CH 8 Inventory Management PDF

CHAPTER 8
Inventory Management
Copyright © 2015 Pearson Education, Inc.

Inventory refers to stocks of goods and

materials that are maintained for many
purposes, the most common being to satisfy
normal demand patterns.
Copyright © 2015 Pearson Education, Inc. 8-2

Inventory management, key component in logistics and supply
chain management
q Inventory decisions drive other business activities like:

q Warehousing
q Transportation
q Materials handling
q Objectives can differ for different functional areas of an
organization, between organizations within supply chain
q Marketing wants sufficient inventory to be available, finance wants to
maintain minimum inventory cost, also, supplier has their own
inventory mngm. philosophy
q Organizations seeks to proper balance (right amount of inventory)
q Trade-offs between inventory carrying cost and stockout cost (quite
difficult)

Inventory Classifications
Inventory Classification
qClassification influence the way that inventory
is managed
qInventory generally exist to satisfy demand
and classified as
qCycle (base) stock
qSafety (buffer) stock
qPipeline (in-transit) stock
qSpeculative stock
© 2008 Prentice Hall 9-4

Cycle or base stock refers to inventory that is needed to satisfy normal
demand during the course of an order cycle (refers to the time from
when a customer places an order to when goods are received).
– One dozen of egg represent cycle stock – we use one egg per day, and
buy eggs every 12 days
Safety or buffer stock refers to inventory that is held in addition to

cycle stock to guard against uncertainty in demand or lead time.
– Demand Uncertainty - Make three-egg omelets as opposed to eating
one egg per day
– Lead time Uncertainty - Buy eggs every 14 days, rather than 12 days
– For both cases, few extra eggs ensure that you wont run out eggs

Pipeline or in-transit stock is inventory that is en route between various fixed
facilities in a logistics system such as a plant, warehouse, or store.
q Eggs are transit between farm and wholesaler’s or retail store to kitchen
Speculative stock refers to inventory that is held for several reasons, including
seasonal demand, projected price increases, and potential shortages of a product.
q Eggs are associate Easter tends to cause an increase in demand prior to Easter
holiday
q Inventory of portable generator shortage before the year 2000
Psychic stock is inventory carried to stimulate demand (e.g., retail stores).

q Customer’s purchase are stimulated by inventory that they can see

Inventory Costs
Inventory is one of the largest
asset on balance sheet, and cost
money.
Inventory costs in the 21st

century represent
approximately one-third of total
logistics costs.
Inventory cost should factor into

an organization’s inventory
management policy.

Inventory Costs
Inventory costs directly effect organizations’
inventory management policies, and include:
qCarrying cost
qOrdering cost
qStockout cost

Inventory Costs
Inventory carrying (holding) costs
q Costs associated with holding inventory.
q Storage costs, handling costs, insurance costs, etc.
q In general expressed in percentage terms and this
percentage is multiplied by the inventory’s value
q Resulting number represents dollar value associated with
holding the particular inventory

Inventory Costs
q Carrying costs percentage effect inventory

q Prefer to carry lower inventory as the carrying costs percentage increase expense
q Carrying costs percentage important for many companies – most assign 25%

Inventory Costs
Consist of number of different components, importance of

these factors vary from product to product
q Obsolescence costs
q Inventory shrinkage
q Storage costs
q Handling costs
q Insurance costs
q Taxes
q Interest costs
Inventory Costs
Component of Inventory Carrying Cost
q Obsolesce refers to the fact products lose value over time, some products
lose their values much more quickly than others
q Perishable items (dairy products, meat, and poultry) are often sold with
expiration dates, causing them to little or no value after a certain date.
q Imperishable items (a box of lead pencils) lose its value much more slowly
through time.
q Shrinkage refers to fact that more items are recorded entering than
leaving warehouse facility.
q Caused by damage, loss, or theft
q Although costs can be reduced, such efforts often generate other costs (e.g.,
better packaging may reduce damage, loss or theft costs, but may increase
packaging costs.)

Inventory Costs
• Storage cost refers to those cost associated with occupying
space in plant, storeroom, or warehousing facility.
– Some products have very specialized storage requirements (e.g.,
Ice cream must be stored at temperature below -20 degrees
Fahrenheit)
– Specialized storage requirements results higher cost.
• Handling costs involve costs of employing staff to receive,
store, retrieve, and move inventory.
– Specialized storage requirements may also increase handling
costs, a refrigerated warehouse requires worker to wear glows,
head covering, and coats to protect them from the cold
temperature.

Inventory Costs
q Insurance cost refers policies protect against different causes of damage

(e.g., fire, flood, theft, and other perils)
q Not uniform across products (e.g., diamonds more costly to insure than
shampoo).
q Taxes are represents yet another component of inventory carrying cost
q Calculated on basis of inventory on hand on particular date
q Considerable effort is made to have that day inventory be as low as possible
q Interest cost refers the money that required to maintain the investment in
inventory
q Special type of carrying costs (e.g., pets and livestock's)
q Opportunity cost refers to a benefit that organization could have received,
but gave up, to another course of action.

Inventory Costs
Ordering Costs refer to those costs associated with ordering inventory,
such as order-costs and setup-costs.
q Order costs (associated with ordering inventory)

q Costs of receiving an order
q Conducting a credit check
q Verifying inventory availability
q Entering orders into the system
q Preparing invoices
q Receiving payment
q Setup costs (associated with setting up equipment to process a
different orders)
q Setting up a machine, work center, or assembly line, to switch from
one order to the next

Inventory Costs
Trade-Off between Carrying and Ordering Costs
qCosts respond in opposite ways to the number of

orders or size of orders
qE.g., An increase in the number of orders leads to
higher order costs but lower carrying costs

Inventory Costs
How to calculate:
Ordering Cost = number of orders per year X ordering cost per order
Carrying Cost = average inventory X carrying cost per unit

Inventory Costs
Weekly demand 100 units, order cost per order is $80, the value of an item is $50,
and carrying cost is 20% of the value of the item. If we place one order per year for
the product
Ordering cost= 1 x $80 = $80
Carrying Cost = [(100 x 52)/2*] x [$50 x 20%]** = 2600 x $10 = $26,000
*Inventory carrying costs are applied to one-half of the order-size.
**carrying cost per unit can be as a dollar value (e.g., $10) or the percent of value of the product
($50 x 20%)
Alternatively, look what happens to ordering and carrying cost if we place an order
per week
Ordering cost= 52 orders x $80 per order = $4,160
Carrying Cost = [(100 x 1)/2*] x [$50 x 20%] = 50 x $10 = $500

Inventory Costs
Stockout costs
q Estimated cost or penalty for a stockout
q Involve an understanding of a customer’s reaction to a company being out of
stock when a customer wants to buy an item. Consider customers responses
to particular stockout situation:
1. Customer says - I’ll be back
2. Customer says - Call me when it is in
3. Customer buys a substitute product that yields a higher profit for the seller
4. Customer buys a substitute product that yields a lower profit for the seller
5. Customer place an order for item that is out of stock (back order)
6. Customer goes to a competitor only for this purchase
7. Customer goes to competitor for this and all future purchases

Inventory Costs
Stockout costs
• This table illustrates
calculation of stockout costs
• Assume that customer
responses to stockout can In this case, may be hold some amount of inventory
be put into three

categories: delayed sale
(Brand-loyal customer), lost Alternative
sale (switches and comes

Scenario
back), lost customer; of 300 .65

.25
.$00.00
9.25
customers who experienced .10

1.00
120.00
$129.25
a stockout) In this case, may be lower inventory

Inventory Costs
Trade-Off between Carrying and Stockout Costs
qCosts move in opposite directions

qE.g., higher inventory levels (higher carrying costs)
result in lower chances of a stockout (lower
stockout costs)

Inventory Costs
Trade-off between Carrying and Stockout Costs
q One way to illustrate this relationship is to look at trade offs between level of safety stock and number of
stockouts prevented
q Inventory can be ordered multiple of 10, and each inventory is valued at $480 with carrying cost 25%
q Incremental carrying cost of moving from 0 to 10 safety stock is $1200. Like wise, incremental carrying cost of
moving from 10 to 20 units of safety stock are $1200.
q Assumes that various of level safety stock prevent a certain number of stockouts (e.g., holding 10 units safety
stock for entire year allows firm prevent 20 stockouts; moving from 10 to 20 units safety stock allows 16 additional
orders to be filled.)
q Using an average cost per stockout of $400, a safety stock of 10 units allows firm to prevent 20 stockouts, which
saves firm $8000 (400 * 20). Saving $8000 is much greater than $1200 value of stockout, so firm wants to hold at
least 10 units safety stock.
q 20 units safety stock results in $1200 of additional carrying cost, where as the additional stockout costs avoid
$6400 (16 x 400)
q In this table, the optimum quantity of safety stock is 70 units. At this point, the cost of 10 additional units of
inventory is $1200, and $1200 saved in stockout costs

Inventory policy
An organization’s inventory policy must answer
the two basic questions:
qWhen to order
qHow much to order

When to Order
Key issue involves when
product should be ordered
q Orders can be placed at fixed
amount (fixed order quantity
system)
q Time interval may be fluctuate
while order size stays constant
(e.g., fill up when thank is Fixed Order Quantity System
empty)
q Orders can be placed at fixed
time intervals (fixed order
interval system)
q Time interval is constant, but
order size may fluctuate (e.g.,
go to grocery shopping every
Sunday) Fixed Order Interval System

When to Order
Fixed-order-quantity system works best when there is a predetermined
reorder point, inventory level is continuously monitored and replenishment
stock is ordered in previously-fixed order quantities - requires relatively
frequent monitoring of inventory system
q If sales start increase, reorder point will be reach more quickly, and new order
automatically be placed
Fixed-order-interval system, inventory levels are monitored regularly at fix

intervals, whenever it falls certain level, an order is placed – requires
relatively less frequent monitoring of inventory system
q Infrequency of inventory monitoring makes fixed interval system much more
sensitive/susceptible to stockout situation, and more likely to see higher levels
of safety stock
Possible that company could have some of its inventory under fixed-order-
quantity system, whereas other inventory uses fixed-order-interval system

When to Order
Reorder (trigger) Point (ROP)
q Level of inventory at which a replenishment order is
placed
q Necessary for efficient fixed order quantity system
q Determining ROP following three factors need to be at
hand
qDemand - Quantity of inventory used or sold each day
qLength of replenishment cycle - Time (in days) it takes for
an order to arrive when an order is placed
qSafety Stock - The quantity of inventory kept on hand
incase there is a unpredictable event like delays in lead
time or unexpected demand

When to Order
Reorder Point (ROP) calculations:
ROP = DD x RC under certainty

ROP = (DD x RC) + SS under uncertainty
where DD = daily demand

RC = length of replenishment cycle
SS = safety stock

When to Order
Reorder Point (ROP) calculations:
Average daily demand is 40 units

Replenishment cycle is 4 days
ROP = 40 x 4 = 160 units, when the inventory level reaches 160

units, reorder is placed (e.g., EOQ)
Suppose that company decides to hold 40 units of safety stock
ROP = (40 x 4) + 40 = 200 units, when the inventory level reaches

200 units, reorder is placed (e.g., EOQ)

How Much to Order
Economic Order Quantity
(EOQ)
q Determine the most efficient
order size for a company
q Deals with calculating the
proper order size with respect
to two costs
q Costs of carrying the inventory
q Costs of ordering the inventory
q Determines the point at which
the sum of carrying costs and
ordering costs is minimized, or
the point at which carrying
costs equal ordering costs

How Much to Order
Economic Order Quantity (EOQ) is grounded in following
assumptions
q A continuous, constant, and known rate of demand

q A constant and known replenishment or lead time
q A constant purchase price that independent of order quantity
q All demand is satisfied (no stockouts allowed)
q No inventory in transit
q Only one item in inventory or no interaction between
inventory items
q An infinite planning horizon
q Unlimited capital availability

How Much to Order
Economic Order Quantity (EOQ) in dollars
!"# = 2&'/)
Where:
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 (%)

How Much to Order
Economic Order Quantity (EOQ) in dollars
– Suppose that $1000 of particular item is used
each year, the order costs are $25 per order
submitted, and inventory carrying cost are 20
percent.
A = annual demand, in dollars
!"# = 2&'/) B = administrative costs per order of placing the order
!"# = (2 ∗ 1000 ∗ 25)/0.20
!"# = 250000 = $ 500 23453 6785

How Much to Order
Economic order quantity (EOQ) in units
!"# = 2&'/)*
Where:
EOQ = the most economic order size, in units
D = annual demand, in units
I = dollar value of the inventory, per unit

How Much to Order
Economic order quantity (EOQ) in units
qSuppose that $1000 of particular item is used each
year, the order costs are $25 per order submitted, and
inventory carrying cost are 20 percent.
qAssuming that the product has a cost of $5 per unit
!"# = 2&'/)*
D = annual demand, in units (200 units; $1000 value of
Inventory / $5 value per unit)
!"# = (2 ∗ 200 ∗ 25)/(0.20 ∗ 5) B = administrative costs per order of placing the order
I = dollar value of the inventory, per unit
I * C = Carrying cost of inventory (Holding cost)
!"# = 10000/1 = 100 23456

How Much to Order
q Although we calculated EOQ, how do we know that the answers are correct?
q Because EOQ is point where carrying cost equal ordering cost, we need to
calculate both of those costs.
q Ordering Cost: Ordering Cost per order $25, EOQ is $500 (100 units), 2 orders per
year, so ordering cost is $50
q Carrying Cost: Average inventory for $500 order size is $250, meaning that our
carrying cost is $50 ($250 * 0.20)

How Much to Order
You’re a buyer for SaveMart.
SaveMart needs 1000 coffee makers per year. The

cost of each coffee maker is $78. Ordering cost is
$100 per order. Carrying cost is 40% of per unit
cost. Length of replenishment cycle (Lead time) is 5
days. SaveMart is open 365 days/yr.
What is the optimal order quantity?

How Much to Order
D = 1000
B = $100
I = $78
C = 40%
D = annual demand, in units
!"# = (2 ∗ 1000 ∗ $100)/(0.40 ∗ $78) I = dollar value of the inventory, per unit
C* I = Holding cost
!"# = 200000/31.2
!"# = 80 234455 67859:

Inventory Flows
Represents an illustration of
inventory flow, based on the
following assumptions
q EOQ of 120 units

q Safety stock of 60 units
q Average demand of 30 units per day
q Replenishment order cycle of 2 days
q Reorder Point (30 x 2) +60 =120
units
q Beginning inventory is equal to the
safety stock plus EOQ (60 + 120 =
180)

Inventory Flows
Inventory EOQ arrive Total Sales Invento Reorder - Notes
(8:00 AM) (8:01 AM) Inventory 8:01 AM – ry EOQ
(8: 01 AM) 5:59 PM (6 PM) (8 AM)
Day 1 60 120 180 30 150
(point A)
Day 2 150 150 30 120
Day 3 120 120 30 90 120 Reorder point
(point B)
Day 4 90 90 30 60
Day 5 60 120 180 60 120
(point C) (point D)
(point E)
Day 7 60 60 60 0 demand satisfied from
(point F) safety stock
Day 8 0 120 120 30 90 120 Reorder point
(point G) (point H)
Day 9 90 30 60
Day 10 60 120 180 30 150
(point I) (point J)
Day 11 150 30 120
(point K)
Day 13 90 30 60
Day 14 60 60 30 30 (1)transportation delay
(point L) (the replenishment
cycle is 3 days instead
of 2, it arrives beginning
of day 15; (2) demand
satisfied from safety
stock
Day 15 30 120 150 30 120
(point M)

Inventory Flows
qSafety Stock can prevent against two problem
areas, as illustrated in inventory flow example
qIncreased rate of demand
qLonger-than-normal replenishment
qWhen fixed order quantity system like EOQ is
used, time between orders may vary
qWhen reorder point is reached, fixed order
quantity is ordered

How Much to Order
Determine the order size for a company, based
on fixed-order-interval system
Q = R – IP
where:
Q = Order quantity
R = Target inventory level (company sets a target inventory
level)
IP = Inventory position

How Much to Order
An auto manufacturer uses a fixed-time interval system for its
inventory of alternators. Also, let’s say its policy is to check
inventory levels every two weeks, and that it has a target
inventory level R (5,000 alternators).
After two weeks the company checks its inventory level and
finds its inventory position IP (2,800 alternators).
How many alternator should be placed based on fix-time

interval system?
Q = R – IP = 5,000 – 2,800 = 2,200 alternators.

Inventory Management: Special
Concerns
qABC Analysis of Inventory

qDead inventory (dead stock)
q Inventory Turnover
qComplementary Products
qSubstitute Products

Concerns
ABC Analysis of Inventory
q recognizes that inventories are not of equal value to a firm

q as such all inventory should not be managed in the same
way
q ABC analysis is an inventory categorization method which
consists in dividing items into three categories (A, B, C):
q A being the most valuable items
q C being the least valuable ones
q This method aims to draw managers’ attention on the
critical few (A-items) not on the trivial many (C-items).

Concerns
Rule of thumb in ABC - Pareto analysis (80/20
rule)
q20% of population owns 80% of nations wealth
q20% of employees cause 80% of problems
q20% of items accounts for 80% of firm’s
expenditure
q20% of firm’s sales come from 80% of firm’s
product

Concerns
ABC approach states that a company should rate items from A to C, basing its
ratings on the following rules:
q A-items are goods which annual consumption value of inventory is the highest; the
top 80% of the annual consumption value typically accounts for only 20% of total
inventory items.
q B-items are the interclass items, with a medium consumption value of inventory;
those 15% of annual consumption value typically accounts for 30% of total
inventory items.
q C-items are, on the contrary, items with the lowest consumption value of
inventory; the lower 5% of the annual consumption value typically accounts for
50% of total inventory items.

Concerns
The annual consumption value of inventory can be

calculated with the formula:
(Annual demand) x (item cost per unit)
Through this categorization, the manager can

identify inventory hot spots, and separate them
from the rest of the items, especially those that are
numerous but not that profitable.
Concerns
Steps for the classification of items:

1. Find out the unit cost and the demand/usage of each item
(demand could be annually, etc.)
2. List out all the items and multiply the unit cost by the demand to
obtain the value for each item
3. Calculate the percentage of the value on total-value, and arrange
them in the descending order
4. Accumulate the percentage of value
5. Find the breakdown points of ABC classification, usually 80%
accounts A-items, 15% B-items, lower 5% C-items
6. Mark them as A, B and C categories

Concerns
Application of ABC Analysis of Inventory
Percentage of Percentage value of

items annual usage
Close day to
Class A items About 20% About 80%
day control
Class B items About 30% About 15% Regular review
Infrequent
Class C items About 50% About 5%
review

Concerns
• Calculate the annual cost
Item number Unit cost Annual demand Annual Cost
101 5 48,000 240,000

102 11 2,000 22,000
103 15 300 4,500
104 8 800 6,400
105 7 4,800 33,600
106 16 1,200 19,200
107 20 18,000 360,000
108 4 300 1,200
109 9 5,000 45,000
110 12 500 6,000
Total Cost 737,900
Annual Cost = Unit Cost x Annual Demand

Concerns
• Calculate the percent of annual cost for each item
Item number Unit cost Annual demand Annual Cost % of annual cost
101 5 48,000 240,000 32,5%

240,000 / 737,900
102 11 2,000 22,000 3%
103 15 300 4,500 0,6%
104 8 800 6,400 0,9%
105 7 4,800 33,600 4,6%
106 16 1,200 19,200 2,6%
107 20 18,000 360,000 48,8%
108 4 300 1,200 0,2%
109 9 5,000 45,000 6,1%
110 12 500 6,000 0,8%
Total Cost 737,900 100%
% of annual cost = Annual cost /total cost

Concerns
• Sort the items by Annual cost descending order
Item Unit Annual Annual % of annual Cumulative % Percentage Category Percentage of
number cost demand Cost cost of annual cost cost (%) Items
107 20 18,000 360,000 48,8% 48,8% A

101 5 48,000 240,000 32,5% 81,3% 81,3% A 2/10=20%
109 9 5,000 45,000 6,1% 87,4% B
105 7 4,800 33,600 4,6% 92% B
102 11 2,000 22,000 3,0% 94,9% B
106 16 1,200 19,200 2,6% 97,5% 16.2% B 4/10 = 40%
104 8 800 6,400 0,9% 98,4% C
110 12 500 6,000 0,8% 99,2% C
103 15 300 4,500 0,6% 99,8% C
108 4 300 1,200 0,2% 100% 2.5% C 4/10=40%
Total 737,900 100%

Concerns
• Result of the calculation
Percentage of
Cathegory Items Percentage cost (%) Action
items
Class A 107, 101 20% 81,3% Close control
Class B 109, 105, 102, 106 40% 16,2% Regular review
Infrequent
Class C 104, 110, 103, 108 40% 2,5%
review

Concerns
Dead Inventory (dead stock)
q is a fourth category, D, to ABC analysis where D stands for

either “dogs” or dead inventory (dead stock)
q refers to product for which there is no sales during a 12
month period (e.g., Atari dumped 20 trailer loads of video
games)
q Dead inventory increases inventory carrying costs and takes
up space in warehousing facility
q In some countries like U.S., donation of dead inventory to
charitable organizations allows business qualify for federal
income tax deduction. (e.g., deduction of up to twice the
cost of the inventory)

Concerns
Inventory Turnover
q Number of times that inventory is sold in a one-year period
q Inventory turnover = cost of goods sold / average inventory
q average inventory is the sum of beginning and ending inventory
divided by two
q Example: Cost of goods sold: $675,000, beginning inventory:
$200,000, ending inventory: $250,000
q Inventory Turnover = $675,000/ [($200,000 + $250,000)/2], or
$675,000 / $225,000, which equal to 3

Concerns
Inventory Turnover
q Provide important insights about organization’s
competitiveness and effectiveness
q Compare with competitors or benchmarked companies
q Low inventory turnover indicates that company is taking
longer to sell its inventory – pricing problem, product
obsolescence
q High inventory turnover may signal a low level inventories,
which can increase the chance of product stockouts
q To increase inventory turnover, reduce average inventory
(tools: ABC analysis and dead inventory)

Concerns
Companies with similar Inventory Turnover Ratio for the quarter ending March Inventory Turnover
31, 2015, within Consumer Non Cyclical Sector Ratio
New Age Beverages Corporation 18.12
Rainbow Coral Corp. 15.62
Deyu Agriculture Corp. 15.26
Sysco Corp 14.72
Pingtan Marine Enterprise Ltd. 14.44
Skypeople Fruit Juice, Inc 14.26
Yew Bio-pharm Group, Inc. 14.23
Freshpet, Inc. 13.86
Lifeway Foods Inc 13.27
Coca Cola Bottling Co Consolidated 13.25
Coca-cola Enterprises, Inc. 12.49
Dr Pepper Snapple Group, Inc. 12.15
China Shianyun Group Corp., Ltd. 12.14
Steelcase Inc 12.01
Golden Enterprises Inc 11.93
South Dakota Soybean Processors Llc 11.79
Mendocino Brewing Co Inc 11.78
Tyson Foods Inc 11.66
Hni Corp 11.59
Chs Inc. 11.52
Whitewave Foods Co 11.29
Source: http://csimarket.com/stocks/singleEfficiencyit.php?code=KRFT
Concerns
Complementary Products
qinventories that can be used or distributed
together, i.e. razor blades and razors.
qIssues associated with
qSpace: So many complementary items exist for
cooking meet and fish, hard to display all of them
in store
q# of inventory: Vacuum cleaner and vacuum
cleaner bag; some might argue the bag should be
dropped favor of fast-moving products because
the bag might be slow-moving product

Concerns
Substitute Products
q products that can fill the same need or want as another
product.
q Substitutability can occur two levels:
q Specific product level (e.g., one brand cola vs another brand of
cola)
q Across Product class (e.g., potatoes vs rice)
q Knowledge of substitutability has important implications
with respect to stockout cost and the size of safety stocks
q If a consumer has little hesitation in substituting another
item for one that is out of stock, there would appear to be
minimal penalties for a stockout, if not, the penalties would
be high.
q Substitution patterns can be important
q Two-way substitution – Coca Cola and Pepsi
q One-way substitution – 7/16 inch diameter bolt and ½ inch diameter.

Contemporary Approaches to
Managing Inventory
Issues/Opportunities with managing
inventory, beyond the traditional inventory
management
qLean Manufacturing
qService Parts Logistics
qVendor Managed Inventory

Managing Inventory
Lean Manufacturing
q Focuses on the elimination of waste and the increase of

speed and flow
q Identifies seven major sources (transport, inventory,
motion, waiting, over-processing, overproduction,
defects)
q Just-in-time (JIT) one of the best known lean inventory
practices (minimize inventory by reducing/eliminating
safety stock while having the required amount of
materials arrive at the production location at the exact
time they are needed)

Managing Inventory
Lean Manufacturing
q JIT goes far beyond inventory management

q JIT’s emphasis low or no safety stock, suppliers must deliver high-
quality materials to the production
q JIT emphasizes minimal inventory levels, as a result customers
tend to place smaller, more frequent orders – efficient supplier’s
order system, close supplier location, trucking as transportation
mode.
q Lean inventory also include efficient consumer response, quick
response
q Organizations carefully consider the potential trade-offs before
adopting a lean philosophy (e.g., larger shipments vs smaller
shipment due to high fuel cost)

Managing Inventory
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.
Source: Mehmet Ferhat Candas and Erhat Kutanoglu, “Benefits of Considering Inventory in Service Parts
Logistics Network

Managing Inventory
Service Parts Logistics
q Gain greater attention and appreciation in recent years

q Customer expectations associated with service part logistic
continue to increase – max customer wait time for repair or
replacement parts one day
q Worldwide economic slowdown 2008-2009, caused
organizations to repair rather than replace
q Challenges
q Difficult to forecast – when and which part of the product
breakdown
q # of warehousing facilities – parts located at one central location
vs numerous warehousing facilities (e.g., transportation cost vs
speed)

Managing Inventory
Vendor-Managed Inventory (VMI) vs Traditional Inventory
Management
q Under TIM, size and timing of replenishment orders are

the responsibility of the party using the inventory, such
as a distributor or retailer.
q Under VMI, size and timing of replenishment orders
are the responsibility of the manufacturer.
q VMI represents a huge philosophical shift for some
organizations in the sense that they are allowing
another party to have control over their inventories
Copyright Notice
All rights reserved. No part of this publication may be reproduced, stored in a

retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording, or otherwise, without the prior written
permission of the publisher. Printed in the United States of America.

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CH 8 Inventory Management PDF

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CHAPTER 8

Copyright © 2015 Pearson Education, Inc.

Inventory refers to stocks of goods and

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q Inventory decisions drive other business activities like:

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© 2008 Prentice Hall 9-4

Safety or buffer stock refers to inventory that is held in addition to

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Psychic stock is inventory carried to stimulate demand (e.g., retail stores).

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Inventory costs in the 21st

Inventory cost should factor into

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q Carrying costs percentage effect inventory

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Consist of number of different components, importance of

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q Insurance cost refers policies protect against different causes of damage

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q Order costs (associated with ordering inventory)

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qCosts respond in opposite ways to the number of

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Carrying Cost = average inventory X carrying cost per unit

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be put into three

sale (switches and comes

back), lost customer; of 300 .65

customers who experienced .10

a stockout) In this case, may be lower inventory

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qCosts move in opposite directions

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Fixed-order-interval system, inventory levels are monitored regularly at fix

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ROP = DD x RC under certainty

where DD = daily demand

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Average daily demand is 40 units

ROP = 40 x 4 = 160 units, when the inventory level reaches 160

Suppose that company decides to hold 40 units of safety stock

ROP = (40 x 4) + 40 = 200 units, when the inventory level reaches

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q A continuous, constant, and known rate of demand

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!"# = (2 ∗ 1000 ∗ 25)/0.20

!"# = 250000 = $ 500 23453 6785

© 2008 Prentice Hall 9-32

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!"# = 10000/1 = 100 23456

© 2008 Prentice Hall 9-34