CHAPTER 9: INVENTORY MANAGEMENT
CHAPTER 9: INVENTORY MANAGEMENT
PART II
END-OF-CHAPTER QUESTIONS
CHAPTER 9: INVENTORY MANAGEMENT
1. What is inventory turnover? How can a high inventory turnover ratio be detrimental to a firm?
Inventory turnover refers to the number of times that inventory is sold in a one year period. It can be calculated by dividing the cost of goods sold for a particular period by the average inventory for that period. High inventory turnover may signal a low level of inventories, which can increase the chance of product stockouts.
2. Distinguish among cycle, safety, pipeline, and speculative stock.
Cycle (base) stock refers to inventory that is needed to satisfy normal demand during the course of an order cycle. Safety (buffer) stock refers to inventory that is held in addition to cycle stock to guard against uncertainty in demand and/or lead time. Pipeline (in-transit) stock is inventory that is en route between various nodes in a logistics system, while speculative stock is inventory that is held for several reasons to include seasonal demand, projected price increases, and potential product shortages.
3. Define what is meant by inventory carrying costs. What are some of its main components?
Inventory carrying costs refer to the costs associated with holding inventory. Inventory carrying costs consist of a number of different components, and their importance can vary from product to product. These components include obsolescence costs, shrinkage costs, storage costs, taxes, and interest costs.
4. Discuss the concept of stockout costs. How can a stockout cost be calculated?
Stockouts refer to situations where customers demand items that are not immediately available and stockout costs refer to the costs associated with not having items available. Calculation of a stockout cost first requires a company to classify potential customer responses to a stockout (e.g., delays the purchase, lost sale, lost customer). Next, the company needs to assign probabilities to the various responses as well as to assign monetary losses to the various responses. The respective probabilities and losses are multiplied together and then all costs are summed to yield an average cost of stockout.
5. Distinguish between a fixed order quantity and fixed order interval system. Which one generally requires more safety stock? Why?
In a fixed order quantity system, the order size stays constant (although the time interval between orders may vary); in a fixed order interval system, the time interval is constant (although the order size may vary). The infrequency of inventory monitoring makes a fixed order interval system more susceptible to stockouts and thus there is likely to be higher levels of safety stock in a fixed order interval system.
6. Explain the logic of the EOQ model.
The logic of the EOQ model is as follows: determining an order quantity requires a company to balance two costs; the costs of carrying the inventory and the costs of ordering it. Inventory carrying costs are in direct proportion to order size; that is, the larger the order, the greater the inventory carrying costs. Ordering costs, by contrast, tend to decline with order size but not in a linear fashion. The EOQ attempts to find the point (quantity) at which ordering costs equals carrying costs.
7. How can inventory flow diagrams be useful to a logistics manager?
They present a visual depiction of additions to, and subtractions from, inventory. This could be helpful in identifying any patterns that might be occurring. In addition, inventory flow examples illustrate how safety stock can offset an increased rate of demand as well as longer than normal replenishment cycles.
8. Discuss what is meant by ABC analysis of inventory. What are several measures that can be used to determine ABC status?
ABC analysis is an approach that recognizes all inventories are not of equal value to a firm and, as a result, all inventory should not be managed in the same way. Measures that can be used to determine ABC status include sales volume in dollars, sales volume in units, the fastest selling items, item profitability, or item importance.
9. What are implications of the JIT approach for supply chain management?
The consequences of JIT actually go far beyond inventory management and JIT has important implications for supply chain efficiency. One implication is that suppliers must deliver high quality materials to the production line, in part because of JIT’s emphasis on low (no) safety stock. Moreover, because customers in a JIT system tend to place smaller, more frequent orders, it is imperative that suppliers’ order systems are capable of handling an increased number of orders in an error-free fashion. Smaller, more frequent orders, coupled with close supplier location, tend to favor truck as a mode of transportation and this means that production and distribution facilities should be designed to support truck shipments.
10. How does vendor-managed inventory differ from traditional inventory management?
In “traditional” inventory management, the size and timing of replenishment orders are the responsibility of the party using the inventory. Under vendor-managed inventory, by contrast, the size and timing of replenishment orders are the responsibility of the manufacturer. This represents a huge philosophical shift for some organizations in the sense that they are allowing another party to have control over their inventories and this requires a great deal of trust among the various parties.
11. Do substitute items or complementary items present the greater managerial challenge? Support your answer.
Either answer would be acceptable. Students should recognize that both substitute items and complementary items present managerial challenges, but the nature of these challenges is different. For instance, one challenge with substitute items might be the amount of product to hold; a challenge with complementary items might be product placement in a retail outlet.
12. Define what it meant by dead inventory. What are several ways to manage it?
Dead inventory refers to product for which there is no demand—at least under current marketing practices. Because dead inventory has often been associated with overproduction of items that customers do not want (or need), one suggestion would be make to order as opposed to make to stock. Having said this, an increasing source of dead stock in recent years involves special, highly customized orders that never end up with the customer. Suggestions for dealing with this situation include partial (or full) prepayment as well as a no-return policy. Another suggestion is for companies to more aggressively market their dead stock, and companies might also sell dead inventory via auctions. Another possibility is to donate the dead inventory to charitable causes. A last resort is to simply throw away the dead inventory in order to free up storage space.
13. Explain how an SKU might have different meanings, depending on one’s position in the supply chain.
A retailer, for example, might keep records in terms of individual items or case lots, while the warehouse that supplies the retailer may deal only with case lots or pallets loads of a product. In turn, the distributor that sells to warehouses may deal with only pallet loads or vehicle loads, and may only accept orders only for pallet loads or vehicle loads—and not case lots or individual items.
14. Why is it important for a manager to understand informal considerations with respect to inventory management?
One reason is that the increasing quest for customer service and customer satisfaction is leading many companies to engage in informal considerations. Even though “formal” inventory analysis should not be ignored, they should not be applied without taking into account informal arrangements. The informal arrangements may not fit any “formal” inventory tenets, but many informal considerations tend to do an excellent job of satisfying customers. And, without customers, businesses are not going to be very successful.
15. Discuss some of the challenges that are associated with managing repair and replacement parts.
One challenge is the difficulty in forecasting the demand for these products—when will products break down or fail? As such, it becomes challenging with respect to which parts to carry as well as the appropriate stocking levels for them. Another challenge involves the number of warehousing facilities to be used: Should the parts be more decentralized or more centralized? These and other challenges have caused some companies to outsource their repair/replacement parts business.
16. Which presents the greater reverse logistics challenge: (1) Returned items or (2) Refurbished and recycled products? Support your answer.
As was the case with question 11, either answer is acceptable. Again, it is important to recognize that both present reverse logistics challenges—but the nature of the challenges is different. For example, there is unpredictability with respect to returned items, in terms of return rates and product content. Refurbishing and recycling, by contrast, are predicated on sufficient product volumes, which require adequate storage space.
17. What are substitute items and how might they affect safety stock policies?
Substitute items refer to products that customers view as being able to fill the same need or want. With respect to safety stock policies, if a consumer has little hesitation in substituting another item for one that is out of stock, there would appear to be minimal penalties for a stockout. It is also important that companies understand substitution patterns in the sense that Product A may be a substitute for Product B, but the reverse may not be true. In such a situation, safety stock policies would need to reflect the appropriate relationships.
18. Which supply chain participant(s) should be responsible for managing inventory levels? Why?
The key to this question is the word “managing.” Although various inventory approaches may require certain select participants to maintain the inventory, supply-chain effectiveness and efficiency would argue that all supply chain participants should be involved with managing inventory levels. Because the supply chain is a system, one company’s inventory policies and practices can impact the other members of the supply chain. Failure to consider these other participants when setting inventory policies and practices could lead to dysfunctional consequences.
19. Should inventories be considered investments? Why?
The text suggests that inventories should be considered investments. Carrying costs for inventories can be significant; the return on investment to a firm for its funds tied up in inventory should be as high as the return it can obtain from other, equally risky uses of the same funds.
20. Since the mid-1990s, many beer and soft-drink cans and bottles have contained a freshness date stamped on them to indicate the latest date that the product should be consumed. What problems might such a system cause for the people responsible for managing such inventories? Discuss.
There are a variety of possible answers to this question. One consideration is that product needs to be in places where it can be bought prior to the expiration date. At a minimum, this means that companies need to be able to identify individual products, locate the products, and move the products to the appropriate place(s). The oldest inventory should be “turned” before other inventory. Another consideration involves what to do with expired product, a situation that brings into play reverse logistics considerations.
PART III
EXAMINATION QUESTIONS
CHAPTER 9: INVENTORY MANAGEMENT
Multiple Choice Questions
1. ____ refers to stocks of goods and materials that are maintained for many purposes, the most common being to satisfy normal demand patterns.
a. Logistics
b. Supply chain management
c. Inventory
d. Production
(c; p. 216)
2. Inventory turnover can be calculated by:
a. adding beginning and ending inventory; divide by two
b. dividing the cost of goods sold by average inventory
c. dividing average inventory by the cost of goods sold
d. multiplying average inventory by 1.5
e. none of the above
(b; p. 218)
3. All of the following are true, except:
a. there is no one optimal inventory turnover ratio
b. high inventory turnover may signal a low level of inventories
c. low inventory turnover results in high inventory carrying costs
d. inventory turnover is calculated by dividing the cost of goods sold by average inventory
e. all are true
(e; p. 218)
4. ____ stock is carried to stimulate demand.
a. Base
b. Speculative
c. Attractive
d. Psychic
(d; p. 218)
5. ____ stock refers to inventory that is needed to satisfy normal demand during the course of an order cycle.
a. Psychic
b. Speculative
c. Base
d. Pipeline
(c; p. 218)
6. ____ stock refers to inventory that is held in addition to cycle stock to guard against uncertainty in demand and/or lead time.
a. Buffer
b. Base
c. Pipeline
d. Speculative
(a; p. 218)
7. ____ stock refers to inventory that is en route between various nodes in a logistics system.
a. Base
b. Safety
c. Pipeline
d. Speculative
(c; p. 218)
8. ____ stock refers to inventory that is held for several reasons, to include seasonal demand, projected price increases, and potential shortages of product.
a. Base
b. Safety
c. Pipeline
d. Speculative
(d; p. 219)
9. A commonly used estimate for inventory carrying costs is ____.
a. 35%
b. 25%
c. 20%
d. 10%
e. none of the above
(b; p. 219)
10. All of the following statements are true, except:
a. in general, inventory carrying costs are expressed in percentage terms
b. in general, companies prefer to carry less inventory as carrying costs increase
c. inventory carrying costs consist of a number of different factors or categories
d. the importance of individual carrying costs factors (categories) is generally consistent from product to product
e. all are true
(d; p. 219)
11. Inventory shrinkage:
a. is another name for inventory turnover
b. refers to the fact that more items are recorded entering than leaving warehousing facilities
c. refers to situations where the size and/or volume of inventory is decreased over time
d. refers to a technique of stabilizing unit loads by using shrink wrap packaging
(b; p. 219)
12. Each of the following is a component of inventory carrying cost except:
a. storage cost
b. accounting cost
c. shrinkage cost
d. interest cost
e. all are components
(b; pp. 219-220)
13. In the
a. Gross Domestic Product growth
b. Consumer Price Index
c. The prime rate of interest
d. The yield on US Treasury bills
(c; p. 220)
14. Which of the following situations is likely the most damaging (costly) with respect to a stockout?
a. the customer buys a substitute product that yields a higher profit for the seller
b. the customer buys a substitute product that yields a lower profit for the seller
c. the customer goes to a competitor for this purchase
d. the customer says “Call me when it’s in”
(c; p. 220)
15. Which of the following statements is false?
a. with respect to stockouts, a delayed sale is virtually costless because of the customer’s brand loyalty
b. the higher the average cost of a stockout, the more inventory (safety stock) that should be held
c. tradeoffs exist between carrying costs and stockout costs
d. stockouts can be more costly than having too many items in stock
e. all are true
(e; pp. 220-221)
16. When marginal analysis is used with respect to safety stocks one is looking for:
a. the point where the costs of holding additional safety stock are equal to the savings in stockout costs avoided
b. the point where the costs of holding additional safety stock are equal to the carrying costs of the EOQ
c. the point at which 95% of possible demand situations can be covered
d. the point at which the marginal cost of one additional unit of safety stock is nearly zero
(a; p. 221)
17. Under conditions of certainty, a reorder point is equal to:
a. average daily demand in units times the length of the replenishment cycle
b. safety stock plus an EOQ
c. base stock plus safety stock
d. base stock minus safety stock
(a; p. 222)
18. The economic order quantity (EOQ) deals with calculating the proper order size with respect to ____ costs and ____ costs.
a. order; stockout
b. stockout; carrying
c. carrying; order
d. accounting; carrying
(c; p. 223)
19. If there were no inventory carrying costs, then:
a. firms would continually place orders and maintain virtually no inventory at all
b. stockout costs would be infinite
c. speculative stocks would decrease
d. customers would hold immense inventory
(d; p. 223)
20. The EOQ determines:
a. the point at which a company should reorder
b. the point at which carrying costs equal ordering costs
c. the point at which the sum of carrying costs and ordering costs is maximized
d. the relevant inventory flow for a particular time period
e. none of the above
(b; p. 224)
21. Concerning the EOQ model, if demand or annual usage increases by 10%, then the EOQ will:
a. increase
b. decrease
c. stay unchanged
d. it depends on the particular product
(a; p. 224)
22. Concerning the EOQ model, if the ordering costs increase by 10% and the product value increases by 10%, then the EOQ will:
a. increase
b. decrease
c. stay unchanged
d. it depends on the particular product
(c; p. 224)
23. Inventory flow diagrams illustrate that safety stock can prevent two problem areas, ____ and ____.
a. increased rate of demand; longer-than-normal replenishment
b. decreased rate of demand; shorter-than-normal replenishment
c. increased rate of demand; shorter-than-normal replenishment
d. decreased rate of demand; longer-than-normal replenishment
(a; p. 226)
24. ____ recognizes that all inventories are not of equal value to a firm and thus all inventories should not be managed in the same way.
a. Vendor-managed inventory
b. Suboptimization
c. Marginal analysis
d. ABC analysis
(d; p. 227)
25. The JIT concept started in:
a.
b.
c.
d.
(d; p. 228)
26. Which of the following statements about JIT is false?
a. the JIT concept started in
b. organizations should give careful consideration before adopting a JIT philosophy
c. the JIT approach views inventory as waste
d. trucking is an important mode of transportation in JIT systems
e. all are true
(a; p. 228)
27. Under ____, the size and timing of replenishment orders are the responsibility of the manufacturer.
a. Quick Response
b. Supply Chain Management
c. Vendor-Managed Inventory
d. Efficient Consumer Response
(c; pp. 229-230)
28. Which of the following is not a potential benefit to vendor-managed inventory (VMI)?
a. higher revenues
b. improved demand forecasts
c. reduced inventories
d. fewer stockouts
e. all are VMI benefits
(e; p. 230)
29. ____ items refer to those that are used or distributed together.
a. Me-too
b. Substitute
c. Co-branded
d. Complementary
(d; p. 230)
30. All of the following are suggestions for dealing with dead stock (inventory), except:
a. aggressive marketing
b. donate to charities
c. make to stock
d. throwing it away
e. all are suggestions
(e; p. 231)
31. A(n) ____ refers to a specific individual item or product for which separate records must be maintained.
a. economic order quantity
b. stock-keeping unit
c. project cargo
d. throughput
(b; p. 233)
32. What appears to be the driving force behind informal arrangements outside the distribution channel?
a. decreasing costs
b. the increasing complexity of formal inventory analysis
c. increasing quest for customer satisfaction
d. improved information systems
e. none of the above
(c; p. 233)
33. ____ can be essential to customer service and satisfaction, yet it can be extremely difficult to forecast demand for them.
a. Repair/replacement parts
b. Complementary products
c. Substitute products
d. Co-branded products
(a; p. 233)
34. All of the following statements concerning reverse logistics are true except:
a. return goods tend to be characterized by unpredictable product content
b. product returns are characterized by a predictable product flow
c. refurbishing and recycling are predicated on sufficient product volumes
d. return rates tend to vary across industry
e. all are true
(b; pp. 234-236)
35. ____ products refer to products that customers view as being able to fill the same need or want as another product.
a. Copycat
b. Cannibalized
c. Substitute
d. Complementary
(c; p. 236)
True-False Questions
1. Inventories are stocks of goods and materials that are maintained for many purposes. (True; p. 216)
2. Inventory carries its greatest costs after value has been added through manufacturing and processing. (True; p. 217)
3. The number of times that inventory is sold in a one year period is referred to as average inventory. (False; p. 218)
4. High inventory turnover indicates that a company is taking longer to sell its inventory. (False; p. 218)
5. Inventory turnover can be calculated by dividing cost of goods sold by average inventory. (False; p. 218)
6. Psychic stock is associated with retail stores. (True; p. 218)
7. Buffer stock can also be called cycle stock. (False; p. 218)
8. Safety stock refers to inventory that is held in addition to cycle stock to guard against uncertainty in demand and/or lead time. (True; p. 218)
9. Pipeline stock refers to inventory that is en route between various nodes in a logistics system. (True; p. 218)
10. As a general rule, companies prefer to carry less inventory as the carrying cost percentage decreases. (False; p.219)
11. Inventory shrinkage refers to the fact that products lose value through time. (False; p. 219)
12. In the
13. Not having enough items can be as bad as, and sometimes worse than, having too many items. (True; p. 220)
14. The higher the average cost of a stockout, the more likely a company is going to want to hold some amount of inventory (safety stock) to protect against stockouts. (True; p. 221)
15. With respect to marginal analysis as applied to stockouts, one is looking for the point at which 95% of possible demand situations can be covered. (False; p. 221)
16. In a fixed order quantity system, the order size stays constant although the time interval between orders may fluctuate. (True; p. 222)
17. A fixed order quantity system is more susceptible to stockouts than is a fixed order interval system. (False; p. 222)
18. A reorder point is equal to average daily demand divided by the length of the replenishment cycle. (False; p. 222)
19. One requirement of a fixed order interval system is that the inventory must be constantly monitored. (False; p. 223)
20. If there were no inventory carrying costs, then customers would continually place orders and maintain virtually no inventory at all, aside from safety stocks. (False; p. 223)
21. The EOQ is the point at which carrying costs equal ordering costs. (True; p. 224)
22. If demand or annual usage increases by 20%, then the relevant economic order quantity will decrease. (False; p. 224)
23. EOQs, once calculated, may not be the same as the lot sizes in which a product is commonly bought and sold. (True; p. 225)
24. Safety stock can prevent against two problem areas: An increased rate of demand and longer-than-normal replenishment. (True; p. 226)
25. ABC analysis recognizes that all inventories should not be managed in the same way. (True; p. 227)
26. In terms of ABC analysis of inventory, no more than 25% of items should be classified as “A’s.” (False; p. 227)
27. The JIT approach originated in
28. The JIT approach views inventory as waste. (True; p. 228)
29. Because of smaller, more frequent orders and closer supplier location, trucking tends to be an important mode of transportation in the JIT approach. (True; p. 228)
30. In vendor-managed inventory, the size and timing of replenishment orders are the responsibility of the manufacturer. (True; pp. 229-230)
31. One drawback of VMI is that retailers often experience lower inventory turnover. (False; p. 230)
32. Complementary products can be defined as inventories that can be used or distributed together, such as razor blades and razors. (True; p. 230)
33. One way of dealing with dead stock (inventory) is for companies to simply throw it away. (True; p. 231)
34. Inventory deals are occurring with greater frequency today than in the recent past. (False; p. 233)
35. The definition of a stock-keeping unit is the same, regardless of a party’s position/role in the supply chain. (False; p. 233)
36. The increasing quest for customer service and customer satisfaction is leading many companies to engage in informal arrangements outside the distribution channel. (True; p. 233)
37. One challenge with repair/replacement parts involves difficulties in determining which parts to carry. (True; pp. 233-234)
38. Return items are characterized by unpredictability of product flow. (True; p. 236)
39. Refurbishing refers to dismantling an existing product in order to collect component parts. (False; p. 236)
40. Product placement is often a key issue with substitute items. (False; p. 236)
PART IV
CASE SOLUTIONS
CASE 9-1: LOW NAIL COMPANY
Question 1: Using the EOQ methods outlined in chapter 9, how many kegs of nails should Low order at one time?
The EOQ formula is:
EOQ = √ 2 (annual use in units) (cost of placing an order) /
annual carrying cost per item per year
= √ 2 (2000) (60) / 2
= √ 120,000
= 345 kegs per order
Note the 2 in the denominator. That is because, on average, the rented warehouse space is only half full, which, makes the average warehousing cost per keg be $2.
Question 2: Assume all conditions in question 1 hold, except that Low’s supplier now offers a quantity discount in the form of absorbing all or part of Low’s order processing costs. For orders of 750 or more kegs of nails, the supplier will absorb all the order processing costs; for orders between 249 and 749 kegs, the supplier will absorb half. What is Low’s new EOQ? (It might be useful to lay out all costs in tabular form for this and later questions.)
Orders/year
Order size
Processing costs ($)
Warehousing costs ($)
Sum of processing and warehousing costs ($)
1
2,000
Free
2,000
2,000
2
1,000
Free
1,000
1,000
3
667
90
667
757
4
500
120
500
620
5
400
150
400
550
6
334
180
334
514
7
286
210
286
496
8
250
240
250
490
9
223
540
223
743
The new EOQ, based on the above information, is 250 kegs.
Question 3: Temporarily, ignore your work on question 2. Assume that Low’s warehouse offers to rent Low space on the basis of the average number of kegs Low will have in stock, rather than on the maximum number of kegs Low would need room for whenever a new shipment arrived. The storage cost per keg remains the same. Does this change the answer to Question 1? If so, what is the new answer?
The relevant table is as follows:
Orders/year
Order size
Processing costs ($)
Warehousing costs ($)
Sum of processing and warehousing costs ($)
1
2,000
60
1,000
1,060
2
1,000
120
500
620
3
667
180
334
524
4
500
240
250
490
5
400
300
200
500
The new EOQ, based on the above information, is 500.
Question 4: Take into account the answer to question 1 and the supplier’s new policy outlined in question 2 and the warehouse’s new policy in question 3. Then determine Low’s new EOQ.
The relevant table is as follows:
Orders/year
Order size
Processing costs ($)
Warehousing costs ($)
Sum of processing and warehousing costs ($)
1
2,000
Free
1,000
1,000
2
1,000
Free
500
500
3
667
90
334
424
4
500
120
250
370
5
400
150
200
350
6
334
180
167
347
7
286
210
143
353
The new EOQ, based on the above information, is 334.
Question 5: Temporarily, ignore your work on questions 2, 3, and 4. Low’s luck at the race track is over; he now must borrow money to finance his inventory of nails. Looking at the situation outlined in question 1, assume that the wholesale cost of nails is $40 per keg and that Low must pay interest at the rate of 1.5% per month on the unsold inventory. What is his new EOQ?
This answer can be done in tabular form as well, with the interest on inventory appearing as a new column. If one order is placed a year, the average inventory is 1,000 kegs, worth $40,000, with annual interest charges (1.5 x 12 = 18%) of $7,200. Other interest costs are calculated in a similar fashion, adjusted for average inventory.
The relevant table is as follows:
Orders/year
Order size
Processing costs ($)
Warehousing costs ($)
Interest costs ($)
Sum of processing, warehousing, and interest costs ($)
1
2,000
60
2,000
7,200
9,260
2
1,000
120
1,000
3,600
4,720
3
667
180
667
2,405
3,252
4
500
240
500
1,800
2,540
5
400
300
400
1,440
2,140
6
334
360
334
1,203
1,897
7
286
420
286
1,030
1,736
8
250
480
250
900
1,630
9
223
540
223
807
1,570
10
200
600
200
720
1,520
11
182
660
182
656
1,498
12
167
720
167
605
1,492
13
154
780
154
555
1,489
14
143
840
143
519
1,502
The new EOQ, based on the above information, is 154 kegs.
Question 6: Taking into account all the factors listed in questions 1, 2, 3, and 5, calculate Low’s EOQ for kegs of nails.
The relevant table is as follows:
Orders/year
Order size
Processing costs ($)
Warehousing costs ($)
Interest costs ($)
Sum of processing, warehousing, and interest costs ($)
1
2,000
Free
1,000
7,200
8,200
2
1,000
Free
500
3,600
4,100
3
667
90
334
2,405
2,829
4
500
120
250
1,800
2,170
5
400
150
200
1,440
1,790
6
334
180
167
1,203
1,550
7
286
210
143
1,030
1,383
8
250
240
125
900
1,265
9
223
540
112
807
1,459
The new answer, based on the above information, is 250 kegs.
CASE 9-2 JACKSON’S WAREHOUSE
(This case can best be assessed only by those familiar with STORM software, although other business analysis software programs might be used. The terminology and approach are not exactly the same as used here, especially the use of Sigma lead times, which are measured in units and can be explained as measuring the “dipping” into safety stocks. Also, some of the topics will be new to readers of this text.)
Question 1: Perform an ABC analysis. Is it of much use if the firm maintains only 12 SKUs? Why or why not?
Here is the ABC analysis printout from one software package, based on total annual usage of $3,212,560:
Item rank
Item name
Item ID
Annual usage ($)
% of cumulative items
% of $ usage
ABC classes
1
Item 2
940
748,900
8.33
23.31
A
2
Item 11
258
546,000
16.67
40.30
A
3
Item 6
447
474,240
25.00
55.07
B
4
Item 5
301
455,000
33.33
69.23
B
5
Item 1
402
312,000
41.67
78.94
B
6
Item 3
660
312,000
50.00
88.65
B
7
Item 4
829
101,400
58.33
91.81
C
8
Item 7
799
83,200
66.67
94.40
C
9
Item 12
62
74,880
75.00
96.73
C
10
Item 9
27
43,680
83.33
98.09
C
11
Item 10
196
36,400
91.67
99.22
C
12
Item 8
597
24,960
100.00
100.00
C
With only 12 SKUs, ABC analysis is probably not useful, unless it is very difficult to keep track of inventory. Nonetheless, one can see the advantages of establishing priorities for keeping track of inventory.
Question 2: Find the reorder point for each of the SKUs expressed as the point to which existing inventory must drop to trigger a replenishment order.
The printout follows:
Item name
Item ID
Orders/setups
Order size
Reorder point
Max orders outstanding
Item 1
402
26.0
8
101
1
Item 2
940
38.5
27
102
1
Item 3
660
25.0
25
164
1
Item 4
829
22.6
69
162
1
Item 5
301
47.9
38
183
1
Item 6
447
48.9
51
212
1
Item 7
799
20.8
20
57
1
Item 8
597
11.1
56
105
1
Item 9
27
14.9
14
86
1
Item 10
196
13.5
77
119
1
Item 11
258
52.0
42
231
1
Item 12
62
19.3
484
1331
1
Question 3: How large a safety stock should be maintained for each SKU?
The printout follows:
Item name
Item ID
Order cost ($)
Working stock cost ($)
Safety stock cost ($)
Total cost ($)
Item 1
402
1,950
1,800
41,871.14
45,621.14
Item 2
940
2,889.89
2,916.00
17,764.42
23,569.31
Item 3
660
1,872.00
1,875.00
20,935.57
24,682.57
Item 4
829
678.26
672.75
2,565.97
3,916.98
Item 5
301
1,436.84
1,425.00
11,102.76
13,964.60
Item 6
447
1,468.24
1,453.50
9,375.67
12,297.40
Item 7
799
624.00
600.00
2,960.74
4,184.74
Item 8
597
334.29
336.00
976.99
1,647.28
Item 9
27
445.71
441.00
5,181.29
6,068.00
Item 10
196
405.19
404.25
1,036.26
1,845.70
Item 11
258
1,560.00
1,575.00
14,186.86
17,321.86
Item 12
62
580.17
580.80
2,763.35
3,924.32
Question 4: How much money will Jackson have as its average investment in inventory?
The printout follows:
Jackson’s Warehouse
AGGREGATE INVENTORY VALUES
Inventory carrying charge = 30%
Service level = 95%
Total number of items
12
Average working stock investment
$46,931.00
Average safety stock investment
$435,736.70
Total inventory investment
$482,667.70
Cost of ordering EOQ items per year
$14,243.59
Average working stock carrying cost per year
$14,079.30
Average safety stock carrying cost per year
$130,721.00
Total inventory carrying cost per year
$144,800.30
Total cost per year
$159,043.90
Number of orders for EOQ items
341
Expected stockouts
17
Question 5: Interest rates drop, and Jackson’s now assumes that its carrying costs are 20%, rather than 30%. How will this change your answers to questions 2, 3, and 4, if at all? Explain.
The printout for question 2, as revised for 20% carrying costs:
Item name
Item ID
Orders/setups
Order size
Reorder point
Max orders outstanding
Item 1
402
20.8
10
101
1
Item 2
940
31.5
33
102
1
Item 3
660
20.1
31
164
1
Item 4
829
18.4
85
162
1
Item 5
301
38.7
47
183
1
Item 6
447
39.6
63
212
1
Item 7
799
16.6
25
57
1
Item 8
597
9.2
68
105
1
Item 9
27
12.2
17
86
1
Item 10
196
11.1
94
119
1
Item 11
258
42.8
51
231
1
Item 12
62
15.8
592
1331
1
The printout for question 3, as revised for 20 % carrying costs:
Item name
Item ID
Order cost ($)
Working stock cost ($)
Safety stock cost ($)
Total cost ($)
Item 1
402
1,560.00
1,500.00
27,914.09
30,974.09
Item 2
940
2,363.64
2,376.00
11,482.95
16,582.58
Item 3
660
1,509.68
1,550.00
13,957.05
17,016.72
Item 4
829
550.59
552.50
1,710.65
2,813.74
Item 5
301
1,161.70
1,175.00
7,401.84
9,738.54
Item 6
447
1,188.57
1,197.00
6,250.44
8,636.02
Item 7
799
499.20
500.00
1,973.82
2,973.02
Item 8
597
275.29
272.00
651.33
1,198.62
Item 9
27
367.06
357.00
3,454.19
4,178.25
Item 10
196
331.91
329.00
690.84
1,351.75
Item 11
258
1,284.71
1,275.00
9,457.91
12,017.61
Item 12
62
474.32
473.60
1,842.24
2,790.16
The printout for question 4, as revised for 20% carrying costs:
Jackson’s Warehouse
AGGREGATE INVENTORY VALUES
Inventory carrying charge = 20%
Service level = 95%
Total number of items
12
Average working stock investment
$57,785.50
Average safety stock investment
$435,736.70
Total inventory investment
$493,522.20
Cost of ordering EOQ items per year
$11,566.67
Average working stock carrying cost per year
$11,557.10
Average safety stock carrying cost per year
$87,147.35
Total inventory carrying cost per year
$98,704.45
Total cost per year
$110,271.10
Number of orders for EOQ items
277
Expected stockouts
14
Question 6: Disregard your answers to questions 4 and 5. Answer question 3 again, this time assuming that Jackson’s wants to keep enough of each SKU to fill orders 90% of the time.
The printout for question 3, assuming Jackson wants to fill orders 90% of the time:
Item name
Item ID
Order cost ($)
Working stock cost ($)
Safety stock cost ($)
Total cost ($)
Item 1
402
1,950.00
1,800.00
32,622.98
36,372.98
Item 2
940
2888.89
2916.00
13,840.76
19,645.65
Item 3
660
1,872.00
1,875.00
16,311.49
20,058.49
Item 4
829
678.26
672.75
1,999.22
3,350.23
Item 5
301
1,436.84
1,425.00
8,650.47
11,512.32
Item 6
447
1,468.24
1,453.50
7,304.84
10,226.58
Item 7
799
624.00
600.00
2,306.79
3,530.79
Item 8
597
334.29
336.00
761.20
1,431.49
Item 9
27
445.71
441.00
4,036.89
4,923.60
Item 10
196
405.19
404.25
807.38
1,616.82
Item 11
258
1,560.00
1,575.00
11,053.38
14,188.38
Item 12
62
580.17
580.80
2,153.01
3,313.97
The printout for question 4, assuming Jackson wants to fill orders 90% of the time:
Jackson’s Warehouse
AGGREGATE INVENTORY VALUES
Inventory carrying charge = 30%
Service level = 90%
Total number of items
12
Average working stock investment
$46,931.00
Average safety stock investment
$339,494.70
Total inventory investment
$386,425.70
Cost of ordering EOQ items per year
$14,243.59
Average working stock carrying cost per year
$14,079.30
Average safety stock carrying cost per year
$101,848.40
Total inventory carrying cost per year
$115,927.70
Total cost per year
$130,171.30
Number of orders for EOQ items
341
Expected stockouts
34
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