Operations Management: Sustainability

and Supply Chain Management

Thirteenth Edition, Global Edition

Chapter 12
Inventory Management

Copyright © 2020 Pearson Education Ltd. All Rights Reserved.

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Outline
• Global Company Profile: Amazon.com
• The Importance of Inventory
• Managing Inventory
• Inventory Models
• Inventory Models for Independent Demand
• Probabilistic Models and Safety Stock
• Single-Period Model
Inventory Management at Amazon.com
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Inventory Management at
Amazon.com
• Amazon.com started as a “virtual” retailer – no inventory,
no warehouses, no overhead – just computers taking
orders to be filled by others
• Growth has forced Amazon.com to become a world leader
in warehousing and inventory management
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Inventory Management at
Amazon.com
1. Each order is assigned by computer to one of the distribution centers
2. A “flow meister” at each distribution center assigns work crews
3. Robots and technology help workers move merchandise and pick the
correct items
4. Items are placed into crates on a conveyor, bar code scanners scan
each item 15 times to virtually eliminate errors
5. Crates arrive at central point where items are boxed and labeled with
new bar code
6. Order arrives at customer within 1 - 2 days

Amazon expects the customer experience to yield the lowest price, fastest
delivery, and error-free order fulfilment.
The Importance of Inventory
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Importance of Inventory
• One of the most expensive assets of many companies
representing as much as 50% of total invested capital
• Less inventory lowers costs but increases chances of
shortages, which might stop processes or result in
dissatisfied customers
• More inventory raises costs but keeps customers happy
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Inventory Management
The objective of inventory management is to strike a
balance between inventory investment and customer
service
• All organizations have some type of inventory
planning and control system.
• An inventory management plan addresses two
issues: how much to order and when to order
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Functions of Inventory
1. To provide a selection of goods for anticipated demand
and to separate the firm from fluctuations in demand
2. To decouple or separate various parts of the production
process
3. To take advantage of quantity discounts
4. To hedge against inflation
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Types of Inventory
• Raw material
– Purchased but not processed
• Work-in-process (WIP)
– Undergone some change but not completed
– A function of flow time for a product
• Maintenance/repair/operating (MRO)
– Necessary to keep machinery and processes
productive
• Finished goods
– Completed product awaiting shipment
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The Material Flow Cycle

Figure 12.1
Managing Inventory
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Managing Inventory
1. How inventory items can be classified (ABC analysis)
2. How accurate inventory records can be maintained
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ABC Analysis
• Divides inventory into three classes based on annual
dollar volume
– Class A - high annual dollar volume (15% of total
inventory, 70-80% of total $ usage)
– Class B - medium annual dollar volume (30% of total
inventory, 15-20% of total $ usage)
– Class C - low annual dollar volume (55% of total
inventory, 5% of total $ usage)
• Used to establish policies that focus on the few critical
parts and not the many trivial ones
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ABC Analysis
Figure 12.2
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ABC Analysis Example

• Silicon Chips, Inc., maker of superfast DRAM chips, wants
to categorize its 10 major inventory items using ABC
analysis.
• ABC analysis organizes the items on an annual dollar-
volume basis. Shown below (in columns 1–4) are the 10
items (identified by stock numbers), their annual demands,
and unit costs.
• Annual dollar volume is computed in column 5, along with
the percentage of the total represented by each item in
column 6. Column 7 groups the 10 items into A, B, and C
categories.
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ABC Analysis
ABC Calculation
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ABC Analysis
• Other criteria than annual dollar volume may be used
– High shortage or holding cost
– Anticipated engineering changes
– Delivery problems
– Quality problems
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ABC Analysis
• Policies employed may include
1. More emphasis on supplier development for A items
2. Tighter physical inventory control for A items
3. More care in forecasting A items
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Record Accuracy
• Accurate records are a critical ingredient in production and inventory
systems
– Periodic systems require regular checks of inventory
▪ Two-bin system
– Perpetual inventory tracks receipts and subtractions on a
continuing basis
▪ May be semi-automated
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Record Accuracy
• Incoming and outgoing
record keeping must be
accurate
• Stockrooms should be
secure
• Necessary to make precise
decisions about ordering,
scheduling, and shipping
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Cycle Counting
• Items are counted and records updated on a periodic
basis
• Often used with ABC analysis
• Has several advantages
1. Eliminates shutdowns and interruptions
2. Eliminates annual inventory adjustment
3. Trained personnel audit inventory accuracy
4. Allows causes of errors to be identified and corrected
5. Maintains accurate inventory records
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Cycle Counting Example

5,000 items in inventory, 500 A items, 1,750 B items, 2,750
C items
Policy is to count A items every month (20 working days), B
items every quarter (60 days), and C items every six months
(120 days)

CYCLE COUNTING NUMBER OF ITEMS

ITEM CLASS QUANTITY
POLICY COUNTED PER DAY
A 500 Each month 500/20 = 25/day
B 1,750 Each quarter 1,750/60 = 29/day
C 2,750 Every 6 months 2,750/120 = 23/day
blank blank blank 77/day
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Control of Service Inventories

• Can be a critical component of profitability
• Losses may come from shrinkage
• Applicable techniques include
1. Good personnel selection, training, and discipline
2. Tight control of incoming shipments
3. Effective control of all goods leaving facility
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Test your Knowledge

David Alexander has compiled the following table of
six items in inventory at Angelo Products, along with
the unit cost and the annual demand in units,
classify the items in an ABC analysis
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Solution
Inventory Models
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Inventory Models
• Independent demand - the demand for item is
independent of the demand for any other item in inventory
• Dependent demand - the demand for item is dependent
upon the demand for some other item in the inventory
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Inventory Models
• Holding costs - the costs of holding or “carrying” inventory
over time (It is calculated per unit held in inventory per unit
time)
• Ordering cost - the costs of placing an order and receiving
goods
• Setup cost - cost to prepare a machine or process for
manufacturing an order
– May be highly correlated with setup time

The order/setup cost has 2 components: a fixed cost K

incurred independent of the size of the order and a
variable cost incurred on a per unit basis
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Holding Costs
Table 12.1 Determining Inventory Holding Costs
COST (AND RANGE)
CATEGORY AS A PERCENTAGE
OF INVENTORY VALUE
Housing costs (building rent or depreciation, 6% (3 - 10%)
operating costs, taxes, insurance)
Material handling costs (equipment lease or 3% (1 - 3.5%)
depreciation, power, operating cost)
Labor cost (receiving, warehousing, security) 3% (3 - 5%)

Investment costs (borrowing costs, taxes, and 11% (6 - 24%)

insurance on inventory)
Pilferage, space, and obsolescence (much higher 3% (2 - 5%)
in industries undergoing rapid change like tablets
and smart phones)
Overall carrying cost 26%

Holding costs vary considerably depending on the business, location, and

interest rates. Generally greater than 15%, some high tech and fashion
items have holding costs greater than 40%.