Chapter Four Inventory Management I. Learning objectives and requirements 1. to know the types and characteristics of Inventory 2. to know the inventory functionality 3. to know some inventory-related definitions 4. to know the components of inventory carrying cost 5. to know the methods of determining when to order and how much to order 6. to know how to manage demand uncertainty and performance cycle uncertainty 7. to understand inventory management policies II. Learning contents Section I. Inventory Functionality and Principles 1. Main contents 1) Inventory Types and Characteristics a) Raw Material Inventory b) Work-In-Process Inventory c) Maintenance/Repair/Operating Supply (MRO) Inventory d) Finished Goods Inventory 2) Inventory Functionality Table 10-2 summarizes inventory functionality. These four functionsgeographical, specialization, decoupling, balancing supply and demand, and buffering uncertainty-require inventory investment to achieve managerial operating objectives. 3) Inventory-Related Definitions a) Inventory Policy Inventory policy consists of guidelines concerning what to purchase or manufacture, when to take action, and in what quantity. It also includes decisions regarding geographical inventory positioning. b) Inventory Performance Indicators The inventory policy essentially determines inventory performance. The two key indicators of inventory performance are service level and average inventory. i)Service Level The service level is the performance target specified by management. It defines inventory performance objectives. Service level is often measured in terms of an order cycle time, case fill rate, line fill rate, order fill rate, or any combination of these. ii) Average Inventory Average inventory consists of the materials, components, work-in-process, and finished product typically stocked in the logistical system. From a policy viewpoint target inventory levels must be planned for each facility. c) Economic Order Quantity (EOQ) The Economic Order Quantity (EOQ) model provides a specific quantity balancing of these two critical cost components. By determining the EOQ and dividing it into annual demand, the frequency and size of replenishment orders minimizing the total cost of cycle inventory is identified. Prior to reviewing EOQ, it is necessary to identify costs typically associated with ordering and maintaining inventory.2. Key concepts and points Inventory, Raw Material Inventory, Work-In-Process Inventory, Maintenance/Repair/Operating Supply (MRO) Inventory, Finished Goods Inventory, Inventory Functionality, Geographical Specialization, Decoupling, Balancing Supply and Demand, Buffering Uncertainty, Inventory Policy, Inventory Performance Indicators, Service Level, Performance Cycle, Case Fill Rate, Line Fill Rate, Order Fill, Average Inventory, Order Quantity, Safety Stock, Reorder Point, Inventory Turns, Economic Order Quantity (EOQ) 3. Issues of application Students shall know well that inventory management is risky, and risk varies depending upon a firms position in the distribution channel; and the typical measures of inventory commitment are time duration, depth, and width of commitment. Section II. Inventory Carrying Cost Components Inventory carrying cost is the expense associated with maintaining inventory. Inventory expense is calculated by multiplying annual inventory carrying cost percent by average inventory value. Standard accounting practice is to value inventory at purchase or standard manufacturing cost rather than at selling price. 1. Main contents 1) Capital Cost Confusion often results from the fact that senior management frequently does not establish a clear-cut capital cost policy. For logistical planning, the cost of capital must be thought out clearly since the final rate of assessment will have a significant impact on system design and performance. 2) Taxes Taxing authorities typically assess inventory held in warehouses. The tax rate and means of assessment vary by location. The tax expense is usually a direct levy based on inventory level on a specific day of the year or average inventory level over a period of time. 3) Insurance Insurance cost is an expense based upon estimated risk or loss over time. Loss risk depends on the product and the facility storing the product. Insurance cost is also impacted by facility characteristics such as security cameras and sprinkler systems that might help reduce risk. 4) Obsolescence Obsolescence cost results from deterioration of product during storage. Obsolescence also includes financial loss when a product be-comes obsolete in terms of fashion or model design. Obsolescence costs are typically estimated based on past experience concerning markdowns, donations, or quantity destroyed. 5) Storage Storage cost is facility expense related to product holding rather than product handling. Storage cost must be allocated on the requirements of specific products since it is not