OM Quiz 3 (Final)

Maintenance/repair/operating (MRO)

- Necessary to keep machinery and processes productive. - They exists because the need of timing and maintenance and repair of some equipment are unknown.

Periodic Inventory Systems

- Require regular checks of inventory - Small retailers and facilities with vendor-managed inventory use these periodic systems - If vendor-managed inventory system is in place, it requires a lot of trust to the vendor for inventory replenishment. Amazon uses vendor managed inventory

Work in Process (WIP)

- Undergone some change but not completed - WIP exists because of the cycle time of the products or different processes they go through - Reducing cycle time can reduce WIP inventory.

Why is inventory management important?

-A firm's inventory strategy can be a key driver of its success or failure. -Uncertain demand -It's expensive

Recording Accurate Inventory Information

-Accurate records are a critical ingredient in production and inventory systems. -Incoming and outgoing record keeping must be accurate -Stockrooms should be secure -Necessary to make precise decisions about ordering, scheduling, and shipping

Why is inventory management important?: Uncertain Demand

-Inventory exists to prevent mismatch between supply and demand -Retailers keep inventory on their shelves since they cannot perfectly predict when shoppers will show up and what they will wish to purchase

Why is inventory management important?: It's Expensive

-Inventory is of the most expensive assets of many companies representing as much as 50% of total invested capital. -Inventory management is one of most crucial elements for organizations to accomplish their competitive priorities -It is not an easy job to determine the level of inventory to hold.

What does less inventory do? What does more inventory do?

-Less inventory lowers costs but increases chances of running out -More inventory raises costs but always keeps customers happy.

Why is inventory management important?: A firm's inventory strategy can be a key driver of its success or failure.

-Poor inventory management can erode customer service and quickly deplete cash, a severe problem for startups or other cash-starved firms -Inventory is also a substantial asset in many supply chains

Inventory Strategy 3 Metrics

1. Customer service 2. Inventory costs 3. Operational performance

Advantages of Cycle Counting

1. Eliminates shutdowns and interruptions 2. Eliminates annual inventory adjustment 3. Trained personnel audit inventory accuracy 4. Allows causes of errors to be identified and corrected 5. Maintains accurate inventory records

Other criteria than annual dollar volume that may be used through ABC Analysis

1. High shortage or holding cost 2. Anticipated engineering changes 3. Delivery problems 4. Quality problems

Systems for Managing Inventory

1. How inventory items can be classified (ABC analysis) 2. How accurate inventory records can be maintained

Based on ABC analysis one can employ policies such as:

1. More emphasis on supplier development for A items; better contracts, and relationships 2. Tighter physical inventory control for A items; more accurate control of the records, security 3. More care in forecasting A items

Accuracy of inventory records can be maintained by:

1. Periodic systems 2. Perpetual systems

Types of Inventory

1. Raw material 2. Work in process (WIP) 3. Maintenance/repair/operating (MRO) 4. Finished goods

Functions of Inventory

1. To provide a selection of goods for anticipated demand and to separate the firm from fluctuations in demand. Such inventories are typical in retail establishments. 2. To decouple or separate various parts of the production process. For example, if a firm's supplies fluctuate, extra inventory might be necessary to decouple production process from suppliers. 3. To take advantage of quantity discounts, because purchases in larger quantities may reduce the cost of goods or their delivery. 4. To hedge against inflation and upward price changes.

Why is managing the inventory strategy 3 metrics hard?

3 metrics are often conflicting, and improving one ends up with the deterioration of the other. For example, maximizing customer service would be easy if managers were not also concerned about manufacturing and inventory-related costs. On the other hand, managers can cut the number of products offered, but at the expense of customer service.

Calculate Days of Inventory

= 365 days / annual inventory turns

Calculate Annual Inventory Turns

=Annual COGS / Avg. Inv. (at cost)

If a business has high stock-out costs...

A business that perceives stock-out costs to be very high will try to maintain high service levels. -Ex: A supplier of windshields to an automobile manufacturer might risk losing its contract if it caused an auto assembly line to shut down. The supplier would perceive its stock out cost to far exceed its cost of carrying inventory where it aims for 100% customer service level.

Inventory Turns

A common way to evaluate inventory management is by measuring inventory turns over a period of time.

Inventory

A complete list of items such as property, goods in stock, or the contents of the building. The goods and materials that a business holds for the ultimate goal of resale.

ABC Classification

A method for determining level of control and frequency of review of inventory items. ABC Analysis can be done to segment items into value categories depending on annual dollar volume.

Pareto Principle

ABC Analysis is an inventory application of what is known s the Pareto principle (19th century Italian economist). The Pareto principle states that "critical few and trivial many". The idea is to establish inventory policies that focus resources on the few critical inventory parts and not to the many trivial ones. It is not realistic to monitor inexpensive items with the same intensity as very expensive items.

What does higher inventory turns mean?

Achieving higher inventory turns usually means that management is managing inventory more efficiently.

Class A Items

Class A items are those which sales or annual dollar volume is high. Typically 15-20% of the items in the inventory accounting for 70%- 80% of the total inventory dollar value.

Class B Items

Class B items are those inventory items of medium dollar value. Typically an additional 25-35% of the items in the inventory accounting for 15-25% of the inventory dollar value.

Class C Items

Class C items are those inventory items with low dollar value. Typically the remaining 55% of the items in inventory accounting for only 5-10% of the inventory dollar value.

Finished Goods

Completed product awaiting shipment. They might be stored for future customer demands can be unknown.

Setup Cost

Cost to prepare a machine or process for manufacturing an order. This includes time and labor to clean and change tools. In manufacturing environments, setup costs can depend on setup time. Reducing setup times could help with improving inventory investments.

Inventory Management

Discipline primarily about specifying the shape and placement of stocked goods. It is the planning and controlling of inventories to meet the competitive priorities of the organization.

ABC Analysis Classes based on annual dollar volume

Divides inventory into three classes based on annual dollar volume: - Class A - high annual dollar volume - Class B - medium annual dollar volume - Class C - low annual dollar volume

Periodic Systems: Cycle Counting

Even though the organization may have made substantial efforts to record inventory accurately, these records must be verified through a continuing audit. These audits are called cycle counting. Cycle counting uses inventory classifications developed through ABC analysis.

Stock-Out for a Retailer

For a retailer, stock-out means a delayed or lost sale.

From an investment perspective what can higher inventory lead to?

From an investment perspective, higher inventory levels can reduce return on assets. An increase in inventory levels without a corresponding increase in profits could erode a company's return on assets.

Stock-Out in Manufacturing Contexts

In manufacturing contexts, insufficient raw materials inventory means costly production stoppages, whereas a shortage of finished goods inventory can lead to lost sales.

Stock-Out in Service Settings

In service settings- customers waiting too long.

Importance of Inventory Related Costs

Industries especially those who have thin profit margins should be careful on how they manage their inventory.

Why can inventory management be difficult?

Inventory is very vital in delivering value to customers. But, carrying inventory is costly... Keeping the balance between customer service and inventory cost is not very straightforward.

How are items counted and how are records updated under cycle counting?

Items are counted and records updated on a periodic basis: -A items will be counted periodically - perhaps once in a month -B items will be counted less periodically - perhaps once in a quarter -C items will be counted perhaps every 6 months.

Obsolescence Costs

Obsolescence costs are incurred when an item in inventory becomes obsolete before it is sold or used. can be due to product perishability (price drop of a banana over time), technological innovations, change in customer tastes etc.

Raw Material

Purchased but not processed inventory. For example, steel, oil, corn, grain, lumber, plastic, coal etc.

If a business has low stock-out costs...

Some others might see their stock-out costs to be low, so they would accept relatively lower customer service levels -Ex: An ice-cream store that ran out of coffee flavor can likely to care less about stock-out cost, since customers can easily switch to another flavor.

Ordering Costs

The fixed costs of systems and labor required to place, receive, and audit a replenishment order. Transportation costs might be included if it's fixed per order

What is the objective of inventory management?

The objective of inventory management is to strike a balance between inventory investment and customer service.

Holding costs or Inventory carrying costs

The per-unit cost of holding or "carrying" an item in inventory over time including costs to finance the inventory, maintain storage facilities, rent, utilities, taxes, and insurance. Holding costs vary considerably depending on the business, location, and interest rates. Generally greater than 15%, some high tech and fashion items have holding costs greater than 40%.

Service Level

The probability that the organization can fulfill a customer's request - is a direct result of inventory decisions. Determining an appropriate service level requires making a critical trade-off between the cost of carrying inventory and the cost of a stock-out

What can turning inventory too fast lead to?

Turning inventory too fast could increase the ordering costs and the likelihood of stockouts.

Days of Inventory

We can also consider days of inventory, which is the "inverse" of inventory turns.

Perpetual Inventory System

tracks receipts and subtractions on a continuing basis (May be semi-automated barcode readers)