Managing Inventory in the Supply Chain

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Requirements

All responses in the discussion board must be written in your own words demonstrating your understanding and analysis of the topics being discussed.

Responds to every aspect of the discussion prompt with originality. Displays an exceptional familiarity with the texts and topics being covered. Response Post: 100+ words

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Includes more than one citation from either the material assigned, or outside material identified by the student. Cites reference materials used without error.

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Discussion Cases:

Case 9.2 Baseball Card Emporium PG. 357

· Complete question #1 & #4.

CHAPTER 9

Managing Inventory in the Supply Chain

Supply Chain Management: A Logistics Perspective (10e)

Coyle, Langley, Novack, and Gibson

May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Discussion Outline

Importance of inventory in the economy and in the firm

Major types of inventory and reasons for carrying them

Major types of costs associated with inventory

Approaches to managing inventory

Inventory classification

Inventory in the US Economy

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INVENTORY COSTS AS A PERCENT OF GDP 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 16.3 15.4 15 14.8 14.9 13.6 13.6 13.5 13.9 14.1 13.9 14.3 13.7 13.2 14.1 14.8 14.8 14.6 14.3

Inventory in the Firm

Source: Table 9.2

2014 Total Logistics Costs ($ Billion)
Carrying Costs—$2.496 Trillion All Business Inventory
Interest	2
Taxes, Obsolescence, Depreciation, Insurance	331
Warehousing	143
SUBTOTAL	476
Transportation Costs—Motor Carriers
Truck—Intercity	486
Truck—Local	216
SUBTOTAL	702
Transportation Costs—Other Carriers
Railroads	80
Water (international 31, domestic 9)	40
Oil Pipelines	17
Air (international 12, domestic 16)	28
Forwarders	40
SUBTOTAL	205
Shipper-Related Costs	10
Logistics Administration	56
TOTAL LOGISTICS COST	1,449

Major Types of Inventory and Reasons for Carrying Them

Types of Inventory and Rationales

Procurement (purchase discounts), production (long production run), and transportation (freight rate discounts)

Demand- and supply-side uncertainties

Inventory costs associated with goods in motion during transportation time period.

Inventory costs associated with goods in process during manufacture or assembly of a complex product.

Seasonality in raw materials supply (e.g. production, transportation), in demand for finished product, or in both

Inventory hold in anticipation that an unusual event (e.g. strikes, significant price increase, extreme weather)

Cycle stocks (Batching economies)

Safety stocks (Uncertainty)

Time/In-Transit (Mode choices)

Work-in-Process stocks (scheduling & production techniques)

Seasonal stocks (Seasonality)

Anticipatory stocks (Risk hedging)

The Importance of Inventory in Other Functional Areas

Objectives of the finance area might obviously conflict with marketing and manufacturing objectives. A more subtle conflict sometimes arises between marketing and manufacturing as the long production runs can cause shortages of some products needed by marketing.

Marketing

In favor of holding sufficient, or extra, inventory to ensure product availability to meet customer needs and new product offerings for continued market growth.

Manufacturing

In favor of long production runs of a single product with minimal changeovers to lower labor and machine costs per unit, resulting in high inventory levels of the product.

Finance

In favor of low inventories to increase inventory turns, reduce liabilities and assets, and increase cash flow to the organization.

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Inventory Costs

Inventory Costs Major Types of Costs

Emphasize of inventory cost analysis should be placed on the variable components of these costs.

Inventory Carrying Cost

Inventory carrying costs incurred by inventory at rest and waiting to be used. Four major components: Capital cost, Storage space cost, Inventory service cost, and Inventory risk cost.

Ordering and Setup Cost

Ordering cost refers to expense of placing an order, excluding the cost of the product itself. Setup cost refers to the expense of changing/modifying a production/assembly process to facilitate line changeovers.

Expected Stockout Cost

The cost associated with not having a product/materials available to meet customer/production demand. Most organizations hold safety stock or buffer stock, to minimize the possibility of a stockout and costs of lost sales.

In-transit Inventory

Carrying Cost

Generally, carrying inventory in transit costs less than in warehouses. But, in-transit inventory carrying cost becomes especially important on global moves since both distance & time increase.

Inventory Costs

Inventory Costs Carrying Cost vs. Ordering Cost

Ordering cost and carrying cost respond in opposite ways to changes in the number of orders or size of individual orders.

Source: Figure 9.2

Inventory Costs Safety Stocks and Service Levels

The higher the service level requirement (lower stockout rate), the higher the inventory level requirement.

Source: Figure 9.3

Approaches to Managing Inventory

Fundamental Approaches: Fixed order quantity & Fixed order interval EOQ

Additional Approaches: JIT, MRP, DRP, and VMI

Inventory Management Approaches

Managing inventory involved four fundamental questions:

How much should inventory be ordered?

When should inventory be ordered?

Where should inventory be held?

What specific line items should be available at specific locations?

Customer Service Level (%)

100

Investment in Inventory ($)

Inventory Management Approaches Cost vs. Service Tradeoff Considerations

Regardless of the approach selected, inventory decisions must consider the basic tradeoff between cost and service.

Source: Figure 9.4

Inventory Management Approaches Key Factors of Difference

Inventory management approaches differ in terms of three key factors.

Key Factors

Dependent vs. Independent demand. Independent demand is unrelated to the demand for other items, while dependent demand is directly related to, or derives from, the demand for another inventory item or product.

Pull vs. Push. The “pull” approach relies on customer orders to move product through a logistics system, while the “push” approach uses inventory replenishment techniques in anticipation of demand to move products.

System-wide vs. Single-facility solutions. A system-wide approach plans and executes inventory decisions across multiple nodes in the logistics system. A single-facility approach does so for shipments and receipts between a single shipping and receiving point.

Inventory Management Approaches Key Differences

Key Factors of Difference	Inventory Management Approaches
	EOQ	JIT	MRP	DRP	VMI
Dependent vs. Independent demand	Both	Dependent	Dependent	Independent	Both
Pull vs. Push.	Both	Pull	Push	Push	Push
System-wide vs. Single-facility solution	Single facility	Single facility	System-wide	System-wide	Both

Inventory Management Approaches EOQ Approach

Two basic forms of the economic order quantity (EOQ) model

Fixed Order Quantity

Fixed Order Interval

Involves ordering a fixed amount of product each time reordering takes place.

Also called two-bin model.

Involves ordering inventory at fixed or regular intervals.

Also called the fixed period or fixed review period approach.

Generally, the amount ordered depends on how much is in stock and available at the time of review.

Inventory Management Approaches Fixed Order Quantity EOQ Approach: Condition of Certainty

In fixed order quantity EOQ model, inventory is reordered when the amount on hand reaches the reorder point. The reorder point quantity depends on the time it takes to get the new order and on the demand for the item during this lead time.

Source: Figure 9.5

Inventory Management Approaches Fixed Order Quantity EOQ: Condition of Certainty (continued)

Given the assumptions, the simple EOQ model considers only 2 basic types of cost: inventory carrying cost and ordering cost.

Basic assumptions of the simple EOQ model

Continuous, constant, and known rate of demand

Constant and known replenishment or lead time

All demand is satisfied.

Constant price or cost that is independent of the order quantity

No inventory in transit

One item of inventory or no interaction between items

Infinite planning horizon

Unlimited capital

Source: Figure 9.11

Inventory Management Approaches Fixed Order Quantity EOQ: Condition of Uncertainty

Because several factors can influence the reliability of demand (or usage rate) and lead time, the fixed order quantity model is adjusted by reformulating the reorder point to allow for safety stock.

Source: Figure 9.12

Inventory Management Approaches Additional Approaches: Just-in-Time (JIT)

JIT systems are designed to manage lead times and eliminate waste. Many JIT systems place a high priority on short, consistent lead times. However, the length of the lead time is not as important as the reliability of the lead time.

EOQ vs. JIT: Attitudes and Behaviors

Factor	EOQ	JIT
Inventory	Asset	Liability
Safety stock	Yes	No
Production runs	Long	Short
Setup times	Amortize	Minimize
Lot sizes	EOQ	1 for 1
Queues	Eliminate	Necessary
Lead times	Tolerate	Shorten
Quality inspection	Important parts	100% process
Suppliers/customers	Adversaries	Partners
Supply sources	Multiple	Single
Employees	Instruct	Involve

Source: Table 9.18

Inventory Management Approaches Additional Approaches: JIT (continued)

JIT commitment to short, consistent lead times and to minimizing or eliminating inventories is JIT principal differentiator from the more traditional approaches.

JIT saves money on downstream inventories by placing greater reliance on improved responsiveness and flexibility.

Successful JIT applications:

Place a high priority on efficient and dependable manufacturing processes.

Demand effective and dependable communications & information systems, and high-quality, consistent transportation services.

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Inventory Management Approaches Additional Approaches: Materials Requirements Planning (MRP)

MRP deals specifically with supplying materials and component parts whose demand depends on the demand for a specific end product.

MRP System Goals

Ensure the availability of materials, components, and products for planned production and for customer delivery.

Maintain the lowest possible inventory levels that support service objectives.

Plan manufacturing activities, delivery schedules, and purchasing activities.

Inventory Management Approaches Additional Approaches: MRP (continued)

An MRP system is designed to translate a master production schedule into time-phased net inventory requirements and the planned coverage of such requirements for each component item needed to implement this schedule.

Source: Figures 9.15 and 9.16

An MRP System

MRP Egg Timer Example

Inventory Management Approaches Additional Approaches: MRP (continued)

Maintain reasonable safety stock levels & minimize or eliminate inventories whenever possible.

Identify process problems and potential supply chain disruptions before they occur, allowing necessary corrective actions.

Base production schedules on actual demand and forecasts of independent demand items.

Coordinate materials ordering across multiple points in a firm’s logistics network.

Suitable for batch, intermittent assembly, or project processes.

Computer-intensive applications, making changes difficult once the system is in operation.

Might increase ordering and transportation costs as firms moving toward a more coordinated system of ordering product in smaller amounts.

Not as sensitive to short-term fluctuations in demand as order point approaches

Frequently become quite complex and sometimes do not work exactly as intended.

Principal advantages of MRP-based systems

Principal shortcomings

of MRP-based systems

Inventory Management Approaches Additional Approaches: Distribution Requirements Planning (DRP)

DRP systems accomplish for outbound shipments what MRP accomplishes for inbound shipments. DRP determines replenishment schedules between a firm’s manufacturing facilities and its distribution centers. DRP is usually coupled with MRP systems to manage the flow and timing of both inbound materials and outbound finished goods.

Source: Table 9.20

Inventory Management Approaches Additional Approaches: Vendor-Managed Inventory (VMI)

Vendor-managed inventory manages inventories OUTSIDE a firm’s logistics network, specifically inventories held in its customer’s distribution centers.

The supplier and its customer agree on which products are to be managed using VMI 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.

The supplier monitors on-hand inventories in the customer’s distribution center, and when the on-hand inventory reaches the agreed-upon reorder point, the supplier creates an order for replenishment, notifies the customer’s distribution center of the quantity and time of arrival, and ships the order to replenish the distribution center.

How VMI Works

Inventory Management Approaches Additional Approaches: VMI (continued)

The knowledge gained by the supplier of real-time inventory levels of its products at its customer locations allows the shipper more time to react to sudden swings in demand to assure that stockouts do not occur.

Suppliers’ uses of VMI to push excess inventory to a customer distribution center at the end of the month in order to meet monthly sales quotas, resulting in the customer holding extra inventory, adding costs to its operations.

Principal advantages of VMI systems

Principal shortcomings

of VMI systems

Inventory Management Approaches Inventory Management Techniques in the Logistics Network

Many organizations today use all of the techniques shown in managing inventories in their logistics networks. In general, as an inventory technique manages inventory closer to the point of real demand (e.g. VMI and CPFR), forecast accuracy increases, forecast cycles decrease, and product availability increases.

Source: Figure 9.19

Inventory Classification

Multiple product lines and inventory control require organizations to focus on more important inventory items and use more sophisticated and effective approaches to inventory management.

ABC Analysis

ABC classification technique assigns inventory items to one of three groups according to the relative impact or value of the items that make up the group. A items are considered to be the most important, B items lesser importance, and C items least important.

Pareto’s Law (The “80–20” Rule)

Pareto’s Law “80–20” rule suggests that a relatively small percentage of inventory might account for a large percentage of the overall impact or value.

Quadrant Model

Quadrant model classifies finished goods inventories using value and risk to the firm as the criteria. Value is measured as the value contribution to profit; risk is the negative impact of not having the product available when it is needed.

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Inventory Classification ABC Classification

In many ABC analyses, a common mistake is to think of the B and C items as being far less important than the A items. However, all items in the A, B, and C categories are important to some extent and each category deserves its own strategy to assure availability at an appropriate level of cost (stockout cost vs. inventory carrying cost).

Source: Figure 9.20

Inventory Classification Quadrant Model

Items with high value and high risk (critical items) need to be managed carefully to ensure adequate supply. Items with low risk and low value (generic or routine items) can be managed much less carefully.

Distinctives

High safety stocks

More than one stocking location

Produce to inventory

Criticals

High safety stocks

Multiple stocking location

Produce to inventory

Generics

Low/no safety stock

Single stocking location

Produce to order

Commodities

Adequate safety stocks

More than one stocking location

Produce to inventory/to order

Risk

High

Low

High

Value

Source: Figure 9.21

Summary

Principal types of inventory are: cycle stock, work-in-process, inventory in transit, safety stock, seasonal stock, and anticipatory stock.

Principal types of inventory costs are: inventory carrying, ordering and setup, expected stockout, and in-transit inventory.

Four major components of inventory carrying costs are: Capital cost, Storage space cost, Inventory service cost, and Inventory risk cost.

Choosing appropriate inventory model considers three key differences: Independent vs. dependent demand, Push vs. pull distribution system, and system-wide vs. specific facility decisions.

Summary (continued)

Two basic forms of the EOQ model are the fixed quantity model and the fixed interval model. The former is the most widely used.

JIT model aims to minimize inventory levels, emphasizing frequent deliveries of smaller quantities and alliances with suppliers or customers.

MRP and DRP are typically used in conjunction to manage the flow and timing of both inbound materials and outbound finished goods.

VMI is used to manage a firm’s inventories in its customers’ distribution centers.

Inventory classification is vital initial step toward efficient inventory management.

Managing Inventory in the Supply Chain

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