Global Supply Chain Management

1. Global Supply Chain Management

2. Chapter #4 Introduction to Inventory Models

3. The Logistics System

4. Overview • We will discuss the role of inventories in global logistics systems • We will look at a few of the classic inventory control models • We will take a quick look at a number of the modern inventory management philosophies • Throughout the discussion, we will examine the relationship between inventories and customer service.

5. Inventory and Customer Service • Recall that part of the customer service equation is having the right product at the right time to meet customer demand • Inventories are used to insure that when the customer makes a request we have the items necessary to deliver the product or service • For business, inventories provide insurance against lost sales …and possibly the loss of a customer (external customers) or a production stoppage (internal customers)

6. Inventory and Customer Service • Inventory management involves decisions about two primarily two issues • How many units to carry • How often to reorder • Recall that our overall objective is to manage logistics for minimum cost while meeting a specified level of customer service

7. Inventory and Customer Service • Inventory management directly impacts a number of factors in the total cost equation • The investment of capital in the inventory items themselves • The carrying cost of the inventory • The lost sales costs • The lost customer costs • And for internal customers, the lost production costs

8. The Functions of Inventory • Inventories serve a number of purposes • They facilitate economies of scale by allowing us to trade off inventory for • Lower transportation costs • Lower production cost through longer production runs and reduced set-up costs • Discounted quantity pricing and lower order costs • They help us balance supply and demand • Production limitations • Seasonality of demand or resource availability

9. The Functions of Inventory • Inventories provide protection against orders from an uncertain market place • Hopefully, we forecast demand • But, demand can never be known with 100% accuracy • Direct sales vary significantly and are influenced by many factors outside our system and thus our control • Transportation difficulties, especially in the global market place • Manufacturing hiccups, etc.

10. The Functions of Inventory • All of these factors and more are good reasons for carrying inventories • Management must, of course, balance the cost or inventories against the risk to develop policies that minimize overall costs • And, as many companies often forget, after formulating a strategy we must • Implement it • Monitor it • Evolve it as required

11. Classification of Inventory • We classify inventories in order to more easily address their management • Normal inventory is that maintained to support demand under conditions of certainty • Safety or Buffer inventories are maintained to cover the uncertain portion of demand • In-transit inventory is that which is in transit to or from our facility…and depends on purchase and sales terms which effect costs, but not other considerations

12. Classification of Inventory • Classification of inventory (cont.) • Speculative inventories are those we maintain because of, for example, uncertainty of future pricing or availability • Seasonal inventories are those we maintain in order to meet known seasonal peaks in customer demand, e.g. the Christmas season • Dead inventories include those items no longer called for by our customers…they should be purged on a regular basis as defined by our inventory strategy/management plan

13. Inventory Management Objectives • Inventories are required to meet customer service expectations • Nonetheless, our challenge as logistic professionals is to manage inventories in order to minimize total system cost • Three primary costs are typically associated with inventory management

14. Inventory Management Objectives • Holding cost include • Storage costs • Handling costs • Obsolescence • Theft • Insurance • Cost of capital • Etc.

15. Inventory Management Objectives • Ordering costs include • Personnel time required to • Place the order • Track the order • Complete invoicing, AR and AP functions • Expedite and/or manage inquiries/problems, etc • Generally expressed in terms of $/order

16. Inventory Management Objectives • Stock-out cost include • The lost sale • The long term cost of losing a customer • Back order cost • Possible penalty cost associated with contracts and purchase orders • Lost production • Etc

17. Classic Inventory Models • Long before logistics became a focus of management, we developed a number of models to help us manage inventories • As we review these models, note that they were developed to manage inventories without much consideration for the impact on the system (our business) as a whole • They were focused primarily on providing a means for a cost center manager to minimize her cost within the parameters set by people outside her organization

18. Classic Inventory Models • Economic Order Quantity Model (EOQ) • Used to calculate the Order size that minimizes total inventory cost with consideration for • Carrying costs • Order costs • This is where it started • Still useful today for some situations, e.g. for slow moving items of relatively low value and where spoilage and/or obsolescence are not considerations

19. Classic Inventory Models

20. Classic Inventory Models • The Economic Order Quantity (EOQ) is given by: • Where EOQ is the quantity ordered • C is the order placement cost • D is the annual demand in units • I is the annual inventory cost as a % of unit value • V is the average $ value of a unit of inventory

21. Classic Inventory Models • Example of EOQ • C = $50/unit • D = 75,000 units • I = 15% • V = $25

22. Classic Inventory Models

23. Classic Inventory Models • Obviously, the EOQ is better than a wild guess, but remember that it was developed under some very specific assumptions: • Demand is constant and known • Lead time is constant and known • Stock-outs do not occur • In-transit inventory is ignored • We assume no interaction with other inventory items

24. Classic Inventory Models • Another approach is to fix the re-order point • We are doing the analysis under the same assumptions, except that demand is not constant • Whenever the item inventory level drops to the calculated reorder point, we place a new order of size EOQ

25. Classic Inventory Models Fixed Order Point

26. Classic Inventory Models • Still another approach is to fix the re-order interval • Once again we are doing the analysis under the same assumptions as EOQ, except that demand is not constant • Orders are placed only on a periodic basis with the objective of matching the sales cycle • Obviously, there is some risk here of running out of product

27. Classic Inventory Models Fixed Reorder Interval=4

28. Classic Inventory Models • None of the models discussed allow for the cost of backorders • We often find it necessary to allow backorders • In addition, there is simply too much uncertainty to depend on these models for all inventory categories…nothing wrong with them for some categories • In almost all situations, we will insist on some level of safety-stock

29. º L average lead time s º standard deviation of lead time L º D average periodic sales s º standard deviation of periodic demand d Classic Inventory Models • At a minimum, we should acknowledge the randomness in Demand (on a periodic basis) and delivery Lead Time • Then assuming:

30. Classic Inventory Models • Then the required safety stock level can be calculated as: • Consider the system in which Demand is ~U(100,150) and Lead Time is ~U(2,6) • The graph on the following slide summarizes 60 days of operation of this system (simulated)

31. Classic Inventory Models

32. Classic Inventory Models • So how do we tell when our inventory strategy is failing us? • Loss of Customers • Increasing numbers of back orders • Stable number of back-orders with a growing investment in inventory • Frequent lack of inventory storage space • Deteriorating channel relationships

33. Improving Inventory Management • Like all organizational strategies, to be taken seriously by members of the organization, inventory management must be a top and visible priority of leadership • ABC analysis can be used to keep our focus on the critical SKUs, those that generate the most profit • Be careful…customers often rely on us for not only these items but less profitable items as well and without availability of those items, they may go elsewhere with all of their business

34. Improving Inventory Management • Inventory management, no matter how enlightened, will not be successful without keeping a watch on the rest of the logistics system • Focus on problems, not symptoms • Transportation • Order processing • Product quality • Etc.

35. Improving Inventory Management • Demand forecasting is essential…we’ll look at it in more detail later • Inventory management software and other data mining tools should be used to track and analyze the data required to support good, timely decision management • MRP • DRP • JIT, etc.

36. Improving Inventory Management • Postponement as a manufacturing and distribution strategy • Delay final assembly as long as possible • Helps insure the right product is available • Minimizes the investment in inventory by reducing value added components • For example, Dell computer • Rising business for FedEx • Possible business for Anchorage

37. MRP Systems • Materials Requirements Planning (MRP) is an inventory management methodology used in manufacturing • Schedules backwards from orders • Insures that materials are ordered and product produced according to a master production schedule • Set of logically related procedures, decision rules and records • MRP is called a “Pull” system because the production schedules pull the parts through the system to meet manufacturing needs

38. DRP • Distribution Resource Planning (DRP) is similar to MRP except that it address the flow and storage of finished goods • DRP begins with customer demand and works backward to define an economically justifiable plan for meeting demand Note that both MRP and DRP attempt to minimize inventories of raw materials, finished goods and WIP

39. JIT • Just-in-Time inventory management grew out of a Toyota strategy to reduce inventories throughout their supply chain, incoming and outgoing • Dates to the early 1970’s • Did not receive much notice in the rest of the world until the early to mid ’80s • Basic philosophy was to reduce inventories being held as a hedge against other supply chain problems and address those problems themselves

40. Basics of JIT • Quality must be a given in the product delivered to the customer • A primary driver for holding inventories has always been to protect against defective product • Allowed the defective unit to be replaced without delay • In a JIT system, production stops when quality problems are detected until the issue is resolved

41. Basics of JIT • Vendors become our partners in the channel as we become the partner of those below us • No longer buy on lowest price • No longer insure supply/quality by dealing with multiple vendors • Requires sharing of information along the entire supply chain (up and down the channel)

42. Basics of JIT • Vendors become our partners (continued) • Close collaboration allows not only us to reduce our incoming materials inventories, but also allows our vendors to reduce their outgoing inventories thus lowering overall supply chain cost • Quality is a key issue and if problems are detected, there are fewer total units in the system that will require rework or scraping

43. Basics of JIT • Vendors should be co-located with their customers • Minimizes the potential for disruptions in the logistics network • Increases trust • Increases the ability to share information …although this is rapidly becoming less of an issue with new information technology • Reduces overall risk • Reduces delays in communication of issues and in the possibility for miscommunication

44. Advantages of JIT • JIT reduces overall inventories • Since the same amount of material, or hopefully more, goes through the supply chain, we say that JIT increases our “inventory-turns”, i.e. the same volume of product is held for shorter times in inventory thus decreasing our capital investment and decreasing the total cost component of obsolescence • While the goal of JIT is to minimize inventories (maximize inventory turns) management must recognize that because of uncertainty, some inventories will always be required

45. Disadvantages of JIT • Increased risk of stock-outs is a natural outcome of a JIT inventory management strategy • Minimize the risk by working closely with vendors and logistics service suppliers • Co-location also minimizes this risk • Increased transportation costs • JIT requires more frequent shipments and can require expedited shipments to correct a hiccup

46. Disadvantages of JIT • Increased purchasing costs • This cost can be mitigated with partnering • Unless the implementation is done across the entire supply chain, smaller members of the chain can see increased costs as their need to hold inventory to guarantee their JIT supply to us increases

47. Disadvantages of JIT • Environmental issues • Pollution increases? • Traffic congestion can increase cost through uncertainty of travel times • For example, Boeing in the greater Seattle area

48. VMI • Vendor Managed Inventories (VMI) is the next step in JIT • Vendor puts sales reps in our facilities • We put sales reps in our customers’ facilities • The sales rep becomes part of our team with the responsibility for order materials from his company

49. VMI • Vendor Managed Inventories (continued) • This can reduce overall cost, e.g. eliminate purchasing function • With good information systems and visibility up and down the chain, VMI may be implemented virtually

50. A Reality Check • First, for some companies, JIT is not the answer • Distance between suppliers and markets • Co-location is not possible • Cost of stock-outs is too high, e.g. blood bank • None is a sufficient reason not to implement as much JIT as is reasonable • JIT should not be viewed as a replacement for MRP or DRP but as an enhancement to one or both of those methodologies