Logistics Chapter 7
4 Reasons Why We Hold Inventory
1. To meet customer demand 2. To Buffer against uncertainty in demand and supply 3. To decouple Supply from demand 4. To decouple dependencies in the supply chain
inventory
A key decision in any product-based supply chain is how much inventory to keep on hand.
Segmentation Strategy: ABC Classification
Allows different inventory management techniques to be applied to different segments of the inventory in order to increase revenue and decrease costs B items require closer management since they are relatively more expensive per unit , require more effort to purchase/ make & may be prone to obsolescence
Inventory Days of Supply
Calendar days of sales available based on recent sales activity SCM seeks to minimize inventory days of supply in order to reduce the risks of excess and obsolete inventory. Excess inventory tends to tie up operational cash flow, so there is a financial benefits to minimizing this metric.
Policies and Parameters
Defined at the detail level
Review Frequency & Reorder Point Formulas
Defines how often inventory levels are reviewed periodic review perpetual review Both methods compare the items on hand and on order inventory to the reorder point. If the total is less than or equal to the order point, then a replenishment order is initiated
Reorder Point
Defines when a replenishment order is initiated
Dependent Demand Items
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 However, these assumptions do not always hold true . .
Inventory Ordering Costs
Incurred each time an order is placed -perpetration costs -transportation costs -receipt processing costs -material handlings cost Total cost is driven by inventory planning decisions which establish when and how much to order Purchase cost+ Ordering cost+ Holding cost= Total Cost
Dependent Demand
Internal demand for parts and materials based on the demand for the final product in which the parts and materials used
Inventory Metrics
Inventory Carrying Costs Inventory Accuracy
Pipeline Inventory
Inventory in the transportation network and the distribution system. Inventory that is already out in the market being held by wholesalers distrbutors and retailers The ownership of this inventory has been transferred to the trading partners, but may still influence decisions the company makes regarding how they manage and control their internal inventory and how much safety stock and or strategic stock
Inventory
Inventory is usually one of the company's largest assets, so careful management of that asset is an essential business requirement.
Obsolete Inventory
Inventory items that have met the obsolescences criteria established by the company Obsolete inventory is stock that is expired, damaged or no longer needed Never be sold or used at full value Cost associated with disposal of the inventory
Cycle Stock
Inventory that a company builds to satisfy its immediate demand Depletes gradually as a customer orders are received and is replenished cyclically when supply orders are received
Inventory Management- Who are your key customers?
Manufacturers (internal/external), Wholesalers, Distributors, Retails, Consumers
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 1. Quick Response 2. Vendor Managed Inventory VMI 3. Profile Replenishment PR
Segmentation Strategy
Specifies all aspects of inventory management for each segment of inventory
3 Levels of Internal Inventory Held By Companies
Strategic Stock Safety Stock Cycle Stock ----------------
Volume Economies of Scale
The EOQ calculation will be impacted by volume economies of scales such as the following - individual item purchase price discounts - multiple item purchase price discounts - transportation freight rate discounts aka - ordering large quantities - ordering combo of items - lower the per unit costs
Performance Cycle
The elapsed time between release of a purchase order by the buyer to the receipt of shipment
Days of Supply DOS
The most common KPI used by managers in measuring the efficiency in supply chain. (Average Inventory/ Monthly demand) x 30
Case Fill Rate
The percent of cases ordered that are shipped as requested
Order Fill Rate
The percent of customer orders filled completely as requested
Calculating Safety Stock- Considerations
There are numerous other deterministic safety stock formulas than those that are covered here. Some models can be quite complex. A company will have to determine which of the many formulas is the most appropriate for their products. Many companies calculate safety stock based on demand uncertainty alone, and rely on that to at least partially cover for supply uncertainty as well. If an item has a known supply uncertainty, an additional quantity of safety stock may be added to compensate.
Maintenance, Repair & Operating MRO supplies
These are materials that you need to run the manufacturing operation and the business, but do not end up as a part of the finished product Separate from production inventory but just as important
Inventory Deployment Planning Approaches
Two planning approaches to coordinate inventory requirements across multiple locations in the supply chain -Fair Share allocation -Requirements Planning
End of Life Management
With the ABC analysis , inventory planners can forecast the declining demand manage the stock levels accordingly; reducing inventory levels to minimize carrying costs and avoid obsolescence
Maintaining adequate Materials Inventory
allows a company to support manufacturing operations and the production plan while avoiding delays.
Failing to Manage Inventory Adequately
can lead to significant issues and inefficiencies throughout the supply chain, including dissatisfied customers, lost sales and revenue, and higher costs
Calculating Safety Stock Formula 2
chapter 7 slide 40
fair share allocation
determines a fair share % of the available supply which is then allocated to each competing demand
PR Profile Replenishment
extends QR and VMI by giving suppliers the right to anticipate future requirements according to their knowledge of a product category (JIT II)
Supply Uncertainty
how long will it take to replenish inventory with our customers
How do the inventory decisions you make?
impact service levels to you customers impact the total cost serve
Requirements Planning
integrates across supply chain taking into consideration unique requirements - MRP materials requirements Planning - Distribution Requirements Planning DRP
Resource Allocation
is a continuous process requiring periodic tracking of class A items. If a class A item is no longer desired by the customers or has lower demand, the item can to be moved to a lower classification.
VMI (Vendor Managed Inventory)
is a modified QR that eliminates the need for replenishment orders
Quick Response
is a technology-driven cooperative effort between retailers and suppliers to improve inventory velocity while matching supply to consumer buying patterns
Periodic Review
monitor inventory status of an item at regular intervals such as weekly or monthly
Perpetual Review
monitor inventory status of an item continuously
Obsolescence
the model may generate an order quantity which would create spoilage or obsolscence
Unitization
the supplier may require the company to order an item in full pack, case, or pallet configurations
Production lot size
the supplier may require the company to order an item in full production lot sizes
Demand Uncertainty
when and how much product will our customers order
Safety Stock in Dependent Demand Situations
3 Approaches to introduce safety stock into dependent demand situations if necessary 1. Add safety time into the requirement plan 2. Increase the replenishment order by a quantity specified by some estimate of expected plan error 3. Utilize statistical techniques to et safety stocks directly for a component rather than to the item of top level demand
Order Quantity Determination : EOQ Economic Order Quantity
A quantity decision model based on the trade off between the annual ordering costs and the annual carrying costs
DRP distributed requirements plannning
A time-phased finished good inventory replenishment plan in a distribution network. The function of determining the need to replenish inventory at branch warehouses. DRP is a logical extension of the MRP system and ties physical distribution to the manufacturing planning and control system
Inventory Optimization
ABC analysis allows inventory planners to organize high priority items aligned to customer requirement. Inventory levels can be set to satisfy to high demand items while also carrying low stock for undesirable items.
Customer Service Levels
ABC analysis allows planners to set customer service levels based on the product classification, which improves the overall supply chain performance by carrying less safety stock. The customer service level is set by product and depends on multiple factors such as the item cost, demand, and margin.
Strategic Pricing
ABC analysis helps in setting the prices strategically for products which bring more value to the company. Prices for highly desirable products can be increased which will have a significant impact on profits.
Segmentation Strategy: ABC Classification
ABC highest to lowest 20% of items is 80% of the cost
Strategic Stock
Additional inventory beyond cycle stock and safety stock, generally used for a very specific purpose of future event and for a defined period of time Also called anticipation stock Protect against a short term disruptive event in supply Life cycle changes, seasonal demand, new product launch
Safety Stock
Also known as Buffer Stock, is inventory that is above and beyond what is actually needed to meet anticipated demand A quantity of stock planned to be inventory to protect against fluctuations in demand or supply Companies operating in a make to stock environment will generally maintain some amount of safety stock
Planning Safety Stock Requires Three Steps
Determine the likelihood of a stockout using a probability distribution, i.e., forecast accuracy/error Estimate the demand during a potential stockout period Establish the desired level of stockout protection, i.e., the desired service level
Know how to calculate EOQ for test
EOQ= square root of ( 2xordercostxannual demand ---------------------- annual inventory carrying cost% x purchase price
Product/ Market Classification
Groups products. markets, or customers with similar characteristics together to facilitate inventory management
Maintaining Adequate Finished Product Inventory
Maintaining adequate finished product inventory allows a company to fill customer orders immediately
inventory carrying costs
Measures how much it costs a company to store inventory over a given period of time. Inventory carrying rate x average inventory value
Calculating Safety Stock Formula 1
Multiply maximum daily usage by maximum replenishment lead time in days. Multiply average daily usage by average replenishment lead time in days. The difference between the two is the calculated Safety Stock.
Common Measures of Service Level Include
Performance Cycle Order Fill Case Fill Rate Line Fill Rate
External Inventory Held
Pipeline Inventory - inventory in transit -inventory held/owned by suppliers
Safety stock to plan for Uncertainty
Planning for both demand and supply uncertainty requires combining two independent variables as the joint impact of the profitability of both demand and supply variations must be determinded METHOD for determining this is to combine standard deviations using a CONVOLUTION formula
Calculating Safety Stock
Probability theory enables the calculation of safety stock for a target service level Service level is equal to 100% minus the 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 error (demand exceeds forecast
Inventory Carrying Cost Policy
The carrying cost percent used by a firm is a managerial policy, typically around 24% 2% per month
Supplier Negotiation
The company can prioritize and focus on negotiating with suppliers of the class A category items since they represent 70% - 80% of the money spent. The negotiation needs to be win-win. The supplier needs to make a reasonable profit from the deal while helping the company get the desired quality product and services at the lowest price.
Independent Demand
The demand for final product. Demand pattern affected by trends, seasonal patterns, & market conditions
Practical Use of EOQ
The experienced supply chain practiioner will check each application of EOQ to be sure that is valid for practical situation at hand In the real world EOQ is geenrally used as a baseline With a thorough understanding of EOQ the technique can be used to yield some benefits by its modification based on experience
EOQ
The intersection of the Annual ordering costs and the annual inventory carrying cost will yield the lowest annual total cost
Inventory Turnover
The number of times that a company's inventory cycles per year. Cost of Goods Sold/ Average Inventory The inventory turnover ratio is a key metric for determining how efficiently a company manages its' inventory and generate sales from it. It measures the number of opportunities to earn profit that a company experience each year from the working capital invested in inventory. A higher inventory turnover means lower inventory levels and indicates an efficient supply chain. Every unit/dollar of inventory that a company can reduce drops right to the bottom line as pure savings
Line Fill Rate
The percent of order lines (items) that were filled completely as requested
Fill Rate
The percentage of a customer's order that is filled on the first shipment. This can be represented as the percentage of items, SKUs or order value that is included with the first shipment. (1-((total items-shipped items)/Total Items))x100
Perfect Order Measurements
The percentage of orders that are error-free. A Perfect Order is delivered complete, on time, at the right location, in perfect condition, with complete and accurate documentation (total orders- error orders)/Total Orders)) x 100
Total US Inventory internal+external
Understanding external pipeline inventory levels may help a company to determine internal safety stock levels internal - average 6 weeks external- average 6 weeks
VMI (Vendor Managed Inventory)
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
Service Levels
is a performance target specified by management and defines inventory performances objectives Generally the higher the service level target, the higher the amount of inventory you will need to assure the target is achieved
Inventory Accuracy
refers to how well the inventory records agree with physical count An important metric because misleading inventory levels may make it seem that a company has more inventory than it actually does, which leads the company to sell stock that is not available which results in dissatisfied customers. Inaccurate inventory data may also obscure inventory that is actually available, which can lead to stock remaining in a warehouse and ultimately becoming obsolete.
Inventory Carrying Costs
the expense associated with maintaining inventory components: - cost of capital -taxes -insurance -obsolescence -storage typically expressed as a percentage of inventory
Transportation
the item being ordered and transported may require specialized or dedicated transportation, impacting the quantity per order
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
Benefits of a Segmentation Strategy such as ABC
1. End of Life Management 2. Supplier Negotiation 3. Inventory Optimization 4. Strategic Pricing 5. Resource allocation 6. Customer service levels
Inventory Mangement Practices
- Product/ Market Classifications - Segmentation Strategy - Policies and Parameters
Assumptions of the EOQ Model
-Calculated for one product at a time - the demand must be known and constant - lead time is known and stable -replenishment and instantaneous
4 Categories of Inventory
-Raw Materials (RM) -Work-in-Process (WIP) sometimes called Work-in-Progress -Finished Goods (FG) -Maintenance, Repair and Operating supplies (MRO) - items within these categories can be current or obsolete
Constraints on the Practical use of EOQ
-limited capital - storage capacity - transportation - obsolescence -production lot size - unitization