Chapter 4- Inventory Management

the quantities of goods and materials that are held in stock
4 categories of inventory
raw materials
work-in-progress (WIP)
finished goods
maintenance, repair, and operating (MRO) supplies
raw materials
purchased items or extracted materials that are converted via the manufacturing process into components and products
a good or goods in various stages of completion throughout the plant, spanning from raw material that has been released for initial processing up to fully processed material awaiting final inspection and acceptance as finished goods
finished goods
items on which all manufacturing operations, including final testing, have been completed. These items are available for sale and/or shipment to the customer
(maintenance, repair, and operating) items used in support of general operations and maintenance such as maintenance supplies, spare parts, and consumables used in the manufacturing process and supporting operations
service inventory
activities carried out in advance of the customer’s arrival
Why hold inventory?
1. to meet customer demand (cycle stock)
2. to buffer against uncertainty in demand and/or supply (safety stock)
3. to decouple supply from demand (strategic stock)
4. to decouple dependencies in the supply chain
Inventory Management
The function of planning and controlling inventories
Goal is to help a company be more profitable by lowering COGs and/or by increasing sales
What is the right amount of inventory?
It depends on the supply chain strategy and set up, the types of products, etc
3 Levels of Internal Inventory
1. Cycle Stock
2. Safety Stock
3. Strategic Stock
cycle stock
inventory that a company builds to satisfy its immediate demand;
gradually depletes as customer orders are received
safety stock
inventory that is above and beyond what is actually needed to meet anticipated demand
strategic stock
additional inventory beyond cycle and safety stock, generally used for a very specific purpose or future event, and for a defined period of time
pipeline inventory
inventory that is already out in the market held by wholesalers, distributors, retailers, and even consumers; also in-transit
obsolete inventory
inventory that is expired, damaged, or no longer needed; will never be used or sold at full value
inventory costs
– direct costs
– indirect costs
– fixed costs
– variable costs
– order costs
– carrying costs
direct costs
directly traceable to unit produced
indirect costs
cannot be traced directly to the unit produced
fixed costs
independent of hte unit volume produced
variable costs
dependent on the unit volume
order costs
labor costs associated with placing an order for inventory and the cost of receiving the order; incurred each time an order is placed
carrying costs
costs for physically having inventory on-site and for maintaining the infrastructure needed to store the inventory and to secure and insure it over time; incurred for holding inventory
effects of having too much inventory
financial resources tied up in inventory
underlying problems being hidden rather than being exposed and solved
no incentive for process improvements
effects of having too little inventory
production disruptions
longer delivery replenishment lead times
reduced responsiveness
measures of inventory investment
Absolute inventory Value
Inventory Turnover
Absolute Inventory Value
the value of the inventory at either its cost or its market value
inventory turnover
the # of times that an inventory cycles or “turns over”, during the year
*the more the better
ratio = COGS/Average Inventory @ Cost
Inventory policy
establishing target inventory levels for all products and materials
1. When to review?
2. When to order?
3. How much to order?
2 Models for Determining When to Review
1. Continuous Review System
2. Periodic Review System
continuous reiew system
inventory levels are continuously reviewed; as soon as inventory falls below a pre-determined level, a replenishment order is triggered
periodic review system
inventory levels are reviewed at a set frequency; at the time of review, if the stock levels are below the pre-determined level, an order for replenishment is placed, other wise no action is taken until the next cycle
Reorder Point
(ROP) the lowest inventory level at which a new order must be placed to avoid a stockout
– set at a level that provides enough inventory so demand is covered during the lead time (L) needed to replenish inventory
Common Inventory Ordering System Categories
Fixed-Order Quantity System
Fixed-Time Period System
Fixed-Order Quantity System
a continuous inventory review system in which the same order quantity is used from order to order
– when inventory position drops to a predetermined reorder point, a predetermined fixed order quantity is placed
Fixed-Time Period System
inventory is checked in fixed time periods against a target inventory level
– if inventory is less than target, a quantity necessary to bring inventory back up to the target level is ordered
Q = R – IP
where Q = order quantity, R = target inventory level, and IP = inventory position
(Economic Order Quantity) a quantitative decision model based on the trade-off b/t annual inventory carrying costs and annual order costs

Where D = annual demand, Q = order quantity (units), and S = ordering costs (per order)

Total Cost
Purchase Cost + Order Cost + Carrying Cost
Annual carrying costs
Where Q = order quantity and H = holding costs (per unit)
annual ordering costs
Where D = annual demand, Q = order quantity (units), and S = ordering costs (per order)
Practical Considerations of EOQ
Volume Economies of Scale
Volume Economies of Scale
Individual Item Purchase Price Discounts
Multiple-Item Purchase Price Discounts
Transportation Freight-Rate Discounts
Individual Item Purchase Price Discounts
discounts for ordering purchase price discounts; if volume discount is sufficient to offset the added cost from carrying additional inventory, then order a larger volume may be desirable
Multiple-Item Purchase Price Discounts
based on total volume across all the items purchased rather than just an individual item’s volume
Transportation Freight-Rate Discounts
ordering a larger quantity may mean that you can take advantage of Transportation Freight Rate Discounts which will lower per unit costs
Limited Capital
storage capacity
production lot size
Limited Capital
company doesn’t have sufficient available funds to purchase at one time
storage capacity
company doesn’t have sufficient storage capacity to handle at one time
item being ordered and transported may require specialized or dedicated transportation, impacting the quantity per order
production lot size
supplier may require the company to order an item in full production lot sizes
supplier may require company to order an item in full pack, case, or pallet configurations
Other Types of inventory Systems
– ABC System
– Bin System
– Base Stock Level System
– “Single-Period” Inventory Model
ABC system
classifies inventory based on the degree of importance
A: Highest Value
B: Moderate Value
C: Least Valuable
Bin System
inventory system that uses either one or two bins to hold quantity of the item being inventoried; mainly used for small or low value items
Base Stock Level System
a type of inventory system that issues an order whenever a withdrawal is made from inventory
single-period model
a type of inventory system is only ordered for one-time stocking
– goal is to maximize profits
Ex) Newspaper stands
barcode systems
help businesses track products and stock levels for inventory management
Types: Linear 1D, 2D, barcode reader
common metrics for inventory
units, dollars, weeks of supply, inventory turns
the # of units available
the amount of dollars tied up in inventory
weeks of supply
(avg. on-hand inventory)/(avg weekly usage)
inventory turns
(COGS)/(avg. inventory value)