Chapter 3

1. Chapter 3 Frameworks for Inventory Management

2. Stock vs. Inventory Stock consists of all the goods and materials that are stored by an organization. It is a store of items that is kept for future use. An inventory is a list of the items held in stock.

3. The Diversity of Stock-Keeping Units Stock keeping unit is an item of stock specified as to function, style, size, color and location. Ex: the same style shoes in two different sizes  two different SKUs the exact same tire at two geographically remote locations  two different SKUs

4. The Diversity of Stock-Keeping Units Items produced and held in inventory may differ in many ways: • Cost, weight, volume, color, physical shape • Stored in crates, barrels, pallets, cardboard boxes, loose on shelves • Packaged in thousands or singly • May be perishable (deterioration over time) • May be subject to obsolescence because of style or technology • May be stored in dust-proof, temperature-controlled rooms

5. The Diversity of Stock-Keeping Units Demand for items may occur in different ways: • Substitutes • Complements • Picked up by customer or delivered by company-owned vehicles, rail, boat, airplane, truck • May wait or want immediate service Arrival of goods may be in different ways: • Damaged • Unavailable • In hours, weeks or months or may not be known

6. The Diversity of Stock-Keeping Units Given that a specific item is to be stocked in a location, three issues must be resolved: • How often the inventory status should be determined • When a replenishment order should be placed • How large the replenishment order should be

7. A Typical Use of Stock

8. A Stock Cycle • An organization buys a number of units of an item from a supplier. • At an arranged time, these units are delivered. • Unless they are needed immediately, the units are put into storage, replenishing the stock. • Customers, either internal or external, create demands for the item. • Units are removed from stock to meet these demands. • At some point, the stock gets low and it is time for the organization to place another order.

9. Stock Levels in a Typical Cycle

10. Functional Classification of Inventories • Cycle inventories: Result from ordering or producing in batches instead of one unit at a time. Inventory on hand at any point in time that results from batches is called cycle stock. Cycle stock is purposeful. Inventory

11. Functional Classification of Inventories Reasons for having batch replenishment: • Economies of scale (because of large setup costs) • Quantity discounts in purchase price or freight cost • Technological restrictions (fixed size of a processing tank in a chemical process)

12. Functional Classification of Inventories • Congestion stocks: Inventories due to items competing for limited capacity. When multiple items share the same production equipment and there are significant setups, inventories build up as they wait for the equipment become available. Congestion stock is not purposeful, it occurs uncontrollably. Limited capacity equipment Congestion stock

13. Functional Classification of Inventories • Safety stock: Inventory kept on hand to allow for the uncertainty of demand and supply in the short run. Safety stocks are not needed if demand and replenishment time are known with certainty. Safety stock is purposeful. Safety stock level is determined by the desired level of service (how often customer demand is met from stock).

14. Functional Classification of Inventories • Anticipation inventory: • Stock accumulated in advance of an expected peak in sales, which can be due to seaonality in demand. Anticipation inventory is purposeful to achieve a stable product rate instead of overtime during peak demand. Production rate Demand Stock

15. Functional Classification of Inventories • Anticipation inventory: • Stock accumulated due to seasonality of supply or climatic conditions (tomatoes used in making ketchup). • Stock accumulated due to events which may result in lower supply rates than demand rate in some periods (labor strike, war crises).

16. Functional Classification of Inventories • Pipeline (or WIP) inventories: Pipeline inventory is the inventory that is being carried between two stations in a system. Pipeline inventory is proportional with rate of usage and transportation time. • Goods in transit between levels of a multiechelon distribution system (on trucks, in railway cars,...). • Inventory between adjacent workstations in a factory (WIP). Manufacturer Depot Pipeline inventory Retailers

17. Functional Classification of Inventories • Decoupling stock: Used in a multiechelon situation to permit the separation of decision making at different echelons. Ex: decentralized decision making at branch warehouses without every decision at the branch having an immediate impact at the central warehouse. Main Warehouse Branch Warehouses

18. ABC Classification Managerial decisions regarding inventories must be made at the individual item level. The specific unit of stock to be controlled is called a stock keeping unit (SKU). In a multi-SKU system, about 20% of SKUs account for 80% of the total annual dollar usage. % of total value Distribution by value curve (Pareto curve) 100% 80% % of total number of SKUs 20% 100%

19. ABC Classification v: value in $/unit D: annual usage (or demand) Calculate D.v for each SKU Rank SKUs in descending order of D.v values Plot cumulative percent of total dollar usage and cumulative percent of total number of SKUs ABC Classification should not be strictly based on D.v values. An item that has small D.v value but that is very important for the production system can be put in Class A.

20. ABC Classification • Class A • Most important items • Most attention from management • The first 15-20% of the SKUs • Account for almost 80% of total D.v • Class B • Intermediate in importance • Moderate amount of attention • Approximately 15% of total D.v

21. ABC Classification • Class C • Least important items • Only a minor part of total D.v • Approximately 50% of SKUs • Simple decision systems % of total value 100% 95% 80% % of total number of SKUs A B C

22. ABC Classification Example: Over the past year a company has sold the following 10 items. Below table shows the annual sales in units and the profit of each item. Group the items into A, B and C categories on the basis of percentage of annual profit.

23. ABC Classification Example:

24. ABC Classification Example:

25. ABC Classification Example: A B C

26. Cost Factors • Unit value or unit variable cost, v • The price paid to the supplier • Any cost incurred to make it ready for sale • Cost of carrying items in inventory • Opportunity cost of the money invested (largest portion) • Expenses incurred in running a warehouse • Handling and counting costs • Costs of special requirements • Deterioration of stock • Damage, theft • Obsolescence • Insurance • Taxes

27. Cost Factors • Cost of carrying items in inventory Carrying costs per year = : average inventory in units r : carrying charge (cost of carrying one dollar of inventory for one year) Opportunity cost: the return on investment that could be earned on the next most attractive opportunity that cannot be taken advantage of because of a decision to invest the available funds in inventory.

28. Cost Factors • Ordering or setup cost, A • Ordering cost: cost of order forms, postage, phone calls, authorization, typing of orders, receiving, inspection, following up on unexpected situations, handling of vendor invoices • Setup cost: wage of labor who works for setup of the machine, cost of producing lower quality and speed at the start • Costs of insufficient capacity in the short run Costs of avoiding stockouts and costs incurred when stockouts take place Cost of changing equipment to run emergency orders, rescheduling, emergency shipment, substituting with less profitable item... Loss of goodwill is difficult to measure.

29. Cost Factors • System control costs Costs associated with the operation of decision system such as data acquisition, data storage and maintenance and computation.

30. Other Key Variables • Replenishment lead time, L Time that elapses from the moment at which it is decided to place the order, until it is physically on the shelf ready to satisfy customer demands. An order should be placed early enough so that the expected number of units demanded during replenishment time will not cause stockout. Variability of demand over L is important. If demand depends on the time of the yearseasonal, if it is unpredictablerandom. Replenishment time may also vary due to several reasons.

31. Other Key Variables • Production vs. Nonproduction In a production environment, capacity constraints at work centers cause complexity. Planning depends on: • Make-to-order or make-to-stock • Purchasing is for known/anticipated production • Demand pattern

32. Other Key Variables