Role of Inventory Management in SCM

© 2007 Pearson Education

Role of Inventory Role of Inventory Management in SCM

Chapter 10By Chandrashekeran


Need for Inventory Management

Fulfills the objectives and challenges of COST AND RESPONSIVENESS Inventory OFFERS various models and

SKU’s Pressure on inventory is higher for “made to

stock” rather than “made to engineer” or “made to stock”

Jewellery, fashion etc.


Inventory Management

Inventory management is the planning and controlling of inventories in order to meet the competitive priorities of the organization.

Effective inventory management is essential for realizing the full potential of any value chain.

Inventory management requires information about expected demands (SKU), amounts on hand (Qty) and amounts on order (EOQ) and price for every item stocked at all locations. The appropriate timing and size of the reorder quantities

must also be determined.


Inventory within supply chain network

SuppliersSubcontractingDirect site Factory

Warehouse

Production-Raw materialWork in processFinished good

Distribution channel or retailer

Customer


Inventory Basics

Inventory is created when the receipt of materials, parts, or finished goods exceeds their disbursement. (HIGH)

Inventory is depleted or replenished when their disbursement exceeds their receipt.(LOW)

An inventory manager’s job is to balance the advantages and disadvantages of both low and high inventories.Both have associated cost characteristics.


Importance of inventory Customer service and product availability Example- Manufacturer of food flavors Production, purchase and transportation

economy Price discount, transportation economy Hedge against price changes. Price of seeds Hedge against uncertainties in demand and

lead time Hedge against strikes, fires, calamities and

mismatch between demand and supply


Types of Inventory Raw Material- Purchased but not processed Ensures Material availability for production Reduces supplier variability in quality, quantity

and time Work in Process- Reduces cycle time (time to

make a product) Finished Goods- Reduces mismatch between

demand and supply Maintenance/ Overhauling/ Repair- Items

consumed in a production but not a part of end product. Lubricants


Classification of Inventory

Cycle Inventory: Average inventory of lot or batch size.

Average cycle inventory =Where Q= Lot or batch size, d= Demand per timeLot Sizing: Lot size refers to quantity that a

supply chain either produces or orders at a given time.

Cycle inventory takes advantages of economies of scale but each stages maintains cycle inventory which increases cost.

Q2


Classification of Inventory Safety Stock Inventory: Surplus inventory that

a company holds to protect against uncertainties in demand, lead time and supply changes. Reduces lost sales

Seasonal inventory- Meets the volatility of demand and supply.

Pipeline Inventory: Inventory moving from point to point in the materials flow system.

Includes orders that have been placed but not served. Pipeline inventory = DL = dL , L= Lead time

© 2007 Pearson Education© 2007 Pearson Education

Estimating Inventory LevelsExample 12.1

A plant makes monthly shipments of electric drills to a wholesaler in average lot sizes of 280 drills. The wholesaler’s average demand is 70 drills a week. Lead time is 3 weeks. The wholesaler must pay for the inventory from the moment the plant makes a shipment. If the wholesaler is willing to increase its purchase quantity to 350 units, the plant will guarantee a lead time of 2 weeks. What is the effect on cycle and pipeline inventories?

Average cycle inventory = = = 140Q2

2802

Pipeline inventory = DL = dL = 70(3) = 210

Under new proposal, the average lot size becomes 350 and lead time of 2 weeks. Average demand remains at 70 drills a week.

Q2Average cycle inventory = = = 175350

2

Pipeline inventory = DL = dL = 70(2) = 140

drills

drills

drills

drills


Pressures for Low Inventories

Inventory holding cost is the sum of the cost of capital and the variable costs of keeping items on hand, such as storage and handling, taxes, insurance, and shrinkage. Cost of Capital is the opportunity cost of investing in an

asset relative to the expected return on assets of similar risk.

Storage and Handling arise from moving in and out of a storage facility plus the rental cost and/or opportunity cost of that space.

Taxes, Insurance, and Shrinkage: More taxes are paid and insurance costs are higher if end-of-the-year inventories are high. Shrinkage comes from theft, obsolescence and deterioration.


Ordering Cost: The cost of preparing a purchase order for a supplier or a production order for the shop.

Setup Cost: The cost involved in changing over a machine to produce a different item.

Labor and Equipment: Creating more inventory can increase workforce productivity and facility utilization.

Transportation Costs: Costs can be reduced. Quantity Discount: A drop in the price per unit when

an order is sufficiently large.


Inventory Models

EOQ Model Production Order Quantity Model Quantity Discount Model


BASIC EOQ Model

Q= EOQ Economic Order QuantityR= Reorder Level

L= Lead time

Cycle inventory


Economic Order Quantity (EOQ) is the lot size that minimizes total annual inventory holding and ordering costs.

Assumptions of EOQ1. The demand rate is constant and known with

certainty.2. There are no constraints on lot size.3. The only relevant costs are holding costs and

ordering/setup costs.4. Decisions for items can be made independently

of other items.5. Lead time is constant and known with certainty.

Economic Order QuantityEconomic Order Quantity


Annual set up/ ordering cost=D.S/Q Annual Holding cost=Q.H/2 At EOQ, Annual set up cost= Annual holding

cost Reorder level=d.L Time between order=(Order size/ annual

demand) x time fraction/year


Ann

ual c

ost (

dolla

rs)

Ann

ual c

ost (

dolla

rs)

Lot Size (Lot Size (QQ))

Total Annual Total Annual Cycle-Inventory CostsCycle-Inventory Costs

Holding cost = (Holding cost = (HH))QQ22

Ordering cost = (Ordering cost = (SS))DDQQ

Total cost = (Total cost = (HH) + () + (SS))DDQQ

QQ22

Q = lot size; C = total annual cycle-inventory costH = holding cost per unit; D = annual demandS = ordering or setup costs per lot


Costing out a Lot Sizing Policy Example 12.2

Bird feeder sales are 18 units per week, and the supplier charges $60 per unit. The cost of placing an order (S) with the supplier is $45.

Annual holding cost (H) is 25% of a feeder’s value, based on operations 52 weeks per year.

Management chose a 390-unit lot size (Q) so that new orders could be placed less frequently.

What is the annual cycle-inventory cost (C) of the current policy of using a 390-unit lot size?

Museum of Natural History Gift Shop:


Costing out a Lot Sizing Policy Example 12.2

What is the annual cycle-inventory cost (C) of the current policy of using a 390-unit lot size?

D = (18 /week)(52 weeks) = 936 units H = 0.25 ($60/unit) = $15

C = $2925 + $108 = $3033

C = (H) + (S) = (15) + (45) Q2

DQ

936390

3902

Museum of Natural History Gift Shop:


3000 3000 —

2000 2000 —

1000 1000 —

0 0 —| | | | | | | |

5050 100100 150150 200200 250250 300300 350350 400400

Lot Size (Q)

Ann

ual c

ost (

dolla

rs)

Ann

ual c

ost (

dolla

rs) Total costTotal cost

Holding costHolding cost

Ordering costOrdering cost

Currentcost

CurrentQ

Lowestcost

Best Q (EOQ)

Lot Sizing at the Museumof Natural History Gift Shop


EOQ POLICY

C = (H) + (S)Q2

DQ

EOQ = 2DSH

D = annual demandS = ordering or setup costs per lotH = holding costs per unit

D = 936 unitsH = $15S = $45

EOQ = 2(936)4515

= 74.94 or 75 units

C = (15) + (45)752

93675

C = $1,124.10

Bird Feeders:


ABC Cycle Ltd. A manufacturer of sports bikes, has an annual demand of 240,000 units in a year. On an average, delivery of an order takes seven working days.

What is the reorder level?


Application 12.1


Application 12.1


Application 12.2


Application 12.2continued


EOQ, is 75 units when annual demand, D, is 936 units/year, setup cost, S, is $45, and holding cost, H, is $15/unit/year. If we mistakenly estimate inventory holding cost to be $30/unit/year, what is the new order quantity, Q, if D = 936 units/year, S = $45, and H = $30/unit/year? What is the change in order quantity, expressed as a percentage of the EOQ (75 units)?

The new order quantity is

The change in percentage is

Solved Problem 3


Problem: Best Buy Demand for deskpro computer at Best Buy is 1000 units per

month. Best buy incurs a fixed order placement cost of $4000 each time an order is placed. Each component costs Best Buy $500 and the retailer has a holding cost of 20%.

Calculate the optimal order size and cycle inventory cost. If management chose a 900-unit lot size (Q) so that new orders could be placed less frequently, What is the annual cycle-inventory cost (C) of the current policy of using a 900-unit lot size?

Show these two situation in cost diagram. If delivery of an order takes place in each month, calculate

reorder level. What is the Time Between Orders (TBO) expressed in months.


Dominick Supermarket Dominick Supermarket sells nut flakes. Demand

for nut flakes is 1000 boxes per week. Dominicks has a holding cost of 25% and incurs $200 for each replenishment order. Calculate the cycle inventory cost.

If the ordering cost decreases to $150 then calculate the % change of cycle inventory cost.

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Role of Inventory Management in SCM