Managing Inventory Flows in The Supply Chain

Chapter 5:
Managing Inventory Flows in the

Supply Chain
Learning Objectives - After reading this
chapter, you should be able to do the following:
 Understand the importance of

coordinated flows of inventory
through supply chains.
 Understand the impact of effective
inventory management
 Appreciate the role and importance
of inventory in the economy
Chapter 6 Management of Business Logistics, 7th Ed. 2
Learning Objectives
 Understand the major reasons for
carrying inventory.
 Explain the role of inventory to major
functional areas in the company.
 Discuss the major types of
inventory-related costs and their
relationships to inventory decisions.
Management of Inventory Flows
in the Supply Chain: Introduction
 Inventory:
 The number of units and/or value
of the stock of goods held by a
company

 Inventory:
 Raw materials, work in process,
finished goods, and supplies
required for creation of a
company's goods and services.

 Inventory flow
 Represents the system companies
use to move consumer products or
raw materials through the
company.

 Inventory flow begins with

purchasing raw materials or
consumer products from a supplier

 Changes in inventory affect return on

assets (ROA), an important internal
and external metric.
 Ultimate challenge is to balance
supply and demand for inventory.

On the Line:
Inventory Turns
 Think of inventory turns as a measure

of how well a company’s products are
doing in the market and how well its
inventory is managed.

On the Line:
Inventory Turns
 Inventory Turns:
 It is a ratio showing how many
times a company's inventory is sold

and replaced over a period

On the Line:
Inventory Turns
 “Ideally, zero inventory will maximize

cash flow.”
 Inventory turnover potential is 30 to
40 times/year.

On the Line:
Inventory Turns
 Generally it is calculated as:
Inventory Turnover = Sales / Inventory

Inventory in the Firm:
Three Types of Inventory
Three types of Inventory

1. Cycle inventory
2. Seasonal inventory
3. Safety inventory

Three Types of Inventory
Cycle Inventory: An inventory system
where counts are performed
continuously, often eliminating the
need for an annual overall inventory.

Batching Economies/Cycle Stocks
 Cycle stock is the average amount

of inventory a business needs to
meet customer demand between
the times it orders more inventory
from suppliers

 Price discounts
 Result in trade-offs between large
purchases qualifying for quantity

discounts and costs of storing
inventory.

 Transportation rate discounts

 Large quantities often result in
carload freight rates.

 Largest shipments may qualify for
even lower multiple truckload,

carload or trainload rates.

 Transportation rate discounts

 Lower freight rates are often
reflected in lower consumer

prices.

 Production economics favor long

production runs.
 Results in cycle stock that must be
stored.

 Production economics favor long

production runs.
 Cycle stocks can be beneficial as
long as the appropriate analysis is

done to cost justify the inventory.

Uncertainty/Safety Stocks
 Safety Stock: The inventory a
company holds above normal
needs as a buffer against delays in
receipt of supply or changes in
customer demand.

 Reasons for uncertainty are
commonplace.
 Net results are the same:
companies accumulate safety

stock to buffer themselves
against uncertainty.

 Reasons for uncertainty are
commonplace.
 Safety stock more challenging
and complex to manage for many

firms.

 Impact of information on uncertainty
 Information technology can be
used in the supply chain to reduce

inventory.

 Bar coding, the Internet have
enabled companies to reduce

uncertainty.

Inventory in the Firm: Time/In-Transit
and Work-In-Process Stocks
 Time-related trade-offs from using

slower to faster transport modes
 Faster modes cost more but may
save a larger amount in inventory

carrying costs.

 Work-In-Process inventory should be

examined for possible trade-offs
especially in the production of high
value goods.

 Work-In-Process inventory is
materials that have been partially
converted through the production
process. These items are typically
located in the production area.

 Scheduling and actual production

times can be closely examined to
reduce inventory.

Seasonal Stocks
 Seasonality: A repetitive pattern of
demand from year to year (or other
repeating time interval), with some
periods considerably higher than
others.

Seasonal Stocks
 Seasonality can occur on the
inbound and/or outbound side of the
firm’s logistics systems.

Seasonal Stocks
 Perishable supply in agricultural
products or seasonal-related
transportation problems.

Seasonal Stocks
 Seasonal demand compressing
selling seasons in some industries
results in smaller plants producing
for stock.

Anticipatory Stocks
 In some cases, companies
anticipate that some forecasted
event will negatively impact the
production cycle.

Anticipatory Stocks
 Anticipatory Stocks:
Components, material, or goods
kept at hand to meet seasonal
fluctuations in demand or to meet
the shortfall caused by erratic
production.

Anticipatory Stocks
 For example
 Labor strikes, shortage of supplies
due to weather or political event, or

significant price increases may
prompt the firm to build inventory
levels higher than normal.

Inventory in the Firm: The Importance
of Inventory in Other Functional Areas
 Marketing uses inventory to provide

strong customer service.
 Manufacturing uses inventory to
schedule longer production runs.

Inventory in the Firm: The Importance
of Inventory in Other Functional Areas
 Finance wants inventory turnover

ratios to be kept high so that risk of
inventory loss is reduced and rate
of return on assets kept
competitively high.

Inventory Costs: Why are they
so important?
 Inventory Cost: The cost of holding
goods, usually expressed as a
percentage of the inventory value;
includes the cost of capital,
warehousing, taxes, insurance,
depreciation, and obsolescence.

so important?
 First, inventory costs are a
significant portion of total logistics
costs for many firms.
 Second, inventory levels affect
customer service levels.

so important?
 Third, inventory cost trade-off
decisions affect inventory carrying
costs.

Inventory Costs:
Inventory Carrying Cost
 1. Capital Cost
 Opportunity cost associated with
investing in inventory, or any

asset.

Inventory Costs:
 An opportunity cost is the cost of
an alternative that must be forgone
in order to pursue a certain action.
 The benefits you could have
received by taking an alternative

action.

Inventory Costs:
1. Capital Cost
 What is the implicit value of
having capital tied up in

inventory, instead of some other
worthwhile project?

Inventory Costs:
2. Storage Space Cost
 Handling costs, rents, utilities.

Inventory Costs:
3. Inventory Service Cost
 Insurance and taxes on stored
goods.
 Varies according to the value of
the goods.

Inventory Costs:
4. Inventory Risk Cost
 Largely beyond the control of the
firm.
 Due to obsolescence, damage,
theft, employee pilferage.

Inventory Costs: Calculating the
Cost of Carrying Inventory
 Step 1 - Identify the value of the
item stored in inventory (e.g. $100).

 Step 2 - Measure each individual
carrying cost component as a
percentage of product value (e.g.
25%).

 Step 3 - Multiply overall carrying
cost (as a percentage) times the
dollar value of the product (e.g.
$100 times 25% = $25 inventory
carrying cost per year.

Inventory Costs:
Nature of Carrying Cost
 Items with basically similar carrying
costs should use the same
estimate of carrying cost per dollar.

Inventory Costs:
Nature of Carrying Cost
 There are exceptions for items that
are subject to special consideration
for purposes of quick obsolescence
or high degree of theft, etc.

Inventory Costs:
Order/Setup Costs
 Order costs
 MIS costs for inventory stock level
tracking.
 Preparing and processing
purchase orders and receiving

reports.

Inventory Costs:
Order/Setup Costs
 Order costs
 Inspecting and preparing
inventory for sale.

Inventory Costs:
Order/Setup Costs
 Setup Costs
 Incurred when production
changes over from one product to

another.
 Preparing machinery and
equipment

Inventory Costs:
Expected Stockout Cost
 Cost of not having product available

when a customer wants it.
 Includes backorder costs (special
order).

Inventory Costs:
 Losing one item profit by substituting

a competing firm’s product.
 Losing a customer permanently if
customer finds they prefer the
substituted product and/or company.

Inventory Costs:
 Possible to handle this by adding

safety stock.
 In a manufacturing firm, a stockout
may result in lost hours of production
until the item is restocked.

Inventory Costs:
Inventory in Transit Carrying Cost
 Any product inbound to the firm
using F.O.B. origin should be
counted.
 Any product outbound from the firm
using F.O.B. destination should be
counted.

Inventory Costs:
 Free on board (FOB) is a trade
term requiring the seller to deliver
goods on board a vessel
designated by the buyer.

Inventory Costs:
 In transit carrying cost is generally
less than for regular inventory
because some cost components
are not present.

Inventory Costs:
 No storage costs, no taxes, and
reduced risk of obsolescence.

Classifying Inventory:
ABC Analysis
 Ranking system
 Developed in 1951 by H. Ford
Dicky of General Electric

ABC Analysis
 Ranking system
 Suggested that GE classify items
according to relative sales

volume, cash flows, lead time, or
stockout cost.

ABC Analysis
 Ranking system
 Most important inventory put in
Group A.
 Lesser impact goods put in
Groups B and C respectively.

ABC Analysis
 Pareto’s Rule (80-20 Rule)
 Based on a nineteenth century
mathematician’s observation that

many situations were dominated
by a very few elements.

ABC Analysis
 Pareto’s Rule (80-20 Rule)
 Conversely, most elements had
very little influence in most

situations.
 Separates the “trivial many” from
the “vital few”.

ABC Analysis
 The 80-20 Rule has been found to
explain many phenomena that
interest managers.
 For example, 80% of sales come
from 20% of customers; and vice

versa.

Inventory Visibility
 The ability of the firm to “see”
inventory on a real-time basis
throughout the supply chain system
requires:

 1. Tracking and tracing inventory
SKUs for all inbound and
outbound orders.

ABC Analysis
 Stock keeping unit (SKU) is a
store's or catalog's product and
service identification code, often
portrayed as a machine-readable
bar code that helps the item to be
tracked for inventory

 2. Providing summary and
detailed reports of shipments,
orders, products, transportation
equipment, location, and trade
lane activity.

 3. Notification of failures in
inventory flow.

Inventory Visibility:
General Benefits
 Improved customer service
 Improved vendor relations and cost
 Increased Return on Assets

General Benefits
 Improved cash flow
 Improved response time and
service recovery
 Improved performance metrics

Evaluating the Effectiveness of a Company’s
Approach to Inventory Management
 Are customers satisfied with the

current level of customer service?
 If standards have been set in
consultation with the customer,

this question can be answered
objectively.

 How frequently does backordering

and/or expediting occur?

 If records of these events are

kept, the answer to this question
can point out the need for a
modification or adoption of new
inventory strategies.

 How does inventory level behave as

sales rise or fall?
 From sales records, the firm can
determine if inventory levels rise

as much as sales, less than sales,
or stay about the same regardless
of sales levels.
Thank You AND God Bless
Managing Inventory Flows in

the Supply Chain
Table 6-8 The Relationship among
Inventory Turnover, Average Inventory,
and Inventory Carrying Costs

Figure 6-3 Saving Inventory
Dollars by Inventory Turns

Figure 6-4 Past and Projected
Inventory Turnover of Finished Goods

Chapter 6:
Summary and Review Questions
Students should review their knowledge of the
chapter by checking out the Summary and Study
Questions for Chapter 6.
This is the last slide for Chapter 6

End of Chapter 6 Slides
Managing Inventory Flows in

the Supply Chain
Learning Objectives - After reading this
chapter, you should be able to do the following:
 Understand the importance of coordinated

flows of inventory through supply chains.
 Understand the impact of effective inventory
management upon the return on assets
(ROA) for a company.
 Appreciate the role and importance of
inventory in the economy and why inventory
levels have declined relative to Gross
Domestic Product (GDP).
Learning Objectives
 Understand the major reasons for carrying
inventory.
 Explain the role of inventory to major
functional areas in the company.
 Discuss the major types of inventory-related
costs and their relationships to inventory
decisions.

Learning Objectives
 Understand how inventory items (stock-
keeping units) can be designed to maximize
the efficiency of managing inventory.
 Appreciate the importance and value of
inventory visibility to increasing supply chain
effectiveness.
 Understand how companies can evaluate the
effectiveness of their inventory management
techniques.
Logistics Profile:
Micros and More
 “Inventory, inventory, inventory….I am sick
and tired of hearing complaints about our
inventory levels and the costs associated with
carrying inventory,” muttered the COO.
 What is the role of inventory?
 What are the important trade-offs in the
management of inventory?
 What are the relevant inventory costs?
 Can the supply chain help control inventory?

Inventory in the Economy
 Inventory in the Economy has decreased.
 As a percentage of the GDP, from 1985 to
2000, inventory levels have decreased

from 5.4% to about 3.8%
 Examine Table 6-1.

Table 6-1: Macro Inventory Cost in
Relation to U.S. Gross Domestic Product

On the Line:
Inventory Turns
 Think of inventory turns as a measure of how well a
company’s products are doing in the market and how
well its inventory is managed.
 There is a continuing move away from traditional
build-to-forecast manufacturing models to more
flexible build-to-demand systems.
 Increasing emphasis on fully integrated supply chain
means inventories barely spend any time sitting idle.
 “Ideally, zero inventory will maximize cash flow.”
 Inventory turnover potential is 30 to 40 times/year.
Rationale for Inventory
 Product Line Proliferation
 Depth & breath of product lines trending up.
 Results in larger inventories.
 Examine Table 6-2 Total Logistics Costs-1999.

 Inventory carrying costs of $332 billion
approach 35 percent of total logistics costs for
companies.

Table 6-2
Total Logistics Costs --- 1999

 Price discounts
 Result in trade-offs between large
purchases qualifying for quantity discounts

and costs of storing inventory.
 Because physical supply inventory is often
raw materials, storage costs are often less

than savings from buying in bulk, so
supplies are stockpiled.

Anticipatory Stocks
 For example
 Labor strikes, shortage of supplies
due to weather or political event, or

significant price increases may
prompt the firm to build inventory
levels higher than normal.
 Risk assessment is important in
these cases.
Inventory Costs:
 Capital Cost
 Minimum ROR expected from
any asset.
 Debate on inventory valuation at
fully allocated or variable costs

only.

Table 6-4
Inventory and Carrying Cost Information
for Computer Hard Disks

Table 6-5 Order Frequency and
Order Cost for Computer Hard Disks

Inventory Costs:
Carrying Cost versus Order Cost
 Examine Table 6-6.
 Order costs and carrying costs respond in
opposite ways to increases in volume.
 This reinforces the logisticians need to be
able to separate costs by how they behave in
relation to changes in volume.
 Assistance from managerial accountants is
available for cost-volume-profit analysis.

Figure 6-1
Inventory Costs

Figure 6-2
ABC Inventory Analysis

Table 6-7 ABC Analysis for Big
Orange Products, Inc.

Seasonal Stocks
 Seasonality can occur on the
inbound and/or outbound side of the
firm’s logistics systems.
 Perishable supply in agricultural
products or seasonal-related
transportation problems.

Inventory Costs:
 Capital Cost
 What is the implicit value of
having capital tied up in

inventory, instead of some other
worthwhile project?
 Minimum ROR expected from
any asset.
Table 6-6 Summary of Inventory
and Cost Information

 Inventory as an asset has taken on

increased significance as companies
struggle to reduce investment in fixed
assets that accommodate inventory
(plants, warehouses, etc.).

 Collaborative planning and
forecasting requirements (CPFR)

is an example.
 Bar coding, the Internet have
enabled companies to reduce

uncertainty.
 Trade-off analysis appropriate to
assess risk and measure inventory

cost.
 Information technology can be
used in the supply chain to reduce

inventory.
Anticipatory Stocks
 Risk assessment is important in
these cases.

Table 6-3 Example of Carrying Cost
Components for Computer Hard Disks
Cost Percentage of Product Value
Capital 12 %
Storage space 2
Inventory service 3
Inventory 8
Total 25 %

Table 6-6 Summary of Inventory
and Cost Information

 Is the company calculating an

Inventory Turnover ratio for each
product SKU?
 This ratio can provide good
information on whether the

inventory is being effectively and
efficiently managed.
Inventory Costs:
 Logistics develops a cost formula
for storage space costs based on

cost behaviors.

Inventory Costs:
 Order costs and carrying costs
respond in opposite ways to
increases in volume.

Inventory Costs:
 This reinforces the logisticians
need to be able to separate costs
by how they behave in relation to
changes in volume.

ABC Analysis
 80-20 Rule
 80% of sales will come from 20%
of the inventory SKUs.

 20% of sales will come from 80%
of the inventory SKUs.

General Benefits
 Improved customer service
 Decreased cost-of-sales
 Improved vendor relations and cost
 Increased Return on Assets

Inventory Costs:
 Public space mostly variable.
 Private space a mix of fixed
and variable.


Managing Inventory Flows in The Supply Chain

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Chapter 5:

Managing Inventory Flows in the

 Understand the importance of

Chapter 6 Management of Business Logistics, 7th Ed. 4

Chapter 6 Management of Business Logistics, 7th Ed. 5

Chapter 6 Management of Business Logistics, 7th Ed. 6

 Inventory flow begins with

Chapter 6 Management of Business Logistics, 7th Ed. 7

 Changes in inventory affect return on

Chapter 6 Management of Business Logistics, 7th Ed. 8

 Think of inventory turns as a measure

Chapter 6 Management of Business Logistics, 7th Ed. 9

times a company's inventory is sold

Chapter 6 Management of Business Logistics, 7th Ed. 10

 “Ideally, zero inventory will maximize

Chapter 6 Management of Business Logistics, 7th Ed. 11

Inventory Turnover = Sales / Inventory

Chapter 6 Management of Business Logistics, 7th Ed. 12

Three types of Inventory

Chapter 6 Management of Business Logistics, 7th Ed. 13

Chapter 6 Management of Business Logistics, 7th Ed. 14

 Cycle stock is the average amount

Chapter 6 Management of Business Logistics, 7th Ed. 15

purchases qualifying for quantity

Chapter 6 Management of Business Logistics, 7th Ed. 16

 Transportation rate discounts

carload freight rates.

even lower multiple truckload,

Chapter 6 Management of Business Logistics, 7th Ed. 17

 Transportation rate discounts

reflected in lower consumer

Chapter 6 Management of Business Logistics, 7th Ed. 18

 Production economics favor long

Chapter 6 Management of Business Logistics, 7th Ed. 19

 Production economics favor long

long as the appropriate analysis is

Chapter 6 Management of Business Logistics, 7th Ed. 20

Chapter 6 Management of Business Logistics, 7th Ed. 21

companies accumulate safety

Chapter 6 Management of Business Logistics, 7th Ed. 22

and complex to manage for many

Chapter 6 Management of Business Logistics, 7th Ed. 23

used in the supply chain to reduce

Chapter 6 Management of Business Logistics, 7th Ed. 24

enabled companies to reduce

Chapter 6 Management of Business Logistics, 7th Ed. 25

 Time-related trade-offs from using

save a larger amount in inventory

Chapter 6 Management of Business Logistics, 7th Ed. 26

 Work-In-Process inventory should be

Chapter 6 Management of Business Logistics, 7th Ed. 27

Chapter 6 Management of Business Logistics, 7th Ed. 28

 Scheduling and actual production

Chapter 6 Management of Business Logistics, 7th Ed. 29

Chapter 6 Management of Business Logistics, 7th Ed. 30

Chapter 6 Management of Business Logistics, 7th Ed. 31

Chapter 6 Management of Business Logistics, 7th Ed. 32

Chapter 6 Management of Business Logistics, 7th Ed. 33

Chapter 6 Management of Business Logistics, 7th Ed. 34

Chapter 6 Management of Business Logistics, 7th Ed. 35

due to weather or political event, or

Chapter 6 Management of Business Logistics, 7th Ed. 36

 Marketing uses inventory to provide