Reasons for Inventory To create a buffer against uncertainties in supply & demand To take advantage of lower purchasing and transportation cost associated with high volume To take advantage of economies of scale associated with manufacturing products in batches To build up seasonal demand for promotional sales To accommodate product flowing from one location to another (work in process or in transit) To exploit speculative opportunities for buying and selling commodities and other products

Goals: Reduce Cost, Improve Service By effectively managing inventory: –Xerox eliminated $700 million inventory from its supply chain –Wal-Mart became the largest retail company utilizing efficient inventory management –GM has reduced parts inventory and transportation costs by 26% annually

Goal: Reduce Cost, Improve Service By not managing inventory successfully –In 1994, “IBM continues to struggle with shortages in their ThinkPad line” (WSJ, Oct 7, 1994) –In 1993, “Liz Claiborne said its unexpected earning decline is the consequence of higher than anticipated excess inventory” (WSJ, July 15, 1993) –In 1993, “Dell Computers predicts a loss; Stock plunges. Dell acknowledged that the company was sharply off in its forecast of demand, resulting in inventory write downs” (WSJ, August 1993)

Inventory Where do we hold inventory? –Suppliers and manufacturers –warehouses and distribution centers –retailers Types of Inventory –WIP –raw materials –finished goods Why do we hold inventory? –Economies of scale –Uncertainty in supply and demand

Why Inventory Reduction Business processes reduce or eliminate inventories mainly by reducing or eliminating uncertainties that make them necessary Better communication and coordination of activities across company functions and between the company and its vendors and customers can greatly reduce uncertainties.

Ways to Reduce Uncertainties Improving the accuracy of forecasts by developing better forecasting methods Promoting better communication between supply chain managers and marketing and sales managers Sharing supply chain information with vendors and other third party providers Consolidating number of locations where products are held Reducing product variety Postponing product customization to downstream stage of the supply chain

Role of Inventory in the Supply Chain

8 Inventory Policy Reduce Buffer Inventory Economies of Scale Supply / Demand Variability Seasonal Variability Cycle InventorySafety Inventory Seasonal Inventory Match Supply & Demand Reduce fixed cost Aggregate across products Volume discounts EDLP Promotion on Sell thru Quick Response measures Reduce Info Uncertainty Reduce lead time Reduce supply uncertainty Accurate Response measures Aggregation Component commonality and postponement

Role of Inventory in the Supply Chain Overstocking: Amount available exceeds demand –Liquidation, Obsolescence, Holding Understocking: Demand exceeds amount available –Lost margin and future sales Goal: Matching supply and demand

Understanding Inventory The inventory policy is affected by: –Demand Characteristics –Lead Time –Number of Products –Objectives Service level Minimize costs –Cost Structure

Cost Structure Order costs –Fixed –Variable Holding Costs –Insurance –Maintenance and Handling –Taxes –Opportunity Costs –Obsolescence

EOQ: A View of Inventory* Time Inventory Order Size Note: No Stockouts Order when no inventory Order Size determines policy Avg. Inventory

EOQ:Total Cost* Total Cost Order Cost Holding Cost

EOQ: Calculating Total Cost* Purchase Cost Constant Holding Cost: (Avg. Inven) * (Holding Cost) Ordering (Setup Cost): Number of Orders * Order Cost Goal: Find the Order Quantity that Minimizes These Costs:

Fixed costs: Optimal Lot Size and Reorder Interval (EOQ) R:Annual demand S: Setup or Order Cost C:Cost per unit h: Holding cost per year as a fraction of product cost H:Holding cost per unit per year Q:Lot Size T:Reorder interval

Example Demand, R = 12,000 computers per year Unit cost, C = $500 Holding cost, h = 0.2 Fixed cost, S = $4,000/order Q = 980 computers Cycle inventory = Q/2 = 490 Flow time = Q/2R = 0.49 month Reorder interval, T = 0.98 month

EOQ: Another Example Book Store Mug Sales –Demand is constant, at 20 units a week –Fixed order cost of $12.00, no lead time –Holding cost of 25% of inventory value annually –Mugs cost $1.00, sell for $5.00 Question –How many, when to order?