Supply Chain Management Chapter 7

Inventory: Supply of items held by a firm to meet demand Types of inventory: - Raw materials and component parts - Work in process inventory (Inventory that is in the production process) - Finished goods inventory - MRO Inventory (Maintenance, repair, and operating supplies) The Roles of Inventory: - Balancing supply and demand - Cycle stock: Inventory repeatedly produced or ordered and then used to fill demand in normal replenishment cycles - Seasonal stocks: Additional inventories produced in advance of seasonal peak demands or held after seasonal peak supplies - Buffering uncertainty in demand or supply - Buffer (or safety) stock: Extra inventory to guard uncertainty in demand/supply - Enabling economies of buying - Speculative stock: Stock purchased or produced to hedge against future price increases or shortages - Enabling geographic specialization: supply locations and demand locations are almost rarely in the same ares - Transit stock: Items being transported from one location to the other Financial impact of inventory: - Balance sheet considerations/costs of inventory: - product cost - Carrying costs: Several expenses that are incurred because inventory is held (opportunity cost, cost of capital, cost of storage, taxes, insurance, costs of loss/disposal, costs of handling materials - Order cost: cost from placing and receiving orders from suppliers - Setup cost: Administrative expenses and the expenses of rearranging a work center to produce and item - Stockout(shortage) cost: Cost when inventory is not available to meet demand Measures of inventory performance: - Asset productivity: Inventory turnover and days of supply: Inventory turnover: Ratio between average inventory and level of sales ● ● ● Cost of goods sold/average inventory @ cost Net sales/Average inventory @ selling price Unit sales/ Average inventory in units - High inventory turnover advantages: Increased sales volume due to rapid flow of new or fresh items Decreased expenses of holding inventory Lower asset investment and increased asset productivity Dangers of having a very high turnover rate - Possible loss of sales due to running out of needed items/stockouts - Increased COGS due to inability to produce/purchase in quantity - Increased purchasing,ordering,receiving time/effort/cost Days of supply: The number of days of business operations that can be supported with the inventory on hand - Days of supply= current inventory/expected rate of daily demand Service level: A measure of how well customer demand is met and stockouts are avoided - Measured as number of percentage of inventory items for which there is no inventory at time of demand Inventory management systems: - Independent demand inventory systems: Inventory management systems used when the demand for an item is beyond the control of the organization (typically for end items and repair parts) - Dependent demand inventory systems: Management systems used when the demand for an item is derived from the demand for some other item - Continuous review model: Inventory is constantly monitored to decide when a replenishment order needs to be placed (large investments in technology) - Periodic review model: Management system built around checking and ordering inventory at some regular interval (lower cost) 2 questions in planning inventories: How much and how often? The continuous review model: - Total acquisition cost (TAC): The sum of all relevant inventory costs incurred each year - Number of orders placed each year= Annual demand/Order quantity - Saw tooth diagram: An illustration of the pattern of ordering and inventory levels - When no safety stock is held, the average inventory is held across the year is half of the order quantity TAC= Annual ordering cost+Annual carrying cost OR TAC= Order cost( number of orders placed each year+ Unit value (inventory carrying cost percentage)(Order quantity/2) Economic order quantity (EOQ): The order quantity that minimizes the sum of annual inventory carrying cost and annual ordering cost - Root of 2(units/year)(cost per order)/Cost per unit EOQ cost trade off diagram: When to order: The reorder point (ROP) - Reorder point: The minimum level of inventory that triggers the need to order more ROP= (average demand per time period)(average supplier lead time) EOQ extensions: (Assumptions that don't hold true in practice): - No quantity discounts (product cost is constant regardless of quantity ordered - No size restrictions - No partial deliveries (one single batch) - No variability (Product demand and replenishment lead time are known and constant, there are no quality or other problems that would introduce uncertainty in either supply or demand - No product interactions (ordering one product is not ties to ordering another product) How to determine order quantity when quantity discounts are available: Step 1) Identify the price breaks offered by the supplier Step 2) Calculate the EOQ for each possible unit price (starting with the lowest) Step 3) Evaluate the feasibility of each EOQ value. If the calculated EOQ for a given price is large enough to qualify for that specific price, then the calculated EOQ is feasible.If the EOQ calculated using the lowest price category is feasible, then it is the lowest TAC order quantity. If it is not feasible (lowest price categories), then go to step 4 Step 4) Calculate the TAC for each feasible EOQ and for the minimum quantity required to attain each price break. TAC includes the product cost itself, because the unit cost now varies as a function of the order quantity Step 5) Pick the order quantity that has the lowest TAC Lot size restrictions: - If you need for example 274 units (after calculating EOQ), and vendors purchase pack of 50, you either have to get 250 or 300, in order to decide you need to calculate TAC at order size of both and pick the order quantity that yields the lowest TAC Partial order deliveries– production order quantity: - In the case that its not one batch the EOQmodification would be: - Production order quantity: The most economic quantity to order when units become available at the rate at which they are produced D: Annual demand D: daily rate of customer demand P: daily rate of production C0: setup cost U: unit cost Ci: annual inventory carrying cost percentage Enter variability and uncertainty: - Determining safety stock: standard deviation of demand during replenishment lead time must be calculated and the company’s policy on desired service level must be determined Determining the standard deviation of demand during lead time: (aka the amount of demand that occurs while waiting receipt of an inventory replenishment order) Oddlt= Standard deviation of demand during lead time t: average lead time Od: standard deviation of demand D: average demand Ot: standard deviation of lead time Service level policy: Specification of the amount of stockout risk a firm is willing to incur - Safety stock (SS)= number of standard deviations (oddlt) required for desired service level(standard deviation of demand during lead time) Relationship between inventory investment and product availability: Revisions for ROP and average inventory for when safety stock is used: ● ROP= (average daily demand x average lead time) + safety stock ● Average inventory= Q/2+SS Single Period Inventory Model: model used to determine the order size for a one time purchase– newsvendor problem (how much to stock before demand is known) Cost of a unit stockout: Unit selling price- unit cost Cost of being overstocked by one unit: Unit cost+Disposal cost-salvage value Target service level (TSL): The probability of meeting all demand for an item Order quantity= Expected demand+SS Cases in which single period inventory model is used: - Fashion; how much to purchase before season for that begins - Restaurants: how much before food spoils - Sizing for hotels, hospitals, arenas for events - Crowdsourcing Location and inventory: - How much and when are the main 2 questions for inventory, but where is also important. - Firms often hold stock closer to customers to meet demands more quickly - Total system inventory: The sum of the inventory held across all of the locations in a company - Relationship between safety stock and demand variation is not linear, and neither is inventory and number stocking locations - Square root rule: A method of estimating the impact of changing the number of locations on the quantity of inventory held: (new locations= more inventory/safety stock) Inventory related to number of locations Location and inventory/service trade offs (where to stock inventories): 1) Centralization: allows the lowering of total system inventories through economies of consolidation,sharing, and demand pooling– capital from inventory savings can be invested in better tech or advertising 2) Localization (stocking inventories in locations close to centers of customer demand): 3) Hybrid (in between) Managing inventory 1) Managing cycle stocks 2) Managing safety stocks: ABC analysis: The ranking of all items of inventory according to importance; often ranked by their (finished goods) annual sales volume/profits, (raw materials/components); usage, cost, or difficulty of acquiring items Pareto’s law: The rule that a small percentage of items account for a large percentage of sales, profit, or importance to a company ABC classification of inventory: Procedure for a quantitative ABC analysis: - Determine annual usage/sales for each item (units and or value) - Determine the percentage of the total usage/sales by item - Rank the items from highest to lower percentage - Classify the items into ABC categories 3) Managing locations 4) Inventory information systems and accuracy (data) - Cycle counting: A process where each item in inventory is physically counted on a routine schedule 5) Implementing inventory models (unique to inventory models) - Ex: continuous review model, the periodic review model, and single period inventory model - Two bin system: Inventory of an item is stored in two different locations. Location can also be known as bin and bin empties The bullwhip effect: A small disturbance generated by a customer produces successively larger disturbances at each upstream stage in the supply chain (sudden change in demand causes retailer to boost orders, and a decrease after– suppliers overreact to changes in order sizes from customers Example: Integrated supply chain inventory management: The three incentives: 1) Supplier managed inventory 2) Collaborative planning, forecasting and replenishment (CPFR) 3) blockchain 1) Supplier managed inventory (SMI):The supplier is responsible for managing the inventory located at a customers facility - Customer saves costs associated with managing inventories, including labor costs - Customer also receives more responsive service from supplier because they are on-site working directly with production - supplier gains better insights into customers operations and does a better job at scheduling replenishment - SMI often blur boundaries between vendors and customers operation management systems Collaborative planning, forecasting, and replenishment (CPFR): A method by which supply chain partners periodically share forecasts, demand plans, and resource plans in order to reduce uncertainty and risk in meeting customer demand Blockchain: A decentralized, distributed, and public digital ledger that is used to record transactions across many computers so that the record cannot be altered without agreement of all network participants. Useful to provide system visibility and to prevent distortion of data Includes: - Automating transactions such as invoices and payments - Establishing an items provenance (source andhistory) to identify the source of a quality problem - Easing access to legal documents such as titles of ownerships and contracts - Preventing data tampering and fraud - Reducing cost by reducing the need for oversight, intermediaries, and duplication of effort