Wednesday, August 6, 2008

Inventory managment and inventory costs

(c)Frank Dooley
Different models are used to manage inventory for products that are continually available (like milk) or products available for limited time (like seed).The Economic Order Quantity (EOQ) model determines the least cost level of inventory to carry, as well as costs. News Vendor models are used for products only available for a single period.

EOQ and News Vendor models have proved useful for managing inventory for many years, analyzing tradeoffs among major cost components. These models are robust and easy to customize to particular industries. Their approach to costing is similar reflecting levels of inventory, as well as shipping costs or quantity discounts.

Inventory costs fall into three classes:
1) carrying costs of regular inventory and safety stock;
2) ordering or setup costs;
3) stockout costs. Inventory control systems balance the cost of carrying inventory against the costs associated with ordering or shortfalls
Firms carry extra inventory to guard against uncertain events. Known as safety stock, the purpose of this inventory is to provide protection against stockouts. Safety stock is costed just like regular inventory, it is an interest rate times the level of safety stock.
If less is sold than expected during the 10 days or if the shipment arrives early, we will still have inventory on the 10th day and no customer service problems are encountered.
Managing the uncertainty surrounding safety stock is the key to reducing inventory levels.
stockout costs involve lost sales when no inventory is on hand. Such costs fall as inventory (and customer service) levels increase. The relationship between stockout costs and inventory depends upon the accuracy of the demand forecast and the ability of the firm to recognize and react to a change in demand.
One way to evaluate an inventory management policy is to choose a service level target. From this target, the inventory policy will determine the inventory requirements and associated costs of providing that level of service. A higher service level implies that more inventory will be held as safety stock.
Check new inventory management software.

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