Reasons for Inventory

1
Reasons for Inventory

• To create a buffer against uncertainties in
  supply demand
• To take advantage of lower purchasing and
  transportation cost associated with high volume
• To take advantage of economies of scale
  associated with manufacturing products in batches
• To build up seasonal demand for promotional sales
• To accommodate product flowing from one location
  to another (work in process or in transit)
• To exploit speculative opportunities for buying
  and selling commodities and other products

2
Goals Reduce Cost, Improve Service

• By effectively managing inventory
• Xerox eliminated 700 million inventory from its
  supply chain
• Wal-Mart became the largest retail company
  utilizing efficient inventory management
• GM has reduced parts inventory and transportation
  costs by 26 annually

3
Goal Reduce Cost, Improve Service

• By not managing inventory successfully
• In 1994, IBM continues to struggle with
  shortages in their ThinkPad line (WSJ, Oct 7,
  1994)
• In 1993, Liz Claiborne said its unexpected
  earning decline is the consequence of higher than
  anticipated excess inventory (WSJ, July 15,
  1993)
• In 1993, Dell Computers predicts a loss Stock
  plunges. Dell acknowledged that the company was
  sharply off in its forecast of demand, resulting
  in inventory write downs (WSJ, August 1993)

4
Inventory

• Where do we hold inventory?
• Suppliers and manufacturers
• warehouses and distribution centers
• retailers
• Types of Inventory
• WIP
• raw materials
• finished goods
• Why do we hold inventory?
• Economies of scale
• Uncertainty in supply and demand

5
Why Inventory Reduction

• Business processes reduce or eliminate
  inventories mainly by reducing or eliminating
  uncertainties that make them necessary

• Better communication and coordination of
  activities across company functions and between
  the company and its vendors and customers can
  greatly reduce uncertainties.

6
Ways to Reduce Uncertainties

• Improving the accuracy of forecasts by developing
  better forecasting methods
• Promoting better communication between supply
  chain managers and marketing and sales managers
• Sharing supply chain information with vendors and
  other third party providers
• Consolidating number of locations where products
  are held
• Reducing product variety
• Postponing product customization to downstream
  stage of the supply chain

7
Role of Inventory in the Supply Chain
Cost
Availability
Responsiveness
Efficiency
8
Inventory Policy
9
Role of Inventory in the Supply Chain

• Overstocking Amount available exceeds demand
• Liquidation, Obsolescence, Holding
• Understocking Demand exceeds amount available
• Lost margin and future sales
• Goal Matching supply and demand

10
Understanding Inventory

• The inventory policy is affected by
• Demand Characteristics
• Lead Time
• Number of Products
• Objectives
• Service level
• Minimize costs
• Cost Structure

11
Cost Structure

• Order costs
• Fixed
• Variable
• Holding Costs
• Insurance
• Maintenance and Handling
• Taxes
• Opportunity Costs
• Obsolescence

12
EOQ A View of Inventory
Note No Stockouts Order when no inventory
Order Size determines policy
Inventory
Avg. Inventory
Order Size
Time
13
EOQTotal Cost
Total Cost
Holding Cost
Order Cost
14
EOQ Calculating Total Cost

• Purchase Cost Constant
• Holding Cost (Avg. Inven) (Holding Cost)
• Ordering (Setup Cost) Number of Orders Order
  Cost
• Goal Find the Order Quantity that Minimizes
  These Costs

15
Fixed costs Optimal Lot Size and Reorder
Interval (EOQ)

• R Annual demand
• S Setup or Order Cost
• C Cost per unit
• h Holding cost per year as a fraction
  of product cost
• H Holding cost per unit per year
• Q Lot Size
• T Reorder interval

16
Example

• Demand, R 12,000 computers per year
• Unit cost, C 500
• Holding cost, h 0.2
• Fixed cost, S 4,000/order
• Q 980 computers
• Cycle inventory Q/2 490
• Flow time Q/2R 0.49 month
• Reorder interval, T 0.98 month

17
EOQ Another Example

• Book Store Mug Sales
• Demand is constant, at 20 units a week
• Fixed order cost of 12.00, no lead time
• Holding cost of 25 of inventory value annually
• Mugs cost 1.00, sell for 5.00
• Question
• How many, when to order?