2. We will spend more time talking about the different types of stock
Communication about inventory management within companies and between
companies is a persistent problem, we need a complete vocabulary with precision to
improve the situation.
We often hear of projects to reduce inventory, and many times they are successful.
We rarely hear careful specificity regarding which types of stock were reduced, yet it
has a huge impact on the short-term and long-term implications of the stock reduction.
2
3. For example, some
erroneously believe
that as long as safety
stock is not reduced,
service levels will
remain unchanged.
Generally, this is a
fallacy that is a result
of a narrow view of
service
3
4. IFT
HE
DEFINITION O
F
SERVICE IS THAT
4
SERVICE is the frequency with
which we run out of stock during
the protection period, such as the
lead time, then that is true.
If it is the total amount of demand
fulfilled from inventory, then it is
wrong.
REDUCING cycle stock hurts
service level as we learn later in
the chapter.
5. In managing
inventory, it is
crucial to
communicate
clearly on what
you are talking
about.
TYPES O
F
INVENTORY
5
6. A COUPLE O
F
DIFFERENT
TYPES O
F
REPLENISHMENT
PROCESSES
Regarding service level measures, we begin by
using
(1) protection period in-stock (PPIS) metric and
(2) item-level fill rate (ILFR) metric.
Regarding replenishment processes, we begin
by using (1) the fixed order point, fixed order
quantity (Q,ROP) process, and the fixed order
interval, order up to level (T,OUL) process.
6
12. Protection period is
the interval of time
over which a stockout
is possible.
This may seem odd
since it would appear
that you could stockout
anytime; however, this is
not the case.
12
13. In that process you
order Q when the
inventory position
reaches the ROP.
1 2
If the ROP > 0, it is
not possible to
stockout prior to
reaching the ROP,
by definition.
3
However, you can
stockout after you
reach the ROP.
4
As soon as you hit
the ROP, you place
an order.
13
14. The time between when the order is placed and the order is received
and available for use is the lead time (L).
So, with the (Q,ROP) process the protection period is the lead time.
Now we can define the PPIS metric for the (Q,ROP) process—namely,
the PPIS for the (Q,ROP) process is the probability of a stockout during
the lead time.
14
15. For the (T,OUL) process, you only order when you get to the reorder
times, which are spaced out by T periods of time.
So, suppose you are at one of the reorder times, and you calculate the
difference between the OUL and the inventory and order that quantity.
Then you wait for the lead time to receive the order.
15
16. You cannot order again until you reach the next reorder
time.
Once you place your order, you can stockout anytime
between order times and the lead time.
Hence, for the (T,OUL) replenishment process the protection
period is T + L and the PPIS is the probability of a stockout
during T + L.
16
17. The item-level fill rate (ILFR) is the percentage of
demand fulfilled from on-hand inventory.
If demand is not fulfilled from on-hand inventory, the
demand is either lost (lost sales) or back-ordered.
In either case, that is the demand loss at that time.
So, the total demand loss over a period of time divided by
the total demand over that time is the ILFR.
17
18. Cycle stock is
the amount of
inventory
between
replenishments.
CYCLE STOCK
18
19. The average amount of inventory
between replenishments is (Q+1)/2
for discrete units7 (such as cartons of
ready-to-eat cereal) and Q/2 for
continuous units (such as gallons of
gasoline).
19
20. The average amount of
inventory between
replenishments is T × d / 2,
where d is average demand
per unit of time.
20
21. If a company always orders in
truckload quantities, the average
cycle stock is the truckload
quantity divided by two; if the
company always orders a pallet,
the average cycle stock is the
pallet quantity divided by two.
21
22. Each pallet has 150 cases, and each case
has 6 bottles.
Assume that the stores only order in case
pack quantities from the distribution
center.
Suppose there are 2 distribution centers
and 200 stores.
The number of bottles per pallet is 6 ×
150 = 900 bottles
Average cycle stock per distribution
center is 900 bottles / 2 = 450 bottles.
22
23. Since there are two distribution centers, the average cycle
stock in the distribution centers combined is 900 bottles.
The average cycle stock per store is 6 + 1 bottles / 2 = 3.5
bottles.
Since there are 200 stores we have 200 stores × 3.5 bottles
per store = 700 bottles.
The total cycle stock in the retail network is 700 bottles plus
450 bottles = 1,150 bottles.
23
24. Historical safety stock is
the average amount of
inventory on hand when
the replenishment
arrives and is available
for use.
24
25. 1. The assumed replenishment process in the safety stock
calculation is different from the actual replenishment process,
2. The assumed distribution of demand is different from the
actual distribution, or the demand is nonstationary
3. The actual lead time distribution differs from the lead time
distribution, if it even exists, or
4. Other types of execution errors exist that are not accounted
for in the forward-looking safety stock calculation.
25
26. In-transit stock is inventory that is not being
stored for later use or sale but is en route to
an inventory holding node.
26
27. The most obvious in-transit stock is inventory
that is in a transportation unit, such as on a
Truck
Train
Ship
Airplane.
27
28. For example, if inventory is
held in a truck trailer for sale
directly from the truck trailer, it
is not in-transit stock; the truck
trailer is actually an inventory
holding node.
28
30. 31
We refer to in-transit stock that is being transported as in-
transport stock.
In-transit stock that is being cross docked, staged, picked,
put away, and so on, we refer to as in-non-transport stock.
So, in-transit stock has in-transport and in-non-transport
stock.
32. Having the correct lead
time is important because it
is used to make safety
stock calculations and
determine the correct time
to place orders.
When lead time is not
correct in an automated
replenishment system, it
can result in either excess
inventory or stockouts.
32
33. When ocean carriage is used, the in-transit stock
naturally is much higher than when air carriage is
used.
For ocean carriage, most likely the preponderance of
the lead time is the transit time, whereas in air
carriage, that might not be the situation.
33
34. There are two categories of promotional stock: a
promoted SKU that is continuously in the assortment, and
a promoted SKU that is not carried continuously
34
35. There are many different types of promotions: temporary price
reductions, promotional displays, buy one get one free, bonus
packs, coupons, samplings, signage, extra inventory in the store,
and many others.
Many times these are used in combination with one another.
For example, a temporary price reduction might be coupled with a
promotional display and extra inventory.
35
36. Inventory held for
the purposes of
demonstration or
display is called
demonstration
stock.
DEMONSTRATION
STOCK
37
37. If it cannot be sold, even if out of stock of the item, it is technically
not a part of safety stock
If it can be sold in the case of an out of stock, it really is a part of
safety stock.
In that case, the safety stock is actually higher than the planned
safety stock, and both the ILFR and the PPIS are actually higher
than planned.
Demonstration stock can be viewed as a part of safety stock for
cost and service calculations
38
38. RETAIL B
A
C
K
R
O
O
M
STOCK
Retail backroom stock1 is
inventory located in the
storage or backroom of a
retail store.
Retail backroom stock may
actually be in-transit stock,
safety stock, or cycle stock
or a combination of safety
stock and cycle stock.
38
39. RETAIL
BACKROOM
STOCK
Node C might be a cross dock or it might be a
retail backroom.
If inventory is ordered from Node A and from Node
B, but it travels from Node B through Node C, and
then on to Node A, then Nodes A and B are
inventory holding nodes and Node C is not.
An inventory holding node is a physical location
from which orders are placed and received.
39
40. If inventory from the shelves is not
replenished from the backroom, then the
backroom is not an inventory holding node
but simply a staging area, and, hence, the
inventory is in-transit stock.
If inventory is planned to be held in the
backroom, the retail shelves are replenished
from the backroom, and the backroom is
replenished from the distribution center (DC)
or supplier, the inventory in the backroom is a
combination of cycle stock and safety stock
40
41. If store safety stock is set to shelf capacity, then on average, no units that
arrive to the shelf from an order will fit on the shelf.
Consider a continuous review (Q,ROP) system. If shelf capacity is equal
to ROP + Q,then units will always fit on the shelf when an order arrives.
Shelf space costs must be weighed against labor costs among other
things in setting shelf capacity.
41
43. Replenished retail shelf
stock20 is inventory that is
on the shelf and consists of
both cycle and safety stock
43
44. Seasonal stock is
inventory held for
a portion of the
year; it may be
replenished during
the season or it
may not be.
44
45. Seasonal stock is usually purchased based on a single
order, even if it is replenished.
The news vendor model is an approach to calculating the
order quantity.
If not enough seasonal stock is purchased, sales and profit
are lost.
If too much is purchased, markdowns become necessary,
reducing the ROI.
The news vendor model attempts to balance these costs.
45
46. In many retail stores, certain items are
found in multiple locations.
For example, candy bars are often at
multiple check stands in the grocery
store and also in the candy aisle.
Items can potentially be out of stock at
many locations and still record daily
sales if they are in stock in other
locations within the store.
Keeping all of the locations stocked is a
store execution challenge.
46
47. Many of these items are impulse items,
meaning that people don’t come to the
store planning on purchasing them but
decide to purchase them when they see
them on the shelf.
This inventory may be a combination of
cycle stock and safety stock for the store
as a whole, but in the individual locations,
the inventory can be difficult to plan and
manage well.
Many times the specific locations the
inventory is held in changes over time,
with the exception of where its continual
location is in the main part of the store.
47
48. Raw material stock is inventory held for production. For example, to make bread,
grain must be held.
Running out of stock of raw material inventory can be expensive because it can
cause the entire production line to shut down.
Also, raw material inventory is relatively less expensive than finished goods
inventory,so holding more of it can easily be argued.
48
49. Suppose a bread manufacturer keeps
introducing new types of bread, and
every time a new bread SKU is
introduced, a new specification of
grain is created, to the point that
eventually there are 100 different
grains for 100 different SKUs.
If it would be possible to have 10
grains and still be able to produce
the 100 different SKUs, the total
amount of inventory required could
be greatly reduced.
49
50. Work in process
stock is inventory
in the process of
being transformed
into the finished
product.
W
O
R
KIN
PROCESS STOCK
50
53. It is sometimes built up
between workstations
so that the entire line
doesn’t have to shut
down if one machine
breaks down.
However, when there is
more stock in between
workstations, the
feedback loop between
the workstations is
longer.
53
54. Suppose two people, Lin and Jim, are at different
workstations.
Lin takes a block of wood and drills a hole in it.
Jim places a wooden peg in the hole.
The hole has to be just right.
If the hole is too big, the peg passes clean
through. If the hole is too small, the peg does
not fit.
To reduce inventory, checks must be in place to
make sure the drill press is reliable. Then,
Suppose that Lin’s drill press is unreliable, but he
drills a lot of blocks and produces 20 days of
supply
54
55. Just-in-time (JIT) came to the United States through the
change in perception of Japanese products being sold here.
The reputation of Japanese and Chinese goods transformed
from one of low quality in terms of product failures or
breakdowns in the late 1960s and early 1970s to one of high
quality in the late 1970s and early 1980s.
55
56. SPARE PARTS STOCK
Spare parts stock is inventory of
components that go into finished products
Spare parts are used for maintenance and
for repair.
Maintenance is usually scheduled way in
advance, so planning for spare parts
inventory is more like planning a project.
56
57. The project is the maintenance, and the spare
parts have to be there when the maintenance
is going to occur.
However, the need for spare parts for use in
repair is not planned but in some cases can
be forecast.
Some laws exist that state that spare parts
must be maintained for a certain number of
years after a product is discontinued.
59
58. THERE ARE TWO
SALIENT
CATEGORIES OF
ORDERING
COSTS
60
Namely, variable
ordering costs and fixed
ordering costs.
Variable ordering costs
are a cost per unit,
whereas fixed ordering
costs are a cost per
order.
