Chapter 12 Inventory management

Operations management Inventory management Direct Design Develop Deliver Operations management Inventory management The market requires… a quantity of products and services at a particular time The operation supplies... the delivery of a quantity of products and services when required Figure 12.1 This chapter covers inventory management

Key operations questions In Chapter 12 – Inventory planning and control – Slack et al. identify the following key questions… What is inventory? Why should there be any inventory? How much should be ordered? When should an order be placed? How can inventory be controlled?

Inventory management Inventory is created to compensate for the differences in timing between supply and demand Time Inventory accumulating Inventory reducing Inventory Time In-flow (supply from previous process) Out-flow (rate of demand from output process) Figure 12.2 Inventory is created to compensate for the differences in timing between supply and demand

Examples of inventory Process, operation or supply network ‘Inventories’ Physical inventories Queues of customers Information in databases Hotel Food items, drinks, toilet items At check in and check out Customer details, loyalty card holders, catering suppliers Hospital Dressings, disposable instruments, blood Patients on a waiting list, patients in bed waiting for surgery, patients in recovery wards Patient medical records Credit card application process Blank cards, form letters Customers waiting on the phone Customer’s credit and personal information Computer manufacturer Components for assembly, packaging materials, finished computers ready for sale Customers waiting for delivery of their computer Customers’ details, supplier information Table 12.1 Examples of inventory held in processes, operations or supply networks

Digital information in databases Some reasons to avoid inventories ‘Inventories’ Physical inventories Queues of customers Digital information in databases Cost Ties up working capital and there could be high administrative and insurance costs Primarily time-cost to the customer, i.e. wastes customers’ time. Cost of set-up, access, update and maintenance Space Requires storage space Requires areas for waiting or phone lines for held calls Requires memory capacity. May require secure and/or special environment Quality May deteriorate over time, become damaged or obsolete May upset customers if they have to wait too long. May lose customers Data may be corrupted or lost or become obsolete Operational/ organizational May hide problems (see lean synchronization – Chapter 15) May put undue pressure on the staff and so quality is compromised for throughput Databases need constant management; access control, updating and security Table 12.2 Some reasons to avoid inventories

Some ways in which physical inventory may be reduced Reason for holding inventory Example How inventory could be reduced As an insurance against uncertainty Safety stocks for when demand or supply is not perfectly predictable Improve demand forecasting Tighten supply, e.g. through service level penalties To counteract a lack of flexibility Cycle stock to maintain supply when other products are being made Increase flexibility of processes, e.g. by reducing changeover times (see Chapter 11) Using parallel processes producing output simultaneously (see Chapter 7) To take advantage of relatively short-term opportunities Suppliers offer ‘time limited’ special low cost offers Persuade suppliers to adopt ‘everyday low prices’ (see Chapter 13) Table 12.3 Some ways in which physical inventory may be reduced

Some ways in which physical inventory may be reduced (Continued) Reason for holding inventory Example How inventory could be reduced To anticipate future demands Build up stocks in low demand periods for use in high demand periods Increase volume flexibility by moving towards a ‘chase demand’ plan (see Chapter 11) To reduce overall costs Purchasing a batch of products in order to save delivery and administration costs Reduce administration costs through purchasing process efficiency gains Investigate alternative delivery channel that reduce transport costs. To fill the processing ‘pipeline’ Items being delivered to customer Reduce process time between customer request and dispatch of items Reduce throughput time in the downstream supply chain (see Chapter 13) Table 12.3 Some ways in which physical inventory may be reduced (Continued)

Inventory has a significant effect on return on assets Profit Total assets Revenues  Costs Working capital + Fixed assets = Ability to supply from stock Obsolescence, damage, loss Cost of funding inventory Storage costs Ordering costs Amount you owe suppliers Amount customers owe you Figure 12.4 Inventory management has a significant effect on return on assets

Inventory profiles chart the variation in inventory level Steady and predictable demand (D) Order quantity = Q Slope = demand rate = Average inventory Q 2 Inventory level Q D Instantaneous deliveries at a rate of Time D Q per period Figure 12.5 Inventory profiles chart the variation in inventory level

Demand (D) = 1,000 items per year Two alternative inventory plans with different order quantities (Q) Demand (D) = 1,000 items per year 400 Plan A Q = 400 Inventory level Average inventory for plan A = 200 Plan B Q = 100 Average inventory for plan B = 50 100 0.1 yr 0.4 yr Time Figure 12.6 Two alternative inventory plans with different order quantities (Q)

Economic order quantity (EOQ) Traditional view of inventory-related costs 400 Total costs Order costs 350 300 250 Costs 200 Holding costs Economic order quantity (EOQ) 150 100 50 50 100 150 200 250 300 350 400 Order quantity Figure 12.7 Graphical representation of the economic order quantity 400

Cycle inventory in a bakery Deliver A Produce A Deliver B Produce B Deliver C Produce C Deliver A Produce A Produce B Deliver B Produce C Deliver C Inventory level Time Figure 12.3 Cycle inventory in a bakery

Inventory profile for gradual replacement of inventory Order quantity Q Slope = P  D Slope = D Q P M Inventory level Time Figure 12.8 Inventory profile for gradual replacement of inventory

Inventory planning allowing for shortages Inventory level Shortages Time

The re-order point Inventory level Time Demand (D) = 100 items per week 400 Order quantity (Q) = 400 Re-order level 300 Re-order point Inventory level 200 100 1 2 3 4 5 6 7 8 Time Order lead time Figure 12.11 Re-order level (ROL) and re-order point (ROP) are derived from the order lead time and demand rate

Distribution of lead-time usage Safety stock(s) helps to avoid stock-outs when demand and/or order lead times are uncertain d1 t2 Re-order level (ROL) d2 Distribution of lead-time usage Q Inventory level t1 ? S Time Figure 12.12 Safety stock (s) helps to avoid stock-outs when demand and/or order lead time are uncertain

The probability distributions for order lead time and demand rate combine to give the lead-time usage distribution 0.4 0.3 0.2 0.1 1 2 3 4 5 Probability Order lead time 0.4 0.3 0.2 0.1 110 120 130 140 Probability Demand rate 0.4 0.3 0.2 0.1 Probability 100–199 Lead-time usage 120–299 300–399 400–499 500–599 600–699 700–799 Figure 12.13 The probability distributions for order lead time and demand rate combine to give the lead-time usage distribution

A periodic review approach to order timing with probabilistic demand and lead time Qm Q1 Q2 Q3 Inventory level T0 T1 T2 T3 Time t1 t2 t3 tf tf tf Figure 12.14 A periodic review approach to order timing with probabilistic demand and lead time

A paper merchant must get its inventory planning and control right Figure 12.10 The role of the paper merchant

Pareto curve for stocked items 100 Class A items Class B items Class C items 90 80 70 60 Percentage of value of items 50 40 30 20 10 10 20 30 40 50 60 70 80 90 100 Percentage of types of items Figure 12.16 Pareto curve for items in a warehouse

Inventory classifications and measures Class A items – the 20% or so of high-value items which account for around 80% of the total stock value Class B items – the next 30% or so of medium-value items which account for around 10% of the total stock value Class C items – the remaining 50% or so of low-value items which account for around the last 10% of the total stock value

Original holding costs Criticism of the EOQ approach If the true costs of stock holding are taken into account, and if the cost of ordering (or changeover) is reduced, the economic order quantity (EOQ) is much smaller Revised total costs Original order costs Original total costs Revised holding costs Revised order costs Costs Revised EOQ Original holding costs Original EOQ Order quantity Figure 12.9 If the true costs of stock holding are taken into account, and if the cost of ordering (or changeover) is reduced, the economic order quantity (EOQ) is much smaller

The ‘Two-bin’ and ‘Three-bin’ systems of reordering Two-bin system Three-bin system Bin 1 Bin 2 Bin 1 Bin 2 Bin 3 Items being used Reorder level + safety inventory Items being used Reorder level inventory Safety inventory Figure 12.15 The two-bin and three-bin systems of re-ordering

Chapter 12 ‘end-of-chapter’ case supplies4medics.com Source: AL RF (Imagemore Co., Ltd)

supplies4medics.com Questions Prepare a spreadsheet-based ABC analysis of usage value. Classify as follows: A-Items: top 20% of usage value B-Items: next 30% of usage value C-Items: remaining 50% of usage value   Calculate the inventory weeks for each item, for each classification, and for all the items in total. Does this suggest that the OM’s estimate of inventory weeks is correct? If so, what is your estimate of the overall inventory at the end of the base year, and how much might that have increased during the year? Based on the sample, analyze the underlying causes of the availability problem described in the text. Calculate the EOQs for the A-items. What recommendations would you give to the company?

supplies4medics.com (Continued) Sample number Catalogue reference number* Sales unit description ** Sales unit cost (Euro) Last 12 months’ Sales (units) Inventory as at last year end Re-order Quantity 1 11036 Disposable Aprons (10pk) 2.40 100 10 2 11456 Ear-loop Masks (Box) 3.60 6,000 120 1,000 3 11563 Drill Type 164 1.10 220 420 250 4 12054 Incontinence Pads Large 3.50 35,400 8,500 10,000 5 12372 150ml Syringe 11.30 430 6 12774 Rectal Speculum 3 Prong 17.40 65 20 7 12979 Pocket Organiser Blue 7.00 160 500 8 13063 Oxygen Trauma Kit 187.00 40 9 13236 Zinc Oxide Tape 1.50 1,260 50 13454 Dual Head Stethoscope 6.25 16 25 11 13597 Disp. Latex Catheter 0.60 3,560 12 13999 Roll-up Wheelchair Ramp 152.50 44 13 14068 WashClene Tube 1.40 22,500 10,500 8,000 14 14242 Cervical Collar 12.00 140 24 15 14310 Head Wedge 89.00 14405 Three-Wheel Scooter 755.00 17 14456 Neonatal Trach. Tube 80.40 268 18 14675 Mouldable Strip Paste 10.20 1,250 172 19 14854 Sequential Comp. Pump 430.00 24943 Toilet Safety Frame 25.60 560 * Reference numbers are allocated sequentially as new items are added to catalogue. ** All quantities are in sales units (e.g. item, box, case, pack). Table 12.10 Representative sample of 20 catalogue Items

Sample # Unit Cost Annual Sales UV Cum Class-ification % of UV Inventory Inventory Value Inventory Turns Stock weeks 19 430.00 430 184,900 A 41.33 40 17,200 4.8 4 3.50 35,400 123,900 308,800 69.02 8,500 29,750 12.5 13 1.40 22,500 31,500 340,300 76.06 10,500 14,700 24.3 2 3.60 6,000 21,600 361,900 80.89 1,200 4,320 10.4 Sub Total 65,970 5.49 9.5 17 80.40 268 21,547 383,447 B 85.70 6 482 1.2 20 25.60 560 14,336 397,783 88.91 18 461 1.7 10.20 1,250 12,750 410,533 91.76 172 1,754 7.2 16 755.00 14 10,570 421,103 94.12 5 3,775 18.6 59,203 6,473 9.15 5.7 8 187.00 7,480 428,583 C 95.79 374 2.6 11.30 4,859 433,442 96.88 120 1,356 14.5 15 89.00 44 3,916 437,358 97.75 178 2.4 11 0.60 3,560 2,136 439,494 98.23 12 7 0.2 9 1.50 1,260 1,890 441,384 98.65 0.0 152.50 1,830 443,214 99.06 6,710 190.7 12.00 140 1,680 444,984 99.46 24 288 8.9 17.40 65 1,131 446,025 99.69 348 16.0 7.00 840 446,865 99.88 160 1,120 69.3 3 1.10 220 242 447,107 99.93 420 462 99.3 1 2.40 100 240 447,347 99.99 10 6.25 63 447,410 100.00 83.2 26,307 10,943 21.6 Total 83,386 5.37 9.7