Reasons for Inventory

1. Reasons for Inventory • To create a buffer against uncertainties in supply & demand • To take advantage of lower purchasing and transportation cost associated with high volume • To take advantage of economies of scale associated with manufacturing products in batches • To build up seasonal demand for promotional sales • To accommodate product flowing from one location to another (work in process or in transit) • To exploit speculative opportunities for buying and selling commodities and other products

2. Goals: Reduce Cost, Improve Service • By effectively managing inventory: • Xerox eliminated $700 million inventory from its supply chain • Wal-Mart became the largest retail company utilizing efficient inventory management • GM has reduced parts inventory and transportation costs by 26% annually

3. Goal: Reduce Cost, Improve Service • By not managing inventory successfully • In 1994, “IBM continues to struggle with shortages in their ThinkPad line” (WSJ, Oct 7, 1994) • In 1993, “Liz Claiborne said its unexpected earning decline is the consequence of higher than anticipated excess inventory” (WSJ, July 15, 1993) • In 1993, “Dell Computers predicts a loss; Stock plunges. Dell acknowledged that the company was sharply off in its forecast of demand, resulting in inventory write downs” (WSJ, August 1993)

4. Inventory • Where do we hold inventory? • Suppliers and manufacturers • warehouses and distribution centers • retailers • Types of Inventory • WIP • raw materials • finished goods • Why do we hold inventory? • Economies of scale • Uncertainty in supply and demand

5. Business processes reduce or eliminate inventories mainly by reducing or eliminating uncertainties that make them necessary Better communication and coordination of activities across company functions and between the company and its vendors and customers can greatly reduce uncertainties. Why Inventory Reduction

6. Ways to Reduce Uncertainties • Improving the accuracy of forecasts by developing better forecasting methods • Promoting better communication between supply chain managers and marketing and sales managers • Sharing supply chain information with vendors and other third party providers • Consolidating number of locations where products are held • Reducing product variety • Postponing product customization to downstream stage of the supply chain

7. Role of Inventory in the Supply Chain Cost Availability Responsiveness Efficiency

8. Inventory Policy Match Supply & Demand Reduce Buffer Inventory • Reduce fixed cost • Aggregate across products • Volume discounts • EDLP • Promotion on Sell • thru • Quick Response measures • Reduce Info Uncertainty • Reduce lead time • Reduce supply uncertainty • Accurate Response measures • Aggregation • Component commonality and postponement Supply / Demand Seasonal Economies of Scale Variability Variability Cycle Inventory Safety Inventory Seasonal Inventory

9. Role of Inventory in the Supply Chain • Overstocking: Amount available exceeds demand • Liquidation, Obsolescence, Holding • Understocking: Demand exceeds amount available • Lost margin and future sales Goal: Matching supply and demand

10. Understanding Inventory • The inventory policy is affected by: • Demand Characteristics • Lead Time • Number of Products • Objectives • Service level • Minimize costs • Cost Structure

11. Cost Structure • Order costs • Fixed • Variable • Holding Costs • Insurance • Maintenance and Handling • Taxes • Opportunity Costs • Obsolescence

12. EOQ: A View of Inventory* Note: • No Stockouts • Order when no inventory • Order Size determines policy Inventory Avg. Inventory Order Size Time

13. EOQ:Total Cost* Total Cost Holding Cost Order Cost

14. EOQ: Calculating Total Cost* • Purchase Cost Constant • Holding Cost: (Avg. Inven) * (Holding Cost) • Ordering (Setup Cost): Number of Orders * Order Cost • Goal: Find the Order Quantity that Minimizes These Costs:

15. Fixed costs: Optimal Lot Size and Reorder Interval (EOQ) R: Annual demand S: Setup or Order Cost C: Cost per unit h: Holding cost per year as a fraction of product cost H: Holding cost per unit per year Q: Lot Size T: Reorder interval

16. Example Demand, R = 12,000 computers per year Unit cost, C = $500 Holding cost, h = 0.2 Fixed cost, S = $4,000/order Q = 980 computers Cycle inventory = Q/2 = 490 Flow time = Q/2R = 0.49 month Reorder interval, T = 0.98 month

17. EOQ: Another Example • Book Store Mug Sales • Demand is constant, at 20 units a week • Fixed order cost of $12.00, no lead time • Holding cost of 25% of inventory value annually • Mugs cost $1.00, sell for $5.00 • Question • How many, when to order?