Managing stock,

Considering alternative sourcing

arrangements
Differences Between Inventory and Stock.

 Stock deals with products that are sold as part of the business's

daily operation,

 Inventory includes sale products and the goods and materials

used to produce them.

Inventories in the Supply Chain
Independent vs. Dependent Demand

 Independent demand items are finished goods or other items sold to

someone outside the company

 Dependent demand items are materials or component parts used in

the production of another item (e.g., finished product)

Types of Inventory:

 Anticipation or seasonal inventory

 Safety stock: buffer demand fluctuations
 Lot-size or cycle stock: take advantage of quantity discounts or
purchasing efficiencies
 Pipeline or transportation inventory
 Speculative or hedge inventory protects against some future
event, e.g. labor strike
 Maintenance, repair, and operating (MRO) inventories
 WHAT IS STOCK MANAGEMENT?

STOCK MANAGEMENT is all about trying to make sure that the business
has a STOCK LEVEL that prevents OVERSTOCKING PROBLEMS and
UNDERSTOCKING PROBLEMS.
OVERSTOCKING
Overstocking means that a business has bought in MORE stock than it regularly needs and so will face the
following problems due to extra unnecessary stock:

 High labour costs for security staff to prevent theft of stock

 High labour costs for warehouse staff to manage stocks

 High storage costs for large premises to store stock

 High costs of insurance for large amounts of stock

 Less chance of wastage or theft being noticed and dealt with

 Risk of losing money on stock that becomes obsolete e.g. if trends change (social factor)

 Money is tied up in stock that could be used for other purposes within the business e.g. buying new
equipment to increase production
UNDERSTOCKING
Understocking means that a business has NOT bought in enough
stock to continue with its ordinary activities and so will face the
following problems from a lack of stock:

 Production may have to stop

 Stockouts may occur (this means there is no stock for customers)

leading to decreased sales and profits, less customer loyalty and a
damaged business reputation

 Unexpected customer orders cannot be met

Costs of holding Stock
 Value of materials
 Space
 Staff costs
 Financing costs
 Effect on cash flow
 Deterioration / shelf life / obsolescence
 Price movements
 costs associated with placing orders
STOCK LEVELS
A MAXIMUM STOCK LEVEL is set in line with consumer demand and storage space
available. This should prevent overstocking.

A MINIMUM STOCK LEVEL is set in line with normal demand and lead times from
suppliers. This should prevent understocking.

A RE-ORDER LEVEL is set between the maximum and minimum levels taking
account of the minimum level, lead time and normal demand. This should
prevent stock-outs.
Relevant Inventory Costs

Item Cost Cost per item plus any other direct costs
associated with getting the item to the
plant
Holding Capital, storage, and risk cost typically
Costs stated as a % of the unit value,
e.g. 15-25%
Ordering Fixed, constant dollar amount incurred
Cost for each order placed

Shortage Loss of customer goodwill, back order

Costs handling, and lost sales
Order Quantity Strategies

Lot-for-lot Order exactly what is needed for the

next period
Fixed-order Order a predetermined amount each
quantity time an order is placed
Min-max When on-hand inventory falls below a
system predetermined minimum level, order
enough to refill up to maximum level
Order n Order enough to satisfy demand for
periods the next n periods
Three Mathematical Models for Determining
Order Quantity
 Economic Order Quantity (EOQ or Q System)
 An optimizing method used for determining order quantity
and reorder points
 Part of continuous review system which tracks on-hand
inventory each time a withdrawal is made
 Economic Production Quantity (EPQ)
 A model that allows for incremental product delivery
 Quantity Discount Model
 Modifies the EOQ process to consider cases where quantity
discounts are available
Economic Order Quantity

 EOQ Assumptions:
 Demand is known & constant - no
safety stock is required
 Lead time is known & constant
 No quantity discounts are
available
 Ordering (or setup) costs are
constant
 All demand is satisfied (no
shortages)
 The order quantity arrives in a
single shipment
EOQ: Total Cost Equation

 D  Q 
TCEOQ   S    H 
Q   2 
Where
TC  total annual cost
D  annual demand
Q  quantity to be ordered
H  annual holding cost
S  ordering or setup cost
EOQ Total Costs
Total annual costs = annual ordering costs + annual holding costs
The EOQ Formula
Minimize the TC by ordering the EOQ:

D  annual demand
2DS H  annual holding cost
EOQ 
H
S  ordering or setup cost
When to Order:
The Reorder Point
 Without safety stock:
R  dL
where R  reorder point in units
d  daily/weekly demand in units
 With safety stock: L  lead time in days/weeks

R  dL  SS
where SS  safety stock in units
EOQ Example
 Weekly demand = 240 units
 No. of weeks per year = 52
 Ordering cost = $50
 Unit cost = $15
 Annual carrying charge = 20%
 Lead time = 2 weeks
EOQ Example Solution

D  52  240  12,480 units / year

H  0.2 15  $3 per unit per year
2DS 2 12,480  50
Q   644.98  645 units
H 3
 D   Q   12,480   645 
TC   S    H     50     3
 Q   2   645   2 
 967.44  967.5  $1,934.94

R  dL  240  2  480 units

EPQ (Economic Production Quantity) Assumptions
 Same as the EOQ except: inventory arrives in increments & is drawn
down as it arrives
EPQ Equations

 D   I MAX 
 Adjusted total cost: TCEPQ   S    H
Q   2 

 d
 Maximum inventory: I MAX  Q1  
 p

2 DS
EPQ 
 Adjusted order quantity:  d
H 1  
 p
EPQ Example
 Annual demand = 18,000 units
 Production rate = 2500 units/month
 Setup cost = $800
 Annual holding cost = $18 per unit
 Lead time = 5 days
 No. of operating days per month = 20
EPQ Example Solution
18,000
d  1500 units / month; p  2500 units / month
12
2 DS 2 18,000  800
Q   2000 units
 d  1500 
H 1   18  1  
 p  2500 

 d  1500 
I MAX  Q1    2000  1    800 units
 p  2500 
D  I   18,000   800 
TC   S    MAX H     800    18 
Q   2   2000   2 
 7,200  7,200  14,400
EPQ Example Solution (cont.)

 The reorder point:

1500
R  dL   5  375 units
20
 With safety stock of 200 units:

1500
R  dL  SS   5  200  575 units
20
Quantity Discount Model Assumptions
 Same as the EOQ, except:
 Unit price depends upon the quantity ordered
 Adjusted total cost equation:

 D  Q 
TCQD   S    H   PD
Q   2 
Quantity Discount Procedure
 Calculate the EOQ at the lowest price
 Determine whether the EOQ is feasible at that price
 Will the vendor sell that quantity at that price?
 If yes, stop – if no, continue
 Check the feasibility of EOQ at the next higher price

 Continue to the next slide ...

QD Procedure (continued)
 Continue until you identify a feasible EOQ
 Calculate the total costs (including total item cost) for the feasible
EOQ model
 Calculate the total costs of buying at the minimum quantity required
for each of the cheaper unit prices
 Compare the total cost of each option & choose the lowest cost
alternative
 Any other issues to consider?
QD Example
 Annual Demand = 5000 units
 Ordering cost = $49
 Annual carrying charge = 20%
 Unit price schedule:

Quantity Unit Price

0 to 999 $5.00
1000 to 1999 $4.80
2000 and over $4.75
 QD Example Solution

 Step 1

2  5,000  49
QP $4.75   718 not feasible 
0.2  4.75

2  5,000  49
QP $4.80   714 not feasible 
0.2  4.80

2  5,000  49
QP $5.00   700  feasible 
0.2  5.00
QD Example Solution (Cont.)
 Step 2

5,000 700
TCQ 700   49   0.2  5.00  5.00  5000  $25,700
700 2

5,000 1000
TCQ 1000   49   0.2  4.80  4.80  5000  $24,725
1000 2

5,000 2000
TCQ  2000   49   0.2  4.75  4.75  5000  $24,822.50
2000 2
ABC Inventory Classification
 ABC classification is a method for determining level of control and frequency of
review of inventory items
 A Pareto analysis can be done to segment items into value categories depending
on annual dollar volume
 A Items – typically 20% of the items accounting for 80% of the inventory value-
use Q system
 B Items – typically an additional 30% of the items accounting for 15% of the
inventory value-use Q or P
 C Items – Typically the remaining 50% of the items accounting for only 5% of the
inventory value-use P
ABC Example: the table below shows a solution to an ABC analysis. The information
that is required to do the analysis is: Item #, Unit $ Value, and Annual Unit Usage. The
analysis requires a calculation of Annual Usage $ and sorting that column from highest
to lowest $ value, calculating the cumulative annual $ volume, and grouping into
typical ABC classifications.

Item Annual Usage ($) Percentage of Total $ Cumulative Percentage of Total $ Item Classification
106 16,500 34.4 34.4 A
110 12,500 26.1 60.5 A
115 4500 9.4 69.9 B
105 3200 6.7 76.6 B
111 2250 4.7 81.3 B
104 2000 4.2 85.5 B
114 1200 2.5 88 C
107 1000 2.1 90.1 C
101 960 2 92.1 C
113 875 1.8 93.9 C
103 750 1.6 95.5 C
108 600 1.3 96.8 C
112 600 1.3 98.1 C
102 500 1 99.1 C
109 500 1 100.1 C
Inventory Record Accuracy
Inaccurate inventory records can cause:
 Lost sales
 Disrupted operations
 Poor customer service
 Lower productivity
 Planning errors and expediting
Two methods are available for checking record accuracy
 Periodic counting-physical inventory
 Cycle counting-daily counting of pre-specified items provides the
following advantages:
 Timely detection and correction of inaccurate records
 Elimination of lost production time due to unexpected stock outs
 Structured approach using employees trained in cycle counting
Inventory Control Risk
Theft
 Theft is one of the biggest risks with regard to inventory control, specifically
when the inventory is higher in value.

 If internal employees are involved in the theft, it is much more difficult to

identify as they know the entire system and would probably be wise enough
to erase all their tracks after the theft.

 Every year, firms spend millions of dollars to prevent theft risk. They invest
money in security measures like cameras or by hiring watch guards to prevent
any incidents of inventory theft.
Inventory Control Risk
Damage

 Occasionally, products get damaged during normal business operations. Some

industries have a higher risk of damaged product than others.

 Industries with high-damaged goods put inventory control policies in place to

minimize damage. For instance, in order to reduce the risk of crushed boxes a
shirt manufacturer might require a maximum stack height of four rows of
cartons per pallet, even though the pallet can hold significantly more weight.
Inventory Control Risk
Inventory Waste & Damage
 Inventory usually tends to get damaged while being used in the normal
business processes. Damaged inventory cannot be used and goes to waste,
increasing the costs of the business.

 To avoid inventory from being damaged and to reduce waste costs,

companies create inventory control policies to minimize the damage as much
as possible as well as issue rules and regulations regarding the effective use
of inventory to prevent waste.
Inventory Control Risk
Inventory Loss

 Inventory is a current asset to a firm. A loss of inventory means a reduction

in the company equity. Goods in the inventory can get lost if the inventory
is not managed properly or if the employees are not careful in handling
inventory.

 Firms have now created an inventory control system to identify the exact
amount of inventory loss as well as the cause of the loss. This enables them
to reduce company expense and prevent such inventory losses.
Inventory Control Risk
Shelf Life
 Many products have a certain amount of shelf life. This poses an inventory
risk for the company.
 Perishable items like milk and eggs have a smaller shelf life than other
products and companies producing such goods may be at a higher
inventory risk.
 This requires manufacturers to have a tight control over their
manufacturing and inventory control policies. In such cases, firms produce
only as much as the demand requires.
 Producing less than required will prevent the company from meeting the
demand while producing a surplus may increase waste costs.
Inventory Control Risk
Lifecycle

 All products go through the product life cycle. Those products that are
in the decline stage are at a higher inventory risk. Firms of such
products tend to tighten their inventory control and manufacturing
policies and only produce enough to sufficiently meet their current
demand. A surplus production of goods that is not sold in the market
will become obsolete and will be a heavy burden on the firm.
Alternative Sourcing Arrangements
 Focus
Sourcing decisions and purchasing activities serve to link an organization with its supply chain partners

 Sourcing decisions –
High level, often strategic decisions regarding which products or services will be provided internally and
which will be provided by external supply-chain partners

 Purchasing –
The activities associated with identifying needs, locating and selecting suppliers, negotiating terms, and
following up to ensure supplier performance
 The Sourcing Decision
Sourcing decisions are high-level, often strategic
decisions that address:
What will use resources within the firm
What will be provided by supply chain partners

 Insourcing –
The use of resources within the firm
to provide products or services
Make-or-Buy
 Outsourcing – Decision
The use of supply chain partners
to provide products or services
Advantages and Disadvantages of Insourcing
Advantages Disadvantages
 High degree of control  Required strategic flexibility
 Ability to oversee the  Required high investment
entire program  Loss of access to superior
 Economies of scale products and services offered by
and/or scope potential suppliers
Advantages and Disadvantages of Outsourcing
Advantages Disadvantages
 High strategic flexibility  Possibility of choosing a bad supplier
 Low investment risk  Loss of control over the process and
 Improved cash flow core technologies
 Access to state-of-the-art products  Communication and coordination
and services challenges
 “Hollowing out” of the corporation
 Factors Affecting the Decision to
Insource or Outsource
Favors Favors
Factor Insourcing Outsourcing

Environmental uncertainty low high

Competition in the supplier market low high
Ability to monitor supplier performance low high
Relationship of product/service to high low
buying firm’s core competencies
Total Cost Analysis
A process by which a firm seeks to identify and
quantify all of the major costs associated with
various sourcing options
• Direct costs –
Costs that are tied directly to the level of
operations or supply chain activities
• Indirect costs –
Costs that are not tied directly to the level of
operations or supply chain activity
 Insourcing and Outsourcing Costs
Insourcing Outsourcing
•Direct material •Price (from invoice)
Direct •Direct labor •Freight costs
costs •Freight costs
•Variable overhead
•Supervision •Purchasing
•Administrative support •Receiving
•Supplies •Quality control
Indirect
•Maintenance costs
costs •Equipment depreciation
•Utilities
•Building lease
•Fixed overhead
Portfolio Analysis

High

Bottleneck Critical
Complexity
or Risk
Impact

Routine Leverage
Low
Low High
Value Potential
Critical Quadrant
 Critical to profitability and operations  Strategy
 Form partnerships with suppliers
 Few qualified sources of supply
 Large expenditures  Tactics
 Increase role of selected suppliers
 Design and quality critical  Actions
 Complex and/or rigid specification  Heavy negotiation
 Supplier process management
 Prepare contingency plans
 Analyze market/competitions
 Use functional specifications
Bottleneck Quadrant
 Complex specifications requiring  Strategy
complex manufacturing or service  Ensure supply continuity
process  Tactics
 Few alternate productions/sources of  Decrease uniqueness of suppliers
supply  Manage supply
 Big impact on  Actions
operations/maintenance  Widen specification
 New technology or untested  Increase competition
processes  Develop new suppliers
 Medium-term contracts
 Attempt competitive bidding
Leverage Quadrant
 High expenditures, commodity items  Strategy
 Maximize commercial advantage
 Large marketplace capacity, ample
inventories  Tactics
 Concentrate business
 Many alternate products and services
 Maintain competition
 Many qualified sources of supply  Actions
 Market/price sensitive  Promote competitive bidding
 Exploit market cycles/trends
 Procurement coordination
 Use industry standards
 Active sourcing
Routine Quadrant
 Many alternative products and  Strategy
services  Simplify acquisition process
 Many sources of supply  Tactics
 Increase role of systems
 Low value, small individual  Reduce buying effort
transactions
 Actions
 Everyday use, unspecified items  Rationalize supplier base
 Anyone could buy it  Automate requisitioning, e.g., EDI, credit
cards
 Stockless procurement
 Minimize administration costs
 Little negotiating
 Sourcing Strategies
• Single sourcing –
The buying firm depends on a single company for all or nearly all
of an item or service
• Multiple sourcing –
The buying firm shares its business across multiple suppliers
• Cross sourcing –
Using a single supplier for a certain part or service and another
supplier with the same capabilities for a similar part
• Dual sourcing –
Using two suppliers for the same purchased product or service
Multicriteria Decision Models in Sourcing and
Purchasing
How do we evaluate alternatives when criteria include
both quantitative measures (such as costs and on-time
delivery performance) and qualitative factors (such as
management stability and trustworthiness)?
 Weighted-Point Evaluation
System - I
Purpose:
• Evaluating potential suppliers
• Tracking suppliers’ performance over time
• Ranking current suppliers

The Process:
• Assign weights to performance dimensions
• Rate the performance of each supplier with
regard to each dimension
• Calculate the total score
 Weighted-Point Evaluation
System - II

Summary Data for Alternative Suppliers

Performance Aardvark Beverly Conan the

Dimension Electronics Hills Inc. Electrician
$4/unit $5/unit $2/unit
Price
Quality 5% defects 1% defects 10% defects

Delivery 95% on time 80% on time 60% on time

reliability
 Weighted-Point Evaluation
System - III
n
Score X   Performance XY  WY
Y 1
Criteria Weights Scoring Scheme

WPrice = 0.3 5 = excellent

4 = good
WQuality = 0.4 3 = average
2 = fair
WDelivery = 0.3 1 = poor

Chapter 10, Slide 58

 Weighted-Point Evaluation
System - IV

Performance Values for Alternative Suppliers

Performance Aardvark Beverly Conan the

Dimension Electronics Hills Inc. Electrician
4 3 5
Price
Quality 3 5 1

Delivery 4 2 1
reliability
 Weighted-Point Evaluation
System - V

Total Scores for Alternative Suppliers

Score Aardvark = (4 x 0.3) + (3 x 0.4) + (4 x 0.3) = 3.6

Score Beverly = (3 x 0.3) + (5 x 0.4) + (2 x 0.3) = 3.5

Score Conan = (5 x 0.3) + (1 x 0.4) + (1 x 0.3) = 2.2

Aardvark should improve their quality

Beverly Hills should improve their delivery and price
Conan is out of the running as a potential supplier