Chapter 10 Inventory Management Planning and Control PDF

CHAPTER 10 Inventory Management, Planning and Control The importance of inventory management · Inventory is another name for materials and is any material that a firm holds to satisfy customer demand (and these customers may be internal and/or external to the firm). · Inventory thus can be fou...

CHAPTER 10 Inventory Management, Planning and Control The importance of inventory management · Inventory is another name for materials and is any material that a firm holds to satisfy customer demand (and these customers may be internal and/or external to the firm). · Inventory thus can be found at multiple locations along the supply chain at the supplier, in the factory, and at the customer's premises. · The purpose of inventory management is to strike a balance between the levels of inventory a firm holds to be able to satisfy customer demand. The importance of inventory management Companies hold inventory for several reasons including the following: · To cope with fluctuations in demand and to provide choice for customers. · On the supply side, to cope with fluctuations in availability. · Quantity discounts are often available for buying in bulk (but note that this can result in excess inventory being carried). Inventory categorisation Inventory is generally categorized into the following types: · Raw material inventory is material purchased and waiting to be processed. · Work in progress (WIP) inventory comprises material that is being processed along the production line. · Finished goods inventory are the products awaiting shipment. Inventory holding costs · Inventory costs money! · The costs associated with holding and managing inventory can be quite high. The inventory holding costs comprise of: – Fixed costs: warehouse space, insurance, security systems, monitoring and management, etc. – Variable costs: light/heat/refrigeration costs, labor costs, damage costs, – Opportunity costs: when money is tied up in inventory, someone must pay for it. The opportunity cost is the amount of money the firm would have earned if the money were invested elsewhere other than in inventory. – Obsolescence costs: the costs associated with having too much inventory and it becomes out of date, or no customers want it. Inventory turnover · Inventory turnover is a concept used to measure a firm’s performance in inventory management. · The turnover ratio is a useful indicator of how effective a firm is in managing its inventory. · Compares annual sales with the amount of average inventory held throughout the year · The higher the turnover, the lower the firm’s inventory costs. Inventory turnover Inventory turnover: Example · PH Pharmaceuticals has the following inventory performance: – Cost of goods sold in a year: $600,000 – Value of inventory at the beginning of the year: $110,000 – Value of the inventory at the end of the year: $130,000 – What are the inventory turns?  ABC classification · ABC analysis is used to establish policies for those firms that have many inventory items or stock-keeping units (SKUs). · SKU is a unique code for a particular product type. · This method separates the most critical items that require more attention in inventory management compared to the many less important/trivial ones. · Items are grouped according to their share of overall sales revenue. In other words, it's calculated as the annual demand/volume multiplied by the price of the item (ADV: Annual Dollar Value). · ABC analysis divides the items into three categories, but the boundary between categories is not a hard and fast rule; the objective is to separate the important few from the trivial many.  ABC classification · A items: can represent anywhere from 65%-80% of the ADV, but only account for 15%-20% of the inventory items. It is considered as a small category with minimal goods, but maximum revenue. · B items: can represent 25%-30% of the ADV and typically account for 15%-25% of inventory items. The goods included in this category are more in number but less in utility. · C items: can represent only about 0%- 10% of ADV but may account for 60%- 70% of items. Products included in category C are more in numbers but least valuable when it comes to generating revenue. ABC classification Inventory Control Systems: ROP · Inventory control systems help inventory managers to decide when to order inventory and in what quantities. · Managers need to know when is the reorder point, how much safety stock is required, and the lead time for transportation. · The reorder point (ROP) can be calculated as follows: ROP= demand per day x lead time for a new order to be received in stock + safety stock ROP= d x L + SS, where SS is safety stock, L Is lead time, and d is demand per day (the last one can be calculated by dividing annual demand by the number of working days. If the company does not want to keep any safety stock, the ROP is d x L. Inventory Control Systems: Safety Stock · Safety stock- or buffer stock- is the inventory held if unforeseen issues lead to insufficient inventory being available to meet demand. · It helps companies cope with the variations of lead time, production, and demand. · How much safety stock a firm should keep is based on the service level the firm wants to provide to its customers. · There is a trade-off between the cost of keeping excess stock and the cost associated with losing sales due to shortages of unfulfilled orders. Inventory Control Systems: In-transit inventory · In-transit inventory comprises those items that are in transit across a supply chain and includes both (1) inventory being transported on ships, trains, trucks, and so forth and (2) inventory that is being loaded and unloaded at ports, warehouses, and other nodes along the supply chain. · In-transit inventory can account for a large share of total inventory holding. · Most firms aim to reduce in-transit inventory. Inventory Planning and Control · Several techniques with associated software systems, have been developed to plan and control the movement and storage of inventory along the supply chain. – MRP – ERP – Independent and dependent demand – VMI Inventory Planning and Control: MRP and ERP · MRP- Materials Requirements Planning: emerged in the decades following World War II because of advances in software. The MRP system relies on understanding how demand varies. – Independent demand: products that are ordered independently of any other product. – Dependent demand: are products whose ordering is dependent upon the demand for other related products. · MRP is an inventory management and control system for ordering and tracking the items needed to make a product. For example: bicycles · ERP- Enterprise Resource Planning: is the modern derivative of MRP which can span across multiple organizations both upstream and downstream in the supply chain. An MRP System A simplified VMI Scenario Source: Adapted from Matthias, H., Disney, S., Holmstrom, J. & Smaros, J. (2005) Supply chain collaboration: Making sense of the strategy continuum, European Management Journal, 23(2), 170–181. Driving Forces for performance measurement in LSCM · Increased reliance on contract manufacturers · The strategic importance of LSPs to Supply chain success · The adoption of manufacturing management techniques, such as JIT and Six Sigma, has increased the demand for metric reporting · Customer expectations · A need for visibility around resource utilization · Information technology improvements. · Empowerment of employees – allowing them to have visibility of KPIs and then using expectations of performance as a motivator. Examples of strategic and operational KPIs in LSCM