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Operations Management Ninth Edition Part Three Deliver Chapter 13 Inventory management Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved ...

Operations Management Ninth Edition Part Three Deliver Chapter 13 Inventory management Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Figure 13.1 This chapter examines inventory management Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Introduction Operation managers have an ambivalent attitude toward inventories. They are costly and risky but providing security in an uncertain environment. It helps smooth supply and demand, and only exists because supply and demand are not in harmony. Items held in stock could deteriorate, become obsolete or just get lost, and, furthermore, they take up valuable space in the operation. They provide some security in an uncertain environment that one can deliver items in stock, should customers demand them Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved What is inventory? Inventory is a term used to describe the accumulations of materials, customers or information as they flow through processes or networks. The accumulation of the transformed resources that flow through processes, operations or supply networks. – Physical inventory also called ‘stock’ (parts, goods, paper) – Queues (customers in line at airport) – Databases (medical records) Managing these accumulations is what we call ‘inventory management’. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved All processes, operations and supply networks have inventories Most operations involve flows of materials, customers and/or information, at some points they are likely to have material and information inventories and queues of customers waiting for goods or services (e.g. airports, tractors assembly plant, tax departments (Table 13.1). Inventories are often the result of uneven flows. If there is a difference between the timing or the rate of supply and demand at any point in a process or network, then accumulations will occur. Figure 13.2 shows a tank of water (inventory) will be needed to maintain supply. When the rate of supply exceeds the rate of demand, inventory increases; when the rate of demand exceeds the rate of supply, inventory decreases. So, if an operation or process can match supply and demand rates, it will also succeed in reducing its inventory levels. But most organizations must cope with unequal supply and demand, at least at some points in their supply chain. Organizations depend on the ability to manage supply and demand inequality through their inventory management. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved All processes, operations and supply networks have inventories Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Figure 13.2 Inventory is created to compensate for the differences in timing between supply and demand Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Example An internet retail operation will process each order it receives, and inventories of information may accumulate because of uneven flows. During order processing customer details could be permanently stored in a database. This information will then be used, not only for future orders from the same customer, but also for other processes, such as targeting promotional activities. The inventory of information has turned from a transformed resource into a transforming resource, because it is being used to transform other information rather than being transformed itself. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Some reasons to avoid inventories Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved  So why have inventory? Inventory provides many advantages for operations and customers, such as reducing customer wait times and collecting personal details. Operations management must allow inventory to accumulate only when its benefits outweigh its disadvantages. Some benefits of the inventory: 1. Physical inventory is an insurance against uncertainty (Buffer inventory - safety inventory) ✓ Inventory is an insurance against uncertainty, providing a buffer against unexpected fluctuations in supply and demand and compensating for uncertainties in the supply process. It is used in retail operations, hospitals, auto servicing factories and airlines. 2. Physical inventory can counteract a lack of flexibility (Cycle inventory) ✓ by providing stock to ensure supply when engaged on other activities. For example, a baker who makes three types of bread must produce each type in batches large enough to satisfy demand. (Figure 13.3- Cycle inventory in a bakery) ✓ So, even when demand is steady and predictable, there will always be some inventory to compensate for the intermittent supply of each type of bread. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Figure 13.3 Cycle inventory in a bakery Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved So why have inventory? Some benefits of the inventory: 3. Physical inventory allows operations to take advantage of short-term opportunities such as a supplier offering a good deal on selected items for a limited time period. 4. Physical inventory can be used to anticipate future demands ✓ Inventory can be used to anticipate future demands by producing products ahead of demand and storing them until needed. ✓ This type of inventory is called anticipation inventory and is most commonly used when demand fluctuations are large but relatively predictable. 5. Physical inventory can reduce overall costs by bulk-buying at the lowest possible cost, leading to the Economic order quantity (EOQ) approach (the quantity of items to order that minimizes the total cost of inventory management. This approach attempts to find the best balance between the advantages and disadvantages of holding stock). 6. Physical inventory can increase in value and become an investment, such as cash. Organizations often try to maximize their inventory of cash to maximize interest. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved So why have inventory? 7. Physical inventory fills the processing 'pipeline', as transformed resources cannot be moved instantly between the point of supply and the point of demand. It can be substantial in geographically dispersed supply networks. When a retail store places an order, its supplier will ‘allocate’ the stock to the retail store in its own warehouse, pack it, load it onto its truck, transport it to its destination, and unload it into the retailer’s inventory. From the time that stock is allocated to the time it becomes available for the retail store, it is pipeline inventory. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved So why have inventory? Some benefits of the inventory: 8. Queues of customers help balance capacity and demand, especially when the main service resource is expensive (e.g. doctor, lawyer, consultant, an expensive equipment). 9. Queues of customers enable prioritization, allowing organizations to serve urgent customers while keeping less urgent ones waiting. 10.Queuing gives customers time to chose products/services, allowing them to make their order without holding up the server. 11.Queues enable efficient use of resources- By allowing queues to form customers can be batched together to make efficient use of operational resources, such as elevators and airports. 12.Databases provide efficient multi-level access to information- Databases provide different levels of access for different people. E.g. doctors, pharmacists, and receptionists have different access to patient records. 13.Databases allow single data capture, there is no need to capture data at every transaction with a customer or supplier, but checks may be required. 14.Databases speed the process store customer information (e.g. delivery address and credit card info) to make Copyright © 2019, purchases faster 2016, 2013 Pearson and Education, Inc. easier. All Rights Reserved  Reducing Physical Inventory The objective of managers who manage physical inventories is to reduce the overall level (and/or cost) of inventory whilst maintaining an acceptable level of customer service. (Table 13.3) Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Reducing Physical Inventory Table 13.3 Some ways in which physical inventory may be reduced Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved  The effect of inventory on return on assets Inventory governs the operation’s ability to supply its customers. Inventory may become obsolete as alternatives become available. Inventory incurs storage costs. Inventory involves administrative and insurance costs. Inventory ties up money, in the form of working capital. Inventory contracts with suppliers can dictate the timing of when suppliers need to be paid. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Figure 13.4 Inventory management has a significant effect on return on assets Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved How much to order? The volume decision Operations managers must try to identify the costs which will be affected by their decision (the effect of inventory on the components of return on assets). 1. Cost of placing the order. 2. Price discount costs. 3. Stockout costs. 4. Working capital costs. 5. Storage costs. 6. Obsolescence costs. 7. Operating inefficiency costs. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved The economic order quantity (EOQ) formula The most common approach to deciding how much of any particular item to order when stock needs replenishing is called the economic order quantity (EOQ) approach. This approach attempts to find the best balance between the advantages and disadvantages of holding stock. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Should the cost of inventory be minimized? ✓ Many organizations (such as supermarkets and wholesalers) make most of their revenue and profits simply by holding and supplying inventory. Because their main investment is in the inventory, it is critical that they make a good return on this capital, by ensuring that it has the highest possible ‘stock turn’ and/or gross profit margin. ✓ Alternatively, they may also be concerned to maximize the use of space by seeking to maximize the profit earned per square meter. ✓ The EOQ model does not address these objectives. Similarly for products that deteriorate or go out of fashion, the EOQ model can result in excess inventory of slower-moving items. ✓ In fact, the EOQ model is rarely used in such organizations, and there is more likely to be a system of periodic review for regular ordering of replenishment inventory. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Should the cost of inventory be minimized? ✓ For example, a typical builders’ supply merchant might carry around 50,000 different items of stock (SKUs). However, most of these cluster into larger families of items such as paints, sanitary ware or metal fixings. ✓ Single orders are placed at regular intervals for all the required replenishments in the supplier’s range, and these are then delivered together at one time. ✓ For example, if such deliveries were made weekly, then on average, the individual item order quantities will be for only one week’s usage. Less popular items, or ones with erratic (irregular) demand patterns, can be individually ordered at the same time, or (when urgent) can be delivered the next day by carrier. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved How can inventory be controlled? operations managers have to do two things. – First, they have to discriminate between different stocked items, so that they can apply a degree of control to each item which is appropriate to its importance. – Second, they need to invest in an information- processing system which can cope with their particular set of inventory control circumstances. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved How can inventory be controlled? One common way of discriminating between different stock items is to rank them by the usage value (their usage rate × individual value). Items with a particularly high usage value are deemed to warrant the most careful control, Items with low usage values need not be controlled quite so rigorously (strictly). Generally, a relatively small proportion of the total range of items contained in an inventory will account for a large proportion of the total usage value. This phenomenon is known as the Pareto law (80/20 rule). It is called this because, typically, 80% of an operation’s sales are accounted for by only 20% of all stocked item types. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Inventory priorities – the ABC system (Pareto law) Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved  Inventory priorities – the ABC system (Pareto law) Class A items are those 20 per cent or so high usage value items which account for around 80 per cent of the total usage value. Class B items are those of medium usage value, usually the next 30 per cent of items, which often account for around 10 per cent of the total usage value. Class C items are those low usage value items which, although comprising around 50 per cent of the total types of items stocked, probably only account for around 10 per cent of the total usage value of the operation. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved  Sometimes the cost of too much stock is total destruction p. 454 What are some of the ways Burberry can reduce inventory? Reducing inventory too much can be problematic, why? How can forecasting assist in managing inventory? What issues can overstock lead to? Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved