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Chapter 2

Stocks within an Organization

Functions of logistics

• Procurement /Purchasing

• Inward transport

• Receiving

• Material handling

• Warehousing

• Inventory control

• Order picking

• Outward transport (Physical distribution)

• Recycling, returns and waste disposal

• Location

• Communication

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Places of Logistics Activities

within an Organization

Operations CustomersSuppliers Deliveries Deliveries

Procurement

Inward

transport

Receiving

Warehousing

Inventory

control

Materials

handling

Order picking

Outward

transport

Reverse

Logistics

Location

Communications

Integrating Logistics

within an Organization

Disadvantages of fragmented logistics:• creating different, often conflicting, objectives within an

organization;

• duplicating effort and reducing productivity;

• interrupting information flows;

• reducing coordination;

• increasing uncertainty;

• making planning more difficult;

• introducing unnecessary buffers, such as stocks of work-in-

progress;

• obscuring important information, such as the total costs involved;

• giving logistics a low status.

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Worked Example

RP Turner Corp.

Worked Example

RP Turner Corp.

Finance

Production

Marketing

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Worked Example

RP Turner Corp.

Marketing wanted:• high stocks of finished goods to satisfy customer demands

quickly;

• a wide range of finished goods always held in stock;

• locations near to customers to allow delivery with short lead

times;

• production to vary output in response to customer orders;

• emphasis on an efficient distribution system;

• optimistic sales forecast to ensure production has enough

capacity for actual demands.

Worked Example

RP Turner Corp.

Production wanted:• high stocks of raw materials and work in progress to

safeguard operations;

• a narrow range of finished goods to give long production

runs;

• locations near to suppliers so that they can get raw

materials quickly;

• stable production to give efficient operations;

• emphasis on the efficient movement of materials through

operations;

• realistic sales forecasts that allow efficient planning.

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Worked Example

RP Turner Corp.

Finance wanted:• low stocks everywhere;

• a narrow range of products to give low unit costs;

• few locations to give economies of scale and minimize

overall costs;

• long production runs to reduce unit costs;

• make-to-order operations;

• pessimistic sales forecasts that discourage under-used

facilities.

Setting the Aims of Inventory Management:

Three Types of Objectives

• Broad view: contributing to the smooth flow of

materials through the entire supply chain

• Organizational view: supporting logistics in

achieving the overall aims of the organization

• Functional view: making sure that materials are

available when they are needed

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Setting the Aims of Inventory Management:

Levels of Decisions

• Strategic decisions are most important, have effects over

the long term, use many resources and are the most risky.

These set the overall direction for operations.

• Tactical decisions are concerned with implementing the

strategies over the medium term; they look at more detail,

involve fewer resources and some risk.

• Operational decisions are concerned with implementing the

tactics over the short term; they are the most detailed,

involve few resources and little risk.

Types of Decision within an Organization

Mission

Corporate Strategy

Business strategy 1

Business strategy 2

Other strategy

Tactical decisions for

others

Operational decisions

Logistic strategy

Tactical decisions for

logistics

Operational decisions for

logistics

Other strategy

Tactical decisions for

others

Operational decisions

Business strategy 3

For the whole

organization

For each business unit

For each function

Strategic decisions

Tactical decisions

Operational

decisions

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Structure of Decision about Stocks

Sr.

Logistics/Inventory

Mangers

Business

Strategy

Operational decisions

about stocks

Lower Inventory

Mangers

Other Sr.

Mangers

Logistic

Strategy

Tactical decisions

about stocks

Tactical decisions

about stocks

Agreement

Decisions

Connections

Alternative Strategies

• Cost leadership — makes the same, or comparable products

cheaper;

• Product differentiation — makes products that customers

cannot get anywhere else;

• Niche supplies — find a unique niche in the market.

Lean and agile strategies for supply chain.• Lean strategy — tries to do every operation with the least

possible resource – people, space, stock, equipment, time, $

• Agile strategy — gives a high customer service by

responding quickly to different or changing circumstances.

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Lean Practice:

Eliminating Wastes

• Quality — that is too poor to satisfy customers.

• Wrong production level or capacity — making products that

are not currently needed or having unused capacity.

• Poor process — having unnecessary, too complicated or

time-consuming operations.

• Waiting — for operations to start or finish, for materials to

arrive, for equipment to be repaired, etc.

• Movement — with products making unnecessary, long, or

inconvenient movements during operations.

• Stock — holding too much stock, increasing complexity and

raising costs.

Strategic Focus

• Timing — fast deliveries give good customer service, and they

also bring lower costs, improved cash flow, less risk, and

simpler operations.

• Quality — guaranteeing high quality goods and services.

• Product flexibility — which is the ability to customize products

to individual specifications.

• Volume flexibility — which allows an organization to responds

quickly to such changes.

• Diversification or specialization — which describes how wide

a range of products is offered.

• Technology — developing and using the latest technologies.

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Strategic Focus

• Location — using convenient and cost-effective sites.

• Time compression — which is a form of lean operations that

concentrates on wasted time.

• Environmental protection — a small, but increasing, number

of organizations are focusing on sustainable operations and

environmental protection.

• Increased productivity — using available resources as fully as

possible.

• Adding value — expanding the product definition to add as

much customer value as possible.

• Growth — aiming for economies of scale to give both lower

costs and better service.

Framework for inventory decisions

Broader

Strategic

decisions

Decisions about

stocks

Internal

strengths and

distinctive

competence

Customer

requirements

and business

environment

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Implementing the Strategies

The balance of service and cost can be described as

a utility

• place utility: if materials are in the right

place,

• time utility: if they are available at the right

time

maximizing customer utility

Strategic Roles of Stock:

1. Buffer between Production and Sales

• Smooth operations are much more efficient than

variable ones, with easier planning, regular

schedules, routine workflow, fewer changes, etc.

• the organization does not have to install enough

capacity to match peak sales

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Strategic Role of Stock(Smooth operations)

Quarter 1 2 3 4 5 6

Sales 70 110 120 105 90 80

% Change 57.1% 9.1% -12.5% -14.3% -11.1%

Production 100 105 105 95 95 95

% Change 5.0% 0.0% -9.5% 0.0% 0.0%

Change in stock 30 -5 -15 -10 5 15

• Proper inventory management allowed higher sales,

lower production costs and higher profits.

Strategic Roles of Stock:2. Contribution to Financial Performance

𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐴𝑠𝑠𝑒𝑡𝑠 =𝑃𝑟𝑜𝑓𝑖𝑡𝑠 𝑒𝑎𝑟𝑛𝑒𝑑

𝐴𝑠𝑠𝑒𝑡𝑠 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑

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Effect of stocks on the return on assets

Stocks

Property,

equipment

Customer

satisfaction

Operating

costs

Product

features

Current

assets

Fixed

assets

Sales

Profit

margin

Price

Assets

Profit

Return on

assets

Strategic Roles of Stock(Contribution to Financial Performance)

1. Current assets. Assets are conventionally described as

current or fixed. Better management can reduce stock

levels and hence the current assets. Lower investment in

stock also frees up cash for more productive purposes and

reduces the need for borrowing (see Walters, 1992).

2. Fixed assets. Stocks need related investments in

warehouses, materials handling equipment, information

systems and other facilities which form part of the fixed

assets. Reducing stock levels can, therefore, bring

associated reductions in fixed assets.

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Strategic Roles of Stock(Contribution to Financial Performance)

3. Sales. Careful management of stocks increases the

availability of products, reduces lead times, allows proper

delivery size and frequency, and gives faster delivery. This

raises their perceived value and gives higher customer

satisfaction. The result is more frequent orders from

customers, more repeat orders, greater customer loyalty, new

customers and generally higher sales.

4. Profit margin. More efficient inventory management gives

lower operating costs. It can also improve procurement,

monitor and control stock levels, set optimal order sizes and

generally reduce inventory costs. The result is higher profit

margins, or price reductions to increase sales.

Strategic Role of Stock(Contribution to Financial Performance)

5. Price. Point 3 suggested that stocks could raise the

perceived value of a product, and then customers are

willing to pay a premium price. Stocks can also allow

some finishing operations to add value to the overall

product package, and again allow an increased price.

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Worked Example

CMJ Constructors Ltd. currently has sales of £20 million a

year, with a stock level of 25 per cent of sales. Annual holding

cost for the stock is 20 per cent of value. Operating costs

(excluding the cost of stocks) are £15 million a year and other

assets are valued at £30 million. What is the current return on

assets? How does this change if stock levels are reduced to

20 per cent of sales?

Costs of Holding Stock

(Value of Stocks)

1. Actual cost.

2. First-in-first-out (FIFO)

3. Last-in-first-out (LIFO)

4. Weighted average cost.

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Worked Example

Ulrika Harkness records the following monthly purchases and

sales of an item. Assuming she has no opening stock, what is

the value of her stock at the end of the period? What is the

profit and profit margin if each unit sold for €35?

Month Number

bought

Cost of each

unit (€)

Number

sold

November 110 22 73

December 60 26 71

January 70 30 49

February 50 28 53

March 80 24 37

April 40 32 71

Costs of Holding Stock

(Types of Cost)

1. Unit cost.

2. Reorder cost.

3. Holding cost.

4. Shortage cost.

% of unit cost

cost of money 10-15

storage space 2-5

loss 4-6

handling 1-2

administration 1 -2

insurance 1-5

Total 19-35

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Stock Turnover

Stock turnover =number of units sold in a period

average stock

Stock turnover =cost of units sold

average value of stock

Worked Example

Emergent Technologies Wholesale (Scandinavia) buys an

item for €100 a unit and sells it for €150. Annual sales of the

item are around 1,000 units, with average stock of 150 units.

Each unit held in stock costs approximately 25 per cent of

cost a year.

1. Describe the stock holdings.

2. What are the benefits if average stocks of the item are

reduced to 100 units without affecting customer service?

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Approaches to Inventory Control

Basic Questions:

1. What items should we keep in stock?

2. When should we place an order?

3. How much should we order?

Answering the basic questions

1. Independent demand methods assume that the demand

for an item is independent of the demand for any other

item.

2. Dependent demand methods.

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Types of inventory control system

Inventory control

methods

Dependent demand methods

(Part III)

Material requirement

planning (Chap. 9)

Just-in-time

(Chap 10)

Independent demand methods (Part II)

Fixed order quantity

(Chap. 3~5)

Periodic review

(Chap. 5)