real-time management of inventory for items

Inventory Concept

LOGISTIC & WAREHOUSING

Inventory Concepts

Part 1: Introduction

Inventory

• Inventory is a list/record for goods and materials, held available in stock by a business

• Is a large and costly investment.

• Better management of corporate inventories can improve cash flow and return on investment

Inventory serves 5 purposes

1. It enables the firm to achieve economies of scale2. It balances supply and demand3. It enables specialization in manufacturing4. It provides protection from uncertainties in demand and

order cycle5. It acts as a buffer between critical interfaces within the

channel of distribution

Part 2: Basic Inventory Concept

• Inventory is required to realized the economies of scale in purchasing, transportation or manufacturing

• Example: ordering large quantities of raw materials/ finished goods inventory allows the manufacturer to take advantage of the per unit price reductions associated with the volume purchases.

• Purchased materials have a lower transportation cost per unit if ordered in large volumes because less handling is required.

1. Economies of scale

• Seasonal supply or demand may make it necessary for a firm to hold inventory

• Example: Boxed Chocolate sales increase during Mother’s Day

• Demand for a product may be relatively stable throughout the year, but raw materials may be available only at certain times during the year (e.g. producer of canned fruits and vegetables) this makes necessary to manufacture finished products in excess of current demand and hold in inventory

2. Balancing Supply and Demand for Seasonal Inventories

• Inventory makes it possible for each of a firm’s plants to specialize in the products that it manufactures

• The finished product can be shipped to field warehouses where they are mixed to fill customer order

• The specialization by facility is known as Focused Factories

3. Specialization

• Inventory is held to prevent a stock-out in the case of variability in demand or variability in the replenishment cycle

• example: price increase, supply shortage and to maintain a source of supply

4. Protection from Uncertainties and Order Cycle

• Inventory is held throughout the supply chain to act as a buffer for the following critical interfaces:

1. Supplier – procurement (purchasing)2. Procurement – production3. Production – marketing4. Marketing – distribution5. Distribution – intermediary6. Intermediary – consumer/user

5. Inventory as a Buffer

Raw materials inventory

Supplier inventory

Work-in-process

inventory

Finished goods

inventory at plant location

Retail inventory

Reworking or

repackaging of product

Waste and by product

Waste disposal KEY: Forward logistics flow

Reverse logistics plow

The Logistics Flow

Reverse logistic move product backward through the channel for a number of reasonExample: a customer may return a product because it is damaged/ manufacturer may need to recall a product because of defects

Finished goods inventory at field

location

Consumer inventory

1. Cycle stock

• That results from replenishment of inventory sold or used• It is required in order to meet demand under conditions of

certainty; when the firm can predict demand and replenishment times (lead times)

• Example: if the rate of sales for a product is a constant 20 units per day and the lead time is always 10 days no inventory beyond the cycle stock would be required

Types of Inventory

Basic inventory Principles – cycle stock

0 10 20 30 40 50 60

0 10 20 30 40 50 60

0 10 20 30 40 50 60

300

600

100

200

200

400Inventory Order

place

Order arrival

Orderplace

Order arrival

AverageCycleinventory

Days

B Order quantity of 200 units

Inventory Orderplace

Order arrival:

AverageCycleinventory

Days

C Order quantity of 600 units

Inventory

Orderplace

Order arrival:Next order placed

AverageCycleinventory

Days

A Order quantity of 400 units

Orderplace

2. In-transit Inventories

• Items that are en route from one location to another• Considered part of cycle stock even though they are not

available for sale or shipment until after they arrive at the destination

• In-transit inventory should be considered as inventory at the place of shipment origin since the items are not available for use, sale or subsequent reshipment

3. Safety or Buffer Stock

• Is held in excess of cycle stock because of uncertainty in demand or lead time

• Average inventory at a stock-keeping location is equal to half the order quantity plus the safety stock

Average inventory investment under conditions of uncertainly

Inventory200

100

SafetyStock(50)

10

8

20Days

3040

AverageCycleinventory

Inventory200

100

SafetyStock(40)

121020Days

3040

AverageCycleinventory

B With variable lead time

Inventory200

100

SafetyStock(100)

121020Days

3040

AverageCycleinventory

C With variable demand and lead time

8

a With variable demand

10

4. Speculative Stock

• Is inventory held for reason other than satisfying current demand.

• Example: materials may be purchased in volumes larger than necessary in order to receive quantity discount, because of a forecasted price increase or materials shortage or to protect against the possibility of a strike.

5. Seasonal Stock

• Is a form of speculative stock that involves the accumulation of inventory before a seasonal periods begins

• Example: agricultural product, fashion industry and seasonal items

6. Dead Stock

• Refers to items for which no demand has been registered for some specified period of time

• Might be obsolete throughout a company or only at one stock-keeping location

Measures of Inventory Management Effectiveness

• The key measure of effective inventory management is the impact that inventory has on corporate profitability

• Effective inventory management can improve profitability by lowering costs or supporting increased sale

• Better inventory management can increase the ability to control and predict how inventory investment will change in response to management policy

Part 3: Basic Inventory Management

• Measured as:

Annual dollar sales volumeAverage dollar inventory investment

• A higher number is preferred, indicating that inventory moves through the firm’s operation quickly, rather than being held for an extensive period

• Example: annual sales = RM500,000 valued at cost and an average inventory investment of RM100,000 would have a turnover of five times.

Inventory Turnover

• A logistics measure of inventory effectiveness at meeting demands

• Is a common measure of the customer service performance of inventory

• Low inventory level can reduce fill rates, hurting customer service and creating loss sales

• Increased sales are often possible if high levels of inventory lead to better-in-stock availability and more and more consistent service level

• Example: Fill rate = 96% 4% of requested unit were unavailable when ordered by the customer

Fill Rate

Pull versus Push Systems

• Pull System If a company waits to produce until customer demand it (customer demand ‘pull’ the inventory)

• Push System if a firm produces to forecast or anticipated sales to customers (the firm is pushing its inventory into the market in anticipation of sales)

Impact of Demand Patterns on Inventory Management

• Independent versus Dependent Demand inventory focuses on whether the demand for an item depends on demand

• An independent demand item is a finished good

• A dependent demand item are a raw materials and components that go into the production of that finished good

• The demand for raw materials or components is derived based on the demand for the finished product

• The need for dependent demand items can be calculated based on the production schedule of the finished product

• The need for production of the finished good may be forecasted or based on customer demand/order

Independent versus Dependent Demand

The components of ordering costs

• Replenishment policy under condition of certainty requires the balancing of ordering costs against inventory carrying costs

• Example: a policy of ordering large quantities infrequently may result in inventory carrying costs in excess of the savings in ordering costs

Inventory Management Under Conditions of Certainty

• Ordering costs for products purchased from an outside supplier include;

1. The cost of transmitting the order2. The cost of receiving the product3. The cost of placing it in storage4. The cost of processing the invoice for payment

• In restocking its own field warehouses, ordering costs include;

1. The cost of transmitting and processing the inventory transfer

2. The cost of handling cost3. The cost of receiving the product4. The cost of documentation

• The best policy by minimizing the total of inventory carrying costs and ordering costs

• The EOQ is a concept which determines the optimal order quantity on the basis of ordering and carrying costs

• When incremental ordering costs equal incremental carrying costs, the most economic order quantity exists

Economic Order Quantity

Two questions seem appropriate in reference to the example of the previous diagram

1. Should we place order for 200, 400, or 600 units, or some other quality?

2. What is the impact on inventory if orders are place at 10, 20, or 30-day intervals, or some other time period? Assuming constant demand and lead time, sale of 20 units per day, and 240 working days per year, annual sales will be 4,800 units. If orders are place every 10 days, 24 orders off 200 units will be placed. With a 20-day order interval, 12 orders of 400 units are required. If the average inventory is 100, 200, and 300 units, respectively. Which of these policies would be best?

Economic Order Quantity

• The EOQ in unit can be calculated using the following formula;

EOQ = 2PDCV

P = The ordering cost (RM per order)D = Annual demand or usage of product (number of unit)C = Annual inventory carrying cost (as a percentage of product

cost or value)V = Average cost or value of one unit of inventory

• Example;

P = RM40D = 4800 unitsC = 25%V = RM100 per unit

EOQ = 2 (40)(4800)(25%)(100)

= 124 units (rounded to 120)

Economic Order Quantity

√√

√

Order Quantity (EOQ)

Number ofOrder (D/EOQ)

Ordering CostP x (D/EOQ)

Inventory Carrying Cost½ EOQ x C X V

Total Cost

40 120 4800 500 5300

60 80 3200 750 3950

80 60 2400 1000 3400

100 48 1920 1250 3170

120 40 1600 1500 3100

140 35 1400 1750 3150

160 30 1200 2000 3200

200 24 960 2500 3460

300 16 640 3750 4390

400 12 480 5000 5480

Cost Trade-Offs Required to Determine the Most Economical Order Qty

Size of order

Inventory carrying cost

Total cost

Annual Cost(dollars) Lowest total cost

(EOQ)

Ordering cost

Cost trade-offs required to determine the most economical order quantity

Fixed Order Point

• An order is placed when inventory on hand reaches a predetermined minimum level necessary to satisfy demand during the order cycle

• The automated inventory control system normally generates an order or at least a management report when the reorder point is reached

Fixed Order Point versus Fixed Order Interval Policy

Fixed Order Interval

• Inventory level are reviewed at a certain, set time interval, perhaps every week

• An order is placed for a variable amount of inventory, whatever is required to get the company back to its desired inventory level

• A weekly order may be placed to reduce ordering costs and take advantage of purchase volume discounts and freight consolidation

• Management should consider factors such as customer relations, customer wants and needs, competitive service levels and the ability of the firm to support continuous production processes

• Management improves customer service levels by adding safety stock because the cost of carrying inventory has often not been calculated for the firm

Inventory and Customer Service

Inventory is a large and costly investment. Better management of corporate inventories can improve cash flow and return on investment

a)Briefly explain what is Inventory Concept and why is it so important to logistics system (3marks)

b)Discuss the purposes to hold inventory in firms or organization (9 marks)

c) Give your explanation on reverse logistics and the impact to inventory (3 marks)

Question 1

Inventory can be classified based on the reasons for which they are accumulated and why they exist.

a)Briefly explain in your own words the types of inventory (9 marks)

b)From your opinion, why inventory is held throughout the supply chain (3 marks)

c) Which types of inventory associate with antique products and why company would hold such inventory (3 marks)

Question 2

The key measure of effective inventory management is the impact that inventory has on corporate profitability

a)Explain in your own words the two measures of Inventory Management Effectiveness (6 marks)

b)Briefly discuss the Impact of the Demand patterns on Inventory Management (6 marks)

c) Which type of Demand pattern would you prefer for your business organization. State your reason.(3 marks)

Question 3

The best ordering policy can be determined by using Economic Order Quantity which is a concept that determines the optimal order quantity

a)Discuss in your own words the concept of Economic Order quantity (6 marks)

b)Explain in detail the policy of Fixed Order Point and Fixed Order Interval(6 marks)

c) Which type of fixed ordering policy would you prefer for your organization. State your reasons.(3 marks)

Question 4