BUS 370: Managing Inventory Notes

Chapter Objectives

• Understand various roles of inventory including different types and drivers.
• Differentiate between independent demand and dependent demand inventory.
• Calculate restocking levels for periodic review systems.
• Compute Economic Order Quantity (EOQ) and Reorder Point (ROP) for continuous review systems.
• Identify best order quantity when volume discounts are available.
• Determine target service level and target stocking point for single-period inventory systems.
• Recognize how inventory decisions influence the supply chain.

Definition of Inventory

• Inventory refers to stocks or items for:
  • Supporting production (raw materials and work-in-progress)
  • Supporting activities (maintenance, repair, and operations)
  • Customer service (finished goods and spare parts).

Forms of Inventory

• Raw Material: Oranges.
• Work-in-scale: Empty cans/components.
• Finished Goods: Filled & sealed cans.
• Notably, inventory constitutes about 30% of current assets in a typical company.

Types of Inventory

• Cycle Stock: Inventory received in bulk, gradually used, then replenished.
• Safety Stock: Extra inventory to protect against uncertainties in demand or replenishment.
• Anticipation Inventory: Held in anticipation of customer demand.
• Hedge Inventory: Built-up inventory to buffer against potential events (e.g., strikes, price increases).
• Transportation Inventory: Moving inventory between supply chain links.
• Smoothing Inventories: Used to reconcile production levels with demand.

Inventory Drivers

• Four business conditions that lead to inventory holding:
  • Uncertainty: Results in safety or hedge stock.
  • Mismatch in Demand: Leads to cycle or smoothing inventory.
  • Production Capacity Issues: Necessitates smoothing inventory.
  • Timing Mismatches: Creates anticipation and transportation inventories.

Independent vs Dependent Demand

• Independent Demand: Demand is influenced by external factors beyond firm control (e.g., retail goods).
• Dependent Demand: Demand is intrinsically tied to another item’s production (e.g., parts of a finished product).

Inventory Management Systems

1. Periodic Review System: Checks inventory at regular intervals to replenish to a predetermined level.

   • Restocking Level Calculation:
     $R = RP + L + (Average ext{ Demand} imes (RP + L)) + Z imes ext{Standard Deviation}$

2. Continuous Review System: Tracks inventory levels continuously, triggering orders upon reaching reorder points. Reorder Point (ROP) is determined by
   $ROP = d imes L$ where $d$ = Demand Rate, $L$ = Lead Time.

3. Single Period Inventory: Applicable for products with a single sales opportunity (e.g., seasonal items).

   • Balances shortage and excess costs.

Economic Order Quantity (EOQ)

• Formula: $EOQ = ext{sqrt}\frac{2DS}{H}$ where:
  • $D$ = Demand
  • $S$ = Cost per order
  • $H$ = Holding cost per unit.

Example Calculation

• For 2000 fans:
  • $S = 10$, $H = 4$
  • EOQ yields:
    $EOQ = ext{sqrt}\frac{2 imes 2000 imes 10}{4} = 200$

Reorder Point and Safety Stock

• ROP is calculated as $ROP = d imes L$ under constant demand/lead times.
• Safety stock covers variability in demand and lead times. The formula to include safety stock is:
  $ROP = d imes L + Z imes ext{Standard Deviation}$

Volume Discounts

• Assess ordering with volume discounts by calculating the total costs for both regular and discounted order sizes, ensuring cost efficiency.

Example

• Order quantities influence total annual costs. For instance, ordering at discounted volume results in lower costs compared to standard EOQ calculations.

Conclusions

• Inventory management requires balancing order quantities, lead times, and demand uncertainties. Consider price breaks when ordering in larger quantities to keep costs minimized.
• The bullwhip effect illustrates how small demand changes can significantly impact inventory upstream in the supply chain.