Chapter 2
2.1 Inventory and Supply Chains
The term inventory can be defined as the quantity of goods that is available on hand or in stock.
There are three main formats of inventory:
Raw material
Work in progress
Finished goods
Why hold inventory?
1. Protect against uncertainty, Uncertainty can be caused by variations in demand or by restrictions in
supply.
2. Cost reduction through inventory is achieved when stock is held close to the customer.
3. Protect against quality defects. A product that is faulty can be substituted quickly when inventory is
held.
4. Stabilize manufacturing, to be able to meet unexpected demand, products/supply must be kept in
stock.
manufacturing technology is expensive and therefore needs to be utilized throughout the year in
order to get a good return on investment.
5. Anticipation stock is similar to the example just mentioned. However, the reason for this sort of
inventory is rather demand than supply driven.
Example; Before the launch of a product innovation like the iPhone, for which the level and rate of
demand was fairly unknown, Apple Inc. might have decided to build up pre-launch anticipation stock
to buffer against demand uncertainty.
To summarize, managing inventory is Essentially; balancing supply and demand.
Different Types of Inventory
– Cycle or replenishment stock: the inventory necessary to meet the normal daily demand.
– Safety stock: this stock buyers against forecast error and the supplier’s unreliability.
– In transit stock: this stock is in the process of being transported to a stocking or delivery point.
– Seasonal stock: this stock is built up in advance to meet increased sales volumes during a particular
time of the year.
1
, – Promotional stock: this stock feeds into marketing campaigns and advertising.
– Speculative stock: held to protect against price increase or periods of limited availability.
– Dead or obsolete stock is no longer usable or saleable in the market.
Although all types of stocks are important, cycle stock and safety stock are those types that are most looked
after in inventory management.
Cycle Stock
When talking about cycle stock, it is worthwhile looking at how much stock we hold throughout the year
What is left of the inventory after sales are made.
An example to understand cyle stock:
The average stock holding calculation is based on the order quantity.
Q
Average stockholding (AS) =
2
Where AS = average stockholding and Q = order quantity.
Example: An electronics retailer annually sells 400 Plasma TV’s, orders once a year and receives one delivery
per year. In this example average stock holding = 400=2 1⁄4 200.
To reduce cycle stock, a company can order more often.
2
,Average cycle stock investment = Average Stockholding (AS) x Product Cost
Safety Stock
Safety stock is different from cycle stock as it does not cover the regular rate of sales but protects against
uncertainty.
There are two parts of the equation to account for in the safety stock calculation:
(a) Safety stock supply that covers unplanned production and delivery delays
(b) Safety stock demand that covers unplanned changes in demand
Safety stock formula= Safety stock supply (a) + Safety stock demand (b)
(a) Safety stock supply = Average demand x supplier uncertainty (SU)
For the first part of the formula, safety stock supply, you need two input variables:
– Average demand can be simply calculated by summing up demands from a number of time periods
and dividing the sum by the number of time periods.
– Supplier uncertainty arises from orders taking different lengths of time to arrive from suppliers.
An example: Average daily demand = 500, Supplier uncertainty = 2 days
The equation of part (a) of the safety stock formula would look like this: 500 x 2 = 1000
(b) Safety stock demand = Standard deviation of demand x Service Level Factor x √ LT+SU
Example;
Forecast error =50
Service level factor = 1.64
Lead-time =4 days
Supplier uncertainty = 2 days
The equation for part (b) of the formula would look like this: 50x1.64x 2+4=200. 85 (Rounded 201)
Thus, in this example the safety stock held to protect for uncertainty in demand would be 201 units of
inventory.
Modelling safety stock, standard deviation of demand
3
, Reducing Inventory
One target for reducing inventory may be to improve the environmental impact and become more
sustainable. green inventory management
There are four ways in which you can positively influence your safety stock position:
1. Reduce lead-time less safety stock is needed to safeguard supply.
2. Reduce supplier uncertainty As suppliers become more reliable a considerably lower safety stock
can be held.
3. Reduce forecast error demand uncertainty can be reduced and thus less safety stock will be
needed.
4. Reduce service level The decision of reducing service levels to improve the overall safety stock
position should be discussed and agreed together with your customer.
2.2 Demand and Supply Planning
Describing Demand
Demand can be segregated into 5 categories:
– Level of demand (high or low) The demand level of that individual item is always measured in
relative terms to your total inventory.
– Frequency of demand (fast demand and slow demand)
Slow items display a less frequent demand pattern and have a number of periods with zero
demand
Fast-moving items, demands around the average
– Patterns of demand, here, demand can be described as stable, trend
or seasonal
Stable demand can be described as demand that
varies around a constant average over time.
A trend demand pattern is a demand pattern where the
average demand can be described as an upward or downward
4
2.1 Inventory and Supply Chains
The term inventory can be defined as the quantity of goods that is available on hand or in stock.
There are three main formats of inventory:
Raw material
Work in progress
Finished goods
Why hold inventory?
1. Protect against uncertainty, Uncertainty can be caused by variations in demand or by restrictions in
supply.
2. Cost reduction through inventory is achieved when stock is held close to the customer.
3. Protect against quality defects. A product that is faulty can be substituted quickly when inventory is
held.
4. Stabilize manufacturing, to be able to meet unexpected demand, products/supply must be kept in
stock.
manufacturing technology is expensive and therefore needs to be utilized throughout the year in
order to get a good return on investment.
5. Anticipation stock is similar to the example just mentioned. However, the reason for this sort of
inventory is rather demand than supply driven.
Example; Before the launch of a product innovation like the iPhone, for which the level and rate of
demand was fairly unknown, Apple Inc. might have decided to build up pre-launch anticipation stock
to buffer against demand uncertainty.
To summarize, managing inventory is Essentially; balancing supply and demand.
Different Types of Inventory
– Cycle or replenishment stock: the inventory necessary to meet the normal daily demand.
– Safety stock: this stock buyers against forecast error and the supplier’s unreliability.
– In transit stock: this stock is in the process of being transported to a stocking or delivery point.
– Seasonal stock: this stock is built up in advance to meet increased sales volumes during a particular
time of the year.
1
, – Promotional stock: this stock feeds into marketing campaigns and advertising.
– Speculative stock: held to protect against price increase or periods of limited availability.
– Dead or obsolete stock is no longer usable or saleable in the market.
Although all types of stocks are important, cycle stock and safety stock are those types that are most looked
after in inventory management.
Cycle Stock
When talking about cycle stock, it is worthwhile looking at how much stock we hold throughout the year
What is left of the inventory after sales are made.
An example to understand cyle stock:
The average stock holding calculation is based on the order quantity.
Q
Average stockholding (AS) =
2
Where AS = average stockholding and Q = order quantity.
Example: An electronics retailer annually sells 400 Plasma TV’s, orders once a year and receives one delivery
per year. In this example average stock holding = 400=2 1⁄4 200.
To reduce cycle stock, a company can order more often.
2
,Average cycle stock investment = Average Stockholding (AS) x Product Cost
Safety Stock
Safety stock is different from cycle stock as it does not cover the regular rate of sales but protects against
uncertainty.
There are two parts of the equation to account for in the safety stock calculation:
(a) Safety stock supply that covers unplanned production and delivery delays
(b) Safety stock demand that covers unplanned changes in demand
Safety stock formula= Safety stock supply (a) + Safety stock demand (b)
(a) Safety stock supply = Average demand x supplier uncertainty (SU)
For the first part of the formula, safety stock supply, you need two input variables:
– Average demand can be simply calculated by summing up demands from a number of time periods
and dividing the sum by the number of time periods.
– Supplier uncertainty arises from orders taking different lengths of time to arrive from suppliers.
An example: Average daily demand = 500, Supplier uncertainty = 2 days
The equation of part (a) of the safety stock formula would look like this: 500 x 2 = 1000
(b) Safety stock demand = Standard deviation of demand x Service Level Factor x √ LT+SU
Example;
Forecast error =50
Service level factor = 1.64
Lead-time =4 days
Supplier uncertainty = 2 days
The equation for part (b) of the formula would look like this: 50x1.64x 2+4=200. 85 (Rounded 201)
Thus, in this example the safety stock held to protect for uncertainty in demand would be 201 units of
inventory.
Modelling safety stock, standard deviation of demand
3
, Reducing Inventory
One target for reducing inventory may be to improve the environmental impact and become more
sustainable. green inventory management
There are four ways in which you can positively influence your safety stock position:
1. Reduce lead-time less safety stock is needed to safeguard supply.
2. Reduce supplier uncertainty As suppliers become more reliable a considerably lower safety stock
can be held.
3. Reduce forecast error demand uncertainty can be reduced and thus less safety stock will be
needed.
4. Reduce service level The decision of reducing service levels to improve the overall safety stock
position should be discussed and agreed together with your customer.
2.2 Demand and Supply Planning
Describing Demand
Demand can be segregated into 5 categories:
– Level of demand (high or low) The demand level of that individual item is always measured in
relative terms to your total inventory.
– Frequency of demand (fast demand and slow demand)
Slow items display a less frequent demand pattern and have a number of periods with zero
demand
Fast-moving items, demands around the average
– Patterns of demand, here, demand can be described as stable, trend
or seasonal
Stable demand can be described as demand that
varies around a constant average over time.
A trend demand pattern is a demand pattern where the
average demand can be described as an upward or downward
4
