INTRODUCTION

This courseware was created to bridge the gap between theory

and application in supply chain. Most textbooks focus on the
theory of supply chain, providing mathematical models to
optimize production or inventory levels. However, most supply
chain roles require an understanding of how to apply the
answers from the models, how to quickly estimate what changes
need to happen, and the people skills to work with both
upstream and downstream partners.
 Principles of
Supply chain
Chapter 5:
inventory management
Learning OBJECTIVES
● Define the different types of inventory
● Explain and provide examples of non-traditional
inventory
● Identify the difference between cycle and safety
inventory
● Calculate appropriate levels of both cycle and
safety inventory
● Justify the importance of reconciling inventory
● Calculate economies of scale
CHAPTER 5

Section 1: Inventory
inventory: a complete and itemized list of parts, including pipeline; raw
materials, including components; work-in-progress, or finished goods

In global sense, it can include people or human capital.

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PHYSICAL Inventory
physical inventory: tangible inventory that takes up space in a
warehouse

● Raw materials
● Components
● Work-in-progress
● Finished goods
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Inventory CLUSTERS
inventory clusters: a way of labeling inventory according to where it is
in the management process

● Backorders ● Pipeline
● Cycle stock ● Obsolete
● Safety stock ● Scrap
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Section 2: Other Types of Inventory

other inventory: inventory that does not reside on a shelf

● Housing
● Employment
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Housing
● Housing as inventory
● Limited due to geography
● Desired because of mild climates
and access to major airports

Source: Danaka Porter

CHAPTER 5

Employment
● Jobs and people as inventory
● Large swings during Covid-19,
booms, and busts
● Booms put pressure on
companies to find employees;
raises pay rates
Source: Getty Images
● Busts lead to an increase in
available employees
CHAPTER 5

Section 3: Inventory management

Inventory management is critical for the operations of any company.
Proper management ensures high part availability, low write-offs, and
better overall control on spend.

● FIFO
● LIFO
● VMI
● RFID
CHAPTER 5

FIRST IN, FIRST OUT AND LAST IN,

First In, First Out (FIFO)
FIRST OUTthat arrives first is used or sold first
● Inventory
● Used to reduce waste

Last In, First Out (LIFO)

● Inventory is used as soon as it arrives, replacing older
inventory
● Used with accounting practices
CHAPTER 5

VENDOR MANAGED INVENTORY

Vendor Managed Inventory (VMI)
● Supplier comes to site or has system access and manages
inventory levels
● Reduces time and effort on company’s part
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RADIO FREQUENCY IDENTIFICATION

Radio Frequency Identification (RFID)
● Use of RFID to track inventory through its entire journey from
warehouse through end user
● Great to prevent loss, and have a firm grasp of pipeline inventory
CHAPTER 5

Inventory Groups
cycle inventory / cycle stock: on-hand inventory essential to meeting
production and customer / end user demand

● Amount based on production schedule, customer pre-sales, or

forecasted demand
● Calculate using economic order quantity (EOQ)
CHAPTER 5
EOQ
● Multiply demand by the
reorder cost, then divide by
the carrying cost
● Take the square root of the
answer
Source: Danaka Porter and Stukent
Suppose Thomas Inc. sells 1,200 units of
product A in a year. Its carrying cost is $5,
while the cost to reorder is $100.
EOQ of Cycle = √((1,200*100)/5) = 155
This means Thomas Inc. should maintain a
cycle stock of 155 units.
 ACTIVITY / ASSIGNMENT 1
1. Redo the example from the last slide and change
the carrying cost to $2.

2. Reset the carrying cost to $5 and decrease reorder cost —

what happens?
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CYCLE COUNTED
Inventory is cycle counted based on the company replenishment
policy.

High-value items and fast-moving items should be counted more

frequently (daily in some situations)

Low-value and or slow-moving items can be counted less frequently,

at once a week or even once a month
CHAPTER 5

CYCLE SERVICE LEVEL

cycle service level (CSL): amount of demand that is required to be
met

● External customers may require it – in the contract

● Internal downstream departments may require it
 COMPARISON

Source: Stukent

A higher CSL means a higher safety stock is required.

CHAPTER 5

SAFETY INVENTORY / SAFETY STOCK

safety inventory / safety stock: amount of inventory that is ordered or
made above what is required

● Allows for easy handling of fluctuations, late arrivals, environmental

issues, or global supply issues
● Mitigates stock outs
● Aids in meeting CSL
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GENERAL RULES
Safety inventory / safety stock general rules:
● Increase safety stock as lead time increases
● Decrease safety stock as lead time decreases
● Increase safety stock as the cost of stocking out (losing
customers, sales, etc.) increases
● Decrease safety stock as the cost of stocking out (losing
customers, sales, etc.) decreases
CHAPTER 5

Safety — YOUNG’S
EXAMPLE
● Maximum demand D
● Maximum lead time LT
● Average demand αD
● Average LT αLT
Source: Danaka Porter and Stukent
Young’s bakery usually sells 300 units
a day, with a lead time of six days. A
few times 350 units sold a day, and a
couple times units took 10 days to
arrive on site.

Source: Danaka Porter and Stukent

CHAPTER 5

Safety — BOONE &

MAEBY’S EXAMPLE
● Average lead time αLT Boone & Maeby’s pet shop usually sells
● Demand deviation σD 300 units of Dogtastic treats per day, with a
● Average demand αD deviation of 50 units. The lead time is six
● Lead time deviation σLT days with a deviation of four days. Their
● The z-score for the CSL contract with purchasers is a CSL of 90%.

Source: Danaka Porter and Stukent

Source: Danaka Porter and Stukent

 Activity
Redo the example from the last slide,
changing the CSL to 95% and then to 97%.
What is the new safety stock
and why does it do what it does?
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Section 3: Safety Stock

Other areas where safety stock rules do not apply:
● Humanitarian aid
● Aerospace and defense
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Section 4: Inventory Reconciliation

Comparing on-hand inventory to what is physically present on site —
blind counted

System inventory: what the system, Excel sheet etc. says is available
— pulled from a report
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REASONS FOR DISCREPANCIES

Reasons for discrepancies:
● Breakage
● Data entry error
● Mislabeled products / parts
● Short or excess from supplier
● Theft
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IMPORTANCE OF Inventory
Inventory reconciliation is a critical part of inventory management and is
Reconciliation
incredibly important to preserving accurate inventory numbers and
ensuring each part of the supply chain operates effectively.
CHAPTER 5

Section 5: Economies of Scale

Economies of scale (EOS) is an economic concept that dates back to
Adam Smith’s Wealth of Nations written in 1776.
● Division of labor = increased productivity

Certain countries have taken this on:

● China and Japan make the most microchips
● USA and Germany design vehicles then send to other
countries to produce
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Economies of Scale
EOS occur when cost to produce one more item is less than cost of
producing prior item
● Average total cost is at a minimum

Reason behind bulk buying for Walmart, Costco

● Large orders so supplier can reduce price; store passes on to
customers
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CALCULATING EOS
Calculating EOS involves reviewing fixed and variable costs.

● Fixed: do not change regardless of production

● Variable: change depending on production
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EOS — PARKER
Parker, a procurement clerk, has an order for 8,000 bolts, at a cost of
EXAMPLE
$0.15 a piece; however, the supplier says if they order over 10,000 bolts
they can pay $0.13 a piece.

The clerk is unsure on the demand and so compares the cost of the two
orders:
● Order A = 8,000 * 0.15 = $1,200
● Order B = 10,000 * 0.13 = $1,300
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EOS — TICHLER &

Tichler & Family makes lawn mowers. They have estimated the cost of
FAMILY
producing each lawn mower (unit) to be $250 ($150 in fixed costs, $100
in variable costs). The company sells them for $550 a unit. Usually, the
company produces 30,000 units per year.

● Fixed costs are $150 x 30,000 = $4,500,000

● Variable costs are $100 x 30,000 = $3,000,000
● Total cost = $7,500,000
 ACTIVITY / ASSIGNMENT 2
Now Tichler & Family decides to produce 50,000 units
and changes nothing in the factory. The fixed costs remain at
$4,500,000 as the factory lease and admin fees have not changed.
Only the variable costs change: $100 x 50,000 = $5,000,000.
CHAPTER 5

EOS
Note capacity of warehouse or production line or people

May be more cost effective to produce more; the amount could far
exceed capacity or demand
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Section 6: Careers
Inventory supervisors and managers are responsible for overseeing
inventory processes, policies, and procedures. This includes
reviewing inventory levels and cycle service levels and performing
or reviewing inventory reconciliations.
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Section 7: Summary
Proper inventory management through
● appropriate classification
● cycle stock
● safety stock
● counts
● inventory reconciliation
helps maintain cost-effective inventory levels while meeting demand.
CHAPTER 5

Summary
Economies of scale allow a firm to review its production and / or
purchasing policy to ensure it is ordering and producing the most cost-
effective amounts.
Thank You