Intro To Supply Chain Management (Peavey Exam 2) - Chapter 4, 5, and 6 Key Terms

Inventory

The stock of items (raw materials, WIP, finished goods, and MRO supplies) a business holds to meet customer demand or support production.

Why is inventory both an asset and liability?

Asset: supports operations; Liability: ties up capital and incurs storage, insurance, and obsolescence costs.

Four major categories of inventory

Raw materials; Work-in-process; Finished goods; MRO supplies.

Three motives for holding inventory

Transaction motive (routine demand); Precautionary motive (uncertainty); Speculative motive (price/demand changes).

Holding (carrying) costs

Costs of maintaining inventory—capital, storage, insurance, taxes, obsolescence, and shrinkage.

Ordering/setup costs

Costs of placing and receiving orders or setting up production (paperwork, shipping, inspection).

Stockout costs

Costs when inventory runs out—lost sales, rush shipping, loss of goodwill.

Ordering vs. holding cost trade-off

Frequent small orders → lower holding cost, higher ordering cost; large orders → lower ordering cost, higher holding cost.

Economic Order Quantity (EOQ)

Order quantity that minimizes total ordering and holding costs.

EOQ formula

Q* = √(2DS / H), where D = annual demand, S = ordering cost, H = annual holding cost per unit.

EOQ assumptions

Constant demand and lead time, no shortages, instantaneous replenishment, fixed ordering cost.

Reorder Point (ROP)

Inventory level at which a new order should be placed. ROP = Lead Time × Demand Rate.

Safety stock

Extra inventory kept to protect against demand or lead-time variability.

Factors affecting safety stock

Demand variability, lead-time variability, desired service level, and stockout cost.

Economic Production Quantity (EPQ)

EOQ variant for items produced and consumed simultaneously.

EPQ formula

Q* = √[2DS / H(1 − d/p)], where d = demand rate, p = production rate.

Average inventory under EPQ

(Q / 2) × (1 − d/p).

Q-system (continuous review)

Inventory is continuously monitored; order a fixed quantity when it hits the reorder point.

P-system (periodic review)

Inventory reviewed at fixed intervals; order enough to reach a target level.

Advantages of Q-system

Lower average inventory, immediate replenishment, responsive to demand changes.

Advantages of P-system

Simple scheduling, batch ordering, consistent review timing.

Inventory on the balance sheet

Appears as a current asset but reduces liquidity and flexibility if excessive.

Modern inventory practices

JIT, Lean, Postponement, Vendor-Managed Inventory (VMI), CPFR.

Purpose of forecasting in inventory

Improves demand estimates, reducing excess inventory and stockouts.

Total inventory cost perspective

Optimize the combination of holding, ordering, and stockout costs—not just one.

Effect of doubling demand on EOQ

EOQ increases by √2 (≈ 41%).

Effect of doubling holding cost on EOQ

EOQ decreases by √½ (≈ 29%).

Why safety stock is a service-level decision

It balances cost of extra inventory with desired probability of avoiding stockouts.

Main goal of inventory management

Maintain enough inventory to meet demand while minimizing total cost.

Procurement

The process of selecting and vetting suppliers, negotiating contracts, establishing payment terms, and purchasing goods and services.

Purchasing

The action of obtaining merchandise, capital equipment, raw materials, services, or MRO supplies in exchange for money; the transactional component of procurement.

Purchase Requisition (PR)

An internal document that identifies the need for goods or services, specifying quantity and timeframe; does not itself create a contractual obligation.

Purchase Order (PO)

A formal external document issued by the buyer to the seller that becomes a legally-binding contract once accepted by the supplier.

E-Procurement

The automation of non-strategic and transactional purchasing activities via web-enabled tools (e.g., RFI/RFQ tools, reverse auctions).

Profit-Leverage Effect

A decrease in purchasing expenditures leads to a dollar-for-dollar increase in profits before taxes, assuming quality is maintained.

Return on Assets (ROA) Effect

Higher ROA indicates effective use of assets; reductions in purchasing cost can improve ROA.

Inventory Turnover Effect

A high inventory turnover ratio means efficient sales relative to inventory held; low turnover implies inefficiency or excess.

Total Cost of Ownership (TCO)

The sum of all costs associated with every activity in a product's supply stream (beyond just purchase price).

QSDP Framework (Quality, Service, Delivery, Price)

The four elements that impact TCO.

Centralized Purchasing

A purchasing structure where decisions are made at the corporate/central office level; advantages include purchase volume leverage, specialization, avoiding duplication.

Decentralized Purchasing

A structure where individual business units or locations make their own purchasing decisions; may support flexibility but reduce volume leverage.

Government & Non-Profit Purchasing

Purchasing functions in public and nonprofit sectors, requiring openness, accountability, often competitive bidding processes such as sealed bids.

Competitive Bidding

A procurement process where bids are solicited from competing suppliers; open vs closed bidding depending on visibility of process.

Bid Bond

A security deposit by a bidder to guarantee that if their bid is accepted they will execute the contract.

Performance Bond

A guarantee by the bidder that the work will meet contract terms (quality/time); forfeited if obligations are not met.

Purchase Order Cycle Time (POCT)

The time span from placing a purchase requisition to transmitting the purchase order to the supplier; a key performance metric.

Supplier Return on Inventory (SROI)

Measures total profit on SKUs provided by a vendor divided by the average inventory value for that vendor; indicates vendor inventory efficiency.

Total Supply Cost (TSC)

The total cost of acquiring and managing supplies, including personnel, support systems, logistics, etc.

Supplier-Item Activity Profile (SIAP)

A data profile tracking purchasing activity by supplier and item (volume, frequency, weight, etc) to support negotiations and optimization.

Strategic vs Operational Purchasing Activities

Strategic: managing relationships with critical suppliers, developing best practices, negotiation of supply contracts. Operational: executing transactions, sourcing standard items, processing orders.

Insourcing vs Outsourcing (Make vs Buy Decision)

The decision whether to produce internally or purchase externally, considering cost, capability, focus, and strategic impact.

Strategic Sourcing

A sourcing method applying strategic analysis (spend, market, supplier) to align sourcing with business goals and optimize total cost and value rather than just price.

Supplier Market Analysis

The process of researching and understanding the supply market (number of suppliers, cost drivers, risks, market share) as part of strategic sourcing.

Spend Analysis

Evaluating historical and current spending patterns (by category, supplier, etc.) to identify opportunities for consolidation and cost reduction.

Total Cost of Ownership (TCO)

The aggregate cost of acquiring, owning, and disposing of a product or service including purchase price, maintenance, inventory, risk, disposal costs.

Category Management

Managing sourcing by grouping similar purchases into 'categories' and applying strategic sourcing practices for each category.

Supplier Segmentation

Classifying suppliers (e.g., strategic, preferred, transactional) based on value and risk to prioritize resources and relationships.

Make-vs-Buy Decision (Insourcing vs Outsourcing)

The decision to produce internally or purchase from an external vendor, based on cost, capability, focus, risk.

Supplier Relationship Management (SRM)

The ongoing process of building and maintaining relationships with suppliers to drive value, innovation, performance.

Risk Management in Sourcing

Identifying, evaluating, and mitigating risks in the supplier/sourcing process — e.g., supply disruption, quality issues, geopolitical risk.

Strategic vs Tactical Sourcing

Strategic: long-term, focused on value, relationships, market; Tactical: transactional, focused on price, day-to-day orders.

Sourcing Strategy Development

Crafting a plan (supplier choices, contract structure, volume leverage, negotiation strategy) to meet category goals and business objectives.

Supplier Consolidation

Reducing number of suppliers in a category to increase volume with fewer suppliers, improving leverage and efficiency.

Competitive Bidding / e-RFX

Using formal solicitation processes (RFI, RFQ, RFP) and sometimes reverse auctions to select suppliers under competitive conditions.

Global Sourcing vs Local Sourcing

Evaluating sourcing from international suppliers (advantages: cost, capacity; disadvantages: risk, logistics) vs domestic/local.

Sustainable and Ethical Sourcing

Including environmental, social, governance (ESG) criteria into supplier and sourcing decisions for long-term value and risk reduction.

Performance Metrics for Sourcing

Measures used to evaluate sourcing success: cost savings, supplier performance (quality/delivery), inventory levels, risk incidents.

Continuous Improvement in Sourcing

The practice of regularly reviewing the sourcing strategy and supplier performance to adjust and improve over time.

Cross-Functional Sourcing Team

Using stakeholders from procurement, operations, finance, legal to ensure sourcing decisions align with overall business strategy.

Strategic Sourcing Process Steps

Common steps: spend analysis → market analysis → cost assessment → supplier selection → implementation → review & improvement.

Value-Based Sourcing

Focusing sourcing decisions on overall business value (innovation, quality, speed to market) rather than only on lowest cost.

Supplier Innovation and Collaboration

Leveraging strategic suppliers not just for cost but for innovation, co-development, continuous improvement.

Leverage vs. Strategic Suppliers

Using high-volume/leverage suppliers for cost reduction vs strategic suppliers for relationship, innovation, competitive advantage.

Tail‐Spend Management

Managing the many small, low-value purchases that often escape strategic sourcing processes to capture savings and reduce risk.

Contract Lifecycle Management in Sourcing

Managing contracts from negotiation to renewal, performance monitoring, termination, to ensure sourcing strategy delivers.

Sourcing Governance & Policy

Establishing rules, roles, approvals, supplier standards, ethics, compliance for sourcing function to operate strategically.

Technology in Strategic Sourcing

Use of analytics, e-sourcing platforms, dashboards, AI to support sourcing data, decisions, supplier management.

Supplier Development / Capability Building

Working with suppliers to improve their capabilities (quality, cost, innovation) over time as part of strategic sourcing.

Spend Visibility

The ability to see, analyze and understand all procurement spend (direct, indirect, services) as a foundation for strategic sourcing.

Segmenting Spend by Value/Risk

Categorizing spend on two dimensions: value to business and risk in supply base, to prioritise sourcing actions accordingly.

Sourcing Policy for Innovation vs Cost

Recognizing when the goal is cost reduction vs innovation acceleration, and tailoring sourcing approach accordingly.

Strategic Sourcing and Supply Chain Resilience

Using sourcing to build resilience: multiple suppliers, local-regional sourcing, risk buffers, supply chain visibility.

Supplier Performance Scorecards

Tools to monitor supplier KPIs: on-time delivery, quality defects, cost of poor performance, innovation contributions.

Collaborative Sourcing

Working with internal stakeholders and suppliers jointly to design sourcing solutions that align with business and supply base.