Inventory and Supply Chain Management One of the most important areas of focus in?pursuing operational excellence is improving inventory and supply chain performance.?As we have seen, s

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JWI 550 (1208) Page 1 of 13

JWI 550: Operational Excellence

Week Six Lecture Notes

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INVENTORY AND SUPPLY CHAIN MANAGEMENT What It Means No business stands alone. Every team and every process in every organization sits somewhere in a supply chain. Each must rely on others to deliver what they need to do their job. They must also rely on others to take their output and transfer it to where additional value is added all the way through to the final consumer. In a competitive and multifaceted market, there is a multitude of opportunities for companies to join forces to leverage synergies. This can include competitors coming together to expand into new markets. It can come from a company acquiring one of its suppliers or distributors to have greater control over the supply chain. It can also come from reducing redundant costs to improve operating efficiencies. Why It Matters

• If your supply chain lacks control and security, or operates less efficiently than those of your competitors, they will have a significant competitive advantage over your organization.

• You have the opportunity to explore your own role in the supply chain to determine (a) if you are the weak link, and (b) what you can personally do to strengthen the chain.

• You are given an opportunity to consider which businesses you should be in and which businesses you should not be in. That means exploring upstream or downstream expansion as well as outsourcing. This is a healthy exercise to assess the long-term viability of your current business model.

“You’ve got to be able to get the customer what they want when they want it.”

Jack Welch

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JWI 550 (1208) Page 3 of 13

THE CHALLENGE AND OPPORTUNITY FOR MANAGERS

“You’ve got to satisfy every constituent by being efficient and effective. But it’s no good if you’re efficient and the customer isn’t getting satisfied. So that’s the balance you’re always driving. But always err on the side of customer satisfaction.”

JACK WELCH

The reason Jack offered this advice is because of the long-term considerations of retaining customers and building a strong reputation that can help attract new customers. With respect to capacity and inventory planning, customer satisfaction is focused on being able to provide customers with your output when they want it. If your inventory is inadequate to meet customers’ demands, then not only will you lose a specific order, you might lose that customer forever. If this happens frequently, your organization may develop a reputation for being unable to meet demand. You will have a hard time attracting new customers once you have this reputation. Given the range of possible outcomes from being out-of-stock, it is hard to determine a firm figure that represents the cost of customer satisfaction. You can, however, model various assumptions and put them into the calculations. For example, what if 5% of the customers whose orders you can’t fill never come back? What if sales growth slows by 10% because of a poor reputation? Try running various scenarios through these models to estimate what the incremental cost of additional capacity and inventory would look like compared with the incremental opportunity cost of lower customer satisfaction. Capacity and inventory-related decisions must be viewed through a financial lens. Changing capacity and inventory means changing the amount of capital you have invested in your assets, as well as your operating costs. Lost sales from unfilled orders means you have opportunity costs (lost profits). These two figures are the financial components of the balancing act.

Careful analysis of your inventory usage can lead to cost reductions by identifying the ideal order quantities and minimum inventory you need to have on hand. Working with your supply chain partners can result in lowering minimum inventory levels if information about demand is shared early and thoroughly throughout the supply chain.

Organizations strive to match their output to meet customer demand in as efficient a manner as possible. Creating excess capacity and inventory is expensive, but being unable to meet customer demand has costs as well. Disappointing a customer is hard to bounce back from. Thus, we have Jack’s advice when it comes to capacity and inventory planning: “Err on the side of customer satisfaction.”

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JWI 550 (1208) Page 4 of 13

YOUR STARTING POINT

1. How do you feel about the relationship you have with your suppliers or distributors? Do you

feel you communicate well? Do you feel you are all part of a team, even if they work for an outside company? What would they say about you if they were asked the same question?

2. Are you aware of what your competitors are paying for their supplies and their distribution costs? Do you get the sense their costs are higher or lower than yours? What evidence do you have to support this?

3. What keeps you up at night worrying about the supplies you need or about what happens to your product once you hand it off? What do you feel most vulnerable about in your current model?

4. What supply chain changes, if made by one of your competitors, would present the most serious threat to your business?

5. Are stockouts (where inventory runs out) and backorders common? Are there stoppages or interruptions in production or work flows because of inventory shortages or late deliveries? Or do you have too much inventory? Do you have to write off excess or obsolete inventory every year?

6. How much money is tied up in inventory? What is your inventory turnover rate?

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JWI 550 (1208) Page 5 of 13

INVENTORY: MANAGE YOUR SUPPLY CHAIN SO IT DOESN’T MANAGE YOU

Every year, certain toys are designated “the hot thing this season.” Some of these become runaway hits while others remain temporary fads. In the 1930s, the Ideal Toy and Novelty Company sold 45 million dollars’ worth of Shirley Temple dolls; according to NBC News, these were the first of the “celebrity-driven dolls.” You may have heard the term “Chatty Cathy,” but you might not know it was a best-selling doll from the 1960s that talked (one version of which featured the voice of Brady Bunch actress Maureen McCormick). Names you might be more familiar with include Cabbage Patch Kids, Teddy Ruxpin, Tickle Me Elmo, and Furby. All of these toys were in such demand when they were released, stores sold out of them prior to Christmas. This prompted parents to search furiously — and sometimes, to pay scalpers’ prices — lest they disappoint their kids on Christmas morning. More recently, the popularity of Disney’s Frozen franchise prompted toy scalpers and eager parents to buy up Frozen toys faster than they could be made. This produced a thriving secondary market for the merchandise at prices far higher than the MSRP. These crazes happen every year. They represent just one aspect of a failure to properly manage inventories. It doesn’t matter if you have a best-selling product that everyone wants. If you don’t have units on the shelves to sell, the financial outcome is the same as not having a product at all. Inventory management involves planning and control of all types of inventories. This may include forecasting demand, purchasing materials, and fulfilling sales orders. Inventory management is built on two frequently made decisions:

1. When to order 2. How much to order

To manage their inventories, business leaders must also decide whether an item should be stocked. If an item is not stocked in anticipation of future demand, the firm must make, assemble, or buy the item to meet surges in demand. This results in customers having to wait for the product on backorder unless the production and order-fulfillment lead time (the time it takes to make and fulfill the customer’s order) is so short that it is part of the expected delivery time. In that case, customers don’t experience additional delays; the Dell computer order fulfillment process is a good example. The objective of inventory management is to strike the best balance between inventory investment and customer service. Functions of Inventory Inventories serve multiple functions. Among them are the following:

• To provide a selection of goods for anticipated customer demand and to protect the firm from fluctuations in that demand

• To decouple various parts of the production process • To take advantage of quantity discounts for inputs of production • To hedge against inflation and upward price changes, which increase the cost of inputs and labor

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JWI 550 (1208) Page 6 of 13

Types of Inventory There are multiple types of inventory. They include the following:

• Raw material inventory– materials, usually purchased, that have yet to enter the manufacturing process

• Work-in-process inventory– products or components that are no longer raw materials, but which have yet to become finished products

• MROs – maintenance, repair, and operating materials

• Finished goods inventory – end items or products ready to be sold

In many companies, inventory represents a significant portion of total invested capital. Costs associated with managing inventory include:

• Holding costs –the costs of holding or “carrying” inventory over time

• Ordering costs –the costs of placing an order and receiving goods

• Setup costs –the cost to prepare a machine or process for manufacturing an order, which may correlate significantly with setup time

To manage inventory, business leaders must recognize that there are two types of demand for inventory. There is demand for finished products, and there is demand for components, parts, and raw materials (the inputs of production). These are termed independent demand and dependent demand, respectively.

• Independent demand –The demand for the item is independent of the demand for any other item in inventory.

• Dependent demand –The demand for the item depends on the demand for some other item in the inventory.

Inventory Turnover A key metric in inventory management is inventory turns or inventory turnover. Inventory turnover is the number of times that the inventory is “turned” or replaced during a time period, usually a year. More turns equals better inventory management, which translates to a high rate of throughput and conversion to sales (cash) for the business. Companies that are managed well, especially those whose leaders implement TPS and Lean, typically exhibit high inventory turnover.

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JWI 550 (1208) Page 7 of 13

FIXED QUANTITY AND FIXED PERIOD INVENTORY CONTROL MODELS

There are two basic models in inventory control. These are fixed quantity (Q) and fixed period (P).

• Fixed quantity (Q) system – an ordering system in which the same amount Q is ordered each time whenever the inventory level falls below the reorder point (ROP). This requires a perpetual inventory system in which records are updated every time an item is added or withdrawn from inventory.

• Fixed period (P) system – a system in which inventory orders are made at regular time intervals (P). Inventory is ordered at the end of a given period, such as a shift, day, week, or month. Then and only then is on-hand inventory counted. Only the amount necessary to bring total inventory up to a prescribed target level (T) is ordered. The shorter the period, the higher the inventory turns. In JIT or TPS/Lean environments, periods can be as short as every shift or even every hour.

SUPPLY CHAIN MANAGEMENT

Managing Inventories and Sourcing Supply chain management describes the coordination of all supply chain activities, starting with raw materials and ending with a satisfied customer. It includes activities required to manage the flow of materials, information, people, and money from the suppliers’ suppliers to the customers’ customers. Supply chain management is the integration of, and coordination between, a number of traditional business functions, including purchasing, operations, transportation, distribution and logistics, marketing and sales, and information systems and technology. The objective of supply chain management is to coordinate activities within the supply chain to maximize the supply chain’s competitive advantage and its benefits to the end user and consumer. Good supply chain management produces lower total system cost (lower inventory, higher quality, higher service levels, increased revenues, and increased profits for the supply chain). A key issue revolves around how the supply chain will share the benefits of improvements among players or partners in the supply chain.

Sourcing Issues: Make or Buy versus Outsourcing Business leaders face another important decision when it comes to sourcing inventory. Will they produce it in-house, or will they have it produced outside the company? Make or buy is a phrase commonly used in inventory management to refer to producing inventory internally, while outsourcing refers to obtaining products and services external to the company.

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JWI 550 (1208) Page 8 of 13

Outsourcing offers certain benefits compared to producing inventory in-house. Outsourcing transfers certain traditional internal activities and resources to outside vendors. These vendors may benefit from specialization and therefore be able to produce certain inputs or finished products more efficiently. This allows the company to focus on its core competencies. For example, a skilled manufacturer of machine parts may not necessarily have the equipment or skills in-house to produce LEDs as efficiently as Cree, one of the world’s best-known LED manufacturers. The company could outsource production of LEDs to Cree while still building most of its products, such as flashlights, in-house. This allows the business to focus on what it does well while purchasing externally those items it can’t easily produce.

Sourcing Strategies There are several common sourcing strategies a business may employ to obtain inputs of production or finished goods. These include the following:

• Many suppliers may be used for commodity products, where purchasing is typically based on price. The suppliers compete with each other, which produces cost savings for the buyer.

• Few or single supplier means the buyer forms longer-term relationships with fewer suppliers to create value through economies of scale and learning-curve improvements. Suppliers are more willing to participate in JIT programs and contribute design and technological expertise, but the cost of changing suppliers and bringing them up to speed is high.

• Vertical integration is another strategy. Integration may be forward, towards the customer, or backward, towards suppliers. This can improve cost, quality, and inventory, but it requires capital, managerial skills, and demand. It is also risky in industries experiencing rapid technological change.

• Joint ventures represent another strategy in which companies formally collaborate with one another. Skills are enhanced, supply is secured, and costs are reduced, producing benefits for all of the participants.

Maintaining an Integrated Supply Chain There are many issues in managing the integrated supply chain. These issues include the following:

• Local optimization can magnify fluctuations. The bullwhip effect occurs when orders are relayed through the supply chain, increasing at each step.

• Incentives push merchandise into the supply chain for sales that have not occurred.

• Large lots reduce shipping costs, but increase inventory holding costs and do not reflect actual sales.

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JWI 550 (1208) Page 9 of 13

Opportunities to address some of these issues include the following:

• Accurate “pull” data and shared information

• Lot size reduction coupled with reduced ordering costs

• Single-stage control of replenishment where there is a single supply chain member responsible for ordering

• Vendor Managed Inventory (VMI), a common practice at the downstream supply chain partner

• Collaborative planning, forecasting, and replenishment (CPFR) throughout the supply chain

• Blanket orders against which actual orders are released

• Electronic ordering and funds transferring speedy transactions and reducing paperwork

• Drop-shipping and special packaging which bypass the seller and reduce costs

Supply Chain Risks and Mitigation Tactics Some of the associated supply chain risks include the following:

• More reliance on supply chains, which means more risk

• Fewer suppliers, which increases dependence

• Globalization and logistical complexity

• Vendor reliability and quality risks

• Political and currency risks

OM leaders can cope with or mitigate risks through the following tactics:

• Researching and assessing possible risks

• Innovative planning

• Reducing potential disruptions

• Preparing responses for negative events

• Maintaining flexible, secure supply chains

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JWI 550 (1208) Page 10 of 13

Real-World Risk Mitigation Examples The following are examples of risks, risk reduction tactics, and how companies address them:

• When McDonald’s opened in Russia, there was a real risk that local suppliers would fail to deliver the inputs ordered. One relevant risk reduction tactic is to use multiple suppliers, employ contracts with penalties, pre-plan the supply chain, and keep other subcontractors on retainer. Every plant involved in McDonald’s production in Russia — bakery, meat, chicken, fish, and produce — is closely monitored to ensure strong links. This makes on-time delivery more likely.

• Darden Restaurants, in an effort to avoid supplier quality failure, engages in careful supplier selection, training, certification, and monitoring. It has placed extensive controls, including third- party audits, on supplier processes and logistics. This ensures constant monitoring and, thus, reduction of risk.

• Walmart has its own trucking fleet and employs numerous distribution centers throughout the United States. Using redundant transportation modes and warehouses, secure packaging, and contracts with penalties is one way to prevent logistics delays and damage to inputs. When necessary, Walmart finds alternative origins and delivery routes, bypassing problem areas.

• Toyota trains its dealers around the world to monitor, select, and contract carefully with its distributors. The principles of the Toyota Production System help dealers to improve customer service, used-car logistics, and body and paint operations. Toyota also provides an excellent example of how to deal with the risk of natural disasters, such as earthquakes, fires, and tsunamis. It maintains at least two suppliers in different geographical regions for each component.

• Boeing uses a state-of-the-art internal communication system that transmits engineering, scheduling, and logistics data to Boeing facilities and suppliers worldwide. The use of redundant databases, secure IT systems, and training of supply chain partners on proper interpretations and uses of information helps prevent information loss or distortion.

• Honda and Nissan have moved manufacturing out of Japan as a means of combating economic risk. Hedging to combat exchange rate risk, as well as employing purchasing contracts that address price fluctuations, are other methods used to combat economic risk. The exchange rate for the Japanese yen makes Japanese-made cars more expensive, at least for the time being.

In Summary… Managing the inputs of production — and ultimately making sure you have a product on the shelves to sell your customers — is a critical part of managing your business. To position itself for economic advantage, a company must manage its inventory to meet the anticipated demand for what it produces. Savvy business leaders must treat inventory management as a critical component of ongoing operations.

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JWI 550 (1208) Page 11 of 13

SUCCEEDING BEYOND THE COURSE

As you read the materials and participate in class activities, stay focused on the key learning outcomes for the week and how they can be applied to your job.

• Explore inventory and supply chain management strategies Consider how inventory is ordered — how much and when it is ordered. There is the Fixed Quantity (Q) system and the Fixed Period (P) system.

o In the Q system, the same amount Q is ordered whenever the inventory level falls below the reorder point (ROP). However, it requires constantly keeping track of inventory levels where records have to be updated every time an item is added or withdrawn from inventory. Are your records accurate? Is Q the correct amount? If you use Economic Order Quantity, do the assumptions of EOQ hold true in practice? Is the ROP too high? Is it too low, thus incurring stockouts? Alternatively, is there too much cash being tied up in inventory?

o On the other hand, the Fixed period (P) system has the advantage and procedural convenience of regular time intervals (P) where ordering takes place periodically. On- hand inventory is counted afterward. Only the amount necessary to bring total inventory up to a prescribed target level (T) is ordered. The shorter the period, the lower the T and the higher the inventory turns. JIT or TPS/Lean environments use the P system. Can your P and T be lowered?

• Evaluate different inventory models to maximize efficiency and effectiveness

An important concern in inventory management is maintaining an adequate service level in the face of variation or uncertainty in demand and/or replenishment lead time. Service level (which measures the performance of the system, and which should not be confused with fill rate, a measure of how effective inventory is at meeting demands) is the complement of the probability of a stockout. Probabilistic inventory control, which uses the average demand for inventory items to predict the demand at various service levels, accounts for such variations. Reorder points (ROP) and target inventory levels (T) are adjusted to accommodate the variation in demand and lead time for a stated service level, typically at 95%. In JIT or TPS/Lean environments, such variation or uncertainty is minimized or even eliminated. If you could find a way to shorten lead-times, you could lower the ROP and reduce your inventory carrying costs. By working closely with suppliers, you may be able to accomplish this goal. Of course, in JIT, error-free deliveries are essential.

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JWI 550 (1208) Page 12 of 13

• Explain ways to manage risk and optimize supply chain operations

The starting point in exploring supply chain improvements is to consider what your supply chain must do to meet your business objectives. You have to address these four questions: Quality – Are the right outputs being delivered at minimally acceptable standards? Capacity – Are the deliverables getting to the people who need them on time? Costs – Are financial resources being deployed in the right way to add maximum value? Control – Is the supply chain stable, secure, and flexible enough to meet the business needs of the organization? Careful analysis of your inventory usage can lead to cost reductions by identifying the ideal order quantities and minimum inventory you need to have on hand. Working with your supply chain partners can result in lowering minimum inventory levels if information about demand is shared early and thoroughly throughout the supply chain.

© Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University.

JWI 550 (1208) Page 13 of 13

ACTION PLAN To apply what I have learned this week in my course to my job, I will…

Action Item(s) Resources and Tools Needed (from this course and in my workplace) Timeline and Milestones

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