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Managing Inventory throughout the Supply Chain

Chapter 11

Chapter Objectives

Be able to:

Describe the various roles of inventory, including the different types of inventory and inventory drivers.

Distinguish between independent demand and dependent demand inventory.

Calculate the restocking level for a periodic review system.

Calculate the economic order quantity (EOQ) and reorder point (ROP) for a continuous review system.

Determine the best order quantity when volume discounts are available.

Calculate the target service level and target stocking point for a single-period inventory system.

Describe how inventory decisions affect other areas of the supply chain. In particular, describe the bullwhip effect, inventory positioning issues, and the

impacts

of transportation, packaging, and material handling considerations.

Inventory Management

Inventory – Those stocks or items used to support production (raw materials and work-in-process items), supporting activities (maintenance, repair, and operating supplies) and customer service (finished goods and spare parts).

© 2010 APICS Dictionary

Inventory Types

Cycle stock

Safety stock

Anticipation inventory

Hedge inventory

Transportation inventory

Smoothing inventory

Types of Inventory

Cycle stock – Components or products that are received in bulk by a downstream partner, gradually used up, and then replenished again in bulk by an upstream partner.

Safety stock – Extra inventory that a company holds to protect itself against uncertainties in either demand or replenishment time.

Types of Inventory

Anticipation inventory – Inventory that is held in anticipation of customer demand.Hedge inventory – A form of inventory buildup to buffer against some event that may not happen.

© 2010 APICS Dictionary

Types of Inventory

Transportation inventory – Inventory that is moving from one link in the supply chain to another

.

Smoothing inventory – Inventory that is used to smooth out differences between upstream production levels and downstream demand.

Inventory Drivers

Inventory drivers – Business conditions that force companies to hold inventory.

Table 11.2

Independent vs. Dependent Demand Inventory

Independent demand inventory – Inventory items whose demand levels are beyond a company’s complete control.

Dependent demand inventory – Inventory items whose demand levels are tied directly to a company’s planned production of another item.

Independent vs. Dependent Demand Inventory

Example:

Independent demand:

K

itchen table – Need 500 tables five weeks from now

Dependent demand:

Kitchen table legs – Need 4 per table or 2,000 legs

Calculation of dependent demand (Chapter 12)

Inventory Control Systems

Periodic Review System – An inventory system that is used to manage independent demand inventory where the inventory level for an item is checked at regular intervals and restocked to some predetermined level.

Continuous Review System – An inventory system used to manage independent demand inventory where the inventory level for an item is constantly monitored and when the reorder point is reached, an order is released.

Periodic Review System

Calculating the order quantity (Q)Q = R-Iwhere R = restocking levelI = inventory level at the time of review.

Figure 11.6

Periodic Review System

Calculating the restocking level (R)

Calculating Service Level

Service Level – A term used to indicate the amount of demand to be met under conditions of demand and supply uncertainty.Assumes that the demand during the reorder period and the order lead time is normally distributed.

Continuous Review System

Key features:

Inventory levels are monitored constantly, and a replenishment order is issued only when the reorder point is reached.

The size of a replenishment order is typically based on the trade-off between holding costs and ordering costs.

The reorder point is based on both demand and supply considerations, as well as on how much safety stock managers want to hold.

Continuous Review System

Assumptions:

Constant demand and lead time

Holding and Ordering cost known and fixed

Price of each unit is fixed.

Continuous Review System

When the demand rate and lead time are constant:

Reorder point = demand x lead timeR = dL

Figure 11.7

Economic Order Quantity

Economic Order Quantity (EOQ) – The order quantity that minimizes annual holding and ordering costs for an item.Holding costs (H)– The cost to hold a single unit in inventory for a year.Ordering costs (S) – The cost of placing an order regardless of the order quantity.

Total Yearly Inventory Costs

Total holding and ordering costs for the year = Total yearly holding cost + Total yearly ordering cost =Yearly holding cost = average inventory x holding costYearly ordering cost = number of orders per year x fixed ordering cost

Comparing Ordering Costs to EOQ

Figure 11.9

Example 11.2

Annual demand (D) = 4,000Annual holding cost (H) = $15Ordering cost (S) = $50/orderOrder quantity (Q) = 1,000 fans

Example 11.2

Calculate the EOQ and use that value as the order quantity to see if the cost is lower and calculate the total yearly inventory cost.Cost Savings:

Reorder Points and Safety Stock

When demand rate (d) and lead time (L) are constant:When demand rate (d) and lead time (L) or both varies:

The impact of varying demand rates and lead time

Figure 11.10

Causes of Variability

The variability of demand

The variability of lead time

The average length of lead time

The desired service level

Safety Stock

Safety stock:= z x standard deviation of demand during the reorder period =

Reorder Point

Reorder Point =

Example 11.3

Example 11.3

Calculate Safety Stock:Calculate Reorder Point:

Quantity Discounts

Quantity Discounts – Price reductions for ordering larger quantities.

Quantity Discounts

Two-step process:

Calculate the EOQ. If the EOQ represents a quantity that can be purchased for the lowest price, stop – we have found the lowest cost order quantity. Otherwise, go to Step 2.

Compare total holding, ordering, and item costs at the EOQ quantity with total costs at each price break above the EOQ. There is no reason to look at quantities below the EOQ, as these would result in higher holding and ordering costs, as well as higher item costs

.

Example 11.4 – Hal’s Magic Shop

Demand (D) = 1,000 masks

Ordering cost (S) = $20Holding cost (H) = $3

Solve for EOQ:

Example 11.4 – Hal’s Magic Shop

Because 115 is not eligible for the lowest price, calculate total cost at 115:

Example 11.4 – Hal’s Magic Shop

And compare to total cost at next price break or 201.Price is cheaper at the 201 price break.

Single-Period Inventory System

When excess inventory cannot be held in the future, firms must weigh the cost of being short against the cost of holding excess units

.

Examples:

Fresh fish, magazines, newspapers, Christmas trees

Single-Period Inventory System

Single-period inventory system – A system used when demand occurs in only a single point in time.

Goals:

Determine a target service level (SL

T

) that strikes the best balance between shortage costs and excess costs.

Use the target service level to determine the target stocking point (TS) for the item.

Single-Period Inventory System

Target service level – The service level at which the expected cost of a shortage equals the expected cost of having excess units.

Target stocking point – The stocking point at which the expected cost of a shortage equals the expected cost of having excess units.

Target Service Level

OR

Target Service Level

The target service level (SLT) is the p value at which holds true

Target Stocking Point

Inventory in the Supply Chain

Bullwhip Effect An extreme change in the supply position upstream in a supply chain generated by a small change in demand downstream in the supply chain. Inventory PositioningCost and value increases and flexibility decreases down the supply chain.Transportation, Packaging, Material HandlingPhysical size and quantity of lot, how it is packaged, material handling equipment needed, and disposal of packaging are all factors in choosing appropriate supplier and distribution process.

© 2010 APICS Dictionary

Demand vs. Order SizeThe Bullwhip Effect

Figure 11.12

Managing Inventory Case Study

Northcutt Bikes: The Service Department

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