Supply Chain, Inventory Management (ch 7)

the stock of any item or resource
used in an organization
Four broad categories of inventories
Finished goods
Raw materials
Work-in-process (WIP)
Maintenance, repair & operating (MRO)
Finished Goods
Completed products ready for shipment, often kept to buffer against unexpected demand changes
Raw Materials
Unprocessed purchased inputs or material for manufacturing the finished goods. Become part of finished goods after the manufacturing process is completed
Work-in-process (WIP)
Describes materials that are partially processed but not yet ready for sales. Reason to keep WIP is to decouple processing stages or to break the dependencies between work centers
Maintenance, Repair and Operating (MRO)
Materials and supplies used when producing the products but are not part of the products. Examples: cutting tools, solvents and lubricants for machines
Where is inventory required?
Manufacturing Distribution/Retail
Independent demand
-Set by market conditions
-Independent of operations -‘Replenishment’ philosophy
-End Consumer
Dependent demand
-Components and assemblies for creating good or service
-Demand is dependent on the factory or service schedule
-Demand comes in clumps
-‘Requirements’ philosophy
How much do I order?
-Simple bin systems, EOQ
-Price Break Model (Quantity Discounts)
What inventory level should be maintained?
-Reorder Point
-Safety Stock
When should orders be placed?
-Periodic Review
-Continuous Review
How much effort to put into managing inventory?
-ABC inventory analysis
-Inventory turnover analysis
ABC Inventory Analysis
Useful technique for determining which inventories should be counted more frequently and manager moe closely and which others should not. Determine annual $ usage, Rank the items according to annual $ usage, 80/20 rule
Why Inventory Management?
Right product, right point-in-time, right place to meet customer demand
Risk Costs
-Inventory shrinkage
Storage Space Costs
Variable storage and handling costs
Service Costs
-Insurance costs
Capital or Finance Costs
-Interest charges
-Opportunity cost
Item cost
direct costs traceable to each unit for material and labor
Stockout Costs
the cost of not having inventory on hand when demand
Inventory accuracy
refers to how well the
inventory records agree with physical count
Cycle Counting
is a physical inventory-taking technique in which inventory is counted on a frequent basis rather than once or twice a year.
Two Bin System
Maintain two bins of item in stock. Use one until it
is gone. Start using the second and order a new
one. Size of the bins should be equal to the reorder
point. This is a fixed order quantity system.
Advantages to the Two Bin System
-Simple & requires no monitoring.
-Good for cheap, common items.
Economic Order Quantity (EOQ)
-Answers the question ‘How much do I order?’
-Used for independent demand items.
-Objective is to find order quantity (Q) that minimizes the total cost (TC) of managing inventory.
-Must be calculated separately for each Stock Keeping Unit
-Widely used and robust (i.e. works well in a lot of situations,
even when its assumptions don’t hold exactly).
EOQ Assumptions
-Demand known and constant
-Order lead time known and constant
-Full replenishment (entire order delivered at one
-Price is constant, no quantity or price discounts
-Order cost is known and constant
-No stockouts
-No limits on capital availability
EOQ Model Formula
Total Annual Inventory Cost
Annual PurchaseCost
Annual Ordering Cost
Annual Holding Cost

TAIC= RC+R/Q(S)+Q/2 (kC)

Total Annual Inventory Cost
Annual Demand
Cost per Unit
# of Orders per Year
Ordering Cost per Order
Average Inventory
Annual Holding cost Per Unit
Deriving the EOQ
Square Root of
2(Annual Demand)(Order or Setup Cost)
Annual Holding Cost
Evaluation of EOQ
-EOQ is a popular inventory model.
-EOQ doesn’t handle multiple locations well.
-EOQ doesn’t do well when demand is not constant.
-Minor adjustments can be made to the basic model.
-Newer techniques take the place of EOQ.
-Understanding EOQ is necessary to understand more
complex models
EOQ System:
Demand & Lead Time Uncertainty
*Uncertainty is a normal condition
-Demand is often affected by exogenous factors—weather, forgetfulness, etc.
-Lead times often vary regardless of
carrier intentions
*Reorder Point
-Becomes the average demand during lead time plus the safety stock
Variability and Average Inventory
Since safety stock on average is not consumed,
the average inventory level including safety
stock can be found by: average inventory equation
Average Inventory
Q/2 + SS
Continuous Review (Q) System
*Fixed-Order Quantity Model
-Event triggered (Example: running out of stock)
*Allows for random demand
*Stock position is monitored continuously
Periodic Review (P) System
*Fixed-Time Period Model
-Time triggered (Example: Monthly sales call by
sales rep.)
*Assume demand is random
*Order up to the ‘target’ level at a specified time
Inventory Investment
*Firms should diligently measure inventory
investment to ensure that it does not adversely affect
competitiveness. Measures include:
• Absolute value of inventory (found on balance sheet)
• Inventory turnover or turnover ratio- how many times
inventory “turns” in an accounting period. Faster is better!
Inventory Turnover Ratio
= Cost of Revenue / Average Inventory

= COGS/ Average Aggregate Inventory Level

The objective of the economic order quantity is to minimize the total:
Annual Inventory Cost
What will be the effect on average inventory if Jack experiences a 50% decrease in demand and a doubling of the ordering costs.
Nothing, it will stay the same
In a continuous review system of inventory management
Quantity ordered is constant per each order.
Which of the following is generally consistent with a centralized warehousing system?
Longer customer delivery lead times
Less-than-truckload (LTL) service requires ____________ handling and loading cost than
does truckload (TL) service.
The safety stock calculation is influenced by:
Demand and Lead-Time Uncertainty
Lead Time Increased
Inventory Increases and Costs Increase
Higher Inventory Turnover