Inventory Management

Concepts

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 Learning Objectives
• Understand the basic concepts of inventory management
and how to apply them to setting and maintaining desired
customer service levels
• Understand why warehousing is important in the logistics
system and the decision factors that contribute to service
and cost outcomes

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Baseline
Material
Purchasing Production Sales Distribution
Control

Functional
Integration
Materials Manufacturing
Distribution
Management Management

Internal
Integration
Materials Manufacturing
Distribution
Management Management

External
Integration
Internal
Suppliers Customers
Supply Chain

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In essence Logistics management seeks to create a single plan with which

to manage all business processes – rather than the traditional situation in
which each part of the business had a different plan. Supply Chain
Management seeks to extend this alignment and process beyond the
boundaries of the organisation
The question we must seek to answer as part of strategic development is,
how much of this needs to be controlled through ownership?

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 Why Hold Inventory?

• Enable firm to achieve economies of scale

• Balances supply and demand
• Enables specialisation in manufacturing
• Provide protection from uncertainties in demand & order
cycle
• Acts as a buffer between critical interfaces in the channel
of distribution

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Why do firms hold inventories?

•Economies of scale – can make savings from unit price reduction when purchases are
made in volume (what is the trade-off when this is done? What other savings might
accrue from deciding to make such a transaction (single transactional cost, transport
savings etc.) – manufacturers can make products in long run production, saving on set-
up and changeover times – what is the trade-off when this is done?
•Balance supply & demand – seasonality means that production must sometimes be in
advance of demand then held against that demand – what are some examples of such a
situation (chocolates for Valentine’s Day, Christmas toy production, Easter Eggs)
alternately raw materials may only be available at a particular time of year – what are
some examples of this situation (dairy, canned fruit & vegetables) – what are the type of
savings this can generate (labour force, asset utilisation)
•Specialisation – finished goods produced by one organisation are mixed or bundled with
FG of another organisation to fill customer orders – for example Whirlpool has
established focused factories that only make one type of good (washing machines,
refrigerators, dryers are each made at a different place and consolidated at warehouses
•Protection from uncertainty – why might variability occur in demand (promotions,
specials) why might variability occur in supply? (strikes, seasonality, capacity)
•Inventory as a buffer – did anyone see the news during the week about the car
factories having to stand people down because a component manufacturer was on
strike? Why did that happen? Inventory can be held as a buffer in a number of places in
the supply chain – supplier/procurement; procurement/production;
production/marketing; marketing/distribution; distribution/intermediary;
intermediary/consumer

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 Relationship Between Inventory and Service

600
Inventory
Investment 500
in
$1,000's NOW
400

300

200

100

75 80 85 90 95 100
97.5
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Ithaca 5

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 Inventory Pipeline

Raw & In-

In-Process Finished Goods

In-Transit Plant Mfg. Plant. In- Field Pick & In-Transit

Vendor to Whse Process Whse Transit Whse Load to Customer
Mfr. to DCs Custmr

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Inventories can be classified based on the reasons for which they are held:
•Cycle stock – resulting from replenishment of inventory sold or used in
production – such as in this slide where the rate of sales and lead time for
replenishment is held to be constant
•In-transit inventory – what might this be, how should it be treated? (same
as cycle inventory)
•Safety or buffer stock – held against variability in demand and supply –
what role would forecasting of demand have to play in determining how
much stock should be held? What role should prediction of supply in terms
of capacity (production, transport and storage) have in determining the level
of buffer stock? How could the level of safety stock be kept at a minimum?
•Speculative stock – volume purchases (trade-offs such as Carter Holt
Harvey holding 2 years of paper stock – what might the cost of that be?;
forecast price increases; expected materials shortage or strike
•Seasonal stock
•Dead stock – what might dead stock be? (expired, obsolete, end of life-
cycle – complete decline of product) Why does it exist? (production of
wrong item – lack of accurate forecasts, lack of sales & marketing effort)
How could it be dealt with? (sell at lower price, give-away, waste, re-cycle)

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 The Effect of Reorder Quantity on Average Inventory
Investment with Constant Demand and Lead Time

Order Order
arrival arrival
Inventory
400
Order Order Order
placed placed placed

200

0
Days 10 20 30 40 50 60

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So, if demand and lead-time are constant as depicted in this slide, why is
any safety stock required?

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 Stockholding Policy:
A Function of Inventory Characteristics

Inventory
Holding

“Fad”
Surge Flow Inventory Products

Seasonal
Fashion
Wave Flow Inventory
Products

Core
Base Flow Inventory Business
Products

Inventory Demand Types Time

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Source: Gattorna JL & Walters DW, Managing the Supply Chain: A Strategic Perspective, MacMillan, London 1996, pp.132-13

Base Flow
Predictable high flow rates
Minimum (zero) stocks. Direct deliveries from suppliers.
Wave Flow
Slow moving flow rates. High criticality. Perishable. Peaks are relatively
predictable.
Minimise stockholdings, building them only during peak demand period.
Direct delivery from supplier where possible.
Surge Flow (1)
High criticality. Low value. Long lead-time. Small physical size.
Hold high level of stock thereby allowing safety stock for delivery lead-time
and demand fluctuations.
Surge Flow (2)
Low criticality. High value. Bulky physical characteristics. Peaks are relatively
predictable.
Minimise stockholdings, building them only during peak demand period.
Direct delivery from supplier where possible.

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 Low Risk Profile

Inventory
Holding
Surge Flow Inventory

Wave Flow Inventory

Base Flow Inventory

Time
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Source: Gattorna JL & Walters DW, Managing the Supply Chain: A Strategic Perspective, MacMillan, London 1996, pp.132-13

The important issue for businesses is that they must classify their inventory
in a way that reflects customer demand in their markets. These patterns of
demand are are usually accompanied by differential levels of margins
reflecting the risk involved in their stockholding.

If we consider variations even within the same industry sector – a low risk
profile might apply to a retailer selling clothes to older (say age 55-70) men,
a fairly predictable group - while a high risk profile would be more
appropriate for a retailer selling clothes to a target market of people in their
late teens (16-20).

In terms of what we spoke of last week – base flow would equate with cycle
stock, wave flow with seasonal stock and surge flow with speculative stock.
The challenge for the channel intermediaries is to decide upon the demand
characteristics of the target customer group and develop a
merchandising/inventory mix that will obtain the required level of
profitability and cash flow while satisfying customer service levels.

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 High Risk Profile

Inventory
Holding

Surge Flow Inventory

Wave Flow Inventory

Base Flow Inventory

Time
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Source: Gattorna JL & Walters DW, Managing the Supply Chain: A Strategic Perspective, MacMillan, London 1996, pp.132-13

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 The “Bullwhip” Effect

Analysis: Babies Nappies

Suppliers Factories Distribution Retail Parents Babies

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Dr Hau L. Lee - Lausanne

The bullwhip effect is one outcome of planning for infinite capacity – as ERP
does – delays caused by a lack of either information or inventory at any
stage in the process send signals that there is a shortage in work-in-
progress or finished goods of a particular type. This leads to production
order generation to make up the supposed shortfall – and, as the line of
information and./or inventory holding extends, the problem is exacerbated.
So, if a mother buys extra packs of babies nappies because the
supermarket has put them on special, the retailer might be sending
incorrect messages to the distributor that demand has increased – when in
fact the increase in demand has been artificially created and will be followed
by a drop in demand when the price goes up again. In the meantime the
factories have responded to the incorrect information about demand they
have received and begun to make more packs of babies nappies – leading
to excessive inventory holdings of babies nappies. This problem can occur
at any point in the system and reverberate throughout the entire supply
chain for lack of accurate information.

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52
 Assumptions of the Simple EOQ Model

• Continuous, constant, and known rate of demand

• Constant and known replenishment cycle or lead time
• Constant purchase price that is independent of the order
quantity or time
• Constant transportation cost that is independent of the order
quantity or time
• Satisfaction of all demand (no stock-outs are permitted)
• No inventory in transit
• Only one item in inventory, or at least no interaction among
items
• Infinite planning horizon
• No limit on capital availability

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Many organisations use a method known as Economic Order Quantity (EOQ)

to determine when and how much they will order of a product. This
methodology is based on these assumptions.
From your experience, reading and learning to date, do you think these
assumptions are reasonable?

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 A – Inventory Level in a
Push System
Unreliable Suppliers

Inaccurate Forecasts

B – Inventory Level in a
Pull System

Volatile Demand
Quality Problems
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Bottlenecks

JIT suggests that, wherever possible, no activity should take place in a system until there is a
need for it – nothing made, no components ordered – until there is a downstream
requirement – a pull concept where demand at the end of the pipeline pulls products towards
the market – and behind that, the flow of components is determined by the same demand.
Traditionally a push system has operated where products are manufactured in anticipation of
demand and positioned in the supply chain as buffers.
Conventional approach to meeting customer requirements was based on some form of
statistical inventory control which typically relied on re-ordering when inventory levels fell to a
particular point. The re-order quantity would then be based on the expected lead-time it
would take to arrive & the anticipated usage during that time, resulting in a EOQ formulation
balancing the cost of holding inventory against the costs of placing replenishment orders.
Weakness – frequently stock levels are higher or lower than they need to be especially where
the rate of demand changes – thinking has been channeled into a belief that there is some
optimal amount to order – but it actually means we will carry excess stock on every day of the
cycle except the last – then, on top of that, we add safety stock
In a push system there is plenty of inventory, so all the problems are hidden – in JIT we are
forced to confront the problems – Kanban was developed to confront these issues – basing
demand at the lowest point in the supply chain and dealing with the bottlenecks progressively
from there through reducing set-up and ordering costs at the appropriate points.
JIT is an extension of the Toyota concept of Kanban – both are focused on the elimination of
waste. Kanban can apply to any manufacturing operation involving repetitive operations –
demanding that items are supplied only at the moment they are needed. JIT extends this to
purchasing, manufacturing and logistics.

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 Strategic Lead Time – OR Pipeline
MANAGEMENT
Regional Customer
Stock Delivery
In-
In-transit
Value-adding time

Finished
Stock
Production

Raw Customer
Material Delivery
Stock
Regional
Stock

Finished
Stock In-
In-transit
Raw
Material Production
Stock
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Cost -adding time

Manufacturing & Procurement lead-times must be linked to the needs of the

marketplace as discussed when we looked at S&OP whilst increasing the speed of
response to those needs.
The goals of pipeline management are:
•Lower costs
•Higher quality process
•More flexible process
•Faster response times
None of these can be achieved without managing the supply chain as an entity and
seeking to reduce the pipeline length and/or speed up flow through the pipeline.
When examining a pipeline it is often found that there are many non-value-adding
activities such as re-positioning pallets within a warehouse – re-engineering is
about eliminating or at least minimising these activities through process
improvement and change management.
The concern is to remove blockages and fractures that occur in the pipeline where
inventory typically builds up and response times lengthen – focusing on reducing
set-up and changeover times on production lines, identify and eliminate
bottlenecks, awareness and management of excess inventory, instituting sequential
order processing and improving visibility throughout the pipeline

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 Quick Response:
Substituting Information for Inventory

Traditional
Inventory

Cost
Quick Response
Inventory

Service Level
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Quick response refers to the combination of IT systems and the JIT logistics
systems that combine together to get the right product in the right place at
the right time
Specifically this is about the advent of Electronic Data Interchange (EDI),
bar coding , Electronic Point of Sale (EFTPOS) systems and laser scanners
Demand is captured as close to real time as possible – and as close to the
consumer as possible
The logistics response is then made based on that information – at the nth
degree Proctor & Gamble receive data directly from Wal-Mart checkouts and
can plan replenishment and delivery to Wal-Mart Based on that information
The result is that Wal Mart carries less inventory AND has fewer stock outs
of Proctor & Gamble products –
P&G benefit because they get better economies in production & logistics –
and they have greatly increased their sales to Wal-Mart
QR also reduces cumulative lead times – also resulting in lower inventory
levels and further reducing response times-
QR has become common in the fashion industry in the US – and has the
potential to greatly impact the $25Bn that logistics costs that industry if
adopted by everyone

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 Production Strategies for Quick Response
RETAILER MANUFACTURER
Interface
Initiate
Order Transmission
order

Inventory Depletion Receive

order & initiate
Remove processing
Complete
product
production
from shelf
& store
Order Processing
In-store Inventory
Warehouse Order
Storage
Production
Place on
shelf Authorise
Retail Warehouse shipping Raw Material
Initiate
Storage Storage
Delivery production
Receive Manufacturer cycle
shipment Inventory
& store Depletion Purchase
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materials

Flexible manufacturing systems hold the key to achieving QR – this is not

just about new technology such as robotics, it is primarily about the time
taken to change – set-up time – often this is not achieved through
technology but by thinking or working differently – coming back to the why
and questioning conventional wisdom, Benetton’s new dying technique
exploits this approach very well – as does Fisher & Paykel’s economies of
scope model.
One way of doing it is by postponing the production decision until the last
possible moment, such as the models used by Dell and Hewlett-Packard

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Efficient Consumer Response

“Working together to fulfil

consumer wishes better, faster,
and at less cost.”

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 Efficient Consumer Response

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The ECR movement began in the mid-90s and was characterised by the emergence of new
principles of collaborative management along the supply chain. It was understood that
companies can serve consumers better, faster and at less cost by working together with
trading partners.
At the heart of ECR was a business environment characterised by dramatic advances in
information technology, growing competition, global business structures and consumer
demand focused on better choice, service, convenience, quality, freshness and safety and
the increasing movements of goods across international borders.
This new reality required a fundamental reconsideration of the most effective way of
delivering the right products to consumers at the right price. Non-standardized operational
practices and the rigid separation of the traditional roles of manufacturer and retailer
threatened to block the supply chain unnecessarily and failed to exploit the synergies that
came from powerful new information technologies and planning tools.
ECR, QR and EFR methodologies have become common over the past 10 to 12 years and
have facilitated the ability of the grocery, retail and foodservice industries to successfully
implement supply chain reform.
Although the full gamut of supply chain savings available has not yet been realised – billions
have been saved. This has occurred mostly in European applications of the ECR model and
North American experience of QR – both primarily due to the holistic approach – which has
been demonstrated to be far more effective than the exercise of market power based
approach used to less effect in other sectors.
Companies, which are not well prepared internally to pursue ECR, are in danger of exposing
this fundamental weakness when starting to work together with their trading partners. And
companies that are unable to work effectively with their trading partners will fall increasingly
behind in the competition and falter in their efforts to meet changing consumer demand.

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 ECR Strategy

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http://www.globalscorecard.net/guide_to_ECR/D01.asp

Commitment to the implementation of Demand Management - with strategic plans,

people & organization, and, information systems fully aligned to this commitment.
The concept covers progress on the key issues of
•developing a clear strategy
•putting in place all the key supporting processes
•developing the appropriate measurement tools into a full scorecard
•developing the supporting information technology
•clarifying how the organization will develop trading relationships
•ensuring the company's organization can cope with Demand Management
•The concept stresses the need to develop these issues in parallel.
The concept can increase costs associated with 'Manage Product Categories' but
these costs are often offset by reduced costs in other sales and marketing activities
and the benefits from increased demand.
While the optimal organization structure will vary depending on the company's strategic
intent and the specific category's role, a number of principles hold generally true:
•internally, demand management requires true cross-functional working, be it within
manufacturers or retailers;
•joint demand management requires a new type of interface structure between
manufacturers and retailers; and
•personal and category performance measures need to be re-aligned from narrow
functional criteria to measures which focus on the category's profitability from an end-
to-end supply chain perspective.
The scorecard looks at the evolution of internal and joint strategy development.

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 ECR - Integration

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http://www.globalscorecard.net/guide_to_ECR/D01.asp

The new Integrators domain in the ECR Scorecard adds truly integrating concepts to the
ECR platform. Two concepts have been defined, the first one being Collaborative Planning
Forecasting and Replenishment that is the ultimate Responsive Replenishment facilitator
starting with specific partners. The second concept is E-Business, Business to Business
that explores new ways of doing business using public standard-based networks.
Open up business processes to trading partners to improve performance by information
sharing.
Create a public electronic marketplace for buying and selling.
Create a public electronic environment for:
buying and selling
forecasting
planning & replenishment
The integrator concepts will have a major impact on the business environment because of
opportunities to:
develop and deliver products and services faster
extend geographical reach
increase process efficiency and effectiveness
redefine products and services
leverage information by providing more flexible infrastructures and business models.
Success is driven by the identification and implementation of business opportunities,
not just by using latest technology.

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 Collaborative Planning, Forecasting & Replenishment

Once 1. Front-End Agreement

Collaborative Planning
Quarterly 2. Joint Business Plan

Collaborative Forecasting
Weekly, 3. Create Sales Forecast
4. Identify Exceptions
Monthly 5. Resolve Expectations

Weekly, 7. Create Sales Forecast

8. Identify Expectations
Monthly 9. Resolve Expectations

Collaborative Replenishment
9. Generate Order

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CPFR stands for Collaborative Planning, forecasting and replenishment. It is

a process enabled by technology and has primarily been applied in the
packaged goods industry. The evolution of CPFR over the past 15 years
features changes in two areas from earlier forms of collaboration:
•Information – improved from retailer orders to inventory information to
POS data
•Relationship – improved from orders to sharing of key business
information, to shared infrastructure and joint forecasting/planning
responsibility

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 Suggested Reading / Research
• “What to Expect: Inventory Management Principles and
Technology” by Neil Jaffe, Just in Time June 2003
• “ECR in the American Grocery Industry” by Donald Lim,
RMIT
• “VMI and Supplier Scheduling” in MHD Supply Chain
Solutions November / December 2000 pp. 32 - 36 by
James G. Hutzel, Donald P. Belmont & Mark A Nichols
• “Managing Supply Chain Inventory: Pitfalls and
Opportunities” by Hau L. Lee and Corey Billington (Sloan
Management Review/Spring 1992)

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