Lesson 8: Managing Inventory

Semester 1, 2023/2024
AGC/ADC604
OPERATIONS
& SERVICE
MANAGEMENT

Assoc. Prof. Dr. Tan Cheng Ling,

Graduate School of Business,
Universiti Sains Malaysia
Course Content

The Importance of Inventory

Managing Inventory

Inventory Models

Probabilistic Models and Safety Stock

Differentiate types of inventory

Adapt methods for maintaining accurate

inventory information
Learning
Outcome
Relate the key decisions and costs

Understand the tactics for reducing inventories

Chapter 12:
Managing Inventories in
Supply Chains

Collier D. A. & Evans J. R. (2023). Operations

Management and Supply Chain Management
(3rd ed.). Cengage.
 Inventory

Any asset held for future use or sale.

A stock of materials used to satisfy customer

demand or to support the production of services
or goods.
What is
inventory?
 Inventory

Independent
demand:
finished • E.g. a tablet; car;
goods, items rack etc.
that are ready
to be sold

Dependent • E.g. parts that make

demand: up the tablet;
components
of finished automotive parts;
products wood etc.
Types of
Inventory
Purchased but not
Raw material processed

Undergone some
Work-in-process change but not
completed

Necessary to keep
Maintenance/repair/ machinery and
operating (MRO) processes
productive

Completed product
Finished goods awaiting shipment
The Importance of Inventory

One of the most To achieve

expensive assets of satisfactory levels
many companies of customer
representing as service while
much as 50% of keeping inventory
total invested costs within
capital reasonable bounds
Managing Inventories in
Global Supply Chains
– Managing inventories in global supply chains requires good technology,
processes, and information technology (IT) support.
– The Purchasing or procurement function is responsible for acquiring raw
materials, component parts, tools, and other items from outside suppliers.
• In the past, purchasing focused primarily on low-price acquisition.
• Today, purchasing must:
− focus on global sourcing and total system cost,
− ensure quality, delivery performance, and technical support,
− seek new suppliers and products and evaluate their potential
to the company.
Managing
Vitamin enrichment:
China
Wheat gluten: Poland
Yeast: Canada

Inventories
in Global
Mostly Mexico

Supply Chain Colombia

New Zealand

Mexico
Beef meat from
several
countries

Garlic Power: Mustad seeds:

Australia Canada Vinegar: Italy
Inventory Management
Decisions and Costs
Inventory managers deal with two fundamental decisions:
1. When to order items from a supplier or when to initiate production
runs, if the firm makes its own items, and
2. How much to order or produce each time a supplier or production
order is placed.
Inventory costs can be classified into four major categories:
1. Ordering or setup costs incurred when placing orders with suppliers
2. Inventory-holding costs associated with carrying inventory
3. Shortage or stockout costs associated with inventory being unavailable
to meet demand
4. Unit cost of the purchased goods or the internal cost of producing them
 MANAGING
INVENTORY

HOW INVENTORY ITEMS CAN HOW ACCURATE INVENTORY

BE CLASSIFIED RECORDS CAN BE MAINTAINED
Inventory Management
Infrastructure
ABC inventory (Pareto) analysis gives managers useful information
to identify the best methods to control each category of inventory.

A vital few stock keeping units (SKUs) represent a high percentage

of the total dollar inventory value.

Used to establish policies that focus on the few critical parts and
not the many trivial ones.
What is ABC Analysis?

ABC Analysis
The process of dividing SKUs into three classes, according to their
dollar usage, so that managers can focus on items that have the
highest dollar value.

A C B
“A” items account for a “C” items account for a “B” items are
large dollar value but small dollar value but a between A and C.
relatively small large percentage of total
percentage of total items. items; can be managed Account 30% of
15% of items yet 70% to using automated items and 15% - 25%
80% of total dollar usage. computer systems. 55% of total dollar usage.
of items yet about 5% to
15% of total dollar usage.
ABC
Analysis
Example

https://www.youtube.com/watch?v=MiZexgEknxU
 Other
• Anticipated engineering changes
criteria than
• Delivery problems
annual dollar • Quality problems
volume may
be used
• High unit cost ABC Analysis

• More emphasis on supplier

Policies development for A items
employed • Tighter physical inventory
may include control for A items
• More care in forecasting A items
Class Exercise 8.1:
A manager has obtained a list of unit costs and estimated annual
demands for 10 inventory items and now wants to categorize the
items on an ABC basis. Conduct ABC analysis for this case.
Item number Annual demand Unit cost (RM)
1 25 360
2 10 70
3 24 500
4 15 100
5 7 70
6 10 1000
7 2 210
8 10 4000
9 80 10
10 5 200

List the item number for category A, B and C with the % of item and % of Annual Dollar Value.
Inventory Counting
Systems
– Periodic System
Physical count of items made at periodic intervals
– Perpetual Inventory System
System that keeps track
of removals from inventory
continuously, thus
monitoring
current levels of
each item
Inventory Counting Systems

TWO-BIN SYSTEM: TWO CONTAINERS OF UNIVERSAL PRODUCT CODE (UPC): BAR CODE RADIO FREQUENCY IDENTIFICATION (RFID)
INVENTORY; REORDER WHEN THE FIRST IS PRINTED ON A LABEL THAT HAS TAGS
EMPTY INFORMATION ABOUT THE ITEM
TO WHICH IT IS ATTACHED
 Where are the Animal?
Using Technology Keeping up with the millions of SKUs in global food
supply chain is a monumental task. Today, tiny RFID
(RFID) to increase chips embedded in packaging or products allow scanners
to track SKUs as they move throughout the store. RFID
inventory accuracy chips help companies locate items in stockrooms and
identify where they should be placed in the store. An
Innovative use of RFIDs is to track and monitor food,
Livestock, and even trees. The technology also helps
Prevent crime, reduce disease, and provides proximity
Information on a real time basis. China, for example,
Wants to use RFIDs to monitor 1.2 billion pigs in its
Sichuan province, which is more than the total number
Of the pigs in the USA. An outbreak of pig disease in
Sichuan in 2005 caused direct losses of $1.5 billion and
Indirect losses of &1.25 billion. New Zealand wants to
Pass a legal requirement that its 100 million pet dogs be
RFID-tagged. Canada is tagging fish; Germany, trees; and
Australia, cattle.
 Smart Fitting Room
Help Inventory
Management

– Bloomingdale designed a smart fitting

room with Apple iPads that connected
to complex inventory management
system uses to track of millions items.
 Inventory Characteristics:
Nature of Demand

Demand can be classified as:

• Independent demand
− demand for an SKU that is unrelated to the
demand for other SKUs and needs to be
forecasted.
• Dependent demand
− directly related to the demand of other SKUs
and can be calculated without needing to be
forecasted
• Static demand
- remains stable over time.
• Dynamic demand
- varies over time.
Inventory Characteristics:
Number and Duration of Time Periods
 Another important inventory characteristic is the number and duration of time
periods.
 Storage planning approaches differ depending on whether inventory is analyzed for
single or multiple periods.
– “Single-period” inventory is typical for short selling seasons with no leftover
items, such as seasonal items during Christmas.
– “Multi-period” inventory is typical for firms concerned with planning inventory
requirements over an extended number of time periods, such as monthly over
a year.

© 2024 Cengage Group. All Rights Reserved.

 Inventory Characteristics: Lead
Time and Stockout

 Lead time is the time between placement of an order and its receipt.
– Lead time may be deterministic or stochastic and is affected by
– transportation carriers, buyer order frequency and size, and
supplier production schedules.
 A stockout is the inability to satisfy the demand for an item.
– In case of stockout, the item is either back-ordered or a sale is lost.
– A backorder occurs when a customer is willing to wait for an
item.
– A lost sale occurs when the customer is unwilling to wait and
purchases the item elsewhere.

© 2024 Cengage Group. All Rights Reserved.

Holding costs - the costs of holding or
“carrying” inventory over time

Holding,
Ordering costs - the costs of placing an Ordering,
order and receiving goods and Setup
Costs

Setup costs - cost to prepare a

machine or process for manufacturing
an order
Need to determine when and how much to order

INVENTORY
Basic economic order quantity
MODELS FOR
INDEPENDENT
DEMAND
Production order quantity

Quantity discount model

 Important assumptions

– Demand is known, constant, and independent

Basic – Lead time is known and constant
EOQ – Receipt of inventory is instantaneous and complete
Model
– Quantity discounts are not possible

– Only variable costs are setup and holding

– Stockouts can be completely avoided

 The Economic Order
Quantity (EOQ) Model

 The economic order quantity model (EOQ) is a classic

economic model that minimizes the total cost.
– Total cost is the sum of the inventory-holding cost and
the ordering cost.
 Several assumptions underline the EOQ model:
– Only a single item (SKU) is considered
– Entire order quantity (Q) arrives in the inventory at
one time
– Deals with only order/setup and inventory-holding
costs
– No stockouts are allowed
– Demand for an item is constant and continuous over
time
– Lead time is constant
© 2024 Cengage Group. All Rights Reserved.
Inventory
Usage Over
Time
Minimizing
Costs
Objective is to minimize total costs
The EOQ
Model
The EOQ
Model
The EOQ
Model
Reorder
Points
Reorder
Point
Curve
Production Order Quantity Model
Production
Order
Quantity
Model
Production
Order
Quantity
Model
Production Order
Quantity Model

Q =Number of pieces per order

p =Daily production rate
H =Holding cost per unit per year
d =Daily demand/usage rate
t =Length of the production run in days
D = Annual demand
S = Setup cost per order
Production
Order
Quantity
Model
Quantity
Discount
Models
Quantity Discount Models
Quantity
Discount
Models
 Increase Q* for discount categories 2 and 3 to the minimum
qualifying quantities of 1,000 and 2,000, respectively.
Quantity
Discount
Models
Quantity
Discount
Example
Quantity
Discount
Example Calculate Q* for every discount
Quantity Discount Example
🤔🤔 Class Exercise 8.2:

D&G manufacturing assembles security systems. It purchases 3,600

high-definition security cameras a year at RM180 each. Ordering costs
are RM50, and annual carrying costs are 20 percent of the purchase
price. Compute the optimal quantity and the total annual cost of
ordering and carrying the inventory.
 Stockouts
Matter
According to the Food Marketing Institute
and Grocery Manufacturers of America,
stock-outs in the fast moving consumer
goods sector are as high as 8.3%, with
promotional products even higher. As a
result, retailers lose around 4% of their
sales because consumers will buy the item
elsewhere, substitute the product with
another brand, or just forget about it.
PROBABILISTIC
MODELS AND
SAFETY STOCK
Safety
Stock
Example
Safety Stock Example
Probabilistic
Demand
Probabilistic
Demand
Other
Probabilistic
Models
https://blog.capterra.com/the-top-5-free-inventory-software-systems/