Contemporary Logistics Eleventh Edition Chapter 8 Inventory Management

Contemporary Logistics Eleventh Edition Chapter 8 Inventory Management Copyright©© 2015, 2012, 2009 Pearson. Education, Inc. All. Rights. Reserved Copyright 1

Learning Objectives • To learn about the ways that inventory can be classified • To discuss inventory costs and the trade-offs that exist among them • To identify when to order an how much to order, with a particular emphasis on the economic order quantity • To differentiate the various inventory flow patterns • To discuss special concerns with inventory management • To identify several contemporary approaches to managing inventory Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 2

Inventory Management Key Terms (1 of 3) • ABC analysis of inventory • Back order • Complementary products • Cycle (base) stock • Dead inventory (dead stock) • Economic order quantity (EOQ) • Fixed order interval system • Fixed order quantity system Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 3

Inventory Management Key Terms (2 of 3) • Inventory carrying (holding) costs • Inventory shrinkage • Inventory turnover • Just-in-time (JIT) approach • Lean manufacturing (lean) • Ordering costs • Pipeline (in-transit) stock Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 4

Inventory Management Key Terms (3 of 3) • Psychic stock • Reorder (trigger) point (ROP) • Safety (buffer) stock • Service parts logistics • Speculative stock • Stockout costs • Substitute products • Vendor-managed inventory (VMI) Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 5

Inventory Management (1 of 3) • Inventory refers to stocks of goods and materials that are maintained for many purposes, the most common being to satisfy normal demand patterns. Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 6

Inventory Management (2 of 3) • Inventory management • Inventory decisions drive other business activities like: • Warehousing • Transportation • Materials handling • Objectives can differ for different functional areas of an organization Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 7

Inventory Management (3 of 3) • Inventory management • Must consider inventory costs • Carrying costs • Ordering costs • Stockout costs Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 8

Inventory Classifications (1 of 2) • Cycle or base stock refers to inventory that is needed to satisfy normal demand during the course of an order cycle. • Safety or buffer stock refers to inventory that is held in addition to cycle stock to guard against uncertainty in demand or lead time. Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 9

Inventory Classifications (2 of 2) • Pipeline or in-transit stock is inventory that is en route between various fixed facilities in a logistics system such as a plant, warehouse, or store. • Speculative stock refers to inventory that is held for several reasons, including seasonal demand, projected price increases, and potential shortages of a product. • Psychic stock is inventory carried to stimulate demand (retail). Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 10

Inventory Costs (1 of 13) • Inventory costs in the twenty-first century represent approximately one-third of total logistics costs. • Inventory cost should factor into an organization’s inventory management policy. • Inventory costs include: • Carrying cost • Ordering cost • Stockout cost Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 11

Inventory Costs (2 of 13) • Inventory carrying (holding) costs • the costs associated with holding inventory. • In general expressed in percentage terms and this percentage is multiplied by the inventory’s value • Resulting number represents dollar value associated with holding the particular inventory Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 12

Inventory Costs (3 of 13) TABLE 8. 1 Magnitude of Inventory Costs Year Value of Business Inventory ($ billion) Inventory Carrying Cost (%) Inventory Carrying Cost ($ billion) Total Logistics Cost ($ billion) Inventory as a Percentage of Total Logistics Cost 2006 1, 859 24. 0 446 1, 305 34. 2 2007 2, 015 24. 1 485 1, 394 34. 8 2008 1, 963 21. 4 420 1, 344 31. 3 2009 1, 833 19. 3 353 1, 101 32. 1 2010 2, 018 19. 2 387 1, 204 32. 1 2011 2, 182 19. 1 478 1, 287 32. 1 2012 2, 269 19. 1 434 1, 331 32. 6 Source: 24 th Annual State of Logistics Report, 2013, prepared by Rosalyn Wilson for the Council of Supply Chain Management Professionals (www. cscmp. org). Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 13

Inventory Costs (4 of 13) TABLE 8. 2 Components of Inventory Carrying Cost Obsolescence costs Inventory shrinkage Storage costs Handling costs Insurance costs Taxes Interest costs Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 14

Inventory Costs (5 of 13) • Ordering costs refer to those costs associated with ordering inventory, such as order costs and setup costs. Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 15

Inventory Costs (6 of 13) • 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 Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 16

Inventory Costs (7 of 13) • Trade-Off between Carrying and Ordering Costs • Costs respond in opposite ways to the number of orders or size of orders • An increase in the number of orders leads to higher order costs but lower carrying costs Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 17

Inventory Costs (8 of 13) • Calculations: • Ordering = # of orders per year x ordering cost per order Cost • Carrying = average inventory x carrying cost per unit Cost Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 18

Inventory Costs (9 of 13) • Stockout costs • an estimated cost or penalty for a stockout • involve an understanding of a customer’s reaction to a company being out of stock when a customer wants to buy an item Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 19

Inventory Costs (10 of 13) TABLE 8. 3 Determination of the Average Cost of a Stockout Alternative Loss Probability Average Cost 1. Brand-loyal customer $00. 00 . 10 $00. 00 2. Switches and comes back 37. 00 . 25 9. 25 1, 200. 00 . 65 780. 00 Empty 1. 00 $789. 25 3. Lost customer Average cost of a stockout Note: These are hypothetical figures for illustration. Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 20

Inventory Costs (11 of 13) • General Rules Regarding Stockout Costs • The higher the average cost of a stockout, the better it is for the company to hold some amount of inventory (safety stock) 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. Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 21

Inventory Costs (12 of 13) • Trade-Off between Carrying and Stockout Costs • Costs move in opposite directions • Higher inventory levels (higher carrying costs) result in lower chances of a stockout (lower stockout costs) Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 22

Inventory Costs (13 of 13) TABLE 8. 4 Determination of Safety Stock Level Number of Units of Safety Stock Additional Safety Stock ($480 per Unit) 25% Annual Carrying Cost Total Value of Incremental Safety Stock Additional Orders Filled Stockout Costs Avoided 10 $4, 800 $1, 200 20 $8, 000. 00 20 9, 600 2, 400 1, 200 16 6, 400. 00 30 14, 400 3, 600 1, 200 12 4, 800. 00 40 19, 200 4, 800 1, 200 8 3, 200. 00 50 24, 000 6, 000 1, 200 6 2, 400. 00 60 28, 800 7, 200 1, 200 4 1, 600. 00 70 33, 600 8, 400 1, 200 3 1, 200. 00 Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 23

When to Order (1 of 3) • Key issue involves when product should be ordered • Can order a fixed amount of inventory (fixed order quantity system) • Or orders can be placed at fixed time intervals (fixed order interval system) Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 24

When to Order (2 of 3) • Reorder (trigger) point (ROP) • Level of inventory at which a replenishment order is placed • Necessary for efficient fixed order quantity system Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 25

When to Order (3 of 3) • Reorder Point (ROP) calculations: • ROP = DD x RC under certainty • ROP = (DD x RC) + SS under uncertainty • Where DD = daily demand • RC = length of replenishment cycle • SS = safety stock Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 26

How Much to Order (1 of 5) • Economic order quantity (EOQ) • Deals with calculating the proper order size with respect to two costs • Costs of carrying the inventory • Costs of ordering the inventory • Determines the point at which the sum of carrying costs and ordering costs is minimized, or the point at which carrying costs equal ordering costs Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 27

How Much to Order (2 of 5) • Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 28

How Much to Order (3 of 5) • Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 29

How Much to Order (4 of 5) FIGURE 8. 1 Determining EOQ by Use of a Graph Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 30

How Much to Order (5 of 5) TABLE 8. 5 EOQ Cost Calculations Number of Orders Per Year Order Size ($) Ordering Cost ($) Carrying Cost ($) Total Cost (sum of Ordering and Carrying Cost) ($) 1 1, 000 25 100 125 2 500 50 50 100 3 333 75 33 108 4 250 100 25 125 5 200 125 20 145 Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 31

Inventory Flows (1 of 2) FIGURE 8. 2 Inventory Flow Diagram Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 32

Inventory Flows (2 of 2) • Safety stock can prevent against two problem areas • Increased rate of demand • Longer-than-normal replenishment • When fixed order quantity system like EOQ is used, time between orders may vary • When reorder point is reached, fixed order quantity is ordered Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 33

Inventory Management: Special Concerns (1 of 3) • ABC Analysis of Inventory • recognizes that inventories are not of equal value to a firm • as such all inventory should not be managed in the same way • Dead inventory (dead stock) • is a fourth category, D, to ABC analysis where D stands for either “dogs” or dead inventory (dead stock) • refers to product for which there is no sales during a 12 month period. Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 34

Inventory Management: Special Concerns (2 of 3) • Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 35

Inventory Management: Special Concerns (3 of 3) • Substitute Products • products that can fill the same need or want as another product. Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 36

Contemporary Approaches to Managing Inventory (1 of 5) • Lean Manufacturing • Focuses on the elimination of waste and the increase of speed and flow • Identifies seven major sources of waste including inventory • Just-in-time (JIT) is one of the best known lean inventory practices Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 37

Contemporary Approaches to Managing Inventory (2 of 5) • Lean Manufacturing • Just-in-time (JIT) • Seeks to minimize inventory by reducing (or eliminating) safety stock while having the required amount of materials arrive at the production location at the exact time they are needed Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 38

Contemporary Approaches to Managing Inventory (3 of 5) • Service Parts Logistics • Involves designing a network of facilities to stock service parts: • Deciding upon inventory ordering policies • Stocking the required parts • Transporting parts from stocking facilities to customers Source: Mehmet Ferhat Candas and Erhat Kutanoglu, “Benefits of Considering Inventory in Service Parts Logistics Network Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 39

Contemporary Approaches to Managing Inventory (4 of 5) • Vendor-Managed Inventory (VMI) • Size and timing of replenishment orders are the responsibility of the manufacturer • Allows manufacturers to have access to a distributor’s or retailer’s sales and inventory data • Benefits include reduced inventories, fewer stockouts and improved customer retention Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 40

Contemporary Approaches to Managing Inventory (5 of 5) FIGURE 8. 4 Advertisement from a Parts Bank Service Source: Courtesy of Associated Distribution Logistics (ADL). Copyright © 2015, 2012, 2009 Pearson Education, Inc. All Rights Reserved 41

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