Inventory Management

Inventory Management
 Inventory is one of
the most expensive
assets of many
companies.

 It represents as
much as 60% to 70%
of total invested
capital.
 Inventory is any stored resource that is used to
satisfy a current or future need.
 Raw materials, work-in-process, and finished
goods are examples of inventory.
Why do we hold Inventory?
 Improve customer service
 Reduce certain costs such as
◦ ordering costs
◦ stockout costs
 Contribute to the efficient and effective operation
of the production system
Why we do not hold Inventory?
 Certain costs increase such as
◦ Carrying costs, Handling cost
◦ Labor Cost
◦ Warehouse Cost
◦ Logistics Cost
◦ cost of return on investment
◦ reduced-capacity costs (Storage, warehouse)
◦ cost of production problems (Excess Inventory)
Two Fundamental Inventory Decisions

 How much to order of each material when

orders are placed with either outside
suppliers or production departments within
organizations
 When to place the orders
Inventory Systems
 Independent Demand Inventory Systems

 Demand for an item carried in inventory is

independent of the demand for any other item in
inventory
 Finished goods inventory is an example
 Demands are estimated from forecasts and/or
customer orders
 Dependent Demand Inventory Systems

 Items whose demand depends on the demands for

other items
 For example, the demand for raw materials and
components can be calculated from the demand for
finished goods
 The systems used to manage these inventories are
different from those used to manage independent
demand items
Independent vs. Dependent Demand
Independent Demand
(finished goods and spare parts)
A
Dependent Demand
(components)

B(4) C(2)

D(2) E(1) D(3) F(2)

Inventory Costs
 Costs associated with ordering too much
(represented by carrying costs)
 Costs associated with ordering too little
(represented by ordering costs)
 These costs are opposing costs, i.e., as one
increases the other decreases
Inventory Costs (continued)
 The sum of the two costs is the total stocking cost
(TSC)
 This cost behavior is the basis for answering the
first fundamental question: how much to order
 It is known as the economic order quantity (EOQ)
 ABC
Classification
of
Inventory
 ABC Classification of Inventory
 Typical observations
◦ A small percentage of the items (Class A) make up a large
percentage of the inventory value
◦ A large percentage of the items (Class C) make up a small
percentage of the inventory value
 These classifications determine how much attention
should be given to controlling the inventory of
different items
 Annual
Part ID Price
Demand Annual $
Value
Identify the SKUs that
5497J $ 2.25 260 $ 585.00 management should spend
3K62 $ 2.85 43 $122.55 time on
88450 $ 1.50 21 $31.50
P001 $ 0.77 388 $298.76 Prioritize SKUs by their value
2M993 $ 4.45 612 $ 2,723.40
3HHT8 $ 6.10 220 $ 1342.00 to firm
56M4 $ 3.10 110 $ 341.00
89KE $ 1.32 786 $ 1,037.52 Create logical groupings
45O3 $ 12.80 14 $ 179.20 Adjust as needed
55K2 $ 24.99 334 $ 8,346.66
978SD3 $ 7.75 24 $ 186.00
78HJQ2 $ 0.68 77 $ 52.36
23LK $ 0.25 56 $ 14.00
990RT $3.89 89 $ 346.21 Example:
58JH4 $7.70 675 $ 5,197.50
2340P $ 6.22 66 $ 410.52
■ Samle of 20 SKUs
3784 $0.85 148 $ 125.80
38JQ2 $ 0.77 690 $ 531.30 ■ Total of 4,677 units
56TT7 $ 1.23 52 $ 63.96
7UJS2 $ 4.05 12 $ 48.60 ■ Total~$22k
4,677 $ 21,983.84
 Annual Annual $ Cum$ Pct Ann
Part ID Price Demand Value Value $ VAlue
55K2 $24.99 334 $ 8,347 $ 8,347 38%
58JH4 $ 7.70 675 $5,198 $ 13,544 62%
2M993 $ 4.45 612 $2,723 $ 16,268 74% A Items:
3HHT8 $ 6.10 220 $1,342 $ 17,610 80% 80% of Value
89KE $ 1.32 786 $1,038 $ 18,647 85% 20% of SKUs
5497J $ 2.25 260 $585 $19,232 87%
38JQ2 $ 0.77 690 $531 $19,763 90%
2340P $ 6.22 66 $411 $20,174 92% B Items:
990RT $ 3.89 89 $346 $20,520 93% 15% of Value
56M4 $ 3.10 110 $341 $20,861 95%
30% of SKUs
P001 $ 0.77 388 $299 $21,160 96%
978SD3 $ 7.75 24 $186 $21,346 97%
45O3 $ 12.80 14 $179 $21,525 98%
3784 $ 0.85 148 $126 $21,651 98%
3K62 $ 2.85 43 $123 $21,773 99% C Items:
56TT7 $ 1.23 52 $64 $21,837 99% 5% of Value
78HJQ2 $ 0.68 77 $52 $21,890 100%
7UJS2 $ 4.05 12 $49 $21,938 100%
50% of SKUs
88450 $ 1.50 21 $32 $21,970 100%
23LK $ 0.25 56 $14 $21,984 100%

4,677 $ 21,984
Order Fulfillment & Customer Service

PART UNIT COST ANNUAL USAGE

1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120
Copyright 2006 John Wiley
17 & Sons, Inc.
Order Fulfillment & Customer Service

TOTAL % OF TOTAL % OF TOTAL

PART PART
VALUE UNIT
VALUECOSTQUANTITY
ANNUAL USAGE
% CUMMULATIVE
9 $30,6001 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 40 11.0
2 14,000 16.4 4.0
A 15.0
3 30 130
1 5,400 6.3 9.0 24.0
4 4
4,800 5.680 6.0 B60 30.0
3 5
3,900 4.630 10.0 100 40.0
% OF TOTAL % OF TOTAL
6
CLASS 6
3,600
ITEMS
4.220
VALUE
18.0 180
QUANTITY
58.0
5 3,000
7 3.510 13.0 170 71.0
10 A 2,400 9, 8, 2 2.8 C 15.0 83.0
8 320 71.0 12.0 50
7 B 1,700 1, 4, 3 2.0 16.5 17.0 25.0100.0
C 9 6, 5, 10, 7510 12.5 6060.0
$85,400
10 20 120
Example 10.1
Copyright 2006 John Wiley
18 & Sons, Inc.
 In ABC classification, items kept in inventory
are not of equal importance in terms of:
◦ dollars invested
◦ profit potential
◦ sales or usage volume
◦ stock-out penalties
End of Topic