Supply Chain Chapters 4-6

Inventory

Quantities of goods and materials that are held in stock

Categories of Inventory

Raw Materials
Work in-Process
Finished Goods
Maintenance, Repair, and Operating Supplies

Raw Materials

Purchased items or extracted materials that are converted via manufacturing into components and products

Work in-Process (WIP)

Goods in various stages of completion throughout the plant, aim to minimize WIP

Finished Goods

Products of which all manufacturing operations have been completed, and are now available for sale and/or shipment to customer

Maintenance, Repair, and Operating (MRO) Supplies

Items used in support of general operations and maintenance, expensed at the time of purchase

Service Inventory

Activities carried out in advance of customer’s arrival

Goal of Inventory Management

Lower COGS and/or increase sales

Why hold inventory?

Meet customer demand

Buffer against uncertainty in supply/demand
Decouple supply from demand
Decouple dependencies in supply chain

Levels of Internal Inventory

Cycle stock, Safety stock, Strategic stockC

External Inventory

AKA pipeline inventory held by downstream supply chain partners

Cycle Stock

Inventory that satisfies its immediate demand

Safety Stock

Inventory that is above and beyond what is needed

Strategic Stock

Beyond safety and cycle, used for a very specific purpose or future event for a defined period of time
AKA anticipation, build, or seasonal stock

Pipeline Inventory

Inventory in transportation network, distribution system, or already out in the market held by wholesalers, distributors, retailers, or consumers

Obsolete Inventory

Inventory that has met the obsolescence criteria established by company, takes up space and costs money to maintain and dispose

Direct Costs

DIirectly traceable to unit produced (materials, labor)

Indirect Costs

Cannot be directly traced to the unit produced (overhead, MRO, equipment)

Variable Costs

Dependent on unit volume produced (materials, labor, utility power)

Fixed Costs

Independent of unit volume produced (buildings, equipment, rent), AKA sunk costs

Carrying Costs

Cost for physically having, storing, and maintaining inventory on-site

Order Costs

Labor costs associated with placing and receiving an order for inventory

Issues with too much inventory

Tied up financial resources, hidden underlying problems, no incentive for process improvements

Issues with too little inventory

Disruptions create additional costs, longer delivery replenishment lead times, reduced responsiveness, lost revenue

Inventory Turnover

COGS / Average Inventory

Periodic Review System

Inventory levels are reviewed at a set frequency and replenishment order is placed if inventory is below a pre-determined level

Advantages of Periodic Review System

Reduces time spent analyzing inventory

Less expensive to implement and operate

Disadvantages of Periodic Review System

Difficult to determine best review intervals

Makes inventory accounts less accurate

Greater need for safety stock

Continuous Review System

Inventory levels are continuously reviewed

Advantages of Continuous Review System

Allows for real-time inventory updates

Facilitates accurate accounting of inventory

Potentially less need for safety stock

Disadvantages of Continuous Review System

Cost of implementing is high

Reorder Point

Lowest inventory level at which new order must be placed to avoid a stockout
= Demand * Lead Time + Safety Stock

Fixed-Time Period System

Inventory levels are checked in fixed time periods
Order Quantity = Target Inventory Level - Inventory Position

Fixed-Order Quantity System

Continuous inventory review system in which same quantity is used order-to-order (uses EOQ to calculate quantity)

Economic Order Quantity

Based on tradeoff between annual inventory order costs and annual inventory carrying costs
= sqrt[ (2 * order cost * annual demand) / (annual carrying cost % * unit cost) ]

ABC System

Classifies inventory based on importance into buckets A, B, and C
A - accounts for 20% of items, 80% of costs
B + C - accounts for 80% of items, 20% of costsB

Bin System

Uses either one or two bins to hold a quantity of the item inventoried, so once the first bin is depleted, an order is placed to refill / replace inventory, usually used for small or low value items

Base Level Stock System

Issues an order whenever a withdrawal is made from inventory (JIT), replenishment quantity is equal to withdrawal amount, used for expensive items

Single-Period Model

Inventory is order for one-time stocking, maximizes profits

Inventory Control Methods

Linear/2D Bar Codes, Barcode Reader, Radio Frequency Identification (RFID)

Radio Frequency Identification (RFID)

Does not require direct line of sight of tag and is updatable

Procurement

Process of selecting and vetting suppliers, negotiating contracts, establishing payment terms, and purchasing goods and services

Purchasing

Action of obtaining merchandise, capital equipment, raw materials, services, or MRO supplies in exchange for money, or equivalent

Supply Management

Newer term that encompasses all acquisition activities beyond simple purchase transactions

Purchase Requisition

Internal document that defines the need for goods or services

Purchase Order (PO)

External commercial document that represents the official offer from buyer to seller to acquire goods or services, becomes legally binding when accepted by supplier

e-Procurement

B2B purchase and sale of supplies and services over the internet

Merchants

Wholesalers and retailers who purchase for resale

Industrial Buyers

Individuals within an organization who purchase raw materials for conversion into products, purchase services, capital equipment, and MRO supplies

Contracting

Term used for the acquisition of services

Request for Information (RFI)

Standard business process whose purpose is to collect written information about capabilities of suppliers

Request for Proposal (RFP)

Detailed capabilities document used to determine a supplier’s capability and interest in the production of a product or service

Request for Quote (RFQ)

Document used to solicit bids from interested and qualified suppliers for goods and services that the organization needs to obtain

Objectives of Purchasing

1. Ensure uninterrupted flow of materials and services at the lowest cost

2. Improve quality of finished goods produced

3. Optimize customer satisfaction

Purchasing Process Steps

1. A need is identified and Purchase Requisition issued

2. Obtain authorization as necessary

3. Identify and evaluate potential suppliers via RFI

4. Make supplier selection and issue an RFP for purchasing new items and RFQ for routine items

5. PO is created and sent to supplier

6. Supplier confirms PO

7. Supplier delivers item to buyer (fulfillment)

8. Receipt of goods

9. Supplier send invoice and reconciliation of PO

10. Payment is processed

11. PO is closed out if all requirements are met

12. Analysis of efficiency and accuracy of process

Advantages of E-Procurement

Automates RFI, RFP, RFQ, analysis, execution, and reverse auction capabilities

Provides visibility of all purchases

Time-savings, cost savings, accuracy, real-time, management, mobility, and trackability

Financial Effects of Purchasing

Profit-Leverage Effect

Return on Assets Effect

Inventory Turnover Effect

Profit-Leverage Effect

Decrease in purchasing expenses directly increases profits before taxes at a greater magnitude than increasing top-line sales

Return on Assets Effect

High ROA indicates managerial prowess in generating profits with lower spending

Inventory Turnover Effect

Increased turnover indicates optimal usage of space and inventory levels, increased sales, and avoidance of obsolescence

Total Cost of Ownership

Sum of all costs associated with every activity in the supply stream

4 Elements of Cost

Quality, Service, Delivery, Price (QSDP)

Factors of Make vs Buy Strategy

1. Business Strategy

2. Risks

3. Economic Factors

Qualitative Reasons for Making

Protect proprietary information

No competent supplier

Control of lead-time

Use existing idle capacity

Better quality control

Quantitative Reasons for Making

Overall lower cost

Control of transportation and warehouse costs

Costs of Making

Direct labor, inventory carrying, capital expenses, purchasing expenses (raw materials), factory opening expenses, managerial expenses, transportation expenses for supplies, follow-on expenses

Qualitative Reasons for Buying

Non-strategic item

Insufficient capacity

Temporary capacity constraints

Lack of expertise

Quality

Multi-sourcing strategy

Brand strategy

Quantitative Reasons for Buying

Cost advantage

Inventory considerations

Costs of Buying

Unit price, transportation expenses, purchasing expenses, receiving and inspection expenses, follow-on expenses

In-Sourcing

Reverting to in-house production when external quality, delivery, and services do not meet expectations

Co-Sourcing

Sharing a process or function between internal staff and an external provider or using dedicated staff at an external provider that works exclusively under your control and direction

Backward Vertical Integration

Refers to acquiring suppliers

Forward Vertical Integration

Refers to acquiring customers

Centralized Purchasing

Purchasing department located in company headquarters

Decentralized Purchasing

Individual, local purchasing departments at plant level

Hybrid Purchasing

Centralized for products and services used throughout the organization, decentralized for products and services used locally at each facility

Import Brokers

Agents licensed by the government to conduct business on behalf of importers, for a service fee

Import Merchants

Person or company engaged in sale of imported commodities

Trading Companies

Buy products in one country and sell them in different countries where they have their own distribution network

Bid

Proposal of quotation submitted in response to solicitation from a contracting authority

Competitive Bidding

Procurement process in which bids from competing suppliers for the right to supply specified materials or services are requested
Does NOT allow negotiation, aims for the lowest price without favoritism

Open Competitive Bidding

Allows full view of sealed bids by those who wish to witness the bid opening

Closed Competitive Bidding

Opens sealed bids in presence of authorized personnel

Bid Bond

Debt secured by bidder that provides a guarantee that the successful bidder will accept the contract once awarded

Performance Bond

Debt secured by bidder that provides a guarantee that the work will be done on time and as per specifications

Payment Bond

Debt secured by a bidder that provides protection against 3rd party liens not fulfilled by bidder

Benchmarking

Process of of measuring the performance of a company’s products, services, or processes against those of another business that are considered the best

Sourcing

Process of identifying a company that provides a needed good or service

Strategic Sourcing

A comprehensive approach for location and sourcing key suppliers, so an organization can leverage its consolidated purchasing power to find the best possible values in the market

Drivers of Strategic Sourcing

Improve long-term financial performance

Increase customer focus

Improve product quality

Reduce cost of materials

Reduce delivery lead times

Optimize number of global suppliers

Deliver more innovative products in less time and less expensively

Objectives of Strategic Sourcing

Improve value-to-price relationship

Understand the category buying and management process to identify improvement opportunities

Examine supplier relationships across organization

Develop and implement multi-year contracts

Leverage organization’s spend

Outsourcing

Purchasing an item or service externally

Single-Source

Multiple potential suppliers, but company purchases from only one

Reasons for Single-Source

Establish good relationship

Less quality variability

Lower cost

Transportation economies

Proprietary product or process

Volume too small to split

Multi-Source

Purchasing a good or service from more than one supplier

Reasons for Multi-Source

Need more capacity

Spread risk of supply disruption

Create competition

More sources of information

Dealing with special kind of business

Functional Products

MRO items and commonly low profit margin items with relatively stable demands and high levels of competition (multi-source)

Innovative Products

Short product life cycles, volatile demand, high profit margins, relatively less competition (single-source)

Framework for Sourcing Strategy Development

1. Identify the targeted spend area

2. Create the sourcing team

3. Develop a team strategy and communication plan

4. Gather market information

5. Develop a supplier portfolio

6. Develop a future state

7. Select suppliers and negotiate

8. Implement Supplier Relationship Management (SRM)

Spend Analysis Process

1. Defining the scope (e.g., expenditures over a specific time period)

2. Identify all of the data sources

3. Gathering and consolidating all of the data into one database

4. Cleansing the data (finding and correcting errors) and standardizing it for easy review

5. Categorizing the data (e.g., commodity and sub-commodities)

6. Analyzing the data for:

   1. the best deals per supplier

   2. to ensure that all purchases are from preferred suppliers

   3. to reduce the number of suppliers per category

7. Repeating the process on a regular schedule