Chapter 6:  Managing Inventory Flows in the Supply Chain
Learning Objectives -   After reading this chapter, you should be able to do the following: <ul><li>Understand the importa...
Learning Objectives <ul><li>Understand the major reasons for carrying inventory. </li></ul><ul><li>Explain the role of inv...
Learning Objectives <ul><li>Understand how inventory items (stock-keeping units) can be designed to maximize the efficienc...
Logistics Profile:  Micros and More <ul><li>“Inventory, inventory, inventory….I am sick and tired of hearing complaints ab...
Management of Inventory Flows in the Supply Chain:  Introduction <ul><li>Inventory as an asset has taken on increased sign...
Inventory in the Economy <ul><li>Inventory in the Economy has decreased. </li></ul><ul><ul><li>As a percentage of the GDP,...
Table 6-1:  Macro Inventory Cost in Relation to U.S. Gross Domestic Product
On the Line:  Inventory Turns <ul><li>Think of inventory turns as a measure of how well a company’s products are doing in ...
Inventory in the Firm:  Rationale for Inventory <ul><li>Product Line Proliferation </li></ul><ul><ul><li>Depth & breath of...
Table 6-2 Total Logistics Costs --- 1999
Inventory in the Firm:    Batching Economies/Cycle Stocks <ul><li>Price discounts </li></ul><ul><ul><li>Result in trade-of...
Inventory in the Firm:    Batching Economies/Cycle Stocks <ul><li>Transportation rate discounts </li></ul><ul><ul><li>Larg...
Inventory in the Firm:    Batching Economies/Cycle Stocks <ul><li>Production economics favor long production runs. </li></...
Inventory in the Firm:    Uncertainty/Safety Stocks <ul><li>Reasons for uncertainty are commonplace. </li></ul><ul><ul><li...
Inventory in the Firm:    Uncertainty/Safety Stocks <ul><li>Impact of information on uncertainty </li></ul><ul><ul><li>Tra...
Inventory in the Firm:  Time/In-Transit and Work-In-Process Stocks <ul><li>Time-related trade-offs from using slower to fa...
Inventory in the Firm:  Seasonal Stocks <ul><li>Seasonality can occur on the inbound and/or outbound side of the firm’s lo...
Inventory in the Firm:  Anticipatory Stocks <ul><li>In some cases, companies anticipate that some forecasted event will ne...
Inventory in the Firm:  The Importance of Inventory in Other Functional Areas <ul><li>Marketing uses inventory to provide ...
Inventory Costs:  Why are they so important? <ul><li>First, inventory costs are a significant portion of total logistics c...
Inventory Costs:  Inventory Carrying Cost <ul><li>Capital Cost </li></ul><ul><ul><li>Opportunity cost associated with inve...
Inventory Costs:  Inventory Carrying Cost <ul><li>Storage Space Cost </li></ul><ul><ul><li>Handling costs, rents, utilitie...
Inventory Costs:  Inventory Carrying Cost <ul><li>Inventory Service Cost </li></ul><ul><ul><li>Insurance and taxes on stor...
Table 6-3  Example of Carrying Cost Components for Computer Hard Disks 25 % Total 8 Inventory 3 Inventory service 2 Storag...
Inventory Costs:  Calculating the Cost of Carrying Inventory <ul><li>Step 1  - Identify the value of the item stored in in...
Inventory Costs:  Nature of Carrying Cost <ul><li>Items with basically similar carrying costs should use the same estimate...
Table 6-4 Inventory and Carrying Cost Information for Computer Hard Disks
Inventory Costs:  Order/Setup Costs <ul><li>Order costs </li></ul><ul><ul><li>MIS costs for inventory stock level tracking...
Table 6-5  Order Frequency and Order Cost for Computer Hard Disks
Inventory Costs:  Carrying Cost versus Order Cost <ul><li>Examine Table 6-6. </li></ul><ul><li>Order costs and carrying co...
Table 6-6  Summary of Inventory and Cost Information
Figure 6-1  Inventory Costs
Inventory Costs:  Expected Stockout Cost <ul><li>Cost of not having product available when a customer wants it. </li></ul>...
Inventory Costs:  Expected Stockout Cost <ul><li>Possible to handle this by adding safety stock. </li></ul><ul><li>In a ma...
Inventory Costs:  Inventory in Transit Carrying Cost <ul><li>Any product inbound to the firm using F.O.B. origin should be...
Classifying Inventory: ABC Analysis <ul><li>Ranking system </li></ul><ul><ul><li>Developed in 1951 by H. Ford Dicky of Gen...
Classifying Inventory: ABC Analysis <ul><li>Pareto’s Rule (80-20 Rule) </li></ul><ul><ul><li>Based on a nineteenth century...
Classifying Inventory: ABC Analysis <ul><li>80-20 Rule </li></ul><ul><ul><li>80% of sales will come from 20% of the invent...
Figure 6-2  ABC Inventory Analysis
Table 6-7  ABC Analysis for Big Orange Products, Inc.
Inventory Visibility <ul><li>The ability of the firm to “see” inventory on a real-time basis throughout the supply chain s...
Inventory Visibility:  General Benefits <ul><li>Improved customer service </li></ul><ul><li>Decreased cost-of-sales </li><...
Evaluating the Effectiveness of a Company’s Approach to Inventory Management <ul><li>Are customers satisfied with the curr...
Evaluating the Effectiveness of a Company’s Approach to Inventory Management <ul><li>How frequently does backordering and/...
Evaluating the Effectiveness of a Company’s Approach to Inventory Management <ul><li>Is the company calculating an Invento...
Evaluating the Effectiveness of a Company’s Approach to Inventory Management <ul><li>How does inventory level behave as sa...
Table 6-8  The Relationship among Inventory Turnover, Average Inventory, and Inventory Carrying Costs
Figure 6-3  Saving Inventory Dollars by Inventory Turns
Figure 6-4  Past and Projected Inventory Turnover of Finished Goods
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Chapter 6: Managing Inventory Flows in the Supply Chain

  1. 1. Chapter 6: Managing Inventory Flows in the Supply Chain
  2. 2. Learning Objectives - After reading this chapter, you should be able to do the following: <ul><li>Understand the importance of coordinated flows of inventory through supply chains. </li></ul><ul><li>Understand the impact of effective inventory management upon the return on assets (ROA) for a company. </li></ul><ul><li>Appreciate the role and importance of inventory in the economy and why inventory levels have declined relative to Gross Domestic Product (GDP). </li></ul>
  3. 3. Learning Objectives <ul><li>Understand the major reasons for carrying inventory. </li></ul><ul><li>Explain the role of inventory to major functional areas in the company. </li></ul><ul><li>Discuss the major types of inventory-related costs and their relationships to inventory decisions. </li></ul>
  4. 4. Learning Objectives <ul><li>Understand how inventory items (stock-keeping units) can be designed to maximize the efficiency of managing inventory. </li></ul><ul><li>Appreciate the importance and value of inventory visibility to increasing supply chain effectiveness. </li></ul><ul><li>Understand how companies can evaluate the effectiveness of their inventory management techniques. </li></ul>
  5. 5. Logistics Profile: Micros and More <ul><li>“Inventory, inventory, inventory….I am sick and tired of hearing complaints about our inventory levels and the costs associated with carrying inventory,” muttered the COO. </li></ul><ul><li>What is the role of inventory? </li></ul><ul><li>What are the important trade-offs in the management of inventory? </li></ul><ul><li>What are the relevant inventory costs? </li></ul><ul><li>Can the supply chain help control inventory? </li></ul>
  6. 6. Management of Inventory Flows in the Supply Chain: Introduction <ul><li>Inventory as an asset has taken on increased significance as companies struggle to reduce investment in fixed assets that accommodate inventory (plants, warehouses, etc.). </li></ul><ul><li>Changes in inventory affect return on assets (ROA), an important internal and external metric. </li></ul><ul><li>Ultimate challenge is to balance supply and demand for inventory. </li></ul>
  7. 7. Inventory in the Economy <ul><li>Inventory in the Economy has decreased. </li></ul><ul><ul><li>As a percentage of the GDP, from 1985 to 2000, inventory levels have decreased from 5.4% to about 3.8% </li></ul></ul><ul><ul><li>Examine Table 6-1. </li></ul></ul>
  8. 8. Table 6-1: Macro Inventory Cost in Relation to U.S. Gross Domestic Product
  9. 9. On the Line: Inventory Turns <ul><li>Think of inventory turns as a measure of how well a company’s products are doing in the market and how well its inventory is managed. </li></ul><ul><li>There is a continuing move away from traditional build-to-forecast manufacturing models to more flexible build-to-demand systems. </li></ul><ul><li>Increasing emphasis on fully integrated supply chain means inventories barely spend any time sitting idle. </li></ul><ul><li>“ Ideally, zero inventory will maximize cash flow.” </li></ul><ul><li>Inventory turnover potential is 30 to 40 times/year. </li></ul>
  10. 10. Inventory in the Firm: Rationale for Inventory <ul><li>Product Line Proliferation </li></ul><ul><ul><li>Depth & breath of product lines trending up. </li></ul></ul><ul><ul><li>Results in larger inventories. </li></ul></ul><ul><li>Examine Table 6-2 Total Logistics Costs-1999 . </li></ul><ul><li>Inventory carrying costs of $332 billion approach 35 percent of total logistics costs for companies. </li></ul>
  11. 11. Table 6-2 Total Logistics Costs --- 1999
  12. 12. Inventory in the Firm: Batching Economies/Cycle Stocks <ul><li>Price discounts </li></ul><ul><ul><li>Result in trade-offs between large purchases qualifying for quantity discounts and costs of storing inventory. </li></ul></ul><ul><ul><li>Because physical supply inventory is often raw materials, storage costs are often less than savings from buying in bulk, so supplies are stockpiled. </li></ul></ul>
  13. 13. Inventory in the Firm: Batching Economies/Cycle Stocks <ul><li>Transportation rate discounts </li></ul><ul><ul><li>Large quantities often result in carload freight rates. </li></ul></ul><ul><ul><li>Largest shipments may qualify for even lower multiple truckload, carload or trainload rates. </li></ul></ul><ul><ul><li>Lower freight rates are often reflected in lower consumer prices. </li></ul></ul>
  14. 14. Inventory in the Firm: Batching Economies/Cycle Stocks <ul><li>Production economics favor long production runs. </li></ul><ul><ul><li>Results in cycle stock that must be stored. </li></ul></ul><ul><ul><li>Cycle stocks can be beneficial as long as the appropriate analysis is done to cost justify the inventory. </li></ul></ul>
  15. 15. Inventory in the Firm: Uncertainty/Safety Stocks <ul><li>Reasons for uncertainty are commonplace. </li></ul><ul><ul><li>Net results are the same: companies accumulate safety stock to buffer themselves against uncertainty. </li></ul></ul><ul><ul><li>Safety stock more challenging and complex to manage for many firms. </li></ul></ul>
  16. 16. Inventory in the Firm: Uncertainty/Safety Stocks <ul><li>Impact of information on uncertainty </li></ul><ul><ul><li>Trade-off analysis appropriate to assess risk and measure inventory cost. </li></ul></ul><ul><ul><li>Information technology can be used in the supply chain to reduce inventory. </li></ul></ul><ul><ul><li>Collaborative planning and forecasting requirements (CPFR) is an example. </li></ul></ul><ul><ul><li>Bar coding, EDI, the Internet have enabled companies to reduce uncertainty. </li></ul></ul>
  17. 17. Inventory in the Firm: Time/In-Transit and Work-In-Process Stocks <ul><li>Time-related trade-offs from using slower to faster transport modes </li></ul><ul><ul><li>Faster modes cost more but may save a larger amount in inventory carrying costs. </li></ul></ul><ul><li>Work-In-Process inventory should be examined for possible trade-offs especially in the production of high value goods. </li></ul><ul><ul><li>Scheduling and actual production times can be closely examined to reduce inventory. </li></ul></ul>
  18. 18. Inventory in the Firm: Seasonal Stocks <ul><li>Seasonality can occur on the inbound and/or outbound side of the firm’s logistics systems. </li></ul><ul><li>Perishable supply in agricultural products or seasonal-related transportation problems. </li></ul><ul><li>Seasonal demand compressing selling seasons in some industries results in smaller plants producing for stock. </li></ul>
  19. 19. Inventory in the Firm: Anticipatory Stocks <ul><li>In some cases, companies anticipate that some forecasted event will negatively impact the production cycle. </li></ul><ul><li>For example, labor strikes, shortage of supplies due to weather or political event, or significant price increases may prompt the firm to build inventory levels higher than normal. </li></ul><ul><li>Risk assessment is important in these cases. </li></ul>
  20. 20. Inventory in the Firm: The Importance of Inventory in Other Functional Areas <ul><li>Marketing uses inventory to provide strong customer service. </li></ul><ul><li>Manufacturing uses inventory to schedule longer production runs. </li></ul><ul><li>Finance wants inventory turnover ratios to be kept high so that risk of inventory loss is reduced and rate of return on assets kept competitively high. </li></ul>
  21. 21. Inventory Costs: Why are they so important? <ul><li>First, inventory costs are a significant portion of total logistics costs for many firms. </li></ul><ul><li>Second, inventory levels affect customer service levels. </li></ul><ul><li>Third, inventory cost trade-off decisions affect inventory carrying costs. </li></ul>
  22. 22. Inventory Costs: Inventory Carrying Cost <ul><li>Capital Cost </li></ul><ul><ul><li>Opportunity cost associated with investing in inventory, or any asset. </li></ul></ul><ul><ul><li>What is the implicit value of having capital tied up in inventory, instead of some other worthwhile project? </li></ul></ul><ul><ul><li>Minimum ROR expected from any asset. </li></ul></ul><ul><ul><li>Debate on inventory valuation at fully allocated or variable costs only. </li></ul></ul>
  23. 23. Inventory Costs: Inventory Carrying Cost <ul><li>Storage Space Cost </li></ul><ul><ul><li>Handling costs, rents, utilities. </li></ul></ul><ul><ul><li>Logistics develops a cost formula for storage space costs based on cost behaviors. </li></ul></ul><ul><ul><ul><li>Public space mostly variable. </li></ul></ul></ul><ul><ul><ul><li>Private space a mix of fixed and variable. </li></ul></ul></ul>
  24. 24. Inventory Costs: Inventory Carrying Cost <ul><li>Inventory Service Cost </li></ul><ul><ul><li>Insurance and taxes on stored goods. </li></ul></ul><ul><ul><li>Varies according to the value of the goods. </li></ul></ul><ul><li>Inventory Risk Cost </li></ul><ul><ul><li>Largely beyond the control of the firm. </li></ul></ul><ul><ul><li>Due to obsolescence, damage, theft, employee pilferage. </li></ul></ul>
  25. 25. Table 6-3 Example of Carrying Cost Components for Computer Hard Disks 25 % Total 8 Inventory 3 Inventory service 2 Storage space 12 % Capital Percentage of Product Value Cost
  26. 26. Inventory Costs: Calculating the Cost of Carrying Inventory <ul><li>Step 1 - Identify the value of the item stored in inventory (e.g. $100). </li></ul><ul><li>Step 2 - Measure each individual carrying cost component as a percentage of product value (e.g. 25%). </li></ul><ul><li>Step 3 - Multiply overall carrying cost (as a percentage) times the dollar value of the product (e.g. $100 times 25% = $25 inventory carrying cost per year. </li></ul>
  27. 27. Inventory Costs: Nature of Carrying Cost <ul><li>Items with basically similar carrying costs should use the same estimate of carrying cost per dollar. </li></ul><ul><li>There are exceptions for items that are subject to special consideration for purposes of quick obsolescence or high degree of theft, etc. </li></ul>
  28. 28. Table 6-4 Inventory and Carrying Cost Information for Computer Hard Disks
  29. 29. Inventory Costs: Order/Setup Costs <ul><li>Order costs </li></ul><ul><ul><li>MIS costs for inventory stock level tracking. </li></ul></ul><ul><ul><li>Preparing and processing purchase orders and receiving reports. </li></ul></ul><ul><ul><li>Inspecting and preparing inventory for sale. </li></ul></ul><ul><li>Setup Costs </li></ul><ul><ul><li>Incurred when production changes over from one product to another. </li></ul></ul>
  30. 30. Table 6-5 Order Frequency and Order Cost for Computer Hard Disks
  31. 31. Inventory Costs: Carrying Cost versus Order Cost <ul><li>Examine Table 6-6. </li></ul><ul><li>Order costs and carrying costs respond in opposite ways to increases in volume. </li></ul><ul><li>This reinforces the logisticians need to be able to separate costs by how they behave in relation to changes in volume. </li></ul><ul><li>Assistance from managerial accountants is available for cost-volume-profit analysis. </li></ul>
  32. 32. Table 6-6 Summary of Inventory and Cost Information
  33. 33. Figure 6-1 Inventory Costs
  34. 34. Inventory Costs: Expected Stockout Cost <ul><li>Cost of not having product available when a customer wants it. </li></ul><ul><li>Includes backorder costs (special order). </li></ul><ul><li>Losing one item profit by substituting a competing firm’s product. </li></ul><ul><li>Losing a customer permanently if customer finds they prefer the substituted product and/or company. </li></ul>
  35. 35. Inventory Costs: Expected Stockout Cost <ul><li>Possible to handle this by adding safety stock. </li></ul><ul><li>In a manufacturing firm, a stockout may result in lost hours of production until the item is restocked. </li></ul>
  36. 36. Inventory Costs: Inventory in Transit Carrying Cost <ul><li>Any product inbound to the firm using F.O.B. origin should be counted. </li></ul><ul><li>Any product outbound from the firm using F.O.B. destination should be counted. </li></ul><ul><li>In transit carrying cost is generally less than for regular inventory because some cost components are not present. </li></ul><ul><ul><li>No storage costs, no taxes, and reduced risk of obsolescence. </li></ul></ul>
  37. 37. Classifying Inventory: ABC Analysis <ul><li>Ranking system </li></ul><ul><ul><li>Developed in 1951 by H. Ford Dicky of General Electric 3 . </li></ul></ul><ul><ul><li>Suggested that GE classify items according to relative sales volume, cash flows, lead time, or stockout cost. </li></ul></ul><ul><ul><li>Most important inventory put in Group A. </li></ul></ul><ul><ul><li>Lesser impact goods put in Groups B and C respectively. </li></ul></ul>
  38. 38. Classifying Inventory: ABC Analysis <ul><li>Pareto’s Rule (80-20 Rule) </li></ul><ul><ul><li>Based on a nineteenth century mathematician’s observation that many situations were dominated by a very few elements. </li></ul></ul><ul><ul><li>Conversely, most elements had very little influence in most situations. </li></ul></ul><ul><ul><li>Separates the “trivial many” from the “vital few”. </li></ul></ul>
  39. 39. Classifying Inventory: ABC Analysis <ul><li>80-20 Rule </li></ul><ul><ul><li>80% of sales will come from 20% of the inventory SKUs. </li></ul></ul><ul><ul><li>20% of sales will come from 80% of the inventory SKUs. </li></ul></ul><ul><li>The 80-20 Rule has been found to explain many phenomena that interest managers. </li></ul><ul><ul><li>For example, 80% of sales come from 20% of customers; and vice versa. </li></ul></ul>
  40. 40. Figure 6-2 ABC Inventory Analysis
  41. 41. Table 6-7 ABC Analysis for Big Orange Products, Inc.
  42. 42. Inventory Visibility <ul><li>The ability of the firm to “see” inventory on a real-time basis throughout the supply chain system requires: </li></ul><ul><ul><li>Tracking and tracing inventory SKUs for all inbound and outbound orders. </li></ul></ul><ul><ul><li>Providing summary and detailed reports of shipments, orders, products, transportation equipment, location, and trade lane activity. </li></ul></ul><ul><ul><li>Notification of failures in inventory flow. </li></ul></ul>
  43. 43. Inventory Visibility: General Benefits <ul><li>Improved customer service </li></ul><ul><li>Decreased cost-of-sales </li></ul><ul><li>Improved vendor relations and cost </li></ul><ul><li>Increased Return on Assets </li></ul><ul><li>Improved cash flow </li></ul><ul><li>Improved response time and service recovery </li></ul><ul><li>Improved performance metrics </li></ul>
  44. 44. Evaluating the Effectiveness of a Company’s Approach to Inventory Management <ul><li>Are customers satisfied with the current level of customer service? </li></ul><ul><ul><li>If standards have been set in consultation with the customer, this question can be answered objectively. </li></ul></ul>
  45. 45. Evaluating the Effectiveness of a Company’s Approach to Inventory Management <ul><li>How frequently does backordering and/or expediting occur? </li></ul><ul><ul><li>If records of these events are kept, the answer to this question can point out the need for a modification or adoption of new inventory strategies. </li></ul></ul>
  46. 46. Evaluating the Effectiveness of a Company’s Approach to Inventory Management <ul><li>Is the company calculating an Inventory Turnover ratio for each product SKU? </li></ul><ul><ul><li>This ratio can provide good information on whether the inventory is being effectively and efficiently managed. </li></ul></ul><ul><ul><li>Examine Table 6-8, Figure 6-3 and Figure 6-4. </li></ul></ul>
  47. 47. Evaluating the Effectiveness of a Company’s Approach to Inventory Management <ul><li>How does inventory level behave as sales rise or fall? </li></ul><ul><ul><li>From sales records, the firm can determine if inventory levels rise as much as sales, less than sales, or stay about the same regardless of sales levels. </li></ul></ul>
  48. 48. Table 6-8 The Relationship among Inventory Turnover, Average Inventory, and Inventory Carrying Costs
  49. 49. Figure 6-3 Saving Inventory Dollars by Inventory Turns
  50. 50. Figure 6-4 Past and Projected Inventory Turnover of Finished Goods
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