SCM: Ch. 9 - Managing Inventory in the Supply Chain

fixed order quantity EOQ model

Condition of certainty; Inventory is reordered when the amount on hand reaches the reorder point. The reorder point quantity depends on the time it takes to get the new order and on the demand for the item during this lead time. Basic assumptions of the simple EOQ model - Continuous, constant, and known rate of demand - Constant and known replenishment or lead time - All demand is satisfied. - Constant price or cost that is independent of the order quantity - No inventory in transit - One item of inventory or no interaction between items - Infinite planning horizon - Unlimited capital Given the assumptions, the simple EOQ model considers only 2 basic types of cost: inventory carrying cost and ordering cost. Because several factors can influence the reliability of demand (or usage rate) and lead time, the fixed order quantity model is adjusted by reformulating the reorder point to allow for safety stock.

Distribution Requirements Planning (DRP)

DRP systems accomplish for outbound shipments what MRP accomplishes for inbound shipments. DRP determines replenishment schedules between a firm's manufacturing facilities and its distribution centers. DRP is usually coupled with MRP systems to manage the flow and timing of both inbound materials and outbound finished goods.

Inventory Costs

Emphasize of inventory cost analysis should be placed on the variable components of these costs. 1. Inventory Carrying Cost: Inventory carrying costs incurred by inventory at rest and waiting to be used. Fourmajorcomponents:Capitalcost, Storage space cost, Inventory service cost, and Inventory risk cost. 2. Ordering and Setup Cost: Ordering cost refers to expense of placing an order, excluding the cost of theproductitself. Setupcostrefersto the expense of changing/modifying a production/assembly process to facilitate line changeovers. 3. Expected Stockout Cost: The cost associated with not having a product/materials available to meet customer/productiondemand. Most organizations hold safety stock or buffer stock, to minimize the possibility of a stockout and costs of lost sales. 4. In-transit Inventory Carrying Cost: Generally, carrying inventory in transit costs less than in warehouses. But, in- transit inventory carrying cost becomes especially important on global moves since both distance & time increas

Approaches to Managing Inventory

Fundamental Approaches: Fixed order quantity & Fixed order interval EOQ Additional Approaches: JIT, MRP, DRP, and VMI Managing inventory involved four fundamental questions: How much should inventory be ordered? When should inventory be ordered? Where should inventory be held? What specific line items should be available at specific locations?

ABC Classification

In many ABC analyses, a common mistake is to think of the B and C items as being far less important than the A items. However, all items in the A, B, and C categories are important to some extent and each category deserves its own strategy to assure availability at an appropriate level of cost (stockout cost vs. inventory carrying cost).

Key Factors of Difference

Inventory management approaches differ in terms of three key factors. 1. Dependent vs. Independent demand: Independent demand is unrelated to the demand for other items, while dependent demand is directly related to, or derives from, the demand for another inventory item or product. 2. Pull vs.Push: The "pull" approach relies on customer orders to move product through a logistics system, while the "push" approach uses inventory replenishment techniques in anticipation of demand to move products. 3. System-wide vs. Single-facility solutions: A system-wide approach plans and executes inventory decisions across multiple nodes in the logistics system. A single-facility approach does so for shipments and receipts between a single shipping and receiving point.

Quadrant Model

Items with high value and high risk (critical items) need to be managed carefully to ensure adequate supply. Items with low risk and low value (generic or routine items) can be managed much less carefully.

Just-in-Time (JIT)

JIT systems are designed to manage lead times and eliminate waste. Many JIT systems place a high priority on short, consistent lead times. However, the length of the lead time is not as important as the reliability of the lead time. - JIT commitment to short, consistent lead times and to minimizing or eliminating inventories is JIT principal differentiator from the more traditional approaches. - JIT saves money on downstream inventories by placing greater reliance on improved responsiveness and flexibility. - Successful JIT applications: -- Place a high priority on efficient and dependable manufacturing processes. -- Demand effective and dependable communications & information systems, and high-quality, consistent transportation services.

Materials Requirements Planning (MRP)

MRP deals specifically with supplying materials and component parts whose demand depends on the demand for a specific end product. 1. Ensure the availability of materials, components, and products for planned production and for customer delivery. 2. Maintain the lowest possible inventory levels that support service objectives. 3. Plan manufacturing activities, delivery schedules, and purchasing activities. An MRP system is designed to translate a master production schedule into time-phased net inventory requirements and the planned coverage of such requirements for each component item needed to implement this schedule.

MRP cons and pros

MRP pros: Maintain reasonable safety stock levels & minimize or eliminate inventories whenever possible. Identify process problems and potential supply chain disruptions before they occur, allowing necessary corrective actions. Base production schedules on actual demand and forecasts of independent demand items. Coordinate materials ordering across multiple points in a firm's logistics network. Suitable for batch, intermittent assembly, or project processes. MRP cons: Computer-intensive applications, making changes difficult once the system is in operation. Might increase ordering and transportation costs as firms moving toward a more coordinated system of ordering product in smaller amounts. Not as sensitive to short-term fluctuations in demand as order point approaches Frequently become quite complex and sometimes do not work exactly as intended.

Inventory Management Techniques in the Logistics Network

Many organizations today use all of the techniques shown in managing inventories in their logistics networks. In general, as an inventory technique manages inventory closer to the point of real demand (e.g. VMI and CPFR), forecast accuracy increases, forecast cycles decrease, and product availability increases.

Inventory Classification

Multiple product lines and inventory control require organizations to focus on more important inventory items and use more sophisticated and effective approaches to inventory management. ABC: ABC classification technique assigns inventory items to one of three groups according to the relative impact or value of the items that make up the group. A items are considered to be the most important, B items lesser importance, and C items least important. Pareto's Law "80-20" rule: suggests that a relatively small percentage of inventory might account for a large percentage of the overall impact or value. Quadrant model: classifies finished goods inventories using value and risk to the firm as the criteria. Value is measured as the value contribution to profit; risk is the negative impact of not having the product available when it is needed.

The Importance of Inventory in Other Functional Areas

Objectives of the finance area might obviously conflict with marketing and manufacturing objectives. A more subtle conflict sometimes arises between marketing and manufacturing as the long production runs can cause shortages of some products needed by marketing. - Marketing: In favor of holding sufficient, or extra, inventory to ensure product availability to meet customer needs and new product offerings for continued market growth. - Manufacturing: In favor of long production runs of a single product with minimal changeovers to lower labor and machine costs per unit, resulting in high inventory levels of the product. - Finance: In favor of low inventories to increase inventory turns, reduce liabilities and assets, and increase cash flow to the organization.

Carrying Cost vs. Ordering Cost

Ordering cost and carrying cost respond in opposite ways to changes in the number of orders or size of individual orders.

VMI pros and cons

Principal advantages of VMI systems: - The knowledge gained by the supplier of real-time inventory levels of its products at its customer locations allows the shipper more time to react to sudden swings in demand to assure that stockouts do not occur. - Principal shortcomings of VMI systems: - Suppliers' uses of VMI to push excess inventory to a customer distribution center at the end of the month in order to meet monthly sales quotas, resulting in the customer holding extra inventory, adding costs to its operations.

Cost vs. Service Tradeoff Considerations

Regardless of the approach selected, inventory decisions must consider the basic tradeoff between cost and service. As customer service level (%) increases, investment in inventory ($) increases.

Safety Stocks and Service Levels

The higher the service level requirement (lower stockout rate), the higher the inventory level requirement.

EOQ Approach

Two basic forms of the economic order quantity (EOQ) model 1. Fixed order quantity: - Involves ordering a fixed amount of product each time reordering takes place. - Also called two-bin model. 2. Fixed order interval: - Involves ordering inventory at fixed or regular intervals. - Also called the fixed period or fixed review period approach. - Generally, the amount ordered depends on how much is in stock and available at the time of review.

Vendor-Managed Inventory (VMI)

Vendor-managed inventory manages inventories OUTSIDE a firm's logistics network, specifically inventories held in its customer's distribution centers. How VMI works: The supplier and its customer agree on which products are to be managed using VMI in the customer's distribution centers => An agreement is made on reorder points and economic order quantities for each of these products => As these products are shipped from the customer's distribution center, the customer notifies the supplier, by SKU, of the volumes shipped on a real-time basis => The supplier monitors on-hand inventories in the customer's distribution center, and when the on-hand inventory reaches the agreed-upon reorder point, the supplier creates an order for replenishment, notifies the customer's distribution center of the quantity and time of arrival, and ships the order to replenish the distribution center.

Types of Inventory and Rationales

1. Procurement (purchase discounts), production (long production run), and transportation (freight rate discounts) 2. Demand- and supply-side uncertainties 3. Inventory costs associated with goods in motion during transportation time period. 4. Inventory costs associated with goods in process during manufacture or assembly of a complex product. 5. Seasonality in raw materials supply (e.g. production, transportation), in demand for finished product, or in both 6. Inventory hold in anticipation that an unusual event (e.g. strikes, significant price increase, extreme weather)