Inventory Management Fundamentals

MGMT-6085-– INVENTORY & DISTRIBUTION MANAGEMENT

MODULE 2 - CHAPTER 03
 Agenda

 Session – Inventory Management Fundamentals

 Discussion on Silex Project
 Function of Inventory

 Acts as a buffer between

 Supply and demand
 Customer demand for finished goods
 Finished goods require component availability
 Parts and materials are needed for production to begin and continue without interruption

Inventory improves operational efficiency

 Operational Efficiency

 Inventories allow operations with different rates of production to operate separately and more
economically
 Continual production allows for the build up of anticipation inventory by lowering costs for
 Overtime
 Hiring & Firing
 Training
 Sub-Contracting
 Operational Efficiency
continued

 Inventories allow for longer production runs which result in

 Lower set-up costs per item
 Increase in production capacity by allowing production resources to be used forb a greater portion
of the time for processing (as opposed to set-up)
 Allows manufacturing to purchase larger quantities, resulting in lower ordering costs per unit
and access to quantity discounts
 Inventory Classifications
Functionality

 Inventories can be classified according to the function they perform

 Anticipation Inventory - Inventory built up in anticipation of future demand
 Safety Stock
 Inventory held to cover random unpredictable fluctuations in supply & demand
 Lot Size Inventory - Items purchased or manufactured in quantities greater than your immediate need
 Pipeline Inventory - Also referred to as movement inventories or in-transit inventory
 Hedge Inventory - Inventory held in anticipation of price adjustments (commodities and minerals)
 Maintenance Repair & Operating (MRO) Inventory -
 Items that support general operations and maintenance that do not become directly part of a product
 Inventory Types
Retail Based

 Promotional Stock
 Used to increase demand
 Two types
 Continual replenishment
 One-time “special” promotion
 Demonstration Stock
 Also referred to as “display only” stock
 Cannot be sold – floor display only
 Not usually considered part of safety stock
 Inventory Types
Retail Based

 Retail Backroom Stock

 Stock usually located in storage area of store
 Often considered part of safety stock
 Replenished Retail Shelf Stock
 Stock on shelf in location
 Considered to be part of cycle and safety stock
 Seasonal Stock
 Available for specific occasions
 May be replenished during season* or may not be replenished
 Inventory Types
Retail Based

 Replenished Multiple Location Impulse Stock

 Stock located in several locations
 Located to create impulse purchase
 Batteries for battery-operated toys
 Can be out of stock in main location, but in stock in impulse locations
 Considered as part of cycle and safety stock
 Inventory Types
Industrial/Commercial

 Raw Material Stock

 Material held for production
 Can also be partially assembled product
 Work in Progress Stock
 Material in the production cycle, not totally completed
 Materials sitting on the production floor or at a workstation waiting to be processed
 Finished Goods Stock
 Completed production ready for delivery/sale
 Distribution Inventory
 Finished goods located in the distribution system
 Same materials in different facilities – can be shifted as needed
 Inventory Types
Industrial/Commercial

 Spare Parts Inventory

 Components of finished product
 Also referred to as Maintenance Repair & Operational (MRO) Inventory
 Can also be finished goods – replacement or repair parts
 Question

 What do you think might cause uncertainty for inventory availability?

 Inventory Uncertainty
Factors

 Weather  Promotions
 Shoppers in a Store/Mall (number of)  Assortment depth/breadth
 Stock-out of product  Parking availability
 Stock-out of substitute product  Road construction
 Advertising – yours and competitors  News reports
 Inventory Uncertainty
Drivers

 Lead Time  MAY RESULT IN:

 Distance to travel  OVER-ORDERING
 Order receiving processes  UNDER-ORDERING
 Order picking processes
 Product availability
 Your location or supplier
 Order staging process
 Carrier reliability
 Mode of transportation
 Inventory Replenishment

 Two things to remember

 Continuous review versus periodic review
 Continuous - Automatic ordering at pre-determined Re-order Point (ROP)
 Periodic – orders can only be placed at specific times – or when need is recognized
 Service Levels & Inventory

 Service levels will drive inventory decisions

 What is the organization’s
 Service level policy?
 Distribution of demand during lead time?
 Safety stock and re-order point?
 Financial resources?
 Re-order Point
Utilizing Economic Order Quantity (EOQ)

√ 2DS
H
D = Demand
S = Order Cost/Set-up Cost
H = Holding Cost

EOQ works best when demand is relatively certain (historic data)

 Costs Associated with Inventory

 Capital Cost  Storage/Handling Cost

 Lost opportunity investment cost  Need to have a place to store inventory
 Should be considered as part of  Need to move inventory in and out
all inventory decisions  Cost associated with company owned
 Is part of holding costs calculation or rented facility
 Need to consider the opportunity costs
also
Understanding Re order Points
AND SAFETY STOCK
Two questions to ask;
1) How much should be re-ordered?
2) What service level is required?

• The higher the service level the more safety

Re order Point Formula stock required.
• This means that higher service levels equate
R= (demand x lead time)+ safety to fewer stock-outs.
stock + standard deviation in • Key Term- Variability of demand during lead
demand time.
• Lead time is … time it takes from order
initiation to order conclusion.
• To understand safety stock & service levels
need to understand the variability of demand
during lead. See the following example
 Example of Variation in Demand During Lead Time

Week Item A Item B Two Items A & B

1 1200 400 10 week sales history
2 1000 600 Lead time is one week
3 800 1600 Average demand during lead time for item A is 1000 units
4 900 1300 Average demand during lead time for item B is 1000 units
5 1400 200
6 1100 1100 Note that weekly demand range for item A is 700 to 1400
7 1100 1500 If we relied on the average to set the safety stock level we would be out
of stock 4 times in 10 weeks
8 700 800
9 1000 1400
10 800 1100Weekly demand range for item B is 200 to 1600
Total 10,000.00 10,000.00 If safety stock level set to average how many times would item run out of
stock in 10 weeks?
Average 1000 1000

From the example for item A we see that if our safety stock was based on the average, 4 times we run out of
stock and 4 times we have too much stock. (demand 700 and safety stock is 1000 so we have excess stock
of 300). 2 times we have exactly the same amount of safety stock as demand. The aim is to have inventory
as low as possible without running out depending on the service level.
We Can calculate this through statistics.
Using Stats to Find Safety Stock & Service Level

 In Statistics we learn that a normal distribution has an average and values above and
below the average. This looks like …
 So if we use 1000 as the average demand(middle line)
 We see at +/- 1 Standard Deviation, 68% of the time
the demand will be in the green area.
 We see at +/- 2 standard Deviations, 95% of the time
The demand will be in the yellow
Since this is not a Stats course…

 We will not review how to find the Standard deviation But…

 We need to know what to do with the standard deviation when it is provided.
 Once we know the standard deviation we use it to Determine the Safety Stock level & Re
order point. This is how we do that…
 First, we need to know the desired service level.
 If the service level is 85% this means 85 % of time we have sufficient stock to meet the demand
while we wait for inventory to be replenished.
 Second, we need to correlate the service level to a safety factor multiplier.
Wait What???

 Don’t worry about how we get the numbers it is based on Statistics. I did it for you andService Level % Safety Factor
50 0
made this chart. Use this chart and reference it for the assignment. 75 0.67
80 0.84
 IF the standard deviation of demand is 200 units. 85 1.04
90 1.28
 And the desired Service level is 85% 94 1.56
95 1.65
 Safety Stock = Standard deviation X safety factor 96 1.75
97 1.88
 = 200 x 1.04 98 2.05
99 2.33
 Safety stock = 208 units. 99.86 3
99.99 4
The Re-order point would be calculated using
the following Formula.

 R= (demand x lead time)+ safety stock + standard deviation in demand

 So If demand is 500
 Lead time is 1 week
 Safety stock for an 85% service level is 208 units
 Standard deviation of demand is 200
 Re-order point is
 500+208+200= 908
 When inventory levels fall below 908 it is time to re-order!
 Costs Associated with Inventory

 Taxes  Ordering Costs

 Building and Government  Variable Ordering Costs
  Cost per unit
Insurance
  Fixed Ordering Costs
Liability
  Cost per order
Fire
  Out of Stock Costs
General Protection
 Not having inventory equals lost sales and
possibly customers
 Costs Associated with Inventory

 Shrinkage
 3 types
 Pilferage/theft
 Employee or customer
 Obsolescence
 “out of style/out of date”
 Deterioration/physical spoilage
 Creates lost value – past “best before date”
 Points to Ponder
Inventory Costs

Vendor Fraud
5.4% According to PricewaterhouseCoopers
 10,000,000.00 per day
Administrative
Error  4,000,000,000.00 dollars per year
12.9%

Employee
Theft 44%

Shoplifting
32.6%
 Inventory Valuation

 Inventory is:
 an Asset on the balance sheet
 A snapshot of the value of inventory at a given moment in time
 Accurate valuation can be difficult
 Things to Think About

 Value Inventory at Cost

 Not reported as retail sales value (profit not yet earned)
 Cash Flow assumption due to changing valuation throughout year
 Accountants Valuations
 FIFO – First In, First Out
 LIFO – Last in, First Out
 Average Cost
 Weighted average
 Moving average
 Standard Cost
 Inventory Valuation
Supply Chain Evaluation

 LIFO – Last in, First Out

 Not taking care to rotate stock on shelf – just put the new stock in front
 Creates a problem with “dated stock”
 FIFO – First in, First Out
 Taking care to rotate stock, move new stock to back of shelf, use old stock first
 Issues oldest dated materials first, always provides fresh product
 Supply Chain Valuations

 Actual Value  Average Cost

 Based on physical inventory count  Cost of average unit is assigned to all units
 Used as a benchmark for future count  Used when inventory turns frequently, but
activity product remains unchanged
 Supply Chain evaluates differences  Standard Cost
between yearly counts
 the practice of substituting an expected cost
 Analysis of patterns and potential for an actual cost in the accounting records
causes
 periodically recording variances showing the
 Develops plans for improvement (if difference between the expected and actual
necessary) costs.
 Supply Chain Valuation

 Out of Stock Costs

 Relates to Customer Service
 Costs associated with not having product available when customer requiring
 Lost Sale at the moment, AND…
 May go somewhere else to purchase
 May defer purchase
 May purchase a competitive item
 Potential lost customer
 Goes where product is always available
 Loss of Profit
 Recap

 Inventory is identified in many different ways

 Retail and commercial identify differently
 Inventory is an asset
 Valuated in several ways
 Uncertainty in valuation
 Next Session

 Preview Module 03 Content

 Complete Assignment #1 (Refer to FOL for Deadline)