Ch09 PPT 10e (Jan 5, 2016) Voice Over

CHAPTER 9
Managing Inventory
in the Supply Chain
Supply Chain Management: A Logistics Perspective (10e)

Coyle, Langley, Novack, and Gibson
© 2016 Cengage Learning. All Rights Reserved.
May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Discussion Outline
 Importance of inventory in the economy and
in the firm
 Major types of inventory and reasons for
carrying them
 Major types of costs associated with inventory
 Approaches to managing inventory
 Inventory classification
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part. 2
Inventory in the US Economy
INVENTORY COSTS AS A PERCENT OF GDP
18
16
14
12
10
8
6
4
2
0
9 6 9 7 9 8 9 9 0 0 0 1 0 2 0 3 0 4 0 5 0 6 0 7 0 8 0 9 1 0 1 1 12 13 14
0
19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 2 20 20 20
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or in part. 3
Inventory in the Firm
2014 Total Logistics Costs ($ Billion)
Carrying Costs—$2.496 Trillion All Business Inventory
Interest 2
Taxes, Obsolescence, Depreciation, Insurance 331
Warehousing 143
SUBTOTAL 476
Transportation Costs—Motor Carriers
Truck—Intercity 486
Truck—Local 216
SUBTOTAL 702
Transportation Costs—Other Carriers
Railroads 80
Water (international 31, domestic 9) 40
Oil Pipelines 17
Air (international 12, domestic 16) 28
Forwarders 40
SUBTOTAL 205
Shipper-Related Costs 10
Logistics Administration 56
TOTAL LOGISTICS COST 1,449
Source: Table 9.2
or in part. 4
Major Types of Inventory
and Reasons for Carrying
Them
Types of Inventory and Rationales
1 Procurement (purchase discounts),
6 Cycle
production (long production run), and
transportation (freight rate discounts)
Anticipatory stocks
stocks (Risk (Batching 1 2 Demand- and supply-side uncertainties
hedging) economies)
5
Inventory costs associated with goods in
Seasonal Safety stocks
3 motion during transportation time
stocks (Uncertainty) period.
(Seasonality)
Work-in- Time/In- 2 4 Inventory costs associated with goods in

process during manufacture or assembly
Process Transit
4 stocks (Mode
of a complex product.
(scheduling choices) 5 Seasonality in raw materials supply (e.g.

&
production
3 production, transportation), in demand
for finished product, or in both
techniques)
6 Inventory hold in anticipation that an
unusual event (e.g. strikes, significant
price increase, extreme weather)
or in part. 6
The Importance of Inventory in Other
Functional Areas
Objectives of the finance area might obviously conflict with marketing
and manufacturing objectives. A more subtle conflict sometimes arises
between marketing and manufacturing as the long production runs can
cause shortages of some products needed by marketing.
Marketing Manufacturing Finance

In favor of holding sufficient, In favor of long production In favor of low inventories
or extra, inventory to ensure runs of a single product with to increase inventory
product availability to meet minimal changeovers to lower turns, reduce liabilities
customer needs and new labor and machine costs per and assets, and increase
product offerings for unit, resulting in high cash flow to the
continued market growth. inventory levels of the product. organization.
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or in part. 7
Inventory Costs
Inventory Costs
Major Types of Costs
Emphasize of inventory cost analysis should be placed on
the variable components of these costs.
Inventory Carrying Cost Ordering and Setup Cost
Inventory carrying costs incurred by Ordering cost refers to expense of
inventory at rest and waiting to be used. placing an order, excluding the cost of
Four major components: Capital cost, the product itself. Setup cost refers to
Storage space cost, Inventory service the expense of changing/modifying a
cost, and Inventory risk cost. production/assembly process to
facilitate line changeovers.
Inventory
Expected Stockout Cost Costs In-transit Inventory
The cost associated with not having a Carrying Cost
product/materials available to meet Generally, carrying inventory in transit
customer/production demand. Most costs less than in warehouses. But, in-
organizations hold safety stock or buffer transit inventory carrying cost becomes
stock, to minimize the possibility of a especially important on global moves
stockout and costs of lost sales. since both distance & time increase.
or in part. 9
Inventory Costs
Carrying Cost vs. Ordering Cost
Ordering cost and carrying cost respond in opposite ways to
changes in the number of orders or size of individual orders.
Source: Figure 9.2
or in part. 10
Inventory Costs
Safety Stocks and Service Levels
The higher the service level requirement (lower stockout rate),
the higher the inventory level requirement.
Source: Figure 9.3
or in part. 11
Approaches to
Managing Inventory
Fundamental Approaches: Additional Approaches:

Fixed order quantity & Fixed JIT, MRP, DRP, and VMI
order interval EOQ
Inventory Management Approaches
Managing inventory involved four
fundamental questions:
 How much should inventory be
ordered?
 When should inventory be
ordered?
 Where should inventory be held?
 What specific line items should
be available at specific locations?
or in part. 13
Cost vs. Service Tradeoff Considerations
Regardless of the approach selected, inventory decisions
must consider the basic tradeoff between cost and service.
Investment in
Inventory ($)
85 90 95 100
Customer Service Level (%)
Source: Figure 9.4
or in part. 14
Key Factors of Difference
Inventory management approaches differ in terms of
three key factors.
Dependent vs. Independent demand. Independent
1
demand is unrelated to the demand for other items, while
dependent demand is directly related to, or derives from,
the demand for another inventory item or product.
Pull vs. Push. The “pull” approach relies on

Key customer orders to move product through a logistics
Factors 2 system, while the “push” approach uses inventory
replenishment techniques in anticipation of
demand to move products.
3 System-wide vs. Single-facility solutions. A

system-wide approach plans and executes inventory
decisions across multiple nodes in the logistics system.
A single-facility approach does so for shipments and
receipts between a single shipping and receiving point.
or in part. 15
Key Differences

Key Factors
of Difference
EOQ JIT MRP DRP VMI
Dependent vs. Both Dependent Dependent Independent Both

Independent
demand
Pull vs. Push. Both Pull Push Push Push

System-wide Single Single System- System-wide Both
vs. Single- facility facility wide
facility
solution
or in part. 16
EOQ Approach
Two basic forms of the economic order quantity (EOQ) model
 Involves ordering a fixed  Involves ordering inventory at

amount of product each time fixed or regular intervals.
reordering takes place.  Also called the fixed period or
 Also called two-bin model. fixed review period approach.
 Generally, the amount
ordered depends on how
much is in stock and available
at the time of review.
Fixed Order Quantity Fixed Order Interval
or in part. 17
Fixed Order Quantity EOQ Approach: Condition of Certainty
In fixed order quantity EOQ model, inventory is reordered when the

amount on hand reaches the reorder point. The reorder point quantity
depends on the time it takes to get the new order and on the demand for
the item during this lead time.
Source: Figure 9.5
or in part. 18
Fixed Order Quantity EOQ: Condition of Certainty (continued)
Given the assumptions, the simple EOQ Basic assumptions of the
model considers only 2 basic types of cost: simple EOQ model
inventory carrying cost and ordering cost.  Continuous, constant, and
known rate of demand
 Constant and known
replenishment or lead time
 All demand is satisfied.
 Constant price or cost that
is independent of the order
quantity
 No inventory in transit
 One item of inventory or no
interaction between items
 Infinite planning horizon
 Unlimited capital
Source: Figure 9.11
or in part. 19
Fixed Order Quantity EOQ: Condition of Uncertainty
Because several factors can influence the reliability of demand (or
usage rate) and lead time, the fixed order quantity model is adjusted
by reformulating the reorder point to allow for safety stock.
Source: Figure 9.12
or in part. 20
Additional Approaches: Just-in-Time (JIT)
JIT systems are designed to manage lead times and eliminate waste. Many JIT
systems place a high priority on short, consistent lead times. However, the
length of the lead time is not as important as the reliability of the lead time.
EOQ vs. JIT: Attitudes and Behaviors

Factor EOQ JIT
Inventory Asset Liability
Safety stock Yes No
Production runs Long Short
Setup times Amortize Minimize
Lot sizes EOQ 1 for 1
Queues Eliminate Necessary
Lead times Tolerate Shorten
Quality inspection Important parts 100% process
Suppliers/customers Adversaries Partners
Supply sources Multiple Single
Employees Instruct Involve
Source: Table 9.18
or in part. 21
Additional Approaches: JIT (continued)
 JIT commitment to short, consistent lead
times and to minimizing or eliminating
inventories is JIT principal differentiator
from the more traditional approaches.
 JIT saves money on downstream inventories
by placing greater reliance on improved
responsiveness and flexibility.
 Successful JIT applications:
 Place a high priority on efficient and
dependable manufacturing processes.
 Demand effective and dependable
communications & information systems,
and high-quality, consistent
transportation services.
Images courtesy of wsdwheel.com
or in part. 22
Additional Approaches: Materials Requirements Planning (MRP)
MRP deals specifically with supplying materials and
component parts whose demand depends on the demand for
a specific end product.
Ensure the availability of materials, components,

1 and products for planned production and for
customer delivery.
MRP
System 2 Maintain the lowest possible inventory levels
that support service objectives.
Goals
3 Plan manufacturing activities, delivery

schedules, and purchasing activities.
or in part. 23
Additional Approaches: MRP (continued)
An MRP system is designed to translate a master production schedule into
time-phased net inventory requirements and the planned coverage of such
requirements for each component item needed to implement this schedule.
An MRP System MRP Egg Timer Example
Source: Figures 9.15 and 9.16
or in part. 24
Additional Approaches: MRP (continued)
Principal advantages Principal shortcomings
of MRP-based systems of MRP-based systems
 Maintain reasonable safety stock levels &  Computer-intensive applications,
minimize or eliminate inventories making changes difficult once the
whenever possible. system is in operation.
 Identify process problems and potential  Might increase ordering and
supply chain disruptions before they occur, transportation costs as firms moving
allowing necessary corrective actions. toward a more coordinated system of
 Base production schedules on actual ordering product in smaller amounts.
demand and forecasts of independent  Not as sensitive to short-term
demand items. fluctuations in demand as order point
 Coordinate materials ordering across approaches
multiple points in a firm’s logistics  Frequently become quite complex and
network. sometimes do not work exactly as
 Suitable for batch, intermittent assembly, intended.
or project processes.
or in part. 25
Additional Approaches: Distribution Requirements Planning (DRP)
DRP systems accomplish for outbound shipments what MRP
accomplishes for inbound shipments. DRP determines replenishment
schedules between a firm’s manufacturing facilities and its distribution
centers. DRP is usually coupled with MRP systems to manage the flow
and timing of both inbound materials and outbound finished goods.
Source: Table 9.20
or in part. 26
Additional Approaches: Vendor-Managed Inventory (VMI)
Vendor-managed inventory manages inventories OUTSIDE a firm’s
logistics network, specifically inventories held in its customer’s
distribution centers.
How VMI Works
The supplier and its customer agree on
An agreement is made on reorder points
which products are to be managed using
and economic order quantities for each of
VMI in the customer’s distribution
these products.
centers.
As these products are

shipped from the The supplier monitors on-hand inventories in the
customer’s distribution customer’s distribution center, and when the on-hand
center, the customer inventory reaches the agreed-upon reorder point, the
notifies the supplier, by supplier creates an order for replenishment, notifies
SKU, of the volumes the customer’s distribution center of the quantity and
shipped on a real-time time of arrival, and ships the order to replenish the
basis. distribution center.
or in part. 27
Additional Approaches: VMI (continued)
Principal advantages Principal shortcomings

of VMI systems of VMI systems
 The knowledge gained by the  Suppliers’ uses of VMI to
supplier of real-time push excess inventory to a
inventory levels of its customer distribution center
products at its customer at the end of the month in
locations allows the shipper order to meet monthly sales
more time to react to sudden quotas, resulting in the
swings in demand to assure customer holding extra
that stockouts do not occur. inventory, adding costs to its
operations.
or in part. 28
Inventory Management Techniques in the Logistics Network
Many organizations today use all of the techniques shown in

managing inventories in their logistics networks. In general, as an
inventory technique manages inventory closer to the point of real
demand (e.g. VMI and CPFR), forecast accuracy increases, forecast
cycles decrease, and product availability increases.
Source: Figure 9.19
or in part. 29
Inventory
Classification
Inventory Classification
Multiple product lines and inventory control require organizations to
focus on more important inventory items and use more sophisticated
and effective approaches to inventory management.
ABC Analysis Pareto’s Law (The “80– Quadrant Model

ABC classification technique 20” Rule) Quadrant model classifies
assigns inventory items to one Pareto’s Law “80–20” rule finished goods inventories
of three groups according to the suggests that a relatively using value and risk to the
relative impact or value of the small percentage of firm as the criteria. Value is
items that make up the group. A inventory might account for measured as the value
items are considered to be the a large percentage of the contribution to profit; risk is
most important, B items lesser overall impact or value. the negative impact of not
importance, and C items least having the product available
important. when it is needed.
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or in part. 31
ABC Classification
In many ABC analyses, a

common mistake is to think
of the B and C items as being
far less important than the A
items. However, all items in
the A, B, and C categories are
important to some extent and
each category deserves its
own strategy to assure
availability at an appropriate
level of cost (stockout cost vs.
inventory carrying cost).
Source: Figure 9.20
or in part. 32
Quadrant Model
Items with high value and high risk (critical items) need to be managed
carefully to ensure adequate supply. Items with low risk and low value
(generic or routine items) can be managed much less carefully.
Distinctives Criticals
High  High safety stocks  High safety stocks
 More than one stocking location  Multiple stocking location
 Produce to inventory  Produce to inventory
Risk
Generics Commodities
Low  Low/no safety stock  Adequate safety stocks

 Single stocking location  More than one stocking location
 Produce to order  Produce to inventory/to order
Low Value High Source: Figure 9.21
or in part. 33
Summary
 Principal types of inventory are: cycle stock, work-in-process,
inventory in transit, safety stock, seasonal stock, and
anticipatory stock.
 Principal types of inventory costs are: inventory carrying,
ordering and setup, expected stockout, and in-transit inventory.
 Four major components of inventory carrying costs are: Capital

cost, Storage space cost, Inventory service cost, and Inventory
risk cost.
 Choosing appropriate inventory model considers three key
differences: Independent vs. dependent demand, Push vs. pull
distribution system, and system-wide vs. specific facility
decisions.
Summary (continued)
 Two basic forms of the EOQ model are the fixed quantity model
and the fixed interval model. The former is the most widely
used.
 JIT model aims to minimize inventory levels, emphasizing
frequent deliveries of smaller quantities and alliances with
suppliers or customers.
 MRP and DRP are typically used in conjunction to manage the
flow and timing of both inbound materials and outbound
finished goods.
 VMI is used to manage a firm’s inventories in its customers’
distribution centers.
 Inventory classification is vital initial step toward efficient
inventory management.

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CHAPTER 9

Supply Chain Management: A Logistics Perspective (10e)

Images courtesy of qainfotech.com, innorange.fi, studiotheory.net

Source: Table 9.2

Work-in- Time/In- 2 4 Inventory costs associated with goods in

(scheduling choices) 5 Seasonality in raw materials supply (e.g.

Marketing Manufacturing Finance

Images courtesy of montagepages.fuselabs.com, industry-illustration.com, actinstitute.com

Source: Figure 9.2

Source: Figure 9.3

Fundamental Approaches: Additional Approaches:

Source: Figure 9.4

Pull vs. Push. The “pull” approach relies on

3 System-wide vs. Single-facility solutions. A

Inventory Management Approaches

Dependent vs. Both Dependent Dependent Independent Both

Pull vs. Push. Both Pull Push Push Push

 Involves ordering a fixed  Involves ordering inventory at

Fixed Order Quantity Fixed Order Interval

In fixed order quantity EOQ model, inventory is reordered when the

Source: Figure 9.5

Source: Figure 9.11

Source: Figure 9.12

EOQ vs. JIT: Attitudes and Behaviors

Ensure the availability of materials, components,

3 Plan manufacturing activities, delivery

An MRP System MRP Egg Timer Example

Source: Figures 9.15 and 9.16

Source: Table 9.20

As these products are

Principal advantages Principal shortcomings

Many organizations today use all of the techniques shown in

Source: Figure 9.19

ABC Analysis Pareto’s Law (The “80– Quadrant Model

Images courtesy of make-icon.com, llumiaustralia.com, innotas.com

In many ABC analyses, a

Source: Figure 9.20

Low  Low/no safety stock  Adequate safety stocks

Low Value High Source: Figure 9.21

 Four major components of inventory carrying costs are: Capital

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