1. Lecture 21 Inventory Fundamentals
Books
Introduction to Materials Management, Sixth Edition, J. R. Tony Arnold, P.E., CFPIM, CIRM, Fleming College, Emeritus, Stephen N. Chapman, Ph.D., CFPIM, North Carolina State University, Lloyd M. Clive, P.E., CFPIM, Fleming College
Operations Management for Competitive Advantage, 11th Edition, by Chase, Jacobs, and Aquilano, 2005, N.Y.: McGraw-Hill/Irwin.
Operations Management, 11/E, Jay Heizer, Texas Lutheran University, Barry Render, Graduate School of Business, Rollins College, Prentice Hall

2. Objectives Inventory Fundamentals Aggregate inventory management
How company use their inventory
Objectives of Inventory management
Relevant inventory cost
Inventory function
Types of inventory
Material Flow
Functions of inventory
Inventory cost
Inventory turns

3. Amazon.com
Amazon.com started as a “virtual” retailer – no inventory, no warehouses, no overhead; just computers taking orders to be filled by others
Growth has forced Amazon.com to become a world leader in warehousing and inventory management

4. Amazon.com
Each order is assigned by computer to the closest distribution center that has the product(s)
A “flow meister” at each distribution center assigns work crews
Lights indicate products that are to be picked and the light is reset
Items are placed in crates on a conveyor. Bar code scanners scan each item 15 times to virtually eliminate errors.

5. Amazon.com
Crates arrive at central point where items are boxed and labeled with new bar code
Gift wrapping is done by hand at 30 packages per hour
Completed boxes are packed, taped, weighed and labeled before leaving warehouse in a truck
Order arrives at customer within a week

6. Inventory Fundamentals
What is inventory?
Materials and supplies that a business or institution carries either for sale or to provide inputs or supplies to the production process.
Those stocks or items used to support production (raw materials and work-in-process items), supporting activities (maintenance, repair, and operating supplies), and customer service (finished goods and spare parts) - APICS Dictionary

7. Inventory Fundamentals
Can production be planned without managing inventory?
since inventory either results from production or supports it, the two cannot be managed separately separately and must be coordinated
Production planning is concerned with overall inventory
Master planning is concerned with end items
Material requirements planning is concerned with component parts and raw material

8. Aggregate Inventory Management
Aggregate inventory management is concerned with managing inventories according to their classifications (raw material, work-in-process, finished goods, etc.) and the function they perform. It is financially oriented and is concerned with the costs and benefits of carrying the classifications of inventories.

9. Aggregate Inventory Management
Aggregate inventory management involves
Flow and kind of inventory needed
Supply and demand patterns
Functions inventory performs
Objectives of inventory management
Costs associated with inventory

10. Item Inventory Management
Management must establish decision rules about individual inventory items:
Importance of inventory items
How they are to be controlled
How much to order at one time
When to place an order

11. How Companies Use Their Inventory
Anticipation or seasonal inventory
Fluctuation Inventory or Safety stock: buffer demand fluctuations
Lot-size or cycle stock: take advantage of quantity discounts or purchasing efficiencies
Transportation or Pipeline inventory
Speculative or hedge inventory protects against some future event, e.g. labor strike
Maintenance, repair, and operating (MRO) inventories

12. Objectives of Inventory Management
Provide desired customer service level
Customer service is the ability to satisfy customer requirements
Percentage of orders shipped on schedule
Percentage of line items shipped on schedule
Percentage of $ volume shipped on schedule
Idle time due to material and component shortages

13. Inventory Objectives con’t
Provide for cost-efficient operations:
Buffer stock for smooth production flow
Maintain a level work force
Allowing longer production runs & quantity discounts
Minimum inventory investments:
Inventory turnover
Weeks, days, or hours of supply

14. Customer Service Level Examples
Percentage of Orders Shipped on Schedule
Good measure if orders have similar value. Does not capture value.
If one company represents 50% of your business but only 5% of your orders, 95% on schedule could represent only 50% of value
Percentage of Line Items Shipped on Schedule
Recognizes that not all orders are equal, but does not capture
$ value of orders. More expensive to measure. Ok for finished goods.
A 90% service level might mean shipping 225 items out of the total 250 line items totaled from 20 orders scheduled
Percentage Of Dollar Volume Shipped on Schedule
Recognizes the differences in orders in terms of both line items and
$ value

15. Inventory Turnover: Weeks/Days of Supply:
Inventory Investment Measures Example: The Coach Motor Home Company has annual cost of goods sold of $10,000,000. The average inventory value at any point in time is $384,615. Calculate inventory turnover and weeks/days of supply.
Inventory Turnover:
Weeks/Days of Supply:

16. Relevant Inventory Costs
Item Cost
Includes price paid for the item plus other direct costs associated with the purchase
Holding Costs
Include the variable expenses incurred by the plant related to the volume of inventory held (15-25%)
Capital Costs
The higher of the cost of capital or the opportunity cost for the company

17. Relevant Inventory Costs
Ordering Cost
Fixed, constant dollar amount incurred for each order placed
Shortage Costs
Loss of customer goodwill, back order handling, and lost sales
Risk costs
Obsolescence, damage, deterioration, theft, insurance and taxes
Storage costs
Included the variable expenses for space, workers, and equipment related to the volume of inventory held

18. Determining Order Quantities
Lot-for-lot
Order exactly what is needed
Fixed-order quantity
Specifies the number of units to order whenever an order is placed
Min-max system
Places a replenishment order when the on-hand inventory falls below the predetermined minimum level.
Order n periods
Order quantity is determined by total demand for the item for the next n periods

19. Functions of Inventory
To decouple or separate various parts of the production process
To decouple the firm from fluctuations in demand and provide a stock of goods that will provide a selection for customers
To take advantage of quantity discounts
To hedge against inflation

20. Types of Inventory Raw material Work-in-process
Purchased but not processed
Work-in-process
Undergone some change but not completed
A function of cycle time for a product
Maintenance/repair/operating (MRO)
Necessary to keep machinery and processes productive
Finished goods
Completed product awaiting shipment

21. The Material Flow Cycle
Cycle time
95% 5%
Input Wait for Wait to Move Wait in queue Setup Run Output
inspection be moved time for operator time time

22. Inventory Management How inventory items can be classified
How accurate inventory records can be maintained

23. Inventory and the Flow of Materials
Inventory can be classified according to the following flow:
Raw material
Work-in-process (WIP)
Raw and In-Process (RIP)
Finished goods
Distribution
Maintenance, repair, and operating supplies (MRO)

24. Inventory and the Flow of Materials
Raw materials - purchased materials, component parts, and subassemblies.
Work-in-process (WIP) - materials that have entered the manufacturing process and are being worked on or waiting to be worked on.
Raw and in-process (RIP) - raw materials or work-in-process, a term used in JIT to account for shipments to point-of-use.

25. Inventory and the Flow of Materials
Finished goods - finished products of the production process that are ready to be sold as completed items.
Distribution inventories - finished goods located in the distribution system.
Maintenance, repair, and operational supplies (MROs) - items used in production that do not become part of the product.

26. Functions of Inventories
Inventory serves as a buffer between:
supply and demand
customer demand and finished goods
finished goods and component availability
requirements for an operation and the output from the preceding operation
parts and materials to begin production and the supplies of materials

27. Functions of Inventories
Purposes of inventory
Anticipation inventory - to anticipate future demand
built up to help level production and to reduce costs of changing production rates
Examples:
created ahead of a peak selling season, a promotion program, vacation shutdown, or possibly a strike

28. Functions of Inventories
Purposes of inventory (continued)
Fluctuation inventory - to cover random fluctuations in supply and demand or lead time (commonly called safety stock)
Purpose - to prevent disruptions in manufacturing or deliveries to customers

29. Functions of Inventories
Purposes of inventory (continued)
Lot-size inventory - to purchase or manufacture in quantities greater than needed immediately
Purpose - to take advantage of quantity discounts, to reduce shipping, clerical, and setup costs, and in cases where it is impossible to make or purchase items at the same rate they will be used or sold

30. Functions of Inventories
Purposes of inventory (continued)
Transportation inventory - to cover the time needed to move goods from one location to another (sometimes called pipeline inventory)
Hedge inventory - to protect against price fluctuations

31. Inventory Objectives
Inventories must be coordinated to meet three conflicting objectives:
Maximize customer service
Low-cost plant operation
Minimum inventory investment

32. Inventory Costs Costs used for inventory management decisions
Item costs
Carrying costs
Ordering costs
Stockout costs
Capacity-related costs

33. Inventory Costs Item costs
Item costs include the cost of the item and all costs to get the item into the facility:
product
transportation
customs duties
insurance
direct material, direct labor, and factory overhead

34. Inventory Carrying Costs
Carrying cost include all costs caused by the amount of inventory carried. Three categories used are:
Capital costs
money tied up in inventory
Storage costs
space, personnel, and equipment
Risk costs
Obsolescence, damage, pilferage, insurance, and deterioration

35. Inventory Carrying Costs
The annual carrying costs depend on the average inventory carried. The more that is ordered at one time, the higher the average inventory.
The annual cost of carrying inventory can be decreased by ordering less at one time.

36. Inventory Ordering Costs
Ordering costs - include the costs of placing an order with a factory or outside supplier.
Categories included in ordering cost are:
Production control costs
Setup and teardown costs
Lost capacity costs
Every time an order is placed on a work center, the time taken to set up is lost as productive output time. It is particularity important with bottleneck operations.
Purchase order costs

37. Inventory Ordering Costs
The annual ordering cost depends on the number of orders placed in a year
The annual cost of ordering can be reduced by decreasing the cost of placing an order and by reducing the number of orders placed
The number of orders per year can be reduced by ordering more at any one time

38. Inventory Costs Stockout costs
If demand during lead time exceeds the forecast and available inventory, we can expect a stockout. Possible costs of a stockout include:
Backorder costs
Lost sales costs
Lost customer costs

39. Inventory Costs Capacity-related costs
These costs are those of changing production levels. They include:
Overtime / slack time
Hiring
Layoff
Training
Shift premiums

40. Inventory Turns
Inventory turns: a measure of how effectively inventories are being used. The ratio of Annual Cost of Goods Sold divided by average inventory in dollars

41. Inventory Turns Example
Example from Page 238
What will be the inventory turns ratio if the annual cost of goods sold is $24 million and the average inventory is $6 million?
Inventory turns = Annual COGS / Avg. inv. $
= $24 million / $6 million = 4

42. Inventory Turns Example
What would be the reduction in inventory if inventory turns were increased to 12?
Avg. inv. $ = Annual COGS / Inventory Turns
= $24 million / 12 = $2 million
Reduction = $6 million - $2 million = $4 million
If the carrying cost is 25%, what will the savings be?
Savings = $4 million X 25% = $1 million!

43. End of Lecture 21