Ch. 10 Inventory Management

ABC Inventory Classification

*ABC classification* is a method for determining level of control and frequency of review of inventory items A Pareto analysis can be done to segment items into value categories depending on annual dollar volume *A Items* - typically 20% of the items accounting for 80% of the inventory value-use Q system *B Items* - typically an additional 30% of the items accounting for 15% of the inventory value-use Q or P *C Items* - Typically the remaining 50% of the items accounting for only 5% of the inventory value-use P

Inventory Metrics

*Days-of-Supply* - The average amount of time (in days) it takes for a unit to flow through the system. *Inventory Turns* - The number of times the average inventory flows through a process in a designated interval of time. *Service Level* - The percent of time of being able to meet customer demand with available stock. *Stock outs:* Number of times there is no inventory is available to meet a customer's needs.

Capabilities Needed for Effective Inventory Management

*Forecasting* how much is needed and where *Data Tracking* where are items *Data Analysis* how can we most efficiently store items *Storage and material handling* building, equipment, etc

Disadvantages of Inventory

*Higher costs* -Item cost -Ordering (or setup) cost ◦Costs of forms, clerks' wages etc. -Holding (or carrying) cost ◦Building lease, insurance, taxes etc. *Difficult to control* (due to "variability" in demand, production and logistics factors, quality etc.) *Hides production* *quality problems*

Inventory Types

*Inventory* The number of flow units within the process. Inventory is found in all stages of processes *Raw material* has not been "worked on" *Work-in-process (WIP)* inventory that is inside the process has been "started on" *Finished goods* the process is complete and does not require additional processing *Safety Inventory* Inventory needed to buffer against demand uncertainty. Also called Safety stock. Safety inventory can be raw materials, WIP or finished goods.

Inventory Costs

*Stockout* occurs when a customer demands an item that is not available in inventory *Opportunity Cost of Capital* the income not earned on the amount *Inventory Storage Cost* cost incurred to properly store, maintain, and insure inventory *Obsolescence Cost* cost associated with losing value over time because of either technology change or shifts in fashion *Spoilage and Shrinkage Costs* costs associated with theft or product deterioration over time *Holding Cost Percentage* ratio of the cost to hold

Inventory Holding Cost Percentage

*The annual holding cost percentage is set by the retailer.* -Varies by product and company -Takes into account the cost of capital for the industry. -*Durable goods* typically have a holding cost percentage of around *20 - 30%.* -*Tech, fashion, and perishable items* can be as high as *50 - 100%.*

Inventories in the Supply Chain

-raw materials -components -work in process (WIP) -finished goods -distribution inventory -maintenance repair & operating supplies (MRO)

Objectives of Inventory Management

1. Provide acceptable level of customer service (on time delivery) 2. Buffer mismatches between supply and demand 3. Allow cost efficient operations 4. Minimize inventory investment

ABC Classification

A - extremely important B - moderately important C - relatively unimportant

Which is true? A.The cost of spoilage increases with lower levels of inventory. B.Companies consider the opportunity cost of holding inventory when determining how much inventory to hold. C.Obsolesce cost is a reason to increase inventory levels. D.A stockout cost is incurred when there is not enough room in the warehouse to hold all of inventory and extra space must be contracted out of the facility.

B.Companies consider the opportunity cost of holding inventory when determining how much inventory to hold.

Which is not a reason to have inventory? A.To level production for anticipated increases in demand. B.To increase the utilization of expensive machines. C.To qualify for a quantity discount on an order. D.All are reasons to hold inventory.

B.To increase the utilization of expensive machines.

The Purpose of ABC Analysis is to: A.Gauge the level of literacy in the work force. B.Reduce the level of inventory. C.Already Been Counted: indicate which items have been inventoried already. D.Determine which items in inventory should be monitored with the most intensity.

D.Determine which items in inventory should be monitored with the most intensity.

Inventory Turns and Days-of-Supply

Days-of-supply = T = Flow time Annual turns = Annual cost of goods sold/Inventory Days-of supply = 365 X Inventory/Annual cost of goods sold

Inventory Performance Metrics

Flow Time = $ Inventory / COGS Inventory Turns = 1/Flow Time Interpretation of inventory turns: *The number of times the company sold out and restocked its inventory during the reporting period.*

Why have Inventory? (continued)

Inventory exists for a number of reasons and in any situation there may be multiple reasons present: *Flow time* it takes time to move something from one place to another *Seasonality* predicted periods of Batching - *Buffers* to deal with variability within a process *Uncertain demand* unpredictable variations in demand *Pricing* quantity discounts *Production Smoothing Strategy* a strategy for scheduling Inflation -

Key Concepts

Inventory is often a necessary evil. Inventory management tries to balance the costs of having too much inventory and having too little. ABC Inventory Management is a method of prioritizing the items that you need to track most closely in your inventory system. -Items that make up the biggest part of the value of your usage are assigned an A and inventory levels should be monitored constantly. -Items that make up the smallest part of the value of your usage are assigned a C and inventory levels can be monitored periodically.

Holding Cost of an Item

Most companies assess their inventory holding costs as a percentage of the cost to purchase an item. For example: If an item costs $50. and the firm assigns a holding cost percentage of 30%, then it costs the firm 0.3 X $50 = $15 to hold that item in inventory for an entire year.

Why have inventory?

Roles of Inventory: 1. *Balancing supply and demand:* decouples differences in supply and demand requirements 2. *Buffers against uncertainties:* variation in supply and demand are managed with buffer (safety) stock 3. *Enabling economies of buying:* price discounts or reduced shipping costs 4. *Enabling geographic specialization:* supply and demand locations vary

What is Inventory Management?

The practice of regulating the *quantity, location, and type of inventory* in a process. Critical for the success of the organization

Stockout Consequences

The result of not have a product when the customer wants can vary from the customer coming back later to not only losing the sale but having the customer take their business to another store.