SUPPLY CHAIN MANAGEMENT – SUMMARY OF SUMMARY
Inventory Management
Inventory = stock of any item/resource used in an organization.
Purpose of inventory analysis: when items should be ordered, and how large the order
should be.
(Inventory comes with costs → including obsolescence, insurance, opportunity).
Types of Manufacturing Inventories:
1. Raw materials
= unprocessed purchase inputs.
2. Work-In-Process (WIP)
= partially processed materials not yet ready for sales.
3. Finished goods
= products ready for shipment.
4. Maintenance, repair & operating (MRO)
= materials used in production (e.g. cleaners, brooms).
Besides these, you also have: buffer (=inventory in a warehouse/distribution center); in-transit (=in
distribution).
Reasons to hold Inventory:
1. Maintain independence of operations
Supply of materials at a workcenter allows flexibility there, in operations.
Workstations independence is desirable on assembly lines → shorter operation times
can compensate for longer operation times.
Buffers during disruptions.
2. Meet unanticipated product demand (=variation)
Safety stock/buffer stock must be maintained to absorb variation.
3. Smooth production requirements
(seasonal inventories)
4. Allow flexibility in production scheduling
Trade-off: lead time may be increased → smoother flow and lower cost through
larger lot sizes are possible.
5. Protect against variation in raw material delivery times
6. Take advantage of economic purchase order size
ordering costs are involved when placing an order →the larger each order, the fewer
1
, the orders that need be written. → the larger the shipment, the lower the per-unit
cost (shipping costs).
7. Take advantage of quantity discounts
(EofS, discounts for large orders)
8. Hedge against price increases
9. Permit operations
10. Reduction of control costs
(inventory costs vs. monitoring cost)
Reasons to not hold Inventory:
1. Opportunity costs of alternative investments
→ inventory is cash equivalent, but cash is more flexible
→ weighted average cost of capital (WACC) can be high (e.g. around 30%)
→ not interest rate, but alternative investment projects matter
2. Taxes and insurance
3. Costs of providing the physical space to store the items
(warehouses)
4. Breakage, spoilage and deterioration
(food)
5. Obsolescence
(innovative products)
6. Reduces agility and adaptability
(reacting to new market opportunities)
Typical Costs in Inventory Management
(→ Minimum total cost of these costs combined establishes the correct order quantity, taking impact of
time on inventory cost in account)
1. Holding (carrying/storage) costs
= costs for storage facilities, handling, insurance, pilferage, breakage, obsolescence,
depreciation, taxes, opportunity cost of capital.
Depend on # of stored products.
2. Set-up (production change/fixed ordering) costs
Depend on # of orders (NOT on order quantity!).
Making each different product includes administration costs, material handling costs,
etc.
do NOT include overhead costs.
3. (Variable) Ordering (purchase) costs
= managerial and clerical costs to prepare the purchase or production order.
Include all the details (unit cost), including costs associated with maintaining the
tracking orders-system.
Proportional to ordering quantity.
4. Shortage (stockout) costs
Depend on the number of unsatisfied orders (backorders, lost sales).
2
, Include additionally delivery costs, loss of goodwill, etc.
→ Trade-off between having too much inventory (expensive and wasteful) and not enough
inventory (lost sales).
Dependent & Independent Demand
Dependent Demand
= Describes the internal demand for parts based on the demand of the final product in
which the parts are used.
The need for any one item is a direct result of the need for some other item (usually of
which it is a part).
Examples: subassemblies, components, raw materials.
Independent Demand
= The demand for final products (external from the firm that sells the product).
The demand is not known, and companies need to forecast the demand for its products, and
having a measure of demand uncertainty.
It has a demand pattern affected by trends, seasonal patterns and general market
conditions.
Supply Chain Inventories: Make-to-Stock Environment
Customer order decoupling point (works as a buffer) → aim: managing the inventory at
these decoupling points.
An important distinction is whether this is a one-time purchase (=single-period model) or
whether the item will be stocked on ongoing basis (=fixed-order quantity / fixed-time
period model).
Inventory Systems:
= provides operating policies and organizational structure, for controlling and maintaining
goods to be stocked (=inventory levels).
a. Single-period inventory model = when making one-time purchase of an item.
→ Seeks to balance the costs of inventory overstock and understock.
b. Multi-period inventory model:
→ Determines optimal order quantity of products at the beginning of each period.
I. Fixed-order quantity model (EOQ) = when we want to maintain an item “in
stock”. When resupplying an item, certain # of units must be ordered each
time. Monitoring inventory for the item, re-order when risk of stocking out is
great enough.
→ Event triggered (e.g. running out of stock).
II. Fixed-time period model = when the item should be in stock and ready to
use. Item is ordered at certain intervals of time.
→ Time triggered (e.g. monthly sales call by sales representative).
Single-Period Model Applications
Characteristics:
- Short selling period.
3
, - No replenishment during this period.
- Significant uncertainty in demand.
- Products lose considerably in value after the period.
- Capacity can’t be ‘’stored’’.
Examples: perishable items (which quantities of fresh products should be ordered/How much blood be
kept in stock in the blood bank?); Ordering of fashion items; Any type of one-time order;
Overbooking of airline flights (How many airplane seats above capacity shall be sold?).
Consideration:
How much risk are we willing to take for running out of inventory?
(Think about statistic, assuming sales of … is normal, probability distribution, with a standard
deviation).
STEPS WHEN P IS NOT GIVEN:
1. Consider the potential profit and loss associated with stocker either too many or
too few units (minimize expected total cost):
CO = Cost per unit of demand overestimated.
= surplus cost (overage cost).
- D ≤ Q.
- CO per unit remaining at the end of the season.
- CO = purchase cost – salvage value
(=marginal cost = cost of buying too many papers (purchasing cost)).
Cu = Cost per unit of demand underestimated.
= Shortage cost (underage cost).
- D > Q.
- Cu = per unit short at the end of the season.
- Cu = sales price – purchase cost
(=marginal cost = cost of the lost profit).
2. Calculate P:
→ Optimal stocking level = at the point where the expected benefits derived from
carrying the next unit < expected costs for that unit.
Expected marginal cost equation (marginal analysis):
P(CO) ≤ (1 – P) Cu
→ Where:
P = cumulative probability that the unit will NOT be sold (P (D ≤ Q)).
1 – P = probability of the unit being sold
Solving for P:
= critical ratio (CR)!!!
4
Inventory Management
Inventory = stock of any item/resource used in an organization.
Purpose of inventory analysis: when items should be ordered, and how large the order
should be.
(Inventory comes with costs → including obsolescence, insurance, opportunity).
Types of Manufacturing Inventories:
1. Raw materials
= unprocessed purchase inputs.
2. Work-In-Process (WIP)
= partially processed materials not yet ready for sales.
3. Finished goods
= products ready for shipment.
4. Maintenance, repair & operating (MRO)
= materials used in production (e.g. cleaners, brooms).
Besides these, you also have: buffer (=inventory in a warehouse/distribution center); in-transit (=in
distribution).
Reasons to hold Inventory:
1. Maintain independence of operations
Supply of materials at a workcenter allows flexibility there, in operations.
Workstations independence is desirable on assembly lines → shorter operation times
can compensate for longer operation times.
Buffers during disruptions.
2. Meet unanticipated product demand (=variation)
Safety stock/buffer stock must be maintained to absorb variation.
3. Smooth production requirements
(seasonal inventories)
4. Allow flexibility in production scheduling
Trade-off: lead time may be increased → smoother flow and lower cost through
larger lot sizes are possible.
5. Protect against variation in raw material delivery times
6. Take advantage of economic purchase order size
ordering costs are involved when placing an order →the larger each order, the fewer
1
, the orders that need be written. → the larger the shipment, the lower the per-unit
cost (shipping costs).
7. Take advantage of quantity discounts
(EofS, discounts for large orders)
8. Hedge against price increases
9. Permit operations
10. Reduction of control costs
(inventory costs vs. monitoring cost)
Reasons to not hold Inventory:
1. Opportunity costs of alternative investments
→ inventory is cash equivalent, but cash is more flexible
→ weighted average cost of capital (WACC) can be high (e.g. around 30%)
→ not interest rate, but alternative investment projects matter
2. Taxes and insurance
3. Costs of providing the physical space to store the items
(warehouses)
4. Breakage, spoilage and deterioration
(food)
5. Obsolescence
(innovative products)
6. Reduces agility and adaptability
(reacting to new market opportunities)
Typical Costs in Inventory Management
(→ Minimum total cost of these costs combined establishes the correct order quantity, taking impact of
time on inventory cost in account)
1. Holding (carrying/storage) costs
= costs for storage facilities, handling, insurance, pilferage, breakage, obsolescence,
depreciation, taxes, opportunity cost of capital.
Depend on # of stored products.
2. Set-up (production change/fixed ordering) costs
Depend on # of orders (NOT on order quantity!).
Making each different product includes administration costs, material handling costs,
etc.
do NOT include overhead costs.
3. (Variable) Ordering (purchase) costs
= managerial and clerical costs to prepare the purchase or production order.
Include all the details (unit cost), including costs associated with maintaining the
tracking orders-system.
Proportional to ordering quantity.
4. Shortage (stockout) costs
Depend on the number of unsatisfied orders (backorders, lost sales).
2
, Include additionally delivery costs, loss of goodwill, etc.
→ Trade-off between having too much inventory (expensive and wasteful) and not enough
inventory (lost sales).
Dependent & Independent Demand
Dependent Demand
= Describes the internal demand for parts based on the demand of the final product in
which the parts are used.
The need for any one item is a direct result of the need for some other item (usually of
which it is a part).
Examples: subassemblies, components, raw materials.
Independent Demand
= The demand for final products (external from the firm that sells the product).
The demand is not known, and companies need to forecast the demand for its products, and
having a measure of demand uncertainty.
It has a demand pattern affected by trends, seasonal patterns and general market
conditions.
Supply Chain Inventories: Make-to-Stock Environment
Customer order decoupling point (works as a buffer) → aim: managing the inventory at
these decoupling points.
An important distinction is whether this is a one-time purchase (=single-period model) or
whether the item will be stocked on ongoing basis (=fixed-order quantity / fixed-time
period model).
Inventory Systems:
= provides operating policies and organizational structure, for controlling and maintaining
goods to be stocked (=inventory levels).
a. Single-period inventory model = when making one-time purchase of an item.
→ Seeks to balance the costs of inventory overstock and understock.
b. Multi-period inventory model:
→ Determines optimal order quantity of products at the beginning of each period.
I. Fixed-order quantity model (EOQ) = when we want to maintain an item “in
stock”. When resupplying an item, certain # of units must be ordered each
time. Monitoring inventory for the item, re-order when risk of stocking out is
great enough.
→ Event triggered (e.g. running out of stock).
II. Fixed-time period model = when the item should be in stock and ready to
use. Item is ordered at certain intervals of time.
→ Time triggered (e.g. monthly sales call by sales representative).
Single-Period Model Applications
Characteristics:
- Short selling period.
3
, - No replenishment during this period.
- Significant uncertainty in demand.
- Products lose considerably in value after the period.
- Capacity can’t be ‘’stored’’.
Examples: perishable items (which quantities of fresh products should be ordered/How much blood be
kept in stock in the blood bank?); Ordering of fashion items; Any type of one-time order;
Overbooking of airline flights (How many airplane seats above capacity shall be sold?).
Consideration:
How much risk are we willing to take for running out of inventory?
(Think about statistic, assuming sales of … is normal, probability distribution, with a standard
deviation).
STEPS WHEN P IS NOT GIVEN:
1. Consider the potential profit and loss associated with stocker either too many or
too few units (minimize expected total cost):
CO = Cost per unit of demand overestimated.
= surplus cost (overage cost).
- D ≤ Q.
- CO per unit remaining at the end of the season.
- CO = purchase cost – salvage value
(=marginal cost = cost of buying too many papers (purchasing cost)).
Cu = Cost per unit of demand underestimated.
= Shortage cost (underage cost).
- D > Q.
- Cu = per unit short at the end of the season.
- Cu = sales price – purchase cost
(=marginal cost = cost of the lost profit).
2. Calculate P:
→ Optimal stocking level = at the point where the expected benefits derived from
carrying the next unit < expected costs for that unit.
Expected marginal cost equation (marginal analysis):
P(CO) ≤ (1 – P) Cu
→ Where:
P = cumulative probability that the unit will NOT be sold (P (D ≤ Q)).
1 – P = probability of the unit being sold
Solving for P:
= critical ratio (CR)!!!
4
