Module 2 Managing Material flow

Inventory Management

Content.
Introduction Type of inventory Inventory related costs Managing cycle stock Managing saftey stock Managing seasonal stock Analysing impact of supply chain redesign on the inventory Managing inventory for short life cycle products Multiple item, multiple location inventory management

Sector-wise Inventory Performance

10 9

1991

1996

2001

2006

in v e n to ry tu rn o v e r ra tio

8 7 6 5 4 3 2 1 0 chemical textile machinery non metallic mineral transport metal and metal products food and beverages

years

Sector-wise Performance on Inventory Turnover Ratio in India

Types of Inventory
Cycle Stock : Economies of scale Safety Stock Anticipation Stock
Seasonal Stock Speculative Stock

Pipeline Inventory Dead stock

Drivers of Inventory
Type of Inventory Cycle Stock Safety Stock Seasonal stock Driver ( Logic) Economies of Scale Uncertainty in demand & Supply Mismatch between demand and supply rate

Speculation Stock Pipeline Stock

Uncertainty in price of material Lead-time in production/transportation process

Dead Stock

Judgmental error/ Change in economic or technological environment

Inventory Management: Key Decisions

How much to order? When to order? Where to hold inventory? When to review?
Continuous review systems ( Fixed order quantity) Periodic review systems

Inventory in Chain

Supply chain consists of series of stock points connected by processes ( conversion processes and transportation processes) Each stock point has demand process and supply process Inventory at stock point : cycle stock, safety stock, seasonal stock Inventory within conversion and transportation processes: pipeline inventory

Pipeline Inventory
Inventory within conversion and transportation processes: Pipeline Inventory
Pipeline Inventory = PLT * D - PLT = Pipeline Lead-time; D = average demand

Illustration : LT -Shipment by air = 7 days LT- Shipment by sea = 45 days Average demand = 100/day

Inventory Management: Relevant Cost

Ordering cost/setup cost Inventory carrying cost Cost of shortage
Lost sales Backlogging cost Service level as proxy for cost of shortage

Purchase cost ( value addition cost) of Item

Not relevant if cost of item is not function of order quantity (No Quantity discount case)

Cycle-stock Inventory

Fixed Order Quality Model ( Cont. Review Model) Q=Order Quantity, Reorder point= L*d Average cycle stock = Q/2

Optimal Order Quantity Trade-offs

Inventory Models: Cycle Stock

__________ Q =2AD/i C A = Ordering Cost / Cost of setup D = Annual Demand i = Inventory carry cost C = cost of item Q= Optimum order quantity

Optimum Order Quantity

Daily Demand = 100 Working days in year=300 Ordering cost = 256 Rs. Cost of item = 30 Rs. Inventory-carrying cost = 0.2 Rs./Rs./Year Supplier LT = 15 Days Optimum order Qty. = _______________________ (2*256*100*300/(30*0.20 ) = 1600

Average cycle stock= 0.5* 1600 = 800 units Reorder point= 15*100 =1500

Total Cost versus Q

Total Cost 15000 10000 5000 0 0 1000 2000 Q 3000 4000 Series1

Optimum order quantity=Q*= 1600

Sensitivity
Q/Q* 0.5 0.75 0.9 1 1.1 1.25 1.5 1.75 2 Q 800 1200 1440 1600 1760 2000 2400 2800 3200

Analysis
Tc 12000 10000 9653.333 9600 9643.636 9840 10400 11142.86 12000

Safety Stock

R= reorder point

Distribution of Demand During Lead Time

Safety Stock

Ordering Policy in Case of Demand and Supply Uncertainty

Order quantity = Q* = Optimum order quantity Reorder point= D * L + K WLead Time Demand K = Safety factor Safety stock= K WLead Time Demand

Impact of Safety Factor on Service Level

Safety factor (K)
0 0.5 1.0 1.5 2.0 2.5 3.0 0.690 0.841 0.933 0.977 0.994 0.998

Service level
0.500

Impact of Service Level On Safety Stock

Safety Stock: Demand Uncertainty Only

S.S = K WLead Time Demand ______ WLead Time Demand = L WD2
D = average Demand ,WD = S.D. of Demand , L = Lead-time, K

= Safety Factor

Safety Stock : Demand and Supply Uncertainty

S.S = K WLead Time Demand ____________ WLead Time Demand = L WD2 + D2 WL2
D = average Demand ,WD = S.D. of Demand , L = Average Lead-time, WL = S.D. of Lead-time

K = Safety Factor

Inventory Profile at Stock Point: Cycle Stock + Safety Stock

Inventor y

Average Inventory

Cycle Inventory Safety Inventory

Time

Basic Demand and Lead-time Data

Demand Data d1 Demand 115 Lead-time data L1 Lead12 time

d2 d3 d4 d5 d6 d7 95 150 125 28 90 93 L2 L3 15 4 L4 21 L5 L6 L7 18 11 12

d8 115 L8 18

d 9 d10 93 96 L 9 L10 19 20

Inventory Management Cycle and Safety Stock

Daily Demand: Mean = 100 , SD = 30 Ordering cost = 256 Rs. Cost of item = 30 Rs. Inventory-carrying cost = 0.2 Rs./Rs./Year Supplier Performance Mean = 15 Days , SD = 5 Service Level = 98%

Impact of Change in Demand and Supply Parameters

Average Demand Standard deviation of demand Average Standard Safety leaddeviation stock time of lead- - units time Safety Remark stock in days of inventory

100 100 100 100 100 100

30 30 0 15 30 30

15 15 15 15 15 7.5

5 0 5 5 2.5 5

1026 232 1000 1006 526 1003

10.3 2.3 10 10 5.3 10

Base case No supply uncertainty, No demand uncertainty Reduce demand uncertainty Reduce supply uncertainty Reduction in lead-time

Managing Seasonal Stock

Capacity versus inventory tradeoff in seasonal demand//supply situation Two basic approaches in aggregate planning ( Sales and operations Planning)
Chase Option : Produce as per demand Level Option: Mix apparoches

Illustration: Managing Seasonal Stock

Q1 Demand Level option Production Hiring Cost Inv. C. Cst Chase option Production Hiring Cost Inv. C. Cst 8000 0 0 8000 0 0 8000 0 0 12000 48000 0 9000 0 3000 9000 0 6000 9000 0 9000 9000 0 0 8000 Q2 8000 Q3 8000 Q4 12000

Cost: level option= 18,000 Chase option= 48000

Centralized Versus Decentralized Systems

Inventory
Safety Stock Cycle stock

Service Level Overhead Costs Customer Lead Time Transportation Cost

Centralized Versus Decentralized Systems: Illustration

Demand distribution at each region ( 16 regions) Daily Demand: Mean = 100 , SD = 30 Ordering cost = 256 Rs. Cost of item = 30 Rs. Inventory Carrying cost = 0.2 Rs./Rs./Year Plant Lead time:= 15 Days ( No supply Uncertainty) Transportation:

Decentralized- Rs. 1 per unit Centralized case: - 10% higher

Decentralise d system 16 stock points Cycle stock/stock point = Q*/2 Safety Stock per stock point Total Inv. in units for the system Total Inv. carrying cost Incremental Transportatio n cost 800

Centralised system 1 stock point 3200

232

928

(232+800) v 16 = 16512 16512 v 6 = 99072

928+3200 = 4128 4128 v 6 = 24768 300v100v1 6v0.1 =48,000

Centralization

Physical centralization Decentralized inventory & centralization of information Specialization at each stock point Mix of Centralization & decentralization

Impact of Inventory Pooling

Centralization of inventory Product substitution Component commonality Postponement

Inventory for Short life-cycle Products: Single Period Model

Balancing cost of under-stocking versus cost of overstocking CU = Cost of under-stocking CO = Cost of overstocking
Optimum service level = (CU *100/ (CU + CO ) Optimum Order size= Mean demand + K * Std. Dev. Demand K= optimum service level

Optimum Order for a New Music CD

CD purchase price = Rs. 200 CD sales price = Rs. 300 CD sales price after first weeks = Rs. 62. Demand: Average 100 and Standard Deviation 30 - What is optimum order quantity - If manufacturer offers buyback scheme , would your decision change? - Cost of administering return- Rs. 53

Selective Inventory Control techniques

ABC classification FSN Classification VED Classification

ABC Classification

Class

Percentage of items

Percentage of Total sales Value

A B C

5-15 20-30 55-75

55-75 20-30 5-15

ABC Classification: Kurlon Case

40

Improving Inventory Turns

Type of Inventory Driver ( Logic) Improvement focus

Cycle Stock Safety Stock

Economies of Scale Uncertainty in demand & Supply

Reduce ordering/setup cost Reduce demand & supply uncertainty & Reduce LT, supply chain redeisgn Reduce Seasonality in demand, Create flexible capacity Risk management Reduce Lead Time

Seasonal stock

Mismatch between demand and supply rate Uncertainty in price of material Lead-time in production/transportation process Judgmental error/ Change in economic or technological environment

Speculation Stock Pipeline Stock

Dead Stock

Anticipate changes in demand structure

Summary
Indian firms find that a significant amount of money is locked up in the inventory. Organizations should use the concept of zero-based inventory planning to improve their performance on the inventory front. The decision maker controls inventory by deciding two critical questions: How much to order and When to order Based on the demand characteristics, supply characteristics, cost structure and desired service level firm can decide optimum level

Backup Slides

inventory turnover ratio 7.00 6.00 5.00 2.00 3.00 4.00 1.00 0.00

INVENTORY TURNOVER RATIO for MANUFACTURING INDUSTRY

YEAR

19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06

Inventory Turns in US economy

Year

Manufacturer

Wholesaler

Retailer

2001 1991

8.57 7.50

8.89 8.89

7.95 8.28

http://www.bea.gov/national/nipaweb/NIPA_Underlying/SelectTable.asp?Benchmar k=P#S0

Inventory Turnover performance in US Retail *

Study looked at 311 publicly listed retailers for years 1987-2000 Overall trend in inventory turns is downward slopping during 1987-2000

time trend is negative for 176 firms time trend is positive for 135 firms

* Guar, Fisher & Ananth Raman- Management Science.

February,2005 51(2) 181-194

EOQ Model: Quantity Discount Case

Minimize Total Cost : Annual purchase cost ( D *c) + Annual ordering cost+ Annual Inv. Carrying cost - Calculate optimal Q* for each price category - Determine optimal feasible Q for each price category - Compare total cost across all the price categories