ch.3 distribution inventory. - iems. distribution inventory... · moving across the great lakes of...

Part 4 : Distribution & Customer Support.

Ch.3 Distribution Inventory.

Edited by Dr. Seung Hyun Lee (Ph.D., CPL)IEMS Research Center, E-mail : [email protected]

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Functions of Inventory.[Coyle, pp186-281]

Inventory Cost in Total Logistics Cost. Units : $ Billion.

Source : Robert Delaney, Cass Information Systems, 2000.

Carrying Costs - $ 1,376 Trillion All Business Inventory ․ Interest ․ Taxes, obsolescence, depreciation, insurance ․ Warehousing

70 (7.6%)187 (20.3%)

75 (8.1%)Transportation Costs. ․ Truck-intercity ․ Truck-local ․ Railroads ․ Water (international 16, domestic 6) ․ Oil pipelines ․ Air (international 7, domestic 19) ․ Forwarders

300 (32.6%)150 (16.3%)

36 (3.9%)22 (2.4%)9 (0.98%)26 (2.8%)6 (0.65%)

Shipper-Related Costs. 5 (0.54%)

Logistics Administration. 35 (3.8%)

TOTAL LOGISTICS COST 921 (100%)

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Inventory Functions. Cycle Stock. ․ Batching economies or cycle stocks usually arise from three sources - acquisition, production, and/or transportation. ․ In the acquisition or purchasing area, it is not unusual to have a schedule of prices that reflects the quantity purchased, that is, lower unit price for larger quantities. ․ A related discount situation occurs with transportation economies can be very complementary. That is, when companies buy larger quantities of raw materials or suppliers, they can ship larger quantities, which can result in transportation discount. ․ The third batching economy is associated with production or manufacturing. Long production runs or batches result in cycle stocks that must be stored until they are sold. Traditionally, companies rationalized long production runs to lower limit costs without really evaluating their inventory carrying cost. which can be high for finished good.

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Inventory Functions. Safety Stock. ․ Fluctuation stock is a cushion of protection against uncertainty in the demand or in the replenishment lead time. ․ On the demand or customer side, there is usually uncertainty about how much customer will buy and when. Forecast demand is a common approach to help resolve uncertainty, but it is never completely accurate. ․ On the supply side, there may be uncertainty about obtaining what is needed from vendors or suppliers and about how long it will take for fulfilling of the order. Uncertainty can arise from transportation in terms of getting reliable delivery.

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Inventory Functions. In-transit and In-process Inventory. ․ The transportation alternatives available for shipping freight may have different transit time as well as other service level differences, for example, reliability and damage rates. The longer freight is in transit, the higher the inventory costs and, probably, the customer service related costs.

․ Work-in-process inventory is associated with manufacturing/production. Significant amounts of inventory can be accumulated in production facilities, particularly in assembly operation such as those of automobiles and computers. The length of time work-in-process inventory sits in a production facility waiting to be included in the assembly of a particular product should be carefully evaluated in relationship to scheduling techniques and the actual production or assembly/technology.

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Inventory Functions. Anticipation Stock. ․ Seasonality can occur on the inbound side of a company's logistics system or the outbound side or both. Usually, companies that are faced with seasonality of supply and/or demand need to carefully analyze how much inventory they should accumulate.

․ Sometimes transportation can cause seasonality, particularly if water transportation is used. Rivers and lakes can freeze in the northern part of the hemisphere, which may interrupt to shipment of basic raw materials causing a need for accumulation of inventory during the period that the service is interrupted. The steel industry faced this problem in the past with iron ore moving across the Great Lakes of down the St. Lawrence Seaway.

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Inventory Functions. Hedging Stock. ․ A fifth reason for inventory arise when companies anticipate some unusual event, for example, strike, significant price increase, a major shortage of supply due to weather or political unrest, and so on. In such situations, companies may accumulate inventory to "hedge" against the unique event. Again, an analysis should be undertaken to assess the risk, probability, and cost of the inventory.

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Inventory Cost.[Coyle, pp186-281]

Inventory Carrying Cost. Capital cost. ․ Sometimes called the interest or opportunity cost, this cost type focuses upon what having capital tied up in inventory costs a company. The capital cost is frequently the largest component of inventory carrying cost.

Storage Space Cost. ․ Storage space cost includes handling costs associated with moving product into and out of inventory, as well as storage costs such as rent, heating, and lighting.

Inventory Service Cost. ․ Another component of inventory carrying costs includes insurance and taxes. Depending upon the product value and type, the risk of loss or damage may require high insurance premiums.

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Inventory Carrying Cost. Inventory Risk Cost. ․ This final major component of inventory carrying cost reflects the very real possibility that inventory dollar value may decline for reasons largely corporate control.

․ Any calculation of inventory risk costs should include the costs associated with obsolescence, demage, pilferage, theft, and other risks to inventoried product. The extent to which inventoried items are subject to such risks will affect the inventory value and thus the carrying costs.

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Calculating Inventory Carrying Cost.

Order Period No. of Orders per year

Average Inventory Total Annual Inventory Carrying

CostUnits Value

1 week 52 50 $ 5,000 $ 1,250

2 week 26 100 10,000 2,500

4 week 13 200 20,000 5,000

13 week 4 650 65,000 16,250

26 week 2 1,300 130,000 32,500

52 week 1 2,600 260,000 65,000

※ One week's inventory supply is 50 units. ※ Value per unit is $100. ※ Percentage carrying cost is assumed to be 25%

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Order/Setup Cost. Order Cost. ․ The costs associated with ordering or acquiring inventory have both fixed and variable components. The fixed element may refer to the cost of the information system, facilities, and technology available to facilitate order-placement activities. This fixed cost remains constant in relation to the number of orders placed.

․ Some of the types of activities that may be responsible for these costs include : (1) reviewing inventory stock levels, (2) preparing and processing order requisitions or purchasing orders, (3) preparing and processing receiving reports, (4) checking and inspecting stock prior to placement in inventory, and (5) preparing and processing payment.

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Order/Setup Cost. Setup Cost. ․ Production setup costs may be more obvious than ordering or acquisition costs. Setup costs are expense incurred each time a company modifies a production line to produce a different item for inventory. ․ The fixed portion of setup cost might include use of the capital equipment needed to change over production facilities, while the variable expense might include the personnel costs incurred in the process of modifying or changing the production line.

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Order/Setup Cost and Order Frequency.

Order Period No. of Orders per year

Total Annual Inventory Carrying Cost

1 week 52 $ 10,400

2 week 26 5,200

4 week 13 2,600

13 week 4 800

26 week 2 400

52 week 1 200

※ Assuming a cost per order of $200

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Inventory Cost Relationship.

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Inventory Classification.[Coyle, pp186-281]

ABC Classification. Pareto's Law, or the "80-20 Rule." ․ Actually, ABC analysis is rooted in Pareto's law, which separates the "trivial many" from the "vital few." In inventory terms, this suggests that a relatively small number of items or stock-keeping units(SKUs) may account for a considerable impact or value.

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Inventory Visibility.[Coyle, pp186-281]

Inventory Visibility. Consideration for Inventory Visibility. ․ Inventory visibility can be interpreted simply as the ability of an organization to "see" inventory on a real-time basis throughout its logistics and/or supply chain system.

․ Inventory visibility implies having knowledge of not only "where" inventory(raw materials, supplies, work in progress, finished goods, etc.) is in the system (vendor locations, plants, warehouses, customer locations, in transit with carriers, etc.) but also how much is "there" (level), to whom it may be promised, what orders need to be fulfilled, when shipments can be delivered.

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Inventory Visibility. Consideration for Inventory Visibility. ․ Keeping inventory visible in the supply chain is a special challenge. Essentially, what is required is : - Tracking and tracing inventory status at the SKU/line item detail level for all order. - Providing summary and detailed reports of shipments, orders, products, transportation equipment, location, and trade lane activity. - Notification of failures and potential delays in the flow of inventory throughout the system.

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Inventory Visibility. Benefits for Inventory Visibility. ․ Improved customer service through on-time deliveries of complete order to customer with visibility into order at all stages of the supply chain.

․ Decreased cost-of-sales by lowering inventory holding costs, minimizing errors and back orders, and decreasing obsolete inventory.

․ Improvement of vendor/supplier relations and cost by providing accurate, timely information regarding requirements.

․ Increased return on assets and shareholder value by lowering investment in inventory, reducing investment in fixed facilities necessary for holding inventory, and turning inventory faster.

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Inventory Visibility. Benefits for Inventory Visibility. ․ Improved cash-to-cash and/or order-to-cash cycle by faster flow of inventory through the supply chain and by faster order fulfillment.

․ Ability to proactively respond and facilitate service recovery when delays and/or stockouts are probable by making adjustment in the system and responding quickly to service demands.

․ Improved performance metrics for overall supply chain, carriers, vendors, logistics service providers, and even customers by having timely accurate information available.

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Inventory Performance.[Coyle, pp186-281]

Inventory Performance Measures. Customer Service. ․ The first question to raise is whether the company's customer are satisfied with existing levels of customer service. - How frequently a need for back ordering or expediting occurs ?

․ The more frequently these occur, the less effective an inventory system is presumed to be.

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Inventory Performance Measures. Inventory Investment. ․ The second question involves inventory turnover measures calculated for an entire product line and for individual products and product groping. ․ Inventory turnover, sometimes referred to as inventory velocity, is calculated by dividing annual sales in dollars by average inventory measured in dollars.

Inventory Turns =

Cost of Goods Sold

Average Inventory

Inventory Turns Deviation from Target =

(Actual Turns - Target Turns) × 100

Target Turns

․ Assuming that the inventory valuation bases are equivalent (e.g., both are valued in terms of retail price or cost of goods sold), the resulting figure measures how many times per year average inventory turns over.

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Inventory Performance Measures.

Saving Inventory Dollars by Inventory Turns

Source : Cass Information Services and The Ohio State University, 1993.

Past and Projected Inventory Turnover of Finished Goods.

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Inventory Planning.[Coyle, pp186-281]

Fixed Order Quantity : EOQ. The principal assumptions of the simple EOQ model. 1. A continuous, constant, and known demand rate. 2. A constant and known replenishment or lead time. 3. The satisfaction of all demand. 4. A constant price or cost that is independent of the order quantity or time. (e.g., purchase price or transport cost) 5. No inventory in transit. 6. One item of inventory or no interaction between items. 7. Infinite planning horizon. 8. No limit on capital availability.

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Fixed Order Quantity : EOQ. Calculating EOQ.

․ A = Annual rate of demand or requirement for period (units)

․ Q = Quantity ordered lot size (units)

․ S = Cost of placing an order or setup cost ($ per order)

․ C = Value or cost of one unit of inventory ($ per unit)

․ i = Carrying cost per dollar value of inventory per year (% of product value)

․ t = Time (days)

Total Inventory Costs = Annual Ordering Cost + Annual Carrying Cost.

= AQ

× S + Q2

× C × i

Economic Order Quantity (EOQ) = 2×A×SC×i

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The Condition of Uncertainty.

Fixed Order Quantity Model Under Conditions of Uncertainty

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The Condition of Uncertainty. Demand Variations. ․ First, customers usually purchase products somewhat sporadically. The usage rates of many items vary depending on weather, social needs, psychological needs, and a whole host of other factors. As a results, sales of most items vary day by day, week by week, or season by season.

Transit Time Variations. ․ In addition, several factors can affect lead time or replenishment time. for example, transit times can and do change despite of carrier efforts.

Order Processing Time Variations. ․ Another factor that can cause variation in lead time or replenishment time is order processing and transmittal. Mailed order can cause delays. Clerks can overlook a particular order or develop undesirable backlogs. For a firm producing or manufacturing an item to order, production schedules can vary for a number of reasons.

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The Condition of Uncertainty. Uncertainty of Demand and LT.

․ If demand and lead time are constant and known in advance, calculating reorder point would be easy.

․ Now that both demand and lead time may vary, the first step is to study the likely distribution of demand during the lead time. Specially, we must accurate estimate the mean and standard deviation of demand during lead time.

Normal Distribution.

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Calculating Safety Stock. Reorder Point and Safety Stock with Uncertainty. ․ ROP = DDLT+SS

․ SS = Service factor × σ where DDLT is demand during lead time. / SS is safety stock.

where σ is standard deviation for demand.

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Calculating Safety Stock. Demand and Replenishment Uncertainty.

․ ROP = R ( XLT ) + SS

․ SS = Service Factor × σ

where X is mean demand during lead time.

σ is standard deviation of demand during lead time.

( σ = XLT (σR )2+ R

2(σLT )

2)

XLT is mean lead time length.

σLT is standard deviation of lead time length.

R is mean daily demand.

σR is standard deviation of daily demand.

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Fixed Order Interval Approach.

Fixed Order Interval Model (with Safety Stock).

․ The Target Replenishment Level (TGT). TGT = D(R + L) + SS where D = Average demand per period. . R = Review period. . L = Lead time. . SS = Safety stock.

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Additional Approaches.[Coyle, pp186-281]

Just In Time. JIT Concept. ․ Generally, JIT systems are designed to manage lead times and to eliminate waste. Ideally, product should arrive exactly when a firm needs it, with no tolerance for late or early deliverables. Many JIT systems place a high priority on short, consistent lead times. This may help to explain the recent popularity of "quick response" system for inventory.

Move card path. When a container of parts is selected for use from an inbound stockpoint, the move card is removed from the container and taken to the outbound stockpoint of the preceding work center as authorized to pick another container of parts.

Production card path. When a container of parts is picked from an outbound stockpoint, the production card is removed and left behind as authorizaton to make a standard container of parts to replace the one taken.

JIT Kanban System : Move and Production Card.

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Material Requirement Planning.

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Material Requirement Planning.

․ Order Quantity ․ On-hand Balance․ Safety Stock ․ Allocated Qty ․ Lead-Time․ Low Level Code

: 50 units: 10: 0 : 0: 1 weeks: 0

Periods1 2 3 4 5

A

Gross Requirements 25 0 15 20 30Scheduled Receipts 50Projected Available 10 35 35 20 0 20Net Requirements 30Planned Order Receipt 50Planned Order Release 50

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Distribution Requirement Planning. DRP Concept. ․ DRP systems are time phased models that include demand forecasts, purchase orders, and customer orders for a facility.

․ A system of determining demands for inventory at distribution centers, consolidating the demand information backwards, and acting as input to the production and materials system. (DRPⅠ)

․ Distribution resource planning (DRPⅡ) is an extension of DRPⅠ. Distribution resource planning extends DRPⅠ to include the planning of key resources in a distribution system-warehouse space, manpower levels, transport capacity, and financial flows.

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Distribution Requirement Planning.

DRP Planning Process.

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Conceptual Design of Integrated MRP/DRP System .

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Conceptual Design of Integrated MRP/DRP System . Benefits of An Integrated Inventory Planning System. ․ The major marketing benefits. 1. Improved service levels that increase on-time deliveries and decrease customer complaints. 2. Improved and more effective promotional and new-product introduction plans. 3. Improved ability to anticipate shortages so that marketing efforts are not expended on products with low stock. 4. Improved inventory coordination with other enterprise functions, since DRP facilities a common set of planning numbers. 5. Enhanced ability to offer customers a coordinated inventory management service.

․ The major logistics benefits. 1. Reduced distribution center freight costs resulting from coordinated shipments. 2. Reduced inventory levels, since DRP can accurately determine what product is needed and when. 3. Decreased warehouse space requirements because of inventory reductions. 4. Reduced customer freight cost as a result of fewer back-orders. 5. Improved inventory visibility and coordination between logistics and manufacturing. 6. Enhanced budgeting capability, since DRP can effectively simulate inventory and transportation requirements under multiple planning scenarios.

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Performance Check.

1. What is the impact on the firm when the firm orders smaller quantities on a more frequent basis ? Ⅰ. Increased transportation costs. Ⅱ. Decreased transportation costs. Ⅲ. Higher ordering costs. Ⅳ. Reductions in inventory investment.

A. Ⅰ, Ⅲ B. Ⅱ, Ⅲ C. Ⅰ, Ⅲ, Ⅳ D. Ⅱ, Ⅲ, Ⅳ

2. Given the same customer service level, low inventory carrying costs lead to A. Multiple warehouse. B. Faster modes of transportation. C. Fewer warehouse. D. None of the above.

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Performance Check.

3. Knowledge of inventory carrying costs is necessary to accurately determine : A. Lot sizing. B. Lead time. C. Competitor's revenue and profit margin. D. Storage location practice.

4. Inventory carrying costs should include only those costs that vary with the quantity of inventory and that can be categorized into which groups : Ⅰ. Capital costs. Ⅱ. Material planning cost. Ⅲ. Inventory risk costs. Ⅳ. Lost capacity costs. Ⅴ. Storage space costs.

A. Ⅰ, Ⅱ, Ⅲ B. Ⅰ, Ⅲ, Ⅴ C. Ⅰ, Ⅲ, Ⅳ, Ⅴ D. Ⅰ, Ⅱ, Ⅲ, Ⅳ, Ⅴ

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Performance Check.

5. Which one of the following is NOT a distinct costing alternative under direct costing ? A. Actual direct costing. B. Standard direct costing. C. Absorption costing. D. First-in-first-out (FIFO).

6. Inventory risk costs typically include : A. Obsolescence and damage. B. Shrinkage and teardown. C. Shrinkage and relocation. D. Theft and field failure costs.

7. The company has just negotiated to have all of the electronic components purchased from a local distributor changed to consignment. Which of the following actions need to be taken prior to the next receipt for the existing inventory ? A. Convert the balances to consignment to standardize on the inventory classification. B. Issue the balances to work in process to zero out raw material inventory. C. Record the balances as company-owned inventory so costs can be segregated. D. Reduce the unit costs to zero to eliminate payments to the supplier upon issue.

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Performance Check.

8. ABC classification of inventory is a means to categorize materials in terms of which of the following ? A. Function. B. Type. C. Storage requirements. D. Annual usage value.

9. Which of the following statements is TRUE about reaching a high level inventory record accuracy ? A. Inventory levels will usually be reduced B. Safety stock negates the need to be very accurate C. The savings would be small and therefore not worth the effort D. It is difficult to achieve and expensive to maintain

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Performance Check.

10. During inflationary periods, which of the following statements would be true if the LIFO method of inventory valuation is used ? A. Inventory value would be lower, cost of goods sold higher B. Inventory value would be higher, cost of goods sold higher C. Inventory value would be higher, cost of goods sold lower D. None of the above

11. Which of the following is a service level measurement method ? A. Amount of dead stock. B. Order fill rate for each supplier. C. Comparison of actual versus targeted inventory levels. D. Percent of stock-outs caused by improved purchasing methods.

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Performance Check.

12. Which of the following are measures used to control inventory ? A. Inventory turnover rates. B. Number of stock-outs resulting form late deliveries. C. Order fill rate for each suppliers. D. Variability in order-cycle time for each supplier.

13. A method of inventory control with a focus on waste management : a program from which to eliminate non-value added activities with the objective of producing high quality products : "zero-defect", are all definition of : A. Just-in-Time. B. Kanban. C. Stockpoint management. D. Total Quality Management.

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Performance Check.

14. Which characteristic is more desirable for controlling production within a pull system ? A. Flexible capacity B. Cycle counts C. Periodic inventory checks D. Management performance check

15. The process of using planned order releases to calculate gross requirements may continue on down through the bill of materials for many levels, until one arrives at the purchase level for every part needed in the manufacturer of a product. This process is called : A. Lead-time offset. B. Explosion. C. Planned order receipt. D. MRP worksheet.

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Performance Check.

16. Investment in inventory is normally justified on basis of all the following, EXCEPT : A. Minimum stockage at inventory points near market centers, based on the JIT approach. B. Provide a hedge against price increase. C. Provide a buffer against seasonal demands. D. Promote production efficiency.

17. Stocks for which there have been no demand for a specified period are termed as : A. Random demand support stocks. B. Speculative stocks. C. Risk contingency stockage. D. Dead stocks.

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Performance Check.18. Given the following item characteristics : ․ Order placement cost : $50 per order. ․ Annual demand : 300 units. ․ Unit cost : $80 per unit. ․ Inventory carrying rate : 5.0%

The Economic Order Quantity is :

A. 20 units. B. 62 units. C. 87 units D. 7500 units.

19. The LIFO inventory valuation method : A. Would be most likely used during periods of cost deflation. B. Tends to increase materials transfer costs, increase the cost of doing business, reduce profit margin, and minimize tax liability. C. Is not used for an item when the FIFO method is applied. D. Tends to reduce inventory issue value and enhance profit margin.

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Performance Check.20. The ABC inventory management approach is applied under all the following circumstances, EXCEPT : A. Management of SKUs with high cost values per unit. B. Management of items with costly storage requirements. C. Management of items with high rates of sale. D. When a majority of items indicate predominant cost impact on the corporate system.

21. Materials Requirements Planning consists of all the following, EXCEPT : A. Preparation of a master production schedule for some period into the future. B. Preparation of the bill of materials for each production item. C. Consolidation of the units on the master production schedule into a system-level requirements schedule, in terms of system quantities and dates needed. D. The scheduling of component inventory replenishment according to necessary lead times and economic order, buying or shipping quantities to conform with the retirement schedule rather than average demand over time.

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Performance Check.22. The predominant elements of inventory costs are : A. Order processing or production set-up, investment, warehousing, plus effects of inventory risks and stock-out. B. Carrying rate, annual demand, order cost, item cost. C. Warehousing, transportation, deterioration, pilferage. D. Lay-in costs, communication cost, transportation cost, material handling cost.

23. Given the following inventory item characteristics. ․ Annual demand : 2,000 units. ․ Holding cost : $1.50 per unit. ․ Order cost : $150. The EOQ and stock-turn rate, respectively, are : A. 633 units, 31.25 stock-turn rate. B. 633 units, 3.16 stock-turn rate. C. 200 units, 4.47 stock-turn rate. D. 200 units, 10.0 stock-turn rate.

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Performance Check.24. An inventory item has the following attributes. ․ Order quantity : 75 units. ․ Unit cost : $100.00 ․ Ordering cost : $150.00 ․ Inventory carrying rate : 5% ․ Annual Demand : 1,000 units. The annual inventory cost is : A. $3,950 B. $2,187 C. $5,750 D. $2,375

25. Inventory makes it possible for each of a firms plants to specialize in the products that it manufactures because : A. Consolidation warehouses allow the firm to disperse manufacturing by plant location B. The finished products can be shipped to large mixing warehouses from which customer orders and products for field warehouses can be shipped C. Savings in transportation costs. D. Costs of additional handling are low.

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Performance Check.

Solutions :

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15C A A B C A C D A A C A A A B

16 17 18 19 20 21 22 23 24 25A D C B D C A B B A

ch.3 distribution inventory. - iems. distribution inventory... · moving across the great lakes of...

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