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IBS3002 Logistics & International Trade: Inventory Management
IBS3002 Logistics & International Trade: Inventory Management
Chapter 4
Inventory management
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Contemporary logistics, Murphy (2015)
Topic areas
Inventory
Classifying inventory
Inventory costs
Inventory decisions
Inventory flow patterns
Inventory management
Contemporary approaches to managing inventory
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Inventory
Inventory: stocks of goods and materials that are maintained for many purposes, the most
common being to satisfy normal demand patterns
Inventory management: is a systematic approach to sourcing, storing, and selling inventory
—both raw materials (components) and finished goods (products).
Inventory management is a key component in logistics & SCM because its decisions are a
driver for other business activities
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Inventory
Management must reduce inventory levels yet avoid stockouts and other problems
Important of inventory in other organizational functions:
Marketing – more inventory for higher customer service
Manufacturing – more inventory to schedule longer productions runs
Finance – less inventory to keep inventory turnover ratios high (reduce risk inventory loss)
and to keep Return on Assets (ROA) high (increase competitiveness)
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Inventory classifications
Cycle (base) stock: inventory that is needed to satisfy normal demand during the course of
an order cycle
Safety (buffer) stock: inventory that is held in addition to cycle stock to guard against
uncertainty in demand or lead time
Pipeline (in-transit) stock: inventory that is en route between various fixed facilities in a
logistics system (plant, warehouse, store…)
Speculative stock: inventory that is held for several reasons, including seasonal demand,
projected price increases and potential shortages of product
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Inventory classifications
Cycle (base) stock: inventory that is needed to satisfy normal demand during the course of
an order cycle
Safety (buffer) stock: inventory that is held in addition to cycle stock to guard against
uncertainty in demand or lead time
Pipeline (in-transit) stock: inventory that is en route between various fixed facilities in a
logistics system (plant, warehouse, store…)
Speculative stock: inventory that is held for several reasons, including seasonal demand,
projected price increases and potential shortages of product
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Inventory costs
Carrying costs:
Carrying costs refer to the costs associated with holding inventory
Inventory costs are expressed in percentage terms & this percentage is multiplied by the
inventory’s value
Components of inventory carrying costs:
- Obsolescence costs - Taxes
- Inventory shrinkage - Interest costs
- Storage costs
- Handling costs
- Insurance costs 8
Inventory costs
Carrying costs:
Obsolescence cots: are incurred when an item in inventory becomes obsolete before it is sold
or used (i.e. perishable products-meat, milk…)
Inventory shrinkage: is the excess amount of inventory listed in the accounting records, but
which no longer exists in the actual inventory (i.e. damage, loss, theft..)
Storage costs: costs associated with occupying space in a plant, storeroom, or warehousing
facility
Handling costs: costs of employing staff to receive, store, retrieve, move inventory
Insurance costs: insure inventory against fire, flood, theft, other perils…
Interest costs: money required to maintain the investment in inventory
Taxes 9
Inventory costs
Ordering costs:
Ordering costs refer to the costs associated with ordering inventory, including order costs
and setup costs
Order costs: the costs of receiving an order. They include:
+ The transaction costs associated with making an international purchase: international wire
transfers, letters of credit, and bank fees.
+ The document costs, such as certificates of origin, import license, customs brokerage
fees.
+ The time spent, as all international purchases take more time than domestic purchases.
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Inventory costs
Ordering costs:
Setup costs: are those necessary to modify production processes to make the products
necessary to satisfy particular orders. They include:
+ The process-change costs associated with switching from making one type of part to
making another type of part. Different raw materials, different settings, different speed.
+ The time involved in making the change, from employees’ costs to production downtime
costs.
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Inventory costs
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Inventory costs
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Lead time
The lead time is the period between the moment an order is placed and the time at which it
arrives.
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When to order
Fixed order interval system: the time interval is constant, the order size may fluctuate
-> The inventory is replenished at regular intervals, and the quantity of goods re-ordered
changes.
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When to order
Fixed order quantity system: the time interval may fluctuate, the order size stays constant
Reorder point (trigger point): the level of inventory at which a replenishment order is
placed.
• The firm reorders the goods when the inventory level has reached a point that is equal to the
expected demand during the lead time.
ROP = DD x RC
- ROP: reorder point
- DD: average daily demand (unit)
- RC: replenishment cycle (day/ week/ month)
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When to order
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When to order
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How to order
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How to order
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How to order
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How to order
EOQ 2 AB / C
- EOQ: the most economic order size, in dollars
- A: annual usage, in dollars
- B: administrative costs per order of placing the order
- C: carrying costs of the inventory (expressed as an annual percentage of the inventory
dollar value)
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How to order
Example: suppose that $1000 of a particular items is used each year, the order costs are $25
per order submitted, inventory carrying costs are 20%. EOQ in dollars
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How to order
EOQ 2 DB / IC
- EOQ: the most economic order size, in units
- D: annual demand, in units
- B: administrative costs per order of placing the order
- C: carrying costs of the inventory (expressed as an annual percentage of the inventory
dollar value)
- I: dollar value of the inventory, per unit
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How to order
Example: suppose that $1000 of a particular items is used each year, the product has a cost
of $5 per unit, the order costs are $25 per order submitted, inventory carrying costs are 20%
- Annual demand: D = 1000/5 = 200 units
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How to order
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Inventory flows
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How to order
* Assumption:
EOQ: 120 units
Safety stock: 60 units
Average demand: 30 units per day
Order cycle: 2 days
Beginning inventory = EOQ + safety stock = 120 + 60 = 180 units
Reorder point = (daily demand x replenishment cycle) + safety stock
= 30x2 + 60 = 120 units
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How to order
• Safety stock can prevent against two problem areas: an increased rate of demand and a
longer-than-normal replenishment
• When a fixed order quantity system (EOQ) is used, the time between orders may vary
• Requirement of using a fixed order quantity system: that the level of inventory must
constantly be monitored, when the reorder point is hit, the fixed order quantity is ordered
-> use technology advances to monitor inventory constantly
-> reorder point is established electronically
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Inventory management: special concerns
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Inventory management: special concerns
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Inventory management: special concerns
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Inventory management: special concerns
ABC Analysis of Inventory:
The determination of what percentage of items should be classified as A, B, C may have
effect on the efficiencies of inventory
-> too high or too low a percentage of A items may reduce the potential efficiencies to be
gained from the classification technique
ABC analysis can determine stocking patterns in warehousing facilities
ABC analysis could be used to determine how frequently inventory gets monitored
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Inventory management: special concerns
ABC Analysis of Inventory:
A items might be checked daily (increasingly, hourly)
B items weekly
C items monthly
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Inventory management: special concerns
Dead Inventory:
Dead inventory (dead stock) refers to a product for which there is no sales during a 12-
month period
Dead inventory increases inventory carrying costs, takes up space in warehousing facilities
-> need to have structured process for managing
How to deal with dead stock?
-> drastic price reductions
bunching it with more attractive products,
use deadstock broker, donations…
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Inventory management: special concerns
Inventory Turnover:
Inventory turnover: the number of times that inventory is sold in a one-year period
Inventory turnover can be calculated:
Inventory turnover = the cost of goods sold / the average inventory
The average inventory = (beginning inventory + ending inventory) / 2
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Inventory management: special concerns
Inventory Turnover:
Inventory turnover measures how fast a company sells inventory & compare it to
competitors or industry averages
-> organization’s competitiveness & efficiency
A low turnover: weak sales, overstocking
A high turnover: strong sales, low level of inventories
Inventory turnover related to trade-offs involving organizational functions:
marketing (price) – finance (profit) – logistics (inventory turnover)
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Inventory management: special concerns
Inventory Turnover:
How to increase inventory turnover?
-> reducing average inventory
-> how to reducing average inventory?
-> ABC analysis & Dead inventory
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Inventory management: special concerns
Complementary and Substitute products:
Complementary goods are products which
are consumed and distributed together (i.e.
razor blades and razors)
-> pressure on retailers/wholesalers
involving inventory maintenance
-> need to consider the amount of
inventory to be carried because
complementary products is necessary
to support the sale of its complement
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Inventory management: special concerns
Complementary and Substitute products:
Substitute goods refer to products that can fill the same need or want as another product
- The substitutability can occur at a specific product level (i.e. Coca-Cola & Pepsi)
or across product classes (i.e. potatoes & rice)
- Implications for stockout costs and the maintaining of
size of safety stock
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Contemporary issues with managing inventory
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Contemporary issues with managing inventory
Just-in-time (JIT)
JIT approach seeks to minimize inventory by reducing (if not eliminating) safety stock, and
by having the required amount of materials arrive at the production location at the exact
time that they are needed
JIT inventory management focuses on minimizing inventory and increasing efficiency in
logistics
JIT emphasizes minimal inventory levels, low (no) safety stock & defective materials
Trucking is an important mode of transportation in the JIT
approach to meet some requirements from JIT system:
smaller orders, more frequent shipments, closer supplier
location
The aim of JIT: encompass movement of materials and 47
component parts from supplier to producer
Contemporary issues with managing inventory
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Contemporary issues with managing inventory
ECR & QR
Efficient consumer response (ECR) and Quick response (QR) tend to focus on product
movement from manufacturer to retailer
ECR is associated with the grocery and beverage industries
QR is associated with the apparel industry
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Contemporary issues with managing inventory
Service Part Logistics
Service parts logistics involves designing a network of facilities to stock service parts,
deciding upon inventory ordering policies, stocking the required parts, and transporting parts
from stocking facilities to customers
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Contemporary issues with managing inventory
Vendor-Managed Inventory (VMI)
Vendor-managed inventory (VMI) is an inventory management technique in which a
supplier of goods, usually the manufacturer, is responsible for optimizing the inventory held
by a distributor.
The size and timing of replenishment orders are the responsibility of the manufacturing
(vendor)
VIM requires the access to EDI or Internet
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Contemporary issues with managing inventory
Vendor-Managed Inventory (VMI)
VMI allows manufacturers to have access to a distributor’s or retailer’s sales and inventory
data -> to plan inventory and place orders
Benefits of VMI: reduced inventories, fewer stockouts, improved customer retention,
reduced reliance on demand forecasting
Drawbacks of VMI: inadequate data sharing between the relevant parties, increase cost in
technology (EDI), resistance in the change to a new system
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Inventory management as a marketing tool
A benefit of good inventory management is that companies are able to deliver goods to their
customers when the goods are needed. There is a greater likelihood that the item is in
inventory and available for sale.
Good inventory practices also lower costs, which allows a company to be more profitable or
allows a company to sell at a lower price, which translates into a competitive advantage.
Good inventory practices (an MRP) allows companies to inform their customers of the
status of an order.
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