ch06_managing inventory flows in the supply chain

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Chapter 6:

Managing Inventory Flows in the

Supply Chain



Chapter 6 Management of Business Logistics, 7th Ed. 2

Learning Objectives - After reading this

chapter, you should be able to do the following:

Understand the importance of coordinatedflows of inventory through supply chains.

Understand the impact of effective inventorymanagement upon the return on assets(ROA) for a company.

Appreciate the role and importance ofinventory in the economy and why inventorylevels have declined relative to GrossDomestic Product (GDP).




Learning Objectives Understand the major reasons for carrying

inventory.

Explain the role of inventory to majorfunctional areas in the company.

Discuss the major types of inventory-relatedcosts and their relationships to inventorydecisions.




Learning Objectives Understand how inventory items (stock-

keeping units) can be designed to maximize

the efficiency of managing inventory. Appreciate the importance and value of

inventory visibility to increasing supply chaineffectiveness.

Understand how companies can evaluate theeffectiveness of their inventory managementtechniques.




Logistics Profile:

Micros and More “Inventory, inventory, inventory….I am sick

and tired of hearing complaints about ourinventory levels and the costs associated withcarrying inventory,” muttered the COO.

What is the role of inventory?

What are the important trade-offs in the

management of inventory? What are the relevant inventory costs?

Can the supply chain help control inventory?




Management of Inventory Flows

in the Supply Chain: Introduction Inventory as an asset has taken on increased

significance as companies struggle to reduce

investment in fixed assets that accommodateinventory (plants, warehouses, etc.).

Changes in inventory affect return on assets(ROA), an important internal and external

metric. Ultimate challenge is to balance supply and

demand for inventory.




Inventory in the Economy Inventory in the Economy has decreased.

As a percentage of the GDP, from 1985 to

2000, inventory levels have decreasedfrom 5.4% to about 3.8%

Examine Table 6-1.




Table 6-1: Macro Inventory Cost in

Relation to U.S. Gross Domestic Product




On the Line:

Inventory Turns Think of inventory turns as a measure of how well a

company’s products are doing in the market and howwell its inventory is managed.

There is a continuing move away from traditionalbuild-to-forecast manufacturing models to moreflexible build-to-demand systems.

Increasing emphasis on fully integrated supply chainmeans inventories barely spend any time sitting idle.

“Ideally, zero inventory will maximize cash flow.”

Inventory turnover potential is 30 to 40 times/year.




Inventory in the Firm:

Rationale for Inventory Product Line Proliferation

Depth & breath of product lines trending up.

Results in larger inventories. Examine Table 6-2 Total Logistics Costs-1999 .

Inventory carrying costs of $332 billion

approach 35 percent of total logistics costs forcompanies.




Table 6-2

Total Logistics Costs --- 1999





Batching Economies/Cycle Stocks Price discounts

Result in trade-offs between large

purchases qualifying for quantity discountsand costs of storing inventory.

Because physical supply inventory is oftenraw materials, storage costs are often lessthan savings from buying in bulk, sosupplies are stockpiled.





Batching Economies/Cycle Stocks Transportation rate discounts

Large quantities often result in carload

freight rates. Largest shipments may qualify for even

lower multiple truckload, carload ortrainload rates.

Lower freight rates are often reflected inlower consumer prices.





Batching Economies/Cycle Stocks Production economics favor long production

runs.

Results in cycle stock that must be stored. Cycle stocks can be beneficial as long as

the appropriate analysis is done to cost justify the inventory.





Uncertainty/Safety Stocks Reasons for uncertainty are commonplace.

Net results are the same: companies

accumulate safety stock to bufferthemselves against uncertainty.

Safety stock more challenging and complexto manage for many firms.




Inventory in the Firm:Uncertainty/Safety Stocks

Impact of information on uncertainty

Trade-off analysis appropriate to assess

risk and measure inventory cost. Information technology can be used in the

supply chain to reduce inventory.

Collaborative planning and forecastingrequirements (CPFR) is an example.

Bar coding, EDI, the Internet have enabledcompanies to reduce uncertainty.




Inventory in the Firm: Time/In- Transit and Work-In-Process Stocks

Time-related trade-offs from using slower tofaster transport modes

Faster modes cost more but may save alarger amount in inventory carrying costs.

Work-In-Process inventory should beexamined for possible trade-offs especially inthe production of high value goods.

Scheduling and actual production times canbe closely examined to reduce inventory.




Inventory in the Firm:Seasonal Stocks

Seasonality can occur on the inbound and/oroutbound side of the firm’s logistics systems.

Perishable supply in agricultural products orseasonal-related transportation problems.

Seasonal demand compressing sellingseasons in some industries results in smallerplants producing for stock.




Inventory in the Firm: Anticipatory Stocks

In some cases, companies anticipate thatsome forecasted event will negatively impact

the production cycle. For example, labor strikes, shortage of

supplies due to weather or political event, orsignificant price increases may prompt the

firm to build inventory levels higher thannormal.

Risk assessment is important in these cases.




Inventory in the Firm: The Importanceof Inventory in Other Functional Areas

Marketing uses inventory to provide strongcustomer service.

Manufacturing uses inventory to schedulelonger production runs.

Finance wants inventory turnover ratios to bekept high so that risk of inventory loss isreduced and rate of return on assets keptcompetitively high.




Inventory Costs: Why are theyso important?

First, inventory costs are a significant portionof total logistics costs for many firms.

Second, inventory levels affect customerservice levels.

Third, inventory cost trade-off decisions affectinventory carrying costs.




Inventory Costs:Inventory Carrying Cost

Capital Cost

Opportunity cost associated with investing

in inventory, or any asset. What is the implicit value of having capital

tied up in inventory, instead of some otherworthwhile project?

Minimum ROR expected from any asset.

Debate on inventory valuation at fullyallocated or variable costs only.





Storage Space Cost

Handling costs, rents, utilities.

Logistics develops a cost formula forstorage space costs based on costbehaviors.

Public space mostly variable. Private space a mix of fixed and

variable.





Inventory Service Cost

Insurance and taxes on stored goods.

Varies according to the value of the goods. Inventory Risk Cost

Largely beyond the control of the firm.

Due to obsolescence, damage, theft,employee pilferage.




Table 6-3 Example of Carrying CostComponents for Computer Hard Disks

Cost Percentage of Product Value

Capital 12 %

Storage space 2

Inventory service 3

Inventory 8

Total 25 %




Inventory Costs: Calculating theCost of Carrying Inventory

Step 1 - Identify the value of the item storedin inventory (e.g. $100).

Step 2 - Measure each individual carrying costcomponent as a percentage of product value(e.g. 25%).

Step 3 - Multiply overall carrying cost (as apercentage) times the dollar value of theproduct (e.g. $100 times 25% = $25inventory carrying cost per year.




Inventory Costs:Nature of Carrying Cost

Items with basically similar carrying costsshould use the same estimate of carrying cost

per dollar. There are exceptions for items that are

subject to special consideration for purposesof quick obsolescence or high degree of theft,

etc.




Table 6-4Inventory and Carrying Cost Informationfor Computer Hard Disks




Inventory Costs:Order/Setup Costs

Order costs

MIS costs for inventory stock level tracking.

Preparing and processing purchase ordersand receiving reports.

Inspecting and preparing inventory for sale.

Setup Costs Incurred when production changes over

from one product to another.




Table 6-5 Order Frequency andOrder Cost for Computer Hard Disks




Inventory Costs:Carrying Cost versus Order Cost

Examine Table 6-6.

Order costs and carrying costs respond in

opposite ways to increases in volume. This reinforces the logisticians need to be

able to separate costs by how they behave inrelation to changes in volume.

Assistance from managerial accountants isavailable for cost-volume-profit analysis.




Table 6-6 Summary of Inventoryand Cost Information




Figure 6-1Inventory Costs




Inventory Costs:Expected Stockout Cost

Cost of not having product available when acustomer wants it.

Includes backorder costs (special order). Losing one item profit by substituting a

competing firm’s product.

Losing a customer permanently if customerfinds they prefer the substituted productand/or company.




Inventory Costs:Expected Stockout Cost

Possible to handle this by adding safety stock.

In a manufacturing firm, a stockout may result

in lost hours of production until the item isrestocked.




Inventory Costs:Inventory in Transit Carrying Cost

Any product inbound to the firm using F.O.B.origin should be counted.

Any product outbound from the firm usingF.O.B. destination should be counted.

In transit carrying cost is generally less thanfor regular inventory because some cost

components are not present.

No storage costs, no taxes, and reducedrisk of obsolescence.




Classifying Inventory: ABC Analysis

Ranking system

Developed in 1951 by H. Ford Dicky ofGeneral Electric3.

Suggested that GE classify items accordingto relative sales volume, cash flows, leadtime, or stockout cost.

Most important inventory put in Group A. Lesser impact goods put in Groups B and C

respectively.





Pareto’s Rule (80-20 Rule)

Based on a nineteenth centurymathematician’s observation that manysituations were dominated by a very fewelements.

Conversely, most elements had very little

influence in most situations. Separates the “trivial many” from the “vital few”.





80-20 Rule

80% of sales will come from 20% of the

inventory SKUs. 20% of sales will come from 80% of the

inventory SKUs.

The 80-20 Rule has been found to explain

many phenomena that interest managers.

For example, 80% of sales come from 20%of customers; and vice versa.




Figure 6-2 ABC Inventory Analysis




Table 6-7 ABC Analysis for BigOrange Products, Inc.




Inventory Visibility

The ability of the firm to “see” inventory on areal-time basis throughout the supply chainsystem requires:

Tracking and tracing inventory SKUs for allinbound and outbound orders.

Providing summary and detailed reports of

shipments, orders, products, transportationequipment, location, and trade lane activity.

Notification of failures in inventory flow.




Inventory Visibility:General Benefits

Improved customer service

Decreased cost-of-sales

Improved vendor relations and cost Increased Return on Assets

Improved cash flow

Improved response time and servicerecovery

Improved performance metrics




Evaluating the Effectiveness of a Company’s Approach to Inventory Management

Are customers satisfied with the currentlevel of customer service?

If standards have been set in consultationwith the customer, this question can beanswered objectively.





How frequently does backordering and/orexpediting occur?

If records of these events are kept, theanswer to this question can point out theneed for a modification or adoption ofnew inventory strategies.





Is the company calculating an InventoryTurnover ratio for each product SKU?

This ratio can provide good information onwhether the inventory is being effectivelyand efficiently managed.

Examine Table 6-8, Figure 6-3 andFigure 6-4.





How does inventory level behave as sales riseor fall?

From sales records, the firm can determineif inventory levels rise as much as sales, lessthan sales, or stay about the sameregardless of sales levels.

Table 6-8 The Relationship among




Table 6-8 The Relationship amongInventory Turnover, Average Inventory,and Inventory Carrying Costs




Figure 6-3 Saving InventoryDollars by Inventory Turns




Figure 6-4 Past and ProjectedInventory Turnover of Finished Goods



Chapter 6:Summary and Review Questions

Students should review their knowledge of thechapter by checking out the Summary and Study

Questions for Chapter 6.

This is the last slide for Chapter 6



End of Chapter 6 Slides

Managing Inventory Flows in

the Supply Chain

ch06_managing inventory flows in the supply chain

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