0134520319 ISM Ch08 - Answers to the questions at the end of the chapters; including the case studies. PDF

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Answers to the questions at the end of the chapters; including the case studies....

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PART II ANSWERS TO END-OF-CHAPTER QUESTIONS CHAPTER 8: INVENTORY MANAGEMENT 8-1. How might different organizational functions have different inventory management objectives? Marketing, for example, tends to want to ensure that sufficient inventory is available for customer demand to avoid potential stockout situations—which translate into higher inventory levels. Alternatively, the finance group generally seeks to minimize the cost associated with holding inventory, which translates into lower inventory levels. 8-2. What makes is difficult for managers to achieve the proper balance of inventory? Achieving the proper balance of inventory can be quite difficult because of the trade-offs between inventory carrying cost and stockout costs. More specifically, holding high levels of inventory (overstock) results in higher inventory carrying costs and low (or no) stockout costs. Alternatively, holding low levels of inventory results in low inventory carrying costs and some (high) stockout costs. 8-3. Distinguish among cycle, safety, pipeline, and speculative stock. Cycle (base) stock refers to inventory that is needed to satisfy normal demand during the course of an order cycle. Safety (buffer) stock refers to inventory that is held in addition to cycle stock to guard against uncertainty in demand and lead time. Pipeline (in-transit) stock is inventory that is en route between various nodes in a logistics system, whereas speculative stock is inventory that is held for several reasons, including seasonal demand, projected price increases, and potential product shortages. 8-4. Define what is meant by inventory carrying costs and list its primary components. Inventory carrying costs refer to the costs associated with holding inventory. Inventory carrying costs consist of a number of different components, and their importance can vary from product to product. These components include obsolescence costs, shrinkage costs, storage costs, taxes, and interest costs. 8-5. What are ordering costs? What is the trade-off between inventory carrying costs and ordering costs? Ordering costs refer to those costs associated with ordering inventory, such as order costs and setup costs. Order costs include, but are not limited to, the costs of receiving an order (e.g., the wages of the person who takes orders by telephone), conducting a credit check, verifying inventory availability, entering orders into the system, preparing invoices, and receiving payment. The trade-off that exists between carrying and ordering costs is that 1 Copyright © 2018 Pearson Education, Inc.

they respond in opposite ways to the number of orders or size of orders. That is, an increase in the number of orders leads to higher order costs and lower carrying costs. 8-6. Discuss the concept of stockout costs. How can stockout costs be calculated? Stockouts refer to situations where customers demand items that are not immediately available; stockout costs refer to the costs associated with not having items available. Calculation of a stockout cost first requires a company to classify potential customer responses to a stockout (e.g., delays the purchase, lost sale, lost customer). Next, the company needs to assign probabilities to the various responses and assign monetary losses to the various responses. The respective probabilities and losses are multiplied, and then all costs are summed to yield an average cost of stockout. 8-7. Distinguish between a fixed order quantity and fixed order interval system. Which one generally requires more safety stock? Why? In a fixed order quantity system, the order size stays constant (although the time interval between orders may vary); in a fixed order interval system, the time interval is constant (although the order size may vary). The infrequency of inventory monitoring makes a fixed order interval system more susceptible to stockouts, and so there are likely to be higher levels of safety stock in a fixed order interval system. 8-8. Explain the logic of the EOQ model. The logic of the EOQ model is as follows: Determining an order quantity requires a company to balance two costs, which are the costs of carrying the inventory and the costs of ordering it. Inventory carrying costs are in direct proportion to order size; that is, the larger the order, the greater the inventory carrying costs. Ordering costs, by contrast, tend to decline with order size, but not in a linear fashion. The EOQ attempts to find the point (quantity) at which ordering costs equals carrying costs. 8-9. What assumptions are associated with the EOQ model? The basic EOQ model is grounded in the following eight assumptions:        

A continuous, constant, and known rate of demand A constant and known replenishment or lead time A constant purchase price that is independent of the order quantity All demand is satisfied (no stockouts are allowed) No inventory in transit Only one item in inventory or no interaction between inventory items An infinite planning horizon Unlimited capital availability.

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8-10. How can inventory flow diagrams be useful to a logistics manager? They present a visual depiction of additions to, and subtractions from, inventory. This could be helpful in identifying any patterns that might be occurring. In addition, inventory flow examples illustrate how safety stock can offset an increased rate of demand as well as longer than normal replenishment cycles. 8-11. Discuss what is meant by ABC analysis of inventory. Name several measures that can determine ABC status. ABC analysis is an approach that recognizes all inventories are not of equal value to a firm and, as a result, all inventory should not be managed in the same way. Measures that can be used to determine ABC status include sales volume in dollars, sales volume in units, the fastest selling items, item profitability, or item importance. 8-12. Define what is meant by dead inventory. What are several ways to manage it? Dead inventory refers to product for which there are no sales during a 12-month period. Because dead inventory has often been associated with overproduction of items that customers do not want (or need), one suggestion would be make to order as opposed to make to stock. Having said this, an increasing source of dead stock in recent years involves special, highly customized orders that never end up with the customer. Suggestions for dealing with this situation include partial (or full) prepayment as well as a no-return policy. Other suggestions are for companies to more aggressively market their dead stock or for companies to sell dead inventory via auctions. Another possibility is to donate the dead inventory to charitable causes. A last resort is to simply throw away the dead inventory in order to free up storage space. 8-13. In what ways can inventory turnover provide important insights about an organization’s competitiveness and efficiency? A particular organization can compare its turnover figures to those of direct competitors or other organizations with “desirable” turnover ratios. With respect to efficiency, low turnover indicates that a company is taking longer to sell its inventory, perhaps because of product obsolescence or pricing problems. By contrast, high turnover may signal a low level of inventories, which can increase the chance of product stockouts. 8-14. Discuss some of the managerial challenges that complementary products present. One managerial issue with complementary products is that so many complementary items might exist for a particular product that it is impossible to display or carry them in the same section of a store. Another issue involves the amount of inventory to be carried. For example, razor blades tend to sell faster than razors, and it might be argued that razors should be dropped in favor of faster-moving products. However, the sale and display of the razors might be necessary to support the sale of the razor blades. 3 Copyright © 2018 Pearson Education, Inc.

8-15. What are substitute items? How might they affect safety stock policies? Substitute items refer to products that customers view as being able to fill the same need or want. With respect to safety stock policies, if a consumer has little hesitation in substituting another item for one that is out of stock, there would appear to be minimal penalties for a stockout. It is also important that companies understand substitution patterns in the sense that Product A may be a substitute for Product B, but the reverse may not be true. In such a situation, safety stock policies would need to reflect the appropriate relationships. 8-16. How might a hospital’s decisions regarding substitute products differ from a supermarket’s decisions regarding substitute products? Because of the many possibilities for substitutability, many grocery chains target in-stock rates of 95 percent for individual stores so that sufficient substitutes exist for a customer to purchase a substitute item rather than go to a competing store. Some of the issues that hospitals confront with respect to substitute products include:    

What safety risks does a substitute product pose for patients and hospital staff? Is the substitute product compatible with current equipment? How will information about the substitute product be communicated to hospital staff? How do a patient’s insurance requirements impact the ability to use a substitute product?

8-17. How do the consequences of JIT go far beyond inventory management? One consequence is that suppliers must deliver high-quality materials to the production line; because of JIT’s emphasis on low or no safety stock, defective materials result in a product line shutdown. In addition, JIT emphasizes minimal inventory levels, and as a result customers tend to place smaller, more frequent orders. As such, it is imperative that suppliers’ order systems be capable of handling an increased number of orders in an error-free fashion. In addition, because the transit-time reliability tends to decrease with distance, suppliers need to be located relatively close to their customers. 8-18. Why should organizations carefully consider potential trade-offs before adopting a lean philosophy? The lean philosophy was conceived and nurtured in an environment—local or regional sourcing, fewer man-made or natural disasters—far different from today’s environment. Today’s emphasis on global sourcing translates into longer and more erratic transit times —and longer and more erratic transit times don’t align very well with lean’s emphasis on shipments that arrive exactly when needed. With respect to man-made or natural disasters, the August 2015 explosion at China’s Port of Tianjin caused tremendous supply chain disruptions—lost inventory, delayed shipments—that are antithetical to the lean philosophy. 4 Copyright © 2018 Pearson Education, Inc.

8-19. Discuss some challenges that service parts logistics creates for logistics managers. One challenge is that it can be extremely difficult to forecast the demand for the necessary parts. The difficulties in forecasting demand lead to challenges with respect to which parts to carry, the appropriate stocking levels for the parts that are carried, and higher inventory levels. Another challenge involves the number of warehousing facilities that should be used. One possibility is to locate the parts at numerous warehousing facilities in that this allows the parts to be fairly close to potential customers. Alternatively, the parts could be located at one centralized facility; although this would require the use of premium transportation for some shipments, this cost can be offset by the inventory cost savings that result from inventory being held in only one facility. 8-20. How does vendor-managed inventory differ from traditional inventory management? In traditional inventory management, the size and timing of replenishment orders are the responsibility of the party using the inventory, such as a distributor or retailer. Under vendor-managed inventory (VMI), the size and timing of replenishment orders are the responsibility of the manufacturer. VMI represents a huge philosophical shift for some organizations in the sense that they are allowing another party to have control over their inventories.

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PART III CASE SOLUTIONS CASE 8-1: LOW NAIL COMPANY Question 1: Using the EOQ methods outlined in the text, how many kegs of nails should Low order at one time? The EOQ formula is: EOQ = √ 2 (annual use in units) (cost of placing an order) / annual carrying cost per item per year = √ 2 (2000) (60) / 2 = √ 120,000 = 345 kegs per order Note the 2 in the denominator. That is because, on average, the rented warehouse space is only half full, which makes the average warehousing cost per keg be $2. Question 2: Assume all conditions in Question 1 hold, except that Low’s supplier now offers a quantity discount in the form of absorbing all or part of Low’s order-processing costs. For orders of 750 or more kegs of nails, the supplier will absorb all the orderprocessing costs; for orders between 249 and 749 kegs, the supplier will absorb half. What is Low’s new EOQ? (It might be useful to lay out all costs in tabular form for this and later questions.) Orders per Year

Order Size

1 2 3 4 5 6 7 8 9

2,000 1,000 667 500 400 334 286 250 223

Processing Costs ($) Free Free 90 120 150 180 210 240 540

Warehousing Costs ($) 2,000 1,000 667 500 400 334 286 250 223

Sum of Processing and Warehousing Costs ($) 2,000 1,000 757 620 550 514 496 490 743

The new EOQ, based on the preceding information, is 250 kegs.

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Question 3: Temporarily, ignore your work on Question 2. Assume that Low’s warehouse offers to rent Low space on the basis of the average number of kegs Low will have in stock, rather than on the maximum number of kegs Low would need room for whenever a new shipment arrived. The storage charge per keg remains the same. Does this change the answer to Question 1? If so, what is the new answer? The relevant table is as follows:

Orders Per Year

Order Size

1 2 3 4 5

2,000 1,000 667 500 400

Processing Costs ($)

Warehousing Costs ($)

60 120 180 240 300

1,000 500 334 250 200

Sum of Processing and Warehousing Costs ($) 1,060 620 524 490 500

The new EOQ, based on the preceding information, is 500. Question 4: Take into account the answer to Question 1 and the supplier’s new policy outlined in Question 2 and the warehouse’s new policy in Question 3. Then determine Low’s new EOQ. The relevant table is as follows: Orders Per Year

Order Size

1 2 3 4 5 6 7

2,000 1,000 667 500 400 334 286

Processing Costs ($)

Warehousing Costs ($)

Free Free 90 120 150 180 210

1,000 500 334 250 200 167 143

Sum of Processing and Warehousing Costs ($) 1,000 500 424 370 350 347 353

The new EOQ, based on the preceding information, is 334. Question 5: Temporarily, ignore your work on Questions 2, 3, and 4. Low’s luck at the race track is over; he now must borrow money to finance his inventory of nails. Looking at the situation outlined in Question 1, assume that the wholesale cost of nails is $40 per keg and that Low must pay interest at the rate of 1.5 percent per month on unsold inventory. What is his new EOQ? This answer can be done in tabular form as well, with the interest on inventory appearing as a new column. If one order is placed a year, the average inventory is 7 Copyright © 2018 Pearson Education, Inc.

1,000 kegs, worth $40,000, with annual interest charges (1.5 x 12 = 18%) of $7,200. Other interest costs are calculated in a similar fashion, adjusted for average inventory. The relevant table is as follows:

Orders Per Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14

Order Size

Processing Costs ($)

2,000 1,000 667 500 400 334 286 250 223 200 182 167 154 143

60 120 180 240 300 360 420 480 540 600 660 720 780 840

Warehousing Costs ($)

Interest Costs ($)

2,000 1,000 667 500 400 334 286 250 223 200 182 167 154 143

7,200 3,600 2,405 1,800 1,440 1,203 1,030 900 807 720 656 605 555 519

Sum of Processing, Warehousing, and Interest Costs ($) 9,260 4,720 3,252 2,540 2,140 1,897 1,736 1,630 1,570 1,520 1,498 1,492 1,489 1,502

The new EOQ, based on the preceding information, is 154 kegs. Question 6: Taking into account all the factors listed in Questions 1, 2, 3, and 5, calculate Low’s EOQ for kegs of nails. The relevant table is as follows:

Orders Per Year 1 2 3 4 5 6 7 8 9

Order Size 2,000 1,000 667 500 400 334 286 250 223

Processing Costs ($) Free Free 90 120 150 180 210 240 540

Warehousing Costs ($) 1,000 500 334 250 200 167 143 125 112

Interest Costs ($) 7,200 3,600 2,405 1,800 1,440 1,203 1,030 900 807

Sum of Processing, Warehousing, and Interest Costs ($) 8,200 4,100 2,829 2,170 1,790 1,550 1,383 1,265 1,459

The new answer, based on the preceding information, is 250 kegs.

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