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 stockpot costs. In the economic order quantity (EGO) model, costs of placing replenishment orders tradeoff against the costs of holding inventory. Under the assumptions of the EGO average inventory is one-half of the order quantity.
The number of orders placed per year varies inversely with order quantity. When we consider stockpot costs, an additional inventory (satiety stock), is held to trade-off costs of poor customer service or costs for expediting shipments trot unreliable suppliers. In the lean systems chapter, we see order quantities (lot sizes) that are much smaller than the “ideal” suggested by the EGO 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 EGO model? It there are, a firm that ignores these costs will make the wrong inventory sections.
These furlong decisions will make the firm less competitive. Let’s examine the relationships between inventory and the nine competitive priorities discussed in the operations strategy chapter. We compare competitors H and L. They are similar in all respects except H maintains much higher inventory than does L _ I. 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 He’s large lot sizes tend to result in large quantities of defectives.
The EGO 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 to product improvements until the old inventory is consumed.
In either case, L gains a competitive advantage. 3. Consistent quality. Consistency in contorting 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. 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 customize compete on service or product variety. They will keep products at raw material or component evils 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 to 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 EGO 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 EGO is etch 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. Fifth 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 tensions and should be managed, not eliminated. It is impossible to eliminate uncertainties in the provision of products or services. In edition, 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. PROBLEMS I _ Lockwood Industries First we rank the SKU from top to bottom on the basis of their dollar usage.
Then we partition them into classes. The analysis was done using MM Explorer Tutor. 1 -?BBC Analysis. Cumulative % Description Sty Seeder’s Value Dollar Usage Pact of Total of Dollar Value of SKU Class 44,000 51. 00 “4,000 60. 0% 12. 5% 70,000 $21 ,oho 286% 88. 7% 25. 0% $4. 50 $4,050 5. 5% 94. 2% 37. 5% 120,000 0. 03 $3,600 50. 0% SO,90 $315 99. 5% 62, $1. 50 5300 0. 4% 99. 9% 75. 0% $0. 45 $45 100. 0% 87. 5% 50. 01 Total 573,322 The dollar usage percentages don’t exactly match the predictions of BBC analysis. For example, Class A SSW account for 88. 7% tooth total, rather than 80%.