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Chapter 8

Quantity and Inventory

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Key Questions Addressed in Chapter 8

How much to acquire?

When to acquire?

How to manage inventory effectively?

Factors Complicating Quantity Decisions

Forecasts

Purchase decisions made a long time before actual requirements are known

Rely on forecasts of future demand, lead times, prices, and other costs

Forecasts are rarely, if ever, perfect

Costs

Costs associated with placing orders, holding inventory, running out of materials, and having a service unavailable when needed

Factors Complicating Quantity Decisions (cont’d)

Availability

Desired quantities may be unavailable without paying a higher price or delivery charge

Price-Volume Relationship

Reduced prices for larger quantities versus carrying costs

Shortages

May cause serious disruptions

Time-Based Strategies

Reduce setup and cycle times

reduce costs

reduce lead times

Coordinate the flow of resources

eliminate process/system waste

ensure on-time or just-in-time arrival in economical sized batches

Forecasting Dilemmas

Where should responsibility for forecasting future usage lie?

Should the supply management group be allowed to second-guess sales, production, or user forecasts?

Should other supply chain members be involved in a collaborative forecasting effort?

Forecasting Techniques: Quantitative

Use past data to predict the future

Causal models

Identify leading indicators

Chosen indicators believed to cause changes

Develop linear or multiple regression models

Time series forecasting

Assumes sales follow a repetitive pattern over time

Identify the pattern and develop a forecast

Forecasting Techniques: Qualitative

Gather opinions and use with judgment to forecast

The Delphi technique: a formal approach

Lack the rigor of quantitative techniques, but are not necessarily any less accurate

Knowledgeable people with intimate market knowledge have a “feel” that is hard to define but that gives good forecasting results

Collaborative Planning, Forecasting, and Replenishment (CPRF)

Links sales and marketing processes to supply chain planning and execution processes among trading partners to:

improve forecasts and service

reduce cost

develop effective replenishment plans

increase product availability

increase sales

reduce inventories

deliver higher service levels

Types of Demand

Dependent or derived demand:

item is part of a larger component or product, and its use is dependent on the production schedule for the larger component

Independent demand:

Not driven by a production schedule

Usage is determined directly by customer orders, independent of production scheduling decisions

Trade-offs

When determining lot sizes in which to make or buy cycle inventories:

the costs of carrying extra inventory

versus

the costs of purchasing or making more frequently

Objective: minimize total costs

Fixed Order Quantity System

Event triggered: Initiates order when stock depleted to a specific level (reorder point)

Inventory replaced in fixed amounts

Economic order quantities

Economic Order Quantity Model

where:

R = annual demand

S = set-up or order cost per order

C = delivered purchase cost

K = carrying cost percentage

therefore:

KC = unit holding cost

Economic Order Quantity Model

Annual Cost ($)

ordering costs

carrying costs

EOQ Order Size

Total carrying and order cost

CTmin

Fixed Order Quantity System

lead time (L)

ROP

cycle

stock

TIME

ROP = L × d

Safety Stock

Held because of uncertainty in supply and/or demand

Trade-off: cost of stocking out versus cost of holding inventory

Levels can be calculated using statistical techniques

e.g., take into account standard deviation of demand

Fixed Order Quantity System: Cycle Stock, Safety Stock and Lead Time

ROP

cycle

stock

(Q)

INVENTORY

TIME

Safety

Stock

lead time (L)

Fixed Time Period Systems

Inventory on-hand counted at specific time intervals and replenished to a desired level

The passage of time triggers reorder

Fixed Time Period System: Cycle Stock, Safety Stock and Lead Time

INVENTORY

TIME

Safety

Stock

review

period

lead

time

Which System is Better?

Fixed order quantity system

Higher maintenance costs

Every transaction logged

Inventory controlled precisely

Fixed time period

Minimal record keeping

Higher average inventories to protect against stock-outs

Higher stock-out rates

Different order quantities for each cycle

Ability to batch orders with suppliers

Materials Requirement Planning (MRP)

Designed for “push” or forecast-driven systems

Based on a master production schedule:

Creates schedules identifying the specific parts and materials required to produce end items

Determines exact numbers needed

Determines the dates when orders for those materials should be released, based on lead times

“Get the right materials

to the right place at the right time.”

Key Inputs to MRP

Master production schedule:

when do we need it

Bill of material (BOM):

what do we need to make one end product

Inventory record:

what do we have and what do we need

Four Basic MRP Lot Sizing Rules

Lot-for-lot (L4L)

Economic order quantity (EOQ)

Least-total-cost (LTC)

Least-unit-cost (LUC)

MRP Implications for Supply

Accurate records for quantities, lead times, bills of material, and specifications

Accurate control of inventory data

Cooperation from suppliers for on-time delivery, proper quantities and batch sizes, exacting quality (zero defects)

May need to re-evaluate existing contracts

Long-term planning horizon

Less “slack” in the system

Capacity Requirements Planning (CRP)

Capacity = amount of work in a set amount of time

CRP translates MRP material plan into

required human and machine resources by workstation and time bucket

compares required resources to availability

if insufficient capacity, either capacity or the master production schedule is adjusted

feedback loop to the master production schedule; closed-loop MRP

Demand Driven MRP

Driven by customer demand and supply chain modeling

Five key components:

strategic inventory positioning

buffer profile and levels

dynamic adjustments

demand driven planning

visible collaborative execution

Enterprise Resource Planning (ERP)

Software that integrates business systems and processes to combine and analyze information

Links customer orders through fulfillment processes

Requires:

highly accurate information, abandoning rules of thumb, and using common data

Opportunities:

reduced inventory levels, higher service coverage, ready access to high-quality information, ability to replan quickly in response to unforeseen problems

https://www.youtube.com/watch?v=dHIupKajJgM

Inventories Exist to Serve Several Potential Purposes

To provide and maintain good customer service.

To smooth the flow of goods through the production process

To provide protection against the uncertainties of supply and demand

To obtain a reasonable utilization of people and equipment

Forms and Functions of Inventory

Functions of Inventories

Transit or pipeline inventories

Cycle inventories

Buffer or uncertainty inventories or safety stock

Anticipation or certainty inventories

Decoupling inventories

Forms of Inventories

Raw materials, purchased parts and packaging

Work-in-process (WIP)

Finished goods

MRO items

Resale items

Inventory: Types, Functions, Objectives

TYPE

FUNCTION

It takes time to move products (transit time, handling time, delays)

Demand pattern does not equal supply pattern (goods produced in lot sizes)

Demand pattern varies. Customer service levels must be maintained.

Variations in demand relative to productive capacity or significant cost advantages to holding supply in anticipation of demand

Distribution and production efficiency gained from independence between stages of production and distribution

OBJECTIVE

Balance in-transit inventory costs against cost of reducing delays

Balance cost of ordering (or setup) and cost of carrying inventory

Balance cost of carrying extra inventory against cost of stocking out

Balance inventory costs against production costs, transportation costs, purchase discounts, and costs of avoiding price changes

Balance efficiency of production - distribution activities against costs

Transit or Pipeline

Cycle

Buffer or Safety

Anticipation

Decoupling

Examples of Inventory Functions

Inventory Forms and Functions

FUNCTION

Transit

Cycle

Buffer

Anticipation

Decoupling

WHY

move speed/distance

make/use batch

cope with variability

smooth peak demand

reduce dependence

OPPORTUNITY

make moves faster/shorter

reduce onetime batch costs

reduce set up time

reduce variability

increase volume flexibility

coordinate/schedule

Annual Inventory Carrying Cost

Basic elements are:

capital costs

inventory service costs

storage space costs

inventory risk costs

Annual Inventory Carrying Cost

(carrying cost per year) = (average inventory value) x (inventory carrying cost as a % of inventory value)

Average inventory value = (average inventory in units) x (material unit cost)

CC = Q/2 x C x I, where

CC = carrying cost per year

Q = order or delivery quantity in units

C = delivered unit cost of the material

I = inventory carrying cost as % of inventory value

Inventory Costs

Ordering or purchase costs:

managerial, clerical, material, telephone, mailing, email, accounting, transportation, inspection, and receiving costs associated with a purchase or production order

Setup costs:

all the purchaser and supplier’s costs of setting up a production run, including early spoilage and low production output until standard rates are achieved, setup, employees’ wages and other costs, machine downtime, extra tool wear, parts (and equipment) damaged during setup

Inventory Costs

Stockout costs:

Costs of not having the required parts or materials on hand when and where needed

Includes lost contribution on present and future lost sales, changeover costs, substitution, rescheduling and expediting, labor and machine idle time, lost customer and user goodwill, penalties

Variations in delivered costs:

Costs associated with purchasing in quantities or at times when prices or delivery costs are higher than at other quantities or times

ABC Classification of Purchases

Class	Percentage of Total Items Purchased	Percentage of Total Purchase Dollars
A	10	70-80
B	10-20	10-15
C	70-80	10-20

Example of ABC Analysis

Number of Items	Percentage of Items	Annual Purchase Value	Percentage Annual Purchase Volume	Class
1,095	10.0%	$21,600,000	71.1%	A
2,168	19.9	5,900,000	19.4	B
7,660	70.1	2,900,000	9.5	C
10,923	100%	$30,400,000	100%

ABC Classification of Inventory

Vendor- or Supplier-Managed Inventory (VMI/SMI)

Also called systems contracting or stockless buying

Merges ordering and inventory functions

Relies on periodic billing procedures

Nonpurchasing personnel issue order releases

Employs special catalogs

Requires suppliers to maintain minimum inventory

Normally does not specify volume

Improves inventory turnover rates

Lean Supply

A management philosophy focused on creating value for the customer while eliminating waste or nonvalue-adding activities:

Overproduction

Waiting, time in queue

Transportation

Nonvalue-adding processes

Inventory

Motion

Costs of quality: scrap, rework, and inspection

Just-in-Time (JIT)

Providing the exact quantity needed at the precise moment it is required

Requires capabilities of:

short production lead times

economical small batch production

flexible resources (labor, material and equipment)

exacting quality

Just-in-Time (JIT) (cont’d)

JIT production systems strive to eliminate waste

inefficient set-up procedures, inventories

focus on all aspects of the production system: human resources, supply, technology, and inventories

Nothing will be produced until it is needed

when a unit is sold, the system pulls a replacement unit from the last position in the system

this process continues throughout the system

Kanban

Kanban is Japanese for “signboard”

A number of visual methods can be used

Use of kanban cards

“Pull” system based on orders from downstream customers

Most useful for high-volume parts used on a regular basis

JIT Imposed Supplier Activities

Frequent deliveries

Small lot sizes

Exacting quality

Long-term relationships/contracts

Reduced number of suppliers

JIT Implications for Supply

Reduction in number of suppliers

Reduction in supplier lead time

Improvement in supplier quality

Improvement in supplier delivery

Increased inventory turnover

Inventory reduction in total dollars

Managing Supply Chain Inventories

Impacts customer service, working capital, profitability

What inventory and where in the supply chain

IT for compatibility and to manage information flows

Operational design of physical flow of goods/services--production and fulfillment, lead times, quality, lot sizes

Confidentiality issues

Share actual consumer demand with suppliers for production planning, to avoid bullwhip effect, reduce costs

Determining Quantity of Services

Forecasting aggregate demand for services often more unreliable than for goods

Multiple contacts: users, specifiers, order placers, and supplier relationship managers

Multiple contracts at varying prices and terms with the same supplier

Organization-wide consumption management is challenging

Difficult for suppliers to determine capacity requirements and project utilization rates

Dimensions of Services

Degree of tangibility

Direction of the service

Production of the service

Nature of demand

Degree of standardized

Skills required

EOQ

TYPE EXAMPLE

Transit or

Pipeline

 parts on trains, forklifts, etc.

 paper forms being moved between departments

Cycle

 a retail store that orders furniture by the truckload to save ordering and

shipping (set-up) costs

 student buys $25 of credit instead of $ 10 for a photocopy card to reduce

trips for extra credit

Buffer or Safety

 extra shirts ordered for unanticipated demand by a retailer

 extra bottles ordered by a brewery to allow for unexpected breakage

Seasonal or

Speculative

 air conditioners produced a nd stored during winter

 sandwiches assembled during the morning and stored for lunch

Decoupling

 plastic moulding machine produces at 100 parts/hr, assemblers work at

50 parts/hr, parts are held in operations to balance production rates ( and

moulding is shutdown periodically).

TYPE	EXAMPLE
Transit or Pipeline	· parts on trains, forklifts, etc. · paper forms being moved between departments
Cycle	· a retail store that orders furniture by the truckload to save ordering and shipping (set-up) costs · student buys $25 of credit instead of $10 for a photocopy card to reduce trips for extra credit
Buffer or Safety	· extra shirts ordered for unanticipated demand by a retailer · extra bottles ordered by a brewery to allow for unexpected breakage
Seasonal or Speculative	· air conditioners produced and stored during winter · sandwiches assembled during the morning and stored for lunch
Decoupling	· plastic moulding machine produces at 100 parts/hr, assemblers work at 50 parts/hr, parts are held in operations to balance production rates ( and moulding is shutdown periodically).