Topic 6: Inventory

Management
 Content

Definition and Inventory costs

Inventory turnover

ROP

Economic Order Quantity (EOQ)

ABC analysis
 Inventory
Management
 Definition: Inventory refers to
stocks of goods and materials
that are maintained for many
purposes.
Right amount
of products
Right time and right place
Right amount and right price
 Fundamental Approaches for Carrying Inventory
TO optimize in a cost benefit perspective how much material is available for demand.
TO develop replenishment (replacement of used/lossed goods) strategies.
TO ensure processes, collaboration, and procedures are in place that maximise the
accuracy and availability (speed) of information.

•Basic issues
• how much to order
• when to order
• where to store inventory
• what items to order
 Inventory
Management
 Four broad categories of inventories
 Raw materials- unprocessed
purchase inputs
 Work-in-process (WIP)- partially
processed materials not yet ready
for sale
 Finished goods- products ready for
shipment
 Maintenance, repair & operating
(MRO)- materials used in
production (e.g., cleaners &
brooms)
Inventory types of car

Finish goods Work-in-Process

Raw materials Purchased parts and Supplies

Exercise:

Raw materials

Purchased parts and supplies

Work-in-process

Finished products
 Inventory Costs

 Inventory costs are important for three

reasons:
 Represent a significant component of
costs in many organizations
 Inventory levels kept affect the level
of service the organization can offer
its customers
 Cost trade-off decisions in logistics
depend on and ultimately impact
inventory carrying costs
Carrying Costs
Obsolescence costs

Inventory
Storage costs
Shrinkage

Handling costs

Interest costs Insurance costs

Taxes
Inventory Costs:
Inventory carrying
costs
Where is the capital cost? Storage
space cost? Inventory service cost?
Inventory risk cost?
The total cost to hold Item 1 is $182.89
or 29.8% (inventory carrying cost
rate)
Inventory Costs: Ordering costs

Setup Costs: costs to modify

production process to satisfy
particular orders
• Setting up the equipment to
make the product/service
Order costs: the cost of receiving an
order
• Receiving an order
• Conducting a credit check
• Entering orders in the system
• Receiving a payment
 Exercises 1:
 Zukipa is a company that specially produces and sells
automated guided vehicle to some wholesalers and retailers.
In order to manage their operations efficiently for the next
year, Zukipa needs to analyze their ordering and carrying
cost based on the data of recent years. They realized that
they demand regularly 2,000 vehicles every month. Every
time they prepare an order, it usually costs
£100. Zukipa sells a vehicle at a price of £610. If they make
orders every 4 months, how much will the ordering cost and
carrying cost be? Note that the carrying cost per item is
25% of the value of a vehicle.
 Exercises 2:
 Komat’su is a brand that has been absolutely famous
for manufacturing and selling forklifts to their retailers.
In their report last year, they publish that they always
sold out 9,000 forklifts every 3 months. Following this
development, they would like to guarantee their
operations effectively by analyzing the ordering cost as
well as carrying cost for the next year. The cost of
placing an order is usually at €1,100. As be advertised,
the price of a forklift is €10,000. They plan to make
orders every 2 months, so how much will the ordering
cost and carrying cost be? Note that the carrying cost per
unit is 26% of the value of a forklift and a year has 52
weeks.
Inventory Costs:
Stock-out costs
Stock out costs: estimating the cost or penalties for a
stockout.
 supplier’s cost for not having the product
available when a customer wants it
Losing the sale to a competitor (one time
substitution)
Losing a customer for life (permanent
substitution)
possible way to handle this is by adding safety
stock
for a manufacturer, stock-out may result in lost
hours of production until the item is restocked
 More safety stock
Inventory Costs: Stock-out costs
Determination of the Average Cost of a Stockout
Alternative Loss Probability Average Cost
Brand-loyal 0$ 10% 0$
Customers
Switches and comes 37$ 25% 9.25$
back

Lost customer 1200$ 65% 780$

Average Cost of 1237$ 100% 789.25$

stock out
Trade off between Carrying cost and Stockout costs?

Why???
Fundamentals Approaches
to Carrying Inventory
 Dependent v. Independent Demand
 Dependent demand is directly related to
the demand for another product
 Independent demand is unrelated to the
demand for another product
 For many manufacturing processes,
demand is dependent
 For many end-use (finished) items,
demand is independent
 Inventory Visibility
 General benefits:
 improved customer service
 decreased cost of lost sales
 improved response time & service
recovery
 improved performance metrics
 Ability of a firm to “see” inventory on a
real-time basis throughout the supply chain
system requires:
 tracking & tracing inventory for all
inbound & outbound orders
 providing summary and detailed reports
of shipments, orders, products,
transportation equipment, location &
trade lane activity
ABC Analysis
 Assigns inventory items to one of three groups according
to the relative impact or value of the items
Classifying
 A itemsare considered to be the most important Inventory
Tight control, accurate record, frequent review
B items being of lesser importance Normal control,
regular attention
C items being the least important  Simplest
possible control
Classifying Inventory: ABC analysis
Classifying Inventory: ABC analysis
Steps in making an ABC Analysis

Establish item characteristics that impact the

result of inventory management

Classify each item into groups based on the

criteria established

Apply a degree of control in proportion to

the importance of the group
Classifying Inventory: ABC analysis
ABC Analysis Exercise
 Inventory Turnover

Inventory turnover: Inventory turnover measures how fast a company sells inventory and
how analysts compare it to industry averages.
The equation for inventory turnover equals the cost of goods sold divided by the
average inventory. Inventory turnover figures can provide important insights
about an organisation’s competitiveness and efficiency.

For example: Cost of good sold is $675000, beginning inventory is $200000, and
ending inventory is $250000
 The Hegemony Toy Company is
reviewing its inventory levels. The
related information is $8,150,000 of
cost of goods sold in the past year, and
Example
the average inventory of $1,630,000.
Calculate the inventory turnover and
determine the days number that the
inventory of Hege money is on hand.
 Reorder Point

Reorder Point (ROP), also known as reorder level, is the level of

inventory which triggers the order for replenishment of inventory

ROP = (DD x RC) + SS

DD: Daily demand
RC: Replenishment Cycle
SS: Safety stocks

XYZ Ltd. is a structural steel retailer. The average daily sales of reinforcing bar is 25
tons. The inventory’s daily consumption rate is constant, and the lead time of 7 days is
also constant. The management of XYZ Ltd. has refused to hold safety stock.
To compute the reorder point, we should put all data available in the formula above.
Reorder point = 25 × 7 = 175 tons
Reorder point
Lead time: the time between the initiation and completion
of a production process.
Jake made an order through Amazon and when he was about to
the final step of confirmation, the payment step, he chose the
option of 3 days delivery (because this was the cheapest option for
delivery service) and then made the payment. Fortunately, after 2
days, he received his package at the doorstep. So the real lead time
is just 2 days.

You walk into a restaurant to have lunch. You leave your

order at 11:00 am and waiter tells you that the chef will
take the 15 minutes to cook for you. However, until 11:20
am, you receive your meal together with the apology from
the staff because of being late. The lead time of your meal
is 20 minutes.
 Reorder Point
 If you sell electronics, and one of your bestsellers in an
iPod, you want to make sure you always have iPods in
stock. Being out-of-stock means your competition gets the
sale instead of you, and having too much stock means you
don’t have room for your stereos, PC’s, and televisions.
 Lead time: you know that it takes 30 days to receive a
new shipment of iPods between the time of order
 Average daily sales: you sell an average of 8 iPods a
day
 ROP: 8 X 30 = 240 Units

 Safety stock: because they’re relatively small, you like to

keep a safety stock of 10 iPods as backup.
 So, your reorder point would be 240 + 10 = Reorder Point.
In this case, you should reorder more iPods when you get
down to 250 iPods
Zukipa is a company that specially produces and sells automated guided
vehicle to some wholesalers and retailers. In order to manage their
operations efficiently for the next year, Zukipa that they demand regularly
2,000 vehicles every month.
Besides, Zukipa also needs to know the right time for placing a new order.
After dealing with their supplier, they know that every time they make a
new order, it will take 5 days for waiting their order arrives. In order to cope
with sudden demand, they have to keep at least 200 vehicles in their
warehouse. Let’s help Zukipa determine the reorder point. Assuming that a
month has 25 days.
 Komat’su is a brand that has been absolutely famous for manufacturing and
selling forklifts to their retailers. In their report last year, they publish that
they always sold out 9,000 forklifts every 3 months. Komat’su also wants
to know the proper time for making a new order. According to their data
last year, every time they place a new order, it always takes 7 days to
receive the products. Consequently, Komat’su has to save minimum 250
forklifts in their storage for serving unexpected demand. Let’s help
Komat’su determine the reorder point. Assuming that a month has 30 days.
 Economic Order Quantity
(EOQ)

 Economic order quantity (EOQ) is the

ideal order quantity a company should
purchase for its inventory given a set cost
of production, demand rate and other
variables. This is done to minimize
variable inventory costs, and the equation
for EOQ takes into account storage,
ordering costs and shortage costs.

 EOQ and Cash-Flow Planning

EOQ is an important tool for management to
minimize the cost of inventory and the
amount of cash tied up in the inventory
balance.
How much to order?
Economic Order Quantity EOQ
 The point at which the sum
of carrying cost and
ordering cost are minimized

 The point at which carrying

cost equal ordering cost
Economic Order Quantity (EOQ)

EOQ = 𝟐𝑨𝑩/𝑪 Eg: 1000$ of an item is used each year, the order
A = Annual usage in dollars costs are 25$ per order, and inventory carrying
B = Administrative costs per order cost are 0.2$. Assuming that the product has a
C = Carrying costs cost of 5$ per unit

EOQ= 𝟐𝑫𝑩/𝑰𝑪 EOQ (dollars) = 2 . 1000 .

25
=
D = Annual demand, in units (Eg: .20

200 units value 1000$ /5$ per unit) 500$ 𝑝𝑒𝑟 𝑜𝑟𝑑𝑒𝑟
B = Administrative cost per order of
placing the order (Cost per order) 25
EOQ (units) = 2 . 200 . = 100 units
I = Dollar value of the inventory, per .20.5
unit (product cost per unit)
C = Carrying costs of the inventory
 Economic Order Quantity (EOQ)
You’re a buyer for SaveMart.

SaveMart needs 1000 coffee makers per year. The cost of each
coffee maker is $78. Ordering cost is $100 per order. Carrying cost
is 40% of per unit cost. Lead time is 5 days. SaveMart is open 365
days/yr.  EOQ (units), ROP
 Economic Order Quantity (EOQ)

EOQ = 9 coffeemakers

ROP = demand over lead time

= daily demand x lead time (days)
=dxl

D = annual demand = 1000

Days / year = 365
ROP = 2.74 x 5 = 13.7 => 14
Daily demand = 1000 / 365 = 2.74
Lead time = 5 days
 Other Approaches to Managing
Inventory

 Time-based approaches to replenishment in logistics:

 Just in Time (JIT)
 Demand Pull approach
 Materials Requirements Planning (MRP 1)
 Demand Push approach
 Distribution Resource Planning (DRP)
 Demand Push approach
 Quick Response (QR)
 Demand Pull approach
 Continuous replenishment
 Efficient Consumer Response (ECR)
 Demand Pull approach
 Continuous replenishment
 Vendor Managed Inventory (VMI)
 Demand Pull/Push approach
 Continuous replenishment
Other Approaches to
Managing Inventory: VMI
 VMI (Vendor-managed Inventory)
 Concept of VMI initiated by Wal-Mart so its
suppliers could manage their inventories
within Wal-Mart distribution centers
 Basis of VMI is that suppliers could manage
Wal-Mart’s inventories better than Wal-Mart
 The supplier monitors on-hand inventories in
the customer’s distribution center and when
these reach the agreed-upon reorder point, the
supplier creates an order for replenishment,
notifies the customer’s distribution center of
quantity and time arrival, and ships the order
Questions?
WMS