2. Inventory Management
• Inventory Reduction Tactics
• Managers are always eager to find cost-effective
ways to reduce inventory in supply chains. In this
section we discuss the basic tactics (which we call
levers) for reducing cycle, safety stock,
anticipation, and pipeline inventories in supply
chains. A primary lever is one that must be
activated if inventory is to be reduced. A
secondary lever reduces the penalty cost of
applying the primary lever and the need for
having inventory in the first place.
3. Inventory Management
• Cycle Inventory
• The primary lever to reduce cycle inventory is simply to reduce the lot sizes of items
moving in the supply chain. However, making such reductions in Q without making
any other changes can be devastating.
• For example, setup costs or ordering costs can skyrocket. If these changes occur,
two secondary levers can be used:
• 1. Streamline the methods for placing orders and making setups to reduce
ordering and setup costs and allow Q to be reduced. This may involve redesigning
the infrastructure for information flows or improving manufacturing processes.
• 2. Increase repeatability to eliminate the need for changeovers. Repeatability is
the degree to which the same work can be done again. Repeatability can be
increased through high product demand; the use of specialization; the devotion of
resources exclusively to a product; the use of the same part in many different
products; the use of flexible automation; the use of the one-worker,
multiplemachines concept; or through group technology. Increased repeatability
may justify new setup methods, reduce transportation costs, and allow quantity
discounts from suppliers.
4. Inventory Management
• Safety Stock Inventory
• The primary lever to reduce safety stock inventory is to place orders closer to the time when they
must be received. However, this approach can lead to unacceptable customer service unless
demand, supply, and delivery uncertainties can be minimized. Four secondary levers can be used
in this case:
• 1. Improve demand forecasts so that fewer surprises come from customers. Design the
mechanisms to increase collaboration with customers to get advanced warnings for changes in
demand levels.
• 2. Cut the lead times of purchased or produced items to reduce demand uncertainty. For
example, local suppliers with short lead times could be selected whenever possible.
• 3. Reduce supply uncertainties. Suppliers are likely to be more reliable if production plans are
shared with them. Put in place the mechanisms to increase collaboration with suppliers.
Surprises from unexpected scrap or rework can be reduced by improving manufacturing
processes. Preventive maintenance can minimize unexpected downtime caused by equipment
failure.
• 4. Rely more on equipment and labor buffers, such as capacity cushions and cross-trained
workers. These buffers are important to businesses in the service sector because they generally
cannot inventory their services.
5. Inventory Management
• Anticipation Inventory
• The primary lever to reduce anticipation inventory is
simply to match demand rate with production rate.
Secondary levers can be used to even out customer
demand in one of the following ways:
• 1. Add new products with different demand cycles
so that a peak in the demand for one product
compensates for the seasonal low for another.
• 2. Provide off-season promotional campaigns.
• 3. Offer seasonal pricing plans.
6. Inventory Management
• Pipeline Inventory
• An operations manager has direct control over lead times
but not demand rates. Because pipeline inventory is a
function of demand during the lead time, the primary lever
is to reduce the lead time. Two secondary levers can help
managers cut lead times:
• 1. Find more responsive suppliers and select new carriers
for shipments between stocking locations or improve
materials handling within the plant. Improving the
information system could overcome information delays
between a distribution center and retailer.
• 2. Change Q in those cases where the lead time depends
on the lot size.
7. Inventory Management
• Inventories in supply chains are managed with
the help of inventory control systems. These
systems manage the levels of cycle, safety stock,
anticipation, and pipeline inventories in a firm.
Regardless of whether an item experiences
independent or dependent demand, three
important questions must be answered: What
degree of control should we impose on an item?
How much should we order? And When should
we place the order?
8. Inventory Management
• ABC Analysis
• Thousands of items, often referred to as stock-
keeping units, are held in inventory by a typical
organization, but only a small percentage of them
deserve management’s closest attention and tightest
control.
• A stock-keeping unit (SKU) is an individual item or
product that has an identifying code and is held in
inventory somewhere along the supply chain.
• ABC analysis is the process of dividing SKUs into
three classes according to their dollar usage so that
managers can focus on items that have the highest
dollar value.
9. Inventory Management
• Cycle counting-An inventory control method,
whereby storeroom personnel physically
count a small percentage of the total number
of items each day, correcting errors that they
find.
10. Inventory Management
• A good starting point for balancing these conflicting pressures and determining the
best cycle-inventory level for an item is finding the economic order quantity (EOQ),
which is the lot size that minimizes total annual cycle-inventory holding and
ordering costs. The approach to determining the EOQ is based on the following
assumptions:
• 1. The demand rate for the item is constant (for example, always 10 units per day)
and known with certainty.
• 2. No constraints are placed (such as truck capacity or materials handling
limitations) on the size of each lot.
• 3. The only two relevant costs are the inventory holding cost and the fixed cost
per lot for ordering or setup.
• 4. Decisions for one item can be made independently of decisions for other items.
In other words, no advantage is gained in combining several orders going to the
same supplier.
• 5. The lead time is constant (e.g., always 14 days) and known with certainty. The
amount received is exactly what was ordered and it arrives all at once rather than
piecemeal.
11. Inventory Management
• Here are some guidelines on when to use or modify the EOQ.
• Do not use the EOQ
– If you use the “make-to-order” strategy and your customer specifies that the
entire order be delivered in one shipment
– If the order size is constrained by capacity limitations such as the size of the
firm’s ovens, amount of testing equipment, or number of delivery trucks
• Modify the EOQ
– If significant quantity discounts are given for ordering larger lots
– If replenishment of the inventory is not instantaneous, which can happen if the
items must be used or sold as soon as they are finished without waiting until
the entire lot has been completed
• Use the EOQ
– If you follow a “make-to-stock” strategy and the item has relatively stable
demand
– If your carrying costs per unit and setup or ordering costs are known and
relatively stable
