Logistics- Supply

chain
Dr. TRAN QUYNH LE
Dr. LE THI DIEM CHAU
Industrial Systems Engineering Department
Mechanical Engineering Faculty
Ho Chi Minh City University of Technology (HCMUT)–
VNUHCM
CHAPTER 4: Managing Inventory Flows in the
Supply Chain

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Learning Objectives
• Understand the importance of coordinated flows of inventory through supply
chains.

• Understand the impact of effective inventory management upon the return

on assets (ROA) for a company.

• Appreciate the role and importance of inventory in the economy and why
inventory levels have declined relative to Gross Domestic Product (GDP).

• Understand the major reasons for carrying inventory.

• Explain the role of inventory to major functional areas in the company.

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Inventory Control
• The maintenance of a company's
inventory levels.

• Keeping detailed statistics on the

quantity and value of a company's
inventory.

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Inventory Management
• Systems and processes that
✓ Identify inventory requirements
✓ Set targets
✓ Provide replenishment techniques
✓ Report actual and projected inventory status.

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Why Inventory

• Protect Against uncertain demand or unexpected demand

• To deal with the demand variability

• Protect against supply uncertainty

• Economies of Scale

• Transportation (lead time)

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Important issues in Inventory Management

• Demand forecasting

• Order quantity calculation

• Since demand is uncertain, forecast demand is a critical element in

determining order quantity.

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Key Factors affect inventory policy

• Customer demand

• Known in advance
✓ Random – use forecasting tools by using historical data.

✓ Estimate the average demand, as well as the amount of demand variability.

• Replenishment lead time (known, random)

• The number of products

• The length of planning horizon

• Costs (ordering and holding)

• Service level requirements

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Cost Associated to Inventory

• Holding Cost = inventory carrying cost

✓ tax, maintenance cost, opportunity cost, obsolescence, deteriorate, insurance,
facilities, interest and opportunity cost, theft

• Purchasing Cost
✓ variable labor cost, variable overhead cost and raw material cost
• Ordering Cost

✓ fixed cost not depend on volume, mail, phone,inspection, receiving and

transportation cost.

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Cost Associated to Inventory

• Penalty Cost = Shortage cost occurred when there is no enough

inventory to meet the demand
✓ Backlogging or Back ordering cost
✓ Lost Sales
• Good will: the brand loyalty

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Inventory System
• Demand
✓ Known in advance
✓ Random
• Lead Time
✓ Known in advance
✓ Random
• Excess Demand
✓ Backlogged
✓ Lost

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Inventory System
• Review Time
✓ Continuous
✓ Periodic
• Changing of Inventory
✓ Perishable
✓ Obsolescence

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Inventory
• Definition: A stock of material held to satisfy some eventual demand
• Category of Inventory:
✓ Raw Material (RM) : Purchasing Department
✓ Work-In-Process (WIP) : Production Control Department
✓ Finished Goods : Distribution Department

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Inventory Evaluation
• Service Level
• Inventory Turnover = Annual sales/average of inventory value
Note: the higher the better but cannot compare with the different type of
inventory
• Stock Cover = Number of Inventory/annual demand (forecast) (year)

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Inventory Evaluation
Types of Demand
• Independent Demand
✓ When the item’s demand is influenced by market conditions and is not related
to production decisions for any item.
✓ Only end items can qualify in manufacturing.
✓ Demand must be forecasted.
• Dependent Demand
✓ When the item’s demand derives from (that is, “depends” on) production
decisions for its parents.
✓ All Intermediate and purchased items in manufacturing.
✓ Demand should be derived
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Classifying Inventory by Purpose
• Cycle Inventory
✓ A physical count of items in inventory
✓ The longer the cycle, the bigger is Q
✓ Helps with customer service, ordering cost, setups, transportation rates, and
material costs.
✓ Equal to Q/2.
• Safety Stock Inventory
✓ Created when we place an order sooner than it is needed.
✓ Protects against three types of uncertainty
▪ Demand
▪ Lead time
▪ Supply
✓ Helps with customer service and missing parts.
✓ Expensive to hold inventory
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Classifying Inventory by Purpose
• Anticipation Inventory
✓ Created by overproducing during the slack season or
✓ overbuying before a price increase or capacity shortage.
✓ Helps absorb uneven rates of
▪ Demand
▪ Supply
• Pipeline (Transit) Inventory

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Essential Aspects of Just in Time
• Reduction/minimization of inventory in supply chains.
• Kanban - a "pull" system of production/materials control
• An employee participation and involvement strategy involving the securing of
commitment and changed work practices leading to elimination of waste

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Just-in-time Demands is not possible without
• Reliable delivery
• Short distances between client and server
• Consistent quality so that server performance and throughput is unaffected
• Stable, predictable production schedules and ability to respond quickly to small
fluctuations in demand.
• If the production system itself is flexible with quick set up times for product changes
- then the data flowing in the JIT system and the ability of servers to respond are
critical.

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Kanban System

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 Classifying Inventory: ABC Analysis

• Ranking system
• Developed in 1951 by H. Ford Dicky of General Electric3.

• Suggested that GE classify items according to relative sales volume,

cash flows, lead time, or stockout cost.

• Most important inventory put in Group A.

• Lesser impact goods put in Groups B and C respectively.

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 Classifying Inventory: ABC Analysis

• Pareto’s Rule (80-20 Rule)

• Based on a nineteenth century mathematician’s observation that

many situations were dominated by a very few elements.

• Conversely, most elements had very little influence in most

situations.

• Separates the “trivial many” from the “vital few”.

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 Classifying Inventory: ABC Analysis

• 80-20 Rule

• 80% of sales will come from 20% of the inventory SKUs.

• 20% of sales will come from 80% of the inventory SKUs.

• The 80-20 Rule has been found to explain many phenomena

that interest managers.
• For example, 80% of sales come from 20% of customers; and vice
versa.

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ABC Inventory Analysis

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ABC Inventory Analysis

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ABC Analysis for Big Orange Products, Inc.

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Demand
• Independent
✓ EOQ, EPQ (Economic Order Quantity and
✓ Economic Production Quantity)
• Dependent
✓ BOM (Bill of Material)
✓ MRP (Material Requirement Planning)

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Inventory Policy
• Constant demand:
✓ Continuous review: Economic Lot Size or EOQ
• Uncertain demand
✓ Continuous review (s, S)
✓ Periodic review base stock policy (S)
✓ Newsboy or Newsvendor problem

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The Inventory Cycle

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Economic Order Quantity (EOQ)
• Decision : How much and when to order
• Objective: Minimize the total cost
• Model Assumptions:
1. Repetitive ordering
2. Continuous ordering/review
3. Constant demand
4. Lead time is zero
5. No shortage are allowed
6. Minimize total cost: ordering cost and holding cost

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EOQ Parameters
• D = Demand rate/ period
• K = Ordering cost/ order
• h = Holding cost/unit
• Q = Order quantity
• Q* = EOQ
• TC = Total Cost
• p = Unit price
• i = Interest rate
• T = Cycle time = Q/D
• N = number of order = D/Q

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EOQ Derivative

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Cost Minimization Goal

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Total Costs with Purchasing Cost (p*D)

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Note on EOQ
• If demand increases by a factor of a, then the optimal lot size
increases by a factor of 𝑎.

• The number of orders placed per year should alsoincrease by a

factor of 𝑎.

• Flow time attributed to cycle inventory should decrease by a

factor of 𝑎.

• To reduce the optimal lot size by a factor of a, the fixed order cost
K must be reduced by a factor of 𝑎2

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EOQ Robustness
• Some time a company could not order exact amount of Q

• What reasons?
✓ Minimum Order Quantity (MOQ)
✓ Lot size order
• We can derive the ratio of TC when we could not order Q*

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Economic Production Quantity (EPQ)
• Decision: How much and when to produce
• Objective: Minimize total cost: set up cost (production cost) and holding
cost.
• Model Assumptions:
✓ Only one item is involved
✓ Annual demand is known
✓ Usage rate is constant
✓ Usage occurs continually
✓ Production rate is constant
✓ Lead time does not vary
✓ No quantity discounts

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Economic Production Quantity (EPQ)
• D = Demand rate/ period
• P = Production rate/period
• K = Set up cost/ order
• h = Holding cost/unit
• Q = Production quantity Inventory Level
• Q* = EPQ
• TC = Total Cost Production
portion of cycle
• p = Unit production cost
• i = Interest rate Demand portion of
cycle with no supply
• T = Cycle time = Q/D
• Tp = Time to produce Q units = Q/P Time
• N = number of production run = D/Q
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Economic Production Quantity (EPQ)

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 Inventory Visibility

• The ability of the firm to “see” inventory on a real-time basis

throughout the supply chain system requires:

• Tracking and tracing inventory SKUs for all inbound and outbound
orders.

• Providing summary and detailed reports of shipments, orders,

products, transportation equipment, location, and trade lane activity.

• Notification of failures in inventory flow.

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Inventory Visibility: General Benefits

• Improved customer service

• Decreased cost-of-sales

• Improved vendor relations and cost

• Increased Return on Assets

• Improved cash flow

• Improved response time and service recovery

• Improved performance metrics

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Evaluating the Effectiveness of a Company’s
Approach to Inventory Management

• Are customers satisfied with the current level of customer

service?
• If standards have been set in consultation with the customer, this
question can be answered objectively.

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 Evaluating the Effectiveness of a Company’s
Approach to Inventory Management

• How frequently does backordering and/or expediting occur?

• If records of these events are kept, the answer to this question can point out the
need for a modification or adoption of new inventory strategies.

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 Evaluating the Effectiveness of a Company’s
Approach to Inventory Management

• Is the company calculating an Inventory Turnover ratio for

each product SKU?
✓ This ratio can provide good information on whether the inventory is
being effectively and efficiently managed.

• How does inventory level behave as sales rise or fall?

✓ From sales records, the firm can determine if inventory levels rise
as much as sales, less than sales, or stay about the same
regardless of sales levels.

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The Relationship among Inventory Turnover, Average
Inventory, and Inventory Carrying Costs

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Saving Inventory Dollars by Inventory Turns

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End of chapter 4

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