Ch 12: Inventory Management

Inventory Basics:

Inventory:

a stock or store of goods

Inventory Basics:

Independent-demand items:

items ready to be sold or used

• demand comes DIRECTLY from customer needs

Inventory Basics:

Dependent-demand items:

components used to assemble a final product

• demand is CALCULATED from demand for the final product

Inventory Basics

Types of Inventory

• raw materials and purchased parts

• work-in-process (WIP)

• finished goods/merchandise

• tools and supplies

• MRO inventory (maintenance, repair, operation)

• goods in transit/pipeline inventory

Functions and Objective of Inventory

functions include…

• permitting operations

• meeting anticipated customer demand

• smoothing production requirements

• decoupling operations

• protecting against stockouts

• taking advantage of order cycles

• hedging against price increases

• taking advantage of quantity discounts

Functions and Objective of Inventory

Overall Objective:

achieve satisfactory customer service while keeping inventory costs within reasonable bounds

Functions and Objective of Inventory

Two Key Decisions:

1. when to order

2. how much to order

Performance Measures and Inventory Costs

Inventory Turnover Rato:

how many times a year inventory is sold and replaced

• ITR = annual units sold / average inventory or annual COGS / average inventory investment

Performance Measures and Inventory Costs

a HIGH turnover ratio usually indicates…

MORE efficient inventory use → but the desirable level depends on the industry and profit margins

Performance Measures and Inventory Costs

Relevant Costs:

1. purchase cost

2. holding/carrying cost

3. ordering cost

4. setup cost

5. shortage cost

Effective Inventory Management and Counting Systems

Effective Inventory management requires…

1. a tracking system for inventory on hand and on order

2. reliable demand forecasts

3. knowledge of lead time and variability

4. cost estimates

5. inventory classification system

Effective Inventory Management and Counting Systems

Periodic System:

physical count of inventory at fixed intervals

Effective Inventory Management and Counting Systems

Perpetual System:

continuously tracks inventory removals and places an order when inventory reaches a predetermined level

• a fixed quantity Q is ordered

Effective Inventory Management and Counting Systems

Two-bin system:

• 2 containers of inventory

• reorder when the 1st container is EMPTY

Effective Inventory Management and Counting Systems

Counting Technologies:

• Universal Product Code (UPC): A standardized 12-digit numeric code required for retail selling to identify products universally across different companies.

• Stock Keeping Unit (SKU): A unique, customizable 8-12 character alphanumeric code created by retailers to track internal inventory, such as size, color, and style.

• Point of Sale (POS) Systems: Software that scans barcodes (UPC or SKU) during checkout to instantly update inventory levels, process sales, and generate reports.

• RFID Tags: Radio Frequency Identification tags, such as ARC Certified NXP UCODE 9, embed chips that transmit data via radio waves. These are increasingly required for tracking, such as item-level apparel at major retailers

A-B-C Analysis and Cycle Counting

A-B-C approach:

classifies inventory items by importance, usually annual dollar value, and allocates control effort accordingly

A-B-C Analysis and Cycle Counting

A items:

about 10% of items and 60% of annual dollar value

A-B-C Analysis and Cycle Counting

B items:

about 30% of items and 30% of annual dollar value

A-B-C Analysis and Cycle Counting

C items:

about 60% of items and 10% of annual dollar value

A-B-C Analysis and Cycle Counting

Annual Dollar Value:

• annual demand x unit cost

  • rank items from highest to lowest annual dollar value before assigning A B C

A-B-C Analysis and Cycle Counting

Cycle Counting:

physical counting of items to reduce discrepancies between inventory records and actual quantities on hand

• A items usually required the most accuracy and attention

EOQ, Quantity Discounts, and Reorder Point

Basic EOQ model:

• finds a fixed order size that minimizes total annual holding and ordering costs

• assumptions include:

  • one product

  • known annual demand

  • even demand

  • constant lead time

  • single delivery

  • no quantity discounts

EOQ, Quantity Discounts, and Reorder Point

Total Inventory Cost =

TIC = (Q/2)H + (D/Q)S

EOQ, Quantity Discounts, and Reorder Point

EOQ =

Q* = sqrt(2DS/H)

EOQ, Quantity Discounts, and Reorder Point

Number of orders per year =

D/Q

EOQ, Quantity Discounts, and Reorder Point

Quantity Discount MODEL =

Total Cost = Carrying Cost + Ordering Cost + Purchasing Cost = (Q/2)H + (D/Q)S + PD.

EOQ, Quantity Discounts, and Reorder Point

Quantity Discount STEPS =

1. calculate EOQ ignoring discounts

2. identify the price range

3. test the EOQ at the price it qualifies for and each cheaper discount breakpoint

4. compute total cost

5. choose the lowest total cost

EOQ, Quantity Discounts, and Reorder Point

Reorder Point Under Certainty:

ROP = d x L

• d = demand rate

• L = lead time

• under uncertainty→ safety stock is added to reduce stockout risk