or performance cycle) UNCERTAINTY involves variation in the time and/or quantity necessary to replenish inventory. TIME BUCKETS are discrete increments of time used to facilitate planning activities REORDER POINT defines when a replenishment order is initiated. CARRYING COST is the expense associated with maintaining inventory. -SAFETY TIME (aka, Safety Lead Time) is ordering an item earlier than necessary based on the lead time, to assure timely arrival. FILL RATE represents the magnitude of a backorder or stockout. Can be case fill rate, line fill rate, etc.

INVENTORY POLICY Who are your key customers/stakeholders?

-Manufacturers (internal/external), Wholesalers, Distributors, Retailers, Consumers -Level of service required (does it differ by customer) -What is important to them? -What value do they create? -What risks do they take?

DEPENDENT DEMAND IS: Determined / Calculated Demand

-Order quantities computed with Material Requirements Planning (MRP). -Relationship between independent and dependent demand shown in Bill of Materials (BOM). -Subassemblies, components, & raw materials are examples of dependent demand items. (Example: Pick-up Truck Engine)

EOQ Model Assumptions

-The model must be calculated for one product at a time. -The demand must be known and constant throughout the year. -The delivery replenishment lead time is known and does not fluctuate. -Replenishment is instantaneous. --There is no delay in the replenishment of the stock, and the order is delivered in the quantity that was demanded, i.e. in one whole delivery. -The purchase price (i.e., unit cost) is constant and no discounts or price breaks are factored into the model. -Carrying cost is known and constant. -Order cost is known and constant. -Stockouts are not allowed

Typical Adjustments to EOQ (Came with quizlet notes)

-Volume Transportation Rates offer a freight-rate discount for larger shipments -Quantity discounts offer a lower per unit cost when larger quantities are purchased -Ordering in full production lot sizes (due to vendor requirement, quality, etc.) -Multiple-item purchase (may generate a volume discount or other benefit) -Limited capital - may not be able to afford to buy the EOQ quantity at one time -Dedicated trucking (due to security reasons, cross contamination concerns, etc.)

Functions of Inventory - Why Hold Inventory?

1) To meet customer demand (Cycle Stock) 2) To buffer against uncertainty in Demand and/or Supply (Safety Stock) 3) To decoupling Supply from Demand (Strategic Stock) 4) To decouple dependencies in the supply chain.

Planning safety stock requires three steps:

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

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

1.) Put safety time into the requirements plan 2.)Increase the replenishment order by a quantity specified by some estimate of expected plan error, i.e., over-planning / top-level demand 3.) set safety stocks directly for a component rather than to the item of top-level demand

What are the 2 types of uncertainty we are trying to account for with safety stock?

1.)DEMAND UNCERTAINTY --When and how much product will our customers order? 2.)SUPPLY (Performance Cycle) UNCERTAINTY --How long will it take to replenish inventory with our customers? Variations must be considered in both areas to make effective inventory planning decisions.

Assumptions of Reactive (Pull) Inventory Logic

1.All customers, market areas, and products contribute equally to profits 2.Infinite capacity exists at the production facility 3.Infinite inventory availability at the supply location 4.Supply cycle time can be predicted and cycle lengths are independent 5.Customer demand patterns are relatively stable and consistent 6.Each distribution warehouse's timing and quantity of replenishment orders are determined independently of all other sites, including the supply source 7.Supply cycle length cannot be correlated with demand

Dependent Demand Replenishment

Dependent demand inventory requirements are a function of known events that are not random -Dependent demand does not require forecasting because there is no uncertainty -Generally, no specific safety stock is needed to support time-phased procurement programs (e.g., MRP) No safety stock ASSUMES: --Procurement replenishment is predictable and constant --Vendors and suppliers maintain adequate inventories to satisfy 100% of purchase requirements

Every unit/dollar of inventory that you can reduce

Drops right to the bottom line as pure savings

Pipeline Inventory

Inventory in the transportation network and the distribution system. Inventory that is already out in the market being held by wholesalers, distributors, retailers, and even consumers.

Cycle Stock (aka base stock)

Inventory that a company builds to satisfy its' immediate demand.

Vendor Managed Inventory (VMI)

Is a modified QR that eliminates the need for replenishment orders

Quick Response (QR)

Is a technology-driven cooperative effort between retailers and suppliers to improve inventory velocity while matching supply to consumer buying patterns

Safety Stock (Buffer Stock)

Is inventory that is above and beyond what is actually needed to meet anticipated demand. (Mostly used in a make-to-stock environment)

Obsolete Inventory

Is stock that is expired/out-of-date or no longer needed.

Formula for Calculating Safety Stock

K X sqrt(Lead time X dc) X 1.25 MAD K= Customer service level Lead time = time to replenish goods DC=Number of distribution centers where there's safety stock MAD = Mean absolute deviation of the monthly demand(past 12 months)

Practical Considerations of EOQ

LIMITED CAPITAL: --The model may generate an order quantity which the company does not have sufficient available funds to purchase at one time. STORAGE CAPACITY: --The model may generate an order quantity which the company does not have sufficient storage capacity to handle at one time. TRANSPORTATION: --The item being ordered and transported may require specialized or dedicated transportation, impacting the quantity per order. OBSOLESCENCE: --The model may generate an order quantity which would create spoilage or obsolescence. PRODUCTION LOT SIZE: --The supplier may require the company to order an item in full production lot sizes. UNITIZATION: --The supplier may require the company to order an item in full pack, case, or pallet configurations.

MRP and DRP

MRP systems reports information to the DRP system utilizing an integrated approach.

An ABC System 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

Inventory Definitions CATEGORIES of INVENTORY

There are four main categories of inventory: -Raw Materials -Work-in-process (WIP) (Sometimes called Work-in-Progress -Finished Goods -Maintenance, Repair, and Operations (MRO) supplies. -- Individual items within each of these inventory categories can be current or obsolete.

Total cost

Total Cost = Purchase Cost + Ordering Cost + Holding Cost Total cost is driven by inventory planning decisions which establish when and how much to order