Name: Mary Lyn B.

Sernal

Subject: Inventory Management and Control

CHAPTER TWO

Inventory Management: Overview and Introduction Part 1

Logistics Visionaries

• Have talked for years about eliminating- or at least drastically reducing- the role of inventory in
modern supply chain.
• Most efficient slack-free supply chain, wouldn’t require any inventory buffer because supply and
demand would be in perfect sync.
• Networks and technologies will enough to eliminate the need for at least minimal inventory.
• Logistics managers have to perform daily, delicate act, and balancing.

Transportations Cost Against Fulfillment Speed:

1. Inventory costs against the cost of stock outs.

(Inventory cost is the money spent to keep things in stock, while the costs of stock outs is the money
lost when things are not available when needed.)
2. Customer satisfaction against cost to serve
(Customer Satisfaction means making customer happy, while the cost to service is how much it
costs to help them)
3. New capabilities and Profitability
(New capabilities means being able to do more things, while profitability is about making more
money.)

Two accelerating business trends are making it even harder to synchronize supply chains:

1. Global Sourcing is forcing supply chains to stretch farther across boarders.

• The goods people consume are increasingly made in some other part of the world,
particularly in Asia.
• When goods cross borders, considerations such as fulfillment speed (activities performed
once order is received) and inventory costs get more complicated.
2. Powerful Retailers and other end customers with clout are starting to push value-added supply
chain responsibilities further up the supply chain.
• More customers are asking manufacturers or third-party logistics providers to label and
prepare individual items so the product are ready to go directly to store shelves.
• Added responsibilities, added costs.
• Upstream supplies always looking for ways to squeeze more costs out of other areas to the
supply chain, such as transportation and distribution.

The UPS Direct approach (UPS means United Parcel Service)- Growing number of companies are
overcoming these barriers by taking more direct approach to global fulfillment.

• The direct-to-store-approach also known as distribution center bypasses or direct distribution.

• Keeps inventory moving from manufacturer to end customer by eliminating stops ate warehouses
along the way.
• Eliminate inventory costs, Direct-to-store can offer good balance between fulfillment speed and
logistics costs.

What’s account for the emergence of the direct-to-store model?

• Global sourcing and the upstream migration of value-added logistics service are certainly primary
drivers.
• Internet enabled electronic links between supply chain partners have allowed better coordination
and collaboration among the various supply chain segments.
 • More accurate sales-forecasting tools take some of the guesswork out of production and reduce the
need for large inventory safety stocks.
• Tracking and tracing tools are available to follow orders across borders and through the hands of
different supply partners.
• Companies no longer much inventory gathering dust in warehouses because they can better
synchronized production and distribution with demand.
• Direct-to-store keep inventory in motion-across borders and around the world.
• That’s what inventory-Money.

Netherland’s beer company figured it could save a whole bunch of money on Inventory-in-transit if it could
shorten the forecasting lead time; (Heineken)

They expect two things to happen:

1. First, they expected to reduce the need for inventory for the pipeline, therefore cutting the amount
of money devoted to inventory itself.
2. Second, they figured that with a shorter forecasting time, forecast could be more accurate, reducing
emergencies and waste.

Forecast were more accurate, and there was another benefit, too.

Heineken found that its salespeople were suddenly more productive.

They could concentrate on good customer service and helping distributions do better. It was a “win” all the
way round.

• The key here involves doing things that decrease your inventory order cycle time and increase the
accuracy of your forecast.
• Use automated system and electronic communication to substitute the rapid movements of
electrons for the cumbersome movement of masses of atoms.

This chapter and present introductory techniques designed to manage inventory in different supply
chain settings. Also, the focus of this chapter is on settings where the desire is to maintain a stock of
inventory that can be delivered to our customer on demand.

The techniques described in this chapter are suited for managing the inventory at these decoupling
points.

There is a trade off where quicker response to customer demand comes at the expense of greater
inventory investment. This is because finished goods inventory is more expensive than raw material
inventory.

The models in this chapter are most appropriate for the upper echelon inventories (retail and
warehouses), and the lower level and rank should use the Materials Requirements Planning (MRP)
Technique.

The techniques describe here the most appropriate when demand is difficult to predict with great precision.

In these models, characterize demand by using a probability distribution and maintain stock so that the risk
associated with stock outs is managed.

1. The single-period model. Used when we want to maintain a one-time purchase of an item.
Example might be purchasing T-shirt to sell at a one-time sporting events.
2. Fixed-order quantity model. This is used when we want to maintain an item “in stock”, and when
we resupply the item, a certain number of units must be ordered each time.
3. Fixed-time period model. This similar to fixed-order quantity model, it is used when the item
should be in stock and ready to use. In this case, rather than monitoring the inventory level and
ordering when the level gets down to a critical quantity, the item is ordered at certain intervals of
time, for example, every Friday morning.
 In this chapter, it shows not only mathematics associated with great inventory control but also
the “art” of managing inventory.

Techniques such as ABC analysis and cycle counting are essential to the actual management of
the system since they focus attention on the high-value items and ensure the quality of the
transactions that affect the tracking of inventory levels.

DEFINITION OF INVENTORY

INVENTORY – is the stock of any item or resources used in an organization.

•Inventory system is set of policies and controls that monitor levels of inventory and determine what level
should be maintained, when stock should be replenished, and how large orders should be.

•Manufacturing Inventory refers to items that contribute to or become part of a firms product output.

Manufacturing inventory is typically classified into raw materials, finished products, component parts,
supplies, and work-in-process.

•Inventory is classified as transit, that it is being moved in the system, warehouses, which inventory in a
warehouse or distribution center.

•Inventory generally refers to the tangible goods to be sold.

Basic purpose of inventory analysis, in manufacturing, distribution, retail, services is to supply:

1. When items should be ordered

2. How large order should be. Many firms enter to longer-term relationships with vendor to supply
their needs for entire year. This change’s “when” and “how many order” to “when” and “how
many to deliver.”

Purpose of Inventory

All firms (including JIT operations) keep a supply of inventory for the following reasons.

1. To maintain independence of operations. A supply of materials at a work center allows that

center flexibility in operations.
• Independence of work stations is desirable on assembly lines as well.
• It is desirable to have a cushion of several parts within the work station so that shorter
performance times can compensate for longer performance time.
• This way the average output be fairly stable
2. To meet variation in product demand.
• If the demand for the product is precisely it may be possible to produce product exactly
meet the demand.
• A safety or buffer stock must be maintained to absorb variation.
3. To allow flexibility in production scheduling. A stock of inventory relieves the pressure on
the production system to get the goods out. Permit production planning for smoother flow
and lower cost operation through larger lot-size production.
4. To provide a safeguard for variation in raw material delivery time. Materials order delays can
occur for a variety of reasons: Normal variation in shipping time, unexpected strike at the vendor’s
plant or at one shipping companies, lost order, or shipment of incorrect or defective material.
5. To take advantage of economic purchase order size. There are costs to place an order: Labor,
typing, postage, and so on. The larger order is, the fewer orders that need to be written. Shipping
costs favor larger orders- the larger shipment, the lower the per-unit cost.
6. Many other domain-specific reasons. Depending on the situation, inventory may need to be
carried. Many reasons why the orders or shipments are pricey like for example inventory that is
bought in anticipation of price changes such as fuel for jet planes and semiconductors for
computer. For each preceding reasons (especially for items 3, 4 and 5) be aware that inventory is
costly and large amounts are generally undesirable.
 INVENTORY COSTS

In making any decisions that affects inventory size, the following costs must be considered:

1. Holding (or carrying) costs. It includes the costs for storage facilities, handling, insurance, taxes
and the opportunity cost of capital. High holding cost tend to favor low inventory levels and frequent
replenishment

2. Setup (or production change) costs. When making different products, it cost money and time to
get ready for each one, like gathering materials and setting up machines. The goal is to make this
changes cheaper so we can make smaller amounts without wasting resources, which can be achieved
through a Just-in-Time (JIT) system.

3. Ordering Costs. Are the managerial and clerical costs to prepare the purchase or production order,
they include counting items, calculating order quantities, and maintaining the system needed to track
orders.

4. Shortage costs. Refers to the trade-off between carrying stock to satisfy demand and the costs
resulting from stock outs and backorders, which can be difficult to balance.

• Shortage costs are about finding the right balance between having enough stock to meet demand and
the costs that come from running out of stock and having to delay orders.

Firms productive facilities involves a search for the minimum total cost resulting from the combined
affects of four individual costs; holding costs, setup costs, ordering costs, and shortage costs. The
timing of these orders is a critical factor that may impact inventory cost.

INDEPENDENT VERSUS DEPENDENT DEMAND

It is important the understand the trade-off involves in using different types of inventory control logic.

Understanding the tradeoffs in inventory control logic, such as transaction cost dependence on
integration and automation, and the risk of obsolescence, is a crucial for careful management of items,
especially those sensitive to technical obsolescence.

We use the terms independent demand and dependent demand to describe thus characters:

In independent demand the demand for various items are unrelated to each other.

(For examples workstation may produce many parts that are unrelated but that meet some external
demand requirements)

In dependent demand, the need for any one item is a direct result of the need for some other item,
usually a higher level item of which it is part.

Dependent demand is a relatively straightforward computational problem.

To determine the quantities of independent items must be produced, firms usually turn to their
sales and market research departments.

They use a variety techniques, including:

• Customer surveys, forecasting techniques, and economic and sociological trends.

Independent demand is uncertain, extra units must be carried in inventory.

 THIS CHAPTER PRESENTS MODELS TO DETERMINE HOW MANY UNITS NEEDS
TO BE ORDERED, AND HOW MANY EXTRA UNITS SHOULD BE CARRIED TO
REDUCE THE RISK OF STOCKING OUT.

Inventory Systems

An inventory systems provides the organizational structure and the operating policies for
maintaining and controlling goods to be stock. It is responsible for ordering and receipt of goods.
Timing the order placement, keeping track of what has been order, how much and from whom.

Follow up to answer question as:

1. Has the supplier received the order?

2. Has it been shipped?
3. Are the dates correct?
4. Are the procedures established for reordering or returning undesirable merchandise?

A. Single- Period Inventory Model

The problem is about a person, like a newspaper or a shirt seller, who needs to decide how many
items to have in stock to maximize profit, considering the uncertainty of demand.

• Single- Period Inventory models are useful for a wide variety of service and manufacturing
applications.

Consider the Following:

1. Overbooking of airline flights. The concept of overbooking airline flights and the costs
associated with both underestimating and overestimating cancellations. (Airlines sometimes
sell more tickets that there are seats on a plane, which can be a problem because of too many
people show up, some might not be able to get on a plane, but if not enough people show up,
the airlines loses money because they could have sold those seats.)
2. Ordering of the fashion items. The retailer often can only place a single order for the entire
season due to long lead times merchandise life. The cost of underestimating demand is the lost
profit from unmade sales. The cost of overestimating demand is the cost of discounting the
excess merchandise.
3. Any type of one time order. Ordering product that become obsolete after a certain period of
time.

B. Multi- Period Inventory Systems

There are two general types of multi-period inventory systems:

• Fixed-order Quantity Models. (Also called the economic order quantity. EOQ and Q
model)
• Fixed-time Period Models. (Also referred to variously as the periodic system, Periodic
review system, Fixed-order interval system, and P model)

Multi- period inventory system are designed to ensure that an item will be available or ordered multiple
times on an ongoing basis throughout the year.

The basic distinction is that fixed-order quantity models are “event triggered” and fixed-time period
model are “time triggered”

The use of Fixed-order quantity models (which place an order when the remaining inventory drops to a
predetermined order point)
In a Fixed-time period model, (counting takes place only at the review period.)

Some additional differences tend to influence the choice of systems:

1. The fixed-time period model has a larger average inventory and it has no review period
2. The fixed-order quantity model favors more expensive items because average inventory is
lower.

FIXED-ORDER QUANTITY MODELS- Fixed-order quantity models attempt to determine the specific
point, R (is always a specified number of units), at which an order will be placed and the sized of that order,
Q (is placed when the inventory available reaches point R.)

INVENTORY POSITION- Is defined as the on-hand plus on-order minus backordered quantities.

ESTABLISHING SAFETY STOCK LEVELS- Safety stock must therefore be maintained to provide
some level of protection against stock outs. Safety stock can be defined as the amount of inventory carried
in addition to the expected demand.

ABC INVENTORY PLANNING- Maintaining inventory through counting, placing orders, receiving
stock, and so on takes personnel time and costs money.

In other words focus on the most important items in inventory.

INVENTORY SYSTEM- must be specify when an order is to be placed for an item and how many units
to order.

ABC INVENTORY CLASSIFICATION scheme divides inventory items into three groupings:

1. High dollar/peso volume

2. Moderate volume dollar and
3. Low dollar/peso volume

Dollar volume is a measure of importance; an item low in cost but high in volume can be more important
than a high-cost item with low volume.

INVENTORY ACCURACY AND CYCLE COUNTING

• To keep accurate, up-to-date records. Using bar codes and RFID tags to minimize input errors.
• Keeping storeroom locked and allowing only personnel access.
• Making record accuracy a measure of performance for personnel evaluation and merit increases.
• Having a record keeping mechanism in every location of inventory storage.
• Conveying the importance of accurate records to all personnel and relying on their assistance.

Another way to ensure accuracy is to count inventory frequently and match this against records.

A widely used method is called cycle counting.

CYCLE COUNTING- is a physical inventory-taking technique in which inventory is counted frequently

rather than once a twice a year.

The key to effective cycle counting and, therefore, to accurate records lied I deciding which items are to be
counted, when, and by whom.