Chapter 7: Inventory

dc

# of distribution centers at which safety stock is contained

Customer Service Level

- measured as "fill rate"

Assumptions of Reactive (Pull) Inventory Logic

-All customers, market areas, and products contribute equally to profits -Infinite capacity exists at the production facility -Infinite inventory availability at the supply location -Supply cycle time can be predicted and cycle lengths are independent -Customer demand patterns are relatively stable and consistent -Each distribution warehouse's timing and quantity of replenishment orders are determined independently of all other sites, including the supply source -Supply cycle length cannot be correlated with demand

Cost components

-Cost of capital -Taxes -Insurance -Obsolescence -Storage

Practical Considerations of EOQ ---Volume Economies of Scale

-Individual Item Purchase Price Discounts -Multiple-Item Purchase Price Discounts -Transportation Freight-Rate Discounts

Other Important Inventory Related Definitions

-Inventory Control -Demand Uncertainty -Supply (or performance cycle) Uncertainty -Time Buckets -Reorder Point -Carrying Cost -Safety Time -Fill Rate

Categories of Inventory

-Raw Materials -Work-in-Process (WIP) sometimes called Work-in-Progress -Finished Goods -Maintenance, Repair and Operating (MRO) supplies

Assumptions of the EOQ Model

-The model must be calculated for one product at a time. -The demand must be known and constant -The delivery replenishment lead time is known and does not fluctuate. -Replenishment is instantaneous. -There is no delay in the replenishment of the stock, and the order is delivered in the quantity that was demanded -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

Functions of Inventory

-To Meet Customer Demand (cycle stock) -To Buffer Against Uncertainty in Demand and/or Supply (safety stock) -To Decouple Supply from Demand (strategic stock) -To Decouple Dependencies in the Supply Chain

Transportation

: The item being ordered and transported may require specialized or dedicated transportation, impacting the quantity per order.

Economic Order Quantity

A quantitative decision model based on the trade-off between the annual ordering costs and the annual inventory holding 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. -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

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.

Cycle Stock

Inventory that a company builds to satisfy its' immediate demand.

Inventory carrying cost is an imputed cost.

It doesn't appear in the financial statement. Companies determine the cost of capital they want to use which is typically the return they expect on investments

Practical Considerations of EOQ -Constraints

Limited Capital Storage Capacity Transportation Obsolescence Production Lot Size Unitization

MAD

Mean Absolute Deviation of the monthly demand. The absolute forecast error expressed as a unit quantity. The MAD is a measurement of the size of the average absolute forecast error over a given period of time. The MAD is normally calculated based on the past 12 months actual sales -vs- the lead-time offset forecast for those months

Obsolete Inventory

Obsolete inventory is stock that is expired, damaged, or no longer needed.

Common measures of service level

Performance Cycle Order Fill Case Fill Rate Line Fill Rate

Total Cost =

Purchase Cost + Ordering Cost + Holding Cost

Safety Stock

Safety stock, also known as "buffer stock," is inventory that is above and beyond what is actually needed to meet anticipated demand.

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.

Obsolescence

The model may generate an order quantity which would create spoilage or obsolescence.

Probability theory enables the calculation of safety stock for a target service level

The most common probability distribution for demand is the normal distribution, i.e., "bell curve" -A one-tailed normal distribution is used because only demand that is greater than the forecast can create a stockout. -Safety stock is only needed for under-forecast (demand exceeds forecast) error!

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.

Maintenance, Repair & Operating (MRO) supplies

These are materials that you need to run the manufacturing operation and the business, but do not end up as part of the finished product.

lead time

Time required to replenish the finished good inventory; expressed in months - the period of the forecast interval

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) Inventory Carrying Cost - (discussed with EOQ)

Quick Response (QR)

a technology-driven cooperative effort between retailers and suppliers to improve inventory velocity while matching supply to consumer buying patterns

Replenishment Programs

are designed to streamline the flow of goods within the supply chain Intent is to reduce reliance on forecasting and position inventory using actual demand on a just-in-time basis

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.

Ordering Costs

are incurred each time an order is placed -Order preparation costs -Order transportation costs -Order receipt processing costs -Material handling costs

Perpetual Review

continuously monitors inventory levels to determine inventory replenishment needs

Inventory control

defines how often inventory levels are reviewed to determine when and how much to order

Reorder Point

defines when a replenishment order is initiated

Segmentation Strategy

definition specifies all aspects of inventory management process for each segment of inventory

Time Buckets

discrete increments of time used to facilitate planning activities

Profile Replenishment (PR)

extends QR and VMI by giving suppliers the right to anticipate future requirements according to their knowledge of a product category (JIT II)

Product/Market Classification

groups products, markets, or customers with similar characteristics to facilitate inventory management

Requirements Planning

integrates across the supply chain taking into consideration unique requirements Materials Requirements Planning (MRP) is driven by a production schedule Distribution Requirements Planning (DRP) is driven by supply chain demand

Vendor Managed Inventory (VMI)

is a modified QR that eliminates the need for replenishment orders

Service Level

is a performance target specified by management and defines inventory performance objectives -Generally, the higher the service level target, the higher the amount of inventory you will need to assure the target is achieved.

Safety Time

is ordering an item earlier than necessary based on the lead time, to ensure timely arrival.

Inventory Control

managerial procedure for implementing an inventory policy

Periodic Review

monitors inventory status of an item at regular intervals such as weekly or monthly

Policies and Parameters

must be defined at a detailed level

Fair Share Allocation

provides each distribution facility with an equitable distribution of available inventory

Fill Rate

represents the magnitude of a backorder or stockout. Can be case fill rate, line fill rate, etc

Performance Cycle

the elapsed time between release of a purchase order by the buyer to the receipt of shipment

Carrying Cost

the expense associated with maintaining inventory

Inventory Carrying Cost

the expense associated with maintaining inventory =Annual inventory carrying cost percent times average inventory value

Case Fill Rate

the percent of cases ordered that are shipped as requested

Order Fill

the percent of customer orders filled completely as requested

Line Fill Rate

the percent of order lines (items) that were filled completely as requested

Demand Uncertainty

variation in sales during the lead time necessary to replenish inventory

Supply (or performance cycle) Uncertainty

variation in the time and/or quantity necessary to replenish inventory.

Safety Stock in Dependent Demand Situations

1. Put safety time into the requirements plan 2. Increase the replenishment order by a quantity specified by some estimate of expected plan error 3. Utilize statistical techniques to set safety stocks directly for a component rather than to the item of top-level demand

K (calculating safety stock)

2.33 for 99%, 2.03 for 98%, 1.64 for 95%