MANAGEMENT INVENTORY FLOWS IN THE SUPPLY CHAIN

1. Chapter 6:
Managing Inventory Flows in the
Supply Chain

2. Learning Objectives - After reading this
chapter, you should be able to do the following:
 Understand the importance of coordinated
flows of inventory through supply chains.
 Understand the impact of effective inventory
management upon the return on assets
(ROA) for a company.
 Appreciate the role and importance of
inventory in the economy and why inventory
levels have declined relative to Gross
Domestic Product (GDP).

3. Learning Objectives
 Understand the major reasons for carrying
inventory.
 Explain the role of inventory to major
functional areas in the company.
 Discuss the major types of inventory-related
costs and their relationships to inventory
decisions.

4. Learning Objectives
 Understand how inventory items (stock-
keeping units) can be designed to maximize
the efficiency of managing inventory.
 Appreciate the importance and value of
inventory visibility to increasing supply chain
effectiveness.
 Understand how companies can evaluate the
effectiveness of their inventory management
techniques.

5. Logistics Profile:
Micros and More
 “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.
 What is the role of inventory?
 What are the important trade-offs in the
management of inventory?
 What are the relevant inventory costs?
 Can the supply chain help control inventory?

6. Management of Inventory Flows
in the Supply Chain: Introduction
 Inventory as an asset has taken on increased
significance as companies struggle to reduce
investment in fixed assets that accommodate
inventory (plants, warehouses, etc.).
 Changes in inventory affect return on assets
(ROA), an important internal and external
metric.
 Ultimate challenge is to balance supply and
demand for inventory.

7. Inventory in the Economy
 Inventory in the Economy has decreased.
 As a percentage of the GDP, from 1985 to
2000, inventory levels have decreased
from 5.4% to about 3.8%
 Examine Table 6-1.

8. Table 6-1: Macro Inventory Cost in
Relation to U.S. Gross Domestic Product

9. On the Line:
Inventory Turns
 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.
 There is a continuing move away from traditional build-
to-forecast manufacturing models to more flexible
build-to-demand systems.
 Increasing emphasis on fully integrated supply chain
means inventories barely spend any time sitting idle.
 “Ideally, zero inventory will maximize cash flow.”
 Inventory turnover potential is 30 to 40 times/year.

10. Inventory in the Firm:
Rationale for Inventory
 Product Line Proliferation
 Depth & breath of product lines trending up.
 Results in larger inventories.
 Examine Table 6-2 Total Logistics Costs-1999.
 Inventory carrying costs of $332 billion
approach 35 percent of total logistics costs for
companies.

11. Table 6-2
Total Logistics Costs --- 1999

12. Inventory in the Firm:
Batching Economies/Cycle Stocks
 Price discounts
 Result in trade-offs between large
purchases qualifying for quantity discounts
and costs of storing inventory.
 Because physical supply inventory is often
raw materials, storage costs are often less
than savings from buying in bulk, so
supplies are stockpiled.

13. Inventory in the Firm:
Batching Economies/Cycle Stocks
 Transportation rate discounts
 Large quantities often result in carload
freight rates.
 Largest shipments may qualify for even
lower multiple truckload, carload or
trainload rates.
 Lower freight rates are often reflected in
lower consumer prices.

14. Inventory in the Firm:
Batching Economies/Cycle Stocks
 Production economics favor long production
runs.
 Results in cycle stock that must be stored.
 Cycle stocks can be beneficial as long as
the appropriate analysis is done to cost
justify the inventory.

15. Inventory in the Firm:
Uncertainty/Safety Stocks
 Reasons for uncertainty are commonplace.
 Net results are the same: companies
accumulate safety stock to buffer
themselves against uncertainty.
 Safety stock more challenging and
complex to manage for many firms.

16. Inventory in the Firm:
Uncertainty/Safety Stocks
 Impact of information on uncertainty
 Trade-off analysis appropriate to assess
risk and measure inventory cost.
 Information technology can be used in the
supply chain to reduce inventory.
 Collaborative planning and forecasting
requirements (CPFR) is an example.
 Bar coding, EDI, the Internet have enabled
companies to reduce uncertainty.

17. Inventory in the Firm: Time/In-Transit
and Work-In-Process Stocks
 Time-related trade-offs from using slower to
faster transport modes
 Faster modes cost more but may save a
larger amount in inventory carrying costs.
 Work-In-Process inventory should be
examined for possible trade-offs especially in
the production of high value goods.
 Scheduling and actual production times
can be closely examined to reduce
inventory.

18. Inventory in the Firm:
Seasonal Stocks
 Seasonality can occur on the inbound and/or
outbound side of the firm’s logistics systems.
 Perishable supply in agricultural products or
seasonal-related transportation problems.
 Seasonal demand compressing selling
seasons in some industries results in smaller
plants producing for stock.

19. Inventory in the Firm:
Anticipatory Stocks
 In some cases, companies anticipate that
some forecasted event will negatively impact
the production cycle.
 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.
 Risk assessment is important in these cases.

20. Inventory in the Firm: The Importance
of Inventory in Other Functional Areas
 Marketing uses inventory to provide strong
customer service.
 Manufacturing uses inventory to schedule
longer production runs.
 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.

21. Inventory Costs: Why are they
so important?
 First, inventory costs are a significant portion
of total logistics costs for many firms.
 Second, inventory levels affect customer
service levels.
 Third, inventory cost trade-off decisions affect
inventory carrying costs.

22. Inventory Costs:
Inventory Carrying Cost
 Capital Cost
 Opportunity cost associated with investing
in inventory, or any asset.
 What is the implicit value of having capital
tied up in inventory, instead of some other
worthwhile project?
 Minimum ROR expected from any asset.
 Debate on inventory valuation at fully
allocated or variable costs only.

23. Inventory Costs:
Inventory Carrying Cost
 Storage Space Cost
 Handling costs, rents, utilities.
 Logistics develops a cost formula for
storage space costs based on cost
behaviors.

Public space mostly variable.

Private space a mix of fixed and
variable.

24. Inventory Costs:
Inventory Carrying Cost
 Inventory Service Cost
 Insurance and taxes on stored goods.
 Varies according to the value of the goods.
 Inventory Risk Cost
 Largely beyond the control of the firm.
 Due to obsolescence, damage, theft,
employee pilferage.

25. Table 6-3 Example of Carrying Cost
Components for Computer Hard Disks
Cost Percentage of Product Value
Capital 12 %
Storage space 2
Inventory service 3
Inventory 8
Total 25 %

26. Inventory Costs: Calculating the
Cost of Carrying Inventory
 Step 1 - Identify the value of the item stored
in inventory (e.g. $100).
 Step 2 - Measure each individual carrying
cost component as a percentage of product
value (e.g. 25%).
 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.

27. Inventory Costs:
Nature of Carrying Cost
 Items with basically similar carrying costs
should use the same estimate of carrying
cost per dollar.
 There are exceptions for items that are
subject to special consideration for purposes
of quick obsolescence or high degree of theft,
etc.

28. Table 6-4
Inventory and Carrying Cost Information
for Computer Hard Disks

29. Inventory Costs:
Order/Setup Costs
 Order costs
 MIS costs for inventory stock level tracking.
 Preparing and processing purchase orders
and receiving reports.
 Inspecting and preparing inventory for sale.
 Setup Costs
 Incurred when production changes over
from one product to another.

30. Table 6-5 Order Frequency and
Order Cost for Computer Hard Disks

31. Inventory Costs:
Carrying Cost versus Order Cost
 Examine Table 6-6.
 Order costs and carrying costs respond in
opposite ways to increases in volume.
 This reinforces the logisticians need to be
able to separate costs by how they behave in
relation to changes in volume.
 Assistance from managerial accountants is
available for cost-volume-profit analysis.

32. Table 6-6 Summary of Inventory
and Cost Information

33. Figure 6-1
Inventory Costs

34. Inventory Costs:
Expected Stockout Cost
 Cost of not having product available when a
customer wants it.
 Includes backorder costs (special order).
 Losing one item profit by substituting a
competing firm’s product.
 Losing a customer permanently if customer
finds they prefer the substituted product and/or
company.

35. Inventory Costs:
Expected Stockout Cost
 Possible to handle this by adding safety stock.
 In a manufacturing firm, a stockout may result
in lost hours of production until the item is
restocked.

36. Inventory Costs:
Inventory in Transit Carrying Cost
 Any product inbound to the firm using F.O.B.
origin should be counted.
 Any product outbound from the firm using
F.O.B. destination should be counted.
 In transit carrying cost is generally less than
for regular inventory because some cost
components are not present.
 No storage costs, no taxes, and reduced
risk of obsolescence.

37. Classifying Inventory:
ABC Analysis
 Ranking system
 Developed in 1951 by H. Ford Dicky of
General Electric3
.
 Suggested that GE classify items
according to relative sales volume, cash
flows, lead time, or stockout cost.
 Most important inventory put in Group A.
 Lesser impact goods put in Groups B and
C respectively.

38. Classifying Inventory:
ABC Analysis
 Pareto’s Rule (80-20 Rule)
 Based on a nineteenth century
mathematician’s observation that many
situations were dominated by a very few
elements.
 Conversely, most elements had very little
influence in most situations.
 Separates the “trivial many” from the “vital
few”.

39. Classifying Inventory:
ABC Analysis
 80-20 Rule
 80% of sales will come from 20% of the
inventory SKUs.
 20% of sales will come from 80% of the
inventory SKUs.
 The 80-20 Rule has been found to explain
many phenomena that interest managers.
 For example, 80% of sales come from 20%
of customers; and vice versa.

40. Figure 6-2
ABC Inventory Analysis

41. Table 6-7 ABC Analysis for Big
Orange Products, Inc.

42. Inventory Visibility
 The ability of the firm to “see” inventory on a
real-time basis throughout the supply chain
system requires:
 Tracking and tracing inventory SKUs for all
inbound and outbound orders.
 Providing summary and detailed reports of
shipments, orders, products, transportation
equipment, location, and trade lane activity.
 Notification of failures in inventory flow.

43. Inventory Visibility:
General Benefits
 Improved customer service
 Decreased cost-of-sales
 Improved vendor relations and cost
 Increased Return on Assets
 Improved cash flow
 Improved response time and service
recovery
 Improved performance metrics

44. Evaluating the Effectiveness of a
Company’s Approach to Inventory
Management
 Are customers satisfied with the current
level of customer service?
 If standards have been set in consultation
with the customer, this question can be
answered objectively.

45. Evaluating the Effectiveness of a
Company’s Approach to Inventory
Management
 How frequently does backordering and/or
expediting occur?
 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.

46. Evaluating the Effectiveness of a
Company’s Approach to Inventory
Management
 Is the company calculating an Inventory
Turnover ratio for each product SKU?
 This ratio can provide good information on
whether the inventory is being effectively
and efficiently managed.
 Examine Table 6-8, Figure 6-3 and
Figure 6-4.

47. Evaluating the Effectiveness of a
Company’s Approach to Inventory
Management
 How does inventory level behave as sales rise
or fall?
 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.

48. Table 6-8 The Relationship among
Inventory Turnover, Average Inventory,
and Inventory Carrying Costs

49. Figure 6-3 Saving Inventory
Dollars by Inventory Turns

50. Figure 6-4 Past and Projected
Inventory Turnover of Finished Goods

51. Chapter 6:
Summary and Review Questions
Students should review their knowledge of the chapter
by checking out the Summary and Study Questions
for Chapter 6.
This is the last slide for Chapter 6

52. End of Chapter 6 Slides
Managing Inventory Flows in
the Supply Chain