Exploring Inventory11

Exploring the Role of Inventory
Slide 1: Exploring the Role of Inventory

Slide 2: Course Overview
As Walmart Stores Inc., the worlds largest retailer, examined its global operation to find
ways to cut costs in the mid-2000s, it discovered a significant problem: too much
inventory. Like Walmart, many companies find that maintaining the level of inventory
necessary to meet customer service objectives and supply chain requirements is
challenging and costly. Inventory costs are often identified as the second largest
expense for most companies, and poor inventory management is a key factor in poor
financial performance.
In this course, you will define the role that inventory plays within an individual company
and in a supply chain. You will identify the costs and benefits that will allow you to
recognize the trade-offs associated with carrying inventory. Finally, you will evaluate
different approaches to inventory management and determine how these approaches
may be used to better manage the inventories held by your company.
Slide 3: Course Objectives

In this course, you will:
Define and classify inventory.
Identify the costs and benefits of inventory.
Identify different approaches to managing inventory.
Slide 4: Define and Classify Inventory

Slide 5: Lesson Introduction
Companies must balance the amount of material they need to complete their products
or services against the costs of obtaining and maintaining that material. Recognizing the
role that inventory plays both within your organization and in your supply chain will
assist you with achieving an appropriate balance.
In this lesson, you will:
Define inventory.
Classify inventory into one of four classifications.
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Explore the purpose of inventory in an organization.

Define the role of inventory in a supply chain.
Discover the dimensions of inventory as assets, revenue generators, and costs.
Slide 6: Define Inventory

Whether you have worked in a manufacturing facility or have only toured one, you
probably noticed that there was inventory located throughout the facility in various
forms. Inventory is stock, goods, or merchandise, and it is an asset that a company
makes for selling to a customer at a profit or buys for use in the production of some
other product. Inventory is held in various forms within an organization and throughout a
supply chain.
Slide 7: Inventory Classification

Introduction
Inventory is an asset that a company purchases or produces and can be classified
according to how it will be utilized into one of four categories: raw materials, work in
progress, finished goods, and merchandise. A company may hold one or several types
of inventory.
To better understand inventory classification, consider a company that manufactures
canned food products and the retailer that sells those products to consumers. Most
canned foods manufacturers will hold three of the four types of inventoryraw
materials, work in progress, and finished goodswhile the retailer will only hold one
type of inventory: merchandise.
Raw Materials
Raw materials are inventory that will be used in the production of another product. For
example, the canned foods manufacturer will have many raw materials such as
vegetables, aluminum cans, aluminum can lids, and labels. Each of these raw materials
will be used in the production of canned foods.
Work in Progress
Work in progress inventory is inventory that is currently in production but has not yet
completed the production process. Often, a company will hold work in progress
inventory at various stages of its production process. For the canned foods
manufacturer, work in progress inventory may be large batches of vegetables that have
been cooked or aluminum cans that have been filled but not sealed or labeled.
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Finished Goods
Finished goods are inventory that has completed the production process and that will be
sold to a customer. For the canned foods manufacturer, finished goods inventory is the
cans of foods that have been filled, labeled, and packaged for shipping. Finished goods
inventory has completed the entire production process and is ready to be shipped to
customers such as food distributors or retailers who will sell them to consumers.
Merchandise
Merchandise is different from finished goods in that merchandise is inventory that is
purchased from a supplier with the intent of selling to a customer. The canned foods
manufacturer does not carry merchandise because it produces the canned foods rather
than purchasing them. However, the retailer that purchases canned foods from the
manufacturer carries inventory that is classified as merchandise. The retailer holds the
merchandise in its warehouse or on its shelves with the intent to sell the merchandise to
consumers.
Slide 8: Inventory in an Organization

There are several reasons for a company to hold inventory, and the most fundamental
reason is to create availability. Availability is having the right inventory in the correct
amount available when the inventory is needed.
For a manufacturer, the availability of raw materials inventory means having the proper
raw materials on hand when they are needed for production. For a retailer, the
availability of merchandise means having the right merchandise on the retail shelf when
the customer wants to purchase it. Regardless of the type of industry or inventory,
availability means having enough inventory available when it is needed.
Slide 9: Inventory in a Supply Chain

While inventory is usually held to create availability, inventory serves other purposes
throughout the supply chain. Inventory may decouple operations within a firm or
decouple firms from one another.
A company may use inventory to maintain independence between its operations. By
holding an inventory of raw materials or work in progress, aspects of the companys
operations maintain a degree of independence from other aspects. For example,
workstations on an assembly line may hold some work in progress inventory to protect
against problems at an earlier stage of production.
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Similarly, a company may hold inventory to decouple itself from other entities within its
supply chain. By decoupling the supply chain, firms are able to maintain a degree of
independence. Additionally, inventory may be held throughout a supply chain to create
and maintain flexibility. By holding inventory, firms within a supply chain may be able to
react to unplanned events such as an unexpected customer order, an unplanned supply
chain disruption, or increased orders that result from a competitors action.
Slide 10: Dimensions of Inventory

Introduction
Inventory has an effect on a firms profitability. The wrong level of inventory can lead to
increased costs and too much capital tied up in current assets. Too little inventory can
result in lost sales, which leads to reduced revenue. To truly understand inventory, you
must recognize it as three distinct yet related aspects: a cost, a revenue generator, and
an asset.
Cost
While inventory serves critical purposes in an organization and the supply chain, holding
inventory comes with an associated cost. This cost includes the cost of capital required
to invest in inventory, as well as other costs such as insurance, taxes, storage space,
and obsolescence.
Since companies are always looking for ways to cut costs, inventories are a likely target.
This cost-cutting approach may be justified since holding inventory may be used to
overcome poor planning or operational performance. When inventory levels are not
justified by customer demand, however, they simply add unnecessary cost. Since
inventory is often the second-largest fulfillment expense next to transportation,
companies may place a significant focus on inventory as a cost.
Revenue Generator
While carrying inventory may be costly, it also has a strategic purpose. Inventory is often
a companys most important asset because inventory can generate revenue. For
example, without adequate inventory in the warehouse or on the shelf, wholesalers and
retailers will lose sales and the subsequent revenue and profit those sales generate.
Inventory is also essential to revenue generation for manufacturers. Manufacturers must
be able to meet the requirements of their customers for product variety and high fill
rates on orders. If a product is always out of stock, customers will look for other
suppliers who can fulfill their entire order consistently, leading to a loss of revenue for
the manufacturer.
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Asset
Inventory is a line item on a companys asset side of the balance sheet. Like any other
asset, a company must invest capital in inventory, and the asset is expected to generate
a return.
To evaluate inventorys productivity as an asset, its return on investment (ROI) can be
calculated by dividing profit by asset investment. By looking at inventory based on ROI,
all three dimensions of inventorycost, revenue and assetare captured.
Slide 11: Check Your Understanding

Slide 12: Lesson Summary
In this lesson, you defined inventory as stock that a company makes to sell to a
customer at a profit or buys to use in the production of some other product. You
discovered that inventory is held in various forms, including raw materials, work in
progress, finished goods, and merchandise.
Inventory can be classified into four categories, and you determined that it has several
purposes within an individual organization and in a supply chain. You also identified the
importance of availability as a critical purpose of inventory and recognized how
inventory can decouple organizations and create flexibility to respond to uncertainties
within the supply chain.
Finally, you explored the multidimensional nature of inventory as an asset on a
companys balance sheet that has associated costs while serving as a revenue
generator.
Slide 13: Identify Inventory Costs and Benefits

Finding an appropriate balance of inventory levels includes recognizing the benefits
gained as well as the cost concerns associated with carrying inventory. Because these
benefits and concerns include intangible aspects, calculating inventory costs is not an
exact formula. Your awareness of what and how to analyze these costs can help you to
determine an acceptable range for your company when carrying inventory.
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Identify the aspects of inventory carrying costs.
Calculate inventory carrying costs.
Examine drivers that affect inventory costs.
Describe inventorys role in meeting customer service objectives.
Explore how inventory can help leverage economies of scale.
Identify inventorys role in demand and supply risk mitigation.
Slide 15: Carrying Costs

Introduction
Inventory costs can be difficult to compute and may be called inventory holding costs or
inventory carrying costs on a ledger. The cost to carry inventory is totaled and divided
by the value of the item to create a percentage called the inventory carrying cost
percentage. Inventory carrying costs generally comprise four categories: capital costs,
storage costs, service costs, and risk costs.
Capital Costs
Capital costs are the costs associated with having money tied up in inventory. They
include the actual cost of borrowing and the opportunity cost associated with the capital
tied up in inventory. Generally, capital costs are the largest portion of inventory carrying
costs. A companys hurdle rate or minimum return on investment can be used to
estimate the inventory capital costs.
Storage Costs
Inventory must be stored somewhere such as in a plant, warehouse, or retail store,
which creates associated storage costs. Generally, the larger the physical size of the
inventory, the more space required to store it. Yet for some products such as coal,
gravel, and bricks, the storage cost is minimal because these products can be stored
outside and require little protection. However, items such as frozen food and jewelry
require expensive space due to the value or characteristics of the products, which
makes storing the inventory costly.
Further, it is generally more expensive to hold inventory at downstream nodes in a
supply chain than at upstream nodes. The value of the product generally increases as it
travels down the supply chain due to the cost associated with movement of the
inventory. Therefore, when making inventory decisions, it is also important to recognize
the storage costs associated with carrying inventory as they correlate with transportation
issues.
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Service Costs
Inventory service costs include the expenses associated with servicing or maintaining
the inventory a company holds. Inventory service costs include any taxes assessed,
physical handling, and the insurance associated with inventory. Usually, inventory
service costs are less than 2% of the value of the items in the inventory.
Risk Costs
When a company holds inventory, it assumes some risk of loss associated with the
inventory. Loss may occur for a variety of reasons. While holding inventory, damage
may occur and result in a loss of the inventory. Loss may also occur because of theft,
also called inventory shrinkage. In addition, loss may occur because of obsolescence.
Finally, the inventory may spoil or become unusable because of other concerns.
Cumulatively, inventory risk costs are the expenses incurred due to these losses or to
protect from such losses.
Slide 16: Calculate Inventory Carrying Costs

To calculate annual inventory carrying costs, consider three factors: the inventory
carrying cost percentage, the average inventory level, and the value of the inventory.
The inventory carrying cost percentage represents the cost of carrying $1.00 of
inventory for one year. For example, if a companys inventory carrying cost percentage
is 25%, then it costs $0.25 to carry $1.00 of inventory for one year.
There are many ways to determine a companys average annual inventory level. One
simple method is to record inventory at the start of a period (such as a week, month,
quarter, or year) and again at the end of the period, add them together, and divide by
two.
Additionally, the value of the inventoried item is needed. With all three numbers, the
annual inventory carrying cost can be calculated as the inventory carrying cost
percentage multiplied by the average inventory multiplied by the value of the item in the
inventory.
Slide 17: Carrying Cost Drivers

Introduction
While calculating inventory carrying costs is important, it is also critical to examine what
drives these costs: largely the level of inventory carried. Understanding this concept is
critical to controlling inventory carrying costs because managers need to be aware of
what may increase inventory levels. Some key factors that drive cost include the size of
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the product line, the number of inventory stocking locations, transportation costs, and
forward buying and discounts.
The Size of the Product Line
Each time a company adds a product line, a separate inventory of the new item is
needed, including safety stock for the new line. The net impact is an increase to the size
of the companys average inventory level.
The Number of Inventory Stocking Locations
As the number of stocking locations where inventory is carried increases, a companys
inventory level may also increase. This is the premise behind the square root law, which
indicates that the inventory carried grows (or shrinks) in proportion to the square root of
the number of stocking locations where inventory is held.
Transportation Costs
Transportation costs are usually a companys largest fulfillment expense, so companies
often attempt to ship large quantities in truckload or railcar quantities, since this is more
cost-effective. Larger shipping quantities usually result in an increased inventory level.
Forward Buying and Discounts
Forward buying strategies and price discounts can cause a company to purchase
inventory either sooner than needed or in larger quantities than usual. While both
forward buying and utilizing price discounts may be economically feasible, the
companys inventory level will increase.
Slide 18: Customer Service Benefits

Customer service is a primary benefit of carrying inventory. Customer service can be
defined in various ways, including the percentage of time when inventory is available
when needed. Using this definition in a retail setting, for example, customer service is
defined as the percentage of replenishment cycles where stockouts do not occur.
Another definition of customer service is the percentage of demand that is filled from on
hand inventory. Regardless of the definition, achieving customer service targets is a
primary benefit of carrying inventory. A direct relationship between a companys
inventory level and its level of customer service exists, so as a company decides to
increase customer service, the company may need to increase inventory and
subsequently incur additional inventory carrying costs.
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Slide 19: Economy of Scale Benefits

Carrying inventory allows a company to take advantage of economy of scale benefits. In
many cases, transportation costs greatly exceed the cost of carrying inventory, so
companies may carry larger inventories to reduce transportation costs. This is the case
with many bulky, low-value products where transport costs are a large portion of the
product's value. The savings from shipping in large quantities may more than offset the
cost of holding additional inventory.
Additionally, the ability to carry inventory may allow a company to take advantage of
discounts. It can be economical to buy in large quantities to take advantage of quantity
discounts if a company can store the inventory.
Slide 20: Supply and Demand Risk Mitigation

Carrying inventory can help a company mitigate supply chain risks. Safety stock is
defined as inventory that is carried to protect against supply and demand uncertainty. By
carrying safety stock, a company protects itself against underlying demand and supply
uncertainty.
Demand is often difficult to predict due to variability. As demand variability increases,
additional safety stock can be carried to keep from stocking out and demand can be
satisfied as it materializes. The more unpredictable the demand, the greater the safety
stock required to protect against stock-outs. Additionally, deliveries are not always on
time. Weather, equipment problems, unloading inefficiencies, mistakes by drivers, traffic
congestionany of these could make a shipment late. Companies also carry safety
stock as a buffer against late shipments so that sales will not be missed.

In this lesson, you identified the costs and benefits of carrying inventory. You discovered
that carrying inventory allows a company to take advantage of economies of scale,
mitigate the risk associated with demand and supply uncertainty, and maintain desired
customer service levels.
Conversely, you observed that carrying inventory comes with associated costs. You
found that inventory carrying costs are made up of capital, storage, service, and risk
costs. You also discovered that a companys inventory carrying costs are largely driven
by the companys inventory level and that several factors drive inventory levels.
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Further, you recognized that adding additional product lines and increasing the number
of stocking locations increases a companys inventory level. Finally, you discovered that
inventory levels might increase because of increased shipment sizes to reduce
transportation costs or to take advantage of quantity discounts.
Slide 23: Evaluate Inventory Management Approaches

Determining the levels of inventory to carry must also involve the functional teams of the
company to coordinate the needs and concerns of the organization. This coordination
will help you to choose an efficient management approach for your companys inventory.
Explore a collaborative approach to inventory management.
Describe the cost-benefit balancing act associated with carrying inventory.
View how a differentiated approach to inventory management may be used.
Identify a just-in-time approach to inventory management.
Slide 25: Collaborative Management Approach

Decisions made throughout the functional areas of a company have an effect on the
companys inventory. To effectively manage inventory, all involved functional areas must
coordinate decisions, including fulfillment, manufacturing, marketing, and procurement.
These functions cannot make decisions in isolation. They all must connect with each
other, have a consistent point of view, understand that decisions will affect the other
functional areas, and realize their decisions will have an influence on the level of
inventory carried.
For example, if procurement negotiates a volume discount, the companys cost of goods
sold is reduced; however, the companys inventory level and inventory carrying costs
may rise. Another example is if fulfillment decides to use less-than-truckload quantities
to reduce inventory, then transportation costs may increase. For a company to
effectively manage inventory, the organization must accept the basic premise that
inventory cannot be managed in isolation. It is a process that requires a collaborative
effort, where stakeholders take a total cost view.
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Slide 26: Balance Total Cost

A companys goal should be an optimal supply chain, not an optimal inventory level.
Consider the trade-off between inventory and transportation. To reduce transportation
costs, a company may decide to increase the size of shipments. Larger shipments could
mean fewer loads, but increasing the size of shipments increases inventory levels.
However, enough fewer loads could reduce transportation costs by more than the added
inventory costs. Thus, a company that takes a total cost view considers the balance of
costs and makes decisions accordingly. Such trade-offs with inventory levels exist
throughout the organization. Companies must consider and balance the trade-offs
associated with managing inventory by examining inventory costs, all other related
supply chain costs, and the subsequent effect on customer service.
Slide 27: Differentiated Management Approach

Not all products are alike in their importance to a company. Many companies will classify
inventories into categories and manage those categories differently.
Many ways exist to categorize or group a portfolio of products, including classifying
products based on their inventory turnover rate, which indicates how quickly a company
sells through its inventory or based on each products margin. The most common
classification factor is sales volume. Classifying products based on sales volume allows
a company to identify which products account for the majority of sales. Often, a small
percentage of products account for a majority of sales dollars.
After classifying products, a company may take a differentiated approach to managing
its portfolio of products. For example, a company may continuously monitor the
inventory levels of the most important products while only monitoring the inventory
levels of less important items on a periodic basis.
Slide 28: Just-in-Time Approach

The just-in-time approach to inventory management is designed to prevent incurring the
costs associated with carrying large inventory levels. To manage inventory using a justin-time method, inventory is only ordered if the current inventory level drops to a
specified reorder level, and inventory is delivered only when it is needed. For example,
raw materials are delivered to the manufacturer when they are needed at the production
line.
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The objective is to deliver the inventory in the correct quantity at the correct time.
Consider a transmission manufacturer that builds and delivers transmissions to an
automobile assembly plant. The automobile manufacturer wants the transmission to
flow into the continuing assembly process at just the right time. Using a just-in-time
approach, the transmission is delivered to the line only when it is required by the
production process, which leads to minimal inventory levels at the production facility.

In this lesson, you explored different approaches to inventory management. You found
that to properly manage inventory, functional areas must collaborate and coordinate
decisions. You also recognized that a company must consider balancing the costs and
benefits associated with carrying inventory. By balancing the associated costs, a
company can make decisions that minimize its total costs.
In addition, you discovered that a company may choose a differentiated inventory
management approach where the inventory of a product is managed based on some
criteria related to its importance to the business. You also examined the just-in-time
approach to inventory management, which attempts to have the right quantity of
inventory arrive just when the inventory is needed.
Slide 31: Course Summary

In this course, you defined inventory as stock that a company makes to sell to a
customer at a profit or buys for use in the production of some other product, and you
explored inventory as a cost, an asset, and a revenue generator. You then examined the
role that inventory plays within a company and throughout a supply chain.
In addition, you explored the costs of carrying inventory, which include capital, storage,
service, and risk costs, along with the benefits of carrying inventory, such as increased
customer service, leveraging of economies of scale, and risk mitigation. By identifying
the costs and benefits of carrying inventory, you can better assess the trade-offs
associated with it.
You also identified the factors that drive a companys inventory level, such as adding
additional product lines and increasing the number of stocking locations. Additionally,
you discovered that inventory levels might increase because of increased shipment
sizes to reduce transportation costs or to take advantage of quantity discounts.
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Finally, you evaluated different inventory management approaches that a company may
adopt to improve inventory management. Recognizing how to implement these
approaches in your company may lead to a positive impact on your companys financial
performance.
Slide 32: Assessment
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Exploring the Role of Inventory

Slide 1: Exploring the Role of Inventory

Slide 3: Course Objectives

Slide 4: Define and Classify Inventory

Explore the purpose of inventory in an organization.

Slide 6: Define Inventory

Slide 7: Inventory Classification

Slide 8: Inventory in an Organization

Slide 9: Inventory in a Supply Chain

Slide 10: Dimensions of Inventory

Slide 11: Check Your Understanding

Slide 13: Identify Inventory Costs and Benefits

In this lesson, you will:

Slide 15: Carrying Costs

Slide 16: Calculate Inventory Carrying Costs

Slide 17: Carrying Cost Drivers

Slide 18: Customer Service Benefits

Slide 19: Economy of Scale Benefits

Slide 20: Supply and Demand Risk Mitigation

Slide 21: Check Your Understanding

Slide 23: Evaluate Inventory Management Approaches

Slide 25: Collaborative Management Approach

Slide 26: Balance Total Cost

Slide 27: Differentiated Management Approach

Slide 28: Just-in-Time Approach

Slide 29: Check Your Understanding

Slide 31: Course Summary

Slide 32: Assessment

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