Supply Chain Chapter 4

Inventory

quantities of goods and materials that are held in stock

(includes all materials used to support production, the finished products needed to provide customer service, and all the other supplies necessary to run a business)

is an asset; however, carrying too much inventory can be a significant liability

Categories of Inventory

• Raw Material

• Work-in-Progress

• Finished Goods

• Maintenance, Repair and Operating (MRO) supplies

individual items within each of these can be current or obsolete

Raw Materials

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

• company that produces a product generally starts with some raw material, part, or starting material

• there are strategies around how much raw material a company should hold in inventory

• companies might be willing to increase costs by storing excess raw material inventory if they fear there may be a potential shortage of the material or if they suspect an upcoming price increase and want to buy at the current lower price

Work-in-Process

a good or goods in various stages of completion throughout the plant, spanning from raw material awaiting final inspection and acceptance as finished goods

• due to the range of potential stages of completion and the fact that materials in WIP may be in a state of continuous transformation, many companies view WIP as the “black hole” of inventory as they may not have very good or very timely visibility into this part of their inventory

• best practice generally suggests minimizing 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

Those items on which all manufacturing operations, including final testing, have been completed. These products are available for sale and shipment to the customer

• from a cost perspective, finished goods are usually worth much more than raw material or WIP since all the material, labor, and overhead costs are fully applied to finished goods

• the amount of finished goods inventory that a company decides to maintain is a strategic decision:

  • companies can operate a Make-to-Order supply chain where the finished goods are not produced until a customer order is received. Little to no finished goods inventory is maintained

  • companies can operate a Make-to-Stock supply chain where the product is produced before receipt of a customer order based on a demand forecast. Significant amounts of finished goods inventory can be maintained

Maintenance, Repair and Operating (MRO)

Items used to support general operations and maintenance, such as maintenance supplies, spare parts, and consumables, and are sued in manufacturing and supporting operations

• materials that you need to run the manufacturing operation and the business but do not end up as part of the finished product

  • some MRO items are consumed while converting raw materials into finished goods, e.g., oil for the manufacturing equipment

  • other MRO items are used to facilitate manufacturing, e.g., cleaning supplies, spare parts, etc.

  • other MRO items may facilitate the company’s administrative activities, e.g., office supplies, coffee for the break room, etc.

Obsolete Inventory

stock that is expired, out-of-date, or no longer needed

will never be used or sold at total value

• writing it off the books and disposing may be difficult decision as all or parts of the outdated product’s value may be lost, reducing a company’s profit

• unusable inventory takes up space and costs money to maintain

• there may be a cost associated with the actual disposal of the inventory

• some companies may donate this inventory to a non-profit organization if it has any remaining value, which not only helps the non-profit but also avoids disposal costs and may result in a tax benefit

Service Inventory

Activities carried out in advance of the customer’s arrival

• companies in the service industry do not maintain inventory of services since services are basically produced and consumed immediately upon demand

• companies can however, maintain inventory of “facilitating goods,” which are those items that are used to help facilitate the service being provided

Inventory Stock Levels

there are three levels of internal inventory which may be held by companies to:

• meet customers demand (Cycle Stock)

• buffer against uncertainty in demand and/or supply (Safety Stock)

• decouple supply from demand (Strategic Stock)

• decouple dependencies in the supply chain (Strategic Stock)

there may also be inventory which is held external to the company by downstream supply chain trading partners

Cycle Stock

Inventory that a compnay builds to satisfy it’s immediate demand.

Cycle stock depletes gradually as customer orders are received, and is replenished cyclically when supply orders are received.

The amount of cycle stock that a company holds is dependent on actual demand in the immediate time period, supply replenishment lead time and order quantities

Safety Stock

Safety stock, also known as “buffer stock,” is 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 fluctuations in demand or supply

Companies operating in a make-to-stock environment will generally maintain some amount of safety stock whether based on a management desicion, or based on a safety stock determination formula

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

A compnay may decide to carry strategic stock to:

• Hedge currency fluctuations

• take advantage of a price discount

• protect against a short-term disruptive event in supply

• for life cycle changes: seasonal demand, new product launch, transition protection

Also called anticipation stock, build stock, or seasonal stock

Pipeline Inventory

Inventory in the transportation network and the distribution system being held by wholesalers, distributors, retailers, or consumers

The ownership of this inventory has been transferred to the trading partners

However, it may still influence the compny’s decisions regarding managing and controlling its internal inventory and how much safety and strategic stock to hold

Costs Related to Inventory: Direct

directly traceable to unit produced (e.g., materials, labor, etc.)

Costs Related to Inventory: Indirect

cannot be traced directly to the unit produced (e.g., overhead; MRO items, buildings, equipment, etc)

Costs Related to Inventory: Variable

dependent on the unit volume produced vary with output level (e.g., materials, labor, utility power, etc)

Costs Related to Inventory: Fixed (Sunk Costs)

independent of the unit volume produced (e.g., buildings, equipemnt, rent, allocated overhead costs, etc.)

Costs Related to Inventory: Carrying

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

Costs Related to Inventory: order

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

Hidden Costs of Inventory

Having too much or too little inventory on hand can create risks for a company

Too much inventory:

• financial resources tied up in inventory

• underlying problems being hidden rather than being exposed and solved, including quality problems not being immediately identified

• no incentive for process improvements

Too little inventory:

• production disruptions creating the need for expediting and additional costs

• longer delivery replenishment lead times

• reduced responsiveness

• lost revenue

Inventory Investment

• Absolute Inventory Value

• Inventory Turnover

Absolute Inventory Value

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

Generally found on the balace sheet

Inventory Turnover

The number of times that an inventory cycles, or “turn over,” during the year

More turns the better

Ratio = cost of goods sold (COGS) / Average Inventory @ Cost

Periodic Review System

inventory levels are reviewed at a set frequency, e.g., weekly or monthly

advantage:

• reduces the time spent analyzing inventory

• less expensive to implement and operate

disadvantage:

• can be challenging to determine the best review/reordering intercals

• it also can make inventory accounting less accurate

• there is a greater risk of inventory dropping well below the reorder point between reviews and, therefore, a greater potential need for safety stock

Continuous Review System

inventory levels are continuously reviewed

advantage:

• allows for real-time updates of inventory, which can make it easier to know when to replenish

• facilitates accurate accounting

• potential require less safety stock

disadvantage:

• generally, it requires an automated system. The hardware and software necessary to run the system can be expensive to purchase, install, and maintain

Reorder Point (ROP)

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

• set a level that provides enough inventory so demand is covered during the lead time (L) needed to replenish inventory

Fixed-Time Period System

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

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

• the amount of inventory ordered will potentially vary from period to period based on the time remaining inventory at each time interval checked

The order quantity is the difference between the on-hand stock on the review day and the pre-determined target inventory level (Q = R - IP)

quantity will differ from one order to another depending on the on-hand quantity on the day of the review

• target inventory level (R) is established

• inventory levels are checked/reviewed in fixed periods (T)

• if (IP) < (R), then (Q) is ordered, and (R) is resotred when each new order is received

Fixed-Order Quantity System

• a continuous inventory review system uses the same order quantity from order to order

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

• the time between orders varies from order to order

If the review determines that an order should be placed, then the order for a pre-defined quantity for that item is placed

The Economic Order Quanitiy (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

(the sum of the annual order costs and the annual inventory carrying costs is minimized)

Order Costs

costs that are incurred each time an order is placed

• order preparation costs

• order transportation costs

• order receipt processing costs

• material handling costs

Carrying Costs

costs that are incurred for holding inventory in storage

• cost of capital - specified by senior management

• taxes - on inventory held in warehouses

• insurance - based on estimated risk or loss over time and facility characteristics

• obsolescence - deterioration of product during storage, and shelf-life

• storage - facility expense related to product holding rather than product handling

Limited Capital

the model may generate an order quantity that the company does not have sufficient available funds to purchase at one time

Storage Capacity

the model may generate an order quantity that the company does not have sufficient storage capacity to handel at one time

Transportation

the item being ordered and transported may require specialized or dedicated transportation, impacting the quantity per order

Obsolescence

the model may generate an order quantity that would create spoilage or obsolescence

Production Lot Size

the supplier may require the company to order an item in full production lot sizes

Unitization

the supplier may require the company to order an item in full pack, case, or pallet configurations

Types of inventory systems: ABC System

classifies inventory based on the degree of importance:

• determine annual usage or sales for each item

• determine % of total usage or sales that each item represents

• rank items from highest to lowest %

• classifying items into groups:

A: Highest Value

B: Moderate Value

C: Least Value

Types of inventory systems: Bin System

uses one or two bins to hold a quantity of the item being inventoried

• it is mainly used for small or low-value items

• when the inventory in the first bin has been depleted, an order is placed to refill or replace the inventory

• the second bin is set up to hold enough inventory to cover demand during the replenishment lead time until the replacement order arrives

Types of inventory systems: Base Stock Level System

an inventory system that issues an order whenever a withdrawal is made from inventory

• replenishment order quantity is equal to the quantity withdrawn from inventory

• this will maintain the inventory at a base stock level

• used primarily for costly items, e.g., airplane engine

• a form of just-in-time

Types of inventory systems: “Single-Period” Inventory Model

Inventory is only ordered for a one-time stocking

• the objective is to maximize profits

EX) Christmans tree lots, and newspaper stands

Inventory Control Tools

Many inventory control tools exist in today’s market. Those that incorporate barcode tracking or RFID tagging generally offer the most flexibility and ease of use

• Linear Barcode

• 2D Barcode

• Radio Frequency Identification (RFID)

Barecode

help businesses track products and stock level for inventory management

Linear (1D) Barcodes

series of alternating bars and space printed or stamped on parts, containers, labels, or other media, representing encoded information that can be read by electronic readers

• limitations: they are dimensional, can only be read horizontally, and can only hold a maximum on 85 characters

2D Barcodes

graphical image that stores information both horizontally and vertically

• can store over 7000 characters, allowing transmission of almost two paragraphs of information

Barecode reader

electronic device that can read barcodes and transmit the data to a computer.

might be handheld cordless devices, corded devices that attach directly to a PC’s USB port, or computers with integrated laser scanners

Radio Frequency Identification (RFID)

successor to the barcode for tracking individual unit of goods

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

RFID: Materials Management

goods automatically counted and logged as they enter the supply warehouse

RFID: Manufacturing

assembly instructions encoded on RFID tag provide information to computer controlled assembly devices

RFID: Distribution Center

shipment leaving DC automatically updates ERP to trigger a replenishment order and notify customer for delivery tracking

RFID: Retail Store

no check out lines as scanners link RFID tagged goods in shopping cart with buyers credit card

Metrics for Inventory: Units

the number of units available

Metrics for Inventory: Dollars

the amount of dollars tied up in inventory

Metrics for Inventory: Weeks of Supply

(avg. on-hand inventory) / (avg. weekly usage)

Metrics for Inventory: Inventory Turns

(cost of goods sold) / (avg. inventory value)