Inventory Categories

Categories of Inventory

• There are four main categories of inventory which include: raw materials, work-in-process (WIP), finished goods, and maintenance, repair, and operating (MRO) supplies.
• Raw materials are items or extracted materials that are converted into components and products.
• Work-in-process (WIP) refers to goods in various stages of completion throughout the plant.
• Minimizing WIP inventory is generally recommended, as excessive WIP can clutter space and impede process flow.
• Finished goods are items on which all manufacturing operations, including final testing, have been completed and are available for sale.
• The amount of finished goods inventory is a strategic decision.
• Make-to-order supply chains typically have little to no finished goods inventory, while make-to-stock supply chains maintain significant amounts.
• Maintenance, repair, and operating (MRO) items support general operations and maintenance.
• MRO items do not end up as part of the finished product.

Functions of Inventory

• Meeting customer demand (cycle stock) involves filling orders promptly and deploying materials near the point of use.
• Buffering against uncertainty in demand and/or supply (safety stock) addresses unexpected sales/usage and potential supply disruptions.
• Decoupling supply from demand (strategic stock) is applicable if the supply pattern differs from the demand pattern.
• Decoupling dependencies in the supply chain involves separating operations in a process.

Costs Related to Inventory

• Direct costs are directly traceable to the unit produced (e.g., materials, labor).
• Indirect costs cannot be traced directly to the unit produced (e.g., overhead, MRO items, buildings).
• Fixed costs (aka sunk costs) are independent of the unit volume produced (e.g., buildings, equipment, rent).
• Variable costs are dependent on the unit volume produced and vary with output level (e.g., materials, labor, utility power).
• Order costs are labor costs associated with placing an order for inventory.
• Carrying costs cover physically having inventory on-site, including infrastructure, security, and insurance.

Purchasing Terms

• A Request for Proposal (RFP) is a detailed evaluation document that determines a supplier's capability and interest in the production of a customized product/service.
• A Request for Quote (RFQ) is a document used to solicit bids from qualified suppliers for goods/services.
• A bid is a tender, proposal, or quotation submitted in response to a solicitation.
• Competitive bidding involves offers submitted by multiple firms competing for a contract.
• A Purchase Requisition is a document that defines the need for goods/services and is an internal document.
• A Purchase Order (PO) is the buyer's offer to acquire goods/services and becomes legally binding when accepted by the supplier.

Inventory Turnover Effect

• Inventory is an asset but also represents financial capital tied up and unavailable for other business uses.
• Inventory turnover is the number of times the company sold through inventory in a given time period.
• The calculation for inventory turnover is Costs of Goods Sold (COGS) divided by Average Inventory.
• A high turnover ratio indicates efficient sales, while a low ratio may indicate overstocking or obsolete products.

Total Cost of Ownership (TCO)

• Total Cost of Ownership (TCO) is the sum of all costs associated with a product's supply stream.
• The purchase price is only one part of the total cost of ownership.
• The four elements of cost are: Quality, Service, Delivery, and Price (QSDP).
• TCO is the sum of cost elements in QSDP.
• The main insight is that the acquisition cost is a small portion of the TOC.

Outsourcing and Insourcing

• Make (Insourcing): Producing materials or products internally within company-owned operations.
• Buy/Outsource: Acquiring materials/components from external suppliers instead of making them in-house.
• Analyzing all relevant expenses associated with making and buying is important.
• Quantitative factors are incremental costs such as manufacuring and labor.
• Qualitative factors include control over quality and supplier reliability.
• Make or buy is a strategic decision.

Centralized vs. Decentralized Purchasing

• The purchasing organization depends on market conditions and material types.
• Centralized purchasing involves a purchasing department at the corporate office.
• Decentralized purchasing involves individual, local purchasing departments at the plant level.

Sourcing Strategies

• Backward vertical integration involves a company acquiring one or more of its suppliers.
• Example: A manufacturer buying a key supplier of a critical material.
• Forward vertical integration involves a company acquiring one or more of its customers.
• Example: A manufacturer buying a wholesaler/distributor.

Procurement Bonds

• Bidders should provide bonds as an incentive to ensure the fulfillment of contracts.
• A bid bond secures a guarantee that the bidder will accept the contract if awarded.
• A performance bond guarantees that the work will be on time and will meet the specifications.
• Payment bonds protect against third-party liens not fulfilled by the bidder.

Strategic Sourcing

• Strategic sourcing is an institutional procurement process to leverage consolidated purchasing power to find values.
• Strategic sourcing differs from conventional purchasing because it emphasizes the entire life-cycle of a product.

Sourcing Categories

• Non-critical items are routine items with a low percentage of the firm's total spend and low supply risk.
• Bottleneck items are unique procurement problems with high supply risk and low availability.
• Leverage items are commodity items with many supply alternatives, low supply risk, and high potential savings.
• Strategic items are strategic items and services that involve a high level of expenditure and are vital to the firm's success.

Sourcing Strategies by Category

• Bottleneck items require maintaining safety stock, contingency plans, strong relationships, and search for alternatives.
• Strategic items require ensure availability of supply, focus on relationship building, process innovation, frequent communications, and supplier performance criteria.
• Non-critical items require simple purchasing process, reduce number of suppliers, and transfer buying responsibility.
• Leverage items require consolidating volume, use of competitive marketplaces, and automated supplier interfaces.

Preferred Suppliers

• A supplier of choice has achieved exceptional performance over time.
• They are typically trusted partners who understand the buyer's organization and processes.
• They provide higher value than competitors and are reliable, responsive, flexible, and cost-effective.
• They provide product and process technology, product development, information on latest trends, capacity for demand, and cost efficiency.

Supplier Certification Programs

• Supplier certification verifies that a supplier operates, maintains, improves, and documents procedures.
• Certification is used to differentiate strategic supplier alliance candidates.
• Companies may develop internal programs or require external certifications like ISO 9000/ISO 14000.

Reverse Auctions

• Reverse auctions involve pre-qualified suppliers entering a website to underbid competitors.
• The buyer makes potential sellers aware of the intent to buy.
• Sellers bid against each other to secure the buyer's business.
• Monitored until the session is over with the lowest price is the winning bidder.
• They are used by private companies, public sector agencies, and non-profit organizations.

Ethical Sourcing

• Ethical sourcing takes into consideration the public consequences of organizational buying.
• Products being sourced should be acquired in a responsibile and sustainable way.
• The people involved should be treated fairly and work in a safe environment.
• The environmental and societal impacts are important considerations.