Forecasting & Inventory Management Exam #1
Unusual Events --> Anticipatory Stocks
Anticipatory Stock - Inventory used to protect against anticipated events Companies anticipate that some forecasted event will negatively impact the production cycle. - Labor strikes - Supply shortage - Price increases Buy inventory to maintain a key vendor relationship during a downturn.
Supply and Demand Integration (Inventory Management)
Balancing supply of inventory with demand for inventory Too little - Stockouts - Lost sales - Poor customer service Too much - High carrying cost - Low inventory turnover - Inefficient performance
Batching --> Cycle Stock
Batching leverages economies of scale - Volume price discounts - Transportation discounts - Long production runs Cycle stock - Portion of inventory available (or planned to be available) for the normal demand during a given period, excluding excess stock and safety stock. It is the stock formed by items arriving infrequently but in large quantities to meet frequent but small-quantity demands Trade off: You must store the extra inventory you don't use immediately.
Why Perform Monte Carlo Analysis?
Combining distributions With more than two distributions, solving analytically is very difficult Simple calculations lose information - mean + mean = mean - 95%ile + 95%ile ≠ 95%ile! - Gets "worse" with 3 or more distributions
Comment
Companies are expanding beyond the basic order quantity and order interval approaches. All of the following techniques incorporate some version of the basic EOQ model into their philosophies.
Using software (Monte Carlo)
Could write this program using a random number generator But, several software packages out there. @risk - user friendly - customizable - r.n.g. good up to about 10,000 iterations
An MRP System
Customer Orders ---> <--- Demand Forecasts Bill of Material Fill ---> <--- Inventory Status File
Recap
DRP accomplishes for outbound shipments what MRP accomplishes for inbound shipments. Focal point is at the manufacturing level. Accurate forecasting required!!!!
Reorder Point
Defined as the minimum stock level that triggers a reorder quantity Under conditions of certainty, the reorder point equals the leadtime in days x the daily demand in units. - R = D * L Under conditions of uncertainty, the normal reorder point is supplement with additional safety stock to account for variation in supply and demand. - R = D * L + SS
Time-Based Approaches to Replenishment Logistics: JIT
Definition and Components of JIT Systems - designed to manage lead times and eliminate waste. - Length of lead time not as important as the reliability of lead time - Kanban - refers to the informative signboards on carts in a Toyota system of delivering parts to the production line. Each signboard details the exact quantities and necessary time of replenishment. - JIT operations - Kanban cards and light warning system communicate possible production interruptions. - Fundamental concepts - JIT can substantially reduce inventory and related costs. Definition and Components of JIT Systems - designed to manage lead times and eliminate waste. - Goal is zero inventory, and zero defects. - Similarity to the two-bin system - one bin fills demand for part, the other is used when the first is empty. - Reduces lead times through requiring small and frequent replenishment. - Widely used and effective for managing the movement of parts, materials, semi-finished products from points of supply to production facilities. - Product should arrive exactly when a firm needs it, with no tolerance for early or late deliveries. - Place a high priority on short, consistent lead times.
Postponement
Delay the final placement and/or form of a product until a demand signal is received - Time postponement - avoid shipping goods in anticipation of demand. Ship when an order is received - Form postponement - avoid creating the final form of a product in anticipation of that form. Customize the final form to an actual order One of the most powerful levers a manager can use to impact logistics and supply chain performance
Supply Chain Strategy Characteristics
Efficient supply chain (Supply-to-stock) • Economical production runs • Finished goods inventories • Economical buy quantities • Large shipment sizes • Batch order processing Responsive supply chain (Supply-to-order) • Excess capacity • Quick changeovers • Short lead times • Flexible processing • Premium transportation • Single order processing
Monte Carlo Background/History
First applied in 1947 to model diffusion of neutrons through fissile materials Limited use because time consuming Much more common since late 80's
80-20 Rule/ABC Analysis
Focuses logistics managers on most important issues Assists with allocating limited resources Almost universal application - Products - Customers - Suppliers Reinforces that not all products, customers, or suppliers should be treated the same way. We need to differentiate the amount of time and resources we dedicate to A,B,C segments
Fixed Order Quantity w/ Uncertainty: Conclusions
Following costs will rise to cover the uncertainty: - Stockout costs. - Inventory carrying costs of safety stock
Stockouts
Four possible outcomes from a stockout - Customers wait - Back orders - Lost sales - Lost customers Expected stockout cost - Cost of not having a product available to meet demand - Difficult to calculate due to uncertainty of future consequences
Supply Chain Strategy "Fit"
Functional Products - (Predictable demand) - (Low margin) Innovative Product - (Unpredictable demand) - (High margin) Match - Functional products, Efficient supply chain - Innovative Product, Responsive supply chain - Ex. Staple food products, Electronic equipment Mis-Match - Innovative Product, Efficient supply chain - Functional Products, Responsive supply chain
Time --> In-Transit & WIP
In-Transit stock (pipeline inventory) - Inventory that is being transported - May be any class of inventory (Raw Materials, Components, Work-in-Progress, Finished Goods) - Generally less expensive - no storage costs, less obsolescence - However, longer the time period, higher the transportation cost Work-In-Process (WIP) stock - Raw materials, parts and sub-assemblies in the process of being converted to finished goods - Length of time inventory sits waiting needs to be evaluated in relationship to scheduling and manufacturing/assembly technology
How Much Safety Stock is Needed?
Increasing the reorder point will increase the probability that lead time demand will not exceed the inventory amount available. ** In case of uncertainty, increasing the reorder point has the same effect as increasing the safety stock commitment.
Is Excess Inventory a Bad Thing?
Inefficient use of cash - Limits company's options to invest in other areas Obsolescence Damage Pilferage Storage costs
Inventory Trends
Inventory value has increased, but inventory in the economy has decreased as a percentage of the GDP. Inventory as a percentage of total logistics costs has decreased. Inventory investment = production - sales
Monte Carlo Analysis
It is a tool for combining distributions, and thereby propagating more than just summary statistics It uses random number generation, rather than analytic calculations It is increasingly popular due to high speed personal computers Takes an equation - example: Risk = probability X consequence Instead of simple numbers, draws randomly from defined distributions Multiplies the two, stores the answer Repeats this over and over and over... Then the set of results is displayed as a new, combined distribution
Types of Postponement
Labeling - Firms selling a product under several brand names - Firms with high unit value products - Firms with high product value fluctuations Packaging - Firms selling a product under several package sizes - Firms with high unit value products - Firms with high product sales fluctuations Assembly - Firms selling products with several versions - Firms selling a product whose cube is greatly reduced if shipped in pieces - Firms with high unit value products - Firms with high product sales fluctuations Manufacturing - Firms with high unit value products - Firms selling products with a high proportion of ubiquitous materials - Firms with high product sales fluctuations Time - Firms with high unit value products - Firms with a large number of distribution warehouses - Firms with high product sales fluctuations
Calculating the Reorder Point with Uncertainty of Demand and Lead Time
Lead Time Uncertainty - Manufacturer --> Distribution Center Demand Uncertainty - Distribution Center --> Manufacturer
80-20 Curve
Logistics problems in any firm are the sum total of individual product problems Individual products are in different stages of their life cycles 80-20 concept recognizes product patterns - The bulk of sales comes from relatively few products - Exact 80-20 ratios are rarely observed - Disproportionality between sales and the number of items generally holds Extremely valuable for logistics planning
Time-Based Approaches to Replenishment Logistics: Distribution Resource Planning
MRP sets a master production schedule and "explodes" into gross and net requirements. DRP starts with customer demand and works backwards toward establishing a realistic system-wide plan for ordering the necessary finished products. Then DRP works to develop a time-phased plan for distributing product from plants and warehouses to the consumer. DRP develops a projection for each SKU and requires9: - Forecast of demand for each SKU. - Current inventory level for each SKU. - Target safety stock. - Recommended replenishment quantity. - Lead time for replenishment.
Inventory Models
Make simplifying assumptions about reality More the model assumes, easier it is to understand but less accurate Examples of Models: - Fixed Order Quantity with Certainty - Fixed Order Quantity with Uncertainty - Fixed Order Interval
Time-Based Approaches to Replenishment Logistics: MRP
Materials Requirements Planning (MRP) - Consists of a set of logically related procedures, decision rules, and records designed to translate a master production schedule into time-phased net inventory requirements for each component item needed to implement this schedule. MRPs re-plan net requirements based on changes in schedule, demand, etc. Goals of an MRP: - Ensure the availability of materials, components, and products for planned production - Maintain lowest possible inventory level - Plan manufacturing activities, delivery schedules, and purchasing activities Principal advantages of MRP: - Maintain reasonable safety stock. - Minimize or eliminate inventories. - Identification of process problems. - Production schedules based on actual demand. - Coordination of materials ordering. - Most suitable for batch or intermittent production schedules. Principal shortcomings of MRP: - Computer intensive. - Difficult to make changes once operating. - Ordering and transportation costs may rise. - Not usually as sensitive to short-term fluctuations in demand. - Frequently become quite complex. - May not work exactly as intended. (Key elements of an MRP): Master production schedule (MPS) - Provides detailed schedule of production timing and quantities Bill of materials file (BOM) - Specifies exact amount of materials needed to produce an independent demand item as well as when material is needed Inventory status file (ISF) - Maintains inventory records with on-hand inventory, gross requirements, net requirements, and lead times MRP program - Plan, schedule, and control inventory to manage manufacturing process Outputs and reports - Information related to quantities needed and timing, required changes of arrival dates, needed cancellations, and MRP status
Order/Setup Costs
Order costs - Incremental costs (fixed and variable) of processing an order - MIS costs for inventory stock level tracking. - Preparing and processing purchase orders and receiving reports. - Inspecting and preparing inventory for sale. - Preparing and processing payment Setup Costs - Expenses incurred each time production or assembly is modified from one product to another (1) Fixed cost might include use of capital equipment need to make modification. (2) Variable cost might include personnel costs incurred during modification.
Product Classification Examples
Predictable/Mature Products •Jello •Corn Flakes •Lawn fertilizer •Ball point pens •Light bulbs •Auto replacement tires •Some industrial chemicals •Tomato soup Unpredictable/Introductory Products •New music recordings •New computer games •Fashion clothes •Art works •Movies •Consulting services existing product lines
Reorder Point with Uncertainty
ROP = Demand during Lead Time PLUS Safety Stock
Inventory Management Metrics
Return on Assets (ROA) - ROA = Annual Profit / Asset Cost - ↓ inventory = ↑ ROA Inventory turns - The number of times per year a business is able to use up / sell off their complete inventory of raw materials / finished goods. - Inventory Turns = COGS / Average Inventory (How to increase ROA) Channel structure management - Use of sourcing - Minimize channel inventories - Improve information - Efficient channel structure Inventory Management - Minimize safety stock - Optimize availability - Improve information - Eliminate obsolete excess items Order Management - Reduce stockouts - Optimize order fill rate - Reengineer order-to-cash cycle - Improve information Transportation management - Improve on-time delivery - Improve information - Optimize mode mix - Reduce transit time variability
Peak Spikes --> Seasonal Stocks
Seasonal Stock - Inventory to support a seasonal demand Seasonal demand (compressed selling period) - Demand spike leading to holiday seasons (1) Example: Hallmark cards are mass produced prior to selling season...no 2nd chance to meet demand if out of stock. - Impact on transportation affects inventory management (1) Winter - water transportation (2) Spring - rail and road transportation
How to do an 80-20/ABC Analysis
Select appropriate criteria - Sales, margin, units, weight, cube, etc. Sort items by criteria in descending order Calculate cumulative % of items Calculate cumulative % of criteria Assign A,B,C groupings - A items = top 20% of items - B items = next 30% of items - C items = bottom 50% of items
Fixed Order Quantity w/ Certainty
Simple EOQ Model Assumptions - Continuous, constant, known and infinite rate of demand on one item of inventory - A constant and known replenishment lead time - Satisfaction of all demand - Constant price/cost, independent of order quantity or time - No inventory in-transit - No limits on capital availability Simple EOQ only considers: - Inventory carrying costs - Order / setup costs Goal: determine replenishment order size that optimizes the total of these costs Goal: Find compromise between ICC and ordering costs that minimizes total cost Recall --> ICC increases for larger orders Recall --> Order (or setup) cost decreases for larger orders
JIT versus EOQ Approaches to Inventory Management
Six major differences: 1. JIT attempts to eliminate excess inventories for both buyer and seller. 2. JIT systems involve short production runs with frequent changeovers ???. 3. JIT minimizes waiting lines by delivering goods when and where needed. 4. JIT uses short, consistent lead times to satisfy inventory needs in a timely manner. 5. JIT relies on high-quality incoming products and on exceptionally high-quality inbound logistics operations. 6. JIT requires a strong, mutual commitment between buyer and seller, emphasizing quality and win-win outcomes for both partners.
Calculating the Cost of Carrying Inventory
Step 1 - Identify the value of the item stored in inventory (e.g. $100). Step 2 - Measure each individual carrying cost component as a percentage of product value (e.g. 25%). Step 3 - Multiply overall carrying cost (as a percentage) times the dollar value of the product (e.g. $100 times 25% = $25 inventory carrying cost per year.
Inventory Management Decisions
Strategic - How much inventory? - What form to hold it? - Where in the channel to hold it? Operational - When to order more? - How much to order?
Types of Supply Chain Strategies
Supply-to-stock ("Push") - Emphasis is on efficient management of supply chain - Manufacture and store to meet forecasted demand Supply-to-order ("Pull") - Emphasis on responsiveness of supply chain - Manufacture just in time to meet customer's orders Anticipatory Model - Forecast Driven - Allocation (Push) Response-based Model - Endcast Driven - Requirements (Pull)
When to Postpone?
Technology and Process Characteristics - It is feasible to decouple primary and postponed operations - Limited complexity of customizing - Modular product design - Sourcing from multiple locations Product Characteristics - High commonality of modules - Specific formulation of products - Specific peripherals - High value density of products - Product cube and/or weight increases through customization Market Characteristics - Short product life cycles - Short and reliable lead-times - Price competition - Varied markets and customers - High sales fluctuations - unpredictable demand
VMI - Vendor Managed Inventory
The basic principles: - The supplier and its customer agree on which products are to be managed using in the customer's distribution centers. - An agreement is made on reorder points and economic order quantities for each of these products. - As these products are shipped from the customer's distribution center, the customer notifies the supplier, by SKU, of the volumes shipped on a real-time basis. This notification is also called "pull" data The vendor is responsible for managing inventory
Managing Inventory = Balancing Act
Too little - Stockouts - Lost sales - Poor customer service Too much - High carrying cost - Inefficient performance
Inventory Issues
Traditional issues - How much to order? - When to order? Supply chain driven issues - Where to store inventory? - What form to have the inventory in? Recent emphasis - How to increase customer service and reduce total logistics cost? -- inventory is a significant % of cost
Uncertainty --> Safety Stocks
Uncertainty comes from many areas - How much will customers buy and when? - Do suppliers have the materials I need? - Are lead-times reliable? Safety Stock - Inventory a company holds beyond normal needs as a buffer against uncertainty due to delays in materials availability and customer order patterns. The need for safety stock may be mitigated by greater information sharing across the supply chain.
Fixed Order Quantity w/ Uncertainty
Uncertainty is a more normal condition - Demand - Lead times - Damage in-transit - Wrong order - Etc.
Inventory at Multiple Locations - The Square Root Law (SRL)
Used to reduce inventory at multiple locations. As locations increase, inventory also increases, but not in the same ratio as the growth in facilities. The square root law (SRL) states that total safety stock can be approximated by multiplying the total inventory by the square root of the number of future facilities divided by the current number of facilities.
Another Approach to Segmenting Items (Quadrant Model)
(Quadrant Model) Distinctives - High safety stocks - More than one stocking location - Produce to inventory - High risk, low value Generics - Low/no safety stock - Single stocking location - Produce to order - Low risk, low value Criticals - High safety stocks - Multiple stocking locations - Produce to inventory - High risk, high value Commodities - Adequate safety stocks - More than one stocking location - Produce to inventory/produce to stock - Low risk, high value
5 Reasons to Hold Inventory
- Batching - Uncertainty - Time - Seasonal - Anticipatory
The hidden rocks (Inventory Management)
- Volatile demand - Inaccurate forecasts - Unreliable suppliers - Quality problems - Bottlenecks - Inventory
Inventory Carrying Costs
1) Capital Cost - Opportunity cost associated with investing in inventory, or any asset - What is the implicit value of having capital tied up in inventory, instead of some other worthwhile project? 2) Storage Space Cost - Handling costs, rents, utilities - Logistics develops a cost formula for storage space costs based on cost behaviors 3) Inventory Service Cost - Insurance and taxes on stored goods - Varies according to the value of the goods 4) Inventory Risk Cost - Possibility that inventory value might decline for reasons beyond the firm's control - Due to obsolescence, damage, theft, employee pilferage.
Anticipatory Model
1. Forecast 2. Buy components and materials 3. Manufacturer 4. Warehouse 5. Sell 6. Deliver * Forecast Driven * Allocation (Push)
Response-based Model
1. Sell 2. Buy components and materials 3. Manufacturer 4. Deliver * Endcast Driven * Requirements (Pull)
The CPFR Model
4. Execution: Collaborate transaction management 5. Demand & Supply Management: Collaborate supply chain management 6. Strategy & Planning: Collaborative sales & promotion planning 7. Analysis: Collaborative insight & product development 1. common data standards 2. data registration 3. data synchronization
Min Max
A replenishment order is placed (usually automatically) when inventory levels fall below a set minimum level. The replenishment order quantity is determined by requesting enough inventory to reach the set maximum level. - No fixed order - No fixed interval Min Max approach are very simple but can be very effective
Fixed Order Interval Approach
A second basic approach Also called Fixed Period Approach Involves ordering at fixed intervals and varying Q depending upon the remaining stock at the time the order is placed. Less monitoring than the basic mode
