Chapter 12: Independent Demand Inventory Management

Overview
This chapter describes the types, uses and objectives of inventory. Inventory
performance measures and relevant costs are presented. The chapter demonstrates how to
calculate the various types of order or production quantities. The benefits of small order
sizes are discussed. This chapter also explains methods used to deal with inventory, such
as single-period inventory policies, the periodic review system, continuous review
system, ABC analysis and cycle counting.
Answers to Discussion Questions in Textbook
1. Visit a local business and identify the different types of inventory used.
I have been to retailers like Office Depot and Kmart in different parts of the country.
Lets examine their different types of inventory. First, the products, such as office or
school supplies that have been purchased from their suppliers are raw materials when
they are received in the store packed in boxes. These items become WIP when they
are in process of being stocked on the shelves. Finally, they become finished goods
when they are purchased by the customer. MRO items include the cleaning supplies
for the floors, bags to put the purchased items in when they are sold, the carts used to
take the boxes of raw materials out to the shelves for stocking and the WD-40 for
ensuring that the wheels on the carts used by the customers move easily and quietly.
2. After visiting a local business, explain the different functions of their inventory.
Lets continue with the example from the question above. We need the raw materials
to be able to prepare to restock shelves once items are sold. We use WIP to move the
inventory through the process since we can not instantaneously restock shelves.
Finished goods are the items sold to the customers. Finally MRO items provide
support in the process and maintenance.
They create anticipation inventory when they buy in cases of the same quantity using
full truckloads in the fall in order to prepare for the Christmas season. They use
fluctuation inventory by keeping more items in the back storeroom to replenish the
shelves in cases where demand is higher than expected. The use of lot-size inventory
occurs when they buy more from their suppliers than they immediately need for the
customers. The MRO items facilitate the operations of the retail facility.
3. Explain the objectives of inventory management at the local business.
We meet the objective of customer service when the items are on the shelves when
the customer wants to purchase them and when the customer can be quickly serviced
through the cash registers. We can determine the percentages shipped on schedule by
determining the lateness associated with paying for the items.

4. Describe how the objectives of inventory management can be measured.

We can measure the percentage of line items that are completely out of stock on the
shelves. We can determine the percentages shipped on schedule by determining the
lateness associated with paying for the items. We could determine our objective in
terms of the time to get through the cash register. For example, an airline study
indicated that customers become frustrated if they have to wait more than eight
minutes in line for check-in.
5. Explain the different methods for measuring customer service.
We can measure the level of customer service by measuring the percentage of orders,
line items and dollar volume shipped on schedule, as well as idle time due to material
or component shortages. The percentage of line items shipped on schedule measures
the ability to deliver specific items. Idle time relates to internal customer service.
6. Compare the two techniques, inventory turnover and weeks of supply.
Inventory turnover tells us how many times we sell our current inventory level on
hand. For example, two inventory turns means our current inventory level will last
about six months since there are two six-month periods in a year. The six month time
periods is 24 weeks of supply, or how long it would take us to sell all our current
inventory without replenishing it. As you can see, these two techniques are related;
they are just different ways of describing our inventory level.
7. Describe the relevant costs associated with inventory policies.
Item costs are the costs associated with purchasing, such as price and transportation
related costs, or making an item, such as direct labor and materials. Holding costs are
the costs we incur as a result of holding inventory, such as capital, storage and risk
costs. Ordering costs are the costs of placing an order or the cost of setups in
production. Shortage costs are associated with a poor level of customer service.
8. Explain what is included in the annual holding cost.
Holding costs include the capital costs associated with the money invested in
inventory. Holding costs include the storage costs of the warehousing space, workers
and equipment that deal with the inventory. Finally, holding costs include the risk
costs of obsolescence, damage, theft, insurance and taxes.
9. Describe what is included in the ordering or setup costs.

Ordering costs include the costs to prepare and handle orders and the received goods.
Setup costs are the costs associated with preparing the order, materials and machines
to make the item.
10. Describe what is included in shortage costs.
Shortage costs are the loss of customer goodwill, which affects future sales,
backorder costs and lost sales.
11. Explain the assumptions of the EOQ model.
EOQ assumes the demand and lead times for receiving the order after placing it are
known and constant. Ordering and setup costs are fixed and constant. These costs
need to be since they are used to calculate the EOQ. Backorders are not permitted.
The quantity ordered arrives at once, just when it is needed just as the company runs
out of inventory. We can replenish the inventory right as we need it since the demand
and lead times are known.
12. Describe techniques for determining order quantities other than EOQ or EPQ.
Lot-for-lot sets the order quantity equal to the amount needed for the time period.
Fixed-order quantity orders the same amount each time an order is placed. For
example, we may order a case full of items each time we need them.
13. Describe how changes in demand, ordering cost, or holding cost affect the EOQ.
Increases in the demand or ordering costs will increase the EOQ since they have a
positive relationship, which also means that decreases in them will decrease the EOQ.
This is the case since both demand and ordering costs are in the numerator of the
EOQ formula. Since holding costs are in the denominator, there is an inverse or
negative relationship between these costs and EOQ. For example, as they increase,
the EOQ decreases and vice versa.
14. Explain how a company can justify smaller order quantities.
We can justify smaller order quantities if we can reduce the setup costs by reducing
the setup time. We can also justify smaller order quantities if the holding costs
increase.
15. Explain what safety stock is for.
Safety stock is extra inventory for dealing with times when demand is higher than
average. Therefore, safety stock determines the level of customer service.
16. Explain how safety stock affects the reorder point.

Safety stock increases the reorder point. The reorder point must at least be set to
equal the expected average demand during the lead time to replenish. Safety stock is
the extra inventory held in case demand is higher than average.
17. Describe the types of products that require a single-period model.
A single-period model is used for items with a very short selling life. Some examples
are magazines, newspapers, and holiday related items, such as pumpkins and lilies.
18. Explain the basic concept of ABC analysis.
ABC classifies the inventory items according to their importance, in terms of volume
and dollar value. We then use this information to allocate time to review and manage
the inventories. The A items are most important; thus, they are most frequently
managed. C items are the least important items.
19. Explain the concept of perpetual review.
Perpetual review is the continuous updating of the inventory record. We can easily
use point-of-sale data to track sales and bar codes to track receipt of inventory.
20. Explain how the two-bin systems work.
The inventory is divided into two bins. The second bin holds a quantity equal to the
expected demand during the replenishment time. The first bin holds the remaining
inventory. Inventory is used out of the first bin until it is depleted. Once we need to
start using the second bin, we place an order for replenishment.