the demand for the end product, then the requirements for all the lower levels can be calculated immediately.
2.2.2 Dependent and Independent Demand Items
In theory, all SKUs that appear at a level below the end product level are dependent demand items and should be treated using MRP‐type procedures. However, there are two exceptions to this rule.
If a company is operating a MTO policy, then everything must be assembled during the time window from receipt of order to the delivery date. Not all the components will necessarily be produced or procured in this time frame, though. Therefore, stocks of the relevant components must be held. Ordering will no longer be based on demand that is completely known over the lead time. Instead, stock levels must be informed by forecasted demand.
The second exception relates to spare parts. Parts may be dependent demand items as far as manufacturing is concerned, but they are independent demand items as far as after‐sales service is concerned. They are subject to unknown demand that varies over time, partly due to chance; such demand is known as ‘stochastic’. Because spare parts demand is not known in advance, it needs to be forecasted, taking into account that spare parts are often subject to intermittent demand.
2.2.3 Make to Stock
Generally, demand is not known in advance in a make to stock environment, where the products need to be in stock when the customer orders are received. The lead time in these cases is expected (as far as the customers are concerned) to be equal to the time taken to ship the product to the customers' premises or, in the retailing sector, the lead time is expected to be zero: it is on‐the‐shelf availability that drives business.
In this book, we consider the case of stochastic demand in make to stock environments. (For an interesting discussion on how intermittent demand may be treated in MTO environments, please refer to the work of Bartezzaghi and Verganti 1995, briefly summarised in Technical Note 2.1.) But given the fact that demand is inherently slow moving, is it always worthwhile keeping an item in stock? This issue is discussed in Section 2.3. In practice, it should be addressed before determining ordering policies and their forecasting requirements.
2.2.4 Summary
There is great scope for advancing the inventory control practices for intermittent demand items. We treat intermittent demand as independent and do not expand further on MRP because the principal forecasting task relates to independent demand items. Dependent demand items present challenges relating to the planning of manufacturing but do not require a forecasting system if orders are known in advance and the items can be obtained within the requisite time frame.
In Section 2.3, we address a fundamental problem in this area, which is whether to stock an item or not. Given a positive stocking decision, follow‐up decisions relate to determining how much to stock and when to replenish. These decisions depend on the stock rules that are in use, and we continue with an overview of appropriate inventory control rules for intermittent demand items. We conclude that, in general, the periodic order‐up‐to (OUT) level policy is appropriate for managing intermittent demand inventories. In the next chapter, we distinguish between systems that are driven by service and cost considerations. In Chapters 4 and 5, we determine what needs to be forecasted to allow inventory decisions to be made.
2.3 Should an Item Be Stocked at All?
A considerable amount of effort is expended by organisations to optimise inventory levels. This is expected, if we consider the huge inventory investments made in industry. Consider, for example, a car manufacturer investing £10 million in inventories of service parts to sustain their after‐sales operations in Europe. A mere 5% reduction of their stock levels translates automatically to £500 000 savings that may be invested in other business areas, or account towards an increase in their profit margin. There are two ways of achieving such savings: (i) ceasing to replenish stock for some items; (ii) continuing to replenish stock for other items but reducing the quantities held. Sometimes, an organisation may become preoccupied with the second option, drawing their attention away from the equally important problem, for SKUs with intermittent demand, of whether the item should be kept in stock at all. The decision to stop replenishing an item does not necessarily coincide with the decision to write off stock from the accounts (Technical Note 2.2).
Of course, management of spare parts is often subject to very specific contractual agreements, such as the obligation to service a piece of equipment by carrying items in stock for an agreed length of time. In these cases, ceasing to replenish an item is obviously not an option. Similarly, the life cycle phase of a product or a service part often dictates inventory decisions beyond cost optimisation. For example, even if it is potentially cost‐optimal not to stock an item in the introductory phase of its life cycle, high service requirements may result in always keeping some stock to satisfy demand.
Moreover, it is important to note that service levels are often targeted and measured on an ‘order’ rather than individual SKU basis. An order consists of a number of units requested for a number of items, and some organisations target the percentage of orders (rather than items) completely satisfied directly from stock on hand. (This is the ‘order fill rate’, which is further discussed in Chapter 3.) In this case, a non‐stock decision, taken on the basis of individual SKU requirements only, may be reversed based on collective considerations.
2.3.1 Stock/Non‐Stock Decision Rules
Having taken contractual and other constraints into account, a careful evaluation of whether an item should be stocked at all is needed. Such decisions typically rely upon an evaluation of the cost of keeping an item in stock, and the cost of not having an item in stock (see, for example, Croston 1974; Tavares and Almeida 1983). These are the two pillars upon which much inventory theory has been built, and so a detailed discussion of them is warranted.
The cost of keeping an item in stock is typically estimated based on the inventory holding charge (
Usually, the inventory holding charge is set to be the same across an entire stock base. (At the time of writing, inventory holding charges in the range 10%–25% over a year reflect