Inventory Control in Supply Chain Management: Concept and Workshop

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1 .. Inventory Control in Supply Chain Management: Concept and Workshop Oran Kittithreerapronchai 1 1 Department of Industrial Engineering, Chulalongkorn University Bangkok THAILAND last updated: November 7, 2013 Inventory in SCM v hr. 1/ 32

2 Outline. 1 Why do we have an inventory. 2 Understanding your demands. 3 Economic Order Quantity. 4 Inventory Review System. 5 Inventory Game Inventory in SCM v hr. 2/ 32

3 What is Inventory? Inventory is a the stock of any item or resource used in an organization. For example, raw materials, finished products, components, parts, supplies, and work-in-process (WIP) Roles of Inventory To prevent variability in demands and delivery time To allow flexibility in production scheduling To take advantage of economic purchase-order size Inventory in SCM v hr. 3/ 32

Inventory Management Type of Inventory Pipeline inventory: transportation, minimal lot-sizing Buffer inventory: imbalance of process, bottleneck

4 Inventory Management Type of Inventory Pipeline inventory: transportation, minimal lot-sizing Buffer inventory: imbalance of process, bottleneck Seasonal inventory: growth/slow down, speculation Cycle inventory: economy of scale Safety inventory: perspective risks Inventory in SCM v hr. 4/ 32

5 Decision Hierarchy of Inventory Supply Chain Decision What are the potential alternatives to inventory? How should the product be designed? Deployment Decision. What items should be carried as inventory? In what form should they be maintained? How much of each should be held and where? Replenishment Decision How often should inventory status be determined? When should a replenishment decision be made? How large should the replenishment be Inventory in SCM v hr. 5/ 32

6 Why inventory is bad Capital: opportunity (i.e., raw materials, labor, money) Perishability/Obsolete: e.g. produces, flower, medication, newspaper Physical space: need shelter and system to take care Liability: risk of theft/fire Inventory = Evil? Inventory is not good, nor bad must be right quantity Inventory is an important tool reduce total costs and improve service level Inventory in SCM v hr. 6/ 32

7 Nature of Demands Deterministic VS Stochastic: Dependent VS Independent: How do we manage inventory? Demand =demand certain + demand random steady safety stock trend seasonal Inventory in SCM v hr. 7/ 32

8 What we should know about forecasting A process to understand systematic of demands Inaccurateness, but all companies need it Forecasting is, typically, incorrect Forecasting is suitable for a group of products Forecasting is inaccurate as time horizon increases Valid for short time and need updated Art & Science: roles of marketing & sale Inventory in SCM v hr. 8/ 32

9 What should we aware before forecast? Description: story, relationship with other data Time Horizon: hour, day, week, year Actual = Forecast + error Pattern of Data: seasonal, trend, cycle Forecasting Model: assumption, data required, parameters, static VS dynamic Accuracy: measuring, how to improve Inventory in SCM v hr. 9/ 32

10 Example: US Air Passengers AirPassengers Year 1949 Year 1950 Year 1951 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Month Inventory in SCM v hr. 10/ 32

11 ABC analysis: Parieto principle Idea: few items affects majority of activity You don t get what you want in life You get what you focus on and expect. Tony Rush Therefore: focus on few that are important Application: ABC analysis Class A important (15-20 percentile for 55-75% of activity) Class B some-what important (20-50 percentile 15-15% of activity) Class C not important ( percentile 5-15% of activity) Inventory in SCM v hr. 11/ 32

Example of ABC analysis Item No. Annual dollar % Total Value 22 95,000 40.69 68 75,000 32.13 27 25,000 10.71 03 15,000 6.43 82 13,000 5.

12 Example of ABC analysis Item No. Annual dollar % Total Value 22 95, , , , , , , $223, % source: Chase and Jacob Inventory in SCM v hr. 12/ 32

13 Inventory Control Questions Two fundamental components When to order items from supplier or when to replenish? How much to order from supplier on each ordering Objective. Ḳeep enough inventory to meet customer demand and also cost effective Independent demand and Dependent demand Independent demand: the demands for various items are unrelated to each other Dependent demand: the need for any one item is a direct result of the need for some other item Inventory in SCM v hr. 13/ 32

14 Inventory Cost Holding costs costs for storage, capital, handling, spoilage, insurance Ordering costs costs of placing an order (fixed & variable) Shortage costs costs of running out, back-order, lost-sale Inventory in SCM v hr. 14/ 32

15 Economic Order Quantity: Simplest model single and independent product uniform (continuous) and constant demand instant replenishment and constant lead time source: Chase and Jacob Inventory in SCM v hr. 15/ 32

16 Derivation of EOQ Parameters: Annual demand (D) Order cost (S) Unit handling cost (h) Unit cost (c) Decision variable: order quantity (Q) Number of annual order = D Q Avg Inventory = Q 2 Total Costs: material cost + ordering cost + holding cost TC(Q) = ordering holding material {}}{{}}{{}}{ c D + S D Q + h Q 2 Inventory in SCM v hr. 16/ 32

17 Economic Order Quantity (EOQ). Economic Order Quantity.. 2D S Quantity (Q ) = h Total Cost (TC(Q )) = cd + 2D S h where, Q = Quantity TC(Q) = Total costs D = Demand rate c = Unit purchasing Cost S = Ordering cost h = Holding cost Inventory in SCM v hr. 17/ 32

18 Example of EOQ At Allied Electric (HK), The expected annual demand of Sumsung TV is 12,000 units. Administrative, transportation, and receiving form the fixed cost of $4000 each time an order is places. Each TV cost $500 to buy and the annual holding cost is 20 % of value. Find EOQ source:chopra and Meindl example 10.1 Parameters Demands (D): Unit cost (c): Ordering Cost (S): holding Cost (h): Inventory in SCM v hr. 18/ 32

19 Insight to Inventory Control Q unaffected by unit cost of product Trade-off between holding cost and ordering cost Q can be reduced by decreasing ordering cost increasing handling cost. Ṭotal holding cost = Total ordering cost Limitation of EOQ instant replenishment zero lead time nearly constant demand Inventory in SCM v hr. 19/ 32

20 Holding cost VS Ordering cost source: Chase and Jacob Inventory in SCM v hr. 20/ 32

21 Example: Ordering carton Parameters Demands (D): Unit cost (c): Ordering Cost (S): holding Cost (h): Inventory in SCM v hr. 21/ 32

22 Can EOQ apply to real world? Demand: stochastic known distribution Lead time: constant/random How: continuous review of current inventory When: enough for expected sale till get a new order Safety Stock: inventory for randomness till waiting a new order.. (Q, q) policy is used for order q: reorder point, expected demand during lead time + safety stock Q: order quantity derived from EQO model (using expected sale) + safety stock chance of out-of-stock service level Inventory in SCM v hr. 22/ 32

23 Real World: Random Demand and Lead Time source: Chase and Jacob Inventory in SCM v hr. 23/ 32

24 Safety Stock Idea: demand is unpredictable; if / buffer inventory, lost sale What: buffer inventory for unexpected demands during ordering Factors variability of demands and lead time Formulation: safety stock = constant standard deviation De-mystify: safety stock demands during lead time Reduce safety stock: reduce variability of lead time reduce expected lead time reduce variability of demand Inventory in SCM v hr. 24/ 32

25 How often inventory should be determined? Continuous review system Idea: continuously tracking inventory Example: two-bin system Tool: IT to improve the speed and accuracy of data entry Periodic review system Idea: checking inventory at regular period Pro: less effort to review Inventory in SCM v hr. 25/ 32

26 Periodic review system Inventory in SCM v hr. 26/ 32

27 Continuous review Inventory in SCM v hr. 27/ 32

28 Do we have good inventory management? Symptoms of bad inventory control insufficient inventory non-moving/ dead stock/ obsolete inaccurate stock KPI product shipped Fill rate: product order Inventory turnover: annual sale inventory Inventory accuracy: 1 actual account actual Inventory in SCM v hr. 28/ 32

29 Inventory turnover Kohl s Revenue Cost of Goods Sold Inventory Net Income Walmart Revenue Cost of Goods Sold Inventory Net Income Inventory turnover = = 3.74 Inventory in SCM v hr. 29/ 32

30 Lamson Corp Role: Operation manager at Lamson Corp, a manufacturer of pipes & tiles Production: Dependent seasonal products to share common cost Pattern: peak in Summer & slow in other High Season: sale in Jul 1 3all sale Adopted from: Leender., M.R Inventory in SCM v hr. 30/ 32

31 Lamson Corp Goals: Minimize total costs (inventory + production + backlog) Constraints: 7 production options (3 w/rt for $1000 & 4 w/ot for $20000) Historical information: 18 Tiles 36 Tiles Max bi-weekly demand Average sale vary ±25% ±25% Holding cost $2.00 $6.00 Backlog cost $20.00 $60.00 Adopted from: Leender., M.R Inventory in SCM v hr. 31/ 32

32 What do we learn? Demands: known demand easy problem Theory: need fresh minds to apply Game, itself very simple ( / company that manufactures 2 products) Life = Tradeoff: inventory < OT < Backlog Analysis: 18 tiles 1 3 cost of 36 tiles OT Production additional cost addition unit Inventory $2.00 per unit biweekly Backlog $20.00 per unit biweekly = $6.3 per 18 tiles Inventory in SCM v hr. 32/ 32

Forecasting Survey. How far into the future do you typically project when trying to forecast the health of your industry? less than 4 months 3%

Forecasting Survey. How far into the future do you typically project when trying to forecast the health of your industry? less than 4 months 3% Forecasting Forecasting Survey How far into the future do you typically project when trying to forecast the health of your industry? less than 4 months 3% 4-6 months 12% 7-12 months 28% > 12 months 57%