Symptoms of Poor Inventory Management

1. Increasing number of back orders

2. Increasing investment in inventory with backorders
remaining constant
3. High customer turnover rate
4. Increasing number of orders cancelled
5. Periodic lack of sufficient storage space
6. Wide variance in turnover of major inventory items in
distribution centers
7. Deteriorating relationship with intermediaries, as typified
by dealer cancellations and declining orders.
8. Large quantities of obsolete items.
 Methods/Techniques of Inventory Reduction
1. Multiechelon inventory planning, ABC analysis
2. Lead time analysis
3. Elimination of low turnover & or obsolete item
4. Analysis of pack sizes and discount structure
5. Examination of procedures for returned goods
6. Encouragement/Automation of product substitute
7. Installation of formal reorder review systems
8. Measurement of fill rates by skus
9. Analysis of Customer demand characteristics
10. Development of formal sales plan and demand forecast by predetermined
logic
11. Reengineering inventory management.
Stock out Costs.
Stock out costs occur when seller is unable to satisfy demand with available
inventory. One of possible events
S occur
t
1. Customer waits until the product is available
t product
2. The customer back orders the
3. The Seller looses a sale
4. The seller losses a customer
Determining stock out cost
5. Identify a stock out's potential consequences I.e. back order, lost sale, Lost
customer
6. Calculate each result’s expense or loss of profit and then to estimate the cost
of single stock out.
7. Assume that 70% of stock out results in back order and a back order results
in extra handling cost. Say 20% result in lost sales for item
 and this loss equals to $20 in lost profit margin; and 10%
result in lost customer, or a loss of say $200.
Calculate the overall impact,
70% of $6.00 = $4.20
20% of $20.00 = $4.00
10% of $200.00 = $20.00
Total $28.20
Estimated cost per stock out.
Since $ 28.20 is the average dollar amount the firm can save
by averting a stock out, the firm should carry additional
inventory to protect against stock outs only as long as
carrying additional inventory costs less than $ 28.20.
 Assumptions
• Inventory transfers between stocking locations at the same level are not
common practice

• Lead times do not vary, and thus inventory concentration is not affected
by inbound supply uncertainty
• .
• Customer service level, as measured by inventory availability, is
constant regardless of the number of stocking locations.

• Demand at each location is normally distributed..

 Elements of Inventory Carrying Cost
Capital Inventory Investment
Costs
Insurance
Inventory Taxes
Service Costs
Plant Warehouses
Inventory
Carrying Public Warehouses
Costs
Storage Rented Warehouses
space Costs
Company Owned WH

Obsolescence

Damage
Inventory
Shrinkage
risk costs
Relocation Costs
 A B C Analysis

Item Annual Sales % of Annual Sales Cumulative Sales % of Items Classification

Code $ category

64R 6800 68% 68% 10.0% A

89Q 1200 12 80 20 A

68j 500 5 85 30 B

37S 400 4 89 40 B

12G 200 2 91 50 B

35B 200 2 93 60 B

61P 200 2 95 70 B

94L 200 2 97 80 C

11T 150 1.5 98.5 90 C

20G 150 1.5 100 100 C

$10,000 100% 100%

 QR
1. QR is effective for synchronizing product flow with
information flow.
2. Vendor commits to meet criteria as lead time, service
levels & fill rates, EDI communication & possibly vendor
managed inventory.
3. Retailer commits to provide accurate timely demand
information
4. Performance criteria applied is precise.
 Elements of Q.R.

• Shorter, compressed time horizon

• Real time information available by S.K.U.
• Seamless, integrated logistic network that depend on
rapid incoming transporting, strategic cross docking, and
effective store receipt and distribution system
• Partnership relationship between manufacturers and
retailers, including sharing of processes and information.
• Redesign of manufacturing operations and processes to
reduce lot sizes and changeover times, enhance flexibility
and responsiveness and coordinate MPS with forecasts
and actual customer orders.
• Commitment to TQM, process improvement and ‘Service
response logistics’.
 Elements of QUICK RESPONSE

Time Horizon

Logistics

Information
Manufacturing
Operations
Supplier
Manufacturer
Relationship
Philosophical/
Cultural Change
Structure of U.S. Textile / Apparel Industry
Synthetics (75% highly concentrated
Fibre
10 firms contribute 90% market

More fragmented
Fabric • 6000 firms
• 12 firms provide 25% market

Extremely fragmented
Apparel
• 15,000 firms
Increasing concentration – Major categories
Retail • Department stores
• Mass merchandisers
• Mail order
• Chains
• Specialty stores

Increasing sophistication
Consumer
Variety expected
Wide choice
REVENUE LOSSES IN THE APPAREL PIPELINE
(% RETAIL SALES)
Fibre& Apparel Retail Total
textile
Forced 0.6% 4% 10% 14.6%
markedown
stockouts 0.1% .4% 3.5% 4%

Inventory@ 1.0% 2.5% 2.9% 6.4%

15%c
total 1.7% 6.9% 16.4% 25%
 Q R System

66 W
Inventories
Retail
Apparel
Textile
46 W Fibre
Weeks inventory

21 W

Present Quick Very quick

 Efficient Consumer Response
• Report for the US Food Marketing Institute States:Today’s
supply chain consists of a series of individual components,
each pushing product to the next player in the supply
chain.Each transaction adds substantial costs: selling
expense, buying expense, purchasing ordering, order
processing, order assembly, shipping, receiving, checking,
put away, invoicing, paying,deducting, reconciling and more.
Further, receivables average several weeks for each
transaction. Very little, if any of these costs add value to the
ultimate product or service the consumer receives.
 Efficient Consumer Response

• The spirit of ECR has been captured by Birds Eye

Wall’s,a Unilever frozen food company in the United
Kingdom. It defines ECR as ‘the process which facilitates
the true working together to achieve ultimate consumer
satisfaction, maximizing business efficiency for mutual
benefit’.
• The objective of ECR as defined by ECR Europe
Conference in 1996, is “ to fulfill consumer wishes better,
faster and at least cost.”Means Reduce Inventory thereby
permitting price reductions or higher margins and
secondly strengthen brand propositions that are
compatible between manufacturer and retailer in order to
meet consumer needs, thereby stimulating category
growth and increasing revenue.
• The power of ECR lies in cooperation and the sharing of
information and expertise between trading partners
towards a common goal of increased consumer
satisfaction.
• ECR is a tool for integrating separate aspects of supply
chain to deliver increased value to the consumer
• ECR takes a process view, defining four core processes
that span all supply chain players
• Research conducted by Anderson Consulting for ECR in
1997 found that most ECR related initiatives had
centered around working together to reduce costs
 Retailer

Wholesaler
Introduce Promote Merchandise Replenish
Product Product Products Products

Manufacturer

Supplier
 ECR Improvement concepts
Demand management

Electronic Electronic Item coding

Data Funds And database
Interchange Transfer maintenance

Supply management

Integrated Synchronized Continuous Automated

Suppliers Production Replenishment Store ordering

Reliable operations Crossdocking

 Improvement Concepts
• Demand Management: which covers those activities focused on
improving the product offering to consumers

• Supply management: which covers several initiatives designed to

improve the flow of product through the supply chain
•
• Enabling Technologies: which are activities that act as enablers for
the other ECR improvement concepts, many of which are related
to electronic commerce
For ECR to be successful. Seven basic capabilities are
required from manufacturing and retail firms.

• Integrated EDI
• Continuous Replacement
• Computer assisted ordering
• Flow through distribution
• Activity based costing
• Category Management – to optimize design, promotion, stocking
etc.
• Flexible manufacturing – to match production with actual
demand.
 Vision of the ECR System
Timely, accurate, paperless information flow

Retailer Consumer
Supplier Distributor
Store household

Smooth, continuous product flow matched to consumption

Consumer purchases
Product ‘A’ from a
Supermarket. The
transaction is recorded
by the stores scanner.
Anatomy of ECR
The scanner forwards the An automatic ordering
Transaction record to an system allows the
Instore computer. The product Product ‘A’ supplier
‘A’ manufacturer whose computers to match production with
Interface with the retailer’s, notes demand using product
The transaction & automatically movement information
Reorders a replacement unit of & forecasting
JIT basis.

The retailer’s in store computer acknowledges

Because production is tied directly into demand,
etailers become increasingly freed from the need
or excess inventory, thus opening the door for
ncreased cross docking & direct store delivery.
receipt of the shipment and automatically
issues a computer generated payment or
electronic fund transfer payment, eliminating
the need for paper invoices & streamlining
the accounting process.
 ECR – Broad Operations

Change Management

Replenishment Integrated EDI Replenishment

Promotion Continuous Replenishment Promotion

Retail
Manufacturing Business
Business
Store Assortment Computer Ordering Store Assortment
Strategy
Strategy ABC
Product Introduction Flexible Mfg. Product Introduction

Open Communication
 Before ECR

Distributor Warehouse
Packing Retail store Consumer
Line Supplier Warehouse (Forward buy 9 days) 26 days purchase
38 days turn inventory 31 days
40 days

104 days
After ECR

Packing Supplier Distributor

Retail store Consumer
Line Warehouse Warehouse
26 days purchase
27 days 12 days

61 days
RWL/LV/PT-17
Cost Structure of Dry Grocery Supply Chain
100
Reducing prices by 10.8%
12.1 Operatin 89.2
g Profit
18.3 Store op 9.8
erations
5.0 16.4
Adminis
trative
8.1 4.8
Logistics
4.1 6.2
Selling b
uying
9.7 3.0
Marketin
g
8.2
42.7
Cost of Goods
40.8
Present ECR

100 = Average consumer price in present dry grocery system

 Bull Whip Effect
The Supply Chain
External Demand

Retailer
Order LT Delivery LT
Wholesaler

Order LT Delivery LT

Distributor
Order LT Delivery LT
Factory
Production LT
 BULLWHIP EFFECT

1. Information reduces inventory in supply chain

2. Information enables make better forecasts, accounting for promotions
and market changes
3. Information results in coordination of manufacturing and distribution
systems strategies.
4. Information enables retailers to better serve their customers by offering
tools for locating desired items.
5. Information enables retailers to react and adapt to supply problems more
rapidly.
6. Information enables lead time reduction.

Increase in variability as we travel up in S.C. is referred to as

“Bullwhip Effect”
 Variability of orders placed by customers
Variability of orders placed by retailers
variability of orders placed by Distributors
wholesaler is forced to carry more inventory as safety stock.
Factory
Distributor
Wholesaler
Retailer
Customer
Order

Time
Factors -
Demand forecasting
Lead time
Batch ordering
Price fluctuations, inflated order.
Order Point = L x AVG + Z. STD x L
L = Lead Time
AVG = Average demand
STD = Standard deviation
t = period
Yt = µt.L + Z.Root
L L .St
µt = average daily demand
St = Standard deviation of daily demand
t = period
Retailer uses moving average technique

t1
pDi
t it
p


t 1
p (Di t)
St 2
 it
p
P = observations
RWL/LV/PT-17
 2
Var(Q)
2L2L
 2
1
Var(D)
PP
12
10
Variability

8
6
4
2
0
5 10 15 20 25 30
P
P - is large
L - small
Variability - Low
Var
(Q)
1.4
Var
(D)
L1 + L2 + L3 = 6 periods
RWL/LV/PT-17
 Summary of Impact on Promotion Timing
Factor
• High forward buying
• High ability to steal market share
• High ability to grow overall market
• High margin
• Low margin
• High holding costs
• High costs of changing inventory
Impact on timing of promotion
• Favours promotion during low demand
periods.
• Favours promotion during peak
demand periods.
• Favours promotion during peak
demand periods.
• Favours promotion during peak
demand periods.
• Favour promotion during low demand
periods.
• -----” ----------
• -----”-----------
 Directions for Replacement Logistics

Direction Objectives Key Programs

 Continuous  Bring supply more in  Automatic system that

replenishment line with the rhythm enables distributors to
(CRP) of demand stock and reorder
inventory goods based on actual
systems. consumer sales.
 Flow through  Space utilization  Increase product flow
distribution handling activities,  Reduce inventory
systems. time and costs timely, coordinated
transport and material
handling.
 Pipeline  Institutionalize key  New role and
logistics product flow responsibilities that
organizations processes, cultivate remove barriers to
total pipe line view' communication,
and coordinate coordination,
operations. accountability, provide
incentives.
 Pipeline  Objectives for  Precise criteria, accurate
performance management decision rules, consistent
measures control of and procedures that support
motivating objectives
appropriate
decision making.

RWL/LV/PT-17
Guidelines for performance Improvement

1. Maintain inventory at four-month level during current year.

Reduce to three months level over the course of next two
years.
2. Establish & maintain a customer service level of 92%
product availability for all regular line items & have such
items ready for shipment within five days of receipt of
order.
3. Develop procedures to maintain logistics operating
expenses at 3.5% of sales during current year.
4. Reduce transportation expenses, including private fleet, to
2.5% of sales during current year, & reduce them to 2.4%
next year.
5. Reduce freight shipment damage rate to 1% of total sales.
6. Maintain employee turnover rate at 12% per year.
7. Achieve and/or exceed overall satisfaction objectives.
 Discounts
Supply Chain Management
• Quantity discount results in Improved coordination in
supply chain & extraction of surplus through price
discrimination.
• Lot size based quantity discounts are justified only for
commodity products for which price is fixed by market.
• Lot size based quantity discount results in SC
coordination, decrease SC costs but increase cycle
inventory.
• Lot size based quantity discounts are not optimal for the
SC for the products for which firm has a market power.
Volume based discounts can be used to achieve
coordination in SC & maximize SC profit..
• For products, for which demand increases, when
price declines, it is better to offer volume based
discounts because supply chain profit increases.
• Short Term Discounting
• Trade Promotions: It is done for a short period
by offering discounted price to induce sales, shift
inventory from manufacturer to retailers & to
customers and also to defend brand against
competition.
• They lead to significant increase in lot size, cycle
inventory and generally reduce SC profit unless
trade promotions reduces demand fluctuations.
• The Supply chain profit is lower if each stage of the
supply chain independently makes its pricing decisions
with the objective of maximizing its own profit. A
coordinated solution results in higher profit. Price
Determination to maximize profits at the manufacture
may also be a reason to offer quantity discounts within a
supply chain. Discounts related to price discrimination
will also be volume based and not lot size based.
• Faced with a short term discounts, it is optimal for
retailers to pass through only a fraction of the discount to
the customer, keeping the rest for themselves.
Simultaneously, it is optimal for the retailer to increase
the purchase lot size and forward buy or future periods.
This leads to an increase of cycle inventory in the supply
chain as the result of a trade promotion without a
significant increase in customer demand.
• Product Fill Rate-It is a fraction of product demand
that is satisfied from product in inventory. It is equivalent
to the probability that the product demand is supplied
from available inventory.
• Order Fill Rate- It is the fraction of orders that are filled
from available inventory.
• Cycle Service Level: It is the fraction of replenishment
cycles that end with all the customer demand being met.
• Both fill rate and cycle service level increase as the
safety inventory is increased.
• For the same safety inventory, an increase in lot size
increases the fill rate but not cycle service level.
• Inventory lot size has no impact on cycle service level
but increases fill rate.
• This is because increase in lot size results in fewer
replenishment cycles.
• The cycle service level is equal to the probability of not
having a stockout in a replenishment cycle.
• Product Substitution:
• Manufacture driven- When the product is not
available so substituted by another product that can
satisfy purpose.
• Customer driven- If the product is not available,
customer decides to buy another which can satisfy him.
• Component Commonality- Component inventories
are held in SC. PC contains several components. When
SC produces large variety of products, component
inventories can become very large.