GDS

Inventory Management Basics: Chapter 1 Summary

Learning Objectives

  • Develop a solid understanding of inventory management concepts, terminology, and principles.

  • Key objectives include:

    • Explain the importance of inventory management.

    • Connect inventory management to planning and scheduling.

    • Utilize statistical tools for problem-solving.

    • Understand forecasting and inventory control basics.

    • Grasp inventory classification and costing methods.

    • Familiarize with inventory control techniques, demand forecasting, reorder points, safety stock, supply chain integration, and technology's role.

Definition of Terms

  • Stocks: Stored materials until needed. Examples: goods in a shop, raw materials in a factory, information in a research company.

  • Inventory: A list of items held in stock, encompassing all goods and materials stored for future use.

  • Item: A distinct product kept in stock (e.g., one-liter bottles of Diet Coke).

  • Unit: The standard size or quantity of an item (e.g., a bottle for Diet Coke).

  • Material: Anything kept in stock.

  • Organizations: All types of companies, including non-profits, government bodies, charities, etc.

  • SKU (Stock Keeping Unit): An alternative term for 'item.'

Inventory Defined

  • Inventory includes:

    • Stocks supporting production (raw materials and work-in-process)

    • Supporting activities (maintenance, repair, operating supplies)

    • Customer service (finished goods, spare parts)

  • Functions of Inventory:

    • Anticipation

    • Hedge

    • Cycle (lot size)

    • Fluctuation (safety, buffer, reserve)

    • Transportation (pipeline)

    • Service parts

  • Represents tangible assets intended to generate revenue.

Inventory Management

  • Encompasses planning, procurement, storage, tracking, and distribution to meet demand while minimizing costs.

  • Ensures product availability, controls costs, and meets customer demand.

  • Effective inventory management entails keeping the right stock at the right time and cost.

Objectives of Inventory Control

  • Achieve satisfactory customer service levels while keeping inventory costs reasonable.

  • Balance customer service levels with ordering and carrying costs.

Importance of Inventory

  • One of the most expensive assets for companies (up to 50% of total invested capital).

  • Balancing inventory levels affects costs and customer satisfaction:

    • Less inventory = lower costs but risk of running out.

    • More inventory = higher costs but improved customer satisfaction.

Why Inventory Management?

  • Involves:

    • Tracking existing inventory

    • Ordering more supplies

    • Avoiding wastage

    • Meeting customer demand

    • Reducing costs

    • Managing working capital

    • Fostering supplier relationships

    • Making data-driven decisions

Examples of Inventory Management

  • A small fruit store tracks apples, bananas, and oranges to ensure fresh stock without excess ordering.

Types of Inventories

  • Categories include:

    • Raw materials and purchased parts

    • Partially completed goods (WIP)

    • Finished goods

    • Replacement parts, tools, and supplies

    • Goods-in-transit

  • Material Flow Cycle: Input, waiting for inspection, moving, waiting in queue, setup, running, output.

Definitions of Inventory Types

  • Raw Materials: Items converted into components/products through manufacturing.

  • Work in Process (WIP): Goods at various completion stages.

  • Finished Goods (FG): Items ready for shipment.

  • Maintenance, Repair & Operations (MRO): Supplies for support operations.

  • In-transit/Pipeline Stock: Inventory moving through the distribution system.

Inventory Functional Categories

  • Support demand and smooth supply-demand fluctuation impacts while creating cost-saving opportunities.

Inventory Functions

  • Meet anticipated demand.

  • Smooth production requirements.

  • Decouple operations.

  • Protect against stock-outs.

  • Hedge against price increases.

  • Permitting operations.

  • Take advantage of quantity discounts.

Cycle Stock/Lot Size

  • Gradual depletion as orders are received; replenished cyclically.

  • Resulting from quantity price discounts or economical shipping costs.

Anticipation Inventory

  • Additional inventory to cover projected sales trends or seasonal demand fluctuations.

  • Built to manage uncertainty, spikes in demand, or planned sales promotions.

Decoupling

  • Creating independence between material supply and usage with buffer inventory.

Buffer Inventory

  • Protects against unforeseen circumstances; used to maintain supply reliability.

Reorder Point Policy

  • Ensures adequate stock levels are maintained and triggers ordering actions.

Hedge Inventory

  • Developed to protect against uncertain events and price increases; risk management strategy.

Summary of Inventory Functions

  • Pipeline Stock: Inventory moving from point A to B.

  • Cycle Stock: Regular use inventory; replenished in batches.

  • Anticipation Inventory: Inventory built for reasonably expected demand events.

  • Decoupling: Separates supply from demand to optimize processes.

  • Buffer: Safety stock protecting against variances in demand/supply.

  • Safety Stock: Accounts for unforeseeable fluctuations.

  • Hedge: Speculative purchases to manage costs and create competitive advantage.

Types of Inventory Related to Supply Chain Strategies

  • Make-to-Stock: Finished goods stocked.

  • Assemble-to-Order: Stock subassemblies and components.

  • Make-to-Order: No finished goods stocked.

  • Engineer-to-Order: No components stocked; low inventory cost.

Key Concepts: Economic Order Quantity (EOQ)

EOQ Definition

  • EOQ is a model to determine the optimal order quantity that minimizes total inventory costs by balancing ordering costs and holding costs.

  • Known as the Wilson EOQ model.

  • Objective: Reduce overall costs.

Key Inventory Terms

  • Lead Time: Time from ordering to receiving an order.

  • Holding Costs: Costs for storing inventory (rent, spoilage).

  • Ordering Costs: Costs incurred when placing an order (shipping, inspection).

  • Shortage Costs: Costs from demand exceeding supply (lost sales).

  • Item Cost: Price paid for purchased items.

Inventory Costs Components

  • Carrying Costs: Cost of capital and storage risks.

  • Order Costs: Costs to setup, purchase orders, follow-ups, and receiving.

  • Purchase Costs: Money spent to acquire inventory.

EOQ Model Assumptions

  • Focuses on a single product.

  • Annual demand and lead time are constant and known.

  • Orders are received in a single delivery.

  • No quantity discounts.

  • Stockouts are avoidable.

  • Considers only variable costs.

EOQ Model Objective

  • Main aim: Minimize total inventory costs through balance.

EOQ Model Derivation and Formula

  • Formula: Q* = √((2DS)/H)

    • Q* = optimal order quantity (EOQ)

    • D = annual demand

    • S = setup/ordering cost per order

    • H = holding cost per unit/year

  • Total cost (TC) = (Q/2)*H + (D/Q)*S

  • U-shaped total cost curve.

Inventory Cycle

  • Shows quantity on hand over time and determines reorder points.

  • Average inventory level is (Q/2).

EOQ Graph

  • Intersection of holding and ordering cost curves signifies EOQ.

Advantages of EOQ

  • Minimizes total costs and balances ordering/holding costs.

  • Prevents shortages and overstocks.

  • Enhances order scheduling and inventory management.

Limitations of EOQ

  • Assumes constant demand; instant restocking relevance.

Key Concepts: Economic Production Quantity (EPQ)

EPQ Definition

  • Also known as Economic Manufacturing Quantity (EMQ) or Economic Batch Quantity (EBQ).

  • Inventory control model for determining optimal batch size to reduce holding/setup costs when producing goods.

  • More realistic for companies manufacturing their products.

EPQ Assumptions

  • Similar to EOQ, but orders are received incrementally during production.

  • Annual demand and usage rates are constant.

EPQ Components

  • Holding Cost: Cost to carry inventory.

  • Setup Cost: Cost for preparing production runs (D/Q).

  • Total Cost Calculation: TC = (Imax/2)*H + (D/Q)*S.

EPQ Formulas

  • Qp = √((2DS)/H) * √((p)/(p-u))

    • p = production rate

    • u = usage rate

Inventory Profile

  • Displays production and usage patterns over time.

Make or Buy Decision

  • EPQ informs when to make versus buy goods based on relevant cost considerations.

Quantity Discount Model

Quantity Discount Model Definition

  • Used when suppliers offer discounts for bulk purchases to incentivize increased total revenue.

  • Incorporates purchase cost into the EOQ model.

Price Breaks

  • Different prices for varying order quantities.

  • Total-cost curves differ based on price breaks.

Optimal Order Quantity

  • The quantity yielding the lowest total costs.

  • Requires testing combinations until the minimal total cost results.

Example of Quantity Discount Model

  • Hospital using 816 cases of liquid cleanser shows how to compare total costs at price breaks.

Overview of EOQ and Total Costs Calculations

  • An example of annual demand calculations, ordering costs, and price schedules demonstrate how to apply these concepts practically.

Reorder Point (ROP) Definition

ROP Calculation

  • ROP = d x L

    • d = demand rate (units per day)

    • L = lead time (days)

ROP with Constant Demand and Lead Time

  • Simple application of ROP calculation.

ROP with Variable Demand and/or Lead Time

  • Incorporates safety stock to protect against shortages due to demand fluctuations.

  • ROP with safety stock = expected demand + safety stock.

Benefits of Using ROP

  • Activates stock requirements automatically.

  • Helps maintain service levels and avoid supply chain bottlenecks.

Real-Life Applications of ROP

  • Various examples demonstrate how to calculate and implement ROP in practice.

Stock Levels Definition

Importance of Stock Levels

  • Ensures regular production and supply delivery.

Major Types of Stock Levels

  • Maximum Level: Avoids overstocking.

  • Minimum Level: Prevents production halting due to shortages.

  • Reorder Level: Triggers fresh orders before reaching a minimum level.

  • Average Level: Representing the average stock held.

  • Danger Level: Urgent replacement needed below the minimum stock level.

Stock Level Diagram

  • Visually represents stock level relationships; assists in understanding inventory flow.

Example Stock Level Calculations

  • Given parameters for calculating reorder levels, maximum stock levels, and minimum stock values highlight practical applications of concepts discussed.