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This chapter explores the critical importance of accurate inventory management in aligning demand with supply. It discusses the impact of technological advancements, as seen in companies like Wal-Mart, and the repercussions of misjudging demand forecasts, as illustrated by Dell's inventory challenges. Key concepts addressed include the costs associated with overstocking and understocking, the role of economies of scale, and the significance of holding costs. Additionally, strategies for optimizing order quantities and timing are presented, providing insights into effective inventory control practices.
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Chapter 6 Inventory Analysis
Accurately Matching Demand with Supply is the Key Challenge: Inventories • ... by 1990 Wal-Mart was already winning an important technological war that other discounters did not seem to know was on. “Wal-Mart has the most advanced inventory technology in the business and they have invested billions in it”. (NYT, Nov. 95). • WSJ, Aug. 93: Dell Computer stock plunges. The company was sharply off in forecast of demand resulting in inventory writedowns. • BW 1997:
Costs of not Matching Supply and Demand • Cost of overstocking • liquidation, obsolescence, holding • Cost of under-stocking • lost sales and resulting lost margin
Where is the Flow Time? Operation Buffer Processing Waiting
6.1: Operational Flows I avg total inv = I input + I in-process + I output I = Ii + Ip + Io Throughput R Inventory I FLOW TIME T I = R T Flow time T = Inventory I / Throughput R
6.2: Why do Buffers Build? Why hold Inventory? • Economies of scale • Fixed costs associated with batches • Quantity discounts • Trade Promotions • Uncertainty • Information Uncertainty • Supply/demand uncertainty • Seasonal Variability • Strategic • Flooding, availability Cycle/Batch stock Safety stock Seasonal stock Strategic stock
6.3: Cost of Inventory • Physical holding cost (out-of-pocket) • Financial holding cost (opportunity cost) • Low responsiveness • to demand/market changes • to supply/quality changes Holding cost Inventory Unit Holding Cost = H = (h + r) C Physical holding cost Rate of return Cost/flow unit Example 6.2
Inventory Profile: # of jackets in inventory over time. Inventory Q R = Demand rate Time t 6.4: Economies of Scale: Inventory Build-Up Diagram R: Annual demand rate, Q: Number per replenishment order • Number of orders per year = R/Q. • I cycle = Q/2 T = Ti + Tp = (Q/2)/R + Ip/R Example 6.3
Total annual costs H Q/2: Annual holding cost S R /Q:Annual setup cost EOQ Batch Size Q Economies of Scale: Economic Order Quantity EOQ R : Demand per year, S : Setup or Order Cost ($/setup; $/order), H : Marginal annual holding cost ($/per unit per year), Q : Order quantity. C : Cost per unit ($/unit), r : Cost of capital (%/yr), h:Physical unit holding cost ($/unit,yr), H = (h + r) C. Total Cost = S(R/Q) + H(Q/2) + CR
Economies of Scale: Example 6.4 R= units C = $ / unit r = %/yr S = $ / order Total annual cost under current plan Example 6.5 EOQ Total annual cost under current plan Icycle = Q*/2 Ti = I cycle / R TC*
Find most economical order quantity: Spreadsheet (Table 6.2, p. 146)
6.6: Role of Leadtime L • The two key decisions in inventory management are: • How much to order? • When to order? ROP = L * R = Lead Time * Throughput Example 6.8
6.8: Levers Ith = R * Tth • Reducing critical activity time • Eliminating NVA activities • Redesigning the process to replace sequential with parallel processing
Learning Objectives: Batching & Economies of Scale • Increasing batch size of production (or purchase) increases average inventories (and thus cycle times). • Average inventory for a batch size of Q is Q/2. • The optimal batch size trades off setup cost and holding cost. • To reduce batch size, one has to reduce setup cost (time). • Square-root relationship between Q and (R, S): • If demand increases by a factor of 4, it is optimal to increase batch size by a factor of 2 and produce (order) twice as often. • To reduce batch size by a factor of 2, setup cost has to be reduced by a factor of 4.
