Chapter 9: Inventory Management Flashcards
Inventory management
The planning and controlling of inventories to meet the competitive priorities of the organization
Lot sizing
A main part of inventory management
The determination of how frequently and in what quantity to order inventory
Lot size
The quantity of an inventory item that management either buys from a supplier or manufactures via internal processes
Level of inventory is determined by
Difference between input flow rate and output flow rate (latter both to customers and to scrap)
Pressures that incentivize small inventories
- cost of capital
- storage and holding costs
- taxes, insurance, and shrinkage
Inventory holding cost
Aka inventory carrying cost
Cost of capital for inventory + variable cost of keeping items on hand (storage, handling, taxes etc…)
Generally stated as % of inventory value
Cost of capital (for inventory)
Opportunity cost of investing in inventory relative to the expected return on assets of similar risk
Generally weighted average cost of capital
Usually the largest component of inventory holding cost
Storage and handling Inventory holding costs
Incurred when a firm could use the storage space and labor productively in some other way
Forms of shrinkage
Pilferage
Obsolescence
Deterioration
If these rates are high a large inventory may be unwise
Pressures that incentivize holding large inventories
- customer service
- ordering cost
- setup cost
- labor and equipment utilization
- transportation cost
- payments to suppliers
Ordering cost
The cost of preparing a purchase order for a supplier or production order for manufacturing
Same regardless of order size so cost efficient to do large orders
Technologies may reduce these costs
Setup cost
Cost involved in changing over a machine or workspace to produce a different item
Again, incentivizes larger production runs for fewer changeovers
Technologies may increase flexibility and lower setup costs
How can holding large inventory increase labor productivity and facility utilization?
- fewer number of set ups (which decrease overall utilization)
- reduced cost of rescheduling production due to lack of inventory
- stabilizes output rate for cyclical or seasonal items
Quantity discount
Drop in price per unit when order is sufficiently large
What relationship does inventory have with working capital?
Because inventory is financed by working capital, increasing inventory increases the need for working capital
Accounting inventory categories
Raw materials (RM)
Work-in-process (WIP)
Finished goods (FG)
Independent demand items
Items for which demand is influenced by market conditions and is not related to the inventory decisions for any other item held in stock or produced
Finished goods
(Wholesale and retail merchandise, service support inventory, product and replacement part distribution, maintenance repair and operating supplies
MRO supplies
Maintenance, repair, and operating supplies
Items that do not become part of the final service or product
Estimating demand for independent demand items
Forecasting
Dependent demand items
Items whose required quantity varies with the production of other items held in the firms inventory. (Are required as components)
Raw materials
Work in process
Demand is calculated, not forecasted
Operational inventory categories
Cycle
Safety stock
Anticipation
Pipeline
Identified conceptually, not physically
Cycle inventory
The portion of total inventory that varies directly with lot size
Given:
- lot size varies directly with elapsed time between orders
- the longer between orders the larger the cycle inventory must be
Inventory at it’s highest at the beginning of the interval (when new lot arrives) and lowest at the end (just before new lot arrives)
Calculating average cycle inventory
= cycle inventory maximum / 2
(Because minimum is approximately 0 just before new lot arrives)
Formula only exact when demand is constant and uniform
Scrap losses may cause estimating errors
Safety stock inventory
Surplus inventory that a company holds to protect against uncertainties in demand, lead time, and supply changes
Anticipation inventlry
Inventory used to absorb uneven rates of demand or supply
Often used when there are predictable, seasonal demand patterns (stockpiling during low demand to be ready for high demand)
Pipeline inventory
Inventory that is created when an order for an item is issued but not yet received
Because firm needs enough inventory on hand plus in transit to cover lead times for the order
Longer lead times or higher demand create more pipeline inventory
Average pipeline inventory between two stocking points
= average demand during lead time = average demand for the item per period * number of periods in the items lead item (time to move between two points)
Note: d (demand) and L (lead time) may not be constant, especially if lot size changes (changes lead time)
Primary inventory reduction lever
Tactic that must be used if inventory is to be reduced
Secondary inventory reduction lever
A tactic that reduces the penalty cost of applying the primary lever and the need for having inventory in the first place
Inventory reduction tactics: cycle inventory
Primary: reduce lot sizes of items moving in the supply chain (may increase set up costs or ordering costs)
Secondary (to manage setup and ordering costs)
- streamline ordering method
- increasing repeatability to eliminate need for changeovers
Repeatability and how to increase it
The degree to which the same work can be done again
Increases via: high product demand, use of specialization, devoting resources exclusive to a product, using same parts in many products, use of flexible automation, use of one-worker multiple-machines set up, via group technology
Results of increased repeatability
May justify new set up methods, reduced transportation costs, allow for quantity discounts
Inventory reduction tactics: safety stock inventory
Primary: place orders closer to time needed (problem if there are any uncertainties)
Secondary levers to address uncertainties:
- improve demand forecasts
- cut lead times of purchased or produced items (local suppliers)
- reduce supply uncertainties (fuller collaboration with suppliers, reduce scrap/rework, preventive maintenance)
- increase reliance on equipment and labor buffers (capacity cushions and cross-trained workers)
Inventory reduction tactics: anticipation inventory
Primary lever: matching demand and production.
Secondary levers to even out customer demand:
- add new products with different demand cycles
- provide off season promotional campaigns
- offer seasonal pricing plans
Inventory reduction tactics: pipeline inventory
Primary lever: reduce lead time
Secondary levers to help cut lead time:
- source from more responsive suppliers and reliable carriers, improve information sharing
- change Q (lot size) when lead time is dependent on lot size
Questions for each item of inventory
1) what degree of control should be imposed?
2) how much to order?
3) when to order?
ABC analysis
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
Class A = highest dollar value, requires close control
Class B = mid range dollar usage, moderate control
Class C = lowest dollar usage, only loose control necessary
Determining SKU Dollar usage
Annual demand rate x cost of SKU = dollar usage
Finding classes for ABC analysis
Plot all SKUs on a chart and look for natural changes in the slope. Dividing lines between classes are inexact
Inventory treatment of class A skus
Review frequently - need to maintain high turnover so lot size should be reduced if possible
Inventory treatment of class B skus
Safety stocks can help provide cost effective coverage