16

Inventory Management

“Every management mistake ends up in inventory.”

Michael C. Bergerac Former Chief Executive Revlon, Inc.

CR (2004) Prentice Hall, Inc.

• Just-in-time (production philosophy)-Attempts to synchronize stock flows so as to

just meet demand as it occurs

-Minimizes the need for inventory

Inventory Management Philosophies

Impact of Demand Patterns on Inventory Management PULL versus PUSH SYSTEMS

PULL SYTEM: The company waits to produce products until customer demand it

PUSH SYSTEM: The firm produces to forecasted or anticipated sales to customers

INDEPENDENT versus DEPENDENT DEMAND

Whether the demand for an item depends on demand for something else-dependent demand demand for an item depends on demand for

something else

Pull strategy

In a pull-based supply chain, production and distribution are demand driven so that they are coordinated with actual customer orders, rather than forecasted demand. Draws inventory into the stocking location Each stocking location is considered

independent Maximizes local control of inventories

Push Strategy Products are pushed through the channel, from

the production side up to the retailer. The manufacturer sets production at a level in

accord with historical ordering patterns of retailers.

It takes longer for a push-based supply chain to respond to changes in demand, which can result in overstocking or bottlenecks and delays (the bullwhip effect), unacceptable service levels and product obsolescence. Allocates production to stocking locations based on

overall demand Encourages economies of scale in production

Push-Pull Boundary

A supply chain is almost always a combination of both push and pull, where the interface between the push-based stages and the pull-based stages is known as the push-pull boundary.

Dell- Inventory levels of individual components are determined by forecasting general demand, but final assembly is in response to a specific customer request. The push-pull boundary would then be at the beginning of the assembly line.

Inventory Management

Inventory management Decisions drive other logistics activities Objectives can differ for different functional areas

of an organization Must consider inventory costs

Carrying costs Ordering costs Stockout costs

© Pearson Education, Inc. publishing as Prentice Hall 8-8

Inventory Carrying Cost

Inventory carrying costs are those costs associated with the amount of inventory stored.

Inventory carrying costs are made up of a

number of different costs.

Unfortunately, many companies have never calculated inventory carrying costs, even though these costs are both real and substantial.

Benchmarking the percentage of inventory

carrying costs-Avon /Revlon

Calculating Inventory Carrying Costs Inventory carrying costs should include only

those costs vary with the quantity of inventory and that can be categorized into the following groups; capital costs, inventory service costs, storage space costs, inventory risk costs.

InventoryCarrying

Costs

Inventory Investment

Insurance

Taxes

Obsolescence

Pilferage

Inventory Carrying Cost Methodology

Storagespace costs

Capitalcosts

Inventoryservicecosts

Inventoryrisk costs

Plant warehouses

Public warehouses

Rented warehouses

Company-owned warehouses

Damage

Relocation costs

5 3

1. Capital Costs on Inventory Investment

Holding inventory ties up money that could be used for other types of investments (Opportunity Cost of the Capital)

Some companies differentiate among projects by categorizing them according to their risk and looking for rates of returns that reflect the perceived level of risk.

Calculating Capital Costs on Inventory InvestmentCost of money In the situation of financing the inventory: cost of money

is actual cost of borrowing

Shortage of capital-cost of money for inventory decisions is high-decrease in inventory

Abundance of cash- cost of money for inventory is low-increase in inventory

2. Inventory Service Costs

Inventory service costs are comprised of ad valorem-personal property costs

taxes, fire and theft insurance paid

as a result of holding the inventory.

3. Storage Space Costs

Storage space costs relate to four general types of facilities:

Plant warehouse costs Public warehouse costs Rented or leased(contract) warehouses Company owned(private) warehouses

4. Inventory Risk Costs

Inventory risk costs vary form company to company, but typically include charges for; Obsolescence cost is the cost of each unit that must

be disposed of at a loss because it can no longer be sold at a regular price.

Damage costs incurred during shipping should be considered a throughput cost, since they will continue regardless of inventory levels.

Shrinkage costs are becoming an increasingly important for businesses (inventory theft, poor record keeping,shipping wrong quantities…)

Relocation costs are incurred when inventory is transshipped from one warehouse location to another for avoiding obsolescence.

Inventory and Corporate Profitability Excessive inventory levels can lower

corporate profitability in two ways;1.Net profit is reduced by out of pocket costs associated with

holding inventory, such as insurance, tax,storage, obsolescence, damage, and interest expense, if the firm borrows money specifically to finance inventories,

2.Total assets are increased by the amount of the inventory investment, which decreases asset turnover, or the opportunity to invest in other more productive assets foregone.

Inventory and Least Total Cost Logistics

Inventory carrying cost is related with the decision of

logistics system design, customer service levels, number and location of DCs, transportation modes, inventory levels production schedules.

Inventory Ordering Costs

© Pearson Education, Inc. publishing as Prentice Hall 8-19

Ordering costs refer to those costs associated with ordering inventory, such as order costs and setup costs.

Inventory Ordering Costs

© Pearson Education, Inc. publishing as Prentice Hall 8-20

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

Trade-Off between Carrying and Ordering Costs

© Pearson Education, Inc. publishing as Prentice Hall 8-21

Ordering cost = number of orders per year x ordering cost per order

Carrying cost = average inventory x carrying cost per unit

Inventory Stockout Costs

© Pearson Education, Inc. publishing as Prentice Hall 8-22

Stockout cost is an estimated cost or penalty that is realized when a company is out of stock when a customer wants to buy an item.

Stockout costs involve an understanding of a customer’s reaction to a company being out of stock.

General Rules Regarding Stockout Costs

© Pearson Education, Inc. publishing as Prentice Hall 8-23

The higher the average cost of a stockout, the better it is for the company to hold some amount of inventory (SS) 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.

Trade-Off between Carrying and Stockout Costs

Higher inventory levels (higher carrying costs) result in lower chances of a stockout (lower stockout costs)

© Pearson Education, Inc. publishing as Prentice Hall 8-24

Table 8-4: Determination of Safety Stock Level

© Pearson Education, Inc. publishing as Prentice Hall 8-25

Inventory carrying cost should be traded off with other logistics costs.

Place/customer service

levels

Product

PromotionPrice

Order processing and information

costs

Warehousingcosts

Transportationcosts

Inventorycarrying costs

Lot quantitycosts

LO

GIS

TIC

S

MA

RK

ET

ING

Source: Adapted from Douglas M. Lambert, The Development of an Inventory Costing Methodology: A Study of the Costs Associated with Holding Inventory (Chicago, IL: National Council of Physical Distribution Management, 1976), p. 7.

51

Inventory Turns Inventory Turns (Inventory Turnover): The number

of times that a company’s inventory cycles or turns over per year.

It is one of the  most commonly used Supply Chain Metrics showing how fast a company is selling through its inventory and efficiently managing its resources

Current Year's Cost of Goods Sold or Cost of Revenues / The average inventory for the period

Inventory Turnover Comparisons

123456789

101112131415

$750,000375,000250,000187,500150,000125,000107,143

93,75083,33375,00068,18262,50057,69253,57150,000

$300,000150,000100,000

75,00060,00050,00042,85737,50033,33330,00027,27325,00023,07721,42820,000

-$150,000

50,00025,00015,00010,000

7,1435,3574,1673,3332,7272,2731,9231,6491,428

InventoryTurns

AverageInventory

Carrying Costat 40 Percent

Carrying CostSavings

The Impact of Inventory Turns on Inventory Carrying Costs

58

Relationship between Inventory Turns and Inventory Carrying Costs

Inventory Turns

$300,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

$250,000

$200,000

$175,000

$150,000

$125,000

$100,000

$75,000

$50,000$37,500$25,000

0

Inventory carrying costs

$225,00

$275,000

0

59

Annual Inventory Carrying Costs Compared to Inventory Turnovers

Variable Manufacturing CostCarrying Cost %Annual Cost to Carry in InventoryMonthly Cost (1/12)

$100x 30%$30

$2.50

Inventory Turns

Inventory carrying costs (per unit)

1 2 3 4 5 6 7 8 9 10 11 1 2

15.00

12.50

10.00

7.50

5.003.752.50

0

$30.00

6.00

510

Symptoms of Poor Inventory Management

Increasing numbers of back orders. Increasing investment in inventory with back orders remaining

constant. High customer turnover rate. Increasing number of orders canceled. Periodic lack of sufficient storage space. Wide variance in turnover of major inventory items between

distribution centers. Deteriorating relationship with intermediaries, as typified by

dealer cancellations and declining orders. Large quantities of obsolete items.

Methods for Reducing Inventory

Multiechelon inventory planning.(ABC analysis) Lead time analysis. Delivery time analysis. Elimination of low turnover and/or obsolete items. Analysis of pack size and discount structure. Examination of procedures for returned goods. Encouragement/automation of product substitution. Installation of formal reorder review systems. Measurement of fill rates by storekeeping units.

Methods for Reducing Inventory (Cont’d)

Analysis of customer demand characteristics. Development of a formal sales plan and emend forecast by

predetermined logic. Expand view of inventory to include inventory management and

information sharing at various levels in the SC. Reengineering inventory management practices to realize

improvements in product flow.

ABC Analysis-Pareto

80/20 concept is useful in distribution and inventory management.

The top 20 %-A ~ wide geographic distribution through many warehouses with high levels of stock availability

The next 30 %- B The remainder 50 %- C~distributed from a

single, central stocking point

Problem:

Suppose that a certain warehouse is to store 11 of the 14 items shown previously. The turnover ration for A group items is 7 to 1, for B items 5 to 1, For C items 3 to 1. If the annual sales through the warehouse are forecasted to be $ 25,000 , how much inventory investment in the warehouse can be expected?

HW 4

Textbook, Chapter 8, questions 2,4,5,6,8, 12 and

Case 8.1, question 1 on p.170-171 Following problem: Economic Order Quantity