5- Inventory Management

Question 1

x5 types of Inventory:

In order of Costs ?

Why do costs increase in this order?

Answer 1

Raw Materials: purchased items or extracted materials transformed into components or products

Components: parts or subassemblies used in final product

Work In Progress: items in process throughout the operation

Finished Goods: Products ready to be Sold to customers

Distribution Inventory: finished goods in the distribution system

Because the production process / supply chain adds value to the input resources at each step, and more valuable inventory is more costly to manage

Question 2

Reasons to hold inventory [x4]

Answer 2

Safety: demand & supply can be unpredictable (uncertainty)

Inflexibility: Counteract inflexibility of capacity management . Bakers who produce bread can do only one type at a time, thus other types must be in inventory

Unanticipated opportunities: supply can also be unpredictable [eg: Covid] or Cost advantages (e.g. supplier price discounts)

Anticipate future demands: Christmas chocolate is produced around the year, so capacity will not be constrained at the end of the year

Question 3

Reason to hold customer queues? x3

Answer 3

Avoid customer shortages and maximise capacity utilisation - eg: fastfood more busy around lunchtime

Enable prioritisation of certain customers over others
EG: Prioritisation: hospitals, nightclubs

Give customers time to choose (this makes serving them more efficient)

Question 4

Explain Make-to-Stock operation?

Give an example?

What does this separate?

Answer 4

Make to stock: customer is served from finished goods inventory; decoupling from customer from manufacturing process. The manufacturer never sees a customer order and inventory acts as a buffer.

A standard retail inventory in a supermarket (make-to-stock) separates the customer from the manufacturer/supplier and allows the supply chain to serve the customer efficiently without disruption to the manufacturing process

Question 5

Explain a Make-to-Order operation?
What type of inventory does it not have?

Give an example?

Answer 5

A make-to-order operation such as an airplane manufacturer does not have a finished goods inventory and thus will place the customer order decoupling point earlier in the supply chain, requiring investments in components and WIP inventory

Question 6

Benfits of Inventory Management? [5]

Answer 6

Isolates processes in the supply chain

Buffers against variations in production or demand

Allows flexiblity in scheduling

Economies of scale

Safeguard against supplier uncertainty

Domain Specific reasons [?]

Question 7

Drawbacks of Inventory Management? 5

Answer 7

Incurs Storage, admin, and insurance costs

Ties in capital that could be used for other purposes

Can be damaged or deteriotate

Oppotunity cost of storage space

Against lean philosophy

Question 8

Equation to calculate total inventory cost?

Explain each Letter meaning?

Answer 8

=𝐷𝐶+𝐷/𝑄 𝑆+𝑄/2 𝐻

D = annual average demand
C = unit cost (value) of item
Q = inventory order size (# of items)
S = unit order cost (per batch)
H = annual holding cost per item

Question 9

What are the assumptions of inventory costs and EOQ calculations?

x7

Answer 9

Assumptions:

Demand is known & constant 
No safety stock is required
Lead time is known & constant
No quantity discounts are available
Ordering (or setup) costs are constant
All demand is satisfied (no shortages)
The order quantity arrives in a single batch

Question 10

What does EOQ mean?

How is it Calculated?

Answer 10

Economic Order Quantity:
EOQ is the economical order size that balances order costs and holding costs and minimises total inventory cost

𝑄^∗=√(2𝑆𝐷/𝐻)

D = annual average demand
C = unit cost (value) of item
Q = inventory order size (# of items)
S = unit order cost (per batch)
H = annual holding cost per item

Question 11

What are 2 benefits of continous review?
What is a drawback?

What might be a better policy and what does it entail?

Answer 11

Continuous review may be costly as inventory must be monitored all the time, but it balances holding and ordering costs and avoids stockouts

Periodic review may be suboptimal as EOQ is not used and stockouts may occur, rather the order size is calculated so as to bring the stock to a predetermined level

Question 12

What is the Pareto Law of inventory?

Answer 12

A rule of thumb found by Italian economist Vilfredo Pareto

Approximately 20% of inventory generates 80% of profits or revenue

Question 13

How do you calculate usage value?

Answer 13

Usage value = usage rate * item value

Therefore the time may have a low value but high usage value if usage rate is high

Question 14

Explain classes A, B and C?

Answer 14

Class A
Those 20% of items that bring 80% of the revenues
Monitor and optimize, use continuous review to avoid stockouts

Class B
Those 30 % of items that bring 10 % of the revenues
Devote some effort to control, use periodic review

Class C
Those 50 % of items that bring 10 % of revenues
Review only occasionally, as stockouts are not damaging

Question 15

What is the trend with Inventories?

What is the change with median inventory?
What is the average inventory change per year? [%]
What is the change with WIP inventories?
What is the change with finished-good inventories?

Answer 15

Between 1981 and 2000…
Median inventory holding days down from 96 to 81
Average rate of inventory reduction 2% per year
WIP declined 6% per year
Finished-goods inventories did not decline

Question 16

Firms with slightly lower than average inventories have?

Firms with the lowest inventories have?

A firm that deals efficiently with its suppliers will have ?

A firm that has efficient internal operations will have ?

A firm that produces based on forecasting may have ?

Answer 16

Firms with slightly lower than average inventories have good stock returns
Firms with the lowest inventories have only ordinary returns.

A firm that deals efficiently with its suppliers will have low raw-materials inventories.
A firm that has efficient internal operations will have low work-in-process inventory.
It appears that firms’ inventory holdings in raw materials and work in process seem to have generally improved significantly over time.

A firm that produces based on forecasting may have higher finished-goods inventory in order to have a higher service level (based on the goods availability). But the firm may have its finished-goods inventory reduced with better forecasting through better supply chain coordination such as vendor-managed inventory. Neither of these contradictory predictions can be shown to have a dominant effect.