OM-Inventory Management

Mahr Irfan Ahmad

B.Sc., FCFMA, MIPA, AFA, OCP
CDBMA
 Inventory Management
• Inventory Reduction Tactics
• Managers are always eager to find cost-effective
ways to reduce inventory in supply chains. In this
section we discuss the basic tactics (which we call
levers) for reducing cycle, safety stock, anticipation,
and pipeline inventories in supply chains. A primary
lever is one that must be activated if inventory is to
be reduced. A secondary lever reduces the penalty
cost of applying the primary lever and the need for
having inventory in the first place.
 Inventory Management
• Cycle Inventory
• The primary lever to reduce cycle inventory is simply to reduce the lot sizes of items
moving in the supply chain. However, making such reductions in Q without making any
other changes can be devastating.
• For example, setup costs or ordering costs can skyrocket. If these changes occur, two
secondary levers can be used:
• 1. Streamline the methods for placing orders and making setups to reduce ordering
and setup costs and allow Q to be reduced. This may involve redesigning the
infrastructure for information flows or improving manufacturing processes.
• 2. Increase repeatability to eliminate the need for changeovers. Repeatability is the
degree to which the same work can be done again. Repeatability can be increased
through high product demand; the use of specialization; the devotion of resources
exclusively to a product; the use of the same part in many different products; the use of
flexible automation; the use of the one-worker, multiplemachines concept; or through
group technology. Increased repeatability may justify new setup methods, reduce
transportation costs, and allow quantity discounts from suppliers.
 Inventory Management
• Safety Stock Inventory
• The primary lever to reduce safety stock inventory is to place orders closer to the time when they
must be received. However, this approach can lead to unacceptable customer service unless
demand, supply, and delivery uncertainties can be minimized. Four secondary levers can be used in
this case:
• 1. Improve demand forecasts so that fewer surprises come from customers. Design the
mechanisms to increase collaboration with customers to get advanced warnings for changes in
demand levels.
• 2. Cut the lead times of purchased or produced items to reduce demand uncertainty. For
example, local suppliers with short lead times could be selected whenever possible.
• 3. Reduce supply uncertainties. Suppliers are likely to be more reliable if production plans are
shared with them. Put in place the mechanisms to increase collaboration with suppliers. Surprises
from unexpected scrap or rework can be reduced by improving manufacturing processes.
Preventive maintenance can minimize unexpected downtime caused by equipment failure.
• 4. Rely more on equipment and labor buffers, such as capacity cushions and cross-trained
workers. These buffers are important to businesses in the service sector because they generally
cannot inventory their services.
 Inventory Management
• Anticipation Inventory
• The primary lever to reduce anticipation inventory is
simply to match demand rate with production rate.
Secondary levers can be used to even out customer
demand in one of the following ways:
• 1. Add new products with different demand cycles so
that a peak in the demand for one product
compensates for the seasonal low for another.
• 2. Provide off-season promotional campaigns.
• 3. Offer seasonal pricing plans.
 Inventory Management
• Pipeline Inventory
• An operations manager has direct control over lead times but not
demand rates. Because pipeline inventory is a function of demand
during the lead time, the primary lever is to reduce the lead time.
Two secondary levers can help managers cut lead times:
• 1. Find more responsive suppliers and select new carriers for
shipments between stocking locations or improve materials
handling within the plant. Improving the information system could
overcome information delays between a distribution center and
retailer.
• 2. Change Q in those cases where the lead time depends on the
lot size.
 Inventory Management
• Inventories in supply chains are managed with the
help of inventory control systems. These systems
manage the levels of cycle, safety stock,
anticipation, and pipeline inventories in a firm.
Regardless of whether an item experiences
independent or dependent demand, three
important questions must be answered: What
degree of control should we impose on an item?
How much should we order? And When should we
place the order?
 Inventory Management
• ABC Analysis
• Thousands of items, often referred to as stock-keeping
units, are held in inventory by a typical organization, but
only a small percentage of them deserve management’s
closest attention and tightest control.
• A stock-keeping unit (SKU) is an individual item or product
that has an identifying code and is held in inventory
somewhere along the supply chain.
• ABC analysis is the process of dividing SKUs into three
classes according to their dollar usage so that managers
can focus on items that have the highest dollar value.
 Inventory Management
• Cycle counting-An inventory control method,
whereby storeroom personnel physically
count a small percentage of the total number
of items each day, correcting errors that they
find.
 Inventory Management
• A good starting point for balancing these conflicting pressures and determining the best
cycle-inventory level for an item is finding the economic order quantity (EOQ), which is
the lot size that minimizes total annual cycle-inventory holding and ordering costs. The
approach to determining the EOQ is based on the following assumptions:
• 1. The demand rate for the item is constant (for example, always 10 units per day) and
known with certainty.
• 2. No constraints are placed (such as truck capacity or materials handling limitations) on
the size of each lot.
• 3. The only two relevant costs are the inventory holding cost and the fixed cost per lot
for ordering or setup.
• 4. Decisions for one item can be made independently of decisions for other items. In
other words, no advantage is gained in combining several orders going to the same
supplier.
• 5. The lead time is constant (e.g., always 14 days) and known with certainty. The
amount received is exactly what was ordered and it arrives all at once rather than
piecemeal.
 Inventory Management
• Here are some guidelines on when to use or modify the EOQ.
• Do not use the EOQ
– If you use the “make-to-order” strategy and your customer specifies that the entire
order be delivered in one shipment
– If the order size is constrained by capacity limitations such as the size of the firm’s
ovens, amount of testing equipment, or number of delivery trucks
• Modify the EOQ
– If significant quantity discounts are given for ordering larger lots
– If replenishment of the inventory is not instantaneous, which can happen if the items
must be used or sold as soon as they are finished without waiting until the entire lot
has been completed
• Use the EOQ
– If you follow a “make-to-stock” strategy and the item has relatively stable demand
– If your carrying costs per unit and setup or ordering costs are known and relatively
stable