Introduction to Global Supply Chain Management Module Seven: Global Inventory Management 1 This project received $24.5M (100% of its total cost) from a grant awarded under TAACCCT, as implemented by the U.S. Department of Labor’s Employment and Training Administration. This is an equal opportunity program and auxiliary aids and services are available upon request to individuals with disabilities.

Presentation Agenda Inventory management defined Strategic considerations for I.M. Operational activities – Economic Order Quantity & Period Order Quantity – Order Point Systems – Safety Stock – ABC Analysis – Cycle Counting KPI’s for the inventory management discipline 2

Inventory Management -Dan Gardner, April “Inventory Management transcends the Buy-Side and Sell-Side of a company’s supply chain to cover all facets of the acquisition, valuation, location, storage, usage, sale, distribution, recovery and disposal of merchandise related to the operation of a business. At a strategic level, inventory management must be aligned with a firm’s organizational, marketing and financial objectives. From a tactical perspective, inventory management is all about making goods available to customers when they want them, in the quantities they’d like to buy, via the means they’d like to make a purchase and at a price that they’re willing to pay. In a global environment, inventory management must be enabled by technology that maximizes visibility across the supply chain, thus allowing management to make dynamic inventory management decisions. Ideally, inventory management software is linked to a company’s ERP system, as well as other “Best-In-Breed” software like Warehouse Management Systems and Transportation Management Systems.”

Different Industries & Business Models Determine How Supply Chains Are Designed Retailer (brick & mortar) E-Commerce Wholesaler/Distributor Manufacturer (OEM) Tier I, II or III supplier Agricultural importer/exporter Marketer/Merchandiser 4

Different Types of Inventory & Operating Models Also Influence How Inventory Management is Executed Operating Model Raw materials Components/sub-assemblies Work In Process Finished goods Distribution inventory Accessories Spare parts MRO Types of Inventory Build to stock Build to order Assemble to Order Engineer to Order Just In Time Vendor Managed Inventories 5

Global Inventory Management: Integrating & Synchronizing the Supply Chain SUPPLIERSSUPPLIERS MANUFACTURER DISTRIBUTION SYSTEM CUSTOMERSCUSTOMERS MATERIALS MANAGEMENT Buy Side DISTRIBUTION MANAGEMENT Sell Side 6 Raw materials, components, sub-assemblies, work-in-process, finished goods, accessories, service parts, MRO

Inventory Management: Guiding Principles & Objectives Maximize customer service (availability of product) Contribute to the maximization of sales Minimize inventory investment Continuously reduce costs Constantly increasing inventory accuracy 7

Inventory Management: Guiding Principles & Objectives Increase productivity Integrate & synchronized Buy-Side, Sell-Side and inventory management activities Enhance overall supply chain performance Increase overall company profitability 8

Global Inventory Management: Strategic & Tactical Considerations Total dollar investment in global inventories Number and type of Stock Keeping Units (SKU’s) or Part Numbers to carry Locations of distribution centers, warehouses and/or satellite operations – By region and/or country Risk Management policies & procedures 9

Global Inventory Management: Strategic & Tactical Considerations In-house inventory management or with a Third Party Logistics (3PL) company Systems integration – Inventory management system – Warehouse management system – Transportation management system Accounting principles – First In/First Out – Last In/First Out 10

Regardless of the Model or Type of Inventory: I.M.-Related Costs to Consider Ordering costs – Clerical & Admin support Carrying costs – Cost of capital – Opportunity cost – Lease – Payroll – Systems – Materials handling equipment – Maintenance – Supplies 11

Regardless of the Model or Type of Inventory: I.M.-Related Costs to Consider Transportation costs – Ocean, air, surface – Returns & reverse logistics Risk management – Theft, pilferage & damage – Insurance – Security Stock-out costs – Expedited transport – Back-order processing – Lost sales – Depletion of customer goodwill 12

Linking Inventory Management With Demand Management Activities 13

Linking Inventory Management With Demand Management Activities Demand Management – Forecasting – Delivery Promising (Available To Promise, ATP) – Order Processing Inventory Management – Order quantities – Order points – Min/Max levels – Periodic Order Points – Safety Stock – ABC Analysis – Cycle Counting 14

Methods for Determining Order Quantities Simultaneous to forecasting for demand, decisions must be made on: – In what quantities goods should be ordered – When orders should be placed Those decisions must be made at an SKU or Part Number level 15

Integrating DRP with Inventory Management: Order Quantities & Order Points In addition to gross-to-net exploding and lead time off-setting, distribution professionals must also determine order quantities and order points for replenishing finished goods in the distribution network – These activities help to integrate and synchronize DRP with Inventory Management Economic Order Quantity (EOQ) calculates the optimum replenishment amount by balancing the total cost of an order with that product’s carrying cost 16

Integrating DRP with Inventory Management: Order Quantities & Order Points An integrating activity between DRP and inventory management, an “Order Point” is reached when a product’s on-hand quantity reaches a pre- determined level When inventory is depleted down to that pre-determined level, a replenishment order is generated by the system (based on EOQ in the form of a Planned Order Release) – Remember, order points are a function of demand during lead time and safety stock requirements 17

Inventory Management: Determining Order Points & Order Quantities Item: ABC Order Qty: 1,000 Lead Time: 2 weeks Product-specific order quantities and order points support gross-to-net exploding and lead-time offsetting by providing the quantity of a product that needs to be ordered and at what point it should be ordered. Order quantities and order points can be determined using a variety of tools such as the Economic Order Quantity formula or the Order Point System. 18

Item-Specific Order Points & Quantities: Essential Information For The Item Record Item name, description, item number and Harmonized System number Vendor(s) Where used Group code Unit cost Unit of measure Stock locations Inventory classification (ABC) 19

Item-Specific Order Points & Quantities: Essential Information For The Item Record Usage (average demand) On-hand balance at each location Amount allocated On-order info by due date Re-order and safety stock information Order quantity Lead time 20

Economic Order Quantity EOQ is a formula that is used to determine a replenishment order quantity for a product that balances the total cost of an order with that product’s carrying cost Variables in the formula are: – Annual usage in units – Unit cost – Annual carrying cost – Ordering cost per order 21

Economic Order Quantity Demand is relatively constant Product is produced or purchased in lots and not continuously Order costs and carrying costs are constant Replacement occurs all at once Lead time is stable No volume discounts used Best used for finished goods with independent (and predictable) demand 22

The EOQ Formula: Where Ordering & Carrying Costs Are Equal A = Annual usage S = Cost per order i = Carrying cost (%) c = Cost per unit √ 2AS ic EOQ = 23

The EOQ Formula: Where Ordering & Carrying Costs Are Equal A = 1000 units S = $20 per order i = 20% c = $5 per unit Q = ? EOQ = 200 √ 2AS ic EOQ = 24

Understanding the EOQ Formula Units In Stock Time (Weeks) Q = 200 -EOQ (Q) is 200 units -Quantity of an item decreases at a uniform rate -Usage is 100 units per week -Lead time is two weeks -Vertical line represents stock arriving at once 25

Understanding the EOQ Formula Units In Stock Time (Weeks) Q = 200 Average inventory = Order quantity = 200 = 100 Units 2 2 Number of orders per year = Annual demand = 100 x 52 = 26 times per year Order quantity

Periodic Order Quantity (POQ) EOQ intends to balance the total cost of an order with its carrying cost Periodic Order Quantity (POQ) calculates the period of time between orders Instead of ordering the quantity, orders are placed to satisfy time intervals (quantities will differ based on actual demand) Assumes that demand is uniform 27

Periodic Order Quantity (POQ) Annual demand: 52,000 units Weekly demand: 1000 units EOQ: 2800 POQ = EOQ Average Weekly Demand = = 2.8 weeks (3) 28

The Order Point System When the quantity of an item falls to a pre-determined level (order point), a replenishment order must be placed The quantity to be ordered is often based on EOQ concepts The key factor about the O.P. methodology is that it considers product demand during lead time (DDLT) O.P. also considers Safety Stock (SS) in its calculation 29

The Order Point System Order Point = DDLT + SS DDLT = Demand During Lead Time SS = Safety Stock (Safety Stock is carried to safeguard against supply chain variance(s)… Forecast, demand, lead time, etc.) 30

Product-Specific Order Point Example Order Point = DDLT + SS DDLT = Demand During Lead Time SS = Safety Stock (Safety Stock is carried to safeguard against supply chain variance(s)… Forecast, demand, lead time, etc.) Demand = 200 units/week Lead time = 3 weeks Safety Stock = 300 units (200 x 3) = Order Point of 900 Units 31

The Order Point System: The Significance of SS, LT & Q Units In Stock Lead Time Q = Order Qty Order Point Safety Stock 32

The Order Point System Order Point = DDLT + SS DDLT = Demand During Lead Time SS = Safety Stock (Safety Stock is carried to safeguard against supply chain variance(s)… Forecast, demand, lead time, etc. Demand = 200 units/week Lead time = 3 weeks Safety Stock = 300 units (200 x 3) = Order Point of 900 Units 33

Inventory Management: The Use of Min/Max Levels A type of order point replenishment system where the “min” is the order point and the “max” is the order up to level Order quantity is variable and depends on item usage during prior periods ERP systems automatically notify the user to place an order Lead time accuracy is integral to min/max success High mins and maxes offer potential to bloat inventories Used often for dependent demand items 34

Safety Stock & Inventory Management Safety stock is additional inventory that is intended to safeguard against supply chain variation – Variation in quantity – Variation in timing Factors that influence SS – Demand variability during lead time – Frequency of reorder – Service level desired – Length of lead time – Variability of lead time 35

Safety Stock & Inventory Management To determine SS, one must be able to measure variation in DDLT It is this same variation that must resonate back up the supply chain through S&OP Safety stock is determined by using the Standard Deviation calculation 36

The Standard Deviation & Determining Safety Stock A statistical value that measures how closely individual values (demand per period) varies from the average The Standard Deviation is the math that lies behind the S&OP practice of comparing actual events to forecasted outcomes – Actual demand vs. Forecasted demand When used properly, the Standard Deviation can determine Safety Stock 37

Essentials of Effective Inventory Management: ABC Classification & Analysis Built upon the premise of Pareto Analysis States that 80% of the output (effect) of a given activity or process is generated by 20% of the inputs (cause) It is a prioritization tool designed to separate the “trivial many from the vital few” Many business applications: – 80% of a company’s sales comes from 20% of the total number of customers – 80% of total inventory value and/or movement comes from 20% of the SKU’s 38

Pareto Curve Effect 39

Essentials of Effective Inventory Management: ABC Classification The application of Pareto Analysis to I.M. is based on the axiom that the vast majority of inventory activity is generated by a small(er) number of SKU’s I.M. take P.A. a step further by classifying items based on a combination of their value and usage – 80% of total inventory value comes from 20% of SKU’s This practice is known as ABC Analysis Example: 16,000 SKU’s Total Value: $5m USD 3200 SKU’s = $4m 12,800 SKU’s = $1m Observation: If 3,200 SKU’s (20%) is too big to manage, 5% of SKU’s = 55% of total value (800 SKU’s = $2.75m) 40

Essentials of Effective Inventory Management: ABC Classification Because ABC Analysis is based on stock value and stock usage, the “Annual Turnover” of an item must be calculated Annual Turnover is found by multiplying an item’s Unit Cost by its Annual Usage To provide more granularity to the analysis, items are classified as either A, B, or C ABC Classification A items = 10% of items, with 65% of turnover B items = 20% of items, with 25% of turnover C items = 70% of items, with 10% of turnover Annual Turnover = Annual Usage x Unit cost 41

ABC Classification AB C 42 SKUs Value

ABC Classification AB C EXAMPLE Total items: 100 Total Value: $1m A = 10 items & $650m value B = 20 items & $250k value C = 70 items & $100k value 43 SKUs Value: $1m

Example of Pareto Analysis 44

ABC Classification By Usage Value 45

Summary of ABC Analysis 46

Inventory Management: Cycle Counting There is a big difference between periodic (yearly) physical inventories and cycle counting Physical inventories are for financial purposes (Balance Sheet) Cycle Counting assures inventory accuracy and is a building block for inventory reductions – The first in reducing inventories is knowing how much you really have Especially effective for “A” items in an ABC System 47

Inventory Management: Cycle Counting C.C. is an inventory accuracy auditing practice driven by a perpetual schedule of item- specific counts Depending on the item, cycle counts can be done weekly, monthly, et al (daily for ultra-high value item like prescription narcotics) Require the counting of certain items every day rotating locations in a warehouse Goal is to find errors in physical counts vs. system records and continuously improve accuracy 48

Inventory Management: KPI’s & Continuous Improvement 49

Supply Chain & Inventory Management Key Performance Indicators Forecast accuracy Inventory $ value Inventory aging Amounts & reductions in S.S. Budget compliance – Headcount, payroll, over time 50

Supply Chain & Inventory Management Key Performance Indicators Carrying costs Target landed costs – Transportation & Customs as a percentage of total cost Lead-time compliance Logistics cost per unit (item, carton, pallet) 51

Supply Chain & Inventory Management Key Performance Indicators Order accuracy Order fill rate Back orders & lost orders (number and dollar value) – Recovery time on back orders 52

Supply Chain & Inventory Management Key Performance Indicators Number of incidents (theft, loss, et al) – Number of claims Insurance premiums Dollar value of shrink 53

End of Module Seven Congratulations!!! 54