Week 2: Inventory Management and Risk Pooling

Question 1

Name toe four types of inventory?

Answer 1

1. Raw materials (inputs received from vendors)
2. Work-in-progress (transformations, conversion during processes)
3. Finished goods inventory (transformation is done, ready to be shipped)
4. Warehouse inventory (outputs ready to be shipped to customers)

Question 2

Name four reasons to hold inventory?

Answer 2

1. Hedge against uncertainty in supply chain and demand
2. Make use of economies of scale
3. Hedge against lead time
4. Capacity limitations

Question 3

What are the 7 components of the inventory cost structure?

Answer 3

1. Order cost (product and transportation cost)
2. Holding costs (capital tied up and physical cost: warehouse space, storage tax etc.)
3. Component devaluation cost (life cycle dependent)
4. Price protection cost (supply contract dependent)
5. Product return cost (also incur operational cost)
6. Obsolescence costs (FG inventory + components in pipeline + probable discount/marketing)
7. Out-of-stock cost (difficult to estimate)

Question 4

Name the three elements of inventory control policies?

Answer 4

1. Decisions
2. Objective
3. Service level

Question 5

What decisions are part of inventory control policies?

Answer 5

• How often should inventory status be checked
• When to place a replenishment order
• How large should order size be

Question 6

What is the objective of inventory control policies?

Answer 6

minimize total inventory costs while meeting a certain service level

Question 7

What are the two components of service levels in inventory control policies?

Answer 7

• Cycle service level (P1): fraction of replenishment cycles with no stock out
• Fill rate (P2): faction of demand satisfied from stock on hand

Question 8

Why is risk pooling important?

Answer 8

Products with high profit margin tend to have highly variable demand, which increases risk

Question 9

How can companies reduce variability in demand and thus pool risk?

Answer 9

 Reduce demand variability by aggregating demand across locations. This increases the likelihood that high demand from one customer/location will be offset by low demand from another.

Question 10

What is the consequence of aggregating demand over multiple locations?

Answer 10

Reduction in variability allows a decrease in safety stock and thus reduces average inventory. This reduces total inventory costs

Question 11

What are the two disadvantages of risk pooling?

Answer 11

• Increase in response time to customer order
• Increase in transportation cost

Question 12

Name two critical points in risk pooling?

Answer 12

• The higher the coefficient of variation, the greater the benefit from risk pooling
  1. Higher variability increases safety stock kept by warehouses. Variability of demand aggegated by single warehouse is lower.
• Benefits from risk pooling depend on behavior of demand from one market relative to demand from another
  1. Risk pooling benefits are higher in situations where demand observed at warehouses are negatively correlated.