Chapter 8

Quantity and Inventory

© 2020 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or
further distribution permitted without the prior written consent of McGraw-Hill Education.
 Key Questions Addressed in Chapter 8

How much to acquire?

When to acquire?
How to manage inventory effectively?

© 2020 McGraw-Hill Education. 8-2

 Factors Complicating Quantity
Decisions (1 of 2)
Forecasts
• Purchase decisions made a long time before actual
requirements are known
• Rely on forecasts of future demand, lead times,
prices, and other costs
• Forecasts are rarely, if ever, perfect
Costs
• Costs associated with placing orders, holding
inventory, running out of materials, and having a
service unavailable when needed

© 2020 McGraw-Hill Education. 8-3

 Factors Complicating Quantity
Decisions (2 of 2)
Availability
• Desired quantities may be unavailable without
paying a higher price or delivery charge
Price-Volume Relationship
• Reduced prices for larger quantities versus carrying
costs
Shortages
• May cause serious disruptions

© 2020 McGraw-Hill Education. 8-4

 Time-Based Strategies

Reduce setup and cycle times

• reduce costs
• reduce lead times
Coordinate the flow of resources
• eliminate process/system waste
• ensure on-time or just-in-time arrival in economical
sized batches

© 2020 McGraw-Hill Education. 8-5

Forecasts and Uncertainty

Access the text alternative for slide images

© 2020 McGraw-Hill Education. 8-6

 Forecasting Dilemmas (1 of 2)

Where should responsibility for forecasting future usage

lie?
• Should the supply management group be allowed to
second-guess sales, production, or user forecasts?
• Should other supply chain members be involved in a
collaborative forecasting effort?

© 2020 McGraw-Hill Education. 8-7

 Forecasting Dilemmas (2 of 2)

If the forecast is wrong, who bears the risks?

• Should suppliers be held responsible for meeting
forecasts or actual requirements?
• Should the supply manager be held responsible for
meeting forecasts or actual requirements?
• When should responsibilities for dealing with results
of inaccurate forecasts be outlined in the contract?
• What role does negotiation play in resolving these
issues?

© 2020 McGraw-Hill Education. 8-8

 Forecasting Techniques: Quantitative

Use past data to predict the future

• Causal models
• Identify leading indicators
• Develop linear or multiple regression models
• Time series forecasting
• Assumes sales follow a repetitive pattern over time

© 2020 McGraw-Hill Education. 8-9

 Forecasting Techniques: Qualitative

Gather opinions and use with judgment to forecast

• Market forecasts: estimates of sales staff
• Top down forecast
• The Delphi technique: a formal approach
Lack the rigor of quantitative techniques, but are not
necessarily any less accurate
Knowledgeable people with intimate market knowledge
have a “feel” that is hard to define but that gives good
forecasting results

© 2020 McGraw-Hill Education. 8-10

 Collaborative Planning, Forecasting,
and Replenishment (CPRF)
Links sales and marketing processes to supply chain
planning and execution processes among trading
partners to:
• improve forecasts and service
• reduce cost
• develop effective replenishment plans
• increase product availability
• increase sales
• reduce inventories
• deliver higher service levels
© 2020 McGraw-Hill Education. 8-11
 Types of Demand

Dependent or derived demand:

• item is part of a larger component or product, and its
use is dependent on the production schedule for the
larger component
• example: demand for bottles and caps for a drink
Independent demand:
• usage is determined directly by customer orders,
independent of production scheduling decisions
• example: demand for an energy drink

© 2020 McGraw-Hill Education. 8-12

 Trade-offs

When determining lot sizes in which to make or buy

cycle inventories:
• the costs of carrying extra inventory versus
• the costs of purchasing or making more frequently
Objective: minimize total costs

© 2020 McGraw-Hill Education. 8-13

 Fixed Order Quantity System (1 of 2)

Event triggered: Initiates order when stock depleted to a

specific level (reorder point)
Inventory replaced in fixed amounts
• Economic order quantities

© 2020 McGraw-Hill Education. 8-14

Fixed Order Quantity System (2 of 2)

Access the text alternative for slide images

© 2020 McGraw-Hill Education. 8-15

Economic Order Quantity Model (1 of 2)

2RS
EOQ 
KC

where:
R = annual demand
S = set-up or order cost per order
C = delivered purchase cost
K = carrying cost percentage
therefore:
KC = unit holding cost
© 2020 McGraw-Hill Education. 8-16
Economic Order Quantity Model (2 of 2)

Access the text alternative for slide images

© 2020 McGraw-Hill Education. 8-17

 Safety Stock

Held because of uncertainty in supply and/or demand

Trade-off: cost of stocking out versus cost of holding
inventory
Levels can be calculated using statistical techniques
• e.g., take into account standard deviation of demand

© 2020 McGraw-Hill Education. 8-18

Fixed Order Quantity System: Cycle
Stock, Safety Stock and Lead Time

Access the text alternative for slide images

© 2020 McGraw-Hill Education. 8-19
 Fixed Time Period Systems

• Inventory on-hand counted at specific time intervals

and replenished to a desired level
• The passage of time triggers reorder

© 2020 McGraw-Hill Education. 8-20

 Fixed Time Period System: Cycle
Stock, Safety Stock and Lead Time

Access the text alternative for slide images

© 2020 McGraw-Hill Education. 8-21

 Which System is Better?

Fixed order quantity system

• Higher maintenance costs
• Every transaction logged
• Inventory controlled precisely
Fixed time period
• Minimal record keeping
• Higher average inventories to protect against stock-outs
• Higher stock-out rates
• Different order quantities for each cycle
• Ability to batch orders with suppliers

© 2020 McGraw-Hill Education. 8-22

 Materials Requirement Planning (MRP)

Designed for “push” or forecast-driven systems

Based on a master production schedule:
• Creates schedules identifying the specific parts and
materials required to produce end items
• Determines exact numbers needed
• Determines the dates when orders for those
materials should be released, based on lead times
“Get the right materials to the right place at the right
time.”

© 2020 McGraw-Hill Education. 8-23

 Key Inputs to MRP

Master production schedule:

• when do we need it
Bill of material (BOM):
• what do we need to make one end product
Inventory record:
• what do we have and what do we need

© 2020 McGraw-Hill Education. 8-24

 Four Basic MRP Lot Sizing Rules

Lot-for-lot (L4L)

Economic order quantity (EOQ)

Least-total-cost (LTC)

Least-unit-cost (LUC)

© 2020 McGraw-Hill Education. 8-25

 MRP Implications for Supply

Accurate records for quantities, lead times, bills of

material, and specifications
Accurate control of inventory data
Cooperation from suppliers for on-time delivery, proper
quantities and batch sizes, exacting quality (zero
defects)
• May need to re-evaluate existing contracts
Long-term planning horizon
Less “slack” in the system

© 2020 McGraw-Hill Education. 8-26

 Demand Driven MRP

Driven by customer demand and supply chain modeling

Five key components:
• strategic inventory positioning
• buffer profile and levels
• dynamic adjustments
• demand driven planning
• visible collaborative execution

© 2020 McGraw-Hill Education. 8-27

 Capacity Requirements Planning
(CRP)
Capacity = amount of work in a set amount of time
CRP translates MRP material plan into
• required human and machine resources by
workstation and time bucket
• compares required resources to availability
• if insufficient capacity, either capacity or the master
production schedule is adjusted
• feedback loop to the master production schedule;
closed-loop MRP

© 2020 McGraw-Hill Education. 8-28

 Enterprise Resource Planning (ERP)

Software that integrates business systems and

processes to combine and analyze information
Links customer orders through fulfillment processes
Requires:
• highly accurate information, abandoning rules of
thumb, and using common data
Opportunities:
• reduced inventory levels, higher service coverage,
ready access to high-quality information, ability to
replan quickly in response to unforeseen problems
© 2020 McGraw-Hill Education. 8-29
 Inventories Exist to Serve Several
Potential Purposes
To provide and maintain good customer service.
To smooth the flow of goods through the production
process
To provide protection against the uncertainties of supply
and demand
To obtain a reasonable utilization of people and
equipment

© 2020 McGraw-Hill Education. 8-30

 Forms and Functions of Inventory

Functions of Inventories Forms of Inventories

Transit or pipeline Raw materials,
inventories purchased parts and
Cycle inventories packaging
Buffer or uncertainty Work-in-process (WIP)
inventories or safety stock Finished goods
Anticipation or certainty MRO items
inventories Resale items
Decoupling inventories

© 2020 McGraw-Hill Education. 8-31

Inventory: Types, Functions, Objectives
TYPE FUNCTION
Transit or It takes time to move products
Pipeline (transit time, handling time, delays)
Cycle Demand pattern does not equal
supply pattern (goods produced in
lot sizes)
Buffer or Demand pattern varies. Customer
Safety service levels must be maintained.
Anticipation Variations in demand relative to
productive capacity or significant
cost advantages to holding supply
in anticipation of demand
Decoupling Distribution and production
efficiency gained from
independence between stages of
production and distribution
© 2020 McGraw-Hill Education.
OBJECTIVE
Balance in-transit inventory costs
against cost of reducing delays
Balance cost of ordering (or
setup) and cost of carrying
inventory
Balance cost of carrying extra
inventory against cost of stocking
out
Balance inventory costs against
production costs, transportation
costs, purchase discounts, and
costs of avoiding price changes
Balance efficiency of production -
distribution activities against costs
8-32
 Examples of Inventory Functions

TYPE EXAMPLE
Transit or Pipeline • parts on trains, forklifts, etc.
• paper forms being moved between departments
Cycle • a retail store that orders furniture by the truckload to save
ordering and shipping (set-up) costs
• students buy $25 of credit instead of $10 for a photocopy card to
reduce trips for extra credit
Buffer or Safety • extra shirts ordered for unanticipated demand by a retailer
• extra bottles ordered by a brewery to allow for unexpected
breakage
Seasonal or • air conditioners produced and stored during winter
speculative • sandwiches assembled during the morning and stored for lunch
Decoupling • plastic moulding machine produces at 100 parts/hr, assembles
work at 50 parts/hr, parts are held in operations to balance
production rates (and moulding is shutdown periodically)

© 2020 McGraw-Hill Education. 8-33

 Inventory Forms and Functions

FUNCTION WHY ELIMINATE REASON BY

Transit move speed/distance make moves faster/shorter
Cycle make/use batch reduce onetime batch costs
Buffer cope with variability reduce variability
Anticipation smooth peak demand increase volume flexibility
Decoupling reduce dependence coordinate/schedule

© 2020 McGraw-Hill Education. 8-34

 Cost of Inventories

Basic elements are:

• capital costs
• inventory service costs
• storage space costs
• inventory risk costs

© 2020 McGraw-Hill Education. 8-35

 Annual Inventory Carrying Cost
(carrying cost per year) = (average inventory value) x
(inventory carrying cost as a % of inventory value)
Average inventory value = (average inventory in units) x
(material unit cost)
CC = Q/2 x C x I, where
CC = carrying cost per year
Q = order or delivery quantity in units
C = delivered unit cost of the material
I = inventory carrying cost as % of inventory value

© 2020 McGraw-Hill Education. 8-36

 Inventory Costs (1 of 2)
Ordering or purchase costs:
• managerial, clerical, material, telephone, mailing,
email, accounting, transportation, inspection, and
receiving costs associated with a purchase order
Setup costs:
• all the purchaser and supplier’s costs of setting up a
production run, including early spoilage and low
production output until standard rates are achieved,
setup, employees’ wages and other costs, machine
downtime, extra tool wear, parts (and equipment)
damaged during setup
© 2020 McGraw-Hill Education. 8-37
 Inventory Costs (2 of 2)
Stockout costs:
• Costs of not having the required parts or materials on
hand when and where needed
• Includes lost contribution on present and future lost
sales, changeover costs, substitution, rescheduling and
expediting, labor and machine idle time, lost customer
and user goodwill, penalties
Variations in delivered costs:
• Costs associated with purchasing in quantities or at times
when prices or delivery costs are higher than at other
quantities or times

© 2020 McGraw-Hill Education. 8-38

ABC Classification of Purchases

Percentage of Total Percentage of Total

Class
Items Purchased Purchase Dollars
A 10 70-80
B 10-20 10-15
C 70-80 10-20

© 2020 McGraw-Hill Education. 8-39

 Example of ABC Analysis

Percentage
Number of Percentage Annual Annual
Class
Items of Items Purchase Value Purchase
Volume
1,095 10.0% $21,600,000 71.1% A
2,168 19.9 5,900,000 19.4 B
7,660 70.1 2,900,000 9.5 C
10,923 100% $30,400,000 100%

© 2020 McGraw-Hill Education. 8-40

Purchase Value is a Combination of
Price and Quantity

Category Unit Value Annual Volume Annual Value

A high high high
A medium high high
A low very high high
B high low medium
B medium medium medium
B low high medium
C medium low low
C low medium low
C low low low

© 2020 McGraw-Hill Education. 8-41

ABC Classification of Inventory

Access the text alternative for slide images

© 2020 McGraw-Hill Education. 8-42
 Vendor- or Supplier-Managed Inventory
(VMI/SMI)
Also called systems contracting or stockless buying
Merges ordering and inventory functions
Relies on periodic billing procedures
Nonpurchasing personnel issue order releases
Employs special catalogs
Requires suppliers to maintain minimum inventory
Normally does not specify volume
Improves inventory turnover rates

© 2020 McGraw-Hill Education. 8-43

 Lean Supply

A management philosophy focused on creating value

for the customer while eliminating waste or nonvalue-
adding activities:
• Overproduction
• Waiting, time in queue
• Transportation
• Nonvalue-adding processes
• Inventory
• Motion
• Costs of quality: scrap, rework, and inspection
© 2020 McGraw-Hill Education. 8-44
 Just-in-Time (JIT) (1 of 2)

Providing the exact quantity needed at the precise

moment it is required
Requires capabilities of:
• short production lead times
• economical small batch production
• flexible resources (labor, material and equipment)
• exacting quality

© 2020 McGraw-Hill Education. 8-45

 Just-in-Time (JIT) (2 of 2)

JIT production systems strive to eliminate waste

• inefficient set-up procedures, inventories
• focus on all aspects of the production system:
human resources, supply, technology, and
inventories
Nothing will be produced until it is needed
• when a unit is sold, the system pulls a replacement
unit from the last position in the system
• this process continues throughout the system

© 2020 McGraw-Hill Education. 8-46

 Kanban

Kanban is Japanese for “signboard”

• A number of visual methods can be used
“Pull” system based on orders from downstream
customers
Most useful for high-volume parts used on a regular
basis

© 2020 McGraw-Hill Education. 8-47

 JIT Imposed Supplier Activities

Frequent deliveries
Small lot sizes
Exacting quality
Long-term relationships/contracts
Reduced number of suppliers

© 2020 McGraw-Hill Education. 8-48

 JIT Implications for Supply

Reduction in number of suppliers

Reduction in supplier lead time
Improvement in supplier quality
Improvement in supplier delivery
Increased inventory turnover
Inventory reduction in total dollars

© 2020 McGraw-Hill Education. 8-49

 Managing Supply Chain Inventories

Impacts customer service, working capital, profitability

What inventory and where in the supply chain
IT for compatibility and to manage information flows
Operational design of physical flow of goods/services--
production and fulfillment, lead times, quality, lot sizes
Confidentiality issues
Share actual consumer demand with suppliers for
production planning, to avoid bullwhip effect, reduce
costs

© 2020 McGraw-Hill Education. 8-50

 Dimensions of Services

Degree of tangibility
Direction of the service
Production of the service
Nature of demand
Degree of standardized
Skills required

© 2020 McGraw-Hill Education. 8-51

 Determining Quantity of Services

Forecasting aggregate demand for services often more

unreliable than for goods
• Multiple contacts: users, specifiers, order placers,
and supplier relationship managers
• Multiple contracts at varying prices and terms with
the same supplier
Organization-wide consumption management is
impossible under these conditions
Difficult for suppliers to determine capacity
requirements and project utilization rates

© 2020 McGraw-Hill Education. 8-52

Accessibility Content: Text Alternatives
For Images

© 2020 McGraw-Hill Education. 8-53