Name: Rena Dumdum

Subject: Inventory Management and Control

Course & Year: BSBA
Chapter 2
Title: Inventory Management: Overview and Introduction Part 2

Transportation costs against fulfillment speed;

1. Inventory costs against the cost of stock outs
2. Customer satisfaction against cost to serve
3. New capabilities against profitability

What’s more, two accelerating business trends are making it even harder to synchronize
supply chains.

 First, global sourcing is forcing supply chains to stretch farther across borders. The
goods people consume are increasingly made in some other part of the world,
particularly in Asia. This acceleration in global sourcing changes the logistics
equation.
 Second, powerful retailers and other end customers with clout are starting to push
value-added supply chain responsibilities further up the supply chain.

The UPS Direct Approach

 A growing number of companies are overcoming these barriers by taking a more

direct approach to global fulfillment. This direct-to-store approach also known as
distribution center bypasses or direct distribution-keeps inventory moving from
manufacturer to end customer by eliminating stops at warehouses along the way.

What accounts for the emergence of the direct-to-store model?

 Global sourcing and the upstream migration of value-added logistics services are
certainly primary drivers. But other pieces of the puzzle have fallen into place in
recent years to make direct-to-store shipments feasible.

Several different types of supply chain inventories that would exist in a make-to-stock
environment, typical of items directed at the consumer. In this case, the models in this chapter
are most appropriate for the upper echelon inventories (retail and warehouse), and the lower
level and rank should use the Material Requirements Planning (MRP) technique.

The techniques described here are most appropriate when demand is difficult to predict with
great precision. In these models, we characterize demand by using a probability distribution
and maintain stock so that the risk associated with stock out is managed. For these
applications, the following three models are discussed:
1. The single-period model. This is used when we are making a one-time purchase of an
item. An example might be purchasing T-shirts to sell at a one-time sporting event.
2. Fixed-order quantity model. This is used when we want to maintain an item “in-
stock,” and when we resupply the item, a certain number of units must be ordered
each time. Inventory for the item is moni- tored until it gets down to a level where the
risk of stocking out is great enough that we are compelled to order.
3. Fixed-time period model. This is similar to the fi xed-order quantity model; it is used
when the item should be in-stock and ready to use. In this case, rather than monitoring
the inventory level and ordering
DEFINITION OF INVENTORY

 Inventory is the stock of any item or resource used in an organization. An inventory

system is the set of policies and controls that monitor levels of inventory and
determine what levels should be maintained, when stock should be replenished, and
how large orders should be. By convention, manufacturing inventory generally refers
to items that contribute to or become part of a firm’s product output. Manufacturing
inventory is typically classified into raw materials, finished products, component
parts, supplies, and work-in-process.

The basic purpose of inventory analysis, whether in manufacturing, distribution, retail, or

services, is to specify;

 When items should be ordered and

 How large the order should be. Many firms are tending to enter into longer-term
relationships with vendors to supply their needs for perhaps the entire year. This
changes the “when” and “how many to order” to “when” and “how many to deliver.”
3.PURPOSES OF INVENTORY
All firms (including JIT operations) keep a supply of inventory for the following reasons:
1. To maintain independence of operations. A supply of materials at a work center allows
that center flexibility in operations. For example, because there are costs for making
each new production setup, this inventory allows management to reduce the number
of setups.
2. To meet variation in product demand. If the demand for the product is known
precisely, it may be possible (though not necessarily economical) to produce the
product to exactly meet the demand. Usually, however, demand is not completely
known, and a safety or buffer stock must be maintained to absorb variation.
3. To allow flexibility in production scheduling. A stock of inventory relieves the
pressure on the production system to get the goods out. This causes longer lead times,
which permit production planning for smoother flow and lower-cost operation
through larger lot-size production. High setup costs, for example, favor producing a
larger number of units once the setup has been made.
4. To provide a safeguard for variation in raw material delivery time. When material is
ordered from a vendor, delays can occur for a variety of reasons: a normal variation in
shipping time, a shortage of material at the vendor’s plant causing backlogs, an
unexpected strike at the vendor’s plant or at one of the shipping companies, a lost
order, or a shipment of incorrect or defective material.
5. To take advantage of economic purchase order size. There are costs to place an order:
labor, phone calls, typing, postage, and so on. Therefore, the larger each order is, the
fewer the orders that need be written. Also, shipping costs favor larger orders-the
larger the shipment, the lower the per-unit cost.
6. Many other domain-specific reasons. Depending on the situation,material being
moved from the suppliers to customers and depends on the order quantity and the
transit lead time.

INVENTORY COSTS
In making any decision that affects inventory size, the following cos must be considered:
1. Holding (or carrying) costs. This broad category includes the costs for storage
facilities, handling, insurance, pilferage, breakage, obsolescence depreciation, taxes,
and the opportunity cost of capital. Obviously, high holding costs tend to favor low
inventory levels and frequent replenishment.
2. Setup (or production change) costs. To make each different product involves obtaining
the necessary materials, arranging specific equipment setups, filling out the required
papers, appropriately charging time and materials, and moving out the previous stock
of material. If there were no costs or loss of time in changing from one product to
another, many small lots would be produced. This would reduce inventory levels, with
a resulting savings in cost. One challenge today is to try to reduce these setup costs to
permit smaller lot sizes. (This is the goal of a JIT system.)
3. Ordering costs. These costs refer to the managerial and clerical costs to prepare the
purchase or production order. Ordering costs include all the details, such as counting
items and calculating order quantities. The costs associated with maintaining the
system needed to track orders are also included in ordering costs.
4. Shortage costs. When the stock of an item is depleted, an order for that item must
either wait until the stock is replenished or be canceled. When the demand is not met
 and the order is canceled, this is referred to as a stock out. A backorder is when the
order is held and filled at a later date when the inventory for the item is replenished.

INDEPENDENT VERSUS DEPENDENT DEMAND

In inventory management, it is important to understand the trade- offs involved in using
different types of inventory control logic.
Transaction cost is dependent on the level of integration and automation incorporated in the
system. Manual systems such as simple two-bin logic depend on human posting of the
transactions to replenish inventory, which is relatively expensive compared to using a
computer to automatically detect when an item needs to be ordered.

An important characteristic of demand relates to whether demand is derived from an end item
or is related to the item itself. We use the terms independent demand and dependent demand
to describe this characteristic.

INVENTORY SYSTEMS
PhilAn inventory system provides the organizational structure and the operating policies for
maintaining and controlling goods to be stocked. The system is responsible for ordering and
receipt of goods: timing the order placement and keeping track of what has been ordered,
how much, and from whom. The system also must follow up to answer such questions as:
1. Has the supplier received the order?
2. Has it been shipped?
3. Are the dates correct?
4. Are the procedures established for reordering or returning undesirable merchandise?

Single – Period Inventory Model

Certainly, an easy example to think about is the classic single- period “newsperson” problem.
For example, consider the problem that the newsperson has in deciding how many
newspapers to put in the sales stand outside a hotel lobby each morning.
The optimal stocking level, using marginal analysis, occurs at the point where the expected
benefits derived from carrying the next unit are less than the expected costs for that unit.

Single-period inventory models are useful for a wide variety of service and manufacturing
applications. Consider the following:
1. Overbooking of airline flights. It is common for customers to cancel flight
reservations for a variety of reasons. Here the cost of underestimating the number of
 cancellations is the revenue lost due to an empty seat on a flight. The cost of
overestimating cancellations is the awards, such as free flights or cash payments, that
are given to customers unable to board the flight.
2. Ordering of fashion items. A problem for a retailer selling fashion items is that often
only a single order can be placed for the entire season. This is often caused by long
lead times and limited life of the merchandise. The cost of underestimating demand is
the lost profit due to sales not made. The cost of overestimating demand is the cost
that results when it is discounted.
3. Any type of one-time order. For example, ordering T-shirts for a sporting event or
printing maps that become obsolete after a certain period of time.

Multi-period Inventory Systems

There are two general types of multi-period inventory systems: fixed-order quantity models
(also called the economic order quantity, EOQQ-model) and fixed-time period models (also
referred to variously as the periodic system, periodic review system, fixed- order interval
system, and P-model).

System dictates the actual quantity ordered and the timing of the order.
The basic distinction is that fixed-order quantity models are “event triggered” and fixed-time
period models are “time triggered.” That is, a fixed-order quantity model initiates an order
when the event of reaching a specified reorder level occurs. This event may take place at any
time, depending on the demand for the items considered.

Some additional differences tend to influence the choice of systems:

1. The fixed-time period model has a larger average inventory because it must also
protect against stock out during the review period, T; the fixed-order quantity model
has no review period.
2. The fixed-order quantity model favors more expensive items because average
inventory is lower.
3. The fixed-order quantity model is more appropriate for important items such as
critical repair parts because there is closer monitoring and therefore quicker response
to potential stock out.
4. The fixed-order quantity model requires more time to maintain because every addition
or withdrawal is logged.

FIXED-ORDER QUANTITY MODELS

  Fixed-order quantity models attempt to determine the specific point, R. At which an
order will be placed and the size of that order, Q. The order point, R. Is always a
specified number of units. An order of size Q is placed when the inventory available
(currently in stock and on order) reaches the point R. Inventory position is defined as
the on-hand plus on-order minus backordered quantities. The solution to a fixed-order
quantity model may stipulate something like this.

When the inventory position drops to 36, place an order for 57 more units. The simplest
models in this category occur when all aspects of the situation are known with certainty. If
the annual demand for a product is 1,000 units, it is precisely 1,000-not 1,000 plus or minus
10 percent. The same is true for setup costs and holding costs. Although the assumption of
complete certainty is rarely valid, it provides a good basis for our coverage of inventory
models.

Establishing Safety Stock Levels

The previous model assumed that demand was constant and known. In the majority of cases,
though, demand is not constant but varies from day to day. Safety stock must therefore be
maintained to provide some level of protection against stock outs. Safety stock can be defined
as the amount of inventory carried in addition to the expected demand. In a normal
distribution, this would be the mean. For example, if our average monthly demand is 100
units and we expect next month to be the same, if we carry 120 units, then we have 20 units
of safety stock.

ABC INVENTORY PLANNING

Maintaining inventory through counting, placing orders, receiving stock, and so on takes
personnel time and costs money. When there are limits on these resources, the logical move is
to try to use the available resources to control inventory in the best way. In other words, focus
on the most important items in inventory.

In the nineteenth century Villefredo Pareto, in a study of the distribution of wealth in Milan,
found that 20 percent of the people controlled 80 percent of the wealth. This logic of the few
having the greatest importance and the many having little importance has been broadened to
include many situations and is termed the Pareto principle:

Any inventory system must specify when an order is to be placed for an item and how many
units to order. Most inventory control situations involve so many items that it is not practical
to model and give thorough treatment to each item. To get around this problem, the ABC
inventory classification scheme divides inventory items into three groupings:
 1. High dollar/peso volume
2. Moderate dollar volume and
3. Low dollar/peso volume

INVENTORY ACCURACY AND CYCLE COUNTING

Inventory records usually differ from the actual physical count inventory accuracy refers to
how well the two agree. Companies such as Walmart understand the importance of inventory
accuracy and expend considerable effort ensuring it. The question is:
1. How much error is acceptable?
2. If the record shows a balance of 683 of part X and an actual count shows 652, is this
within reason?
3. Suppose the actual count shows 750, an excess of 67 over the record; is this any
better?

Cycle counting is a physical inventory-taking technique in which inventory is counted

frequently rather than once or twice a year. The key to effective cycle counting and,
therefore, to accurate records lies in deciding which items are to be counted, when,
and by whom.