CHAPTER 7 Managing Inventories McGraw-Hill/Irwin Copyright © 2014 McGraw-Hill Higher Education. All rights reserved.

Learning Objectives LO7-1 Define the different types and roles of inventory LO7-2 Explain the financial impact of inventory LO7-3 Explain and compute measures of performance LO7-4 Calculate inventory policy parameters to minimize total acquisition cost LO7-5 Determine the cost of a company’s service level policy LO7-6 Explain the advantages and disadvantages of different inventory location strategies LO7-7 Describe practical techniques for inventory planning and management

Types of Inventory Inventory: supply of items held to meet demand Suppliers Suppliers MRO MRO Raw Material Raw Material Components Components Maintenance, repair & Maintenance, repair & operating supplies operating supplies Work in Work in Process (WIP) Process (WIP) Finished Finished Types of Inventory Goods (FGI) Goods (FGI) Transportation Distribution Distribution Customers Customers LO7-1 7–3

Financial Impact of Inventory Carrying (Holding) Costs Opportunity cost (including cost of capital) Storage and warehouse management Taxes and insurance Obsolescence, spoilage, & shrinkage Material handling, tracking and management Ordering and Set-up Costs Purchased items: placing and receiving orders Make items: change-over between items Stockout Costs Lost sales or customer loyalty Expediting Schedule disruption LO7-2 4

Measures of Inventory Performance: Inventory Turnover Inventory turnover: ratio of average inventory on-hand and level of sales = Cost of goods sold / Average inventory at cost = Net sales / Average inventory at selling price = Unit sales / Average inventory in units With an annual cost of goods sold of $500M and average inventory of $80M. Inventory turns = $500/$80 = 6.25 turns Example 7-2 LO7-3 7–5 5

Measures of Inventory Performance: Days, Service Level, Stock outs Days of Supply: length of time operations can be supported with inventory on-hand Days of supply = Inventory/Daily demand If inventory is 2M and daily demand is 25,000 day Days of supply = 2M/25,000 = 80 days Service Level: ability to meet customer demand without a stock out Stock out: no inventory is available Example 7-3 LO7-3

Inventory Management Systems Independent Demand: demand is beyond control of the organization Dependent Demand: demand is driven by demand of another item LO7-4 7–7

Continuous Review Model Continuous Review: inventory levels are constantly monitored to determine when to place a replenishment order Units in Inventory Average Inventory Order Point Time Figure 7-1 LO7-4 7–8

Total Acquisition Costs Total Acquisition Costs: sum of all relevant annual inventory costs Holding costs: associated with storing and assuming risk of having inventory Ordering costs: associated with placing orders and receiving supply TAC = annual ordering cost + annual carrying cost LO7-4 7–9

Economic Order Quantity (EOQ) Economic Order Quantity (EOQ): minimizes total acquisition costs; point at which holding and orders costs are equal How much to order D = Annual Demand Co= Ordering cost U = Unit cost Ci = Holding cost LO7-4 7–10

Periodic Review Model Order Interval: fixed time between inventory review, on-hand level is unknown during this uncertainty period UP = Uncertainty period OI = Order interval t = average lead time d = average lead time z = standard deviations needed for service level = standard deviation of demand during the uncertainty period A = inventory on hand LO7-4 7–11

Single Period Inventory Model Single Period Inventory Model: items are ordered once, and have little left over value (newsvendor problem) Target Service Level: probability of meeting demand LO7-4 7–12

Managing Inventory Managing Cycle Stock: reducing lot sizes Managing Safety Stock: using ABC analysis and reducing lead time Managing Locations: balance inventory, lead time and service levels Implementing Inventory Models: matching management system to specific items LO7-6 7–13

Inventory Information Systems and Accuracy Identification Systems Global Trade Item Number (GTIN): identification system for finished goods sold to consumers Part Number: unique identifier used by a specific firm Inventory Record Accuracy Cycle Counting: inventory is physically counted on a routine schedule LO7-7

Managing Inventories Summary There are multiple types of inventory Inventory fulfills multiple roles Inventory is an asset, and has multiple costs An inventory policy determines how much and when to order Continuous systems monitor on-hand levels Safety stock levels are linked with service levels Periodic systems count inventory at specific intervals Number of storage locations impact inventory levels Managers should work to reduce inventory levels