CHAPTER 9
Inventory Management
Learning Objectives
To determine the costs of holding inventory
To identify the costs associated with a stockout
To understand the EOQ concept
Learning Objectives
To differentiate the various inventory flow patterns
To appreciate the role of scanners in inventory control
Inventory Management
Key Terms
ABC analysis
Economic order quantity (EOQ)
Fixed order interval system
Fixed order quantity system
Key Terms
Handling costs
Insurance costs
Inventory carrying (holding) costs
Inventory shrinkage
Inventory Management
Key Terms
Marginal analysis
Obsolescence
Opportunity cost
Reorder point (ROP)
Safety stocks
Key Terms
Stockouts
Storage costs
Taxes
Vendor-managed inventory (VMI)
Inventory Management
Inventories are stocks of goods and materials that are maintained to satisfy normal demand patterns
Inventory management
Decisions drive other logistics activities
Different functional areas have different inventory objectives
Inventory costs are important to consider
Inventory turnover
Inventory Management
Inventory management (continued)
Inventory costs are important to consider
Inventory turnover: cost of goods sold divided by average inventory at cost
cost of goods sold = inventory turnover
average inventory
$200,000 = inventory is sold 4 times per year
$ 50,000
Compare with competitors or benchmarked companies
Inventory Management
Low inventory turnover = high inventory carrying costs, little (or no) stockout costs
High inventory turnover = low inventory carrying costs, high stockout costs
Managing the tradeoff is important to maintain service levels
Inventory Classifications
Psychic stock (stimulates demand)
Cycle or base stock
Safety or buffer stock
Pipeline or in-transit stock
Speculative stock
Inventory-Related Costs
Inventory carrying (holding) costs
Obsolescence
Inventory shrinkage
Storage costs
Handling costs
Insurance costs
Taxes
Interest charges
Opportunity cost
Stockouts
Table 9-1: Determination of the Average Cost of a Stockout
$
Average cost of a stockout
.25
$1,200
3. Lost customer
$
.65
$
2. Switches and comes back
$
.10
$
1. Brand-loyal customer
Average Cost
Probability
Loss
Alternative
These are hypothetical figures for illustration.
Inventory-Related Costs
Trade-offs exist between carrying and stockout costs
Marginal analysis
Table 9-2: Determination of Safety Stock Level
3
1,200
8,400
33,600
70
1,
4
1,200
7,200
28,800
60
1,
6
1,200
6,000
24,000
50
2,
8
1,200
4,800
19,200
40
3,
12
1,200
3,600
14,400
30
5,
16
1,200
2,400
9,600
20
$6,
20
$1,200
$1,200
$4,800
10
Additional Stockout Costs Avoided
Number of Additional Orders Filled
Carrying Cost of Incremental Safety Stock
25% Annual Carrying Cost
Total Value of Safety Stock ($480 per Unit)
Number of Units of Safety Stock
When to Order
Fixed order quantity system
Fixed order interval system
Reorder point (ROP)
ROP = DD x RC under certainty
ROP = (DD x RC) + SS under uncertainty
Where DD = daily demand
RC = length of replenishment cycle
SS = safety stock
How Much to Reorder
Economic order quantity (EOQ) in dollars
EOQ = √2AB/C
Where
EOQ = the most economic order size, in dollars
A = annual usage, in dollars
B = administrative costs per order of placing the order
C = carrying costs of the inventory (%)
How Much to Reorder
Economic order quantity (EOQ) in units
EOQ = √2DB/IC
Where
EOQ = the most economic order size, in units
A = annual demand, in units
B = administrative costs per order of placing the order
C = carrying costs of the inventory (%)
I = dollar value of the inventory, per unit
Figure 9-2: Determining EOQ by Use of a Graph
Table 9-3: EOQ Cost Calculations
145
20
125
200
5
125
25
100
250
4
108
33
75
333
3
100
50
50
500
2
125
100
25
1,000
1
Total cost (sum of ordering and carrying cost) ($)
Carrying cost ($)
Ordering cost ($)
Order size ($)
Number of orders per year
Figure 9-3: Inventory Flow Diagram
Inventory Flows
Safety stock can prevent against two problem areas
Increased rate of demand
Longer-than-normal replenishment
When fixed order quantity system like EOQ is used, time between orders may vary
When reorder point is reached, fixed order quantity is ordered
Contemporary Approaches to Managing Inventory
ABC Analysis
Just-in Time (JIT) Approach
Vendor-Managed Inventory (VMI)
Inventory Tracking
Inventory Management: Special Concerns
Defining stock-keeping units (SKUs)
Dead inventory
Deals
Substitute items
Complementary items
Informal arrangements outside the distribution channel
Repair/replacement parts
Reverse logistics
