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ch11.pptSCM 304 Principles of Supply Chain Management
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved
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Managing Inventory throughout the Supply Chain
Chapter 11
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You will learn
Describe the various roles of inventory, including the different types of inventory and inventory drivers.
Distinguish between independent demand and dependent demand inventory.
Calculate the restocking level for a periodic review system.
Calculate the economic order quantity (EOQ) and reorder point (ROP) for a continuous review system.
Inventory Management
Inventory – Those stocks or items used to support production (raw materials and work-in-process items), supporting activities (maintenance, repair, and operating supplies) and customer service (finished goods and spare parts).
© 2016 APICS Dictionary
Source:123rf.com
The Role of Inventory
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At retail stores, customers can buy a laptop off the shelf, or they can order one to be customized and shipped directly to them.
Both WolfByte and the retail stores keep spare parts on hand to handle customers’ warranty claims and other service requirements.
Inventory Types
Cycle stock
Safety stock
Anticipation inventory
Hedge inventory
Transportation inventory
Smoothing inventory
Types of Inventory (1 of 6)
Cycle stock – Components or products that are received in bulk by a downstream partner, gradually used up, and then replenished again in bulk by an upstream partner.
Supplier 3 ships 20,000 keyboards at a time to WolfByte. Of course, WolfByte can’t use all those components at once. More likely, workers pull them out of inventory as needed. Eventually, the inventory runs down, and WolfByte places another order for keyboards. When the new order arrives, the inventory level rises and the cycle is repeated.
Types of Inventory (2 of 6)
Safety stock – Extra inventory that a company holds to protect itself against uncertainties in either demand or replenishment time.
What if Supplier 3 is late in delivering the devices? What if demand makes inventory levels fall faster than expected? If either or both these conditions occur, WolfByte could run out of keyboards before the next order arrives.
Extra inventory, or safety stock helps in this situation.
Types of Inventory (3 of 6)
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Companies do not plan on using their safety stock any more than you plan on using a fire extinguisher; it is there just in case!
Types of Inventory (4 of 6)
Anticipation inventory – Inventory that is held in anticipation of customer demand.
Hedge inventory – A form of inventory buildup to buffer against some event that may not happen.
© 2016 APICS Dictionary
In this sense, hedge inventories can be thought of as a special form of safety stock.
WolfByte has stockpiled a hedge inventory of two months’ worth of hard drives because managers have heard that Supplier 2 may experience a temporary shutdown over the next two months.
Types of Inventory (5 of 6)
Transportation inventory – Inventory that is moving from one link in the supply chain to another.
When the physical distance between supply chain partners is long, transportation inventory can represent a considerable investment.
Suppose, for example, that Supplier 2 is located in South Korea, and WolfByte is located in Texas. Hard drives may take several weeks to travel the entire distance between the two companies.
Types of Inventory (6 of 6)
Smoothing inventory – Inventory that is used to smooth out differences between upstream production levels and downstream demand.
WolfByte’s managers may decide to produce a constant 3,000 laptops per day, building up finished goods inventory during periods of slow demand and drawing it down during periods of high demand.
Inventory Drivers (1 of 5)
Inventory ties up space and capital:
The space used to store inventory can often be put to more productive use.
A dollar invested in inventory is a dollar that cannot be used somewhere else.
Inventory poses a significant risk of obsolescence, particularly in supply chains with short product life cycles.
Inventory is often used to hide problems that management really should resolve.
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Inventory Drivers (2 of 5)
Inventory drivers – Business conditions that force companies to hold inventory.
Table 11.2 summarizes the ways in which various inventory drivers affect different types of inventory.
Inventory Drivers (3 of 5)
To the extent that organizations can manage and control the drivers of inventories, they can reduce the supply chain’s need for inventory.
Uncertainty:
Supply Uncertainty
Demand Uncertainty
Inventory Drivers (4 of 5)
Supply Uncertainty – The risk of interruptions in the flow of components from upstream suppliers.
Assessing supply uncertainty:
How consistent is the quality of the goods being purchased?
How reliable are the supplier’s delivery estimates?
Are the goods subject to unexpected price increases or shortages?
Forcing an organization to hold safety stock or hedging inventories
Inventory Drivers (5 of 5)
Demand uncertainty - The risk of significant and unpredictable fluctuations in downstream demand.
In dealing with uncertainty in supply and demand, the trick is to determine what types of uncertainty can be reduced and then to focus on reducing them.
Poor quality
Forecasting to reduce demand uncertainty
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Independent vs. Dependent Demand Inventory (1 of 2)
Independent demand inventory – Inventory items whose demand levels are beyond a company’s complete control.
Dependent demand inventory – Inventory items whose demand levels are tied directly to a company’s planned production of another item.
Independent vs. Dependent Demand Inventory (2 of 2)
Example:
Independent demand:
Kitchen table – Need 500 tables five weeks from now
Dependent demand:
Kitchen table legs – Need 4 per table or 2,000 legs
Calculation of dependent demand (Chapter 12)
Periodic Review System (1 of 4)
One of the simplest approaches to managing independent demand inventory:
Periodic Review System – An inventory system where the inventory level for an item is checked at regular intervals and restocked to some predetermined level.
Periodic Review System (2 of 4)
Order quantity (Q) = The amount required to bring the inventory level back up to R.
Q = R − I
where
Q = order quantity
R = restocking level
I = inventory level at the time of review.
Figure 11.6 Periodic Review System
Periodic Review System (3 of 4)
Restocking Level (R)
where:
μRP+L = average demand during the reorder period and the order lead time
σRP+L = standard deviation of demand during the reorder period and the order lead time
z = number of standard deviations above the average demand (higher z values increase the restocking level, thereby lowering the probability of a stockout)
Periodic Review System (4 of 4)
Service Level – percentage of the time inventory levels will be high enough to meet demand during the reorder period under conditions of demand and supply uncertainty.
Assumes that the demand during the reorder period and the order lead time is normally distributed.
| z Value | Resulting Service Level |
| 1.28 | 90% |
| 1.65 | 95% |
| 2.33 | 99% |
| 3.08 | 99.9% |
Example 11.1 – McCreery’s Chips
Continuous Review System (1 of 14)
Continuous Review System – An inventory system used to manage independent demand inventory where the inventory level for an item is constantly monitored and when the reorder point is reached, an order is released.
Continuous Review System (2 of 14)
Key features:
Inventory levels are monitored constantly, and a replenishment order is issued only when a preestablished reorder point has been reached.
The size of a replenishment order is typically based on the trade-off between holding costs and ordering costs.
The reorder point is based on both demand and supply considerations, as well as on how much safety stock managers want to hold.
Continuous Review System (3 of 14)
Assumptions:
The inventory item we are interested in has a constant demand per period (d). That is, there is no variability in demand from one period to the next. Demand for the year is D.
L is the lead time, or number of periods that must pass before a replenishment order arrives. L is also constant.
Continuous Review System (4 of 14)
Assumptions:
H is the cost of holding a single unit in inventory for a year. It includes the cost of the space needed to store the unit, the cost of potential obsolescence, and the opportunity cost of tying up the organization’s funds in inventory. H is known and fixed.
S is the cost of placing an order, regardless of the order quantity. S is also known and fixed.
P, the price of each unit, is fixed.
Continuous Review System (5 of 14)
Figure 11.7 Continuous Review System (with Constant Demand Rate d, order quantity Q)
What should the reorder point (ROP) be?
Inventory level in this model goes from Q to 0 over and over again, the average inventory level is:
Continuous Review System (6 of 14)
Total holding and ordering costs for the year
= total yearly holding cost + total yearly ordering cost =
Continuous Review System (7 of 14)
There is a trade-off between yearly holding costs and ordering costs.
Reducing the order quantity, Q, will decrease holding costs, but force the organization to order more often.
Conversely, increasing Q will reduce the number of times an order must be placed but result in higher average inventory levels.
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Continuous Review System (8 of 14)
Figure 11.9 The Relationships among Yearly Holding Costs, Yearly Ordering Costs, and the Order Quantity (Q)
How to choose the order quantity (Q)?
Is there a “best” order quantity, and if so, how do holding costs (H) and ordering costs (S) affect it?
Continuous Review System (9 of 14)
Economic Order Quantity (EOQ) – The order quantity that minimizes annual holding and ordering costs for an item.
where:
Q = order quantity
H = annual holding cost per unit
D = annual demand
S = ordering cost
Example 11.2 – Boyer’s Dept Store
Continuous Review System (10 of 14)
The EOQ tells managers how much to order but not when to order.
Reorder Point (ROP)
When demand rate (d) and lead time (L) are constant:
ROP = dL
When demand rate (d) and lead time (L) or both varies:
where:
SS = safety stock
= average demand rate
= average lead time
Continuous Review System (11 of 14)
Figure 11.10 The Impact of Varying Demand Rates and Lead Times
Continuous Review System (12 of 14)
The decision of how much safety stock to hold depends on five factors:
The variability of demand
The variability of lead time
The average length of lead time
The desired service level
The average demand
Continuous Review System (13 of 14)
Safety Stock (SS) =
Continuous Review System (14 of 14)
Reorder Point (ROP) =
Example 11.3 – Boyer’s Dept Store (1 of 3)
Example 11.3 – Boyer’s Dept Store (2 of 3)
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Example 11.3 – Boyer’s Dept Store (3 of 3)
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Single-Period Inventory Systems (1 of 6)
Assumed so far: any excess inventory we order can be held for future use. This is not always true!
In some situations, excess inventory has a very limited life and must be discarded, sold at a loss, or even hauled away at additional cost if not sold in the period intended.
Examples include fresh fish, magazines and newspapers, and Christmas tree
Single-Period Inventory Systems (2 of 6)
When excess inventory cannot be held in the future, firms must weigh the cost of being short against the cost of holding excess units.
The following costs are calculated:
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For example, say that an item that costs $50 sells for $200, but must be disposed of at a cost of $5 if not sold. This item has the following shortage and excess costs:
Single-Period Inventory Systems (3 of 6)
Single-period inventory system – A system used when demand occurs in only a single point in time.
Goal: to establish a stocking level that strikes the best balance between expected shortage costs and expected excess costs.
Two-step process:
Determine a target service level (SLT) that strikes the best balance between shortage costs and excess costs.
Use the target service level to determine the target stocking point (TS) for the item.
Single-Period Inventory Systems (4 of 6)
Target service level:
The probability that there are enough units to meet demand.
The service level at which the expected cost of a shortage equals the expected cost of having excess units.
Unlike a periodic and continuous review system, there is no reorder period to consider here—either there is enough inventory or there isn’t.
Single-Period Inventory Systems (5 of 6)
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Single-Period Inventory Systems (6 of 6)
Target stocking point:
The stocking point at which the expected cost of a shortage equals the expected cost of having excess units.
To complete the development of a single-period inventory system, we next translate the target service level (a probability) into a target stocking point.
To do so, we have to know something about how demand is distributed:
Approximate the demand distribution from historical records
Use theoretical distribution, such as the normal distribution or Poisson distribution.
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