CHAPTER 8,Managing Uncertainty in a Supply Chain: Safety Inventory,9-2,Learning Objectives,To determine the costs of holding inventory. To identify the costs associated with a stockout. To understand the EOQ concept. To differentiate the various inventory flow patterns. To appreciate the contemporary approaches to managing inventory.,9-3,Overview of Inventory Management,Inventories are stocks of goods and materials that are maintained for many purposes, the most being to satisfy normal demand patterns.,Inventory management is a key component of supply-chain management, in part because inventory decision are often a start point, or driver, for other business activities such as warehousing, transportation, and materials handling.,Different functional areas have different inventory objectives. Marketing tends to want to ensure that sufficient inventory is available for customer demand in order to avoid potential stockout situations higher inventory levels. Finance group generally seeks to minimize the costs associated with holding inventory lower inventory levels.,One of the most prominent concerns about inventory is its cost, which is presented in greater detail later in this chapter. Finished goods inventories are much more expensive to hold than raw materials or work in process. The focus on inventory costs has intensified in recent years because of concern with inventory turnover.,9-7,Inventory turnover is the number of times that inventory is sold in a 1-year period. Inventory turnover: cost of goods sold divided by average inventory at cost. cost of goods sold = inventory turnover average inventory $200,000 = inventory is sold 4 times per year. $ 50,000 Inventory turnover figures can provide important insights about an organizations competitiveness and efficiency.,9-8,Compare with competitors or benchmarked companies. Low inventory turnover = high inventory carrying costs, little (or no) stockout costs. High inventory turnover = low inventory carrying costs, high stockout costs.,Its easy to say that organizations should strive for a proper balance of inventory; actually achieving it can be quite difficult because of trade-offs that are involved. Managing the tradeoff is important to maintain service levels.,9-10,Inventory Classifications,Its important to know the key classifications of inventory because the classification influences the way that inventory is managed.,Inventory is most frequently classified as Psychic stock ; Cycle or base stock; Safety or buffer stock; Pipeline or in-transit stock; Speculative stock.,While inventory generally exists to service demand, in some situations inventory is carried to stimulate demand, also known as psychic stock. Retail stores stock huge amounts of certain merchandise.,Cycle, or base, stock refers to inventory that is needed to satisfy normal demand during the course of an order cycle. We use one egg per day and we buy eggs every 12 days.,Safety, or buffer, stock refers to inventory that is held in addition to cycle stock to guard against uncertain in demand and/or lead time. making a three-egg omelet; buying eggs every 14 days.,Pipeline, or in-transit, stock is inventory that is en route between various nodes (i.e., fixed facilities such as a plant, warehouse, store) in a logistics system. eggs in transit between the retail store and your kitchen.,Speculative stock refers to inventory that is held for several reasons, including seasonal demand, projected price increases, and potential shortages of product. Spring Festival, tends to cause an increase in demand for eggs.,9-17,Inventory-Related Costs,Inventory-related costs are most frequently classified as Inventory carrying (holding) costs; Stockout costs.,Inventory carrying (holding) costs including: Obsolescence Inventory shrinkage Storage costs and handling costs Taxes Interest charges Opportunity cost,In general, inventory carrying costs are expressed in percentage terms, and this percentage is multiplied by the inventorys value. However, the calculation of a carrying cost percentage can be quite unstructured.,Stockout costs: Such costs can accrue during stockouts, when customers demand items that arent immediately available.,Although calculation of stock costs can be difficult and inexact, it is important for organization to do so because such knowledge can be beneficial when determining how much inventory to hold.,Estimating the costs or penalty for a stockout involves an understanding of customer reaction to a company being out of stock when a customer wants to buy an item. (Page 273 ),9-23,Table 9-1: Determination of the Average Cost of a Stockout,These are hypothetical figures for illustration.,As a general rule, the higher the average cost of a stockout, the better it is for the company to hold some amount of inventory (safety stock) to protect against stockouts. The higher the probability of a delayed sale, the lower the average stockout costsand the lower the inventory that needs to be held by