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Inventory Management

Consulting Group
Learning Objectives

What is inventory.?
Why do we care about inventory?
What do you consider to define your inventory?
Describe the different types and uses of inventory.
Describe the objectives of inventory management.
Calculate inventory performance measures.
Understand relevant costs associated with inventory.
Inventory management video

Learning Objectives cont
Understand inventorys role in service organizations
Calculate order quantities
Evaluate the total relevant costs of different inventory
Understand why companies dont always use the optimal
order quantity
Understand how to justify smaller order sizes
Calculate appropriate safety stock inventory policies
Calculate order quantities for single-period inventory

What is inventory?

Inventory is the raw materials, component

parts, work-in-process, or finished
products that are held at a location in the
supply chain.
Why do we care?
At the macro level:

Inventory is one of the biggest corporate assets

Investment in inventory is currently over
$1.25 Trillion (U.S. Department of
This figure accounts for almost 25% of GNP.

Enormous potential for efficiency increase by

controlling inventories
Why do we care?
At the firm level:

Sales growth: right inventory at the right

place at the right time
Cost reduction: less money tied up in
inventory, inventory management,

Higher profit
Why do we care?
Each of Solectrons big customers, which include Cisco,
Ericsson, and Lucent was expecting explosive growth for
wireless phones and networking gear.when the bottom
finally fell out, it was too late for Solectron to halt orders
from all of its 4,000 suppliers. Now, Solectron has $4.7
billion in inventory. (BW, March 19, 2001)

When Palm formally reported its quarterly numbers in

June, the damage was gruesome. Its loss totaled $392
million, a big chunk of which was attributable to writing
down excess inventory - piles of unsold devices. (The
Industry Standard, June 16, 2001)

Liz Claiborne said its unexpected earnings decline is the

consequence of higher than anticipated excess
inventories. (WSJ, August 1993)
How do you manage your inventory?
How much do you buy? When?

Toilet paper
What Do you Consider?

Cost of not having it.

Cost of going to the grocery or gas station
(time, money), cost of drawing money.
Cost of holding and storing, lost interest.
Price discounts.
How much you consume.
Some safety against uncertainty.
Types of Inventory

Inventory comes in many shapes and sizes such as:

Raw materials purchased items or extracted
materials transformed into components or products
Components parts or subassemblies used in final
Work-in-process items in process throughout the
Finished goods products sold to customers
Distribution inventory finished goods in the
distribution system

Types of Inventory

How Companies Use Their
1. Anticipation or seasonal inventory
2. Fluctuation Inventory or Safety stock: buffer demand
3. Lot-size or cycle stock: take advantage of quantity
discounts or purchasing efficiencies
4. Transportation or Pipeline inventory
5. Speculative or hedge inventory protects against some
future event, e.g. labor strike
6. Maintenance, repair, and operating (MRO) inventories

Objectives of Inventory
Provide desired customer service level
Customer service is the ability to satisfy customer
Percentage of orders shipped on schedule
Percentage of line items shipped on schedule
Percentage of $ volume shipped on schedule
Idle time due to material and component shortages

Inventory Objectives cont

Provide for cost-efficient operations:

Buffer stock for smooth production flow
Maintain a level work force
Allowing longer production runs & quantity discounts

Minimum inventory investments:

Inventory turnover
Weeks, days, or hours of supply

Customer Service Level Examples

Percentage of Orders Shipped on Schedule

Good measure if orders have similar value. Does not capture value.
If one company represents 50% of your business but only 5% of your
orders, 95% on schedule could represent only 50% of value
Percentage of Line Items Shipped on Schedule
Recognizes that not all orders are equal, but does not capture
$ value of orders. More expensive to measure. Ok for finished goods.
A 90% service level might mean shipping 225 items out of the total
250 line items totaled from 20 orders scheduled
Percentage Of Dollar Volume Shipped on Schedule
Recognizes the differences in orders in terms of both line items and
$ value
Inventory Investment Measures Example: The Coach Motor
Home Company has annual cost of goods sold of $10,000,000. The
average inventory value at any point in time is $384,615. Calculate
inventory turnover and weeks/days of supply.

Inventory Turnover:
annual cost of goods sold $10,000,000
Turnover 26 inventory turns
average inventory value $384,615

Weeks/Days of Supply:
average inventory on hand in dollars $384,615
Weeks of Supply 2weeks
average weekly usage in dollars $10,000,000/52

Days of Supply 10 days
Relevant Inventory Costs

Item Cost Includes price paid for the item plus

other direct costs associated with the
Holding Include the variable expenses incurred
Costs by the plant related to the volume of
inventory held (15-25%)
Capital Costs The higher of the cost of capital or the
opportunity cost for the company

Relevant Inventory Costs

Ordering Fixed, constant dollar amount incurred for

Cost each order placed
Shortage Loss of customer goodwill, back order
Costs handling, and lost sales

Risk costs Obsolescence, damage, deterioration, theft,

insurance and taxes
Storage Included the variable expenses for space,
costs workers, and equipment related to the volume
of inventory held

Inventory management video

End of class 1