Inventory basics. 35A00210 Operations Management. Lecture 12 Inventory management. Why do companies use inventories? Think about a Siwa store

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1 35A00210 Operations Management Lecture 12 Inventory management Lecture 12 Inventory management Inventory basics Inventory basics Pros and cons of inventory Inventory numbers Inventory management in practice Think about a Siwa store What kind of decisions do they need to make regarding their inventories? What kind of factors complicate their inventory management? Which is worse for them: having too much inventory or not having any? Why do companies use inventories? Inventory Time Uncertainty Capacity 3 4

2 What is an inventory? the stock of any item or resource used in an organization impacts directly company s investments, costs, utilization of machines and space, capacity, employees, customer service and strategic success Importance of inventory management Material management a required part of getting the product to customers hands - in theory JIT-based mode of action ideal Inventory management impacts strongly company costs and customer satisfaction - especially in trade single most important factor in balance sheet - impacts almost all daily operations Operative side an art form itself - layout, technology, tools, materials etc. - automation increasing all the time (cost and flexibility still the biggest constraints) - organizational solutions (outsourcing growing) 5 6 There are inventories in many locations Single-stage and two-stage inventory systems Classical process point of view: Producers facilities Single-stage inventory system Two-stage inventory system Supplier Step 1 Step 2 Customer Stock Sales operation Central depot Distribution Local Sales distributionoperation point In Raw transit material WIP Finished products In transit + support inventories (maintenance, spare parts, equipment, supplies) Suppliers e.g. Local retail store Suppliers e.g. Automotive parts distributor 7 8

3 A multi-stage inventory system A multi-echelon inventory system Suppliers Input stock Stage 1 WIP e.g. Television manufacturer Stage 2 WIP Stage 3 Finished goods stock Yarn producers Garment manufacturers Cloth manufacturers Regional warehouses Retail stores 9 10 Multiple ways to categorize inventories sales inventory vs. operating inventory high vs. low value (ABCD-analysis) safety stock vs. anticipation inventory perishable vs. non-perishable independent vs. dependent demand product parts vs. excess capacity Lecture 12 Inventory management Pros and cons of inventories 11

4 Three perspectives on inventory Inventory is good (just in case) Total costs matter (EOQ) Inventory is bad (just in time) 13 Inventories provide many advantages Enable responding to market demand - expected and unexpected demand, ordinary fluctuations - customer satisfaction (e.g. large product assortment) Protection from uncertainty - problems with raw material supplies (quality, time, price) - guarantee level production processes and independence - provide flexibility on work scheduling - prepare for economic changes (e.g. inflation) Ability use scale economics/advantages - production and purchasing volumes (e.g. volume discounts) - opportunity for price speculation Support corporate strategy - e.g. no labor lay offs during bad times 14 Inventories are expensive A lot of capital tied in inventories - 90% from working capital - 34% from current assets Inventories seem to be everywhere - for every production sector s GDP euro there is 40% worth of inventories On average logistics costs are 21% from the sales price - in GDP term 10,5 % Inventories block the view on other problems Long set-ups Uneven demand Machine breakdowns Bad demand forecasts Bad scheduling Unreliable suppliers Sick days Quality problems High tide Higher inventory level Low tide Lower inventory level Bottlenecks Communication problems Unbalanced line Bad layout 15 Lowering inventory levels help to see and solve other problems! 17

5 Inventory management s basic problem Lecture 12 Inventory management Service level Inventory Costs Inventory numbers Finding a balance Marketing Finance 18 Cost components of inventory Cost components of inventory Ordering costs selection costs ordering and payment process - spinning papers personnel office and supplies shipment and transportation receiving and checking up Set up costs machine set-ups - re-tooling often time consuming sample lots and their testing personnel costs required paperwork cleaning Holding costs cost of capital facilities - fixed and variable costs - technique (e.g. IT) personnel - work and management insurance and taxes loss / theft spoilage, breakdowns quality issues production problems 20 21

6 Shape of cost functions and common sense Cost components of inventory Smaller order quantity means more orders Larger order quantity means more products to be inventoried Holding costs Other costs Costs Order Ordering costs Size of order quantity Order cost of capital facilities - fixed and variable costs - technique (e.g. IT) personnel - work and management insurance and taxes loss / theft spoilage, breakdowns quality issues production problems over inventoring - e.g. extra-campaigns stock-out costs - lost sales and image - information costs - e.g. backorders - cost of rushing and production stoppages - fines purchasing and production costs - relevant e.g. in volume discount cases Key inventory ratios e s impact on inventory management Inventory turnover: sales per year ( ) (purchased prices) average inventory ( ) (all inventories) Days sales: days in a year inventory turnover Internet enables more efficient use of capital and better profit potential 24 26

7 Service level and costs clash Service level and costs clash X% from customers get the product from the shelves More efficient inventory system Cost Can anything be done? Cost Management should try to influence different inventory costs Service level - % Service level - % 28 OM-decisions behind corporate success - case Wal-Mart vs. Kmart - Kmart clear market leader till the late 1980 s sales: Wal-Mart $16B vs. Kmart $26B - both companies were founded in 1962 In 10 years Wal-Mart shoot ahead sales: Wal-Mart $137B vs. Kmart $37B Operations the best explanation - Wal-Mart concentrated on operations and cost cutting - focused heavily on information technology (EDI) and logistics - better inventory management and transportation system (faster delivery and better service-levels) - inventory turns and sales/m2 2-4 times better than Kmart - Kmart concentrated on marketing - emphasis on television commercials and product selection - e.g. Jacklyn Smith had her own product line 29 Inventory management and success - case Dell - Manufacture to order No products in distribution channel No margin for middleman 10-15% cost advantage 31

8 Strategy should not be forgotten Centralized vs. decentralized Customer service Innovation Price Centralized Decentralized Availability and flexibility is guaranteed with multilevel decentralized warehousing Small and irregular orders are guaranteed with fast deliveries from decentralized warehouses Minimize costs with centralized warehousing and minimum inventory levels Lower inventory costs - lower inventory levels - lower holding costs (EoS) Better service level Easier to coordinate - control and employees expertise Faster deliveries Possibly lower transportation costs - less transportation problems Current warehouses investments are already sunken costs! How to lower inventory costs? Inventories and finance A00110 Make better demand forecasts Think about structural changes to production - make to stock vs. make to order Speed up production and distribution Keep components and modules in inventory instead of finished products Have flexible/extra capacity to meet uncertainty and demand variability Use new technology in ordering (cheaper per order) - decreases directly lot sizes and inventory levels Move more information and less products - e.g. EDI -communication and supply chain management Use subcontractors, outsourcing services, vendoring Short term reducing inventory shows up in cash flow and balance sheet (not directly in profit and loss account) Long term Reducing inventory may show up in profit and loss account either positively or negatively (improved flexibility and problem solving vs. vulnerability to problems in material flow) 34 35

9 Lecture 12 Inventory management Inventory management in practice Basics of inventory management Running an efficient inventory system is a comprehensive process - you have to make reliable demand forecasts - you must be able to categorize you product portfolio and choose the suitable control models for each product - you must estimate correctly each product s inventory cost components - your inventory bookkeeping has to be flawless and you must set up policies that keep them data up-to-date - you must understand order-delivery lead times and their variability Central questions for each product; how much and when to order - the objective is to guarantee desired service level with reasonable inventory costs 37 Inventory management decisions What? How much? Inventory management depends on demand Independent demand (often consumer driven) e.g mobile phones Dependent demand (often related to company s own production decisions) e.g instruction booklets When? 38 39

10 Inventory management depends on demand Carriage demand Carriage tyres demand 40 OM 09 - L6 - Customer order People Plants Parts Processes Planning Pickers, IT-personnel, management, marketing Office, warehouses, help desks... Books, CD s, boxes... Receiving orders, picking, shipment... Size of warehouses, number of employees, work schedules, quality control, procurement... Customer receives the order Warehousing in practice - case Amazon and USA - Customer orders three products from Amazon (e.g. book, game and camera) via Internet. Computer in Seattle allocates the order to one of Amazon s distribution centers - five build in total warehouse area m 2 Warehousing in practice - case Amazon and USA - Three lights go on in an Atlanta suburb - customer order has been directed to the nearest warehouse with all the desired products - warehouse holds over million products - red lights indicate which products have been ordered Collectors move from light to light and signal that the product has been picked off the shelf - computer directs the route of each employee 43 44

11 Warehousing in practice - case Amazon and USA - Collected products are put in boxes and on to a conveyor belt - box contains orders for several customers - conveyor belts span over 15km and move at 3km/hour - each products bar code is scanned 15 times during the journey - some automatically, some by employees (in total 600 employees) Warehousing in practice - case Amazon and USA - The three products ordered are first gathered together in in the trough-area and then into a box - all transport boxes arrive to a single point, where the bar codes are connected to the order numbers - the three ordered products first end up in a 1-meter-wide trough and then into a box (new bar code) - warehouse has thousands of troughs Items intended as gifts are wrapped by hand - specially trained gift wrappers can process 30 packages per hour (slower are moved to other tasks ) Warehousing in practice - case Amazon and USA - Customer s order is packed, and the box is taped up, weighed and marked before the truck journey - Atlanta warehouse is designed to handle 200,000 orders a day - postal service transports 60% of shipments, UPS most of the rest - both have offices within a 15 km radius Warehousing in practice - case Amazon and USA - Order is delivered to customer s home in 1-7 days 47

12 A good inventory system is not always enough Case seasonal products - season has a limited duration - consumption fairly uncertain - replenishments often difficult to carry out - a sales- and marketing plan is a cornerstone of inventory control - ABCD-classification often helps Productional solutions often necessary - enhancing flexibility, fast response systems - delaying strategies - (postponement) - make-to-order production Marketing and production have a significant effect on warehousing! 50