Chapter 4
Single period model
"Single-Period" Inventory Model - a type of inventory system in which inventory is only ordered for a one time stocking. -The objective is to maximize profits. Examples: Christmas tree lots, and Newspaper stands.
fixed
(aka sunk costs) - independent of the unit volume produced (e.g., buildings, equipment, rent, allocated overhead costs, etc)
1. To meet customer demand
(cycle stock) -immediately fill customer orders -deploy the product/material near where it will be used
Pipeline inventory
(external inventory) -inventory in transit -inventory held/owned by suppliers, or by wholesalers, distributors, and customers
2. To buffer against uncertainty in demand/or supply
(safety stock) -uncertainty in demand: sales or usage above expectations -uncertainty in supply: shortages, delays, disruptions -or both
3. To decouple supply from demand
(strategic stock) Supply pattern is different from demand pattern: -achieve economies of scale in purchasing; take advantage of volume price breaks/discounts -speculative buying in anticipation of a price increase -economical order size, lot size, production output -seasonal products/demand
Other types of inventory systems
-ABC System -Bin System -Base Stock Level System -"Single-Period" Inventory Model
C items
-C items have the lowest value, and hence the lowest priority
Disadvantages to Periodic Review System
-Can be difficult to determine the best review/reordering intervals. -It also can make inventory accounting less accurate. -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.
Disadvantages to Continuous Review System
-Cost of implementation. Generally requires an automated system. The hardware and software necessary to run the system can be expensive to purchase, install, and maintain.
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.
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 -the amount of cycle stock that a company holds is dependent on actual demand in the immediate time period, supply replenishment lead time and order quantities
Advantages of Periodic Review System
-Reduces the time spent analyzing inventory. -Less expensive to implement and operate than a Continuous Review System.
Safety Stock
-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 in inventory to protect against fluctuations in demand or supply -companies operating in make to stock environment will generally maintain some amount go safety stock whether based on a management decision, or based on a safety stock determination formula
Assumptions of the EOQ model
-The model must be calculated for one product at a time. -The demand must be constant throughout the year. -The delivery replenishment lead time does not fluctuate. -Replenishment is instantaneous. -The purchase price (i.e., unit cost) 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. in the "real world" these assumptions do not hold true over time supply chain managers must make adjustments to the basic EOQ
the amount of finished goods inventory that a company decides to maintain is a strategic decision:
-companies can operate a make to order supply chain where the 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 -companies can operate a make to stock chain where 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
Costs related to inventory
-direct -indirect -variable -fixed -carrying -order
Having too much inventory can result in effects like:
-financial resources 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
Inventory is an asset and potentially a liability
-holding some inventory may be necessary to maintain operations and ensure that products are available when customers demand them -too much inventory ties up capital which could otherwise be used for purposes such as research and development, marketing and sales, stockholder dividends, salary increases, etc. -the more inventory a company holds, the more space is needed, and space costs money -in addition to storage costs, a company may also have to pay for security, insurance, taxes, etc. to hold inventory -inventory can become a liability if it becomes unusable due to expiration, obsolescence, damage, or spoilage
Pipeline Inventory (In-Transit 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 -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 to hold
Constraints on the Practical use of EOQ
-limited capital -storage capacity -transportation -obsolescence -production lot size -unitization
Radio Frequency Identification (RFID) - automates the supply chain
-materials management -manufacturing -distribution center -retail store
Two models for determining when to review inventory
-periodic review system -continuous review system
having too little inventory can result in effects like
-production disruptions creating the need for expediting and additional costs -longer delivery replenishment lead times -reduced responsiveness -lost revenue
In an effort to achieve inventory management's goal, effective inventory management balances two competing consideration:
-reducing the amount of inventory half in stock while -ensuring there is enough inventory to satisfy customer demand
Two main variables to calculate for fixed order quantity system
-reorder point (ROP) -order quantity (Q)
Examples of Service Inventory
-restaurants offer dining services, but cannot inventory the actual dining service; they can only begin the dining service when the customers arrive -restaurants can inventory the food, tableware, and other elements of the dining operation as these are facilitating goods necessary to provide the service -restaurants can even prepare some of their meal options in advance, such as salads or deserts. they can inventory these facilitating products so they are ready to go when the customers arrive for the dining service
4. To decouple dependencies in the supply chain
-separating opérations in a process -smoothing production and reducing peak period capacity needs
Inventory Stock Levels
-strategic stock -safety stock -cycle stock
Steps to the ABC system
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: highest value, moderate value, least value
There are three levels of internal inventory which may be held by companies to:
1. meet customer demand 2. buffer against uncertainty in demand and/or supply 3. decouple supply from demand 4. decouple dependencies in the supply chain
Functions of inventory - Why hold inventory?
1. to meet customer demand 2. to buffer against uncertainty in demand and/or supply 3. to decouple supply from demand 4. to decouple dependencies in the supply chain
2D Bar Codes
2D Bar Codesare a graphical image that stores information both horizontally and vertically. —2D Barcodes can store over 7,000 characters, allowing transmission of almost two paragraphs of information.
A barcode reader
A barcode reader(or barcode scanner) is an electronic device that can read barcodes and transmit the data to a computer. These might be handheld cordless devices, corded devices that attach directly to a PC's USB port, or computers with integrated laser scanners
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. -due to the range of potential stages of completion, and the fact that materials in WIP may be in a state of continuous transformation, many companies view WIP as the "black hole" of inventory as they may not have very good or very timely visibility into this part of their inventory -best practice generally suggests minimizing the amount of WIP inventory in the manufacturing area since too much WIP may clutter up the physical space and impede the process flow
A items
A itemsare 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.
Inventory management intro
A key decision in any product-based supply chain is how much inventory to keep on hand -inventory is usually one of the company's largest assets, so careful management of that asset is an essential business requirement -maintaining adequate finished product inventory allows a company to fill customer orders immediately -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 revenues, and higher costs
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 -protect against a short term disruptive event in supply -take advantage of a business opportunity -for life cycle changes: seasonal demand, new product launch, transition protection Also called anticipation stock, build stock, or seasonal stock
Advantages to Continuous Review System
Allows for real-timeupdates of inventory, which can make it easier to know when to replenish. -Facilitatesaccurate accounting, since the inventory system can generate real-time costs of goods sold. -Potentially requires less safety stock because inventory is constantly monitored, and replenishment actions are taken more quickly.
ABC system
An ABC system classifies inventory based the degree of importance 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
Continuous Review System
As the name implies, inventory levels are continuously reviewed. -As soon as inventory falls below a pre-determined level (i.e., a reorder point), a replenishment order automatically is triggered.
B and C items
B & C items account for the other 80% of the total number of items, but only 20% of total inventory cost.
B items
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.
Barcodes
Barcode systems help businesses track products and stock levels for inventory management. -linear 1D bar codes -2D bar codes -a barcode reader
Base stock level system
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. -This will maintain the inventory at a base stock level. -Used primarily for very expensive items, e.g., airplane engine -A form of just-in-time.
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) -InventoryTurns- (cost of good sold) / (avg. inventory value)
ROP =
Demand during Lead Time (dL) d = demand L = lead time
Distribution center
Distribution Center - shipment leaving DC automatically updates ERP to trigger a replenishment order and notify customer for delivery tracking
The Economic Order Quantity (EOQ) Model
EOQ is a fixed-order quantity model A quantitative decision model based on the trade-off between annual inventory order costs and annual inventory carrying costs. -where the sum of the annual order costs and the annual inventory carrying costs is minimized -order costs -carrying costs
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.
What is inventory?
Inventory is the quantities of goods and materials that are held in stock -includes all of the raw materials and work in process items used to support production, all of the finished products needed to provide customer service, and all of the other materials and suppliers needed to run a business, i.e., maintenance, repair, and operating supplies -inventory can be one of the largest and most important assets of an organization -however, too much inventory can also be a significant liability
Obsolete Inventory (obsolescence criteria)
Inventory items that have met the obsolescence criteria established by the company Obsolete inventory is stock that expired, damaged, or no longer needed Obsolete inventory will never be used or sold at full value -writing obsolete inventory off of the books and disposing of it may be a difficult decision to make as all or part of the obsolete product's value may be lost and it may reduce a company's profit -unusable inventory takes up space and costs money to maintain, so it may be better to absorb the loss as soon as an item has met the obsolescence criteria rather than delay and continue to lose money on storage and related fees -there may be a cost associated with the actual disposal of the inventory -some companies may donate this inventory to a non profit organization if it has any remaining value, which not only helps the non profit but also avoids disposal costs and may result in a tax benefit for the company
Periodic Review System
Inventory levels are reviewed at a set frequency e.g., weekly, monthly - At the time of review, if the stock levels are below the pre-determined level (i.e., a reorder point), an order for replenishment is placed, otherwise no action is taken until the next cycle.
Bin system
Inventory system that uses either one or two bins to hold a quantity of the item being inventoried. -It is 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.
So, what is the right amount go inventory?
It depends -it depends on the supply chain strategy and set up, the type of product(s), customers' expectations, customer service objectives, product shelf life, etc
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 you need to run the manufacturing operation and the business but do NOT end up as part of the finished product
Linear 1D Bar Codes
Linear1D) Bar Codesare "a series of alternating bars and spaces printed or stamped on parts, containers, labels, or other media, representing encoded information that can be read by electronic readers. —Linear bar codes do have some limitations: they are one-dimensional, can only be read horizontally, and can only hold a maximum of 85 characters.
Manufacturing
Manufacturing- assembly instructions encoded on RFID tag provide information to computer controlled assembly devices
Inventory Control tools
Many inventory control tools exist in today's market. Those that incorporate barcode tracking or RFID tagging generally offer the most flexibility and ease of use. -Linear Barcode -2D Barcode -Radio Frequency Identification (RFID)
materials management
Materials Management - goods automatically counted and logged as they enter the supply warehouse
TransportationFreight-RateDiscounts
Ordering a larger quantity may mean that you can take advantage of Transportation Freight-Rate Discountswhich will lower the per unit costs.
Raw Materials
Purchased items or extracted materials that are converted via the manufacturing process into components and products -every company that produces a product generally starts with some type of raw material, component part of starting materials -there are strategies around the question of how much raw material a company should 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 -companies might be willing to increase costs by storing excess raw material inventory if they feat there may be a potential shortage of the material or if they suspect that there is an upcoming price increase and want to buy at the current lower price
REtail store
Retail Store - no check out lines as scanners link RFID tagged goods in shopping cart with buyers credit card
Inventory in the Service Inventory
Service Inventory - Activities carried out in advance of the customer's arrival
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 information on the tag is updatable.
Volume economies of scale impact EOQ
The EOQ calculation will be impacted by volume economies of scale such as the following: -individual item purchase price discounts -multiple item purchase price discounts -transportation freight rate discounts
Inventory Management
The function of planning and controlling inventories
When to Order Inventory?
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 (L) needed to replenish inventory.
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
Order quantity formula for fixed time period system
The order quantity is the difference between the inventory position on the review day, and the pre-determined target inventory level Q = R - IP where: Q= ORDER QUANTITY R = TARGET INVENTORY LEVEL IP = INVENTORY POSITION
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
How much to order?
The two common inventory ordering system categories are -fixed time period system -fixed order quantity system
Categories of Inventory
There are four main categories of inventory: -raw materials -work in process (WIP) sometimes called work-in-progress -finished goods -maintenance, repair and operating (MRO) supplies -individual items within each of these inventory categories can be current or obsolete
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 -from a cost perspective, finished goods are usually worth much more than raw materials or WIP since all of the material, labor, and overheard costs are fully applied to finished goods
order costs
are costs that are incurred each time an order is placed. -Order preparationcosts -Order transportationcosts -Order receiptprocessing costs -Material handling costs
carrying costs
are costs that are incurred for holding inventory in storage. -cost of capital -taxes -insurance -obsolescence -storage
insurance
based on estimated risk or loss over time and facility characteristics
indirect
cannot be traced directly to the unit produced (e.g., overhead; MRO items, buildings, equipment, etc)
inventory investment
common measures include: -absolute inventory value -inventory turnover
Inventory Turnover Ratio
cost of goods sold/average inventory at cost
carrying
costs for physically having inventory on side and for maintaining the infrastructure needed to store the inventory and to secure and insure it over time
variable
dependent on the unit volume produced vary with output level (e.g., materials, labor, utility power, etc)
The order quantity in Fixed time period system, will differ from one order to another
depending on the on hand quantity on the day of the review -A target inventory level (R) is established -Inventory levels are checked/reviewed in fixed time periods (T) -If (IP) < (R) then (Q) is ordered and (R) is restored when each new order is received.
obsolescence
deterioration of product during storage, and shelf-life
direct
directly traceable to unit produced (e..g, materials, labor, etc)
Companies in the service industry
do not maintain inventory of services since services are basically produced and consumed immediately upon demand -companies can however, maintain inventory of "facilitating goods," which are those items that are used to help facilitate the service being provided
some MRO items are consumed
during the process of converting raw materials into finished goods, e.g., oil for the manufacturing equipment
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
Other MRO items are used to
facilitate the manufacturing operation, e.g., cleaning supplies, spare parts, etc
storage
facility expense related to product holding rather than product handling
Hidden costs of inventory
having too much or too little inventory on hand can sometimes build hidden costs that create a risk for a company
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
order
labor costs associated with placing an order for inventory and the cost of receiving the order
maintenance, repair, and operating (MRO) supplies
not directly related to product creation
taxes
on inventory held in warehouses
cost of capital
specified by senior management
Obsolete inventory
stock that is expired, out of date, or no longer needed
Because of these constraints and assumptions,
the EOQ is generally only used as a baseline. supply chain managers make adjustments to the EOQ based on their judgements
transportation
the item being ordered and transported may require specialized or decimated transportation, impacting the quantity per order
obsolescence - in constraints
the model may generate an order quantity which would create spoilage or obsolescence
inventory turnover
the number fo times that an inventory cycles, or "turns over", during the year the more turns, the better
absolute inventory value
the value of the inventory at either its cost or market value generally found on the balance sheet
Fixed-order quantity system - if the review determines that an order should be placed,
then the order for a pre-defined quantity for that item is placed
External
there may also be inventory which is held external to the company by downstream supply chain trading partners
Maintenance, Repair, and operating (MRO) supplies
these materials that you need to run the manufacturing operation and the business but do not end up as part of the finished product -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. -MRO inventory is separate from production inventory, but it is just as important. -Frequently these items are expensedat the time they are purchased, and there may be a separate function, group, or individual who plans and orders these MRO items, from those who plan and order production items.
Inventory Policy - set target inventory levels
to set target inventory levels for all products and materials, you need to address these three fundamental questions 1. when to review inventory 2. when to order inventory 3. how much inventory to order
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 (i.e., order period) varies from order to order.
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.
Assumptions to Fixed order quantity system
•A constant demand (d) rate, i.e., not erratic, seasonal, etc. •Inventory position (IP) is reduced (i.e., consumed/used) by a rate of (d). •Replenishment order placed when reorder point (ROP) is reached. •When inventory is received, (IP) increases by the order quantity (Q). •(Q) computed using the economic order quantity (EOQ) model. •Lead time (L), i.e., the time between placing an order and receiving delivery of the order, is known and constant. •Inventory position (IP) is reviewed on continual basis.
