Inventory Management
By: Ot Chan Dy, BE & Msc. Management Institute of Cambodia
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After finish this chapter you should be able to
Explain the importance of inventory management
Calculate profit from various inventory holding scenarios
Perform ABC analysis, calculate stock cover, stock turn over rate, use simple method to reduce stockholding, Explain the zero inventory philosophy and application of Just-in-time Calculate the Safety Stock & Setting the right stock level
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Content
Introduction to inventory Basic of inventory control Managing inventory Just in time management Safety Stock Setting the right stock level
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Introduction
All operation have to hold levels of inventories. The typical reasons for this are:
To act as a buffer between different operations
To allow for mismatches between supply and demand rates
To allow for demands that are larger than expected
To allow for deliveries that are delayed or too small
To avoid delays in passing products to customers
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Introduction
All operation have to hold levels of inventories. The typical reasons for this are:
To take advantage of price discounts
To buy items when the price is low and expected to rise
To make full loads and reduce transport costs
To provide cover for emergencies
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Introduction
There are problems with holding inventories
Storage costs Interest is tie up – therefore, a loss on capital Obsolete stock Less money is available for the business Prices fall on held items
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Introduction
Conversely, there are problems with inventory “stockouts”
Failure to satisfy customer demands Costly emergency procedures to rectify situations Higher replenishment costs for stock replacement
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Introduction
Looking back…
Management wisdom between 1950s – 1980s: own the whole supply-chain
Adopted from: Brown,2000
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Introduction
Reasons for vertical integration:
The need for control (cost, assurance of delivery, quality) within the chain Possibility of diversification of business activities There was a commonly believe that “the bigger we are, the better we are” – bigger on the balance sheet “Asset”
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Introduction
This strategy is changing…
Western firms began to understand how Japanese companies manage buyers-suppliers relationship.
“Nowhere has the contrast between Western and Japanese manufacturing been more evidence than in materials – or inventory – management.”
Inventory management have become the indication of world class practices. It is a key parameter to assess the capabilities of management.
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Basic of Inventory Control
The role of inventory management
Supplying goods to its customers => suitable products available at an acceptable price within reasonable timescale.
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Basic of Inventory Control
Objectives for inventory control
Customer service Inventory cost Operating cost
The most profitable policy is not to optimize one of these at the expense of the others.
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Basic of Inventory Control
Profit through inventory management
Natural Food Ltd. International Food Corporation
Annual sale: 5 million $
Employing: 85 people Fix asset: 2.5 million $ Stock value: 0.5 million $
Annual sale: 5 million $
Employing: 85 people Fix asset: 2.5 million $ Stock value: 0.5 million $ + 2 million $ (borrow) Interest: 0.3 million $ per annum
Return on sale: 5% Annual WH cost: 23,000 $
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Return on sale: 5% Annual WH cost: 23000+30000
Return on sale: Profit/Annual sale Return on Asset: Profit/Asset employed
Basic of Inventory Control
Reason for current stock
Stock level is the result of effectiveness of stock control But what is there is probably not ideal
Let’s examine the factors:
Purchase order quantity frequent, small deliveries keep stock low
Batch size, transportation mode, different rate of consumption Unexpected demand, supply chain failure
Safety stock invest in information or inventory
Market changes detect trends and react automatically
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Managing Inventory
Using Pareto analysis for control
It is also call 80/20 rule In WH, 80% of space occupied by 20% of the product types or 80% of value/return result from 20% of product type.
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Managing Inventory
Using Pareto analysis for control Example
“Consider a stock of 12 000 types of items in store. Pareto’s Law shows that for a stock value of $800 000 we find that 2400 items account for $640 000 of inventory. The remaining 9600 items are worth only $160 000. Therefore, by concentrating on the 2400, control over the total value will be tight.”
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Managing Inventory
ABC Analysis:
Some items have higher stock due to no want would buy it Therefore, it is better to rank the items according to annual turnover.
Annual turnover = Annual Consumption x Unit cost
A = 10% of stock numbers, giving 65% of turnover B = 20% of stock numbers, giving 25% of turnover C = 70% of stock numbers, giving 10% of turnover
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Managing Inventory
ABC Analysis:
A – are not too many, so control tightly B – class let the system manage it C – don’t take risk, be lazy
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Managing Inventory
Stock cover
The purpose of controlling the inventory is to drive the stocks toward their proper level which is determined by the characteristics of supply and demand patterns. The major factors are:
supply lead time average demand rate variability of demand supply frequency customer delivery time allowed.
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Managing Inventory
Stock cover There are also practical considerations such as:
reliability of the supplier criticality of the item availability of item from other sources.
The concept “balance” is the most important in ensuring the maximum service is produce from a minimum stockholding cost
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Managing Inventory
Stock cover The inventory of performance of each item can be monitored using “stock balance” or “stock cover”
current stock Stock cover =
Forecast annual sale/usage
x 52
Stock cover gives an insight into the priority for action It indicates where the review is require
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Managing Inventory
Stock cover
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Managing Inventory
Stock turnover or stockturn
In FMCG industry, Financial Managers are often more interested in use of funds stock turnover
Value of annual sale/usage Value of stock
Stock turnover =
Example:
Value of stock in the stores is $150 000 Issued for the last 12 months amount $900 000 Stock turnover is therefore 900 000 ÷ 150 000 = 6. This means that the stock value would be used up completely 6 times per year
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Managing Inventory
Setting target stock
Stock could have control limits to avoid extremes of inventory Allowable stock range can be set by ABC inventory classes in a ratio which theoretically 1:3:7
A class: between 1 – 4 weeks B class: between 2 – 8 weeks C class: between 3 – 20 weeks
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Managing Inventory
Practical method of reduce stock holding
The principle:
Decrease in stock = Output – Input
Average stock:
(max. + min.) Average stock = 2
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Managing Inventory
Practical method of reduce stock holding
Average stock:
To reduce the average stock:
Reduce order quantity OR Safety stock
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Managing Inventory
Practical method of reduce stock holding
Batch quantity: The lowest inventory will result from receiving the same order size into stock as the issues to customers. The parameter for order quantity on this basis is “buy one” Supplier deliver quantities are more important than lead times
Safety stock
Minimize safety stock could result in lower customer service
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Managing Inventory
Practical method of reduce stock holding
Lead times:
By negotiating lead times, safety stock can be reduced It require collaboration, forecasting, supply chain management so that supplier can arrange and make items available by the demand date with much lower short time.
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Managing Inventory
Practical method of reduce stock holding
Lead times:
Demand pattern, if the demand were ten every week consistently, than there would be no need for safety stock. But “what opportunity are there to smooth out the demand pattern?”
Understand demand – smooth customer demand by getting them to buy little and often Flatten demand – Remove sporadic demand from stock by buying to order and give customer a longer lead time Agree schedule supply – organize a continuous supply by schedule
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Managing Inventory
Practical method of reduce stock holding
The reduction project:
Examine safety stock and order quantity Starting with the stock of most value and continue down to parato curve Target reduction should always set i.e reduce overall stock value by 20%
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Just in Time Management
Zero inventory philosophy
Conventional vs. JIT approach:
Why stock exist? It is normally uncertainty or over caution that cause inventory JIT is simply that have items when they are needed and none when they are not needed. JIT supply is a result of high reliability of supplier
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Just in Time Management
Zero inventory philosophy
JIC vs. JIT approach:
Just-in-time
Conventional (Just-in-Case)
Satisfied with status quo
Lead time is fixed Product range is sale issue Management provide methods Stock in case of customer demand Convenient purchase batch size
Continuous improvement
Reducing lead time is continuing challenge Product range reduction is inventory issue Operators are responsible for practices Stock to meet demand rate Buy singly or small quantities
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Just in Time Management
Zero inventory philosophy
JIT approach:
JIT is the outcome of other techniques, not a technique of its own It is the logical aim of tight inventory control, effective process planning and plant design, workforce motivation, cost reduction, logistics and even material require planning. JIT works as pull system whereas conventional stock control and material require planning (MRP) are essentially push system
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Just in Time Management
Zero inventory philosophy
JIT approach:
Pull system: The first action in the chain is that the item is demanded To satisfy this demand there is an item in stock As soon as this stock is used up, another item is supplied, either from outside or production process
The supply is well organized so that its lead time is “short” and very small quantity
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Just in Time Management
Zero inventory philosophy
JIT approach:
Pull system – apply @ lucky burger “double burger set”
Burger deliver to custome r
Burger deliver to the box
Burger prepara tion
Verbal inform to chef
Order confirme d
Custome r ordered
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Just in Time Management
JIT environment
The ideal situation
Narrow product range Manufacturer Stable market Good quality management Local reliable suppliers Dependent suppliers Fast-cycle process Move to a true JIT require changing of attitude: “We are doing alright, don’t risk it” has to be replaced “What we need to do and how do we make it happen?”
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Just in Time Management
Advantage of JIT
Operational benefits
Inventory investment “Supply to order” instead of “provision for stock” Less slow moving stock Better flexibility Simplified administration Waste elimination Less scrap should there be a problem
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Safety Stock
Learning from history
Three main factors determine safety stock
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The variability of demand The reliability of supply The dependability of transport
2.
3.
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Safety Stock
Learning from history
Reason for safety stock
1.
Supply failure Production shortfall Transport failure Slow, unreliable or incorrect information Other source of disruption
2.
3.
4.
5.
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Setting the right stock level
Simple assessment of review level
The basic calculation:
Our aim is to maintain the “balance” of inventory to service customer Re-order point is where we can influence on stock level and ensuring the “balance” It is also a point at which customer satisfaction or excess inventories are created. The technique for calculating the right time to order inventory is crucial to balance this conflicting pressures
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Order Order Delivery
Quantity in Stock
Supply Lead time
Delivery
Delivery Qty
Review Level
Safety Stock
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Setting the right stock level
Simple assessment of review level
The basic calculation:
The maximum stock is the result of negotiation with suppliers on delivery quantities Three parameters to use for controlling delivery quantities:
Review level Safety Stock Delivery quantity
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Setting the right stock level
Simple assessment of review level
The basic calculation:
Safety Stock:
Quantity
Demand History (weeks)
Quantity
Demand History (weeks)
Safety Stock = Service Factor x Demand SD x √Lead Time
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Customer Service Factor
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Setting the right stock level
Simple assessment of review level
The basic calculation:
Review level:
Review level = Usage rate x supply lead time + Safety Stock
Supplier warning level:
Current stock level < Safety Stock
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Setting the right stock level
Managing lead times
Supplier power vs. customer power Sale lead time vs. supply lead time will determine the necessity of stockholding
Lead times for purchasing are governed by production and transport
Lead times for manufacturing result from capacity, material availability and planning
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Setting the right stock level
Managing lead times
Components of lead time
Order review time – the intervals at which low stock situation is reviewed Order processing time purchasing & communication – the time it takes to:
Review order Decide to buy Raise an order Gain the appropriate authority Transmit to ordering system Inform the supplier (fax, phone, email)
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Supplier lead time (manufacturing, buying, and dispatch) Transport time – transfer of items from supplier to receive bay Receiving time – time taken from the goods inwards and updating stores records
Setting the right stock level
Managing lead times
Setting the right lead time
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Setting the right stock level
Managing lead times
Minimizing lead time
One of simplest way is being more “precisely” request
To be deliver in December, 2009 To be deliver in December, 12th 2009 by noon
Or:
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Setting the right stock level
Target stock levels (TSL)
Target Stock Level is maximum stock level which can be use to calculate the order quantities. TSL vs. Review Level
Review levels fix the order quantity and vary frequency TSL fix order frequency and vary order quantity
TSL application is aim for “A” class item and support the efficiency of purchasing department
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