Class #13 - Chapter 4: Inventory Management Part 1

inventory turns

(COGS)/(avg inventory value)

weeks of supply

(avg on-hand inventory)/(avg weekly usage)

1. to meet customer demand

(cycle stock) - immediately fill customer orders - deploy the product / material near where it will be used

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

2. to bugger against uncertainty in demand and/or supply

(safety stock) - uncertainty in demand: sales or usage above expectations - uncertainty in supply: shortages, delays, disruptions

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

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

work-in-process (WIP)

- 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 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

the economic order quantity model (EOQ)

- a quantitative decision model based on the trade-off between annual inventory carrying costs and annual ordering costs - a *fixed-order quantity model* - seeks to determine the optimal order quantity *where the sum of the annual ordering costs and the annual inventory carrying costs is minimized*

the order quantity in this 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.

common measures include

- absolute inventory value - inventory turnover

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 of continuous review system

- 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 realtime cost of goods sold

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 a make-to-stock environment will generally maintain some amount of safety stock whether based on a management decision, or based on a safety stock determination formula

2D bar codes

- are a graphical image that stores information both horizontally and vertically. - can store over 7,000 characters, allowing transmission of almost two paragraphs of information.

strategies on 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

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 suppliers in advance; *little to no finished goods inventory is maintained* - companies can operate a *make-to-stock* supply 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*

two models for determining when to review:

- continuous review system - periodic review system

carrying costs examples

- cost of capital - taxes - insurance - obsolescence - storage

disadvantage of 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

inventory costs

- direct costs - indirect costs - fixed costs - variable costs - ordering costs - carrying costs

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

3. how much to order?

- fixed-order quantity system - fixed-time period system

fixed-order quantity system variables and assumptions

- if the review determines that an order should be placed, then the order for a pre-defined quantity for that item is placed *two main variables to calculate* - reorder point (ROP) - order quantity (Q) *assumptions* - a constant demand (d) rate, i.e., not erratic, not 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.

pipeline inventory

- inventory in transit - inventory held/owned by suppliers, or by wholesalers, distributors, retailers, and customers - 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

fixed-time periodic 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.

obsolete inventory

- inventory items that have met the obsolescence criteria established by the company - stock that is expired, damaged, or no longer needed - obsolete inventory will never be used or sold at full value

continuous review system

- inventory levels are continuously reviewed - as soon as inventory falls below a pre-determined level (ex: a reorder point) a replenishment actions are taken more quickly

periodic review system

- inventory levels are reviewed at a set frequency - at the time of review, if the stock levels are below the pre-determined level (ex: reorder point) 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.

cycle stock

- inventory that a company builds to satisfy its' immediate demand. - 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

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

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 ex: - linear barcode - 2D barcode - radio frequency indentification (RFID)

radio frequency identification (RFID) automates the supply chain:

- materials management - manufacturing - distribution center - retail store

disadvantages of periodic review system

- may not provide accurate inventory counts for businesses with high sales. - can be difficult to determine the best review/reordering intervals. - also can make inventory accounting less accurate.

ordering costs examples

- order preparation costs - order transportation costs - order receipt processing costs - material handling costs

having too little inventory can result in effects like

- production disruptions - longer delivery replenishment lead times - reduced responsiveness to customer demand

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 or starting material - there are strategies around the question of how much raw material a company should hold in inventory - companies might be willing to increase costs by storing excess raw material inventory if they fear 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

the four main categories of inventory:

- raw materials - work-in-process (WIP) - finished goods - maintenance, repair, and operating (MRO) supplies

advantages of periodic review system

- reduces the time spent analyzing inventory - less expensive than a continuous review system

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

4. to decouple dependences in the supply chain

- separating operations in a process - smoothing production and reducing peak period capacity needs

materials that you need in the manufacturing operation and the business *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 (ex: oil for the manufacturing equipment) - other MRO items are used to facilitate the manufacturing operation (ex: cleaning supplies, spare parts, etc.) - while still other MRO items may be used to facilitate the company's administrative activities (ex: office supplies, coffee for the break room, etc.)

inventory stock levels (internal)

- strategic stock - safety stock - cycle stock

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.

what is the right amount of inventory

- the answer to that right question is, "it depends" - it depends on the supply chain strategy and set-up, the type of products, customers' expectations, customer service objectives, product shelf life, etc - we will explore this questions throughout the remainder of this chapter

reorder point

- the lowest inventory level at which a new order must be placed to avoid a stockout - set at a level that provides enough inventory so demand is covered during the lead time (L) needed to replenish inventory

assumptions of 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. - there is no delay in the replenishment of the stock, and the order is delivered in the quantity that was demanded, i.e. in one whole delivery - the purchase cost (i.e., unit cost) is constant and no discounts or price breaks are factored into the model. - carrying cost is known and constant. - ordering cost is known and constant. - stockouts are not allowed

inventory turnover

- the number of times that an inventory cycles, or "turns over", during the year - the more turns, the better

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 overhead costs are fully applied to finished goods

common metrics for inventory

- units - dollars - weeks of supply - inventory turns

inventory

- usually one of the company's largest assets, so careful management of that asset is an essential business requirement - 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 ready to be sold to customers, and all of the other materials and supplies needed to run a business (ex: maintenance, repair, and operating (MRO) supplies - can be one of the largest and most important assets of an org - however, too much inventory can also be a significant liability

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

reorder point with safety stock

ROP = D x LT + SS (answer in units)

linear (1D) bar codes

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

fixed costs

aka sunk costs independent of the unit volume produced ex: buildings, equipment, rent, allocated overhead costs, etc

manufacturing RFID

assembly instructions encoded on RFID tag provide information to computer controlled assembly devices

barcodes

barcode systems help business track products and stock levels for inventory management - linear (1D) bar codes - 2D bar codes - barcode reader

insurance

based on estimated risk or loss over time and facility characteristics

indirect costs

cannot be traced directly to the unit produced ex: overhead, MRO items, buildings, equipment, etc

inventory turnover raito

cost of goods sold (COGS) (aka cost of sales or cost of revenue)/ average inventory value

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

ROP

demand during lead time (dL)

variable costs

dependent on the unit volume produced vary with output level ex: materials, labor, utility power, etc

obsolescence

deterioration of product during storage and shelf-life

direct costs

directly traceable to unit produced ex: materials, labor, etc

inventory policy

establishing target inventory levels for all products and materials

storage

facility expense related to product holding rather than product handling

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

fill customer orders immediately

example of ROP

given: demand (d) = 600/month lead time (L) = 6 days d = (600/30 days) = 20/day ROP = dL = 20 x 6 = 120 a new inventory replenishment order is placed when the current inventory level reaches 120 units remaining

materials management RFID

goods automatically counted and logged as they enter the supply warehouse

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*

EOQ on graph

holding aka carrying

ordering costs

labor costs associated with placing an order for inventory and the cost of receiving the order

inventory can become a...

liability, if it becomes unusable due to expiration, obsolescence, damage, or spoilage

holding some inventory may be necessary to...

maintain operations and ensure that products are available when customers demand them

retail store

no check out lines as scanners link RFID tagged goods in shopping cart with buyers credit card

taxes

on inventory held in warehouses

EOQ example

ordering cost - 25 per order annual demand - 5000 units annual inventory carrying cost - 20% per year purchase cost - 5 per unit EOQ = sqrt (2 x 25 x 5000)/(.20 x 5) = 500 units

external inventory

pipeline inventory

in addition to storage costs, a company may also have to pay for...

security, insurance, taxes, etc. to hold inventory

distribution center

shipment leaving DC automatically updates ERP to trigger a replenishment order and notify customer for delivery tracking

failing to manage inventory adequately can lead to

significant issues and inefficiencies throughout the supply chain, including dissatisfied customers, lost sales and revenue, and higher costs

cost of capital

specified by senior management

maintaining adequate materials inventory allows a company to...

support manufacturing operations and the production plan while avoiding delays

inventory management

the function of planning and controlling inventories

the more inventory a company holds...

the more space is needed, and space costs money

fixed-time period system (equation)

the order quantity is the difference between the on-hand stock on the review day, and the pre-determined target inventory level Q = R - IP

absolute inventory value

the value of the inventory at either its cost or its market value (generally found on the balance sheet)

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

total inventory cost (equation)

total inventory cost = purchase cost + ordering cost + carrying cost

why hold inventory

1. to meet customer demand 2. buffer against uncertainty in demand and/or supply 3. to decouple supply from demand 4. to decouple dependences in the supply chain

inventory policy addresses these three fundamental questions

1. when to review 2. when to order 3. how much to order