Supply Chain Management

By
Adeel ur Rehman
Faculty Member- IQRA University
Introduction

• The most expensive, sophisticated software package will not

automatically result in an optimal level of inventory for an electrical
wholesaler. ‘Optimal’ means a high level of customer service and
inventory turns, but with low inventory investment. To achieve and
maintain an optimal level, employees educated in the principles of
effective inventory management must understand how to set certain
parameters; then set them and keep them set right
Chapter 7 Inventory Management

• Distinguish dependent from independent demand inventories

• Describe the four basic types of inventories and their functions
• Understand the costs of inventory and inventory turnovers
• Understand ABC classification
• Understand the EOQ model and its underlying assumptions
• Understand the Quantity Discount and the EMQ Models and their
relationships with the basic EOQ mode
Introduction

• A firm’s inventory management strategy can be a key driver for its

success and failures
• Poor inventory strategy can erode customer service and quickly
deplete cash especially for cash-starved firm
• The US Census department estimates that total business inventory in
March 2018 was $1.924 trillion , 35 % greater than estimated $1.426
trillion sales
Introduction- Continue

• Inventory plays a critical role in overcoming the mismatch of demand

and supply
• However, carrying inventory offers risk as it incurs carrying cost, ties
capital cost and creates the risk of obsolesce
• Buffer stocks may make manufacturing process smooth, hiding the
problems that cause unnecessary process variability
Introduction To The Topic

• Inventory can be one of the most expensive assets of an organization

• It may account for more than ten percent of total revenue or total
assets for some organizations
• companies in the manufacturing sector usually carry more inventory
than service firms
• The ratio of inventory to total revenue and total assets is accounted
for determination of the inventory investment
• Inventory management policy affects how efficiently a firm deploys its
assets in producing goods and services
Dependent Demand and Independent
Demand
• Dependent demand is the internal demand for parts based on the
demand of the final product in which the parts are used.
Subassemblies, components and raw materials are examples of
dependent demand items.
• Material requirements planning (MRP) software is often used to
compute exact material requirements
• Independent demand is the demand for a firm’s end products and
has a demand pattern affected by trends, seasonal patterns and
general market conditions
The Functions of Inventory

• Inventory includes all the materials and goods that are purchased,
partially completed materials and component parts and the finished
goods produced
• The primary functions of inventory are to buffer uncertainty in the
marketplace and to decouple, or break the dependencies between
stages in the supply chain
Basic Types of Inventory

• Raw materials are unprocessed purchased inputs or materials for

manufacturing the finished goods
• Work-in-process (WIP) describes materials that are partially
processed but not yet ready for sales. WIP inventories is to decouple
processing stages or to break the dependencies between work
centers
• Finished goods are completed products ready for shipment
• Maintenance, repair and operating (MRO) supplies are materials and
supplies used when producing the products but are not parts of the
products
Inventory Costs

• The bottom line of effective inventory management is to control inventory costs

and minimize stockout
• Inventory costs can be categorized in many ways: as direct and indirect costs;
fixed and variable costs; and order (or setup) and holding (or carrying) costs
• Direct costs are those that are directly traceable to the unit produced
• Indirect costs are those that cannot be traced directly to the unit produced
• Fixed costs are independent of the output quantity, but variable costs change as
a function of the output level
• Order costs are the direct variable costs associated with placing an order with
the supplier, whereas holding or carrying costs are the costs incurred for holding
inventory in storage
Inventory Investment

• A widely used measure to determine how efficiently a firm is using its

inventory to generate revenue is the inventory turnover ratio or
inventory turnovers
• This ratio shows how many times a company turns over its inventory
in an accounting period
• Faster turnovers are generally viewed as a positive trend because it
indicates the company is able to generate more revenue per dollar in
inventory investment
Cycle Counting

• A common problem with many inventory management systems is the

challenge to maintain accurate inventory records
• Many organizations use cycle counting to reconcile discrepancies
between their physical inventory and inventory record on a monthly
or quarterly basis
• Cycle counting, or physically counting inventory on a periodic basis,
also helps to identify obsolete stocks and inventory problems so that
remedial action can be taken in a reasonable amount of time
• Cycle counting can be costly and time-consuming and can disrupt
operations
The ABC Inventory Control System

• The ABC inventory control system is a useful technique for determining

which inventories should be counted more frequently and managed more
closely and which others should not
• ABC analysis is often combined with the 80/20 rule or Pareto analysis
• The 80/20 rule suggests that 80 percent of the objective can be achieved by
doing 20 percent of the tasks
• The ABC inventory control system prioritizes inventory items into Groups A, B
and C
• A items are given the highest priority, while C items have the lowest priority
and are typically the most numerous (the B items fall somewhere in between
Inventory Models

• The deterministic inventory models are discussed that assume

demand, delivery lead time and other parameters are deterministic
• These models use fixed parameters to derive the optimum order
quantity to minimize total inventory costs
• Thus, these models are also known as the fixed order quantity models
The Economic Order Quantity Model

• The basic order decision is to determine the optimal order size that
minimizes total annual inventory costs—that is, the sum of the annual
order cost and the annual inventory holding cost
• The issue revolves around the trade-off between annual inventory
holding cost and annual order cost
• The EOQ model thus seeks to find an optimal order size that
minimizes the sum of the two annual costs
Assumptions of the Economic Order Quantity
Model
• The demand is known and constant
• Order lead time is known and constant
• Replenishment is instantaneous
• The entire order is delivered at one time and partial shipments are not allowed
• Price is constant
• Quantity or price discounts are not allowed
• The holding cost is known and constant. The cost or rate to hold inventory must be
known and constant
• Order cost is known and constant. The cost of placing an order must be known and
remains constant for all orders
• Stockouts are not allowed. Inventory must be available at all times
Deriving the Economic Order Quantity

• TAIC=Annual purchase Cost +Annual holding cost + Annual  order cost

• TAIC=APC + AHC + AOC
• TAIC= (R*C) + (Q/2)*(K*C) + (R/Q)*S
• TAIC=total annual inventory cost APC=annual purchase cost
AHC=annual holding cost AOC=annual order cost
R=annual requirement or demand C=purchase cost per unit
S=cost of placing one order
k=holding rate; where annual holding cost per unit= K × C
Q=order quantity
Deriving the Economic Order Quantity

•  Since R, C, k and S are deterministic

• Put dTAIC / dQ = 0
• EOQ =
• The managerial implication here is that purchase cost does not affect
the order decision if there is no quantity discount
• Thus, the annual purchase cost is ignored in the classic EOQ model
The Quantity Discount Model

• The quantity discount model or price-break model is one variation of the classic
EOQ model
• It relaxes the constant price assumption by allowing purchase quantity discounts
• Unlike the EOQ model, the annual purchase cost now becomes an important
factor in determining the optimal order size and the corresponding total annual
inventory cost
• The quantity discount model must consider the trade-off between purchasing in
larger quantities to take advantage of the price discount (while also reducing the
number of orders required per year) and the higher costs of holding inventory
• A price break point is the minimum quantity required to get a price discount