ESCM 2724

SUPPLY CHAIN MANAGEMENT

PROF C HENDRIKS
LEARNING UNIT 3: INVENTORY MANAGEMENT (CH 10)
After you have studied this chapter, you should be able to:

•provide reasons why it is necessary to hold inventory;

•differentiate between the various types of inventory;

•explain some basic inventory concepts;

•identify inventory-ordering costs and inventory-carrying costs;

LEARNING UNIT 3: INVENTORY MANAGEMENT
•What is inventory:

Inventory refers to material resources that are stored for usage at a later stage, either through
transformation from a raw to a finished state, or through use in the current state.

Inventory can be seen in different categories, such as raw materials inventory, work-in-process
inventory and finished goods inventory.
LEARNING UNIT 3: INVENTORY MANAGEMENT
10.2 The purpose of inventory

There are various reasons why businesses on different levels in the supply chain hold inventory. The
functions of inventories can be classified into the following broad categories:

• Decoupling

• Balancing supply and demand

• Buffering against uncertainties in supply and demand

• Geographical specialization

• Preventing the cost of a stockout.

LEARNING UNIT 3: INVENTORY MANAGEMENT
The purpose of inventory

• Decoupling

• Decoupling provides maximum operating efficiency in a logistics environment by keeping

inventories at different stages or different locations in the supply chain. Holding inventory
at different stages may lead to economies of scale.
LEARNING UNIT 3: INVENTORY MANAGEMENT
The purpose of inventory
• Balancing supply and demand
• To reconcile supply with the demand for a product. Balancing is concerned with the elapsed time
between consumption and manufacturing and links the economies of manufacturing with variations in
consumption.
• The balancing function of inventory is most prominent in seasonal supply and/or demand. This
seasonality can take two forms:
• •Seasonal production, but year-round consumption
• •Seasonal consumption, where supply must meet peak demand.
LEARNING UNIT 3: INVENTORY MANAGEMENT
The purpose of inventory

Buffering against uncertainties in supply and demand.

Protect the supply chain against three types of uncertainty:

• Uncertainty of future demand

• Lead-time uncertainty

• Uncertainty in supply
LEARNING UNIT 3: INVENTORY MANAGEMENT
The purpose of inventory

Geographical specialization

The economic location of factories is often based mostly on the availability and cost of the factors of
production, such as land, power, materials, water and human resources.

The factors of production are not necessarily close to the markets where the final product is consumed.

Example: Factory in Italy and factory in Portugal needs different inventor.

LEARNING UNIT 3: INVENTORY MANAGEMENT
The purpose of inventory

• Preventing the cost of a stockout.

• The most important function of inventories is to ensure the availability of products – either raw materials,
semi-finished goods or final products. If these are not available, the result is the cost of a stockout.

• There are three possible costs attached to a stockout. In order of severity, these are:

• The cost of a backorder

• The cost of a lost sale

• The cost of a lost customer.

LEARNING UNIT 3: INVENTORY MANAGEMENT
10.3 Types of Inventory

10.3.1 Inventory based on its position in the supply chain

• Raw material

• Work-in-process

• Packaging material

• Finished goods inventory

LEARNING UNIT 3: INVENTORY MANAGEMENT
10.3 Types of Inventory

10.3.2 Classification of inventory based on its purpose

• Cycle stock

From a manufacturing perspective, cycle stock is the amount of stock produced in an average
production run.

From a distribution perspective, cycle stock is the inventory required to meet normal or average
demand for the product.
LEARNING UNIT 3: INVENTORY MANAGEMENT
10.3 Types of Inventory
10.3.2 Classification of inventory based on its purpose
• Transit inventory- stock that is enroute
• Safety (buffer) stock
– Demand uncertainty
– Lead-time uncertainty
– Duration of the lead time
– Service level policy of the business
– •Order quantity.
LEARNING UNIT 3: INVENTORY MANAGEMENT
10.3 Types of Inventory
10.3.2 Classification of inventory based on its purpose
• Speculative stock
To qualify for quantity discounts
When a price increase in goods is expected
When a shortage of the goods is expected
To protect against a strike
To provide for the promotion (marketing campaign) of a certain item
To provide for seasonal sales.
 LEARNING UNIT 3: INVENTORY MANAGEMENT
10.3 Types of Inventory

10.3.2 Classification of inventory based on its purpose

Dead stock

Dead stock is the term used for items for which there has been no demand for a specified
period of time. Such stock is normally obsolete and should be disposed of, since it occupies
space that could be put to better use.
LEARNING UNIT 3: INVENTORY MANAGEMENT
10.4. Inventory Concepts

10.4.1 Availability

10.4.2 Average inventory

Average inventories include cycle stock, safety stock and transit inventory.

Average inventory for a specific item is calculated as half-order quantity plus safety stock.
Where applicable, transit inventory must also be added.
LEARNING UNIT 3: INVENTORY MANAGEMENT
10.4.2 Average inventory

Order quantity = 500, then ½ order quantity is 250

Assume that safety stock is 50 then average inventory = 250 + 50 = 300

LEARNING UNIT 3: INVENTORY MANAGEMENT
LEARNING UNIT 3: INVENTORY MANAGEMENT

• 10.4.3 Inventory turnover

• Inventory turnover (or stock turnover) is a measure of how well stock is managed. It gives an indication
of how many times during a year the average stock is used up and can be expressed as follows:
Inventory turnover = total annual sales ÷ average inventory.

• If you only sell 600 ÷ 300 = turnover = 2

• But if sell 2400 ÷ 300 = turnover = 8

LEARNING UNIT 3: INVENTORY MANAGEMENT
• 10.5.1Ordering costs

• Ordering costs consist typically of administration, communication and handling costs, associated with
order placement, processing and receiving.
LEARNING UNIT 3: INVENTORY MANAGEMENT

10.5.2 Carrying costs

Costs associated with holding products in stock. Together with transport costs, these are regarded as one
of the major components of logistics costs.

Assuming a carrying cost of 25 per cent, the annual inventory cost for a business with R1 million in
average inventory is calculated as follows:
Inventory-carrying costs= value of average inventory × carrying cost %
= R1 000 000 × 25%
= R250 000
LEARNING UNIT 3: INVENTORY MANAGEMENT
• Inventory-carrying costs can be broadly categorised as follows:
• Capital costs on inventory investment
• Insurance
• Inventory risk costs
– Obsolescence
– Damage
– Shrinkage
• Storage costs.
• Leave out 10.5.3 and 10.5.4