Supply Chain Exam 2

What is one of a company’s largest assets?

Inventory

Why is maintaining adequate finished product inventory important?

Allows a company to fill customer orders immediately

Why is maintaining adequate materials inventory important?

Allows a company to support manufacturing operations and the production plan while avoiding delays

Failing to manage inventory adequately can lead to:

significant issues and inefficiencies throughout the supply chain

• dissatisfied customers

• lost sales and revenue

• higher costs

What is inventory?

The quantity of goods and materials that are held in stock

Includes:

• all materials used to support production

• all finished products needed to provide customer service

• all other supplies needed to run a business

Why is holding inventory important?

May be necessary to maintain operations and ensure that products are available when customers demand them

Problems with too much inventory

• Ties up capital which could be used for other purposes

• The more inventory a company holds, the more space is needed, and space costs money

• A company may also have to pay for security, insurance, taxes, etc., to hold inventory

• Inventory can become a liability if it becomes unusable due to expiration, obsolescence, damage, or spoilage

Categories of Inventory

• Raw Materials

• Work-in-Process (WIP)

• Finished Goods

• Maintenance, Repair, and Operation (MRO) supplies

Raw Materials

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

Strategies for holding raw materials in inventory

• Buy from a supplier and have it delivered to the operation just in time for when it is needed

• Buy and hold a larger quantity for strategic reasons

Reasons company’s store raw materials in inventory

• If they fear a potential shortage of the material

• If they suspect upcoming price increase and want to buy at a current lower price

Work-in-Process (WIP)

Goods in various stages of completion throughout the plant, spanning from raw material that has been released for initial processing up to fully processed material awaiting final inspection and acceptance as finished goods

Best practices when it comes to WIP

Minimize the amount of WIP inventory in the manufacturing area, since too much WIP may clutter up the physical space and impede the process flow

Finished Goods

Items on which all manufacturing operations, including final testing, have been completed. These products for sale and/or shipment to the customer.

What are finished goods worth?

Finished goods are usually worth much more than raw materials or WIP since all of the material, labor, and overhead costs are fully applied

Amount of finished goods inventory a company maintains is based on?

• Make-to-Order: little to no finished goods inventory is maintained

• Make-to-Stock: significant amounts of finished goods inventory is maintained

Maintenance, Repair, and Operating (MRO)

Items used in support of general operations and maintenance, but do not end up as part of the finished product

Types of MRO items

• Consumed during the process of converting raw materials into finished goods (oil for the manufacturing equipment)

• Facilitate the manufacturing operation (cleaning supplies, spare parts)

• Facilitate the company’s administrative activities (office supplies, coffee for break room)

Service Inventory

Activities carried out in advance of the customer’s arrival

Inventory in the Service Industry

Companies do not maintain inventory of services since services are produced and consumed immediately upon demand, but they maintain inventory of facilitating goods

Facilitating Goods

Items used to help facilitate the service being provided

• Restaurants cannot inventory dining services, but they can inventory food, tableware, and other elements

Functions of Inventory - Why Hold Inventory?

• To meet customer demand (cycle stock)

• To buffer against uncertainty in demand and/or supply (safety stock)

• To decouple supply from demand (strategic stock)

• To decouple dependencies in the supply chain (strategic stock)

Cycle Stock

• Inventory that a company builds to satisfy its immediate demand

• Depletes gradually as customer orders are received, and is replenished cyclically when supply orders are received

• Amount held is dependent on actual demand in the time period, supply replenishment lead time, and order quantities

Safety Stock

• Also known as buffer stock

• Inventory that is above and beyond what is actually needed to meet anticipated demand

• A quantity of stock planned to be in inventory to protect against fluctuation in demand or supply

• Used by companies operating in a make-to-stock environment

Strategic Stock

• Additional inventory beyond cycle and safety stock, generally used for a very specific purpose or future event, and for a defined period of time

• Also called anticipation stock, build stock, or seasonal stock

Inventory Management

The function of planning and controlling inventories

Goal of inventory management

To help a company be more profitable by lowering the cost of goods sold and/or by increasing sales

What does effective inventory management balance?

• Reducing the amount of inventory held in stock

• Ensuring there is enough inventory to satisfy customer demand

What is the right amount of inventory?

“It depends”

• Depends on the supply chain strategy, type of product, customer expectations, product shelf life, etc.

Pipeline Inventory

• Inventory in the transportation network and distribution system

  • Already out in the market held by wholesalers, distributors, retailers, and even consumers

• Ownership of this inventory has been transferred to the trading partners, but may still influence decisions the company makes

Obsolete Inventory

• Inventory items that have met the obsolescence criteria established by the company

• Stock that has expired, damaged, or is no longer needed

• Will never be used or sold at full value

Inventory Costs

• Direct

• Indirect

• Variable

• Fixed (Sunk Costs)

• Carrying

• Order

Direct Costs

Directly traceable to unit produced (materials, labor, etc.)

Indirect Costs

Cannot be traced directly to the unit produced (overhead, MRO items, buildings, equipment, etc.)

Variable Costs

Dependent on the unit volume produced and vary with output level (materials, labor, utility power, etc.)

Fixed Costs (Sunk Costs)

Independent of the unit volume produced (buildings, equipment, rent, allocated overhead costs, etc.)

Carrying Costs

Costs for physically having inventory on-site and for maintaining the infrastructure needed to store the inventory and to secure and insure it over time

• Cost of capital

• Taxes

• Insurance

• Obsolescence

• Storage

Order Costs

Labor costs associated with placing an order for inventory and the cost of receiving the order

• Order preparation costs

• Order transportation costs

• Order receipt processing costs

• Material handling costs

Hidden Costs of Inventory

• Having too much inventory

  • financial resources tied up in inventory

  • no incentive for process improvements

  • underlying problems are hidden

• Having too little inventory

  • longer delivery replenishment lead times

  • reduced responsiveness

  • lost revenue

Inventory Investment

• Absolute Inventory Value

  • the value of the inventory at either its cost or its market value

  • generally found on the balance sheet

• Inventory Turnover

  • the number of times that an inventory cycles or “turns over” during the year

  • the more turns, the better

Inventory Turnover Ratio

Cost of goods sold (COGS) / Average inventory at cost

Fundamental questions to set target inventory levels

• When to review inventory?

• When to order inventory?

• How much inventory to order?

Models for determining when to review inventory

• Periodic Review System

• Continuous Review System

Periodic Review System

• Inventory levels are reviewed at a set frequency (weekly, monthly, etc.)

  • at the time of review, if stock levels are below the pre-determined level, an order is placed

Advantages Period Review System

• Reduces the time spent analyzing inventory

• Less expensive to implement and operate than a continuous review system

Disadvantages Periodic Review System

• Difficult to determine the best review/reordering intervals

• Can make inventory accounting less accurate

• Greater risk of inventory dropping below the reorder point between reviews

Continuous Review System

• Inventory levels are continuously reviewed

  • As soon as inventory falls below a pre-determined level, a replenishment order is automatically triggered

Advantages Continuous Review System

• Allows for real-time updates of inventory

• Facilitates accurate accounting

• Requires less safety stock because inventory is constantly monitored

Disadvantages Continuous Review System

• Cost of implementation is high

Reorder Point

• The lowest inventory level at which a new order must be placed to avoid a stockout

• ROP = Demand * Lead Time + Safety Stock

Common inventory ordering system categories

• Fixed-Time Period System

• Fixed-Order Quantity System

Fixed-Time Period System

• Inventory is checked in fixed time periods against a target inventory level

• If the inventory is less than the target, a quantity necessary to bring the inventory back up to the target level is ordered

• Order Quantity = Target Inventory Level - Inventory Position

Fixed-Order Quantity System

• A continuous inventory review system in which the same order quantity is used from order to order

• When the inventory position drops to a predetermined reorder point, a predetermined fixed order quantity is placed

Economic Order Quantity (EOQ) Model

• Fixed-order quantity model

  • a quantitative decision model based on the trade-off between annual inventory order costs and annual inventory carrying costs

  • where the sum of the annual order costs and the annual inventory carrying costs is minimized

What will the EOQ calculation be impacted by?

• Individual item purchase price discounts

  • discounts for ordering larger quantities, ordering a larger volume might be better

• Multiple-item purchase price discounts

  • if you purchase a combination of items from a supplier, you may be able to take advantage of a volume discount

• Transportation freight-rate discounts

  • ordering a larger quantity mat mean you can take advantage of these discounts which will lower the per-unit costs

Constraints on the practical use of EOQ

• Limited capital

• Storage capacity

• Transportation

• Obsolescence

• Production lot size

• Unitization

Other types of inventory systems

• ABC System

• Bin System

• Base Stock Level System

• “Single-Period” Inventory Model

ABC System

• Classifies inventory based on the degree of importance

• A method to determine which inventories should be counted and managed more closely than others

• A —> highest priority; C —> lowest priority

Bin System

• Uses either one or two bins to hold a quantity of the item being inventoried

• Mainly used for small or low-value items

Base Stock Level System

• Issues an order whenever a withdrawal is made from inventory

• Will maintain the inventory at a base stock level

• Used primarily for very expensive items (airplane engine)

• A form of just-in-time

Single-Period Inventory Model

• Inventory is only ordered for a one-time stocking

• Objective is to maximize profits

• Ex. Christmas tree lots and newspaper stands

Inventory Control Tools

• Linear Barcode

• 2D Barcode

• Radio Frequency Identification (RFID)

Barcodes

• Help businesses track products and stock levels for inventory management

• Linear: a series of alternating bars and spaces printed or stamped that can be read by electronic readers

• 2D: a graphical image that stores information both horizontally and vertically

Radio Frequency Identification (RFID)

• Does not require a direct line of sight to read a tag and the information on the tag is updatable

• Automates the supply chain

  • Materials Management - goods are automatically counted and logged as they enter the supply warehouse

  • Manufacturing - assembly instructions are encoded on the tag to provide information to computer-controlled assembly devices

  • Distribution Center - shipment leaving DC automatically updates ERP to trigger a replenishment order and notify the customer for delivery tracking

  • Retail Store - no checkout lines as scanners link RFID-tagged goods in the shopping cart with the buyer’s credit card

Measuring Inventory Performance

• Units

  • the number of units available

• Dollars

  • the amount of dollars tied up in inventory

• Weeks of Supply

  • (average on-hand inventory) / (average weekly usage)

• Inventory Turns

  • (cost of goods sold) / (average inventory value)

Procurement

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

• Concerned with acquiring all of the goods, services, and work that are vital to an organization

• Overarching or umbrella term within which the action of purchasing can be found

Purchasing

The action of obtaining merchandise, capital equipment, raw materials, services, or maintenance, repair, and operating (MRO) supplies in exchange for money, or its equivalent

• The process of how goods and services are ordered from an external third party

• Can be described as the transactional function of procurement for goods or services

• Represents the function of and the responsibility for acquiring materials, supplies, and services for an organization

Supply Management

A newer term that encompasses all acquisition activities beyond the simple purchase transaction, including the function of determining the materials and services that a company needs

Purchase Requisition

An internal document that defines the need for goods and/or services

• Does not constitute a contractual relationship with an external party

• Generated by a user department to notify purchasing personnel of items to order, their quantity, and the timeframe

Purchase Order

An external commercial document that is the official offer issued by a buyer to a seller to acquire goods or services

• Used to control the purchasing of products and services from external suppliers

• Indicates types, quantities, and agreed prices for products or services

• Becomes a legally binding contract only when accepted by the supplier

e-Procurement

The business-to-business (B2B) purchase and sale of suppliers and services over the Internet

• The term used to describe the automation, through web-enabled tools, of the non-strategic and transactional activities that would otherwise consume the majority of a buyer’s time

• Typically automates all or part of solicitation tools such as RFI, RFQ, or RFP, execution and analysis, and reverse auction capabilities

Merchants

Wholesalers and retailers who purchase for resale

Industrial Buyers

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

Contracting

A term often used for the acquisition of services

Request for Information (RFI)

A standard business process whose purpose is to collect written information about the capabilities of various suppliers

Request for Proposal (RFP)

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

Request for Quote (RFQ)

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

Primary objectives of purchasing

• Ensure an uninterrupted flow of materials and services at the lowest total cost

• Improve the quality of the finished goods produced

• Optimize customer satisfaction

Purchasing Process Steps

• A need is identified, and a purchase requisition is issued

• Obtain authorization as necessary

• Identify and evaluate potential suppliers

• Make supplier selection

• Purchase Order (PO) is created and delivered to the supplier

• Supplier confirmation of the purchase order

• Fulfillment

• Receipt of Goods

• Invoice and Reconcilation

• Payment

• Close out the Purchase Order

• Analysis

e-Procurement process

• An electronic purchase requisition and/or purchase order

• An invoice

• A payment

• Authorization of the purchase order

• Reconciliation of the invoice

Advantages of e-Procurement

• Time-Savings

• Cost-Savings

• Accuracy

• Real-time

• Management

• Mobility

• Trackability

• Benefits to the suppliers

Profit-Leverage Effect

• A decrease in purchasing expenditures directly increases profits before taxes

• A 10% cost reduction generates significantly more profit before tax than does a 10% sales increase

• Main reason to reduce purchase costs

Return on Assets (ROA) Effect

• A high ROA indicates that the company can generate profits with lower spending

• A 10% cost reduction generates a significantly higher ROA than does a 10% sales increase, given the same number/value of assets

Inventory Turnover Effect

The number of times the company sold through inventory in a given time period

• Cost of Goods Sold (COGS) / Average Inventory

A high turnover ratio is beneficial because it means the company is generating sales efficiently to sell inventory

Total Cost of Ownership (TCO)

The sum of all costs associated with every activity in the supply stream of a product

• The four elements are Quality, Service, Delivery, Price (QSDP)

• TCO is the sum of the cost elements in QSDP

• Other considered factors

  • Quantity discounts

  • Cash discounts

  • Value-added Services

  • Administrative Expenses

  • Poor Supplier Quality

Components of Total Cost of Ownership (TCO)

• Pre-Transaction Costs

  • Identifying sources

  • Qualifying sources

  • Certifying sources

  • Supplier database update

  • Training/education of supplier

  • Activities carried out prior to the actual buy and sell transaction

• Transaction Costs

  • Price negotiations

  • Delivery confirmation

  • Purchase order administration

  • Transportation

  • Delivery/receiving

  • Reconcilation

  • Taxes/tariffs/duties

  • Invoicing/payment

  • Incoming inspection

  • Rejected goods return to supplier

  • Close-out

  • Activities carried out as part of the actual buy and sell transaction

• Post-Transaction Costs

  • Returns from customer

  • Replacement

  • Repair parts and labor

  • Maintenance

  • Disposal of returned product

  • Activities carried out following the actual buy and sell transaction

Make vs. Buy Decision

Make: Producing materials or products internally

Buy/Outsource: Buying materials or products from a supplier

Based on three key pillars:

• Business strategy

• Risks

• Economic Factors

Business Strategy

Includes the strategic importance to the company of the product or service that is being considered for outsourcing

• Choose make when product is critical to company performance and buy when it is not as important

Risks

Lower quality, reliability, and predictability of outsourced solutions as compared to in-house manufacturing

Economic Factors

Includes the impact of outsourcing on capital expenditures, return on invested capital, and return on assets, as well as possible savings achieved through outsourcing

Qualitative Reasons for Making

• Protect proprietary technology

• No competent supplier available

• Control over lead time

• Use existing idle capacity

• Better quality control

Quantitative Reasons for Making

• Overall lower cost

• Control of transportation and warehousing costs

Cost factors for the make analysis

• direct labor expenses

• incremental inventory-carrying expenses

• incremental capital expenses

• incremental purchasing expenses

• incremental factory operating expenses

• incremental managerial expenses

• transportation expenses for purchased starting/raw materials

• any follow-on expenses resulting from quality and associated problems

Qualitative Reasons for Buying or Outsourcing

• Non-strategic item

• Insufficient capacity

• Temporary capacity constraints

• Lack of expertise

• Quality

• Multi-sourcing strategy

• Brand strategy

Quantitative Reasons for Buying or Outsourcing

• Cost advantage

• Inventory considerations

Cost factors for the buy analysis

• unit price of the purchased item

• transportation expenses

• incremental purchasing expenses

• receiving and inspection expenses

• any follow-on expenses associated with service or quality

Risks of Outsourcing

• potential loss of control over production designs, intellectual property, etc.

• increased reliance on suppliers

• increased need for supplier management

Benefits of Outsourcing

• Concentrate on core capabilities

• Reduce staffing levels

• Accelerate reengineering efforts

• Reduce internal management problems

• Improve manufacturing flexibility

In-Sourcing

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

Co-sourcing

The sharing of a process or function between internal staff and an external provider, where the staff at the external provider works exclusively under your control and direction