Chapter 10 Inventory management Chapter 11 Strategic Leadership

Chapter 10 Inventory management Chapter 11: Strategic Leadership

Overview Functions Types Costs PLANNING Optimum levels MODELS CONTROL Maintain appropriate levels Chapter 11: Strategic Leadership

Outcomes • Understand why businesses keep stock • Differentiate between the various types of inventory • Identify inventory-ordering costs and inventorycarrying costs • Determine a suitable carrying cost percentage • Set optimum inventory levels • Perform effective inventory control Chapter 11: Strategic Leadership

Functions of inventories • Geographical specialisation – Location economies – Consolidation – Economic specialisation • Decoupling – – WIP Economic lot sizes greater than demand Large shipments at lower transport costs Lower cost of purchasing Chapter 11: Strategic Leadership

Functions of inventories (continued) • Balancing supply and demand – Seasonal production, but year-round consumption – Seasonal consumption: provide for peaks • Buffer uncertainties – Demand uncertainty – Lead-time uncertainty • Prevent cost of stockout Chapter 11: Strategic Leadership

Types of inventory • Based on position in supply chain: – – Raw material Work-in-process (WIP) Packaging material Finished goods • Based on purpose: – – Cycle stock Transit inventory Safety stock Speculative stock Chapter 11: Strategic Leadership

Important inventory concepts • Availability – Definition – Measurements • Average inventory – half order quantity + safety stock • Inventory turnover Chapter 11: Strategic Leadership

Average inventory and order quantity Chapter 11: Strategic Leadership

Inventory costs • Ordering costs • Carrying costs Chapter 11: Strategic Leadership

Inventory-ordering costs • Consist of: – Administration costs – Handling costs • Depend on where stock is replenished – Outside supplier – Restocking own field warehouse Chapter 11: Strategic Leadership

Carrying-cost percentage • • Used to calculate carrying costs Expressed as annual % value Applied to average inventory ICC = average inventory x % Example: R 1 000 x 20% = R 200 000 • Assign factor to each cost element Chapter 11: Strategic Leadership

Determine carrying-cost percentage Cost element Determinants Capital investment - Prime interest rate - Return on investment - Direct levy based on risk or exposure - % of insurance costs on average inventory value - Preventative measures - Problematic to quantify - Deterioration of product while stored - Difference in price Net amount after claims Direct loss related to inventory storage Insurance Obsolescence Damage Shrinkage Storage Space Total Chapter 11: Strategic Leadership - Allocated to specific products - Type of warehouse Example 17% 2% 0, 5% 1% 5% 26%

Setting optimum inventory levels • How much to order – Simple EOQ – EOQ extensions • When to order – Reorder point • Safety stock Chapter 11: Strategic Leadership

Simple EOQ: the concept • Trade-off between ordering and carrying costs • Remember: – Average inventory = half order size • Therefore, high OQ results in: – high average inventory and – high carrying costs • Graph • Formula Chapter 11: Strategic Leadership

Simple EOQ: trade-off Chapter 11: Strategic Leadership

Simple EOQ: formula EOQ Where P D C V Chapter 11: Strategic Leadership = = ordering costs ($ per order) = annual demand or sales volume in units = carrying-cost percentage = cost or value per unit

EOQ adjustments • • Volume transport rates Quantity discounts Production lot size Multiple-item purchases Limited capital Own transport Unitisation Chapter 11: Strategic Leadership

Determining order point • When to order • Expressed in SKU units or days of supply • Formula: R = D x T + SS Where R = reorder point in units D = average daily demand T = average lead time SS = safety stock Chapter 11: Strategic Leadership

Target-level replenishment • • • Fixed order interval Short interval periodic review Order quantities vary Quantity to meet target level Review period added to lead time to arrive at targeted reorder point (ROP) Chapter 11: Strategic Leadership

Target-level replenishment (continued) • TSL = Where D = T = P = SS = D (T + P) + SS average daily demand average lead time review period (days) safety stock • Now order to reach target • Q Where Q TSL I Qo Chapter 11: Strategic Leadership = = = TSL - I – Qo quantity to be ordered target level inventory status quantity on order

Demand uncertainty • Safety stock added to base inventory • Average inventory = half order quantity + SS • Normal distribution • Only consider when demand is greater than 50% in normal distribution • Calculate: – Mean – Standard deviation Chapter 11: Strategic Leadership

Normal distribution theory Chapter 11: Strategic Leadership

Normal distribution theory (continued) Chapter 11: Strategic Leadership

Demand uncertainty • Mean – Average of all values in series – Formula: μ = ∑ xi /n • Standard deviation – Formula: √ (1/n x ∑ (xi-μ)2 Chapter 11: Strategic Leadership

Lead-time uncertainty • Lead time a combination of: – Order communication time – Processing time – Transport time • Calculation: – Same as demand uncertainty (i. e. calculate standard deviation) Chapter 11: Strategic Leadership

Combined standard deviation Formula: s = √ TSs 2 + D 2 St 2 Where s = combined standard deviation T = average lead time Ss= sales standard deviation D = average sales St = lead time standard deviation Chapter 11: Strategic Leadership

Fill rate • Normal distribution theory gives indication of probability of stockout. • Percentage, not indication of availability levels. • Fill rate gives indication of magnitude of stockout rather than probability. • Fill rate = desired customer service objective. • Fill rate = percentage of units out of stock relative to demand. Chapter 11: Strategic Leadership

Fill rate and order size • Fill rate influenced by: – Probability of stockout – Replenishment order size • The larger the order quantity, the lower the magnitude of potential stockouts. • Example: 20 -day period – OQ sufficient for 10 days, stockouts can occur twice – OQ sufficient for 20 days, stock-outs will occur once Chapter 11: Strategic Leadership

Fill rate formula • Formula for SL: SL = 1 -[(s/EOQ) x f(k)] Where f(k) = function of right tail Or f(k) = (1 -SL) x (Q/s) s = combined standard deviation Chapter 11: Strategic Leadership

Safety stock for given fill rate • Formula for SS: First calculate f(k) SS = kxs Where k = safety factor for corresponding f(k) s = combined standard deviation k can also be calculated: k = SS/s Chapter 11: Strategic Leadership

Calculating safety stock: example • Information – EOQ = 300 – S = 13 – Desired FL = 99% • Solution First calculate f(k)= (1 -0, 99) x (300/13) = 0, 01 x 23, 08 = 0, 2308 k = 0, 4 (corresponding factor f(k) of 0, 2308) SS = 0, 4 x 13 Chapter 11: Strategic Leadership = 5, 2 units

Calculating fill rate: example • Information – EOQ – s – SS = 200 = 13 =8 • First calculate k k = 8/13 Therefore f(k) = 0, 6154 = 0, 16 (roughly) • Fill rate SL Chapter 11: Strategic Leadership = = = 1 -[(s/OQ) x f(k)] 1 -[(13/200) x 0, 16] 1 -[0, 0650 x 0, 16] 1 -0, 0104 0, 99 or 99%

Logistics requirements planning (LRP) Chapter 11: Strategic Leadership

Procedure for LRP • • Plan weekly Start with independent demand Demand forecasting Calculate how long stocks will last Deduct safety stock Add stock in transit Calculate date when safety stock is reached Chapter 11: Strategic Leadership

Procedure for LRP (continued) • Calculate date of shipment (allow lead time) • Plan production • Calculate delivery date of materials • Calculate shipment allowing for lead time Chapter 11: Strategic Leadership

Just in time (JIT): approach • We have items when they are needed and none when they are not needed. • Demand for one item triggers demand for another. Chapter 11: Strategic Leadership

Conventional vs JIT systems • Push system • Satisfied with status quo • Fixed lead time • Product range is a sales issue • Stock in case of demand • Convenient purchase batch size Chapter 11: Strategic Leadership • Pull system • Continuous improvement • Reducing lead time • Product range reduction: inventory issue • Purchase to meet demand • Buy single or small quantities

JIT application possibilities • Typical features of ideal company: – – – – – Narrow product range Manufacturer High volume Stable market Influential Good quality management Local suppliers of goods and services Dependent and reliable suppliers Fast-cycle processes Personal commitment Chapter 11: Strategic Leadership

JIT requirements • • Short lead time Long-term agreements Close co-operation Local suppliers Customers must smooth forecasts Good estimate of long-term demand Frequent deliveries Chapter 11: Strategic Leadership

Collaborative inventory initiatives • Collaborative planning, forecasting and replenishment (CPFR) • Quick response (QR) • Vendor-managed inventory (VMI) • Profile replenishment (PR) Chapter 11: Strategic Leadership

Pareto analysis Pareto principle: – Villefredo Pareto: 18 th century – 20% of people control 80% of wealth – True in everyday life – 80% of effect is provided by 20% of cause Chapter 11: Strategic Leadership

ABC analysis using Pareto • Purpose – Facilitate control – Minimise effort – Provide service with least cost and effort • Procedure – Rank items/lines according to annual turnover – Annual turnover = annual usage x unit costs • Classification – A = 10% of lines giving 65% turnover – B = 20% of lines giving 25% turnover – C = 70% of lines giving 10% of turnover Chapter 11: Strategic Leadership

ABC analysis based on the Pareto principle 80 Chapter 11: Strategic Leadership

Different service levels for inventory categories CLASS TURNOVER VALUE (%) LOS (%) WEIGHTED LOS (%) A 66, 8 98 65, 5 B 23, 2 90 20, 9 C 10 85 8, 5 OVERALL SERVICE LEVEL 94, 9 Chapter 11: Strategic Leadership

Stock cover Time in which stock will run out Tool for measuring total inventory Monitor performance of each item Formula: current stock x 52 SC = forecast usage • Result: weeks in hand • • Chapter 11: Strategic Leadership

Stock turnover • Measures inventory management effectiveness • Formula: Stock turnover = Value of annual usage Value of stock in store • Shows number of times that stock will be used up during the year Chapter 11: Strategic Leadership

Setting stock targets • Based on ABC • ‘A’ class: tighter control and lower stock cover • Target for each class • Acceptable ranges: –A –B –C 1 to 4 weeks 2 to 8 weeks 3 to 20 weeks Chapter 11: Strategic Leadership