i Inventory is ocy is created when the recci their disbursemene itt deat eeeine of m . o ment; it ol lateria!: arts, oF finished geo oe Sunply-Chain Manageme cepa Tener eeetey ccc eet aaa a Slamagenicut chapter), tn ths setion, we identify he ptessutes foe bi used to reduce inventories a the different types of inventory, discuss tactics that ean aan prantories when apron, dentify the wade-offs involved in mak . i at dec : i imanlecuring inventory placement decsiony and icin howto ik the iv PRESSURES FOR LOW INVENTORIES ry manager's job i for both low and ie : Jaliis to Galases a) conflicting costs and pressures that ar primary reason for keeping it pried and deretminie appropriate invenery levels.” primary reason for Keeping inventories low is that inventory represents a tempot st. Inverory bl e goods on which a firm must pay (rather than receive) in including interest. B (or carrying) cost is the variable cost of keeping items on hi components chang storage and handling, taxes, insurance, and shrinkage. When t! gatead tern ahd with inventory levels, so docs the holding cost. Comyanies ust TE Eee cee period of timeas.a percent of its value. The annual co Suppose that a fem’s holding Co typically ranges from 20 to 40 percent of its ve Suppose holding cost is 30 percent. If the average value of toral inven percent of sales, the average annual cost to hold inventory is 6 perce £0.30(0 of total sales, This cost is sizable in terms of gross profit margins, which ofter less than 10 percent. Thus, the components of holding cost create pressures for inventories. in a lo: a company may ob ive ret TEREST OR OPPORTUNITY COST. To {i he opportunity of an investment promising an artra\ wonity cost, whichever is preater, usually is the largest component = For example, 2 car dealer may obtain a loon rate of 11 percent, or the dealer may pay in the stock market sam exp forge oppo: often zs high as 1S pescet ory of cars at an annual interest to invest the money inven: and fo:go the opportunity revurn of 13 percent. STORAGE AND HANDLING COSTS. Inventory tekes up space and must be mov gy end handling.costs may be incorred when 2 firm sents sp term basis, There alsa is an opportunity cost for # aly in some other way out of storage. Stor ither + long- oF shor ud use storage space product cith firm xes are paid if end en there is more to insure. by customers or employees, Jyen inventory €21 inkag sa TAXES, INSURA cE, AND SHRINKAGE. More high, end insura cases * ims. Pilferage, or the ce on ansers incr of invento: three pencertage of sales for some buses Obsolescence occurs eee dat full value, ovsing eo model tons, tte Tow demand, bsoescence 2 speci fC veda counts on ceasonal clothing are offered 2t the end ofa 4 Tn : tion t cor din eee waive, Fo aid Wserages 27 S00 ; pee sel Lines reacies, When a have tn be dise ignilding large # tories May joration i hgh. > | Scanned with CamScannertot PRESSURES FOR HIGH INVENTORIES story hell the Us ests that there ate pressures tor large briefly at each type ot press CUSTOMER SERVICE. Creating, inventury can speed deli Inventory reduces the potential for stockouts and backordess. which aoe of wholesalers and retailers A stockout oer len tem sat is type sot available tw sais a demand the moment it asc, testing in Tons of he A bachorder isa cuswamer onder tha cannot be fille when promised or desu i is fille tater. Customers may be willing to wait fora backorder but next tine el be theie business elsewhere. Sometimes customers are given discounts for the ool? Yenience of waiting on. and unprove ey f MANNE dota livery 1 time frm places a new ode it ines am axdsring on, o ay nx a purchase order fora supplier oF a production order for ical For the same tem, the ordering vost isthe same, regardless 08 the wade size Theo chasing agent must take the time to decide how much to order 1, perhaps, selcey is sapplie and negotiate terms, Tine abo is spent on paperwork, follow-up, and rec, tng the case wt prostion uke for a manufactured ier. x Naepein and soe instructions often must accompany the shop order. The Internet (se the Technelas Management and the Supply-Chain Management chapters} can help streamline dh. order proxess and reduce the cows of placing orders. ORDERING COST. cost of prepa SETUP COST. The cost involved in changing over a machine to produce a different com ponent or itein is the setup cast. | des labor and time to make the changeover, steaning. and new tools o¢ fistures, Scrap or rework costs can Fe schyeantially | at the start of the run. Setup vost also is independent of order sizc, so there is presnure component and hold it in inventor’ LAZOR AND EQUIPMENT UTILIZATION. By creating nore inventory, management can increase workforce productivity and facility utilization in three ways, Firs, placing lager kes frequent production orders reduces the nuinbee uf unproductive setups, which al value to a product or service. Second, holding, inventory reduces the chance of custly sheduling of production ordess because the components needed to make the product 1g inventories improves resource it by stabil spur rate for industries when demand is cyclical or seasonal Th sxtra demand in psak seasons and mint nd addicional equipme re are not in inventory, Third, build tng the « inventory builk during slack: periods to handle izes the need for extra shifts, hiring, layoffs, evertim TRANSPOATATION COST. Sometimes, outhound transportation cast can be reduced by in-teasing ventory levels, Having inventory on hand alles sore carkoad shone spore d to expedite shipments by more expenyve modes of transpa! ion cite outbound tranypotation ot (see the and minimizes the 1 tion, Forward placement of inventory so rede even though the pooling effect is lessened and mare inventors is 8 ; Supply-Chain Management chapter). Inbound trenssportation cost iso may be rel by creating nore inventury. Somesimes, several items are usdered trom the Sar oe Combining these orders and placing them at the same time may lead to rate dose thereby decreasing the casts of transportation and raw materia’. ccrwsal ts —— Scanned with CamScannertop sen ty ery thot ina rand ter or CHAPTER tamernys. ” PAYMENTS To SUPPLIERS, \ Hien trate hiher invertors levels Suppe in ir See, HEE. Might he chest f Si la the price unc Lat HE ft ments te supphers it ean tal th 1 Ley supplier iy about to ler a Larger quantity thin ws eee firm can take calvantage ti hough, invent will incteave temporarily. chy the prive per wag Of quantity discenats. Aq order larger quantineg nt APs When the vider ie sathente larnes is an incentive TYPES OF INVENTORY " ‘assy it by how iris created. In this context, od play {OF aM item: cycle, safety, anticipation, and pipelines fed physically; that i, an inventory manager car's nok ea pile Cera path ones are cycle inventory and which ones we pi peline Hpescomes into being, in an enticely ; and the Ices, You ean prescribe different ways » which we discuss in the next section. CYCLE InvenTony, called cycle iny called lot si The portion of roeal inventory that varies directly with lot size ls empty. Determining how frequently to order, and in what quantity, ic 1. Twa principles apple 1, The lot size, O, varies directly with the elapsed time (or cycle) between orders. 11a lot is ordered every five weeks, the averaze lot site mast equal Fee weclen demand. 2. The longer the time hetween orders for afiven item, the preater the evele inventory must be. Ac the beyinning of the interval, the cycle invensory is at its maximum, of . Atthe end of the interval, just hefore a new lot arnves, evele inventory draps te its 0, The average cycle inventory is the average of these two extremes: nun OF docs provide a rea ce even when detand rates are not const Factors other than the demand rate (e.g. scrap losses) alo may cause estinssti when this simple formula is used. SAFETY STOCK INVENTORY. Ty avoid cussamer service problems and the hiv) unavailable components, companies hold safety stock, Safety stuck inventory protesy y stacks are desi inst uncertainties in demand, lead . leat fail to deliver the desired quarnity ified date with seceptabte ean ats of serap are not disrupted when siah problems We. + for delivery carher than when the item when supplic 4 quality: or x licon manufactured itenis | Safery stock taventory ensures that operation occur, allowine subsequent operations w To create safety stock, a firm places 2ni is typically necded,! The replenishorest onde: fv ago IME uncertainty. For exam therefore arrives ahead of times grin thot the average le Scanned with CamScannerLage Ha weapocees on , | HDD players in isforen states. 9 orders for a single custamcr low, ean fet har In its shipping fociline Also, Am -ast demands by areas of te eon ; are forecasted by 21? code and ihe pene im 1a tho warehouse serving that area Nil time it lakes to get a product to the nN the amount of inventory of the tem i" min the [seo the discussion of Inventory po” in anagement chapter) upesations 0 improve ye ol ce-puesedent anit genet fied four things Amazon has done t through inventory management apa vickly Three million square yin es th soar, which enabled of cycle, safely wehous e capacity in less than y evelnn the appropriate ame nation mvpntories to service its custaress he-art automation and mechanizatiGn ficient and llewt'e enough to move are e! a supplier is three weeks but a policy creates a safery stock equal to ANTICIPATION [NVENTORY Inventory’ a, uneven: F js referred to as anticipation inventory. atterns lend themselves to the use of anticipation invenruy 1 which businesses often fac sonal demand p. rates with in firm ord Manufacturers of air conditioners, for example, can experience 90 annual demand during just three months of a year. Such w manufacturer te stockpile anticipation inventory during pertods of low ger output levels do not have to be increased much when demand peab ry can increase productivity force size can be costly. Anticipation inventory also can help when sup; ageanenp oo vy iN 1 the shopping experience the cystoryy and (7 Hg 9 Mt ved the system across tho distribution a Reni fae capacity, automation, an jee tn ny allows Amazon to expaniin te rot cea of parnershis and alliances ane a bo replicated, Amavon has the cap, in tyoelat fashion as new warehouses ar "g agproach 15 10 control inventarign Mey, ate this important function ty anothee, While tho use of the Internat is expanding a the dream of a seamless interface between anit customers must still awart the devel teclinolomy Amara ren tu de eu Fooncess Wingate, Nick. “Amaron Vins to Ave - aiermas Rush: Too Many Kermit Phones,” Wallstreet jougs E roi), p. Wl; “QEA Wiih feitees ten ks in advance just ¢ — 3). sate. Th a two weeks" supply (4 used to absorb uneven rates of demand or suppl Pradhira hye cent of athe may lead nd soth meothing eum ven dem: because varying outpuy demand, is uneven, A company may stock up ana certain purchased item if 'sy supp! ers are threatened with a strike or have ses PIPELINE INVENTORY Inventory moving from Materials move peling inventory, ipacity limitations. ntte point in the materials thew om suppliers to a plant, from Scanned with CamScannerrene bac * Ma, miery S prnare yep inecarory Moseis scryicmensi. Hove, 0a 0 eer gees tata we call Irnern) $77 1escvO REO O een me ccory in 22 be redaces. fh secumisty Sever heros nd the nerd fae baring sererteey m che 1 cons ao spplving che promary lever # cree mvenrony, The prumary lever it senply to redace the len Girt. Moctves og reodcci ‘ieee Lene Spree chaptes see catecreely sal Yet, trae aan ean egasiong scvezal mechs (oe cen ete!) 22797 Hormcoe wg ee ms nD within making any onbee chang can be Grvactation tap at ple, scrap comme c25 Sh leads 1 wee of the tts eecemdaey Iovee, 1. Sereamilne methods for placing ondetn ed maak weap, which peti cederine sed wrap cmett and allows () 10 be edisced 2 pepeseaciy to elianate the rocd to ehangerress. Reyattbeyg sees! enh car be ore sonin. ft ean be increas non ge high prada lend ro encceerenble comomer service—ericst 2. nes con be canoe. é 5 orn be ated. leprove dear chaps comoTen can eves be emcee or prodzcre 1 P redtext them, permitting mi arerpected scrap or tes ely more en equpment and shor bufters, crowrtrained workers. These are the oni serve sector decause they can't Tere Services ANTIDPETION INVENTORY. The primary Inez tor >! to mutch demand rate with peeadoction rate. Sex one of the talleneme ways: demand te ‘Scanned with CamScanner‘ti Pena ee b Leep inventory records elt Sitges . “ a eep ee palance is 200 un's. costly inventory is being AP Pyate IS Fe de the P lor size ar 100 units but the actu Ta class A item is bought outside, h centralized buying, switching su, For class C items, much looser contr as crucial as for a class A item, but “These features suggest th: stock, larger lot sizes, Nc 7 purchasing, may be able ¢ tive Contr let n iers, or More et is appropriate. A stockout of a class C << inventory holding cost of levels cc can be tends to be that more satety ter, may suffice for class C items. higher inventor, japs even a visual syste ECONQMIC ORDER QUANTITY Y Recall tha cess in setups. A: the best which ist anagers face conflicting pres~ to keep inveatories low enough to avoid pry holding costs but high er ough to reduce the freauence « d starting point for halancit inventory level for an item ? lox size that mininuzes te The appro ch to determining the EOO is these conflictin, nding the economic order quantity :EOQ), vual inventory | sed on the tollow Pressures arc Scanned with CamScannerThe demand #3: known wy 2h 2. There are no constraints te. on the sue of each lee. 3 Dec uns tor one item can be made independectly of decisic’ Uc. no advantage it gained in combining several orders gang to the sepplier), 5. There ts no uncertainty in lead time or supply. The lead ume ts ont always 14 days) and known with certainty. The amount received is exact what was ordered aad it arrives al! 2t once rather than piecemeal The economic onder quantity will be optimal when th: five assemptices are sats fied. In reality, few seasons are uo sisnple and well bebaved In fac, dtferecs keane approaches are needed to reflect qeantcy discounts, cneven Cxmand 2204, © Hons between items (see the Specia! Inventory Modes supplement). often is 3 reasonable fine approximati: the acismption: do nce quze apply. CALCULATING THE £00 lewsinen We beris by formulating the total cost for any lee siz2 © Bs which a oe that minimizes ental cost. Finalis. we desorite how to convert ry behaves 2s ch hangens when eee ‘Scanned with CamScanner| i | 3 7 | 3 7 ¥ ae i Creerng cost | g| “x i i Molaing cost Let size K ( Lot ize (Gr Let size 1 (a) Annual holding cost {b) Annsal ordering cost je) Tota! annual cost nual ordering <¢ of orders rear\( Ordering of serup cone Annual ordenag cost = (Nut Holiiing, Ordering, am Total Costs ‘The average number of orders per year equals annoal pile, if 1,200 units mast be ordered each year and the average lor size is 10 12 orders will be placed daring the yea The annual ordening of setup con norilnearty ay O increases, as shown tn Figure 13.4 b), because fewer orders are “The total annus cost.2 as graphed in Figure 13.4¢c), is the sum of the ro ponents: ag cou + Aernalo ral he Toral gest 9 Su -s5 where ize, in umits olding one unix i inv oren calculated 252 proportion of D = aznwal demand, in units per veer st of ordering oF setting up «a Soca eer 44 yee ensh Piece oe im perm ate "Toe mameter ot teceal eaters Hirer et ‘Scanned with CamScannerInventory Management © CSET TITERS. rns in thew ‘One of the selling ity per week, and the supplier charges $60 per swith the supplice # $48, Annual holdin ena i625 percent af a feeder’s valu nperates §2 weeks pier year. Manazement chose a J0lunit lot size so thas new ender cost af the eurrent policy of est The evst of placiay ial. the mu placed levs frequently, What is Would a lot size of 468 be better? SOLUTION We begin by computing the annual demand and holding cost as D = (18 wnitswerky(52 weekvyear) = 9X6 units H = 0.25(S60/unit) = S15 ‘The annual cost for the current policy is o D Mh = Gs 390 936 w= 320.1545) + 238 gasp = $2,925 + $108 ~ 3,033 32 (si) + yy (S45) = $2,925 + $108 = 3, ‘The annual cost for the alternative tor size is A8isis + GIR isasy = 53,s10 + $90 = $3609 Decision Point The lot size of 468 writs, option than the cureent poly, The evings in order costs are more tha In holding costs. Management shou! alternatives. 7 Figure 13.5 ulisplays tt Example 13.2. Fight different lor sizes were evaluated in adsition (0 the Hoth holding, and ordering costs were plorted, the important feature. The 5 Cost dfeeder 30/800 best Current {E00} a Lot size 10) Scanned with CamScanner cr group ar the muscuin’s polr shay wea bundtced et an order could be $4Q-unit lot size? which isa half-year supply, would be a more expensive 1 offset hy the increase Iu use the total cost equation to explore other lot-size he impact of using several Q values for the biedfeeder in rent one. bur their sum—the total cost curve—is coph shows that the hest lot size, or OQ, is the lowestUNE. Operanne be herween 50nd 10 units, Obi, curve, or he sult in significant saviny © 390) ean result in sip . ie Aa the FOQ formula roach is t0 My Fe re suerent lot-sze polis) A more efferent apr H 2 0 okt the EO forrnala from the total cost formuty te ies deca of ora cost function wth tespect 10 Qu set H eanal tog, a te for Q. As Figure 13. szates, the FOQ is the order quantity for whic annie ing cost equals annual ordering cost. Using this insight, we can alsy, obtain qe formula by equating the formulas for annual ordering geet and annual hoi and solving for Q. The eraph in Figure 13.5 also reveal s that, when the annual ke cost for any Q exceeds the annual ordering cost, a5 with the 390.umie Oder, immediately conclude that O is too big. A smaller reduces holding Cost and ince ordering cost, bringing them into balance. Similarly, if che annual ordering cose oes the annual holding cos, Q should be increased." eh Sometimes inventory policies are based on the tims between replenishment rather than the number of units in the lot size. The time between orders (TRO) fo, Sevlar los size is the average clapsed rime between receiving (or placing) Teplenishneny orders of Q units. Expressed as a fraction of a year, 22 TBO is simply © die snnual demand, When we use the EOQ and express time in terms of months, the TRO TROpoq = Foo (2 montis/year} erie, ays tn Example 13.3, we show how to calculate TBO for vears, months, wee sand dar, Finding the EOQ, Total Cost and TRO For the bi orders be SOLUTION Using the furraulas for EOQ and annual cost, we get [aps 2936)45) = 74,98 7S units Fog = V2 =, 7483. or 7S unit Vai 1s {isthe 136 shows that he tcl znmual costs much leg 2 the $3,033 cost ofthe st icy of placing 390-unit orders. Hecders ia Example 13.2, ealelate the FOQ and its wales How trequenth laced if the EO is used? ‘Aorual Costs besed on £00 Orta HgUEr sz Scanned with CamScannerh THISTEES ne COMPARATIVE ADVANTAGES OF THE QANO P SYSTEMS Neither the © nar P system is best tor all situations, Three P-svstem advantages must he balanced against three Q-system advantages. The advantages of one system are implicitly disadvantages of the othe: one. The primary advantages of P systems are the followin Administration of the system is convenient because replensshments are made at fixed intervals. Employees can regularly set aside a day or part of a day to con- centrate on this parcicular task, Fixed replenishment intervals also allow for standardized pickup and delivery times. Orders for snukiple items from the same supplier may be combined .nto a single purchase order. This approach reduces ordering and transportation costs and may result in a price break from the supplier. z The inventary position, IN, needs to be known only when 2 review is made (not continuously, as in a Q system). However, this advantage is moot for firms using computerized record-keeping systems, in which a transaction is reported upon each receipt or withdrawal. When inventory records are always current, the system is called a perpetual inventory system, : The primary advantages of Q systems are the following: w we 1, The review frequency of each item may be individualized. Tailoring the review frequency to the item can reguce total ordering and holding costs. 2, Fixed lot sizes, if large enough, may result in quantity discounts. Physical tations such as truckload cazacities, materials handling mechods, and furnace is also may require 2 fixed lot size, capacit 3. Lower safety stocks result in savings. t. Which one is berter ations. Mai tem. In conclusion, the choice berween © and P systemsis not clear cx c relative impo: of as adh igh each alternative c2refully in selecting the best s¥ ges in various depends on ¢ ment must HYBRID SYSTEMS Various hybrid inventory control s:stems merge some but not all the features of the P tems. We briefly examine wo such systems: optional replenisament and base OPTIONAL REPLENISHMENT SYSTEM. Sometimes called the optional min-max, or is, S) system, the optional replenishment system is much like the F system. It is used to review the inventory position at fixed time intervals and, if the position h (or below) a predetermined level, 20 place a vatiable-sized order to ccver expected needs. The new order is large enozzh to hring the inventory position up to a t2rgei invertory, similar to T for the P secem. However, orders are not placed after a review unless the inventory position has é:opped to the predetermined minimum level. Tht dl acts as reorder poir: R Goes in 3 Q system, If the zargct is 100 and th er size is 40 (or 100 ~ 60). The optional review ularly attractive when both ceview ie minimum le minimum level is 60), the minimus system avoids continuous reviews znd so is p. dering costs are significant, and DASE-STOCK SYSTEM. In its simplest = cm, the base-stock system sues a replenishmen che withdraw: ji each time 3 withdrawal is ade, forthe sane amount a: ss withdrawal. Th pilin ae re dhe feemutae pessition at a base-stock leve Scanned with CamScanner Siento onl aren