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CHAPTER 8
Inventory Management
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Learning Objectives
To learn about the ways that inventory can be classified
To discuss inventory costs and the trade-offs that exist among them
To identify when to order an how much to order, with a particular emphasis on the economic order quantity
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Learning Objectives
To differentiate the various inventory flow patterns
To discuss special concerns with inventory management
To identify several contemporary approaches to managing inventory
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4. Inventory Management Key Terms
ABC analysis of inventory
Back order
Complementary products
Cycle (base) stock
Dead inventory (dead stock)
Economic order quantity (EOQ)
Fixed order interval system
Fixed order quantity system
Inventory
Inventory carrying (holding) costs
Inventory shrinkage
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5. Inventory Management Key Terms
Inventory turnover
Just-in-time (JIT) approach
Lean manufacturing (lean)
Ordering costs
Pipeline (in-transit) stock
Psychic stock
Reorder (trigger) point (ROP)
Safety (buffer) stock
Service parts logistics
Speculative stock
Stockout costs
Substitute products
Vendor-managed inventory (VMI)
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Inventory Management
Inventory refers to stocks of goods and materials that are maintained for many purposes, the most common being to satisfy normal demand patterns.
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Inventory Management
Inventory management
Inventory decisions drive other business activities like:
Warehousing
Transportation
Materials handling
Objectives can differ for different functional areas of an organization
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Inventory Management
Inventory management
Must consider inventory costs
Carrying costs
Ordering costs
Stockout costs
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9. Inventory Classifications
Cycle or base stock refers to inventory that is needed to satisfy normal demand during the course of an order cycle.
Safety or buffer stock refers to inventory that is held in addition to cycle stock to guard against uncertainty in demand or lead time.
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10. Inventory Classifications
Pipeline or in-transit stock is inventory that is en route between various fixed facilities in a logistics system such as a plant, warehouse, or store.
Speculative stock refers to inventory that is held for several reasons, including seasonal demand, projected price increases, and potential shortages of a product.
Psychic stock is inventory carried to stimulate demand (retail).
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Inventory Costs
Inventory costs in the twenty-first century represent approximately one-third of total logistics costs.
Inventory cost should factor into an organization’s inventory management policy.
Inventory costs include:
Carrying cost
Ordering cost
Stockout cost
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Inventory Costs
Inventory carrying (holding) costs
the costs associated with holding inventory.
In general expressed in percentage terms and this percentage is multiplied by the inventory’s value
Resulting number represents dollar value associated with holding the particular inventory
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Inventory Costs
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Inventory Costs
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Inventory Costs
Ordering costs refer to those costs associated with ordering inventory, such as order costs and setup costs.
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Inventory Costs
Examples of order costs include:
Costs of receiving an order (wages)
Conducting a credit check
Verifying inventory availability
Entering orders into the system
Preparing invoices
Receiving payment
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Inventory Costs
Trade-Off between Carrying and Ordering Costs
Costs respond in opposite ways to the number of orders or size of orders
An increase in the number of orders leads to higher order costs but lower carrying costs
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Inventory Costs
Calculations:
Ordering = # of orders per year x ordering cost per order
Cost
Carrying = average inventory x carrying cost per unit
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Inventory Costs
Stockout costs
an estimated cost or penalty for a stockout
involve an understanding of a customer’s reaction to a company being out of stock when a customer wants to buy an item
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Inventory Costs
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Inventory Costs
General Rules Regarding Stockout Costs
The higher the average cost of a stockout, the better it is for the company to hold some amount of inventory (safety stock) to protect against stockouts.
The higher the probability of a delayed sale, the lower the average stockout costs and the lower the inventory that needs to be held by a company.
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Inventory Costs
Trade-Off between Carrying and Stockout Costs
Costs move in opposite directions
Higher inventory levels (higher carrying costs) result in lower chances of a stockout (lower stockout costs)
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Inventory Costs
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When to Order
Key issue involves when product should be ordered
Can order a fixed amount of inventory (fixed order quantity system)
Or orders can be placed at fixed time intervals (fixed order interval system)
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When to Order
Reorder (trigger) point (ROP)
Level of inventory at which a replenishment order is placed
Necessary for efficient fixed order quantity system
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When to Order
Reorder Point (ROP) calculations:
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
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27. How Much to Order Economic order quantity (EOQ)
Deals with calculating the proper order size with respect to two costs
Costs of carrying the inventory
Costs of ordering the inventory
Determines the point at which the sum of carrying costs and ordering costs is minimized, or the point at which carrying costs equal ordering costs
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28. How Much to Order Economic order quantity (EOQ) in dollars 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 (%)
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How Much to Order
Economic order quantity (EOQ) in units
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
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How Much to Order
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How Much to Order
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Inventory Flows
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Inventory Flows
Safety stock can prevent against two problem areas
Increased rate of demand
Longer-than-normal replenishment
When fixed order quantity system like EOQ is used, time between orders may vary
When reorder point is reached, fixed order quantity is ordered
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34. Inventory Management: Special Concerns
ABC Analysis of Inventory
recognizes that inventories are not of equal value to a firm
as such all inventory should not be managed in the same way
Dead inventory (dead stock)
is a fourth category, D, to ABC analysis where D stands for either “dogs” or dead inventory (dead stock)
refers to product for which there is no sales during a 12 month period.
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35. Inventory Management: Special Concerns
Inventory Turnover
number of times that inventory is sold in a one-year period. (Compare with competitors or benchmarked companies
Inventory turnover = cost of goods sold
average inventory
Complementary Products
inventories that can be used or distributed together, i.e. razor blades and razors.
Substitute Products
products that can fill the same need or want as another product.
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36. Contemporary Approaches to Managing Inventory
Lean Manufacturing
Focuses on the elimination of waste and the increase of speed and flow
Identifies seven major sources of waste including inventory
Just-in-time (JIT) is one of the best known lean inventory practices
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37. Contemporary Approaches to Managing Inventory
Lean Manufacturing
Just-in-time (JIT)
Seeks to minimize inventory by reducing (or eliminating) safety stock while having the required amount of materials arrive at the production location at the exact time they are needed
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38. Contemporary Approaches to Managing Inventory
Service Parts Logistics
Involves designing a network of facilities to stock service parts:
Deciding upon inventory ordering policies
Stocking the required parts
Transporting parts from stocking facilities to customers
Source: Mehmet Ferhat Candas and Erhat Kutanoglu, “Benefits of Considering Inventory in Service Parts Logistics Network
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39. Contemporary Approaches to Managing Inventory
Vendor-Managed Inventory (VMI)
Size and timing of replenishment orders are the responsibility of the manufacturer
Allows manufacturers to have access to a distributor’s or retailer’s sales and inventory data
Benefits include reduced inventories, fewer stockouts and improved customer retention
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40. Contemporary Approaches to Managing Inventory
FIGURE 8.4 Advertisement from a Parts Bank Service
Source: Courtesy of Associated Distribution Logistics (ADL)
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