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Chapter 10

Inventory management. Chapter 10. Overview. Functions. Types. Costs. PLANNING Optimum levels. MODELS. CONTROL Maintain appropriate levels. Outcomes. Understand why businesses keep stock Differentiate between the various types of inventory

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Chapter 10

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  1. Inventory management Chapter 10

  2. Overview Functions Types Costs PLANNING Optimum levels MODELS CONTROL Maintain appropriate levels

  3. Outcomes • Understand why businesses keep stock • Differentiate between the various types of inventory • Identify inventory-ordering costs and inventory-carrying costs • Determine a suitable carrying cost percentage • Set optimum inventory levels • Perform effective inventory control

  4. Functions of inventories • Geographical specialisation • Location economies • Consolidation • Economic specialisation • Decoupling • WIP • Economic lot sizes greater than demand • Large shipments at lower transport costs • Lower cost of purchasing

  5. Functions of inventories (continued) • Balancing supply and demand • Seasonal production, but year-round consumption • Seasonal consumption: provide for peaks • Buffer uncertainties • Demand uncertainty • Lead-time uncertainty • Prevent cost of stockout

  6. Types of inventory • Based on position in supply chain: • Raw material • Work-in-process (WIP) • Packaging material • Finished goods • Based on purpose: • Cycle stock • Transit inventory • Safety stock • Speculative stock

  7. Important inventory concepts • Availability • Definition • Measurements • Average inventory • half order quantity + safety stock • Inventory turnover

  8. Average inventory and order quantity

  9. Inventory costs • Ordering costs • Carrying costs

  10. Inventory-ordering costs • Consist of: • Administration costs • Handling costs • Depend on where stock is replenished • Outside supplier • Restocking own field warehouse

  11. Carrying-cost percentage • Used to calculate carrying costs • Expressed as annual % value • Applied to average inventory • ICC = average inventory x % Example: R1 000 000 x 20% = R200 000 • Assign factor to each cost element

  12. Determine carrying-cost percentage

  13. Setting optimum inventory levels • How much to order • Simple EOQ • EOQ extensions • When to order • Reorder point • Safety stock

  14. Simple EOQ: the concept • Trade-off between ordering and carrying costs • Remember: • Average inventory = half order size • Therefore, high OQ results in: • high average inventory and • high carrying costs • Graph • Formula

  15. Simple EOQ: trade-off

  16. Simple EOQ: formula EOQ = Where P = ordering costs ($ per order) D = annual demand or sales volume in units C = carrying-cost percentage V = cost or value per unit

  17. EOQ adjustments • Volume transport rates • Quantity discounts • Production lot size • Multiple-item purchases • Limited capital • Own transport • Unitisation

  18. Determining order point • When to order • Expressed in SKU units or days of supply • Formula: R = D x T + SS Where R = reorder point in units D = average daily demand T = average lead time SS = safety stock

  19. Target-level replenishment • Fixed order interval • Short interval periodic review • Order quantities vary • Quantity to meet target level • Review period added to lead time to arrive at targeted reorder point (ROP)

  20. Target-level replenishment (continued) • TSL = D (T + P) + SS Where D = average daily demand T = average lead time P = review period (days) SS = safety stock • Now order to reach target • Q = TSL - I – Where Q = quantity to be ordered TSL = target level I = inventory status = quantity on order Qo Qo

  21. Demand uncertainty • Safety stock added to base inventory • Average inventory = half order quantity + SS • Normal distribution • Only consider when demand is greater than 50% in normal distribution • Calculate: • Mean • Standard deviation

  22. Normal distribution theory

  23. Normal distribution theory (continued)

  24. Demand uncertainty • Mean • Average of all values in series • Formula: μ = ∑xi /n • Standard deviation • Formula: √ (1/n x ∑ (xi-μ)2

  25. Lead-time uncertainty • Lead time a combination of: • Order communication time • Processing time • Transport time • Calculation: • Same as demand uncertainty (i.e. calculate standard deviation)

  26. Combined standard deviation Formula: s = √ TSs2 + D2 St2 Where s = combined standard deviation T = average lead time Ss = sales standard deviation D = average sales St = lead time standard deviation

  27. Fill rate • Normal distribution theory gives indication of probability of stockout. • Percentage, not indication of availability levels. • Fill rate gives indication of magnitude of stockout rather than probability. • Fill rate = desired customer service objective. • Fill rate = percentage of units out of stock relative to demand.

  28. Fill rate and order size • Fill rate influenced by: • Probability of stockout • Replenishment order size • The larger the order quantity, the lower the magnitude of potential stockouts. • Example: 20-day period • OQ sufficient for 10 days, stockouts can occur twice • OQ sufficient for 20 days, stock-outs will occur once

  29. Fill rate formula • Formula for SL: SL = 1-[(s/EOQ) x f(k)] Where f(k) = function of right tail Or f(k) = (1-SL) x (Q/s) s = combined standard deviation

  30. Safety stock for given fill rate • Formula for SS: First calculate f(k) SS = k x s Where k = safety factor for corresponding f(k) s = combined standard deviation k can also be calculated: k = SS/s

  31. Calculating safety stock: example • Information • EOQ = 300 • S = 13 • Desired FL = 99% • Solution First calculate f(k) f(k) = (1-0,99) x (300/13) = 0,01 x 23,08 = 0,2308 k = 0,4 (corresponding factor for f(k) of 0,2308) SS = 0,4 x 13 = 5,2 units

  32. Calculating fill rate: example • Information • EOQ = 200 • s = 13 • SS = 8 • First calculate k k = 8/13 = 0,6154 Therefore f(k) = 0,16 (roughly) • Fill rate SL = 1-[(s/OQ) x f(k)] = 1-[(13/200) x 0,16] = 1-[0,0650 x 0,16] = 1-0,0104 = 0,99 or 99%

  33. Logistics requirements planning (LRP)

  34. Procedure for LRP • Plan weekly • Start with independent demand • Demand forecasting • Calculate how long stocks will last • Deduct safety stock • Add stock in transit • Calculate date when safety stock is reached

  35. Procedure for LRP (continued) • Calculate date of shipment (allow lead time) • Plan production • Calculate delivery date of materials • Calculate shipment allowing for lead time

  36. Just in time (JIT): approach • We have items when they are needed and none when they are not needed. • Demand for one item triggers demand for another.

  37. Push system Satisfied with status quo Fixed lead time Product range is a sales issue Stock in case of demand Convenient purchase batch size Pull system Continuous improvement Reducing lead time Product range reduc-tion: inventory issue Purchase to meet demand Buy single or small quantities Conventional vs JIT systems

  38. JIT application possibilities • Typical features of ideal company: • Narrow product range • Manufacturer • High volume • Stable market • Influential • Good quality management • Local suppliers of goods and services • Dependent and reliable suppliers • Fast-cycle processes • Personal commitment

  39. JIT requirements • Short lead time • Long-term agreements • Close co-operation • Local suppliers • Customers must smooth forecasts • Good estimate of long-term demand • Frequent deliveries

  40. Collaborative inventory initiatives • Collaborative planning, forecasting and replenishment (CPFR) • Quick response (QR) • Vendor-managed inventory (VMI) • Profile replenishment (PR)

  41. Pareto analysis Pareto principle: • Villefredo Pareto: 18th century • 20% of people control 80% of wealth • True in everyday life • 80% of effect is provided by 20% of cause

  42. ABC analysis using Pareto • Purpose • Facilitate control • Minimise effort • Provide service with least cost and effort • Procedure • Rank items/lines according to annual turnover • Annual turnover = annual usage x unit costs • Classification • A = 10% of lines giving 65% turnover • B = 20% of lines giving 25% turnover • C = 70% of lines giving 10% of turnover

  43. ABC analysis based on the Pareto principle 80

  44. Different service levels for inventory categories

  45. Stock cover • Time in which stock will run out • Tool for measuring total inventory • Monitor performance of each item • Formula: current stock x 52 forecast usage • Result: weeks in hand SC=

  46. Stock turnover • Measures inventory management effectiveness • Formula: Stock turnover = Value of annual usage Value of stock in store • Shows number of times that stock will be used up during the year

  47. Setting stock targets • Based on ABC • ‘A’ class: tighter control and lower stock cover • Target for each class • Acceptable ranges: • A 1 to 4 weeks • B 2 to 8 weeks • C 3 to 20 weeks

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