Inventory Management

1. Inventory Management

2. Class Announcements • Assignment #6 due October 31st • Assignment #7 due November 7th • Midterms returned at the end of class • No “back flush” or “lean” costing p 718-728 • Patti Wylie, General Manager Nova Scotia Egg Producers will be in class at 11:15am ONLY on Monday November 4th in SCHW 204 (there will be only one class that day and all students are to attend at 11:15am if able)

3. Class Objectives • Inventory Management as a non-value added activity • Understanding the costs associated with Inventory Management • Economic Ordering Quantitiy (EOQ)

4. Inventory Management • Managing inventory is a non-value added activity; reduction or elimination of costs is focus. • Inventory management is planning, coordinating, and controlling activities related to the flow of inventory into, through, and out of an organization. • For retailers, inventory is the largest cost; improving management of inventory improves net income.

5. Inventory Management: Costs • Managing inventories to increase net income requires effectively managing costs that fall into these six categories: • Purchasing costs • Ordering costs • Carrying costs • Stockout costs • Quality costs • Shrinkage costs

6. Inventory Management: Costs • Purchasing costs—the cost of goods acquired from suppliers, including freight • Ordering costs—the costs of preparing and issuing purchase orders, receiving and inspecting the items included in the orders, and matching invoices received, purchase orders, and delivery records to make payments • Carrying costs—the costs that arise while holding inventory of goods for sale;includes the opportunity cost of the investment tied up in inventory, and costs associated with storage. • Stockout costs—the costs that result when a company runs out of a particular item for which there is customer demand (stockout) and the company must act quickly to meet the demand or suffer the costs of not meeting it.

7. Inventory Management: Costs • Quality costs—the costs that result when features and characteristics of a product or service are not in conformance with customer specifications. These costs include: • Prevention • Appraisal • Internal failure • External failure • Shrinkage costs—costs that result from theft, embezzlement, and clerical errors

8. Inventory Management: Cost Concepts • Economic order quality (EOQ) - a decision model that calculates the optimal quantity of inventory to order under a given set of assumptions. • Reorder point - the quantity level of inventory on hand that triggers a new purchase order. • Safety stock - inventory held at all times regardless of the quantity of inventory ordered using the EOQ model. • Safety stock is a buffer against unexpected increases in demand, uncertainty about lead time, and unavailability of stock from suppliers.

9. Inventory Management: EOQ Assumptions • There are only ordering and carrying costs. • The same quantity is ordered at each reorder point. • Demand, purchase-order lead time, ordering costs, and carrying costs are known with certainty. • Purchasing costs per unit are unaffected by the quantity ordered. • No stockouts occur. • EOQ ignores purchasing costs, stockout costs, and quality costs.

10. D = Demand in units for specified period P = Relevant ordering costs per purchase order C = Relevant carrying costs of one unit in stock for the time period used for D Key intuition is that relevant total costs are minimized when relevant ordering costs equal relevant carrying Inventory Management: EOQ Formula

11. Inventory Management: Ordering and Carrying Costs (Illustrated)

12. Inventory Management: Ordering Points (Calculation) • Reorder point—the quantity level of inventory on hand that triggers a new purchase order.

13. Inventory Management: Ordering Points (Illustrated)

14. Inventory Management: Carrying Costs • Relevant inventory carrying costs consist of relevant incremental costs and the relevant opportunity cost of capital. • Relevant incremental costs—those costs of the purchasing firm that change with the quantity of inventory held. • Relevant opportunity cost of capital—the return foregone by investing capital in inventory rather than elsewhere. This cost equals the required rate of return multiplied by the unit costs that vary with the number of units purchased and are incurred at the time the units are received.

15. Inventory Management: Cost of a Prediction Error • Three steps in determining the cost of a prediction error: • Compute the monetary outcome from the best action that could be taken, given the actual amount of the cost per purchase order. • Compute the monetary outcome from the best action based on the incorrect amount of the predicted cost per purchase order. • Compute the difference between steps 1 and 2.

16. Inventory Management: Just-in-Time (JIT) Purchasing • Just-in-time (JIT) purchasing is the purchase of materials or goods so they are delivered just as needed for production or sales. • JIT is popular because carrying costs are actually much greater than estimated because warehousing, handing, shrinkage, and investment costs have not been correctly estimated. • JIT reduces the cost of placing a purchase order because: • Long-term purchasing agreements define price and quality terms. Individual purchase orders covered by those agreements require no additional negotiation regarding price or quality. • Companies are using electronic links to place purchase orders at a small fraction of traditional methods (phone or mail). • Companies are using purchase-order cards.

17. Inventory Management:Just-in-Time(JIT) Production • JIT (lean) production is a “demand-pull” manufacturing system that manufactures each component in a production line as soon as and only when needed by the next step in the production line. • Demand triggers each step of the production process, starting with customer demand for a finished product and working backward. • Demand pulls an order through the production line.

18. Inventory Management:JIT Production Goals • JIT production systems produces close coordination among work-stations • Smoothes the flow of goods • Achieves low quantities of inventory • JIT aims to simultaneously: • Meet customer demand in a timely manner • Produce high quality products • Generate the lowest possible costs

19. Inventory Management:JIT Production Features • Production is organized in manufacturing cells, a grouping of all the different types of equipment used to make a given product. • Workers are hired and trained to be multi-skilled (cross-trained). • Defects are aggressively eliminated. • Setup time is reduced. • Suppliers are selected on the basis of their ability to deliver quality materials in a timely manner.

20. Inventory Management:Other Benefits of JIT Production • Lower overhead costs • Lower inventory levels • Heightened emphasis on improving quality by eliminating the specific causes of rework, scrap, and waste • Lower manufacturing lead times

21. Egg Production: Industry • http://www.eggs.ca/onthefarm/ • Canada has approximately 1,100 registered egg farms. • The average egg farm has 10,000 to 20,000 hens, although Canadian egg farms can range from a few hundred to more than 400,000 hens. • In Canada, a total of 25 million hens (including unregistered hens) produce about 500 million dozen eggs per year – that's 6 billion eggs! • The egg industry contributes about $500 million to the Canadian economy.

22. Nova Scotia Egg Producers • The Nova Scotia Egg Producers (NSEP) is incorporated under the Natural Products Act for Nova Scotia. The act provides the NSEP the authority to carry out its mandate of effective promotion, control and regulation of eggs and pullets in Nova Scotia. • The NSEP is governed by an eight person Board of Directors consisting of seven members who represent egg producers in geographic zones throughout the province and one who represents the pullet sector. • NSEP uses a supply management system to provide a stable supply of eggs to consumers at fair prices and a fair return to producers.

23. Capacity Levels: Indicators • Four different capacity level indicators are: • Theoretical capacity - level at full efficiency (ideal goal; unattainable • Practical capacity – reduces theoretical capacity by unavoidable operating interruptions • Normal capacity utilization – satisfies demand over the period • Master Budget capacity utilization – level of capacity that is budgeted

24. The Cost of an Egg: Capacity • Theoretical capacity – size of barn,# cages, # hens per cage, # eggs per hen • Practical capacity – illness of hens, breed/type, age of hens, weather • Normal capacity utilization – demand, contractual obligation • Master Budget capacity utilization – changing demographics, egg marketing campaigns, etc.

25. The Cost of an Egg: Capacity • NSEP uses a supply management system to provide a stable supply of eggs to consumers at fair prices and a fair return to producers. • http://eggs.ca/farmers-and-farming/journey-of-the-egg • Inventory Management (Producer) • Inventory Management (Retailer)

26. The Cost of an Egg: Capacity • Inventory Management (Producer) • Quota • Age of chickens • Demand from retailers • InventoryManagement (Retailer) • Average demand per day/ per week • Space in cooler • Lead time for delivery • Planned spoilage

27. Midterm Results • Average: 54/75 (72%) • Range: • Hi: 75/75 (100%) • Lo: 18/75 (24%) • Comments: • Answer question (e.g. Manager concern over B/E, factors affecting ABC) • Support opinions, assertions, & statements (E C) • Demonstrated strong technical ability