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Chapter 13

SMG OM 323 Chapter Notes - Chapter 13: Opportunity Cost, Lead Time, Devaluation

Operations & Technology Management
Course Code
SMG OM 323
Justin Ren

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Inventory Management
What is Inventory?
An inventory is a stock or store of goods. Many items firms carries relate to the kind of
business it engages in.
Manufacturing firm carry supplies of raw materials, purchased parts, partially finished
goods, as well as spare parts for machines, tools, and other supplies.
Department stores carry clothing, furniture, carpeting, stationary, cosmetics, cards, and toys
Hospital stock drugs, surgical supplies, etc.
Why Hold Inventory?
To deal with uncertainty (safety stock):
o In supply
o In demand
o The risk of shortages can be reduce by holding safety stock, which are stocks in excess of
expected demand to compensate for variabilities in demand and lead time.
To achieve economies of scale (cycle stock)
o Fixed costs
o Quantity discounts
To smooth capacity requirements (pre-build stock)
To hedge against possible price increases in the near future (speculative stock)
To keep supply lines full to permit operations (pipeline stock)
o Intermediate stocking of goods which includes RM, semifinished items, and FG at production
sites, leads to pipeline inventories throughout a production-distribution system
o Little鈥檚 Law can be useful in quantifying pipeline inventory
It states that the average amount of inventory in a system is equal to the product of the
average rate at which inventory units leave the system (average demand rate) and the average
time a unit is in the system.
For example, if units are in the systems for 10 days, and the demand rate is 5 units a day,
average inventory is 5 units/day x 10 days = 50 units.
Costs of Holding Inventory
Average ~30% (ranges from 20% to 40% of item cost :
o Opportunity cost of investment (interest) : associated with having funds that could be used
Usually the largest and most important element
Variable portion of these costs is pertinent
Warehousing, insurance, taxes
Taxes, interest, and insurance are based on dollar value of inventory
Breakage, spoilage, theft
o Items that are easily concealed are prone to theft
o Fresh seafood, meats and poultry, produce and baked goods are subject to spoilage
Devaluation and obsolescence
Price protection and returns (in some industries)
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