Business conditions that force companies to hold inventory.
The risk of interruptions in the flow of components from upstream suppliers.
From this discussion, we can see that inventory is a useful resource. However, companies don’t want to hold more inventory than necessary. Inventory ties up space and capital: A dollar invested in inventory is a dollar that cannot be used somewhere else. Likewise, the space used to store inventory can often be put to more productive use. Inventory also poses a significant risk of obsolescence, particularly in supply chains with short product life cycles. Consider what happens when Intel announces the next generation of processor chips. Would you want to be stuck hold-ing the old-generation chips when the new ones hit the market?
Finally, inventory is too often used to hide problems that management really should resolve. In this sense, inventory can serve as a kind of painkiller, treating the symptom without solving the underlying problem. Consider our discussion of safety stock. Suppose WolfByte’s managers decide to hold additional safety stock of hard drives because of quality problems they have been experi-encing with units received from Supplier 2. While the safety stock may buffer WolfByte from these quality problems, it does so at a cost. A better solution might be to improve the quality of incoming units, thereby reducing both quality-related costs and the need for additional safety stock.
With these concerns in mind, let’s turn our attention to inventory drivers—business condi-tions that force companies to hold inventory. Table 11.2 summarizes the ways in which various inventory drivers affect different types of inventory. To the extent that organizations can manage and control the drivers of inventories, they can reduce the supply chain’s need for inventory.
In managing inventory, organizations face uncertainty throughout the supply chain. On the upstream (supplier) end, they face supply uncertainty, or the risk of interruptions in the
Inventory Drivers and
|Uncertainty in supply or demand||Safety stock, hedge inventory|
|Mismatch between a downstream partner’s demand and the most|
|efficient production or shipment volumes for an upstream partner||Cycle stock|
|Mismatch between downstream demand levels and upstream|
|production capacity||Smoothing inventory|
|Mismatch between timing of customer demand and supply||Anticipation inventory|
|chain lead times||Transportation inventory|
332 PART IV • Planning and Controlling Operations and Supply Chains
The risk of significant and unpredictable fluctuations in downstream demand.
flow of components they need for their internal operations. In assessing supply uncertainty, managers need to answer questions such as these:
· How consistent is the quality of the goods being purchased?
· How reliable are the supplier’s delivery estimates?
· Are the goods subject to unexpected price increases or shortages?
Problems in any of these areas can drive up supply uncertainty, forcing an organization to hold safety stock or hedging inventories.
On the downstream (customer) side, organizations face demand uncertainty, or the risk of significant and unpredictable fluctuations in the demand for their products. For example, many suppliers of automobile components complain that the big automobile manufacturers’ forecasts are unreliable and that order sizes are always changing, often at the last minute. Under such conditions, suppliers are forced to hold extra safety stock to meet unexpected jumps in de-mand or changes in order size.
In dealing with uncertainty in supply and demand, the trick is to determine what types of uncertainty can be reduced and then to focus on reducing them. For example, poor quality is a source of supply uncertainty that can be substantially reduced or even eliminated through business process or quality improvement programs, such as those we discussed in Chapters 4 and 5. On the other hand, forecasting may help to reduce demand uncertainty, but it can never completely eliminate it.
Another common inventory driver is the mismatch between demand and the most efficient production or shipment volumes. Let’s start with a simple example—facial tissue. When you blow your nose, how many tissues do you use? Most people would say 1, yet tissues typically come in boxes of 200 or more. Clearly, a mismatch exists between the number of tissues you need at any one time and the number you need to purchase. The reason, of course, is that packaging, shipping, and selling facial tissues one at a time would be highly inefficient, especially because the cost of holding a cycle stock of facial tissues is trivial. On an organizational scale, mismatches between demand and efficient production or shipment volumes are the main drivers of cycle stocks. As we will see later in this chapter, managers can often alter their business processes to reduce produc-tion or shipment volumes, thereby reducing the mismatch with demand and the resulting need for cycle stocks.
Likewise, mismatches between overall demand levels and production capacity can force companies to hold smoothing inventories (Figure 11.5). Of course, managers can reduce smooth-ing inventories by varying their capacity to better match demand or by smoothing demand to better match capacity. As we saw in Chapter 10, both strategies have pros and cons.
The last inventory driver we will discuss is a mismatch between the timing of the cus-tomer’s demand and the supply chain’s lead time. When you go to the grocery store, you expect to find fresh produce ready to buy; your expected waiting time is zero. But produce can come from almost anywhere in the world, depending on the season. To make sure that bananas and lettuce will be ready and waiting for you at your local store, someone has to initiate their move-ment through the supply chain days or even weeks ahead of time and determine how much anticipation inventory to hold. Whenever the customer’s maximum waiting time is shorter than the supply chain’s lead time, companies must have transportation and anticipation inventories to ensure that the product will be available when the customer wants it.
How can businesses reduce the need to hold anticipation inventory? Often they do so both by shrinking their own lead time and by persuading customers to wait longer. It’s hard to be-lieve now, but personal computers once took many weeks to work their way through the supply chain. As a result, manufacturers were forced to hold anticipation inventories to meet customer demand. Today, manufacturers assemble and ship a customized laptop or tablet directly to the customer’s front door in just a few days. Customers get fast and convenient delivery of a prod-uct that meets their exact needs. At the same time, the manufacturer can greatly reduce or even eliminate anticipation inventory.
In the remainder of this chapter, we examine the systems that are used in managing vari-ous types of inventory. Before beginning a detailed discussion of these tools and techniques of inventory management, however, we need to distinguish between two basic inventory catego-ries: independent demand and dependent demand inventory. The distinction between the two is crucial because the tools and techniques needed to manage each are very different.