Reader’s Choice—“We want to turn our inventory faster than our people.”—James Sinegal, former founder and CEO of Costco
Bell, P.C., and Noori, H., Managing Inventories Through Difficult Economic Times: A Simple Model, Interfaces, 15(5), 1985, p. 39. This paper presents an inventory model for unusual demand volatility, price, and financial conditions in difficult economic times. The model results when applied to a company’s inventory planning for the 1981–1983 recession period paralleled the company’s actual inventory situations.
Canen, A.G., and Galvao, R.D., An Application of ABC Analysis to Control Imported Material, Interfaces, 10(4), 1980, p. 22. An ABC analysis of a Brazilian company improved firm’s performance. The inventory-related costs were reduced by almost 30%.
Cohen, M., Kamesam, P.V., Kleindorfer, P., Lee, H., and Tekerian, A., Optimizer: IBM’s Multi-Echelon Inventory System for Managing Service Logistics, Interfaces, 20(1), 1990, p. 65.
This paper describes IBM’s “Optimizer” system for managing service levels and inventory of spare parts. The use of Optimizer achieved inventory reductions, better service, improved flex- ibility to meet service requirements, and better planning and control.
Farasyn, I., Perkoz, K., and Van de Velde, W., Spreadsheet Models for Inventory Target Setting at Procter & Gamble, Interfaces, 38(4), 2008, p. 241. This paper describes the
application of spreadsheet models for inventory planning in Procter & Gamble (P&G). The models identify the best inven- tory levels that provide the required customer service levels under the supply chain constraints. The models are being used worldwide by supply chain planners and have helped in reduc- ing inventory levels by $350 million.
Karmarkar, U.S., Kekre, S., Kekre, S., and Freeman, S., Lot- Sizing and Lead-Time Performance in a Manufacturing Cell, Interfaces, 15(2), 1985, p. 1. This paper examines how lot-siz- ing policies affect manufacturing lead times. The paper com- pares the simulation model developed by Eastman Kodak Co.
(Rochester, New York) and a mathematical model (Q-LOTS) available in literature. Both models gave similar results.
Kleutghen, P.P., and McGee, J.C., Development and Implementation of an Integrated Inventory Management Program at Pfizer Pharmaceuticals, Interfaces, 15(1), 1985, p. 69. This paper describes Pfizer’s inventory management sys- tem that includes demand forecasting, production planning, materials requirements planning, purchasing, and inventory management. Pfizer reduced inventories by $23.9 million and back orders by 95% over a 3-year time period.
Lee, H.L., Billington, C., and Carter, B., Hewlett-Packard Gains Control of Inventory and Service Through Design for Localization, Interfaces, 23(4), 1993, p. 1. This paper presents a model to study the impact of different design alternatives on inventory costs and delivery service. The focus is on design for localization in the manufacture of DeskJet Plus printers at Hewlett-Packard.
Pasternack, B.A., Filling Out the Doughnuts: The Single Period Inventory Model in Corporate Pricing Policy, Interfaces, 10(5), 1980, p. 96. This paper addresses the single period inventory problem for donuts, a product with short shelf life, to help managers of individual donut shops that are part of a decentralized chain to make pricing decisions that align closely with the firm’s objective. The modifications led to increased profitability.
This chapter discusses inventory control policies for effective material management in an organization. Whether making things with materials or using them to pro- vide services, materials are the major circulation system of supply chains. Materials are used in making goods and providing services. Materials flow through the sup- ply chains, which must always begin with raw materials. P/OM transforms the raw materials into materials that are work in process and finally into finished goods.
After reading this chapter, you should be able to:
◾ Explain what inventory management entails.
◾ Describe the difference between static and dynamic inventory models.
◾ Discuss demand distribution effects on inventory situations.
◾ Discuss lead-time effects on inventory situations.
◾ Describe all costs relevant to inventory models.
◾ Differentiate inventory costs by process types.
◾ Explain order point policies (OPPs) and when they are used.
◾ Discuss the use of economic order quantity (EOQ) models for determining the optimal order size for batch delivery.
◾ Discuss the use of economic production quantity (EPQ) models for determining the optimal production run for continuous delivery.
◾ Explain the operation of the perpetual inventory model and explain why it is the most widely used inventory con- trol system.
◾ Explain the operation of the periodic inventory model and describe the special circumstances that make its use desirable.
◾ Describe the quantity (price) discount model and explain how it indicates when a discount should be taken.
◾ Perform ABC classification of materials.
5.1 Introduction
Materials management is a system of broad-based planning and control over one of the most important components of the cost of goods sold (COGS). Two trends have been pervasive. The first is the marked decline of the direct labor component of the COGS. The second is the marked rise in the direct and indirect (overhead) cost of materials. Because material costs are now critical to profitability, most organiza- tions have created positions of high responsibility to oversee the many parts of the system that have to be integrated for materials management.
Materials management involves organizing and coordinating all management functions that are responsible for every aspect of materials movements and trans- formations—called the materials management system. This system is triggered by demands (including those forecasted) that deplete stocks, causing inventory man- agement to request replenishment through purchasing agents or direct contact with suppliers or vendors.
There are three main classes of materials that have to be purchased and managed.
First, there are raw materials. These are generally extracted from the ground and then refined, but they are still the basic ingredients. Examples include mined metals such as copper, gold, and platinum; chemicals such as sodium and potas- sium salts, manganese, and phosphates; grains such as wheat and rye; beans such as coffee; natural gas, and petroleum.
Raw materials have value-added by operations. Value-adding occurs when pur- chased components are further transformed by the company’s production process.
Thus, refining, processing, packaging, and shipping when done by the organization are value-adding and profit-making processes. All buyers of raw materials specify their required quality standards. Grains can be too dirty. All soy is not alike. Coffee prices vary with the perceived quality of the taste of the beans. Raw materials can be bulky and require special spacious storage bins. Companies prefer to locate their refining operations near the source of raw materials, so they do not have to transport tons of materials from which pounds or even ounces are eventually derived for use.
Organizations that are in the business of supplying raw materials at the very start of the upstream acquisition process are themselves dependent on purchas- ing. A quick summary includes the equipment to dig in the mines or harvest the crop. The deposits in which the mines are located must be acquired. The land to be planted and farmed must be procured. Mining requires tools and lubricants, and farming demands seeds and fertilizer. This leads to the somewhat trite statement that “every organization has a supplier.”
Second, components and subassemblies are purchased materials that have greater value-added than the raw materials. They are, in fact, composed of raw materials that already have experienced value-adding. Components and subassemblies are characterized by some degree of fabrication, assembly, and manufacture.
They are assembled into higher-order products by combining them with each other and with other parts made by the producer. This produces the third class of materials that need to be managed. Work in process can be stored and eventu- ally shipped as finished goods. Work in process has more value-added than the purchased subassemblies. There is a progression of value-adding that starts at raw materials and moves up the supply chain to finished goods—sold and shipped.
Inventory management encompasses the widest spectrum of activities related to materials. Let us start with the primary activities which include when and how much to make or purchase. In addition, timing of replenishments and decisions about storage are important decisions as well.
Inventories serve several functions in an organization. The main function of inventories is to reduce the interdependency of various stages of the production and delivery system. Consider three subsystems of an organization representing the supplier, production, and the market. These three subsystems are rigidly connected with each other, without any inventories, as shown in Figure 5.1.
Raw materials and purchased parts are flowing from various suppliers to manufacturing, and finished products are going from manufacturing to the mar- ket. Within the manufacturing department, semifinished goods move from one