Introduction to Global Supply Chain Management Module Seven: Global Inventory Management

1. Introduction to Global Supply Chain ManagementModule Seven: Global Inventory Management

2. Presentation Agenda • Inventory management defined • Strategic considerations for I.M. • Operational activities • Economic Order Quantity & Period Order Quantity • Order Point Systems • Safety Stock • ABC Analysis • Cycle Counting • KPI’s for the inventory management discipline

3. Inventory Management “Inventory Management transcends the Buy-Side and Sell-Side of a company’s supply chainto cover all facets of the acquisition, valuation, location, storage, usage, sale, distribution, recovery and disposal of merchandise related to the operation of a business. At a strategic level, inventory management must be aligned with a firm’s organizational, marketing and financial objectives. From a tactical perspective, inventory management is all about making goods available to customers when they want them, in the quantities they’d like to buy, via the means they’d like to make a purchase and at a price that they’re willing to pay. In a global environment, inventory management must be enabled by technology that maximizes visibility across the supply chain, thus allowing management to make dynamic inventory management decisions. Ideally, inventory management software is linked to a company’s ERP system, as well as other “Best-In-Breed” software like Warehouse Management Systems and Transportation Management Systems.” -Dan Gardner, April 2015

4. Different Industries & Business Models Determine How Supply Chains Are Designed • Retailer (brick & mortar) • E-Commerce • Wholesaler/Distributor • Manufacturer (OEM) • Tier I, II or III supplier • Agricultural importer/exporter • Marketer/Merchandiser

5. Different Types of Inventory & Operating ModelsAlso Influence How Inventory Management is Executed Operating Model Types of Inventory Build to stock Build to order Assemble to Order Engineer to Order Just In Time Vendor Managed Inventories • Raw materials • Components/sub-assemblies • Work In Process • Finished goods • Distribution inventory • Accessories • Spare parts • MRO

6. As a Vital Component of S&OPInventory Management Really Is A Balancing Act • To a very real extent, S&OP is a balancing act between the need to maximize sales/profits and the amount that must be invested in inventories • That balancing act begins with a forecast and S&OP then comes down to making adjustments between forecasted and actual sales • Within that framework top line sales, landed costs, lead times and inventory investment reign supreme

7. Balancing Sales & Inventories:Financial Outcomes Inventory Investment Balance Sheet Income Statement Sales & Profits Cash Flow from Operating Activities

8. Global Inventory Management:Integrating & Synchronizing the Supply Chain Raw materials, components, sub-assemblies, work-in-process, finished goods, accessories, service parts, MRO S U P P L I E R S C U S T O M E R S MANUFACTURER DISTRIBUTION SYSTEM MATERIALS MANAGEMENT Buy Side DISTRIBUTION MANAGEMENT Sell Side

9. Inventory Management:Guiding Principles & Objectives • Maximize customer service (availability of product) • Contribute to the maximization of sales • Minimize inventory investment • Continuously reduce costs • Constantly increasing inventory accuracy

10. Inventory Management:Guiding Principles & Objectives • Increase productivity • Integrate & synchronized Buy-Side, Sell-Side and inventory management activities • Enhance overall supply chain performance • Increase overall company profitability

11. Global Inventory Management:Strategic & Tactical Considerations • Total dollar investment in global inventories • Number and type of Stock Keeping Units (SKU’s) or Part Numbers to carry • Locations of distribution centers, warehouses and/or satellite operations • By region and/or country • Risk Management policies & procedures

12. Global Inventory Management:Strategic & Tactical Considerations • In-house inventory management or with a Third Party Logistics (3PL) company • Systems integration • Inventory management system • Warehouse management system • Transportation management system • Accounting principles • First In/First Out • Last In/First Out

13. Regardless of the Model or Type of Inventory:I.M.-Related Costs to Consider • Ordering costs • Clerical & Admin support • Carrying costs • Cost of capital • Opportunity cost • Lease • Payroll • Systems • Materials handling equipment • Maintenance • Supplies

14. Regardless of the Model or Type of Inventory:I.M.-Related Costs to Consider • Transportation costs • Ocean, air, surface • Returns & reverse logistics • Risk management • Theft, pilferage & damage • Insurance • Security • Stock-out costs • Expedited transport • Back-order processing • Lost sales • Depletion of customer goodwill

15. Linking Inventory Management WithDemand Management Activities

16. Linking Inventory Management WithDemand Management Activities • Demand Management • Forecasting • Delivery Promising (Available To Promise, ATP) • Order Processing • Inventory Management • Order quantities • Order points • Min/Max levels • Periodic Order Points • Safety Stock • ABC Analysis • Cycle Counting

17. Methods for Determining Order Quantities • Simultaneous to forecasting for demand, decisions must be made on: • In what quantities goods should be ordered • When orders should be placed • Those decisions must be made at an SKU or Part Number level

18. Integrating DRP with Inventory Management:Order Quantities & Order Points • In addition to gross-to-net exploding and lead time off-setting, distribution professionals must also determine order quantities and order points for replenishing finished goods in the distribution network • These activities help to integrate and synchronize DRP with Inventory Management • Economic Order Quantity (EOQ) calculates the optimum replenishment amount by balancingthe total cost of an order with that product’scarryingcost

19. Integrating DRP with Inventory Management:Order Quantities & Order Points • An integrating activity between DRP and inventory management, an “Order Point” is reached when a product’s on-hand quantity reaches a pre-determined level • When inventory is depleted down to that pre-determined level, a replenishment order is generated by the system (based on EOQ in the form of a Planned Order Release) • Remember, order points are a function of demand during lead time and safety stock requirements

20. Inventory Management: Determining Order Points & Order Quantities Item: ABC Order Qty: 1,000 Lead Time: 2 weeks Product-specific order quantities and order points support gross-to-net exploding and lead-time offsetting by providing the quantity of a product that needs to be ordered and at what point it should be ordered. Order quantities and order points can be determined using a variety of tools such as the Economic Order Quantity formula or the Order Point System.

21. Item-Specific Order Points & Quantities:Essential Information For The Item Record • Item name, description, item number and Harmonized System number • Vendor(s) • Where used • Group code • Unit cost • Unit of measure • Stock locations • Inventory classification (ABC)

22. Item-Specific Order Points & Quantities:Essential Information For The Item Record • Usage (average demand) • On-hand balance at each location • Amount allocated • On-order info by due date • Re-order and safety stock information • Order quantity • Lead time

23. Economic Order Quantity • EOQ is a formula that is used to determine a replenishment order quantity for a product that balances the total cost of an order with that product’s carrying cost • Variables in the formula are: • Annual usage in units • Unit cost • Annual carrying cost • Ordering cost per order

24. Economic Order Quantity • Demand is relatively constant • Product is produced or purchased in lots and not continuously • Order costs and carrying costs are constant • Replacement occurs all at once • Lead time is stable • No volume discounts used • Best used for finished goods with independent (and predictable) demand

25. The EOQ Formula:Where Ordering & Carrying Costs Are Equal √ 2AS ic EOQ = A = Annual usage S = Cost per order i = Carrying cost (%) c = Cost per unit

26. The EOQ Formula:Where Ordering & Carrying Costs Are Equal √ 2AS ic EOQ = EOQ = 200 A = 1000 units S = $20 per order i = 20% c = $5 per unit Q = ?

27. Understanding the EOQ Formula 200 Q = 200 Units In Stock 100 -EOQ (Q) is 200 units -Quantity of an item decreases at a uniform rate -Usage is 100 units per week -Lead time is two weeks -Vertical line represents stock arriving at once 3 2 1 4 Time (Weeks)

28. Understanding the EOQ Formula 200 Q = 200 Units In Stock 100 Average inventory = Order quantity = 200 = 100 Units 2 2 Number of orders per year = Annual demand = 100 x 52 = 26 times per year Order quantity 200 3 2 1 4 Time (Weeks)

29. Periodic Order Quantity (POQ) • EOQ intends to balance the total cost of an order with its carrying cost • Periodic Order Quantity (POQ) calculates the period of time between orders • Instead of ordering the quantity, orders are placed to satisfy time intervals (quantities will differ based on actual demand) • Assumes that demand is uniform

30. Periodic Order Quantity (POQ) EOQ Average Weekly Demand POQ = 2800 1000 = = 2.8 weeks (3) Annual demand: 52,000 units Weekly demand: 1000 units EOQ: 2800

31. The Order Point System • When the quantity of an item falls to a pre-determined level (order point), a replenishment order must be placed • The quantity to be ordered is often based on EOQ concepts • The key factor about the O.P. methodology is that it considers product demand during lead time (DDLT) • O.P. also considers Safety Stock (SS) in its calculation

32. The Order Point System Order Point = DDLT + SS DDLT = Demand During Lead Time SS = Safety Stock (Safety Stock is carried to safeguard against supply chain variance(s)… Forecast, demand, lead time, etc.)

33. Product-Specific Order Point Example Order Point = DDLT + SS Demand = 200 units/week Lead time = 3 weeks Safety Stock = 300 units (200 x 3) + 300 = Order Point of 900 Units DDLT = Demand During Lead Time SS = Safety Stock (Safety Stock is carried to safeguard against supply chain variance(s)… Forecast, demand, lead time, etc.)

34. The Order Point System:The Significance of SS, LT & Q Order Point Q = Order Qty Safety Stock Units In Stock Lead Time

35. The Order Point System Order Point = DDLT + SS Demand = 200 units/week Lead time = 3 weeks Safety Stock = 300 units (200 x 3) + 300 = Order Point of 900 Units DDLT = Demand During Lead Time SS = Safety Stock (Safety Stock is carried to safeguard against supply chain variance(s)… Forecast, demand, lead time, etc.

36. Inventory Management:The Use of Min/Max Levels • A type of order point replenishment system where the “min” is the order point and the “max” is the order up to level • Order quantity is variable and depends on item usage during prior periods • ERP systems automatically notify the user to place an order • Lead time accuracy is integral to min/max success • High mins and maxes offer potential to bloat inventories • Used often for dependent demand items

37. Safety Stock &Inventory Management • Safety stock is additional inventory that is intended to safeguard against supply chain variation • Variation in quantity • Variation in timing • Factors that influence SS • Demand variabilityduring lead time • Frequency of reorder • Service level desired • Length of lead time • Variability of lead time

38. Safety Stock &Inventory Management • To determine SS, one must be able to measure variation in DDLT • It is this same variation that must resonate back up the supply chain through S&OP • Safety stock is determined by using the Standard Deviation calculation

39. The Standard Deviation &Determining Safety Stock • A statistical value that measures how closely individual values (demand per period) varies from the average • The Standard Deviation is the math that lies behind the S&OP practice of comparing actual events to forecasted outcomes • Actual demand vs. Forecasted demand • When used properly, the Standard Deviation can determine Safety Stock

40. Essentials of Effective Inventory Management:ABC Classification & Analysis • Built upon the premise of Pareto Analysis • States that 80% of the output (effect) of a given activity or process is generated by 20% of the inputs (cause) • It is a prioritization tool designed to separate the “trivial many from the vital few” • Many business applications: • 80% of a company’s sales comes from 20% of the total number of customers • 80% of total inventory value and/or movement comes from 20% of the SKU’s

41. Pareto Curve 100 80 Effect 60 40 20

42. Essentials of Effective Inventory Management:ABC Classification Example: 16,000 SKU’s Total Value: $5m USD 3200 SKU’s = $4m 12,800 SKU’s = $1m Observation: If 3,200 SKU’s (20%) is too big to manage, 5% of SKU’s = 55% of total value (800 SKU’s = $2.75m) • The application of Pareto Analysis to I.M. is based on the axiom that the vast majority of inventory activity is generated by a small(er) number of SKU’s • I.M. take P.A. a step further by classifying items based on a combination of their value and usage • 80% of total inventory value comes from 20% of SKU’s • This practice is known as ABC Analysis

43. Essentials of Effective Inventory Management:ABC Classification • Because ABC Analysis is based on stock value and stock usage, the “Annual Turnover” of an item must be calculated • Annual Turnover is found by multiplying an item’s Unit Cost by its Annual Usage • To provide more granularity to the analysis, items are classified as either A, B, or C Annual Turnover = Annual Usage x Unit cost ABC Classification A items = 10% of items, with 65% of turnover B items = 20% of items, with 25% of turnover C items = 70% of items, with 10% of turnover

44. ABC Classification 100 90 80 70 60 50 40 30 20 10 Value A B C SKUs 10 20 30 40 50 60 70 80 90 100

45. ABC Classification Value: $1m EXAMPLE Total items: 100 Total Value: $1m A = 10 items & $650m value B = 20 items & $250k value C = 70 items & $100k value 100 90 80 70 60 50 40 30 20 10 A B C SKUs 10 20 30 40 50 60 70 80 90 100

46. Example of Pareto Analysis

47. ABC Classification By Usage Value

48. Summary of ABC Analysis

49. Inventory Management:Cycle Counting • There is a big difference between periodic (yearly) physical inventories and cycle counting • Physical inventories are for financial purposes (Balance Sheet) • Cycle Counting assures inventory accuracy and is a building block for inventory reductions • The first in reducing inventories is knowing how much you really have • Especially effective for “A” items in an ABC System

50. Inventory Management:Cycle Counting • C.C. is an inventory accuracy auditing practice driven by a perpetual schedule of item-specific counts • Depending on the item, cycle counts can be done weekly, monthly, et al (daily for ultra-high value item like prescription narcotics) • Require the counting of certain items every day rotating locations in a warehouse • Goal is to find errors in physical counts vs. system records and continuously improve accuracy