1. Inventory planners have to make critical decisions about how much inventory to stock.

What
key components of inventory management must the planner take into consideration when
planning for inventories?

Inventory replenishment mechanics are driven by nine main components:

 Demand. This component is defined as a need for a particular product or component.

Demand comes from any number of sources, such as a customer order, a forecast, an
interplant requirement, a request for a service part, or production. Demand reduces the
available on-hand balances of items. The more the demand for an item occurs at a
stable rate, the easier it is to determine when it will need to be replenished.
 Cycle stock. Cycle stock is defined as the average amount of inventory on hand for a
product sufficient to satisfy demand during the replenishment lead time. The size of the
cycle stock is a function of average usage, ordering lot quantity, and replenishment lead
time.
 Safety stock. Safety or buffer inventory is defined as a quantity of stock planned to be in
inventory to protect against fluctuations in demand or supply. This extra safety
inventory is held in stock in addition to the cycle stock. If the exact demand for products
was always known and rarely varied, cycle inventories would be sufficient to supply
demand. In real life, however, demand is uncertain. The purpose of safety inventory is
to guard against the possibility of higher than expected demand or variation in supply
that will cause a stock out.
 Replenishment trigger. The event that alerts planners to start replenishment action is
some form of replenishment trigger. This trigger could be a visual check of inventory
levels, an empty stocking container, or a statistically derived reorder point. The
replenishment trigger provides a signal that the current on-hand balance for an item
equals the anticipated demand for the item during the replenishment lead time.
 On-hand balance. This component establishes the current available inventory balance of
an item. This inventory record signifies the quantity of stock that is available for all
demand occurring in the future. Basically, as long as the on-hand balance is equal to or
greater than demand during the replenishment lead time, no order action is required of
inventory planners.
 Review interval. This component defines at what point in time inventory planners
should review the balance records of items for possible replenishment action.
Replenishment techniques are subject to either continuous review or periodic review.
 Lead time. This component defines the span of time from the moment the need for a
replenishment order is identified until it has been received. The lead time is composed
of several possible time elements such as order preparation, order transmission,
supplier production and delivery time, transportation, receiving, and order put away.
 Reorder quantity. Once the trigger point is reached, a replenishment order needs to be
created that will restore the stocking level to some point above the trigger point. The
 goal of determining the size of the reorder quantity is to strike a balance between the
cost of ordering and the cost of stocking the inventory. Once the replenishment order is
received, the quantity is added to the current on-hand balance, and the replenishment
cycle begins again.
 Lot size. This component determines the standard quantity in which items are either
produced or purchased. The lot size must be equal to or greater than the demand
during the replenishment lead time. For items that are produced, the lot size is
calculated as the quantity that balances the cost to make it and the cost to stock it. For
items that are purchased, the lot size is calculated as the quantity that balances the cost
to order it and the cost to stock it. In both cases, as the lot quantity increases, the cost
for each item in the lot decreases. Planners must be careful, however, not to increase
the cost of carrying an item just because the per-unit purchase cost declines when
acquired in a large lot size.

2. Explain the distinction between independent and dependent demand in the management of
inventories.

The distinction between independent and dependent demand in the management of inventories are:

Inventory demand is demand for an item that is unrelated to the demand for other items.
Demand for finished goods, parts required for destructive testing, and service parts requirements are
examples of independent demand. In the management of these items, inventory planners use ordering
methods driven by statistical calculations derived from demand history to manage each item
individually. Since the goal is to have just the right quantity on hand to service the customer without
creating excess inventories, these ordering methods seek to determine the best time to reorder by
calculating the correct levels of cycle and safety stocks, and the optimal cost benefit trade-offs between
money spent in carrying inventory versus the cost of lost sales.

The critical question for inventory availability is one of quantity rather than timing. An item is
subject to dependent demand when it is directly related to, or derived from, demand for another item.
Item dependencies are described as vertical, such as when a component is required to build a
subassembly or finished product, or horizontal, as in the case of an accessory that must accompany the
product. Dependent demand is characteristic of production inventories in a typical manufacturing
company. Manufacturers purchase raw materials and components that are not sold as received but are
stocked and then issued to production to build the finished products the firm sells. This demand is
conceived as being created internally as a function of scheduling items to be converted into higher-level
assemblies and finished products. Dependent demand items are described as follows:

 Dependent demand items are always planned and managed in relation to other items as
detailed in the bills of material (BOMs) in which they are specified.
  Replenishment quantities for production inventories are precisely determined by
establishing the demand on “parent” level assemblies and then using the BOM structure to
calculate exactly the “child” item requirements and due dates.
 Future demand for production inventories should not be forecasted.
 Inventory planning decisions directly impact the demand for these items.
 Dependent demand items rarely use safety or reserve stocks.
 The critical question for inventory availability is one of timing rather than quantity.

3. Discuss the various techniques of replenishing inventory available to the inventory planner

Visual Review System – This system is a relatively simple inventory ordering technique in which
replenishment is determined by physically reviewing the quantity of inventory on hand. If replenishment
is required, a target quantity is ordered that restores balances to a pre-established stocking level. The
replenishment trigger is determined by such simple decision rules as reorder when the bin is half-full, or
when there are two pallets of stock remaining. Visual review systems can be used effectively for very
low-volume or low-cost commodity items with short lead times, and for controlling floor stocks located
near the point of use. The prime advantage of this system is the low cost of record keeping and minimal
training for employees. The disadvantages are that organizations cannot ensure items are being
reviewed on a timely basis; random storage of multiple product lots may make it difficult to view all of
the stocked inventory on a given item; and ordering rules are rarely updated to reflect changes in
current demand, supply, and lead time patterns, resulting in either possible overstocks or shortages.

Two-Bin System – This technique is defined as a fixed-ordering system in which inventory is carried in
two bins (or some other form of container). One of the bins is located in the forward picking or process
area, and the other is held in reserve either at the processing area or preferably in a reserve location in
the stockroom. Procedurally, when the picking bin is emptied, the reserve bin is brought forward from
the stockroom to service the empty bin. The empty bin serves as the trigger for replenishment. Often a
control card containing such information as item number, order quantity, supplier, and so on,
accompanies each bin and is used for order reference. The quantity required per bin is calculated as the
minimum cycle stock necessary to service demand while waiting for the arrival of the replenishment
stock from the supply source. When the replenishment quantity arrives, it is placed in the empty bin
along with the control card and stocked in a reserve location until the forward picking bin’s inventory is
depleted.

Visual review and two-bin systems are widely used, are easy to understand and implement.
They can be abused and misapplied. The following points must be taken into consideration when using
this:

 It is best for low-cost, bulk, or low-volume items whose replenishment lead times are
short. Items using these methods for the most part would be classified as C items in an
ABC classification distribution.
 Two-bin system results in needlessly high levels of inventory
 This technique is insensitive to changes in demand patterns.
 The advantage of using a two-bin system is discounted if the time and money saved is
not used to establish tighter controls over high-value, high-volume items.
 The use of visual controls is usually associated with loose transaction control, whereas
perpetual record keeping is associated with tight controls over inventory.
 For those companies involved in production or postponement processing, the assembly
of a finished good item requires the availability of Class C as well as Class A items.
Poorly controlled C items will result in item shortages, preventing the completion of
manufactured products.

Period Review – In this ordering system, a fixed review cycle is established for each product, and
replenishment orders are generated at the conclusion of the review to meet a predetermined maximum
stocking level. The review cycle is established in days, weeks, months, or quarters, whichever best
satisfies the demand requirements. It does not require perpetual inventory record keeping and is
inexpensive to use. The system, also, can be maintained manually without the use of a computer.

Reorder Point – In this replenishment system, a targeted stocked quantity is determined as the reorder
or trigger point. When the inventory position falls below this reorder point, replenishment action is
taken to restore quantities back above the reorder point. The quantity to order is manually determined,
or some form of economic order quantity (EOQ) can be used. Unlike visual review, two-bin, and periodic
review methods, the reorder point technique requires close perpetual inventory transaction control. As
receipts, adjustments, scrap, shipments, transfers, and so on occur, inventory control must perform
detailed record keeping activities that enable planners to determine whether resulting balances have
fallen below the assigned trigger levels and warrant replenishment action.

Time-Phase Order Point (TPOP) – It is computerized replenishment tool that plans inventory needs in a
priority-sequenced, time-phased manner to meet customer and forecast demand as it occurs. This
technique is at the heart of material requirements planning (MRP) and distribution requirements
planning (DRP) systems used for the control of production and distribution channel inventories. The
major advantage of the TPOP method is that inventory order action is triggered by matching supply with
anticipated demand as it is planned to occur in future time periods. At the point in the future where
demand exceeds the supply, the system alerts the inventory planner to order the item according to a
predetermined lot size and have it available on the date when the anticipated stock out appears.

Lean Inventory Systems – It is a way to eliminate waste in the production process; supply chain planners
have found that lean offers them an approach targeted at eliminating waste in such logistics system
functions as transportation, warehousing, and quality control. Lean provides supply channels with new
opportunities for inventory control, purchasing management, and buyer- supplier relationships. Lean
replenishment techniques use methods such as Kanban cards to trigger inventory replenishment and
purchasing contracts that ensure product quality and delivery.

4. What are the key components in calculating the optimal order quantity?

Understanding the effect of cost when determining an economic order quantity first requires reviewing
how inventory order and carrying costs are calculated. The first calculation is concerned with
determining the order cost. To arrive at an answer, the inventory planner first determines the annual
inventory usage for each item, the cost to create an order, and a potential order quantity. The order cost
is then calculated by using the following equation:

Ordering cost X annual inventory/order quantity

The second calculation determines the carrying cost. To determine this cost the order quantity is first
divided by 2 (average inventory) and then multiplied by the unit cost and the carrying cost percent. The
equation is:

(Order quantity/2) X unit cost X carrying cost percent

Finally, the order and carrying costs are added together to provide the total cost.

Once these calculations are done, the question then becomes, “Is the order quantity going to provide an
economical cost?” To find out, the planner would have to go through a trialand-error process, trying
various order quantities, recalculating ordering and carrying costs, and comparing resultant total costs.
The order quantity with the lowest cost is the winner!

5. Explain the concept of stock replenishment.

Answer:
The inventory subject to statistical ordering techniques are managed according to the concept
of stock replenishment. The theory behind stock replenishment is that for each item, an optimal
stocking and ordering quantity can be determined either statistically or through some form of
validated heuristic. Replenishment means to become full again; to restore to a state of original
fullness. Simply, the object of stock replenishment is to ensure that the optimum stocking levels
for all items is always maintained. Stock replenishment techniques are structured to
compensate for the inability of planners to determine the precise timing and quantity of
demand and supply in the short-term future. Since it is often difficult to determine exactly when
a demand order will occur, planners using replenishment techniques seek to always have
sufficient on-hand stock to satisfy the orders that do materialize. Poorly determined inventory
levels or failure to launch replenishment orders on a timely basis risks item stock out.