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Chapter 12: Independent Demand Inventory Management

This chapter describes the types, uses and objectives of inventory. Inventory
performance measures and relevant costs are presented. The chapter demonstrates how to
calculate the various types of order or production quantities. The benefits of small order
sizes are discussed. This chapter also explains methods used to deal with inventory, such
as single-period inventory policies, the periodic review system, continuous review
system, ABC analysis and cycle counting.
Answers to Discussion Questions in Textbook
1. Visit a local business and identify the different types of inventory used.
I have been to retailers like Office Depot and Kmart in different parts of the country.
Let’s examine their different types of inventory. First, the products, such as office or
school supplies that have been purchased from their suppliers are raw materials when
they are received in the store packed in boxes. These items become WIP when they
are in process of being stocked on the shelves. Finally, they become finished goods
when they are purchased by the customer. MRO items include the cleaning supplies
for the floors, bags to put the purchased items in when they are sold, the carts used to
take the boxes of raw materials out to the shelves for stocking and the WD-40 for
ensuring that the wheels on the carts used by the customers move easily and quietly.
2. After visiting a local business, explain the different functions of their inventory.
Let’s continue with the example from the question above. We need the raw materials
to be able to prepare to restock shelves once items are sold. We use WIP to move the
inventory through the process since we can not instantaneously restock shelves.
Finished goods are the items sold to the customers. Finally MRO items provide
support in the process and maintenance.
They create anticipation inventory when they buy in cases of the same quantity using
full truckloads in the fall in order to prepare for the Christmas season. They use
fluctuation inventory by keeping more items in the back storeroom to replenish the
shelves in cases where demand is higher than expected. The use of lot-size inventory
occurs when they buy more from their suppliers than they immediately need for the
customers. The MRO items facilitate the operations of the retail facility.
3. Explain the objectives of inventory management at the local business.
We meet the objective of customer service when the items are on the shelves when
the customer wants to purchase them and when the customer can be quickly serviced
through the cash registers. We can determine the percentages shipped on schedule by
determining the lateness associated with paying for the items.

line items and dollar volume shipped on schedule. Idle time relates to internal customer service. Item costs are the costs associated with purchasing. 8. an airline study indicated that customers become frustrated if they have to wait more than eight minutes in line for check-in. Finally. Describe what is included in the ordering or setup costs. Ordering costs are the costs of placing an order or the cost of setups in production. workers and equipment that deal with the inventory. such as direct labor and materials. Holding costs include the capital costs associated with the money invested in inventory. holding costs include the risk costs of obsolescence. Explain what is included in the annual holding cost. We can determine the percentages shipped on schedule by determining the lateness associated with paying for the items. Shortage costs are associated with a poor level of customer service. Describe the relevant costs associated with inventory policies. as well as idle time due to material or component shortages. . Holding costs include the storage costs of the warehousing space. The percentage of line items shipped on schedule measures the ability to deliver specific items. inventory turnover and weeks of supply. Inventory turnover tells us how many times we sell our current inventory level on hand. As you can see. or making an item. 6. Explain the different methods for measuring customer service. For example. Compare the two techniques. We could determine our objective in terms of the time to get through the cash register. Describe how the objectives of inventory management can be measured.4. damage. We can measure the level of customer service by measuring the percentage of orders. 9. theft. or how long it would take us to sell all our current inventory without replenishing it. 7. storage and risk costs. two inventory turns means our current inventory level will last about six months since there are two six-month periods in a year. We can measure the percentage of line items that are completely out of stock on the shelves. they are just different ways of describing our inventory level. The six month time periods is 24 weeks of supply. For example. these two techniques are related. 5. Holding costs are the costs we incur as a result of holding inventory. insurance and taxes. such as price and transportation related costs. such as capital.

Describe techniques for determining order quantities other than EOQ or EPQ. safety stock determines the level of customer service. materials and machines to make the item. ordering cost. Shortage costs are the loss of customer goodwill. backorder costs and lost sales. 15. Backorders are not permitted. as they increase. 10. For example. which also means that decreases in them will decrease the EOQ. Setup costs are the costs associated with preparing the order. Explain what safety stock is for. EOQ assumes the demand and lead times for receiving the order after placing it are known and constant.Ordering costs include the costs to prepare and handle orders and the received goods. which affects future sales. This is the case since both demand and ordering costs are in the numerator of the EOQ formula. Explain how safety stock affects the reorder point. or holding cost affect the EOQ. just when it is needed just as the company runs out of inventory. Since holding costs are in the denominator. Increases in the demand or ordering costs will increase the EOQ since they have a positive relationship. Describe how changes in demand. These costs need to be since they are used to calculate the EOQ. . Ordering and setup costs are fixed and constant. Explain the assumptions of the EOQ model. Explain how a company can justify smaller order quantities. We can also justify smaller order quantities if the holding costs increase. 12. Lot-for-lot sets the order quantity equal to the amount needed for the time period. there is an inverse or negative relationship between these costs and EOQ. Therefore. The quantity ordered arrives at once. the EOQ decreases and vice versa. We can replenish the inventory right as we need it since the demand and lead times are known. 16. For example. 13. we may order a case full of items each time we need them. 11. 14. Fixed-order quantity orders the same amount each time an order is placed. Safety stock is extra inventory for dealing with times when demand is higher than average. We can justify smaller order quantities if we can reduce the setup costs by reducing the setup time. Describe what is included in shortage costs.

in terms of volume and dollar value. A single-period model is used for items with a very short selling life. The first bin holds the remaining inventory. C items are the least important items. 18. Inventory is used out of the first bin until it is depleted. they are most frequently managed. such as pumpkins and lilies. The A items are most important. The reorder point must at least be set to equal the expected average demand during the lead time to replenish. Describe the types of products that require a single-period model. Once we need to start using the second bin. 20. We can easily use point-of-sale data to track sales and bar codes to track receipt of inventory. we place an order for replenishment. Explain the basic concept of ABC analysis. newspapers. Explain the concept of perpetual review. 19. We then use this information to allocate time to review and manage the inventories. ABC classifies the inventory items according to their importance. Explain how the two-bin systems work. . Perpetual review is the continuous updating of the inventory record. and holiday related items.Safety stock increases the reorder point. The inventory is divided into two bins. Safety stock is the extra inventory held in case demand is higher than average. 17. thus. Some examples are magazines. The second bin holds a quantity equal to the expected demand during the replenishment time.