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APICS Operations Management Body of Knowledge Framework, Third Edition

5.9 Inventory models

Once items are shipped through the distribution network, inventory is replenished. This is especially true for make-to-stock situations. (See section 4.2.2.) Several models are available to help determine how much inventory should be brought in to restock the products or parts.

5.9.1 Single-period ordering

Single-period ordering occurs when an item is purchased one time, such as a daily newspaper purchase or holiday season order. This method balances the trade-off associated with an insufficient order (and the resulting loss in profit) and ordering too much (and the resulting costs of disposing of the excess).

5.9.2 Economic order quantity (EOQ)

EOQ is a formula-driven lot-sizing method that balances the trade-off between carrying costs and ordering costs. EOQ is most useful for repetitive parts with stable demand to determine how much to buy. Companies might use EOQ as a check on their current lot-sizing methods. EOQ has numerous variations. (See section 3.11.6.)

5.9.3 Replenishment models

Distribution inventories and independent demand environments use different types of replenishment models based on dependent demand situations.

Reorder point. A reorder point is calculated for each independent demand item. When inventory levels drop to the reorder point, a signal is sent to replenish inventory in a fixed quantity amount. The reorder point is equal to the expected demand during lead time plus safety stock to cover demand in excess of expectations.

Periodic review. A periodic review occurs when inventory is ordered at fixed intervals, such as weekly. This is desirable when vendors make routine visits to customers and take orders for a complete line of products, or when buyers want to combine orders to save transportation costs. The order quantity is determined by subtracting the current inventory position from a maximum quantity calculated to protect against stockouts during the review period and lead time.

Safety calculations. Safety stock for independent demand items protects against fluctuations in customer demand. Safety stock calculations use statistics to mitigate the risk of stockout. A service criterion measures risk as the probability of not stocking out during the order cycle. The fill rate criterion measures risk as a function of the expected percentage of demand met.

Normal distribution.The normal distribution can be used to characterize in-dependent demand. It is defined by the mean and standard deviation of demand over a specified period of time to help calculate safety stock in inventory control systems.

5.9.4 Quantity discounts/price breaks/promotions

Purchasing decisions often are influenced by quantity discounts, price breaks and other promotions. Specialized techniques help analyze these decisions by considering trade-offs between purchasing and transporting costs, inventory carrying costs, and fixed ordering costs.

5.9.5 Low-volume items

Specialized techniques and distributions may be required for low-volume items, since the normal distribution assumption might not be applicable.

5.9.6 ABC inventory control

ABC inventory control is a method of ranking items by their importance, as focusing on the most important items is crucial when resources are limited. Criteria for determining item importance in include annual cost, annual usage, revenue generated, and usage by priority customers. In a typical situation, about 20 percent of items make up 80 percent of the yearly cost and become A items. Another 30 percent of the items make up 15 percent of the cost and become B items. C items make up the remaining 50 percent of items and consume only the remaining 5 percent of the cost. In ABC inventory control, A items are carefully managed and ordered frequently to minimize investment; less time and resources are devoted to the B items; a very low amount of time and resources are dedicated to the C items.

ABC Inventory control also is used in cycle counting. For example, the A items are counted often—once per month, for example. The B items are counted less often—once per calendar quarter, for example. The C items may be counted even less often—once per year, for example.

5.9.7 Inventory accuracy

High inventory accuracy is mandatory for optimal operation of production and automated systems. The inventory physically located in distribution must be reflected accurately in the system. Due to the automation and integration of enterprise resources planning (ERP) systems, inventory is linked to other functions within a company, such as the tracking of dollars in accounting for inventory receipts and shipments. ERP implementation demands inventory accuracies as high as 99 percent.

Auditing. Along with maintaining peak operational functionality, another reason distribution inventories must be kept accurate is to satisfy accounting and government reporting requirements. In order to comply with these strict practices, some companies choose to audit their inventories. In an audit, stocks of a particular item are counted and compared to a system balance. If an inaccuracy is found, the system is adjusted.

Cycle counting. Cycle counting takes the audit concept one step further. In cycle counting, after an audit is performed, the cycle counting process will search for a root cause for the inaccuracy. Once resolved, inventory accuracy is increased, because the problem will not reoccur for that item and other items affected by the improvement.

Some companies will work alongside finance and implement a cycle counting schedule similar to an ABC inventory control process. This type of counting schedule works best when inventory physically resides in fixed locations. Lean distribution environments work towards eliminating cycle counting and annual physical inventory counts, as inventory levels are minimized. Some organizations can eliminate cycle counting entirely, if high inventory accuracy can be demonstrated without cycle counting.

5.9.8 Pooling inventory

In a multiple-warehouse distribution architecture, decisions as to where items are warehoused are of particular importance. Stocking every item in every warehouse often is not required. Pooling strategies are employed when items have highly variable demand in certain warehouses. If inventory can be consolidated in a centralized warehouse rather than stocked in all warehouses, the variability of customer demand will be reduced. However, this strategy may result in longer delivery lead times and increased expediting and shipping costs.

5.9.9 Postponement

Postponement strategies delay the completion of assembly at some point in the 
supply chain until the customer order is received.