Inventory Management

1. Inventory Management

2. What is Inventory 1. In commerce it is a stock of goods; the merchandise or stock that a store or company has on hand. 2. A list of items: a list of things, especially items of property, assets, or other resources 3  A record of assets: a record of a business's current assets, including property owned, merchandise on hand, and the value of work in progress and work completed but not sold. When we talk about Inventory in this course, we mean the “stuff” that that flows to, through, and out of an organization, making up value chains that are essential to an organization’s business.

3. Inventory Basics • Inventory consists of materials, parts, and finished goods. (Stuff in the supply chain, being worked on, and completed but not yet sold.) • Inventory is depletedwhen it’s sold or destroyed. • An inventory-manager’s job is to balance the pros and cons of both low and high inventories. • Both low and high inventory levels have associated cost characteristics. • The ideal cost situation is to have “some” inventory.

4. TYPES OF INVENTORY • Raw Materials: Stuff that needs to be worked on for production and resale. (Value needs to be added.) • Work-In-Process (W.I.P.): Stuff being worked on. • Finished Goods:Value has been added. • Anticipation: Extra stuff held in anticipation of … • Cycle: The quantity that cycles from high to low. • Pipeline: Stuff ordered but not yet received. • Safety Stock: Extra stuff held for the unexpected.

5. WHY HAVE INVENTORY • So you have it when you need it. • To get Quantity Discounts • Buy it while it’s cheap if... • You expect a price increase • You expect a shortage or higher demand • To buffer Supply and Demand Systems • This is the most common use of inventory.

6. Buffering Supply & Demand Differences SUPPLY SIDEDEMAND SIDE • Arrival Rate (availability of raw materials • Usage Rate of raw materials in production • Rate of Production offinished goods. • Rate of Sale of(demand for) finished goods • Purchase of finished goods for resale. (EG: Retail stores.) • Rate of resale of finished goods

7. INVENTORY AS A BUFFER between unmatched supply and demand. • It “decouples” supply and demand systems. • Rarely do supply rates and demand rates match. • In decoupling the systems it hides problems. • Problems with unreliable (late) suppliers • Unbalanced line processes (bottlenecks) • Poor layout of processes • Equipment and/or manpower delays

8. REASONS FOR LOW INVENTORY • To uncoverproblems and correct them! • To reduce the ordering and holding costs • ORDERING COSTS • Paperwork and processing time • HOLDING COSTS (carrying costs) • Idle capital (inventory) and associated opportunity costs. • Inventory Storage and Handling costs • Taxes and Insurance costs • Damage, loss, spoilage, obsolescence

9. Arguments for High Inventory • To Prevent Stock-Outs • The cost of lost business or lost time if you run out of inventory. • To Reduce Ordering Costs: Themore inventory you buy with each order, the less frequently you need to process orders. • Quantity Discounts: Lower cost-per-unit with large orders. • To Reduce Setup Costs: (The costs involved in changing over a line to produce a different item.) Long production runs require fewer setups, but larger lot sizes, thus requiring more W.I.P. inventory. • Transportation Costs:Bulk shipments reduce shipping costs. • Labor and Equipment Productivity: Balance delays (from imbalanced lines) are avoided by having inventory to work on.

10. WAYS TO REDUCE INVENTORY • Improved demand forecasting to better match supply and demand (“Uncertainty craves inventory.”) • Better standardization and quality controlto reduce scrap, waste, rework, and returns. (Lower work-in-process inventory) • Line balancing to reduce work-in-process inventory • Reduce the set-up time (idleness)for production runs • Better process management to avoid delays • Better preventative maintenance to avoid or reduce equipment breakdowns

11. You can’t eliminate inventory • There is too much uncertainty in supply and demand • Inadequate control over external variables such as… • Supplier schedules • Supplier quality • Supplier reliability • Market/customer demand uncertainty • Middlemen (Middlepersons)  • Without work-in-process (W.I.P.) inventory, there would be nothing for workers or machines to do.

12. COST MINIMIZATION • The focus of inventory control is usually on minimizing inventory costs. • http://www.youtube.com/watch?v=qkZQxXJuqKo • Major inventory costs categories: • Cost of not having inventory when you need it. (Losing customers) Stock Outs • Cost of having inventory: Carrying Costs • Cost of ordering inventory: Ordering Costs

13. Cost as a function of Inventory Level Some moderate level of inventory is most desirable. Total Costs $ Carrying/holding Costs Stock-out Costs Inventory Level

14. Cost as a function of Order Quantity The ideal amount of inventory to order so as to minimize total inventory costs. $ Total Costs Carrying/holding Costs Ordering Costs Order Quantity (Lot Size) This is the basic model for the inventory homework problems: Determining the optimal order quantity in order to minimize total inventory costs.

15. TERMS • SAFETY STOCK is a reserve for unanticipated problems. It can be a safety stock of finished goods, or of raw materials. • LOT SIZE is the amount you order each time you purchase inventory and/or the amount you produce in each production run. • Lead Time is the time it takes (hours, days, weeks, etc.) to receive an order once you place the order. • CYCLE INVENTORY is that portion of total inventory that varies directly with the amount you purchase or produce (lot size). • It is half of the lot size (The average of what is cycling up and down) • AVERAGE INVENTORYis the cycle inventory plus the safety stock. • PIPELINE INVENTORY is the amount of inventory on order that has not yet been received.

16. TERMS (cont.) Anticipationinventoryis the amount of inventory ordered (or produced) above the normal amount in anticipation of uneven supply or demand. For example… • If you are expecting a price increase in materials… • If your supplier is expecting a strike… • If you are anticipating a surge in demand… • If there is a hurricane coming… (Safety stock is for “unanticipated” events.)

17. Q REORDER POINT ORDER QUANTITY OR LOT SIZE SAFETY STOCK TIME LEAD TIME If you are producing the inventory instead of buying it, the order arrives over time rather than all at once. INVENTORY CYCLE Order arrives Slope represents the Rate of demand REORDER POINT Reorder point may be determined by the level of inventory or by the lead time.

18. Q REORDER POINT SAFETY STOCK TIME LEAD TIME INVENTORY CYCLE ORDER QUANTITY or LOT SIZE Cycle Inventory is the average of what is cycling up and down. In this case it’s half of the purchased lot size, or if you are producing it, it is half of the production lot size. Average Inventory is cycle inventory + safety stock.

19. 702 Q2 Average inventory = = = 35 Q Order Quantity is 70 Order Lead Time is three weeks. 2 3 Weeks Pipeline Inventory is thus 70 x 3= 210 1 © 2013 Lew Hofmann A wholesaler orders weekly shipments of electric drills inlot sizes (order quantities)of 70 because average demand is 70 drills a week. Lead time is 3 weeks. The order quantity must be paid for when the supplier makes a shipment. What is the average inventory and pipeline inventory? Average Inventory is the same as Cycle Inventory because there is no safety stock in this example.

20. If the wholesaler is willing to double its purchase quantity to 140units and order every two weeks, the supplier will reduce its delivery time from 3 weeks to 2 weeks. What is the effect on cycle and pipeline inventories? Q Order quantity is 140 1402 Q2 Average (cycle) inventory = = = 70 1 2 3 Weeks Order Lead Time is 2 weeks. Pipeline Inventory is thus140 © 2013 Lew Hofmann Under the new proposal, the order quantity becomes 140. Average inventory doubles to 70. Orders are now placed once every two weeks, but the lead time is only two weeks. Thus pipeline inventory is reduced. Note: Average inventory increases, but pipeline inventory decreases. Ordering costs also go down since you half as often. However, you need to know the ordering & holding costs to determine if this option is better.

21. Reducing Cycle Inventory • The primary tactic for reducing cycle inventory is to reduce your order quantity (or production lot size). • Your average inventory will thus be lower, so your holding costs (carrying costs) will go down. • However, ordering costs will increase because you need to order more frequently. • If you are going to order more frequently, you should reduce your order lead time to reduce pipeline inventory. • You should also reduce setup times. (Setup time is idle, unproductive time.)

22. Reducing Safety Stock This will lower average inventory, thus lowering holding costs, but stock-out costs can wipe out this savings. Stock outs must be prevented by… • Improved demand forecasts will reduce the uncertainty in demand, and thus lower the need for safety stock. • Shorter lead times of purchased or produced items. Lead times are times of demand uncertainty. The longer you wait for deliveries the more risk. • Reduce supply uncertainties: • Share your production plans with suppliers so they can better meet your needs. • Unexpected scrap or rework can be reduced by improving manufacturing processes. Improve the quality of materials you receive by working with suppliers or changing suppliers. • Preventive maintenance can minimize unexpected downtime caused by equipment failure. • Rely more on equipment and labor buffers, such as capacity cushions and cross-trained workers to help absorb some of the supply/demand uncertainty.

23. Reducing Anticipation Inventory • The primary way to reduce anticipation inventory is to match demand rate with production rate. • Have products with different demand cycles so that a peak in the demand for one product compensates for the seasonal low demand for another. • Sometimes called “counter-seasonal” products. (Summer clothes and winter clothes.) • Provide off-season promotional campaigns to smooth out demand fluctuations. (After Christmas sales) • Offer seasonal pricing plans also help level out demand. • EG: Resort prices and airline tickets go down in off seasons.

24. Reducing Pipeline Inventory The primary way to reduce pipeline inventory is to reduce lead times (The time it takes to receive inventory.) • Closer suppliers, faster shipping and handling Find closer and/or more responsive suppliers and faster carriers for shipments. Also, improve materials handling within the plant. But be careful, because faster shipping can be more expensive. • Decrease the order quantity or production lot sizeIn manufacturing, smaller jobs require less time to complete. However, smaller order quantities for parts and materials often get less priority with suppliers, which may increase lead time. And you won’t get the quantity discounts that you get with large orders.

25. INVENTORY PLACEMENTWhat to do with the stuff you have produced. • Managers make inventory placement decisions by designating an item as either a special or a standard. • STANDARDS (Make-to-stock items) • Tend to be forward placement (warehoused close to outlets) • Inventory value is generally in finished goods. • Delivery times to customers are shorter, but inventory is greater. • SPECIALS (Make-to-order orAssemble-to-order) • Tend to be pooled placement (stored at or near the factory) • Inventory value is mostly in raw materials and/or supplies.

26. PROCESS-FOCUSED(Flexible Flow) Demand is less predictable Higher Safety Stock needed Lower Output Volume Less clout with suppliers Poorer vendor relations Longer lead times Higher pipeline inventory PRODUCT-FOCUSED(Line Flow) Demand is more predictable Lower Safety Stock needs High Output Volume More clout with suppliers Better vendor relations Shorter lead times Lower pipeline inventory Process-Focused firms have Higher Inventory (days of supply)

27. PROCESS-FOCUSED(Flexible Flow) Quality & Flexibility focus Higher profit margins Can afford greater inventory Complex Production Flows Longer production times Higher work-in-process inventory (W.I.P.) PRODUCT-FOCUSED(Line Flow) Price Competition Lower profit margins Can’t afford high inventory Repetitive Production Faster production time Lower work-in-process inventory (W.I.P.) Process-Focused firms spenda greater percentage of overall costs on Inventory