Inventory Management - Basics

Rohit Kapoor

Outline

Introduction
Inventory Turns
Inventory Costs
Review of Various Inventory Models

Introduction
To keep pace with demands, retail chain
outlets
Shoppers Stop
Staggering 300,000 SKUs at each outlet
Ensuring the availability of each SKU across 21 stores!
Supply chain challenge
4 regional distribution centres at Delhi, Mumbai,
Bengaluru and Kolkatta entire network
Over 400 vendors supply the regional distribution
centres!

Possible Options
Given
Supply chain design
Changing the structure
Optimal number of stock points

Improving integration
By changing supply demand parameters

Improvising the individual stock point performance

Inventory management

Some Basics
Aggregation
1000 units of paper clips and 1000 units of
computers?
Way out?
Example, K-Mart large U. S. retailer

Excerpts from Financial

Statements of Kmart and WalMart (All Numbers in Millions)
28-Jan-07 27-Jan-08 26-Jan-09 31-Jan-10 29-Jan-11
Kmart Corp.
Inventory
$6,367
Income
Total Operating Revenue $33,674
Cost of Goods Sold $26,319
Net Income
$518

$6,536

$6,350

$5,796

$4,825

$35,925
$28,161
$364

$37,028
$29,732
($268)

$36,151
$29,853
($2,446)

$30,762
$26,258
($3,219)

28-Jan-07 27-Jan-08 26-Jan-09 31-Jan-10 29-Jan-11

Wal-Mart Stores, Inc.
Inventory
$16,497 $17,076 $19,793 $21,644 $22,749
Income
Total Operating Revenue $119,299 $139,208 $166,809 $193,295 $219,812
Cost of Goods Sold $93,438 $108,725 $129,664 $150,255 $171,562
Net Income
$3,526
$4,430
$5,377
$6,295
$6,671

Inventory Turns and Margins for

Selected Retail Segments
Retail Segment
Apparel and Accessory
Catalog, Mail-Order
Department Stores
Drug and Proprietary Stores
Food Stores
Hobby, Toy/Game Stores
Home Furniture Equipments
Jewelry
Radio, TV, Consumer Electronics
Variety Stores

Examples
Ann Taylor, GAP
Spiegel, Land End, L. L. Bean
Sears, JCPenny
Rite Aid, CVS
Albertson's, Safeway
Toys R Us
Bed Bath & Beyond, Linens N' Things
Tiffany
Best Buy, Circuit City, CompUSA
Kmart, Wal-Mart, Target

Source: Based on Gaur, Fisher and Raman 2002

Annual
Inventory
Turns
4.57
8.6
3.87
5.26
10.78
2.99
5.44
1.68
4.1
4.45

Gross
Margin
37%
39%
34%
28%
26%
35%
40%
42%
31%
29%

Relationship Between Inventory

Turns and Gross Margin
10
9

Retailer B

Inventory Turns

8
7
6
5
4
Retailer A

3
2
1
0
0%

10%

20%

30%

40%

50%

Gross Margin (%)

Relationship between Inventory Turns and Gross Margins

Source: Based on Gaur, Fisher and Raman 2002

Performance of the Top 10 Indian

Manufacturing Companies
[Source: Prowess (CMIE)]
Inventory Turnover Ratio

16
14
12
10
2000

2010

6
4
2
0
Indian Oil
Corpn Ltd.

Reliance
Industries
Ltd.

Bharat
Petroleum
Corpn Ltd.

Hindustan
Petroleum
Corpn Ltd.

Steel
Authority of
India Ltd.

Chennai
Petroleum
Corpn Ltd.

Tata Motors
Ltd.

Tata Steel Bharat Heavy Maruti Udyog

Ltd.
Electricals
Ltd.
Ltd.

Performance on Inventory Turnover

Ratio of Indian Industry: Sector-wise

Food and
Metal and
Beverages Chemical Textile Machinery Transport Non-Metallic Metal Products
Worst
1.2
1.2
1.9
1.2
2.1
2.0
2.5
Average
4.0
8.5
5.3
5.5
5.1
5.1
5.5
Best
31.0
32.5
45.2
17.1
78.1
44.0
42.5
Source: Prowess, CMIE

Analytical Aspects
When demand is known
Deterministic scenario

When demand is random

Probabilistic scenario

Objective/Output of Inventory Models

When to order?
How much to order?

Costs Involved in Inventory

Models
Ordering Costs
Administrative costs
Cost to enter orders
Procurement process approval

Transportation costs
Receiving costs
Processing after receipts
Quality checking
Invoice checking and payment

Holding or Carrying Costs

Financing costs
Storage & handling cost
Investment cost

Stock-out or Shortage Cost

EOQ Model
Repetitive Ordering
Constant Demand
Continuous Ordering

EOQ Model
Indian Airlines uses 500 tail-lights per year.
Each time an order is placed, an ordering
cost of Rs. 300 is incurred. Each light costs
Rs. 24, and the holding cost is Rs.
4.8/light/year. Assume that demand occurs
at a constant rate and shortages are not
allowed. What is the EOQ? How many
orders will be placed each year? How much
time will be elapsed between the placement
of orders?

Answers

Q* = 250
No. of orders = 2
Time between orders = year
Issues:
It is difficult to estimate holding & ordering
cost
Sensitivity analysis

Sensitivity Analysis
q
50
100
150
200
250
300
350
400

HC (q)
120.0
240.0
360.0
480.0
600.0
720.0
840.0
960.0

OC (q)
3000.00
1500.00
1000.00
750.00
600.00
500.00
428.57
375.00

HC (q) + OC (q)
3120.00
1740.00
1360.00
1230.00
1200.00
1220.00
1268.57
1335.00

HC (q) + OC (q) for Indian Airlines Example

3500.00
HC (q) + OC (q)

3000.00
2500.00
2000.00

HC (q) + OC (q)

1500.00
1000.00
500.00
0.00
50

100 150 200 250 300 350 400

q

Learning
The curve is flat around Q*
Even a moderate error in the determination
of Q* will only increase cost by a slight
amount

Effect of Non Zero Lead Time

Case 1: Demand during LT <= Q*
Suppose it takes one month for a shipment of
tail lights to arrive
Reorder point (L * D)

Case 2: Demand during LT > Q*

If L = 15 months

EOQ with Uncertain Demand

Illustrative Example
Each year, a computer sells an average of 1000 boxes of
disks. Annual demand for boxes of disks is normally
distributed with a standard dev. of 40.8 boxes. The store
orders disks from a regional distributor. Each order is filled
in 2 weeks. The cost of placing an order $50 and the
annual cost of holding one box of disk in the inventory is
$10. The per-unit stockout cost (because of loss of
goodwill and the cost of placing a special order) is
assumed to be $20. The store is willing to assume that all
the demand is backlogged. Find the inventory policy
parameters.

Answers

Q* = 100
P(X>=r) = 0.05
Z = 1.645
r = 51.66
r-E(X) = 13.20

Variable Lead Time

Suppose the lead time has mean of 2 weeks
and std. dev. of 1 week. Find the reorder
level and safety stock level.
r = 72.83
SS = 34.37