Inventory management• It is a stock of materials (inventory) which is keptin stock to combat variations in demand, whichcan be regarded as a “safety stock”.• Inventory held along the various nodes of asupply chain is termed “work in process”.• Inventories can cost 15-40% of their value inhandling, storage, insurance and slippage(damage/theft)……therefore it is easy tounderstand why inventory turn is so important.International Business - Inventorymanagement - Liam Fassam2
Inventory locationInventories usually comprise 3 elements:1. Input stock (Raw materials/packaging)2. Process stocks (semi finished goods)3. Output stocks (Finished products)So in the “farm to fork” example:• Crops in transit from farmer to manufacturing plant are?• The raw material being processed into cereal is?• The finished product sitting in a distribution centre is?• The finished product sitting in a retail store is?International Business - Inventorymanagement - Liam Fassam3
Holding costInventories can accumulate as a result of poor planning andscheduling or as by design (purposeful stock holding).Generally, inventory is viewed as a negative impact onbusiness as it incurs:• Costs of capital (interest paid or interest fore gone)• Storage space• Handling• Insurance• Increased risk of damage and theft• Obsolescence.International Business - Inventorymanagement - Liam Fassam4
Holding cost - risk• Fashion changes (style, colour and texture),• Past ‘use-by-date’ for foods• Deterioration• Obsolescence due to new technology or tomodel changes which make ‘old’• Models out of date• Damage• Pilfering/theftInternational Business - Inventorymanagement - Liam Fassam5
Holding cost - storage• Building – the more inventory the larger thepremises• Racking – larger quantities requires specialistequipment to store• Temperature controlled – food items often requiretemp control, the larger the stock the greater theenergy demands to maintain good controls• Handling cost – specialised equipment such asforklifts and staff wages; each time a box is touchedit has a cost!International Business - Inventorymanagement - Liam Fassam6
Holding cost - finance• Interest on money invested in stocks ofmaterials, either the organization has had toborrow money to pay for the stock held or themoney ‘invested’ in the stock could have beenused elsewhere in the organisation.• Insurance – the greater the value of stock onhand, the higher the insurance value will needto be to cover loss and therefore increasedpremiums.International Business - Inventorymanagement - Liam Fassam7
Re-order point – “pull” systemsInternational Business - Inventorymanagement - Liam Fassam8Stock dropsto theagreedlevel andnew orderis placedThe agreedre-order QTYis placed,note thestock usedafter orderduring thelead timeLead timefrom orderto receiptThis is the “pull” process in action – sales happen, stock drops, order placedThe supply chain pulling product through – “value chain”Safetystock, topreventagainststockouts ifnetworkbreakdownsoccur
Re-order point – “Push” systemReorderpointSafetystockTimeStockonhandLead timePeriod 1 Period 2 Period 3Output matchesdemandDemand out performs outputand we eat in to safety stockAs we need to replen safety stockused in previous period our outputdoes not give us full stock on handrequirements but low sales meanswe have too much stockThis is the “push” process in action – output is premised on cost efficientManufacturing premised on the economic order quantity (EOQ)International Business - Inventorymanagement - Liam Fassam9
Push versus PullInternational Business - Inventorymanagement - Liam Fassam10
Push versus PullIn short…..The pull system ensures inventory is madeavailable downstream based on demand…..The push system feeds inventory through thesupply chain regardless of current demand…..International Business - Inventorymanagement - Liam Fassam11
Economic order quantity (EOQ)EOQ is a push system that can be used when there isan advantage in bulk purchase/manufacture ratherthan making several small purchases.EOQ assumes:• Demand is constant and known.• Deliveries are to specification, the right quantity andon time.• There is no slippage of stock due to theft ordamage. This means that what the computershows as being in stock is correct.International Business - Inventorymanagement - Liam Fassam12
Calculating the EOQThe formula for EOQ isQ = The square root of 2 x DO/PHQ is the EOQD is the annual demand in unitsO is the cost of raising an orderP is the price of a unitH is the holding costInternational Business - Inventorymanagement - Liam Fassam13
EOQ model simplified!OptimalorderquantityOrderset upOrderquantityAnnualcostTotalcostHoldingcostWhere the costsintercede is where ourmost efficient costdriver for EOQ residesInternational Business - Inventorymanagement - Liam Fassam14
EOQ calculation exampleDemand (D) 60,000 units per annumOrder cost (O)€100 per order raisedPrice per unit (P) €75Holding cost (H) 12% per annumTherefore:2 x 60,000 x 100 = 12,000,000Divided by / 75 x 0.12 = 912,000,000 / 9 = 1,333,333Square root of 1,333,333 = 1,154International Business - Inventorymanagement - Liam Fassam15
EOQ calculation example cont.• If we assume the supplier manufactures units inbatches of 100, each order would be 1,154 opposedto 1,200.• As the total annual demand is 60,000 our resultantEOQ gives us a delivery schedule of 52 per year.• Therefore it is important in a push system to haveconstant periodic reviews to ensure output matchesdemand.International Business - Inventorymanagement - Liam Fassam16
Safety stock calculation• Quite often it is purported that safety stock is simplycalculated as:Demand / 50% Lead time = X days reserve (safety stock)• Where organisations have fairly stable supply lines andlittle variation, this simplistic over deployed method willresult in too much inventory being carried.• For organisations that have severe demand fluctuationsthis will entail constant stock outs.This is all too simplified, does not allow for world class SCMpractices such as constant review through S&OP practices.International Business - Inventorymanagement - Liam Fassam17
Calculating the safety stockWhen calculating the safety stock we need to understand thedemand and lead time deviation, on a constant review basis (once ayear at budget time does not suffice!)Therefore first stage of safety stock calculation equates to:Demand variation + lead time variation = safety stockThe final step is ratifying the above against an expected service level(The level of service to your customers – remember in value chainsthis has effects up/down stream and therefore ratifies the need tounderstand the auspices of supply chain theoretical capacity)Lets walks through the following example:International Business - Inventorymanagement - Liam Fassam18
Calculating the demand deviationForecast demand Actual usage Deviation1 50 60 102 76 80 43 80 70 -10International Business - Inventorymanagement - Liam Fassam19Demand in period 1 and 2 gives a deviation (10+4)/2=7We do not include the deviation for period 3, as our forecast washigher than usage, therefore by including this figure would onlyincrease the amount of safety stock on hand…….so we only look atthe areas of historical or live data that can have a detrimentaleffect in satisfying the customer needs, thus avoiding stock outs.
Calculating the lead-time deviationInternational Business - Inventorymanagement - Liam Fassam20Expected lead time Actual lead time Deviation1 10 days 17 days 7 days2 8 days 13 days 5 days3 8 days 6 days -2 daysDemand in period 1 and 2 gives a deviation (7+5)/2=6We do not include the deviation for period 3, as with the quantitydeviation, the lead time in period 3 was sooner than expected andtherefore will not have a detrimental effect on satisfying customerdemand.
Total safety stock deviationIf our demand is 90 pieces per period and each period consistsof 18 work days the daily demand is:90/18 = 5 pieces per day demandGiven our lead time deviation is 6 days we need to multiplythis by the daily demand:6 * 5 = 30 piecesTo appreciate the full safety stock we also need to include thedeviation in sales we ascertained early of 7 pieces over 2periods:30 + 7 = 37 pieces of safety stock for 3 periods (QTR1)International Business - Inventorymanagement - Liam Fassam21
Calculating the service level deviationInternational Business - Inventorymanagement - Liam Fassam22Deviation multiple Customer service level2 95%3 97%4 99%The standard deviations used by organisations to achieve a certain service level arehighlighted aboveIn our example if we chose to attain a 95% service level for meeting demand:Our safety stock relating to standard deviation (demand/lead time) is 37 pieces.Therefore:37 * 2 = 74 piecesSo our safety stock for 3 periods based on deviation in lead time,Demand and expected service level is 74 pieces.
Lets work through thefollowing two examples inyour own time and evaluateoutcomes:International Business - Inventorymanagement - Liam Fassam23
Example 1International Business - Inventorymanagement - Liam Fassam24Forecast demand Actual usage Deviation1 100 110 102 110 120 103 120 80 -40Expected lead time Actual lead time Deviation1 10 days 15 days 5 days2 9 days 15 days 6 days3 8 days 6 days -2 days(10 + 10) / 2 = 10we ignore period 3 as it does not have detrimental effect on order fulfilment(5 + 6) / 2 = 5.5 dayswe ignore period 3 as it does not have detrimental effect on order fulfilment(Lead time * daily demand) + forecast deviation = (5.5 * 5) + 10 = 37.5 piecesService level deviation (95%) = 2 * 37.5 = 75 pieces (97% service level = 112.5 pieces)
Example 2International Business - Inventorymanagement - Liam Fassam25Forecast demand Actual usage Deviation1 1,000 2,000 1,0002 2,200 2,400 2003 2,500 2,600 100Expected lead time Actual lead time Deviation1 30 days 10 days -20 days2 30 days 32 days 2 days3 30 days 60 days 30 days(1,000 + 200+100) / 3 = 433.33(2 + 30) / 2 = 16 dayswe ignore period 1 as it does not have detrimental effect on order fulfilment(Lead time * daily demand) + forecast deviation = (16 * 5) + 433.33 = 513.33 piecesService level deviation (95%) = 2 * 513.33 = 1026.66 (97% service level = 1539.99pieces)