OM 9.06

ABC Analysis and Inventory Management

When conducting ABC analysis, it's essential to consider the breakpoint, which is the gap between items when assessing their dollar value.

• Example: If Class A items end with a value of $93,000$ and Class B items start at $3,200$, there's a significant gap. Similarly, a gap exists between Class B and Class C items.

Purpose of ABC Analysis

ABC analysis leads to better mining focus, especially in terms of finances, and it needs to be applied to inventories.

Inventory Management Systems

Different inventory management systems are applied based on item classification:

• Class A Items: Continuous review system (EOQ and ROP models).
• EOQ (Economic Order Quantity): Determines the quantity to order.
• ROP (Reorder Point): Indicates the timing for placing orders.
• Class C Items: Periodic review system (fixed ordering interval model).

Continuous vs. Periodic Review Systems

• Continuous Review System: Fixed quantity, variable order interval.
• Periodic Review System: Fixed order interval, variable quantity.

Fixed Order Interval Model

In the fixed order interval model, the order quantity is determined by subtracting the on-hand inventory from the target inventory level (order up to level).

Determining the Fixed Review Time

The fixed review time is determined using common sense related to process analysis and the management model.

• Formula: $\text{Rate} = \frac{\text{Unit}}{\text{Time}}$, thus $\text{Time} = \frac{\text{Unit}}{\text{Rate}}$

Economic Order Quantity (EOQ)

EOQ is the order quantity that minimizes total inventory cost, which consists of inventory holding cost and ordering cost. Purchase cost is fixed and doesn't play a role in EOQ calculation unless there's a quantity discount.

EOQ Formula

$EOQ = \sqrt{\frac{2DS}{IC}}$, where:

• $D$ = Annual demand
• $S$ = Ordering cost per order
• $I$ = Holding cost rate percentage
• $C$ = Item cost

Example Calculation

Given an annual demand of $5,600$ units, ordering cost of $40 per order, a holding cost rate of $35\%$, and an item cost of $50 per unit:

$EOQ = \sqrt{\frac{2 \times 5,600 \times 40}{0.35 \times 50}} = 160$

Important Note

Ensure the measurement units match (annual, quarterly, monthly, weekly) when calculating EOQ.

Reorder Point (ROP)

ROP is calculated as the expected demand during lead time plus safety stock.

• $ROP = \text{Expected Demand During Lead Time} + \text{Safety Stock}$

Calculating Expected Demand During Lead Time

• $\text{Expected Demand During Lead Time} = \text{Daily Demand} \times \text{Lead Time}$

To match the measurement unit, divide annual demand by the number of working days per year and multiply by the lead time. For example:

$\frac{5,600}{300} \times 3$

Calculating Safety Stock

Safety stock is calculated as $z \times \sigma_{DL}$, where:

• $z$ = Z-value corresponding to the desired service level
• $\sigma_{DL}$ = Standard deviation of demand during lead time

Standard Deviation of Demand During Lead Time

• Demand varying, lead time constant: $\sigma<em>{DL} = \sigma</em>D \times \sqrt{L}$
• Lead time varying, demand constant: $\sigma<em>{DL} = \sigma</em>L \times D$

Where: $\sigma_D$ is standard deviation of demand and $L$ is lead time.

Finding the Z-Value

The z-value is found using the service level from the normal distribution table. For example, if the service level is $90\%$, the corresponding z-value is $1.28$. Thus, safety stock is:

$1.28 \times \sqrt{3} \times 5 = 67.49$

Excel Functions for Z-Value

• Finding Z-value from percentage: NORM.S.INV(percentage)
• Finding cumulative percentage from Z-value: NORM.S.DIST(z, cumulative)

Supplier Relationship Management

• SRS Analysis: Supplier Relationship Segmentation Analysis.
• SI Analysis: Strategic Importance Analysis.
• RA Analysis: Relationship Attractiveness Analysis.

Supplier Assessment

Supplier assessment includes:

• Supplier performance assessment.
• Supplier capability assessment.

Strategic Importance Analysis

Strategic Importance Analysis involves spend analysis and category management strategy.

• Value Risk Matrix: Categories include critical strategic items, bottleneck items, leverage items, and routine items.

Sourcing Strategies

• Ambidextrous Sourcing Strategy (AT Kearney):
  • Collaborative sourcing for critical strategic and bottleneck items.
  • Competitive sourcing for leverage and routine items.

Leveraging Strategies for Collaborative Sourcing

• Improving supply relationship.
• Improving process jointly.
• Improving specifications.

Price Analysis

Different types of price analysis:

• Price analysis.
• Cost analysis.
• Value price analysis.

Cost Analysis

Cost analysis involves analyzing the true cost by examining the price structure of first-tier, second-tier, and third-tier suppliers.

Value Price Analysis

Value Price Analysis includes Total Cost of Ownership (TCO), which considers acquisition cost and possible failure costs.

Relationship Attractiveness

Considers supplier's profit and buyer's profit.

Goal is to move towards high mutual interest (win-win situation).

Price should be set at a fair and reasonable level.

Supplier Segmentation Matrix

Suppliers are classified into strategic supplier, leveraged supplier, and transactional suppliers based on SI analysis and relationship attractiveness.

Supplier Strategies

• Strategic Suppliers: Optimize a few strategic suppliers' proposals, joint process improvements, long-term contracts, and mutual agreement on supplier profit.
• Collaborative Suppliers: Improve quality delivery, reduce cost of qualified suppliers, and use long-term contracts and incentives.
• Transactional Routine Suppliers: Seek to lower costs through auctions and overseas sourcing (low-cost country sourcing).

Supplier Performance and Capability Assessment

Assessment includes various categories such as quality systems, management, environmental compliance, CSR, and ESG.

Scoring Suppliers' Performance

Involves comparing different suppliers based on performance assessment scores and SLAs.

Postal Case and Supplier Classification

Classifies suppliers into strategic priority and general segments (A, B, C, D) based on performance and capability assessment; Postal used to limits large suppliers to sourcing less than 30% of their revenue from them.

Collaborative Support and Incentives

Includes collaboration support and financial support (e.g., lending money at lower interest rates).

Purchasing Strategies

• Shift from price-driven to capability-based supplier selection.
• Move towards cooperative, collaborative relationships with suppliers.

Supplier Relationship Dynamics

• The research indicates it is better to manage the ongoing relationship to your suppliers

Toyota's Approach

Select partners, target costing, and provide training/education (TPS).

Saving Weak Suppliers

Companies give a probation period for suppliers to improve (forgiving approach).

Technology Collaboration

Involves supplier suggestion about the stack and cost by giving the concept of the product needed (blueprint approval method).

Insourcing vs. Outsourcing

• When supplier's performance capability is weak and strategic importance is low, that is best outsourcing candidate.
• If a company is much better than a supplier, they will make it in-house.
• If the item is very important strategically, probably, the company does not want to outsource.