CHAPTER 9 Inventory Management

© 2008 Prentice Hall 9-2 Learning Objectives F To determine the costs of holding inventory F To identify the costs associated with a stockout F To understand the EOQ concept

© 2008 Prentice Hall 9-3 Learning Objectives F To differentiate the various inventory flow patterns F To appreciate the role of scanners in inventory control

© 2008 Prentice Hall 9-4 Inventory Management F Key Terms –ABC analysis –Economic order quantity (EOQ) –Fixed order interval system –Fixed order quantity system F Key Terms –Handling costs –Insurance costs –Inventory carrying (holding) costs –Inventory shrinkage

© 2008 Prentice Hall 9-5 Inventory Management F Key Terms –Marginal analysis –Obsolescence –Opportunity cost –Reorder point (ROP) –Safety stocks F Key Terms –Stockouts –Storage costs –Taxes –Vendor-managed inventory (VMI)

© 2008 Prentice Hall 9-6 Inventory Management F Inventories are stocks of goods and materials that are maintained to satisfy normal demand patterns F Inventory management –Decisions drive other logistics activities –Different functional areas have different inventory objectives –Inventory costs are important to consider u Inventory turnover

© 2008 Prentice Hall 9-7 Inventory Management F Inventory management (continued) –Inventory costs are important to consider u Inventory turnover: cost of goods sold divided by average inventory at cost cost of goods sold = inventory turnover average inventory $200,000 = inventory is sold 4 times per year $ 50,000 u Compare with competitors or benchmarked companies

© 2008 Prentice Hall 9-8 Inventory Management F Low inventory turnover = high inventory carrying costs, little (or no) stockout costs F High inventory turnover = low inventory carrying costs, high stockout costs F Managing the tradeoff is important to maintain service levels

© 2008 Prentice Hall 9-9 Inventory Classifications F Psychic stock (stimulates demand) F Cycle or base stock F Safety or buffer stock F Pipeline or in-transit stock F Speculative stock

© 2008 Prentice Hall 9-10 Inventory-Related Costs F Inventory carrying (holding) costs –Obsolescence –Inventory shrinkage –Storage costs –Handling costs –Insurance costs –Taxes –Interest charges –Opportunity cost F Stockouts

© 2008 Prentice Hall 9-11 Table 9-1: Determination of the Average Cost of a Stockout AlternativeLossProbabilityAverage Cost 1. Brand-loyal customer$ $ Switches and comes back $ $ Lost customer$1, Average cost of a stockout 1.00$ These are hypothetical figures for illustration.

© 2008 Prentice Hall 9-12 Inventory-Related Costs F Trade-offs exist between carrying and stockout costs –Marginal analysis

© 2008 Prentice Hall 9-13 Table 9-2: Determination of Safety Stock Level Number of Units of Safety Stock Total Value of Safety Stock ($480 per Unit) 25% Annual Carrying Cost Carrying Cost of Incremental Safety Stock Number of Additional Orders Filled Additional Stockout Costs Avoided 10$4,800$1,200 20$6, ,600 2,400 1, , ,400 3,600 1, , ,200 4,800 1,2008 2, ,000 6,000 1,2006 1, ,800 7,200 1,2004 1, ,600 8,400 1,

© 2008 Prentice Hall 9-14 When to Order F Fixed order quantity system F Fixed order interval system F Reorder point (ROP) ROP = DD x RC under certainty ROP = (DD x RC) + SS under uncertainty Where DD = daily demand RC = length of replenishment cycle SS = safety stock

© 2008 Prentice Hall 9-15 How Much to Reorder F Economic order quantity (EOQ) in dollars EOQ = √2AB/C Where EOQ = the most economic order size, in dollars A = annual usage, in dollars B = administrative costs per order of placing the order C = carrying costs of the inventory (%)

© 2008 Prentice Hall 9-16 How Much to Reorder F Economic order quantity (EOQ) in units EOQ = √2DB/IC Where EOQ = the most economic order size, in units A = annual demand, in units B = administrative costs per order of placing the order C = carrying costs of the inventory (%) I = dollar value of the inventory, per unit

© 2008 Prentice Hall 9-17 Figure 9-2: Determining EOQ by Use of a Graph

© 2008 Prentice Hall 9-18 Table 9-3: EOQ Cost Calculations Number of orders per year Order size ($) Ordering cost ($) Carrying cost ($) Total cost (sum of ordering and carrying cost) ($) 11,

© 2008 Prentice Hall 9-19 Figure 9-3: Inventory Flow Diagram

© 2008 Prentice Hall 9-20 Inventory Flows F Safety stock can prevent against two problem areas –Increased rate of demand –Longer-than-normal replenishment F When fixed order quantity system like EOQ is used, time between orders may vary F When reorder point is reached, fixed order quantity is ordered

© 2008 Prentice Hall 9-21 Contemporary Approaches to Managing Inventory F ABC Analysis F Just-in Time (JIT) Approach F Vendor-Managed Inventory (VMI) F Inventory Tracking

© 2008 Prentice Hall 9-22 Inventory Management: Special Concerns F Defining stock-keeping units (SKUs) F Dead inventory F Deals F Substitute items F Complementary items F Informal arrangements outside the distribution channel F Repair/replacement parts F Reverse logistics