Inventory Management:

Customer Service
 Objectives
• Describe safety stock processes used
to support customer service strategies
• Describe the importance of inventory
valuation & how it affects inventory
investment
• Identify inventory accuracy
methodologies used to improve &
sustain part count & inventory
investment accuracy
 Definition of Safety Stock
• In general a qty of stock planned to
be in inventory to protect against
fluctuation in demand or supply
 Purpose of Safety Stock

Reorder
point

a b c

LT
A: stock out occurs for some period
Without having safety stock
B: stock out just as the replenishment
Order arrives
C: no safety stock is required, excess
Inventory occurs
 Role of Safety Stock
• Usually the only reason safety stock is
planned for dependent demand items is that
the supply of the items is subject to
variation, either in delivery from the supplier
or fallout in the production process.
• Parts subject to independent & dependent
demand may also have safety stock for the
independent portion
• In this case MRP will need to keep the 2
categories separate in terms of the
requirements used to determine gross
requirements
 The Meaning of Customer
Service
• Orders shipped on schedule
• Line items of orders shipped on
schedule
• Dollar volume shipped on schedule
• Ordering periods without a stock out
• Backorders
 Opportunities for Stock Out

OQ

Time

Smaller order qty, more time per year opportunity for stock out

OQ

Time
Reorder Point / Safety Stock

zL
 MAD & Standard Deviation
• MAD (mean absolute deviation) is the
average of the absolute deviations
– Calculate with only summary values
from the previous month in combination
with current values
• Standard deviation requires a longer
history of forecast & demand
 Example
Deviation
Week Actual Sales Forecast Deviation squared
1 4900 5000 -100 10000
2 5000 5000 0 0
3 5100 5000 100 10000
4 5400 5000 400 160000
5 5300 5000 300 90000
6 4800 5000 -200 40000
7 5200 5000 200 40000
8 5000 5000 0 0
9 4900 5000 -100 10000
10 5200 5000 200 40000
Total 50,800 50000 1600 400000

Std deviation = √(400,000/no. of period-1) = 211

MAD= sum of deviation/no. of periods= 1600/10=160

 N & n-1 comparison
• N is used when there are more than
30 periods
• N-1 is used when there are less than
30 periods
• From the previous example: std
deviation (n-1) = 211
• Standard deviation (n) = 200
 Tracking Table
Actual usage Deviation Running Tracking
Fixed (adjusted (actual Mean sum of signal
for usage- absolute forecast (RSFE
fore days/mon foreca deviation errors /MAD
Period cast th) st (MAD) (RSFE) )
1 100 100 0 0 (0/1) 0 0
2 100 90 -10 5 (10/2) -10 -2
3 100 80 -20 10 (30/3) -30 -3
4 100 120 20 12.5 (50/1) -10 0.8
5 100 110 10 12 (60/5) 0 0
6 100 100 0 10 (60/6) 0 0
7 100 80 -20 11.4 (80/7) -20 -1.75
8 100 140 40 15 (120/8) 20 1.3
9 100 100 0 13.3 (120/9) 20 1.5
10 100 130 30 15 (150/10) 50 3.3

Check 1000 1050 150 15 (150/10) 50 3.3

Tracking signal = RSFE/MAD = 50/15 =
3.3

Tracking signal=running sum of forecast error/MAD

indicating that the forecast tend to be low
 Table of Safety Factors
Desired
service For standard
level deviation For MAD
50 0 0
80 0.84 0.672
84.13 1 0.8
90 1.28 1.924
95 0.165 1.32
97.72 2 1.6
98 2.05 1.64
99 2.33 1.684
99.87 3 2.4
99.93 3.2 2.56
99.99685 4 3.2
 Safety Stock Equation

• Safety stock = safety factor x standard

deviation or
• Safety stock = safety factor x 1.25 x
MAD
 Service Level
Desired Safety stock = safety X std
service level factor deviation

50 % 0 0 211

90 % 349 1.65 x 211

99 % 492 2.33 211

 Lead Time Example
Desired Safety = safety X std X
service stock factor deviation √(LT/F)
level
50 % 0 0 211 √(6/4)

95 % 427 1.65 211 √(6/4)

99 % 603 2.33 211 √(6/4)

 Lead Time Equation
• Lead time= std deviation x
β
Lead time β
• 0 < < 1.0, square root formula
Forecast interval
 Safety Stock calculation exercise
Deviation
Month Actual Sales Forecast Deviation Squared
January 346 364    
February 312 364    
March 387 364    
April 350 364    
May 406 364    
June 364 364    
July 353 364    
Aug 338 364    
Sept 392 364    
Oct 385 364    
Nov 372 364    
December 365 364    
 Time Period Safety Stock
• A time period safety stock allows an even
amount of safety stock, equal to the
usage, over a designated time frame
• Providing a one month time period of
safety stock protects against the following
situations:
– End of month review that do not indicate
reorder
– Next day available balance is taken below the
reorder point
 Time Period Safety Stock
Example
• 2 weeks safety stock time period
• 40 pcs forecast monthly usage,
normalized at 20 days/month
• Time period safety = 2 weeks/(4
weeks/month) x (40 pcs/month) = 20
pcs safety stock
 Fixed Safety Stock
• A new part is being phased in
• A part being phased out has along
history of usage
• Parts that are dependent demand &
do not have any unplanned usage &
are completely planned by the MS &
MRP systems
 Safety Stock Analysis
Alternative Required Appropriate
Create individual part Set a safety stock level Independent demand
safety stock qty based on for each part independent part
statistical, fixed or time of any product
period techniques relationships. Calculate
the qty of safety stock
required
Set up the value of having Allocate the cost among Dependent demand
safety stock by product or the various parts. part
product line Calculate the qty of safety
stock required

Establish an arbitrary Allocated among parts via When amount of money

dollar level for safety one or two methods available to invest in
stock investment described previously safety stock is limited
 Definition of Inventory Valuation

• The value of the inventory can be determined

by either cost or market value. Because
inventory value can change with time, some
recognition is take of the age distribution of
inventory
 Purpose of Inventory
Valuation
• Inventory is considered a short term
asset because it is expected to be
used or sold within a relatively short
period
• Inventory includes raw materials, WIP
& FG owned by the company
• Most maintenance, repair & operating
supplies (MRO) are not included as an
asset at all, but they are considered
expenses
 Types of Inventory
Valuation
• FIFO
• LIFO
• Transfer
• Standard cost
• Actual cost
• Project cost
• Process cost
 Costing Method Example
• Record of purchase:
– April 100 units $10.00 each
– May 100 units $12.00 each
– June 100 units $14.00 each
• Standard cost $12.50
• Expected price in July $16.00
• Ending 1st quarter inventory: 0 units
• Ending 1st quarter unit cost $10.00
• 2nd quarter usage: 210 units at 70/month
 Costing method comparison

Cost of Good Sold

Method Inventory ($) ($)
FIFO 1260 (90x$14) 2340
LIFO 900 (90x$10) 2700
Average 1080 (90x$12) 2520
Standard 1125 (90x$12.5) 2625
Replacement 1440 2360
Actual 1080 2520
Costing Method-FIFO Calculation
Qty Issue Issue
Date Received Unit cost Inventory Value Usage Qty unit cost value

March $10.00 $0.00 $10.00 $0

April 100 $10.00 $1,000 70 $10.00 $700

May 100 $12.00 $1,200 30 $10.00 $300.00
June 100 $14.00 1400 60 $12.00 $720.00

10 $14.00 $140.00

July $16.00  

CGS $2,340

July starting inventory of 90 at $14 $1,260

 Data Accuracy
• Accurate
• Timely
• Fix root causes of inaccuracy
• Eliminate the informal system
 Definition of Inventory
Accuracy
• For accounting: dollars
• For planning: acceptable percentage
range
• For production: absolute count
accuracy
 Purpose of inventory
Accuracy
• In an integral environment, records
reflect the balance of inventory on
hand
• It is easy for physical balances &
record balances to differ
• Because planning & replenishment
system rely on record data, it is
essential that record balances be
verified
 The Cost of Inaccurate
Record
• Lost sale • Shortages
• Excess production • Missed schedules
• Low productivity • Late delivery
• Excessive expediting • Excess freight costs
• High inventory levels • High levels of
obsolescence
ABC Analysis
Class C
100 — Class B

90 —
Percentage of dollar value

Class A
80 —

70 —

60 —

50 —

40 —

30 —

20 —

10 —

0—
10 20 30 40 50 60 70 80 90 100
Percentage of items
 Uses of ABC Classification
• Cycle counting
• Customer service
• Engineering priorities
• Replenishment systems
• Investment decision
 ABC Calculation
• Calculate annual usage in units for
each item
• Multiply usage by unit cost to
determine annual dollar usage
• Rank items by annual dollar usage
from highest to lowest
• Assign ABC categories
 ABC Analysis Exercise
Annual
Item usage
  Number (units) Unit cost Rank Class
           
1 30,000 100 3,000,000     
2 280,000 150  42,000,000 A   
3 3000 100 300,000     
4 110,000 50 5,500,000     
5 4000 50 200,000     
6 220,000        
7 15,000 50 750,000     
8 90,000 50 4,500,000     
9 60,000 15O 9,000,000  A   
10 8,000 100 800,000     
 Cycle Counting vs. Periodic
Inventory
• Cycle counting
• Efficient use of a few
experienced people
continuously throughout the
year.
• The result:
• Timely detection & correction
of causes of errors
• Fewer mistakes in item
identification
• Minimum loss of production
time
• Systematic improvement of
record accuracy
• Inefficient use of many
inexperienced people in a
short, hectic period once a
year
• The result:
• No correction of causes of
errors
• Many mistakes in item
identification
• Plant & warehouses
shutdown for inventory
• One time improvement of
record accuracy
 Sources of Problem
• Poor design of form • Untrained
• Carelessness personnel
• Inaccurate supplier • Poor document
receipt control
• Inadequate storage • Items not properly
space identified
• Open (insecure)
storage areas
 Conflicts

Finance

Operation
Sales
 Inventory Objectives
• Maximize customer service
– Delivering in a timely manner
– Buffering against uncertainty
– Providing variety
• Minimize plant costs through small but
prudent inventory investment
– In purchasing
– In production
• Minimize aggregate investment
• Efficient operation
Customer Service Objectives
• High quality level
• High flexibility to change such thing
as volume, specifications & delivery
• High service level
• Short lead times
• Low variability in meeting targets
• Low cost
 Internal Measurement of Customer
Service
• Percentage measures • Absolute value
include measures include:
• % of order shipped on • Order days out of
schedule stock
• % total units shipped
• Line item days
on schedule
• % of $ volume shipped • Out of stock
on schedule • $ volume days out of
• % of operating items stock
not out of stock • Idle time due to
• % of ordering period material & component
without a stock out stoppage
 Customer Service Elements

Service Element Customer Perspectives

On time shipment or Requested ship/required
delivery date
Correct part Required part
Correct qty Exact required qty
Correct method of As specified or
shipment required
Correct material Required part
identification identification (by customer
or industry standard
identification)
Correct paperwork Packing slips & required
 Cont..
Service Element
Correct container
Correct quality
Correct delivery location
Customer Perspectives
Requested container type (as
applicable for returnable
dunnage and/or ergonomic
handling requirements)
100% conformance to
incoming inspection or usage
requirements
Specific dock location or door

Response time for information Immediately upon request