Why do we need inventory? Types of Inventory Optimum ordering quantity

1. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
AEMN328
Logistics and Transportation
Logistics and Transportation
(Supply Chain Management)
Inventory Management
Inventory Management
Mohammad Tawfik

2. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Inventory
Inventory

3. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
What are Inventories?
●
Inventories are goods or materials that are in
any stage of readiness that are being held for
future sale

4. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Reasons for Inventories
●
Transactional efficiency
●
Speculation
●
Hedging

5. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Types of Inventories
●
Based on stage of completion
– Raw material
– Work-In-Process
– Finished goods

6. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Types of Inventories
●
Based on reason for keeping
– Cycle inventory due to batching
– Anticipation inventory for seasonality
– Safety stock to buffer against uncertainty
– Pipeline inventory that is on-order or in-transit
– Strategic inventory to position for better negotiation

7. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Inventory
Inventory
Management
Management

8. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Back to Zeco :)

9. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org

10. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
What inventory does Zeco have?

11. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
The most important question that YOU need to
answer is:
WHY do I need inventory?
WHY do I need inventory?

12. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
The motive for inventory:
●
Transaction motive
Transaction motive: Economies of scale is
achieved when the number of set-ups are
reduced or the number of transactions are
minimized.
Donglei Du

13. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Imagine having to buy sugar 10 times a day each
for 1 kg!

14. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
The motive for inventory:
●
Precautionary motive
Precautionary motive: hedge against
uncertainty, including demand uncertainty,
supply uncertainty
Donglei Du

15. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
What if you get to buy sugar, and your supplier is
out of it!!!

16. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Or worse …
Customer have to wait until you purchase the
sugar each time a cup of coffee is ordered!!!

17. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
The motive for inventory:
●
Speculative motive
Speculative motive: hedge against price
increases in materials or labour
Donglei Du

18. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Imagine having to say:
“Sorry sir, but the coffee price have changed
because the sugar price went up an hour ago”

19. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
What is the purpose of inventory management?

20. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Purpose of Inventory Management
●
The objective of inventory is to achieve
satisfactory levels of customer service while
keeping inventory costs within reasonable
inventory costs within reasonable
bounds
bounds.
Donglei Du

21. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Purpose of Inventory Management
●
Level of customer service:
– (1) in-stock rate
”Yes sir, coming right-away”
”Yes sir, coming right-away”
– (2) number of back orders
”Sorry sir, you need to wait until we buy the sugar”
”Sorry sir, you need to wait until we buy the sugar”
– (3) inventory turnover rate: the ratio of average cost of
goods sold to average inventory investment
”Since we use sugar all the time, let’s build a sugar factory”
”Since we use sugar all the time, let’s build a sugar factory”
Donglei Du

22. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Purpose of Inventory Management
●
Inventory cost: cost
cost of ordering
ordering and carrying
carrying
trade-off
Donglei Du

23. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Inventory Metrics
●
Macro level metrics
●
Inventory Turnover Ratio or Inventory Turns
– = Cost of Goods Sold / Average Inventory (over a certain period)
●
Periods(days/weeks/months) of Inventory
– = Average Inventory / Cost of Goods Sold
●
Inventory Turnover is the reciprocal of Periods of Inventory

24. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Example
●
To make sure that he never runs out of stock,
Zeco decided to keep 1 day-worth of supplies,
all the time, in the store.
●
What is the inventory turnover ratio of Zeco
cafe?

25. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org

26. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Solution
●
Inventory Turnover Ratio or Inventory Turns
– = Cost of Goods Sold / Average Inventory (over a
certain period) = 1/1.5 = 66.7%
●
Periods(days/weeks/months) of Inventory
– = Average Inventory / Cost of Goods Sold = 1.5/1 =
150%

27. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Question!
●
In the case of Zeco Cafe, can the average
inventory become zero?
●
If yes, how?
●
If no, what is the minimum average inventory
period in any given period?

28. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Order Quantity

29. Supply Chain Management
Mohammad Tawfik
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Inventory Related Costs
●
Transaction costs for each order
– Ordering
– Receiving
– Costs of transporting

30. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
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Inventory Related Costs
●
Holding costs (depend on how much average
inventory)
– Storage costs
– Cost of working capital

31. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Economic Order Quantity

32. Supply Chain Management
Mohammad Tawfik
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http://SCM.AcademyOfKnowledge.org
The simplest case
●
Demand is known with certainty
●
Demand (D) is constant
●
Order is received instantaneously

33. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
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Ordering
●
Order Cost = Number of
Orders * (Shipping Cost +
Ordering Cost + Receiving
Cost)
●
Inventory Cost = Holding
Cost * Average Inventory +
Storage Cost

34. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Ordering
●
Total Cost = C*D/Q + H*Q/2 + S
●
To minimize cost, differentiate and equate by
zero
●
Q(optimum) = sqrt(2*D*C/H)

35. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Practical Considerations
●
Difficult to accurately assess costs
●
Suppliers insist on minimum order quantities
●
Suppliers only supply in package quantity

36. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
Assignment #3
Assignment #3

37. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
AlYomn Steel Sales
●
According to the demand data provided in the spreadsheet:
– What is the average monthly demand?
– What is the standard deviation in the monthly demand?
– If the transportation cost is LE2400, the cost of working capital is 15%
annual returns, warehouse cost is free, receiving cost LE250. What
would the optimum ordering quantity be?
– If the steel is subject to deterioration rate of 1% per month, how much
would the optimum ordering quantity be?
– Download the data spreadsheet from this link

38. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
References
References

39. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
References
●
Supply Chain Logistics, Rudolf Leuschner, Ph.D.
https://www.coursera.org/learn/supply-chain-logistics?specialization=supply-
chain-management
●
Supply Chain Operations, Rudolf Leuschner, Ph.D.
https://www.coursera.org/learn/operations?specialization=supply-chain-man
agement
●
Supply Chain Planning, Rudolf Leuschner, Ph.D.
https://www.coursera.org/learn/planning?specialization=supply-chain-manag
ement
●
Supply Chain Sourcing, Rudolf Leuschner, Ph.D.
https://www.coursera.org/learn/sourcing?specialization=supply-chain-manag
ement

40. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
References
●
Supply Chain Management Strategy, Rudolf Leuschner, Ph.D.
https://www.coursera.org/learn/supply-chain-management-strategy
●
Operations Management: Analysis and Improvement Methods, Udatta
Palekar, PhD
https://www.coursera.org/learn/operations-management?specializatio
n=value-chain-management
●
Operations Management: Strategy and Quality Management for the
Digital Age, Udatta Palekar, PhD
https://www.coursera.org/learn/process-improvement?specialization=
value-chain-management

41. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
References
●
“What does a Supply Chain Engineer do?”, StepStone,
https://www.stepstone.be/career-advice/article/supply-chain-engineer/
●
“Supply Chain Engineer job description template”, Hiring Resources,
https://recruitee.com/hiring-resources/job-description-templates/supply-chain-e
ngineer/
●
“What is supply chain management (SCM)?”, TechTarget®
https://searcherp.techtarget.com/definition/supply-chain-management-SCM
●
“Supply chain management”, WikiPedia,
https://en.wikipedia.org/wiki/Supply_chain_management
●
“The three flows of supply chain”, Nifemi Aluko,
https://kpakpakpa.com/spotlight/the-three-flows-of-supply-chain/

42. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
References
●
“Consumer Behaviour, Brand Management, Marketing and Psychology”,
Brandalyzer,
https://brandalyzer.blog/2016/03/23/the-five-major-flows-in-supply-chain/
●
“Top 3 Strategies To Improve The Supply Chain Performance In Your Business”,
Darren Woolard,
https://www.dmg-freight.com/top-3-strategies-to-improve-supply-chain-performance
-in-business/
●
“5 Ways to Increase Supply Chain Performance”, Zoe Meeken,
https://www.business.org/software/supplier/ways-to-increase-supply-chain-perform
ance/
●
“7 Tips for Effective Inventory Management in Global Supply Chain”, TradeGecko,
https://www.tradegecko.com/blog/7-tips-for-effective-inventory-management-in-a-gl
obal-supply-chain

43. Supply Chain Management
Mohammad Tawfik
#AcademyOfKnowledge
http://SCM.AcademyOfKnowledge.org
References
●
“Supply Chain Management: Inventory Management”, Donglei Du
●
“Business-Plan Forecasting”, Steven D. Peterson, Peter E. Jaret, Barbara
Findlay Schenck
●
“Excel Sales Forecasting For Dummies”, Conrad Carlberg
●
“Sales Forecasting: A Practical Guide”, Mark Blessington
●
“Sales and Operations Planning The How-To Handbook”, Thomas F.
Wallace and Robert A Stahl
●
“Introduction to Financial Forecasting in Investment Analysis”, John
Guerard