CHAPTER 8: INVENTORY MANAGEMENT

1. How might different organizational functions have different inventory management objectives?
Marketing, for example, tends to want to ensure that sufficient inventory is available for customer demand to avoid potential stockout situations—which translate into higher inventory levels. Alternatively, the finance group generally seeks to minimize the cost associated with holding inventory, which translates into lower inventory levels.
2. What makes is difficult for managers to achieve the proper balance of inventory?
Achieving the proper balance of inventory can be quite difficult because of the trade-offs between inventory carrying cost and stockout cost. More specifically, holding high levels of inventory (overstock) result in higher inventory carrying costs and low (or no) stockout costs. Alternatively, holding low levels of inventory result in low inventory carrying costs and some (high) stockout costs.
3. Distinguish among cycle, safety, pipeline, and speculative stock.
Cycle (base) stock refers to inventory that is needed to satisfy normal demand during the course of an order cycle. Safety (buffer) stock refers to inventory that is held in addition to cycle stock to guard against uncertainty in demand and/or lead time. Pipeline (in-transit) stock is inventory that is en route between various nodes in a logistics system, while speculative stock is inventory that is held for several reasons to include seasonal demand, projected price increases, and potential product shortages.
4. Define what is meant by inventory carrying costs, and list its primary components.
Inventory carrying costs refer to the costs associated with holding inventory. Inventory carrying costs consist of a number of different components, and their importance can vary from product to product. These components include obsolescence costs, shrinkage costs, storage costs, taxes, and interest costs.
5. What are ordering costs, and what is the trade-off between inventory carrying costs and ordering costs?
Ordering costs refer to those costs associated with ordering inventory, such as order costs and set up costs. Order costs include, but are not limited to, the costs of receiving an order (e.g., the wages of the person who takes orders by telephone), conducting a credit check, verifying inventory availability, entering orders into the system, preparing invoices, and receiving payment. The trade-off that exists between carrying and ordering costs is that they respond in opposite ways to the number of orders or size of orders. That is, an increase in the number of orders leads to higher order costs and lower carrying costs.
6. Discuss the concept of stockout costs. How can a stockout cost be calculated?
Stockouts refer to situations where customers demand items that are not immediately available and stockout costs refer to the costs associated with not having items available. Calculation of a stockout cost first requires a company to classify potential customer responses to a stockout (e.g., delays the purchase, lost sale, lost customer). Next, the company needs to assign probabilities to the various responses as well as to assign monetary losses to the various responses. The respective probabilities and losses are multiplied together and then all costs are summed to yield an average cost of stockout.