Chapter89
MANAGING
INVENTORY IN THE
SUPPLY CHAIN
Learning Objectives
After reading this chapter, you should be able to do the following:
● Appreciate the role and importance of
inventory in the economy.
● List the major reasons for carrying
inventory.
● Discuss the major types of inventory, their
costs, and their relationships to inventory
decisions.
● Understand the fundamental differences
among approaches to managing inventory.
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part.
Learning Objectives, continued
● Describe the rationale and logic behind the
economic order quantity (EOQ) approach
to inventory decision making, and be able
to solve some problems of a simple
nature.
● Understand alternative approaches to
managing inventory—just-in-time (JIT),
materials requirement planning (MRP),
distribution requirements planning (DRP),
and vendor-managed inventory (VMI).
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part.
Learning Objectives, continued
● Explain how inventory items can be
classified.
● Know how inventory will vary as the
number of stocking points changes.
● Make needed adjustments to the basic
EOQ approach to respond to several
special types of applications.
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part.
Introduction
● Inventory is an asset on the balance sheet
and a variable expense on the income
statement.
● Inventories also have an impact on return
on investment (ROI) for the firm.
● Inventories also have an impact on return
on investment (ROI) for an organization.
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part.
Inventory in the Firm
● Batching Economies or Cycle Stocks
• Arises from three sources.
○ procurement
○ production
○ transportation
● Uncertainty and Safety Stocks
• All organizations are faced with uncertainty.
• On the demand side, there is usually uncertainty in
how much customers will buy and when they will buy
it.
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part.
Inventory in the Firm, continued
● Uncertainty and Safety Stocks, continued
• On the supply side, there might be uncertainty about
obtaining what is needed from suppliers and how long
it will take for the fulfillment of the order.
● Time/In-Transit and Work-in-Process
Stocks
• The time associated with transportation means that
even while goods are in motion, an inventory cost is
associated with the time period. The longer the time,
the higher the cost.
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part.
Inventory in the Firm, continued
● Time/In-Transit and Work-in-Process
Stocks, continued
• WIP inventories, associated with manufacturing, can
be significant while the length of time the inventory
sits in a manufacturing facility waiting and should be
carefully evaluated in relationship to scheduling
techniques and the actual manufacturing/assembly
technology.
● Seasonal Stocks
• Seasonality can occur in the supply of raw materials,
in the demand for finished product, or in both.
• Those faced with seasonality issues are constantly
challenged when determining how much inventory to
accumulate.
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part.
Inventory in the Firm, continued
● Seasonal Stocks, continued
• Seasonality can impact transportation.
● Anticipatory Stocks
• A fifth reason to hold inventory arises when an
organization anticipates that an unusual event might
occur that will negatively impact its source of supply.
● The Importance of Inventory in Other
Functional Areas
• Logistics interfaces with an organization’s other
functional areas.
○ Marketing
○ Manufacturing
○ Finance
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part.
Inventory Costs
● Inventory Carrying Costs
• Capital Cost (interest or opportunity cost)
○ cost of capital tied up in inventory and the resulting lost
opportunity from investing that capital elsewhere
○ hurdle rate
○ weighted average cost of capital (WACC)
● Storage Space Cost
• Includes handling costs associated with moving
products into and out of inventory, as well as such
costs as rent, heat, and light.
• Can be variable.
©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part.
Inventory Costs, continued
● Inventory Service Cost
• Includes insurance and taxes.
● Inventory Risk Cost
• Reflects the possibility that inventory value might
decline for reasons beyond firm’s control.
● Calculating the Cost of Carrying Inventory
• First, determine the value of the item stored in
inventory.
• Second, determine the cost of each individual
carrying cost component to determine the total direct
costs consumed by the item while being held in
inventory.
• Third, divide the total costs calculated in Step 2 by the
value of the item determined in Step 1. 11
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part.
Inventory Costs, continued
● Order and Setup Cost
• Order Cost
○ cost of placing order which may have both fixed and variable
components
• Setup Costs
○ expenses incurred each time an organization modifies a
production or assembly line to produce a different item for
inventory
● Expected Stockout Cost
• Back order - results in the vendor incurring incremental variable
costs associated with processing the extra shipment.
• Customer might decide to purchase a competitor’s product
resulting in a direct loss for the supplier.
• Customer might decide to permanently switch to a competitor’s
product with loss of income.
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part.
Figure 9.2
Inventory Costs
Source: C. John Langley, Ph.D.
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part.
Inventory Costs, continued
● In-Transit Inventory Carrying Cost
• Owner of product while it is in transit will incur
resulting carrying costs.
• In-transit inventory carrying cost becomes especially
important on global moves since both distance and
time from the shipping location both increase.
• Owner should consider its delivery time part of its
inventory carrying cost.
● Key Differences Among Approaches to
Managing Inventory
• Dependent versus Independent Demand
○ independent when such demand is unrelated to the demand
for other items
○ dependent when it is directly related, or derives from, the
demand for another inventory item or product
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part.
Figure 9.3
Safety Stocks and Service Levels
Source: Robert A. Novak, Ph.D.
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part.
Figure 9.4
Inventory and Service Levels
Source: Robert A. Novak, Ph.D.
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part.
Inventory Costs, continued
● Key Differences Among Approaches to
Managing Inventory, continued
• Pull versus Push
○ The “pull” approach relies on customer orders to move
product through a logistics system, while the “push” approach
uses inventory replenishment techniques in anticipation of
demand to move products
● Principle Approaches & Techniques for
Inventory Management
• Fixed order quantity model involves ordering a fixed
amount of product each time reordering takes place
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part.
Inventory Costs, continued
● Principle Approaches & Techniques for
Inventory Management, continued
• Simple EOQ Model
○ The following are the basic assumptions of the simple EOQ
model:
A continuous, constant, and known rate of demand
A constant and known replenishment or lead time
All demand is satisfied
A constant price or cost that is independent of the order
quantity (i.e., no quantity discounts)
No inventory in transit
One item of inventory or no interaction between items
Infinite planning horizon
Unlimited capital
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part.
Figure 9.5
Fixed Order Quantity Model with Certainty
Source: John C. Coyle, DBA
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part.
Figure 9.8
Inventory Costs
Source: John C. Coyle, DBA
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part.
Inventory Costs, continued
● Principle Approaches & Techniques for
Inventory Management, continued
• Simple EOQ Model, continued
○ Mathematical formulation
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part.
Figure 9.11
Graphical Representation of EOQ
Source: C. John Langley, Ph.D.
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part.