Chapter 9 Managing Inventory in the Supply Chain

1. Chapter 9 Managing Inventory in the Supply Chain Learning Objectives After reading this chapter, you should be able to do the following: • Appreciate the role and importance of inventory in the economy. • List the major reasons for carrying inventory. • Discuss the major types of inventory, their costs, and their relationships to inventory decisions. • Understand the fundamental differences among approaches to managing inventory. • Describe the rationale and logic behind the economic order quantity (EOQ) approach to inventory decision making, and be able to solve some problems of a simple nature.

2. Learning Objectives (cont.) After reading this chapter, you should be able to do the following: • Understand alternative approaches to managing inventory—just-in-time (JIT), materials requirement planning (MRP), distribution requirements planning (DRP), and vendor-managed inventory (VMI). • Explain how inventory items can be classified. • Know how inventory will vary as the number of stocking points changes. • Make needed adjustments to the basic EOQ approach to respond to several special types of applications.

3. Introduction • Inventory is an asset on the balance sheet and a variable expense on the income statement. • Inventories also have an impact on return on investment (ROI) for the firm. • Inventories also have an impact on return on investment (ROI) for an organization.

5. GDP versus Inventory • Nominal GDP grew by 127.2 percent between 1990 and 2006. • The value of inventory increased by 78.4 percent during the same time period. • Inventory costs as a percent of GDP declined from 17.9 percent in 1990 to 14.1 percent in 2006. • The absolute value of inventory increased during this time period, but it decreased as a percentage of GDP.

7. Batching economies or cycle stocks • arises from three sources • procurement • production • transportation Scale economies are often associated with all three, which can result in the accumulation of inventory that will not be used or sold immediately

8. Uncertainty/Safety Stocks • All organizations are faced with uncertainty. • On the demand side, there is usually uncertainty in how much customers will buy and when they will buy it. • On the supply side, there might be uncertainty about obtaining what is needed from suppliers and how long it will take for the fulfillment of the order.

9. Time/In-Transit and Work-in-Process Stocks • The time associated with transportation means that even while goods are in motion, an inventory cost is associated with the time period. The longer the time, the higher the cost. • WIP inventories, associated with manufacturing, can be significant while the length of time the inventory sits in a manufacturing facility waiting and should be carefully evaluated in relationship to scheduling techniques and the actual manufacturing/assembly technology.

13. Seasonal Stocks • Seasonality can occur in the supply of raw materials, in the demand for finished product, or in both. • Those faced with seasonality issues are constantly challenged when determining how much inventory to accumulate. • Seasonality can impact transportation. Anticipatory Stocks • A fifth reason to hold inventory arises when an organization anticipates that an unusual event might occur that will negatively impact its source of supply.

14. The Importance of Inventory in Other Functional Areas • Logistics interfaces with an organization’s other functional areas • Finance • Marketing • Manufacturing

15. Inventory Costs • Inventory Carrying Costs • Capital Cost (interest or opportunity cost) • cost of capital tied up in inventory and the resulting lost opportunity from investing that capital elsewhere • hurdle rate • weighted average cost of capital (WACC).

16. Storage Space Cost • includes handling costs associated with moving products into and out of inventory, as well as such costs as rent, heat, and light • Can be variable Inventory Service Cost • includes insurance and taxes Inventory Risk Cost • reflects the possibility that inventory value might decline for reasons beyond firm’s control

17. Calculating the Cost of Carrying Inventory • Calculating the cost to carry (or hold) a particular item in inventory involves three steps. • First, determine the value of the item stored in inventory. • Second, determine the cost of each individual carrying cost component to determine the total direct costs consumed by the item while being held in inventory. • Third, divide the total costs calculated in Step 2 by the value of the item determined in Step 1.

21. Nature of Carrying Cost • Ordering Cost or Setup Cost • refers to the expense of placing an order for additional inventory, not including product cost • Order Cost • Cost of placing order which may have both fixed and variable components • Setup Costs • expenses incurred each time an organization modifies a production or assembly line to produce a different item for inventory

24. Expected Stockout Cost • several consequences might occur: • Back order, which results in the vendor incurring incremental variable costs associated with processing and making the extra shipment • Customer might decide to purchase a competitor’s product resulting in a direct loss for the supplier. • Customer might decide to permanently switch to a competitor’s product with loss of income.

25. Safety Stock • Cost calculation Formula

26. In-Transit Inventory Carrying Cost • Owner of product while it is in transit will incur resulting carrying costs. • In-transit inventory carrying cost becomes especially important on global moves since both distance and time from the shipping location both increase. • Owner should consider its delivery time part of its inventory carrying cost.

28. Determining the Cost of In-Transit Inventories • The capital cost of carrying inventory in transit generally equals carrying inventory • storage space cost not relevant to inventory in transit • insurance needs requires special analysis • obsolescence or deterioration costs are lesser risks for inventory in transit

30. Dependent versus Independent Demand • “independent” when such demand is unrelated to the demand for other items • “dependent” when it is directly related, or derives from, the demand for another inventory item or product Pull versus Push • The “pull” approach relies on customer orders to move product through a logistics system, while the “push” approach uses inventory replenishment techniques in anticipation of demand to move products.

31. Principle Approaches -Techniques for Inventory Management • Fixed order quantity model involves ordering a fixed amount of product each time reordering takes place • Simple EOQ Model • The following are the basic assumptions of the simple EOQ model: • 1. A continuous, constant, and known rate of demand • 2. A constant and known replenishment or lead time • 3. All demand is satisfied • 4. A constant price or cost that is independent of the order quantity (i.e., no quantity discounts) • 5. No inventory in transit • 6. One item of inventory or no interaction between items • 7. Infinite planning horizon • 8. Unlimited capital

36. The EOQ model can be developed in standard mathematical form, using the following variables:

38. Determining Q can be accomplished by differentiating the TAC function with respect to Q, as shown in Formula 9-5

47. Total cost model formulas:

50. The Just-in-Time Approach • Four major elements • zero inventories • short, consistent lead times • small, frequent replenishment quantities • high quality, or zero defects