SCM Chapter 4 - Inventory Management

Service Inventory

Activities carried out in advance of the customer's arrival

Failing to manage inventory leads to...

dissatisfied customers, lost sales and revenue and higher costs

A key decision in any product-based supply chain is...

how much inventory to keep on hand

Inventory is one of the company's...

largest assets

Having too much inventory:

-Financial resourced tied up in inventory -Underlying problems being hidden rather than being exposed and solved, including quality problems not being immediately identified -No incentive for process improvements

Fixed-Time Period System

-Inventory is checked in fixed time periods against a target inventory level -If the inventory is less than target, a quantity necessary to bring inventory back up to the target level is ordered -The amount of inventory ordered will potentially vary from period to period based on the remaining inventory at each time interval checked

Facilitating goods

Because companies in the service industry do not maintain inventory of services since services are basically produced and consumed immediately upon demand, they maintain inventory of *"facilitating goods"* which are items that are used to help facilitate the service being provided

How much raw material should a company hold in inventory?

- Buy from a supplier and have it delivered to the operation just in time for when it is needed - Buy and hold a larger quantity for strategic reasons

Barcodes

Barcode systems help businesses track products and stock levels for inventory management -Linear (1D) Bar codes > Have limitations: They are 1D, can only be read horizontally, and can only hold a max of 85 characters -2D Bar codes: graphical image that stores info both horizontally and vertically >Can store over 7k characters, allows transmission of almost 2 paragraphs of info -Barcode reader

Base Stock Level System

a type of inventory system that issues an order whenever a withdrawal is made from inventory - replenishment order quantity is equal to the quantity withdrawn from inventory - used for very expensive items - *a form of JIT*

Internal Inventory Stock Levels

1. Strategic Stock 2. Safety Stock 3. Cycle Stock

Why hold inventory?

1. To meet customer demand (cycle stock) 2. To buffer against uncertainty in demand and/or supply (safety stock) 3. To decouple supply from demand (strategic stock) 4. To decouple dependencies in the supply chain

Measuring Inventory Performance

Common metrics for inventory: -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) Every unit/dollar of inventory that you can reduce drops right to the bottom line as pure savings

Safety Stock De-couples the Supply Chain

Cumulative Lead Time without Safety Stock is 15 months Cumulative Lead Time with Safety Stock to De-Couple Al and FG Lead Times is 2 months

Inventory Policy

Establishing target inventory levels for all products and materials -Addresses these three fundamental questions: 1. When to review? 2. When to order? 3. How much to order?

Make-to-Order

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. *Little to no finished goods inventory is maintained.*

A. Fixed Order Quantity System

If the review determines that an order should be placed, then the order for a pre-defined quantity for the item is placed. Two main variables to calculate: -Reorder Point -Order Quantity

Practical Considerations of EOQ (Volume Economies of Scale)

Individual Item Purchase Price Discounts -Discounts for ordering larger quantities -If the volume discount is sufficient to offset the added cost from carrying additional inventory, then ordering a larger volume may be desirable Multiple-Item Purchase Price Discounts -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 Transportation Freight-Rate Discounts -Ordering a larger quantity may mean that you can take advantage of Transportation Freight-Rate Discounts which will lower the per unit costs

Practical Considerations of EOQ (Constraints)

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

Inventory Control Tools

Many inventory control tools exist in today's market. i.e., Linear barcode, 2D barcode

Inventory Order Costs and Carrying Costs

Order Costs - incurred each time an order is placed -Order preparation costs -Order transportation costs -Order receipt processing costs -Material handling costs Carrying Costs - incurred for holding inventory -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 -Storage: facility expense related to product holding rather than product handling

What is inventory?

Quantities of goods/materials held in stock Examples: raw materials, work-in-process, items supporting production, finished products needed to provide customer service

ROP without Safety Stock is less than

ROP with Safety Stock

Safety Stock Policy

Safety stock to cover for variability in both Demand and Supply

Obsolete Inventory

Stock that is expired, damaged, or no longer needed - Will never be used or sold at full value

Inventory Management

The function of planning and controlling inventories - The goal of inventory management is to help a company be more profitable by lowering the cost of goods sold and/or by increasing sales

Safety Stock

"Buffer stock" is inventory that is above and beyond what is actually needed to meet anticipated demand -Companies operating in a make-to-stock environment will generally maintain some amount of safety stock

Having too little inventory:

-Production disruptions -Longer delivery replenishment lead times -Reduced responsiveness

Companies store excess raw material inventory if:

-they fear there may be a potential shortage -they suspect an upcoming price increase

How much to Order?

1. Fixed-Order Quantity System 2. Fixed-Time Period System

4 main categories of inventory

1. Raw materials 2. Work-in-Process (WIP) 3. Finished goods 4. Maintenance, Repair and Operating (MRO) supplies

Work-In-Process

A good, or goods in various stages of completion throughout the plant, spanning from raw material that has been released for initial processing up to fully processed material awaiting final inspection and acceptance as finished goods

"Black hole"

Many companies WIP as the "black hole" of inventory as they may not have very good/timely visibility into this part of their inventory

Other Types of Inventory Systems

Other types of inventory systems which are essentially variations on the basic continuous and periodic review methods are: - ABC System - Bin System - Base Stock Level System - "Single-Period" Inventory Model

External Inventory Stock Levels

Pipeline Inventory

Radio Frequency Identification (RFID)

Successor to the barcode for tracking individual unit of goods. RFID does not require direct line of sight to read a tag, and the info on the tag is updatable

When to Order?

The lowest inventory level at which a new order must be placed to avoid a stockout is known as the Reorder Point (ROP) The ROP is set at a level that provides enough inventory so demand is covered during the lead time needed to replenish inventory

B. Fixed-Time Period System

The order quantity is the difference between on-hand stock on the review day, and a pre-determined target inventory level. The order quantity will differ from one order to another depending on the on-hand quantity on the day of the review.

Finished Goods

Those items on which all manufacturing operations, including final testing, have been completed. These products are available for sale and/or shipment to the customer

When to Review?

Two models for determining When to Review: -Continuous Review System -Periodic Review System

Single-Period Model

a type of inventory system in which inventory is only ordered for a one-time stocking -objective: to maximize profits

Maintaining adequate finished product inventory allows a company to...

fill customer orders immediately

Inventory can be ...

one of the largest and most important assets of an organization. However, too much can be a significant liability

Finished goods are usually..

worth much more than raw materials or WIP since all of the material, labor, and overhead costs are fully applied to finished goods

ABC System

An ABC system classifies inventory based on 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

RFID

Automates the supply chain: -Materials management: goods automatically counted and logged as they enter the supply warehouse -Manufacturing: assembly instructions encoded on RFID tag provide info to computer controlled assembly devices -Distribution Center: shipment leaving DC automatically updates ERP to trigger a replenishment order and notify customer for delivery tracking -Retail Store: no check out lines as scanners link RFID tagged goods in shopping cart with buyers credit card

Fixed-Order Quantity System

-A continuous inventory review system in which the same order quantity is used from order to order -When the inventory position drops to a predetermined reorder point, a predetermined fixed order quantity is placed -The time between orders varies from order to order

Inventory Investment

-Absolute inventory value: the value of the inventory at either its cost or its market value (generally found on the balance sheet) -Inventory Turnover: the number of times that an inventory cycles, or "turns over" during the year (The more it turns, the better!)

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. -A company may decide to carry strategic stock to: >hedge currency fluctuations >take advantage of a price discount -Also called anticipation stock, build stock or seasonal stock

Assumptions of the EOQ Model

-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 -The purchase price 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

Make-to-Stock

Product is produced prior to receipt of a customer order. A forecast and demand plan are created and the finished goods are produced and held in inventory until a customer order is received. *Significant amounts of finished goods inventory can sometimes be maintained.*

Raw Materials

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

It is best practice to

minimize the amount of WIP inventory since too much WIP may clutter up the physical space and impede the process flow

Maintaining adequate materials inventory allows a company to...

support manufacturing operations and production plan while avoiding delays

Costs Related to Inventory

-Direct costs: directly traceable to unit produced (materials, labor, etc.) -Indirect costs: cannot be traced directly to the unit produced (overhead, MRO items, buildings, equipment) -Fixed costs: independent of the unit volume produced (buildings, equipment, rent) -Variable costs: dependent on the unit volume produced vary with output level (materials, labor, utility power) -Order costs: labor costs associated with placing an order for inventory and the cost of receiving the order -Carrying costs: costs for physically having inventory on-site and for maintaining the infrastructure needed to store the inventory and to secure and insure it over time

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 -Ownership of this inventory has been transferred to the trading partners but can still influence decisions the company makes regarding how they manage and control their internal inventory and how much safety stock and/or strategic stock to hold

Cycle Stock

-Inventory that a company builds to satisfy its' immediate demand -Cycle stock depletes gradually as customer orders are received, and is replenished cyclically when supply orders are received -Amount of cycle stock depends on actual demand in the immediate time period, supply replenishment lead time and order quantities

Effective inventory management balances two competing considerations:

-Reducing the amount of inventory held in stock while... -Ensuring there is enough inventory to satisfy customer demand

MRO

-Some MRO items are consumed during the process of converting raw materials into finished goods e.g., oil for the manufacturing equipment -Other MRO items are used to facilitate the manufacturing operation e.g., cleaning supplies, spare parts, etc. -While still other MRO items may be used to facilitate the company's administrative activities e.g., office supplies, coffee for the break room, etc.

ABC System (continued)

A method to determine which inventories should be counted and managed more closely than others -Groups inventory as A, B, or C based on a set criterion - 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 - 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

Economic Order Quantity Model (EOQ)

A quantitative decision model based on the trade-off between annual inventory carrying costs and annual order costs. EOW is a fixed-order quantity model -Seeks to determine an optimal order quantity where the sum of the annual order costs and the annual inventory carrying costs is minimized

Continuous Review System

Inventory levels are continuously reviewed -As soon as inventory falls below a pre-determined level, a replenishment order is triggered -More costly than periodic review system, but requires less safety stock because inventory is constantly monitored and replenishment actions are taken more quickly >Advantages: -Allows for real-time updates of inventory, which can make it easier to know when to replenish -Facilitates accurate accounting, since the inventory system can generate real time costs of goods sold >Disadvantages: -Cost of implementation. Generally requires and automated system. The hardware and software necessary to run the system can be expensive to purchase, install, and maintain

Periodic Review System

Inventory levels are reviewed at a set frequency (weekly, monthly) -At the time of review if the stock levels are below the pre-determined level, an order for replenishment is placed, otherwise no action is taken until the next cycle. -Since items are only reviewed periodically, there is a greater risk of inventory dropping well below the reorder point between reviews and, therefore, a greater potential need for safety stock >Advantages: -Reduces the time spent analyzing inventory -Less expensive than a Continuous Review System >Disadvantages: -May not provide accurate inventory counts for businesses with high sales -Can be difficult to determine the best review/reordering intervals -It also can make inventory accounting less accurate

Bin System

Inventory system that uses either one or two bins to hold a quantity of the item being inventoried -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 arrives

Maintenance, Repair and Operating (MRO)

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. -Materials that need to run the manufacturing operation and the business but *do not end up as part of the finished product*