SCM Inventory 21 Oct BT

Inventory Management in Supply Chain
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Importance of Inventory Management in the Supply Chain

Resource availability (such as that of finance and space) has forced management to consider how best to lower the levels of inventory within the supply chain management systems in order to maintain margins The realization by many companies that a greater return- oninvestment (ROI) can be obtained by developing the core business, and that investment in working capital items, such as inventory and debtors, returns far less in comparison to other initiatives. The developments IT front provides a potential tool to reduce the inventory. Inventory and information can be traded. The better the information lower is the need for inventory. Information systems such as POS (point of sales), ERP (Enterprise Resource Planning systems) can significantly reduce the inventory.
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Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra
Why inventory?
Leverage economies of scale by producing in large volumes (typically unit costs are lowest when product is a manufactured in long production run at constant quantities). Exploit economies of scale in purchase and transportation based on the notion that both product procurement and transportation costs will be reduced if lot sizes are large. Inventory provides hedges against price changes: Especially In India, observe the tendency to hoard commodities in anticipation of price rise just before the budget (in the months of Jan/Feb, just before the financial budget). This suggests that volume purchases will minimize the impact of suppliers price increases. Inventory protects against demand and lead-time uncertainties.
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Tradeoff between Inventory & service
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Inventory
Type of demand Characteristics Inventory policy
Constant demand
or
uniform
Predictable high flow rates
Minimum stock. Direct deliveries from suppliers.
Wavy pattern
Slow moving flow rates, High critically. Perishable, Peaks are relative predictable
Minimize Inventory holding, building them only during peak demand period. Direct delivery from supplier where possible. Hold high level of stock thereby allowing safety stock for delivery leadtime and demand fluctuations.
Sudden Upshot: Type (a)
High criticality, Low value, Long leadtime, Small physical size.
Sudden Upshot: Type (b)
Low criticality, High value, Bulky physical characteristics, Demand Peaks are relatively predictable.
Minimize stockholding, building them only during peak demand period. Direct delivery from supplier where possible.
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Selective Inventory Control: Pareto Analysis or ABC analysis

Pareto analysis (sometimes referred to as the 80/20 rule and as ABC analysis) is a method of Pareto analysis (sometimes referred to as the 80/20 rule and as ABC analysis) is a method of classifying items, events, or activities according to their relative importance. It is frequently used in inventory management where it is used to classify stock items into groups based on the total annual expenditure for, or total stockholding cost of, each item. Companies often concentrate on the high value/important items.
ABC analysis is used to prioritize the items.
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Pareto (ABC) Analysis Vital few/ Trivial many!

100 90 Class A 80 70 60 50 40 30 20 Class B Class C
Percentage of dollar value
10
0 10 20 30 40 50 60 70 80 90 100
Percentage of items
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Inventory Costs
Purchase or Production Cost of item
Holding Costs
Ordering or Setup Cost
Stock out Cost
Total Inventory Cost
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Inventory Decisions: How and When

How many units should be ordered when an order is placed? When should the order be placed?
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Continuous Review (Q System)

IP Order received Order received
IP Order received
IP Order received
On-hand inventory
OH
OH
OH
R
Order placed L TBO TBO Order placed L TBO Order placed L
Time
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Uncertain Demand
IP Order received Order received Order received Q OH Q Q IP Order received
On-hand inventory
R
Order placed Order placed Order placed
L1 TBO1
L2 TBO2 TBO3
L3
Time
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Periodic Review Systems (P System)

T IP On-hand inventory
Order received
OH
IP
Order received
IP Order received
Q3
Q1 IP1 IP3 Order placed IP2
Q2
OH
Order placed
L P
L P
Time
Protection interval
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EOQ Model
EOQ - Economic Order Quantity Model Assumptions
Delivery is immediate - There is no time lag between purchasing and availability - lead time is zero
Demand is deterministic
Demand is constant over a period of time

We know how much will be demanded and when the demand will occur There are no space/budget constraints
No interaction of items
A lot of items can be broken down into identifiable, individual items.
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EOQ Model
D = units of demand per year
c = unit item cost

A = Ordering cost for each order H = cost to hold a unit in inventory for one year Q = Order quantity
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Example
Excel purchases a component part for one of their specialty assembly from an outside vendor
Item cost Mu 1.20 each.
Ordering cost : Mu 50
Inventory Holding Rate : 25 % Average demand : 1600 units /week
MU: Monetary Unit
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Analysis
Average Weekly = 1600 units Annual Demand = 52 weeks x 1600 = 83,200 Daily Demand = 83,200/365 = 228
How many to order and how often?

Option 1: Order every 4 days Order 4 x 228 = 912 units Number of Orders = 365/4 = 91.2
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Inventory Option 1
Q=912 Inventory Level
900
Maximum Inv.
600
Average Inv.
Q/2 = 456
300
Minimum Inv.
00
6 8 Working Day
10
12
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Costs
Holding Cost = H Per Unit = (.25)(1.20) = Mu 0.30 = H (note: annual per unit holding cost is 25% of price) Annual Holding = (H) (Q/2) Annual = (.30) (456 units) = Mu 136.80 Ordering Cost = A Per Order = Mu 50.00 = A Annual Ordering = (D/Q)A Annual Cost = (91.2)(Mu 50) = Mu 4560 TC = (H) (Q/2) + (D/Q)A + c(D) Holding Ordering Purchasing = 136 + 4560 + 99840 TC = Mu 104,536
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Finding a better choice

for Q
Since the unit purchase cost, c, is a constant regardless of what we select for Q, it can be ignored and we can deal only with the holding and ordering cost portion of total cost. Thus for Q = 912 units
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Inventory Cost Analysis

c= h= D= A= 1.2 0.3 83200 50
Order Quantity
500 1000 1500 2000 2500 3000 3500 4000 4500 5000 5500 6000 6500 7000 7500
Orders
166 83 55 42 33 28 24 21 18 17 15 14 13 12 11
Holding Cost Order Cost

$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 75.00 150.00 225.00 300.00 375.00 450.00 525.00 600.00 675.00 750.00 825.00 900.00 975.00 1,050.00 1,125.00 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 8,320.00 4,160.00 2,773.33 2,080.00 1,664.00 1,386.67 1,188.57 1,040.00 924.44 832.00 756.36 693.33 640.00 594.29 554.67
Total Cost
$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 8,395.00 4,310.00 2,998.33 2,380.00 2,039.00 1,836.67 1,713.57 1,640.00 1,599.44 1,582.00 1,581.36 1,593.33 1,615.00 1,644.29 1,679.67
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Inventory Costs Analysis

(Cont.)
$9,000.00 $8,000.00 $7,000.00 $6,000.00 $5,000.00 $4,000.00 $3,000.00 $2,000.00 $1,000.00 $Holding Cost Order Cost Total Cost
Minimum Total Cost
Cost
50 0 20 00 35 00 50 00 65 00 80 00 95 00
Order Quantity
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Inventory Costs Analysis

(Cont.)
Average Inventory Value vs Lots Per Year
7000 6000 5000 4000 3000 2000 1000 0 0 50 100 Lots Per Year 150 200
Average Inventory Value
Ave. Inv. Value = c (Q/2)
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Solving for the Optimal Quantity EOQ

EOQ=
Q* =
2DA H
EOQ=
2(83200)(50) Q = = 5266.25 .30

*
TC = (Q/2)(H) + (D/Q)(S) = (5266.25/2)(.30) + (83200/5266.25)50 = Mu 789.94 + Mu 789.94 = Mu 1579.88
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Issue of Sensitivity
Inventory Costs are not particularly sensitive to small changes in lot size
Total Cost
$ $ $ $ $ 1,580.37 1,580.07 1,579.91 1,579.88 1,580.00
Order Quantity Orders (Lots) Holding Cost Order Cost

5400 5350 5300 5250 5200 15 16 16 16 16 $ $ $ $ $ 810.00 802.50 795.00 787.50 780.00 $ $ $ $ $ 770.37 777.57 784.91 792.38 800.00
EOQ = 5266
Total Cost = Mu 1579.88
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Time Between Orders

T = Q* = EOQ = D D 5266.25 = .063 years 83200
T = .063 x 365 days = 23.1 days = 23 days Thus inventory Model : Order 5266 units every 23rd Day
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SCM Inventory 21 Oct BT

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Inventory Management in Supply Chain

Importance of Inventory Management in the Supply Chain

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Tradeoff between Inventory & service

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Predictable high flow rates

Minimum stock. Direct deliveries from suppliers.

Sudden Upshot: Type (a)

High criticality, Low value, Long leadtime, Small physical size.

Sudden Upshot: Type (b)

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Selective Inventory Control: Pareto Analysis or ABC analysis

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Pareto (ABC) Analysis Vital few/ Trivial many!

Percentage of dollar value

Purchase or Production Cost of item

Ordering or Setup Cost

Stock out Cost

Total Inventory Cost

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Inventory Decisions: How and When

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Continuous Review (Q System)

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Periodic Review Systems (P System)

Q1 IP1 IP3 Order placed IP2

Demand is constant over a period of time

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

c = unit item cost

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Item cost Mu 1.20 each.

MU: Monetary Unit

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

How many to order and how often?

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Finding a better choice

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Inventory Cost Analysis

Holding Cost Order Cost

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Inventory Costs Analysis

Minimum Total Cost

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Inventory Costs Analysis

Average Inventory Value

Ave. Inv. Value = c (Q/2)

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Solving for the Optimal Quantity EOQ

2(83200)(50) Q = = 5266.25 .30

TC = (Q/2)(H) + (D/Q)(S) = (5266.25/2)(.30) + (83200/5266.25)50 = Mu 789.94 + Mu 789.94 = Mu 1579.88

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Order Quantity Orders (Lots) Holding Cost Order Cost

Total Cost = Mu 1579.88

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Time Between Orders

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra

Exit the Show Restart the Show

Supply Chain Management by R P Mohanty & S G Deshmukh Biztantra