SCHM2301 Chapter 7 - SCHM 2301 Notes PDF

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SCHM 2301 Notes...

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Thursday, March 4th

Chapter 7: Managing Inventories 

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Inventory = supply of times held by a firm to meet demand o

Variability in supply and demand, process lead times, and cost associated with managing inventory create a picture that is rather complex, and the alternatives are many

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MRO example: office supplies, toilet paper, cleaning supplies

Roles of Inventory o

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Balancing supply and demand: decouples differences in supply and demand requirements 

Cycle stock: enables firms to produce or ship inventories in batches to take advantages of economies of scale

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Seasonal stocks: inventories characterized by a demand at a particular or different times of the year

Buffers against uncertainties: variation in supply and demand are managed with buffer (safety) stock 

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Enabling economies of buying: price discounts or reduced shipping costs 

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Buffer (or safety) stock: extra inventory to guard against potential uncertainties in demand or supply

Speculative stock: buying more stock ahead of need when expecting that prices may increase or that there may be supply disruptions or shortages in the future

Enabling geographic specialization: supply and demand locations vary 

Transit stock: inventory that is being transported from one place to another 

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Ex.) from a plant to a warehouse to a retail store

Financial Impact of Inventory

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Product cost: amount paid to suppliers for the products purchased

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Carrying (Holding) costs

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Opportunity cost (cost of capital)

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Storage and warehouse management

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Taxes and insurance

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Obsolescence, spoilage & shrinkage, loss and disposal

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Material handling, tracking and management

Ordering and Set-Up costs 

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Order cost = a transaction cost associated with replenishing inventories 

Purchased items: placing and receiving orders

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Make items: change-over between items

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Order preparation, order receiving, accts payable processing

Setup cost = administrative expenses and expenses of rearranging a work center to produce an item

Stockout Costs = cost incurred when inventory is not available to meet demand 

Lost sales or customer loyalty

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Expediting

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Schedule disruption

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Backorders

Measures of Inventory Performance o

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Inventory turnover: ratio of average inventory on-hand and level of sales (asset productivity) 

= Cost of goods sold/average inventory at cost

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= Net sales/average inventory at selling price

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= Unit sales/average inventory in units

With an annual cost of goods sold of $500M and average inventory (cycle stock) of $80M 

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Inventory turns= $500/$80 = 6.25 turns

Advantages of high turnover:

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Fresh inventory from high sales

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Reduced risk or mark down from obsolescence

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Reduced total carrying costs

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Lower asset investment and higher productivity

Dangers of high turnover: 

Stockouts may mean lower sales

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Increased costs from missing quantity requirements

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Increased ordering costs

Measures of Inventory Performance o

Days of supply: days of operation that can be supported with inventory on-hand 

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Days of supply = Current inventory/Daily demand 

If inventory is 2M and daily demand is 25,000/day

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Days of supply = 2M/25,000= 80 days

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Service level: ability to meet customer demand without a stock out

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Stock out: no inventory available

Inventory Management Systems o

Independent demand inventory systems: demand is beyond control of the organization

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Dependent demand inventory systems: demand is driven by demand of another item

2 Types of Major Independent Demand inventory systems: 1. Continuous review Model = inventory constantly monitored to decide when replenishment is needed 

With this model a computer system tracks sales and keeps running tally of quantities son hand

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It is more accurate, but more costly 

LIFO – FIFO – JIT

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Cycle counting

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Manual – Bar code – RFID – Robotics

2. Periodic Review Model = management system reviews and orders inventory at some regular interval

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Total Acquisition Costs = sum of all relevant annual inventory costs o

Ordering costs: (setup) associated with placing orders and receiving supply

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Holding costs: (carrying) associated with storing and assuming risk of having inventory 

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Common trade off between the two

TAC = annual ordering cost + annual carrying cost

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Economic Order Quantity (EOQ) = minimizes total acquisition costs; points at which holding and orders costs are equal o

How much to order

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If demand increases, order quantity goes up

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If ordering cost goes down, order qty and avg inventory also go down

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If inventory carrying cost increases, EOQ goes down

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TAC with a discount

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Price Discounts & Lot Sizes o

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Determining best price break quantity: 

Identify price breaks/lot size restrictions

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Calculate EOQ for each price/lot size

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Evaluate viability of each option

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Calculate TAC for each option

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Select best TAC option

Determining Service Levels o

Service Level Policy: determining the acceptable stock out risk level

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A way to decrease inventory without reducing service level is to tackle variability of both demand and lead time

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Revisiting ROP and Average Inventory to include Safety Stock

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Periodic Review Model

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Managing Inventory o

ABC analysis: ranking inventory by importance

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Pareto’s Law: small percentage of items have a large impact on sales, profit or costs

Inventory Information Systems and Accuracy o

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Identification Systems 

Global trade item number (GTIN): identification system for finished goods sold to consumers

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Part Number: unique identifier used by a specific firm

Inventory Record Accuracy 

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Cycle counting: inventory is physically counted on a routine schedule

Managing Inventory o

Managing cycle stock: reducing lot sizes

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Managing safety stock: using ABC analysis and reducing lead time

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Managing locations: balance inventory, lead time, and service levels

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Implementing Inventory Models: matching management

Managing Inventory Across the Supply Chain o

Bullwhip Effect: variation increases upstream in the supply chain (from consumer to manufacturers)

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Vendor-managed Inventory (VMI): the vendor is responsible for managing inventory for the customer

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Vendor monitors and replenishes inventory balances

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Customer saves holding costs

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Vendor has higher visibility of inventorsy usage

Collaborative planning, forecasting, and replenishment (CPFR): supply chain partners sharing information...