Chapter 7 INVENTORY MANAGEMENT Prepared by Mark A. Jacobs, PhD ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Learning Objectives You should be able to: Distinguish dependent from independent demand inventories Describe the four basic types of inventories & their functions Understand the costs of inventory & inventory turnovers Understand ABC classification, ABC inventory matrix & cycle counting ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

LEARNING OBJECTIVES (Continued) Know RFID & how it can be used in inventory management Understand the EOQ model & its underlying assumptions Understand the Quantity Discounts & the EMQ Models & their relationships with the basic EOQ model Understand & able to distinguish among the various statistical ROP models Describe the continuous review & periodic review systems 3 ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter Outline Introduction Dependent and Independent Demand Concepts and Tools of Inventory Management Inventory Models ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Introduction Inventory can be one of the most expensive assets of an organization Inventory may account for more than 10% of total revenue or 20% of total assets Management must reduce inventory levels yet avoid stockouts and other problems This chapter will discuss: Dependent & independent demand Tools for managing inventory Basic types of inventories Various inventory management approaches

Matching Supply & Demand Suppliers must accurately forecast demand so they can produce & deliver the right quantities at the right time at the right cost Suppliers must find ways to better match supply & demand to achieve optimal levels of cost, quality, & customer service to enable them to compete with other supply chains Problems that affect product & delivery will have ramifications throughout the chain

Dependent & Independent Demand Inventory management models – Generally classified as dependent demand and independent demand models Dependent Demand – Describes the internal demand for parts based on the demand of the final product in which the parts are used. Subassemblies, components, & raw materials are examples of dependent demand items. Independent Demand – The demand for final products & has a demand pattern affected by trends, seasonal patterns, & general market conditions.

Concepts and Tools of Inventory Management Functions and Basic Types of Inventory The primary functions of inventory are to – Buffer from uncertainty in the marketplace & Decouple dependencies in the supply chain (e.g., safety stock) Four broad categories of inventories Raw materials- unprocessed purchase inputs. Work-in-process (WIP)- partially processed materials not yet ready for sales. Finished goods- products ready for shipment. Maintenance, repair & operating (MRO)- materials used in production (e.g., cleaners & brooms).

Concepts and Tools of Inventory Management (Continued) Inventory Costs Direct costs- directly traceable to unit produced (e.g., labor) Indirect costs- cannot be traced directly to the unit produced (e.g., overhead) Fixed costs- independent of the output quantity (e.g, buildings, equipment, & plant security) Variable costs- vary with output level (e.g., materials) Order costs- direct variable costs for making an order. In mfg, setup costs are related to machine setups Holding or carrying costs- incurred for holding inventory in storage

Concepts and Tools of Inventory Management (Continued) Inventory Investment Firms should diligently measure inventory investment to ensure that it does not adversely affect competitiveness. Measures include: Absolute value of inventory (found on balance sheet) Inventory turnover or turnover ratio- how many times inventory “turns” in an accounting period. More is better because its faster! Cost of Revenue Average Inventory Inventory Turnover Ratio =

Concepts and Tools of Inventory Management (Continued) ABC Inventory Control System Determines which inventories should be counted & managed more closely than others Groups inventory as A, B, & C Items A items are given the highest priority with larger safety stocks. A items, which account for approximately 20% of the total items, are about 80% of the total inventory cost B & C items account for the other 80% of total items & only 20% of costs. The B items require closer management since they are relatively more expensive (per unit), require more effort to purchase/make, & may be more prone to obsolescence C items have the lowest value and hence lowest priority

Concepts and Tools of Inventory Management (Continued) 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 information on the tag is updatable. (Fig. 7.4)

Concepts and Tools of Inventory Management (Continued) RFID Automates the supply chain: Materials Management – goods automatically counted and logged as they enter the supply warehouse Manufacturing – assembly instructions encoded on RFID tag provide information to computer controlled assembly devices Distribution Center – shipment leaving DC automatically updates ERP to trigger a replenishment order and notify customer for delivery tracking Retail Store – no check out lines as scanners link RFID tagged goods in shopping cart with buyers credit card

Inventory Models The Economic Order Quantity (EOQ) Model – A quantitative decision model based on the trade-off between annual inventory holding costs & annual order costs The EOQ model seeks to determine an optimal order quantity, where the sum of the annual order cost & the annual inventory holding cost is minimized. Order Cost is the direct variable cost associated with placing an order. Holding Cost or carrying cost is the cost incurred for holding inventory in storage.

Inventory Models (Continued) Assumptions of the EOQ Model Demand must be known & constant. Delivery time is known & constant. Replenishment is instantaneous. Price is constant. Holding cost is known & constant. Ordering cost is known & constant. Stock-outs are not allowed.

Inventory Models (Continued) EOQ Model (Fig. 7.5)

Inventory Models (Continued) Illustration Inventory on hand & relationships to – EOQ, average inventory, lead time, reorder point, & order cycle (Fig. 7.6)

Inventory Models (Continued) The Statistical Reorder Point (ROP) The lowest inventory level at which a new order must be placed to avoid a stockout. Demand and delivery lead time are never certain and require safety stock. The models used under uncertainty are – Statistical ROP with Probabilistic Demand and Constant Lead Time The Statistical ROP with Constant Demand and Probabilistic Lead Time The Statistical ROP when Demand and Lead Time are both Probabilistic

Inventory Models (Continued) The Continuous Review System versus The Periodic Review System Order quantity & ROP models assume that the physical inventory is precisely known at every point in time Reality shows that stock records and actual quantity are different & requires continuous review of inventory to determine when to reorder A Continuous Review System is costly to conduct but requires less safety stock than the The Periodic Review System, which reviews physical inventory at specific points in time and requires higher level of safety stock