Chapter 4 inventory management

Chapter 4 Inventory management IBS3002 Logistics International Trade 9232020 1 IBS3002 Logistics International Trade Chapter 4 Inventory management 1 Contemporary logistics, Murphy (2015) Topic areas  Inventory  Classifying.

9/23/2020 IBS3002 Logistics & International Trade Chapter Inventory management Contemporary logistics, Murphy (2015) Topic areas  Inventory  Classifying inventory  Inventory costs  Inventory decisions  Inventory flow patterns  Inventory management  Contemporary approaches to managing inventory 9/23/2020 Inventory  Inventory: stocks of goods and materials that are maintained for many purposes, the most common being to satisfy normal demand patterns  Inventory management: is a systematic approach to sourcing, storing, and selling inventory—both raw materials (components) and finished goods (products)  Inventory management is a key component in logistics & SCM because its decisions are a driver for other business activities Inventory  Management must reduce inventory levels yet avoid stockouts and other problems  Important of inventory in other organizational functions:  Marketing – more inventory for higher customer service  Manufacturing – more inventory to schedule longer productions runs  Finance – less inventory to keep inventory turnover ratios high (reduce risk inventory loss) and to keep Return on Assets (ROA) high (increase competitiveness) 9/23/2020 Inventory classifications  Cycle (base) stock: inventory that is needed to satisfy normal demand during the course of an order cycle  Safety (buffer) stock: inventory that is held in addition to cycle stock to guard against uncertainty in demand or lead time  Pipeline (in-transit) stock: inventory that is en route between various fixed facilities in a logistics system (plant, warehouse, store…)  Speculative stock: inventory that is held for several reasons, including seasonal demand, projected price increases and potential shortages of product Inventory classifications  Cycle (base) stock: inventory that is needed to satisfy normal demand during the course of an order cycle  Safety (buffer) stock: inventory that is held in addition to cycle stock to guard against uncertainty in demand or lead time  Pipeline (in-transit) stock: inventory that is en route between various fixed facilities in a logistics system (plant, warehouse, store…)  Speculative stock: inventory that is held for several reasons, including seasonal demand, projected price increases and potential shortages of product 9/23/2020 Inventory costs  Inventory costs are important: - Represent a significant component of costs in many organizations - Inventory levels kept affect the level of service the organization can offer its customers - Cost tradeoff decisions in logistics depend on and ultimately impact inventory carrying costs  Inventory costs include: - Carrying costs - Ordering costs - Stockout costs Inventory costs  Carrying costs:  Carrying costs refer to the costs associated with holding inventory  Inventory costs are expressed in percentage terms & this percentage is multiplied by the inventory’s value  Components of inventory carrying costs: - Obsolescence costs - Taxes - Inventory shrinkage - Interest costs - Storage costs - Handling costs - Insurance costs 9/23/2020 Inventory costs  Carrying costs:  Obsolescence cots: are incurred when an item in inventory becomes obsolete before it is sold or used (i.e perishable products-meat, milk…)  Inventory shrinkage: is the excess amount of inventory listed in the accounting records, but which no longer exists in the actual inventory (i.e damage, loss, theft )  Storage costs: costs associated with occupying space in a plant, storeroom, or warehousing facility  Handling costs: costs of employing staff to receive, store, retrieve, move inventory  Insurance costs: insure inventory against fire, flood, theft, other perils…  Interest costs: money required to maintain the investment in inventory  Taxes Inventory costs  Ordering costs:  Ordering costs refer to the costs associated with ordering inventory, including order costs and setup costs  Order costs: the costs of receiving an order They include: + The transaction costs associated with making an international purchase: international wire transfers, letters of credit, and bank fees + The document costs, such as certificates of origin, import license, customs brokerage fees + The time spent, as all international purchases take more time than domestic purchases 10 9/23/2020 Inventory costs  Ordering costs:  Setup costs: are those necessary to modify production processes to make the products necessary to satisfy particular orders They include: + The process-change costs associated with switching from making one type of part to making another type of part Different raw materials, different settings, different speed + The time involved in making the change, from employees’ costs to production downtime costs 11 Inventory costs An offset printing machine incurs a setup cost when production changes from one job to another 12 9/23/2020 Inventory costs  Stockout costs:  Stockout costs (shortage costs) are costs caused by product shortages on the shelf  They may be an effect of wrong forecasting, supplier-retailer communication and/or logistics management  It involves an understanding of a customer’s reaction to a company being out of stock when a customer wants to buy an item  There are types of customer response to a stockout: + delayed sale (brand loyalty) + lost sale (switches and comes back) + lost customer => cost of stockout 13 Inventory costs  Trade-off between Carrying & Ordering costs: • The trade-off that exists between carrying and ordering costs is that they respond in opposite ways to the number of orders or size of orders • An increase in the number of orders leads to higher order costs & lower carrying costs  Trade-off between Carrying & Stockout costs: • The trade-off between carrying and stockout costs is that both move in opposite directions – higher inventory levels (higher inventory carrying costs) result in lower chances of a stockout (lower stockout costs) 14 9/23/2020 Inventory costs 15 Lead time  The lead time is the period between the moment an order is placed and the time at which it arrives 16 9/23/2020 When to order  Fixed order interval system: the time interval is constant, the order size may fluctuate -> The inventory is replenished at regular intervals, and the quantity of goods reordered changes 17 When to order  Fixed order quantity system: the time interval may fluctuate, the order size stays constant -> The inventory is replenished whenever inventory level reaches a certain point The periodicity changes 18 9/23/2020 When to order  Reorder point (trigger point): the level of inventory at which a replenishment order is placed • The firm reorders the goods when the inventory level has reached a point that is equal to the expected demand during the lead time ROP = DD x RC - ROP: reorder point - DD: average daily demand (unit) - RC: replenishment cycle (day/ week/ month) 19 When to order  Example: Average daily demand is 40 units, the replenishment cycle is days The order point is 40x4=160 units -> when the inventory level reaches 160 units, a reorder is placed  Reorder point is used for an efficient fixed order quantity system -> require relatively frequent monitoring of inventory levels  Inventory levels are monitored much less frequent in fixed order interval system -> make this system much more susceptible to stockout situations -> higher levels of safety stock 20 10 9/23/2020 How to order 25 How to order EOQ  AB / C - EOQ: the most economic order size, in dollars - A: annual usage, in dollars - B: administrative costs per order of placing the order - C: carrying costs of the inventory (expressed as an annual percentage of the inventory dollar value) 26 13 9/23/2020 How to order  Example: suppose that $1000 of a particular items is used each year, the order costs are $25 per order submitted, inventory carrying costs are 20% EOQ in dollars EOQ  x1000 x25 / 0.2  250000  500dollars -> Therefore, EOQ is $500 order size 27 How to order EOQ  2DB / IC - EOQ: the most economic order size, in units - D: annual demand, in units - B: administrative costs per order of placing the order - C: carrying costs of the inventory (expressed as an annual percentage of the inventory dollar value) - I: dollar value of the inventory, per unit 28 14 9/23/2020 How to order  Example: suppose that $1000 of a particular items is used each year, the product has a cost of $5 per unit, the order costs are $25 per order submitted, inventory carrying costs are 20% - Annual demand: D = 1000/5 = 200 units EOQ  2DB / IC  x200 x25 / 0.2 x5  10000 /  100units -> Therefore, EOQ is 100 units 29 How to order The total cost calculations for several other order size: -> The total cost is minimized at EOQ 30 15 9/23/2020 Inventory flows 31 How to order * Assumption:  EOQ: 120 units  Safety stock: 60 units  Average demand: 30 units per day  Order cycle: days  Beginning inventory = EOQ + safety stock = 120 + 60 = 180 units  Reorder point = (daily demand x replenishment cycle) + safety stock = 30x2 + 60 = 120 units 32 16 9/23/2020 How to order • Safety stock can prevent against two problem areas: an increased rate of demand and a longer-than-normal replenishment • When a fixed order quantity system (EOQ) is used, the time between orders may vary • Requirement of using a fixed order quantity system: that the level of inventory must constantly be monitored, when the reorder point is hit, the fixed order quantity is ordered -> use technology advances to monitor inventory constantly -> reorder point is established electronically 33 Inventory management: special concerns  ABC Analysis of Inventory:  ABC analysis of inventory is the classification of a group of items in decreasing order, based on their value to the business The A group is the most important in terms of the value contributing to the company, whilst C items are the least valuable  The 80/20 rule: 80% of a company’s sales come from 20% of its products & conversely  Company should focus on the 20% of products that generate the 80% of sales -> decrease inventory carrying costs 34 17 9/23/2020 Inventory management: special concerns  ABC Analysis of Inventory: 35 Inventory management: special concerns  ABC Analysis of Inventory:  Measures to determine ABC status: sales volume in dollars, sales volume in units, the fastest-selling items, item profitability & item importance  Group A usually represents 10-20% by number of items and accounts for 50-80% of dollar volume  Group C contains 60-70% of the items but only accounts for 10-30% of the dollar volume  Group B has more items than group C but less than group A, with the value is higher than group C but far less than group A in volume 36 18 9/23/2020 Inventory management: special concerns  ABC Analysis of Inventory:  The determination of what percentage of items should be classified as A, B, C may have effect on the efficiencies of inventory -> too high or too low a percentage of A items may reduce the potential efficiencies to be gained from the classification technique  ABC analysis can determine stocking patterns in warehousing facilities  ABC analysis could be used to determine how frequently inventory gets monitored 37 Inventory management: special concerns  ABC Analysis of Inventory:  A items might be checked daily (increasingly, hourly)  B items weekly  C items monthly 38 19 9/23/2020 Inventory management: special concerns  Dead Inventory:  Dead inventory (dead stock) refers to a product for which there is no sales during a 12-month period  Dead inventory increases inventory carrying costs, takes up space in warehousing facilities -> need to have structured process for managing  How to deal with dead stock? -> drastic price reductions bunching it with more attractive products, use deadstock broker, donations… 39 Inventory management: special concerns  Inventory Turnover:  Inventory turnover: the number of times that inventory is sold in a one-year period  Inventory turnover can be calculated: Inventory turnover = the cost of goods sold / the average inventory The average inventory = (beginning inventory + ending inventory) / 40 20 9/23/2020 Inventory management: special concerns  Inventory Turnover:  Inventory turnover measures how fast a company sells inventory & compare it to competitors or industry averages -> organization’s competitiveness & efficiency  A low turnover: weak sales, overstocking  A high turnover: strong sales, low level of inventories  Inventory turnover related to trade-offs involving organizational functions: marketing (price) – finance (profit) – logistics (inventory turnover) 41 Inventory management: special concerns  Inventory Turnover:  How to increase inventory turnover? -> reducing average inventory -> how to reducing average inventory? -> ABC analysis & Dead inventory 42 21 9/23/2020 Inventory management: special concerns  Complementary products: and Substitute  Complementary goods are products which are consumed and distributed together (i.e razor blades and razors) -> pressure on retailers/wholesalers involving inventory maintenance -> need to consider the amount of inventory to be carried because complementary products is necessary to support the sale of its complement 43 Inventory management: special concerns  Complementary and Substitute products:  Substitute goods refer to products that can fill the same need or want as another product - The substitutability can occur at a specific product level (i.e Coca-Cola & Pepsi) or across product classes (i.e potatoes & rice) - Implications for stockout costs and the maintaining of size of safety stock 44 22 9/23/2020 Contemporary issues with managing inventory  Lean Manufacturing (Lean)  Lean manufacturing is the methodology that focuses on the elimination of waste and the increase of speed and flow  The idea of lean manufacturing was first championed by the model “The Toyota Way” (Toyota Production System) in the 1930 at Toyota - Japan  It was officially called “Lean” in the book “The Machine that Changed the World” in the 1990s 45 Contemporary issues with managing inventory  Lean Manufacturing (Lean)  Lean thinking aims to identify and remove wastes from work processes  Waste is any action or step in a process that does not add value to the customer In other words, waste is any process that the customer does not want to pay for  major sources of waste – TIMWOOD  TIMWOOD - Transportation, Inventory, Motion, Waiting, Overproduction, Overprocessing and Defects 46 23 9/23/2020 Contemporary issues with managing inventory  Just-in-time (JIT)  JIT approach seeks to minimize inventory by reducing (if not eliminating) safety stock, and by having the required amount of materials arrive at the production location at the exact time that they are needed  JIT inventory management focuses on minimizing inventory and increasing efficiency in logistics  JIT emphasizes minimal inventory levels, low (no) safety stock & defective materials  Trucking is an important mode of transportation in the JIT approach to meet some requirements from JIT system: smaller orders, more frequent shipments, closer supplier location  The aim of JIT: encompass movement of materials and component parts from supplier to producer 47 Contemporary issues with managing inventory 48 24 9/23/2020 Contemporary issues with managing inventory  ECR & QR  Efficient consumer response (ECR) and Quick response (QR) tend to focus on product movement from manufacturer to retailer  ECR is associated with the grocery and beverage industries  QR is associated with the apparel industry 49 Contemporary issues with managing inventory  Service Part Logistics  Service parts logistics involves designing a network of facilities to stock service parts, deciding upon inventory ordering policies, stocking the required parts, and transporting parts from stocking facilities to customers 50 25 9/23/2020 Contemporary issues with managing inventory  Vendor-Managed Inventory (VMI)  Vendor-managed inventory (VMI) is an inventory management technique in which a supplier of goods, usually the manufacturer, is responsible for optimizing the inventory held by a distributor  The size and timing of replenishment orders are the responsibility of the manufacturing (vendor)  VIM requires the access to EDI or Internet 51 Contemporary issues with managing inventory  Vendor-Managed Inventory (VMI)  VMI allows manufacturers to have access to a distributor’s or retailer’s sales and inventory data -> to plan inventory and place orders  Benefits of VMI: reduced inventories, fewer stockouts, improved customer retention, reduced reliance on demand forecasting  Drawbacks of VMI: inadequate data sharing between the relevant parties, increase cost in technology (EDI), resistance in the change to a new system 52 26 9/23/2020 Inventory management as a marketing tool  A benefit of good inventory management is that companies are able to deliver goods to their customers when the goods are needed There is a greater likelihood that the item is in inventory and available for sale  Good inventory practices also lower costs, which allows a company to be more profitable or allows a company to sell at a lower price, which translates into a competitive advantage  Good inventory practices (an MRP) allows companies to inform their customers of the status of an order 53 27 ... sold / the average inventory The average inventory = (beginning inventory + ending inventory) / 40 20 9/23/2020 Inventory management: special concerns  Inventory Turnover:  Inventory turnover... -> decrease inventory carrying costs 34 17 9/23/2020 Inventory management: special concerns  ABC Analysis of Inventory: 35 Inventory management: special concerns  ABC Analysis of Inventory: ... concerns  Inventory Turnover:  How to increase inventory turnover? -> reducing average inventory -> how to reducing average inventory? -> ABC analysis & Dead inventory 42 21 9/23/2020 Inventory management: