# Category Archives: Inventory Systems for Independent Demand

## Current Trends in Inventory Management

Current Trends in Inventory Management

tory
really isn't an asset, but rather a liability. Consequently, the average amount of inventory  that these fir.ms have on hand relative to their annual sales has been going down in recent years. even though in many cases the number of products they make has increased. Firms have been able to reduce their inventories for several reasons.First,  companies  ave focused their efforts on reducing setup or order costs. The lower these costs, the smaller the economic order quantities. In addition, companies are working much closer now with their vendors. Through these relationships, product throughput times and thus lead times have been reduced significantly, again reducing the need to carry inventory. Finally, through advances in technology. many companies, like Dell Computer, are now building to order rather than to stock. thereby totally eliminating finished goods inventories.

Problem 1
Items purchased from a vendor cost \$20 each, and the forecast for next year's demand is
1,000 units. If it costs \$5 every time an order is placed for more units and the carrying cost
is \$~ per unit per year, what quantity should be ordered each time?
a. What is the total ordering cost for a year?
b. What is the total carrying cost for a year?
Solution
The quantity to be ordered each time is
J2DS /2(1,000)5
EOQ = H = 4 = 50 umts
a. The total ordering cost for a year is
D S = 1,000 (\$5) = \$100
Q 50

Problem 2
A department store sells (among other things) sports shirts for casual wear. Mr. Koste is in
charge of the men's department, and knows that the annual demand for one of these shirts
is fairly constant at 250 shirts per year. These shirts are obtained only from the manufacturer,
who charges a delivery fee of S65, regardless of the number of shirts delivered with
that order. In addition, in-house costs associated with each order total \$6.
The manufacturer Charges S16.25 per shirt, but is willing to lower the price by 3 percent
per shirt if the department store \ ill order at least 2 gross (288) each time. Of course, this
means that some shirts must be kept in inventory, and the holding costs have been estimated
at 8.5 percent per year. . Should Mr. Koste recommend that the department store accept the offer of the quantity

## ABC Inventory Planning

ABC Inventory Planning

All inventory systems are plagued by two major problems: maintaining adequate control over each inventory item and ensuring that accurate re cords of stock on hand are kept. In this section, we present ABC analysis-an inventory system offering a control technique and inventory cycle counting that can improve record accuracy.Maintaining inventory through counting, placing orders, receiving stock. and so on takes personnel time and costs money. When there are limits on these resources. as is mo often the case, the logical move is to try to use the available resources to control inventory in the best way. In other words, focus on the most important items in inventory. In theIbth century, Villefredo Pareto, in a study of the distribution of wealth in Milan. found that 20 percent of the people controlled 80 percent of the wealth. This logic of the few having the greatest importance and the many having little importance has been broadened  to include many situations and is termed the Pareto Principle. This is true in our everyday lives. where most of the decisions we make are relatively unimportant but a few shape our future. and is certainly true in inventory systems. where a few items account for the bulk of our investment. (As noted earlier in Chapter 6, Pareto analysis is also used in quality management  o identify the most frequent types of errors.) Any inventory system must specify when an order is to be place d for an item and how many units to order. In most situations involving inventory control. there are so many items involved that it is not practical to model and give thorough treatment to each and every item. To get around this problem, the ABC class notification scheme divides inventory items into three groupings: high dollar volume (A), moderate dollar volume (B), and low dollar volume (C). Dollar volume is a measure of importance: an item low in cost but high in \'01- use can be more important than a high-cost item with low volume. If the annual usage of items in inventory is listed according to dollar volume. generally the list shows that a small number of items account for a large dollar volume and that a large number of items account for a small dollar volume, Exhibit 16.11 illustrates this relationship. The ABC approach divides this list into three groupings by  value: A items Constitute roughly the top 15 percent of the items, B items the next 35 percent, and C ems the last 50 percent. From observation, it appears that the list in Exhibit 16.11 may be  meaningfully grouped with A including 20 percent (2 of the 10). B including 30 percent. and C including 50 percent. These points show clear delineations between sections. The result of that.

## Additional Issues in Inventory Management

Determining Realistic Costs

Determining Realistic Costs
lost inventory models give optimal solutions so long as the conditions of the system meet he constraints and/or assumptions of the model. While this is easy to state. it is difficult to implement. Obtaining actual order. setup. carrying. and shortage costs is often difficultvmetimes impose .ible. Part of the problem occurs because accounting data are usually average. areas to determine the proper lot sizes we need the marginal costs. Exhibit 16.10 prepares the assumed smoothly a sending cost to the more realistic actual cost. For example.  J Corporate buyer is a salaried per-en. The marginal cost for the buyer's labor toC additional order, up to a full workload i', zero. When another buyer i•..hired. it is a step toll. ( ln theory. the marginal co-t of the order that caused hiring the new buyer is the for the additional buy cr.i The same problem occur, in determining carrying costs. Warehouse costs. for example. , close to zero if empty 'LOr.t~'l' are.r- are available. Also. most companies only can te actual carrying costs, <since the~ Include obsolescence (a gues . at be ..•t), cost of I ( which depends on internal money a available, alternate investment opportunities. and 01 new capital). and in France  ts which may range from zero if current

insurance premiums cover more than the assets on hand, to the cost of a new policy l. It i therefore important that we take these circumstances into consideration when applying the inventory models presented in this chapter.

## THE APPLICATION OF YIELD MANAGEMENT AT AMERICAN AIRLINES

THE APPLICATION OF YIELD MANAGEMENT AT AMERICAN AIRLINES

Yield management is widely used today in the airline industry to maximize revenues and profits. American Airlines was
one of the first companies to use yield rat engagement to (a) establish prices, (b) determine for a given flight what   percentage of capacity it should allocate to each price, and (c) determine the restrictions necessary to segment the markets. Listed below is a sampling of the different prices for a round-trip flight between Boston, Massachusetts, and London, England.

example, airlines usually require a 21-day advance purchase for their super-sax er fares. which offer the lowest prices; similarly, organizations holding conferences usually reserve 0 hotel rooms years in advance of their meeting, again at substantially reduced rates. At the same time, however, the service manager does not want to turn away a last minute customer who usually pays the full rate because the capacity had been previously sold at a discounted rate. When this happens, opportunity costs are ir.curred. The methodology  or determining the percentage of capacity to allocate to each market segment or prices referred to as yield management or revenue management. By using yield management.the service manager is Samuel nervously managing both the supply and demand for the firms capacity. Demand is controlled by the different price rises: 1 er prices increase demand;higher prices decrease demand. Supply is controlled by limiting the capacity available at each of the different price structures. As an illustration of how a service firm will use pricing to manage demand, the accompanying OM in Practice provides a sampling of the different airfares that American Airlines offers between Boston, Massachusetts, and London, England, and the restriction .

## Inventory Management in Services

Inventory Management in Services

In service operations, the "product" sold is considered highly perishable. As discussed in the previous chapter, hotel rooms that are unoccupied for one night cannot be saved for another night. Similarly, airline seats on a plane that.are not used on a given date cannot be saved for use at a future time

Yield Management or Revenue Management

Because the product sold in service operations is so perishable, the approach to managing te sale of the product is similar to that for the single-period inventory problem. As discussed in Chapter 15, a service should have certain characteristics in order to  take full advantage of yield management, including a cost structure that consists of high fixed and low-variable costs. Examples of such services, as mentioned earlier, include airlines, hotels, and car  rental co panties. For these types of services, profits are directly  related to sales because variable costs, as a percentage of sales, are very low. Consequently, the goal for these firms is to maximize sales or revenues by maximizing capacity utilization, even if it means selling some of the available capacity at reduced prices-as long as these prices are greater than the variable cost. For example, if the variable cost to clean and restock a hotel room with towels. soap. shampoo, and so forth is \$25. then any room rate  greater than \$25 will contribute to profit. Thus, it would be better to let a hotel guest have the room for \$50 for a night than to let the room remain empty, even if the regular or "rack" rate is S 135 per night. The challenge for managers of these types of services is to determine what percentage of available capacity to allocate to different prices. On the one hand, substantial amounts of capacity can usually be sold in advance at rates that are significantly discounted. For