Inventory Management

Introduction Sanjay ChoudhariIndian Institute of Management Indore

Importance of Inventory

Importance of Inventory Balance the advantages and disadvantages of small and large inventories

Pressures for small inventoriesInventory holding costCost of capitalStorage and handling costsTaxes, insurance, and shrinkage

Importance of Inventory Pressures for large inventoriesCustomer serviceOrdering costSetup costLabor and equipment utilizationTransportation costPayments to suppliers

Reasons for Holding InventoryTo meet anticipated customer demandTo protect against stock outsTo take advantage of economic order cyclesTo maintain independence of operationsTo allow for smooth and flexible production operationsTo guard against price increases

In Short,Buffer against uncertainty in..

Supply (Raw material inventories)

Production process ( Work in process inventories)&Demand (Finished good inventories)

Type of Inventory Process stageDemand TypeOthersRaw Materials WIP Finished GoodsIndependent DependentSpares ConsumablePurposeCycleSafetySeasonalPipeline

Independent Demand(demand for item is independent of demand for any other item)Dependent Demand(demand for item is dependent upon the demand for some other item)Independent vs. Dependent Demand

Independent vs. Dependent Demand..ItemMaterials WithIndependent DemandMaterials WithDependent DemandDemandSourceCompany CustomersParent ItemsMaterialTypeFinished GoodsWIP & Raw MaterialsMethod ofEstimatingDemandForecast & BookedCustomer OrdersCalculatedPlanningMethodEOQ & ROPMRP

Inventory Type : Purpose Seasonal stocksThese are accumulated to absorb seasonal fluctuations in supply or demand.

Cycle stocksDue to fixed transportation and handling charges or set up requirements, it is economical to order or produce large quantities at a time.

Safety stocksThese are built as a hedge against uncertainties in supply or demand.

Pipeline stocksInventories in-transit.

ABC AnalysisStock-keeping units (SKU) Identify the classes so management can control inventory levelsA Pareto chart

ABC Analysis

ABC ProblemBookers Book Bindery divides SKUs into three classes, according to their dollar usage.Calculate the usage values of the following SKUs and determine which is most likely to be classified as class A.

SKU NumberDescriptionQuantity Used per YearUnit Value ($)1Boxes5003.002Cardboard (square feet)18,0000.023Cover stock10,0000.754Glue (gallons)7540.005Inside covers20,0000.056Reinforcing tape (meters)3,0000.157Signatures150,0000.45

ABC Problem

SKU NumberDescriptionQuantity Used per YearUnit Value ($)Annual Dollar Usage ($)1Boxes5003.00=1,5002Cardboard (square feet)18,0000.02=3603Cover stock10,0000.75=7,5004Glue (gallons)7540.00=3,0005Inside covers20,0000.05=1,0006Reinforcing tape (meters)3,0000.15=4507Signatures150,0000.45=67,500Total81,310

ABC Problem

Inventory Cost Holding costs - associated with holding or carrying inventory over time

Ordering costs - associated with costs of placing order and receiving goods

Setup costs - cost to prepare a machine or process for manufacturing an order

Shortage cost

Terms used in InventoryMaterial cost = Ci (Average price paid per unit purchased is a key cost in the lot-sizing decision )Fixed ordering cost = Co (Fixed ordering cost includes all costs that do not vary with the size of the order but are incurred each time an order is placed)Holding cost = CH = %*Ci (Holding cost is the cost of carrying one unit in inventory for a specified period of time i.e. $ CH/Unit/Year)

Quantity in a lot or batch size = Q (Quantity is either produced or purchased at a time, EOQ* = Q* )

Demand per unit time = D (i.e. Demand in one 1 year, d = average demand per week, So, D = d *52 / year)

Inventory Cost Holding Costs (CH)ObsolescenceInsuranceExtra staffingInterestPilferageDamageWarehousingetc.Ordering Costs (Co)SuppliesFormsOrder processingClerical supportetc.Clean-up costsRe-tooling costsAdjustment costsetc.Setup Costs (Cs)

Holding cost (CH)Cost of CapitalObsolescence costHandling costVary with quantity of product received , ZERO otherwiseOccupancy costVary with quantity of product stored, ZERO otherwiseMiscellaneous costsTheft, security, damage, tax, insuranceInventory Cost

Ordering cost (Co)Buyer timeTime of buyer for placing extra order, ZERO otherwiseInternet and communication has reduced this cost significantlyReceiving costsAdministrative work such as purchase order matching with updating inventory recordsQuantity dependent should not be included hereTransportation costsFixed cost should be included hereInventory Cost

Shortage CostsWhen occurs, company faces two possibilities..

It can meet the shortage with some type of rush, special handling or priority shipmentIt cannot meet the shortage at all

So. It depends on How company handles the problem ?

PermanentLost profits due to unsatisfied demandLost profits of future sales

Temporary (CB)Backordered, so not necessarily lostSpecial clerical & paperwork costsExtraordinary transportation cost to customerShortage Costs

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