PART II
ANSWERS TO END-OF-CHAPTER QUESTIONS
CHAPTER 8: INVENTORY MANAGEMENT
8-1. How might different organizational functions have different inventory management objectives?
Marketing, for example, tends to want to ensure that sufficient inventory is available for customer
demand to avoid potential stockout situations—which translate into higher inventory levels.
8-2. What makes is difficult for managers to achieve the proper balance of inventory?
Achieving the proper balance of inventory can be quite difficult because of the trade-offs between
inventory carrying cost and stockout costs. More specifically, holding high levels of inventory
8-3. Distinguish among cycle, safety, pipeline, and speculative stock.
Cycle (base) stock refers to inventory that is needed to satisfy normal demand during the course of an
order cycle. Safety (buffer) stock refers to inventory that is held in addition to cycle stock to guard
8-4. Define what is meant by inventory carrying costs and list its primary components.
Inventory carrying costs refer to the costs associated with holding inventory. Inventory carrying costs
8-5. What are ordering costs? What is the trade-off between inventory carrying costs and ordering
costs?
Ordering costs refer to those costs associated with ordering inventory, such as order costs and setup
costs. Order costs include, but are not limited to, the costs of receiving an order (e.g., the wages of the
person who takes orders by telephone), conducting a credit check, verifying inventory availability,
8-6. Discuss the concept of stockout costs. How can stockout costs be calculated?
Stockouts refer to situations where customers demand items that are not immediately available;
stockout costs refer to the costs associated with not having items available. Calculation of a stockout
8-7. Distinguish between a fixed order quantity and fixed order interval system. Which one generally
requires more safety stock? Why?
In a fixed order quantity system, the order size stays constant (although the time interval between
orders may vary); in a fixed order interval system, the time interval is constant (although the order size
8-8. Explain the logic of the EOQ model.
The logic of the EOQ model is as follows: Determining an order quantity requires a company to
balance two costs, which are the costs of carrying the inventory and the costs of ordering it. Inventory
8-9. What assumptions are associated with the EOQ model?
The basic EOQ model is grounded in the following eight assumptions:
A continuous, constant, and known rate of demand
A constant and known replenishment or lead time
A constant purchase price that is independent of the order quantity
8-10. How can inventory flow diagrams be useful to a logistics manager?
They present a visual depiction of additions to, and subtractions from, inventory. This could be helpful
8-11. Discuss what is meant by ABC analysis of inventory. Name several measures that can determine
ABC status.
ABC analysis is an approach that recognizes all inventories are not of equal value to a firm and, as a
result, all inventory should not be managed in the same way. Measures that can be used to determine
8-12. Define what is meant by dead inventory. What are several ways to manage it?
Dead inventory refers to product for which there are no sales during a 12-month period. Because dead
inventory has often been associated with overproduction of items that customers do not want (or need),
one suggestion would be make to order as opposed to make to stock. Having said this, an increasing
source of dead stock in recent years involves special, highly customized orders that never end up with
8-13. In what ways can inventory turnover provide important insights about an organization’s
competitiveness and efficiency?
A particular organization can compare its turnover figures to those of direct competitors or other
organizations with “desirable” turnover ratios. With respect to efficiency, low turnover indicates that a
8-14. Discuss some of the managerial challenges that complementary products present.
One managerial issue with complementary products is that so many complementary items might exist
for a particular product that it is impossible to display or carry them in the same section of a store.
8-15. What are substitute items? How might they affect safety stock policies?
Substitute items refer to products that customers view as being able to fill the same need or want. With
respect to safety stock policies, if a consumer has little hesitation in substituting another item for one
that is out of stock, there would appear to be minimal penalties for a stockout. It is also important that
8-16. How might a hospital’s decisions regarding substitute products differ from a supermarket’s
decisions regarding substitute products?
Because of the many possibilities for substitutability, many grocery chains target in-stock rates of 95
percent for individual stores so that sufficient substitutes exist for a customer to purchase a substitute
8-17. How do the consequences of JIT go far beyond inventory management?
One consequence is that suppliers must deliver high-quality materials to the production line; because of
JIT’s emphasis on low or no safety stock, defective materials result in a product line shutdown. In
addition, JIT emphasizes minimal inventory levels, and as a result customers tend to place smaller,
8-18. Why should organizations carefully consider potential trade-offs before adopting a lean
philosophy?
The lean philosophy was conceived and nurtured in an environment—local or regional sourcing, fewer
man-made or natural disasters—far different from today’s environment. Today’s emphasis on global
sourcing translates into longer and more erratic transit times—and longer and more erratic transit times
8-19. Discuss some challenges that service parts logistics creates for logistics managers.
One challenge is that it can be extremely difficult to forecast the demand for the necessary parts. The
difficulties in forecasting demand lead to challenges with respect to which parts to carry, the
appropriate stocking levels for the parts that are carried, and higher inventory levels. Another challenge
8-20. How does vendor-managed inventory differ from traditional inventory management?
In traditional inventory management, the size and timing of replenishment orders are the responsibility
of the party using the inventory, such as a distributor or retailer. Under vendor-managed inventory
PART III
CASE SOLUTIONS
CASE 8-1: LOW NAIL COMPANY
Question 1: Using the EOQ methods outlined in the text, how many kegs of nails should Low order at
one time?
The EOQ formula is:
EOQ = √ 2 (annual use in units) (cost of placing an order) /
annual carrying cost per item per year
Question 2: Assume all conditions in Question 1 hold, except that Low’s supplier now offers a
quantity discount in the form of absorbing all or part of Low’s order-processing costs. For orders of
750 or more kegs of nails, the supplier will absorb all the order-processing costs; for orders between
249 and 749 kegs, the supplier will absorb half. What is Low’s new EOQ? (It might be useful to lay out
all costs in tabular form for this and later questions.)
Orders per Year Order Size Processing Costs
($)
Warehousing
Costs ($)
Sum of
Processing and
Warehousing
Costs ($)
1 2,000 Free 2,000 2,000
2 1,000 Free 1,000 1,000
3 667 90 667 757
4 500 120 500 620
Question 3: Temporarily, ignore your work on Question 2. Assume that Low’s warehouse offers to
rent Low space on the basis of the average number of kegs Low will have in stock, rather than on the
maximum number of kegs Low would need room for whenever a new shipment arrived. The storage
charge per keg remains the same. Does this change the answer to Question 1? If so, what is the new
answer?
The relevant table is as follows:
Orders Per Year Order Size Processing Costs
($)
Warehousing
Costs ($)
Sum of
Processing and
Warehousing
Costs ($)
1 2,000 60 1,000 1,060
2 1,000 120 500 620
Question 4: Take into account the answer to Question 1 and the supplier’s new policy outlined in
Question 2 and the warehouse’s new policy in Question 3. Then determine Low’s new EOQ.
The relevant table is as follows:
Orders Per Year Order Size Processing Costs
($)
Warehousing
Costs ($)
Sum of
Processing and
Warehousing
Costs ($)
1 2,000 Free 1,000 1,000
2 1,000 Free 500 500
3 667 90 334 424
Question 5: Temporarily, ignore your work on Questions 2, 3, and 4. Low’s luck at the race track is
over; he now must borrow money to finance his inventory of nails. Looking at the situation outlined in
Question 1, assume that the wholesale cost of nails is $40 per keg and that Low must pay interest at the
rate of 1.5 percent per month on unsold inventory. What is his new EOQ?
This answer can be done in tabular form as well, with the interest on inventory appearing as a
new column. If one order is placed a year, the average inventory is 1,000 kegs, worth $40,000,
The relevant table is as follows:
Orders Per Order Size Processing Warehousing Interest Costs
Sum of
Processing,
Warehousing,
Year Costs ($) Costs ($) ($) and Interest
Costs ($)
1 2,000 60 2,000 7,200 9,260
2 1,000 120 1,000 3,600 4,720
3 667 180 667 2,405 3,252
4 500 240 500 1,800 2,540
Question 6: Taking into account all the factors listed in Questions 1, 2, 3, and 5, calculate Low’s EOQ
for kegs of nails.
The relevant table is as follows:
Orders Per
Year
Order Size Processing
Costs ($)
Warehousing
Costs ($)
Interest Costs
($)
Sum of
Processing,
Warehousing,
and Interest
Costs ($)
1 2,000 Free 1,000 7,200 8,200
2 1,000 Free 500 3,600 4,100
3 667 90 334 2,405 2,829
4 500 120 250 1,800 2,170