Inventory Management

Supply Chain Management

Inventory Management
Inventory is one of
the most expensive
assets of many
companies.

It represents as
much as 60% of
total invested
capital.
Supply Chain Management
Inventory is any stored resource that is used
to satisfy a current or future need.
Raw materials, work-in-process, and finished
goods are examples of inventory.
Maintenance, repair, and operational supplies
(MRO) – item that do not become part of the
product
Supply Chain Management
Why do we hold Inventory?
Improve customer service
Reduce certain costs such as
ordering costs
stockout costs
Contribute to the efficient and effective operation
of the production system
Supply Chain Management
Why we do not hold Inventory?
Certain costs increase such as
Carrying costs, Handling cost
Labor Cost
Warehouse Cost
Logistics Cost
cost of return on investment
reduced-capacity costs (Storage, warehouse)
cost of production problems (Excess Inventory)
Supply Chain Management
Two Fundamental Inventory Decisions

How much to order of each material

when orders are placed with either
outside suppliers or production
departments within organizations
When to place the orders
Supply Chain Management

Inventory Systems
Supply Chain Management
Independent Demand Inventory
Systems

Demand for an item carried in inventory is

independent of the demand for any other item in
inventory
Finished goods inventory is an example
Demands are estimated from forecasts and/or
customer orders
Supply Chain Management
Dependent Demand Inventory Systems

Items whose demand depends on the demands

for other items
For example, the demand for raw materials and
components can be calculated from the demand
for finished goods
The systems used to manage these inventories
are different from those used to manage
independent demand items
Supply Chain Management
Independent vs. Dependent Demand
Independent Demand
(finished goods and spare parts)
A
Dependent Demand
(components)

B(4) C(2)

D(2) E(1) D(3) F(2)

Supply Chain Management
Inventory Costs
Costs associated with ordering too much
(represented by carrying costs)
Costs associated with ordering too little
(represented by ordering costs)
These costs are opposing costs, i.e., as one
increases the other decreases
Supply Chain Management
Inventory Costs (continued)
The sum of the two costs is the total stocking cost
(TSC)
This cost behavior is the basis for answering the
first fundamental question: how much to order
It is known as the economic order quantity (EOQ)
Supply Chain Management

Economic Order Quantities (EOQ)

Supply Chain Management
Behavior of EOQ Systems
As demand for the inventoried item occurs, the
inventory level drops
When the inventory level drops to a critical point,
the order point, the ordering process is triggered
The amount ordered each time an order is placed
is fixed or constant
When the ordered quantity is received, the
inventory level increases
Supply Chain Management
Economic Order Quantities
Typical assumptions made
annual demand (D), carrying cost (C) and
ordering cost (S) can be estimated
average inventory level is the fixed order
quantity (Q) divided by 2 which implies
 no safety stock
 orders are received all at once

 demand occurs at a uniform rate

 no inventory when an order arrives

Supply Chain Management

EOQ = 2 DS / C
Supply Chain Management

ABC
Classification
of
Inventory
Supply Chain Management
ABC Classification of Inventory
Typical observations
A small percentage of the items (Class A) make up a large
percentage of the inventory value
A large percentage of the items (Class C) make up a small
percentage of the inventory value
These classifications determine how much attention
should be given to controlling the inventory of
different items
 How important is the item?
 Segmentation of Inventory
■ Not all inventory is created equally

■ Different classes of inventory

Result in different levels of profitability / revenue

Have different demand patterns and magnitudes
And thus -require different control policies

ABC Analysis
Commonly used in practice
Classify items by revenue or value
Combination of usage, sales price, etc.

nter for Transportation & Logistics - ESD.260 3 © Chris Caplice

 ABC Analysis
Annual Identify the SKUs that
Demand Annual $
Part ID Price Value management should
5497J $ 2.25 260 $ 585.00
3K62 $ 2.85 43 $122.55 spend time on
88450 $ 1.50 21 $31.50
P001 $ 0.77 388 $298.76 Prioritize SKUs by their
2M993 $ 4.45 612 $ 2,723.40 value to firm
3HHT8 $ 6.10 220 $ 1342.00
56M4 $ 3.10 110 $ 341.00 Create logical groupings
89KE $ 1.32 786 $ 1,037.52
45O3 $ 12.80 14 $ 179.20 Adjust as needed
55K2 $ 24.99 334 $ 8,346.66
978SD3 $ 7.75 24 $ 186.00
78HJQ2 $ 0.68 77 $ 52.36
23LK $ 0.25 56 $ 14.00 Example:
990RT $3.89 89 $ 346.21
58JH4 $7.70 675 $ 5,197.50 ■
Sample of 20 SKUs
2340P $ 6.22 66 $ 410.52
3784 $0.85 148 $ 125.80 ■
Total of 4,677 units
38JQ2 $ 0.77 690 $ 531.30
56TT7 $ 1.23 52 $ 63.96
■
Total~$22k
7UJS2 $ 4.05 12 $ 48.60
4,677 $ 21,983.84
ABC Analysis
Pct
Annual Annual Cum$ Ann $
Part ID Price Demand $ Value Value VAlue
55K2 $24.99 334 $ 8,347 $ 8,347 38%
58JH4 $ 7.70 675 $5,198 $ 13,544 62%
2M993 $ 4.45 612 $2,723 $ 16,268 74%
A Items:
3HHT8 $ 6.10 220 $1,342 $ 17,610 80% 80% of Value
89KE $ 1.32 786 $1,038 $ 18,647 85% 20% of SKUs
5497J $ 2.25 260 $585 $19,232 87%
38JQ2 $ 0.77 690 $531 $19,763 90%
2340P $ 6.22 66 $411 $20,174 92% B Items:
990RT $ 3.89 89 $346 $20,520 93% 15% of Value
56M4 $ 3.10 110 $341 $20,861 95% 30% of SKUs
P001 $ 0.77 388 $299 $21,160 96%
978SD3 $ 7.75 24 $186 $21,346 97%
45O3 $ 12.80 14 $179 $21,525 98%
3784 $ 0.85 148 $126 $21,651 98%
3K62 $ 2.85 43 $123 $21,773 99% C Items:
56TT7 $ 1.23 52 $64 $21,837 99% 5% of Value
78HJQ2 $ 0.68 77 $52 $21,890 100%
7UJS2 $ 4.05 12 $49 $21,938 100%
50% of SKUs
88450 $ 1.50 21 $32 $21,970 100%
23LK $ 0.25 56 $14 $21,984 100%
$
4,677 21,984
Supply Chain Management
ABC Classification
Class A
5 – 15 % of units
70 – 80 % of value
Class B
30 % of units
15 % of value
Class C
50 – 60 % of units
 5 – 10 % of value

Copyright 2006 John

18Wiley & Sons, Inc.
Supply Chain Management
ABC Classification:
PART UNIT COST ANNUAL USAGE
1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120

Copyright 2006 John

23Wiley & Sons, Inc.
Supply Chain
Management
ABC Classification:
TOTAL % OF TOTAL % OF TOTAL
PART PART UNIT
VALUE VALUECOST ANNUAL
QUANTITY USAGE
% CUMMULATIVE
1
9 $30,600 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 40 11.0
2 14,000 16.4 4.0
A
3 30 130 15.0
1 5,400 6.3 9.0 24.0
4 4
4,800 80
5.6 6.0 60 30.0
B
3 5
3,900 30
4.6 10.0 100 40.0
6 6
3,600 20
4.2 18.0 180 58.0
5 3,000
7 3.5
10 13.0 170 71.0
10 2,400 2.8 12.0 C
8 320 50 83.0
7 1,700 2.0 17.0 100.0
9 510 60
$85,400
10 20 120
Example 10.1
Copyright 2006 John
24Wiley & Sons, Inc.
Supply Chain Management
% OF TOTAL % OF TOTAL
CLASS ITEMS VALUE QUANTITY
A 9, 8, 2 71.0 15.0
B 1, 4, 3 16.5 25.0
C 6, 5, 10, 7 12.5 60.0
Supply Chain Management
In ABC classification, items kept in inventory
are not of equal importance in terms of:
 dollars invested
 profit potential
 sales or usage volume
 stock-out penalties
Supply Chain Management

End of Topic