Chapter
9 Inventory Management
DISCUSSION QUESTIONS
1. The short answer is that higher inventories do not provide an advantage in any of the
nine competitive priority categories. The important point is that firms must have the
“right amount” of inventory to meet their competitive priorities.
The only relevant costs considered in this chapter are ordering costs, holding costs, and
stockout costs. In the economic order quantity (EOQ) model, costs of placing
replenishment orders tradeoff against the costs of holding inventory. Under the
assumptions of the EOQ, average inventory is one-half of the order quantity. The
number of orders placed per year varies inversely with order quantity. When we
consider stockout costs, an additional inventory (safety stock), is held to trade-off costs
of poor customer service or costs for expediting shipments from unreliable suppliers.
In the lean systems chapter, we see order quantities (lot sizes) that are much smaller
than the “ideal” suggested by the EOQ model. As a result, lean systems average
inventory is also much lower. Are there some other relevant costs of holding inventory
that we have not considered in the EOQ model? If there are, a firm that ignores these
costs will make the wrong inventory decisions. These wrong decisions will make the
firm less competitive.
Let’s examine the relationships between inventory and the nine competitive priorities
discussed in the “Using Operations to Compete” chapter. We compare competitors H
and L. They are similar in all respects except H maintains much higher inventory than
does L.
1. Low-cost operations. Costs include materials, scrap, labor, and equipment capacity
that are wasted when products are defective. When a process drifts out of control,
competitor H’s large lot sizes tend to result in large quantities of defectives. The
EOQ does not consider the cost of defectives, and erroneously assumes that setup
costs are constant. Small lots cause frequent setups, but the cost per setup decreases
due to the learning curve. Competitor L will enjoy competitive advantages with
lower setup, materials, labor, equipment, and inventory holding costs.
2. Top quality. Superior features, durability, safety, and convenience result from
improved designs. High inventories force competitor H to choose between
scrapping obsolete designs or delaying introduction of product improvements until
the old inventory is consumed. In either case, L gains a competitive advantage.
3. Consistent quality. Consistency in conforming to design specifications requires
consistency in supplied materials, setups, and processes. Small lots made frequently
tend to increase consistency. Again, advantage goes to L.
4. Delivery speed. Large lots take longer to produce than small lots. A customer will
wait less time for competitor L to set up and produce orders made in small batches.
Copyright © 2016 Pearson Education, Inc.
,9-2 • PART 2 • Managing Customer Demand
5. On-time delivery. Contrary to expectations, large inventories do not equate to on-
time delivery. It’s more like, lots of inventory equals lots of chaos. Big lots make
big scheduling problems. Big lots get dropped, mishandled, and pilfered. Most lean
companies experience dramatic improvement in on-time delivery.
6. Development speed. This response is similar to that given for top quality. Low
inventories result in getting new designs to the market more quickly.
7. Customization. Lean companies usually don’t claim an advantage in customization.
However, large inventories provide no advantage with regard to customization
either. It remains unlikely that a customized product will be found in inventory, no
matter how large.
8. Variety. Mass customizers compete on service or product variety. They will keep
products at raw material or component levels until a customer orders a specific
configuration. Inventories are at as low a level as possible.
9. Volume flexibility. Lean (low inventory) companies tend to produce the same
quantity of every product every day, but they claim considerable volume flexibility
from month to month. On the other hand, a large finished goods inventory can be
used to absorb volume fluctuations.
In summary, a case can be made that several competitive priorities are not considered in
the EOQ model. It is sometimes difficult to place a dollar value on these competitive
advantages, but the advantages invariably go to the low-inventory, small lot-size firm.
So if the EOQ is too large, what is the “ideal” lot size? According to the lean
philosophy, the “ideal” lot size is one.
2. The continuous review system requires the determination of two parameters: the order
quantity and the reorder point. The ordering cost for each firm will decrease, which
means that the economic order quantities will decrease. Because of this, there may be
some implications for the logistics system. Smaller, more frequent shipments could
require more costly less-than-truckload shipments. In addition, while the order
quantities will decrease, the reorder points will also decrease because the lead times will
be smaller. The supply chain should experience smaller pipeline inventories as a
consequence.
If the new information system also reduces the variance of demand or lead times,
there can be additional safety stock savings. However, all of these benefits will come at
some additional expense for the incorporation of the new system. There will be capital
costs for equipment and potential training costs involved.
3. Organizations will never get to the point where inventories are unneeded. Inventories
provide many functions and should be managed, not eliminated. It is impossible to
eliminate uncertainties in the provision of products or services. In addition, unless
materials can be transported instantaneously, there will always be pipeline inventories.
Cycle inventories will exist unless we universally get to the point where production of
single units is feasible.
Copyright © 2016 Pearson Education, Inc.
, Inventory Management • CHAPTER 9 • 9-3
PROBLEMS
Types of Inventory
1. A part
a. Average cycle inventory =Q 2
= 1000 2 = 500 units
Value of cycle inventory = (500 units) ($50+$60)
= $55,000
b. Pipeline inventory = dL
[(3800 units/year)/(50wks/yr)](6 weeks)
= 456 units
Value of the pipeline inventory = (456 units)($50+$30)
= $36,480
2. Prince Electronics
a. Value of each DC’s pipeline inventory
= (75 units/wk)(2 wk)($350/unit)
= $52,500
b. Total inventory = cycle + safety + pipeline
= 5[(400/2) + (2*75) + (2*75)]
= 2,500 units
3. Terminator Inc.
a. Average cycle inventory =Q 2
= 250/2
= 125 units
Value of cycle inventory = (125 units)($450)
= $56,250
⎧ ( 4, 000 units yr ) ⎫
b. Pipeline inventory = dL = ⎨ ⎬ ( 3 wk )
⎩ 50 wk yr ⎭
= 240 units
Value of pipeline inventory = (240 units)($150 + $300/2)
= $72,000
Inventory Reduction Tactics
4. Ruby-Star Incorporated
a. As seen in the Table below, the value of aggregate inventory if vendor 1 is used
equals $28,125
b. The value of aggregate inventory if vendor 2 is used equals $30,000. Thus, using
vendor 1 will allow Ruby-Star to carry less inventory and lower its aggregate
inventory value for this product.
Copyright © 2016 Pearson Education, Inc.
, 9-4 • PART 2 • Managing Customer Demand
Calculation of
Calculation of aggregate
aggregate average
Type of Inventory average inventory value
inventory value for
for vendor 1
vendor 2
Cycle 350/2 = 175 500/2=250
Safety stock 2x50=100 2x50=100
Anticipation 0 0
Pipeline 2x50=100 1x50=50
Average aggregate
375 400
inventory
Value of aggregate
75x375=$28,125 75x400=$30,000
inventory
c. As seen in the table below, if average weekly demand increased to 100 units per
week, the value of aggregate inventory using vendor 1 is now greater than using
vendor 2.
Calculation of
Calculation of aggregate
aggregate average
Type of Inventory average inventory value
inventory value for
for vendor 1
vendor 2
Cycle 350/2 = 175 500/2=250
Safety stock 2x100=200 2x100=200
Anticipation 0 0
Pipeline 2x100=200 1x100=100
Average aggregate
575 550
inventory
Value of aggregate
75x575=$43,125 75x550=$41,250
inventory
5. Haley Photocopying
The policy changes enabled by the new vendor location will allow Haley to reduce
their average inventory level by 1,150 units and their average aggregate inventory
value by $17,250 for paper.
Calculation of
Calculation of aggregate
aggregate average
Type of Inventory average inventory and its Savings
inventory and its value
value after policy change
before policy change
Cycle 1000/2=500 200/2=100 400 units
Copyright © 2016 Pearson Education, Inc.
9 Inventory Management
DISCUSSION QUESTIONS
1. The short answer is that higher inventories do not provide an advantage in any of the
nine competitive priority categories. The important point is that firms must have the
“right amount” of inventory to meet their competitive priorities.
The only relevant costs considered in this chapter are ordering costs, holding costs, and
stockout costs. In the economic order quantity (EOQ) model, costs of placing
replenishment orders tradeoff against the costs of holding inventory. Under the
assumptions of the EOQ, average inventory is one-half of the order quantity. The
number of orders placed per year varies inversely with order quantity. When we
consider stockout costs, an additional inventory (safety stock), is held to trade-off costs
of poor customer service or costs for expediting shipments from unreliable suppliers.
In the lean systems chapter, we see order quantities (lot sizes) that are much smaller
than the “ideal” suggested by the EOQ model. As a result, lean systems average
inventory is also much lower. Are there some other relevant costs of holding inventory
that we have not considered in the EOQ model? If there are, a firm that ignores these
costs will make the wrong inventory decisions. These wrong decisions will make the
firm less competitive.
Let’s examine the relationships between inventory and the nine competitive priorities
discussed in the “Using Operations to Compete” chapter. We compare competitors H
and L. They are similar in all respects except H maintains much higher inventory than
does L.
1. Low-cost operations. Costs include materials, scrap, labor, and equipment capacity
that are wasted when products are defective. When a process drifts out of control,
competitor H’s large lot sizes tend to result in large quantities of defectives. The
EOQ does not consider the cost of defectives, and erroneously assumes that setup
costs are constant. Small lots cause frequent setups, but the cost per setup decreases
due to the learning curve. Competitor L will enjoy competitive advantages with
lower setup, materials, labor, equipment, and inventory holding costs.
2. Top quality. Superior features, durability, safety, and convenience result from
improved designs. High inventories force competitor H to choose between
scrapping obsolete designs or delaying introduction of product improvements until
the old inventory is consumed. In either case, L gains a competitive advantage.
3. Consistent quality. Consistency in conforming to design specifications requires
consistency in supplied materials, setups, and processes. Small lots made frequently
tend to increase consistency. Again, advantage goes to L.
4. Delivery speed. Large lots take longer to produce than small lots. A customer will
wait less time for competitor L to set up and produce orders made in small batches.
Copyright © 2016 Pearson Education, Inc.
,9-2 • PART 2 • Managing Customer Demand
5. On-time delivery. Contrary to expectations, large inventories do not equate to on-
time delivery. It’s more like, lots of inventory equals lots of chaos. Big lots make
big scheduling problems. Big lots get dropped, mishandled, and pilfered. Most lean
companies experience dramatic improvement in on-time delivery.
6. Development speed. This response is similar to that given for top quality. Low
inventories result in getting new designs to the market more quickly.
7. Customization. Lean companies usually don’t claim an advantage in customization.
However, large inventories provide no advantage with regard to customization
either. It remains unlikely that a customized product will be found in inventory, no
matter how large.
8. Variety. Mass customizers compete on service or product variety. They will keep
products at raw material or component levels until a customer orders a specific
configuration. Inventories are at as low a level as possible.
9. Volume flexibility. Lean (low inventory) companies tend to produce the same
quantity of every product every day, but they claim considerable volume flexibility
from month to month. On the other hand, a large finished goods inventory can be
used to absorb volume fluctuations.
In summary, a case can be made that several competitive priorities are not considered in
the EOQ model. It is sometimes difficult to place a dollar value on these competitive
advantages, but the advantages invariably go to the low-inventory, small lot-size firm.
So if the EOQ is too large, what is the “ideal” lot size? According to the lean
philosophy, the “ideal” lot size is one.
2. The continuous review system requires the determination of two parameters: the order
quantity and the reorder point. The ordering cost for each firm will decrease, which
means that the economic order quantities will decrease. Because of this, there may be
some implications for the logistics system. Smaller, more frequent shipments could
require more costly less-than-truckload shipments. In addition, while the order
quantities will decrease, the reorder points will also decrease because the lead times will
be smaller. The supply chain should experience smaller pipeline inventories as a
consequence.
If the new information system also reduces the variance of demand or lead times,
there can be additional safety stock savings. However, all of these benefits will come at
some additional expense for the incorporation of the new system. There will be capital
costs for equipment and potential training costs involved.
3. Organizations will never get to the point where inventories are unneeded. Inventories
provide many functions and should be managed, not eliminated. It is impossible to
eliminate uncertainties in the provision of products or services. In addition, unless
materials can be transported instantaneously, there will always be pipeline inventories.
Cycle inventories will exist unless we universally get to the point where production of
single units is feasible.
Copyright © 2016 Pearson Education, Inc.
, Inventory Management • CHAPTER 9 • 9-3
PROBLEMS
Types of Inventory
1. A part
a. Average cycle inventory =Q 2
= 1000 2 = 500 units
Value of cycle inventory = (500 units) ($50+$60)
= $55,000
b. Pipeline inventory = dL
[(3800 units/year)/(50wks/yr)](6 weeks)
= 456 units
Value of the pipeline inventory = (456 units)($50+$30)
= $36,480
2. Prince Electronics
a. Value of each DC’s pipeline inventory
= (75 units/wk)(2 wk)($350/unit)
= $52,500
b. Total inventory = cycle + safety + pipeline
= 5[(400/2) + (2*75) + (2*75)]
= 2,500 units
3. Terminator Inc.
a. Average cycle inventory =Q 2
= 250/2
= 125 units
Value of cycle inventory = (125 units)($450)
= $56,250
⎧ ( 4, 000 units yr ) ⎫
b. Pipeline inventory = dL = ⎨ ⎬ ( 3 wk )
⎩ 50 wk yr ⎭
= 240 units
Value of pipeline inventory = (240 units)($150 + $300/2)
= $72,000
Inventory Reduction Tactics
4. Ruby-Star Incorporated
a. As seen in the Table below, the value of aggregate inventory if vendor 1 is used
equals $28,125
b. The value of aggregate inventory if vendor 2 is used equals $30,000. Thus, using
vendor 1 will allow Ruby-Star to carry less inventory and lower its aggregate
inventory value for this product.
Copyright © 2016 Pearson Education, Inc.
, 9-4 • PART 2 • Managing Customer Demand
Calculation of
Calculation of aggregate
aggregate average
Type of Inventory average inventory value
inventory value for
for vendor 1
vendor 2
Cycle 350/2 = 175 500/2=250
Safety stock 2x50=100 2x50=100
Anticipation 0 0
Pipeline 2x50=100 1x50=50
Average aggregate
375 400
inventory
Value of aggregate
75x375=$28,125 75x400=$30,000
inventory
c. As seen in the table below, if average weekly demand increased to 100 units per
week, the value of aggregate inventory using vendor 1 is now greater than using
vendor 2.
Calculation of
Calculation of aggregate
aggregate average
Type of Inventory average inventory value
inventory value for
for vendor 1
vendor 2
Cycle 350/2 = 175 500/2=250
Safety stock 2x100=200 2x100=200
Anticipation 0 0
Pipeline 2x100=200 1x100=100
Average aggregate
575 550
inventory
Value of aggregate
75x575=$43,125 75x550=$41,250
inventory
5. Haley Photocopying
The policy changes enabled by the new vendor location will allow Haley to reduce
their average inventory level by 1,150 units and their average aggregate inventory
value by $17,250 for paper.
Calculation of
Calculation of aggregate
aggregate average
Type of Inventory average inventory and its Savings
inventory and its value
value after policy change
before policy change
Cycle 1000/2=500 200/2=100 400 units
Copyright © 2016 Pearson Education, Inc.
