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McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 12 12 Inventory Management
McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
1212
Inventory Management
12-2
Learning ObjectivesLearning Objectives
Define the term inventory and list the major reasons for holding inventories; and list the main requirements for effective inventory management.
Discuss the nature and importance of service inventories
Discuss periodic and perpetual review systems. Discuss the objectives of inventory management. Describe the A-B-C approach and explain how it
is useful.
12-3
Learning ObjectivesLearning Objectives
Describe the basic EOQ model and its assumptions and solve typical problems.
Describe the economic production quantity model and solve typical problems.
Describe the quantity discount model and solve typical problems.
Describe reorder point models and solve typical problems.
Describe situations in which the single-period model would be appropriate, and solve typical problems.
12-4
Independent Demand
A
B(4) C(2)
D(2) E(1) D(3) F(2)
Dependent Demand
Independent demand is uncertain. Dependent demand is certain.
Inventory: a stock or store of goods
InventoryInventory
12-5
Inventory ModelsInventory Models
Independent demand – finished goods, items that are ready to be sold E.g. a computer
Dependent demand – components of finished products E.g. parts that make up the computer
12-6
Types of InventoriesTypes of Inventories
Raw materials & purchased parts Partially completed goods called
work in progress
Finished-goods inventories (manufacturing firms)
or merchandise (retail stores)
12-7
Types of Inventories (Cont’d)Types of Inventories (Cont’d)
Replacement parts, tools, & supplies
Goods-in-transit to warehouses or customers
12-8
Functions of InventoryFunctions of Inventory
To meet anticipated demand
To smooth production requirements
To decouple operations
To protect against stock-outs
12-9
Functions of Inventory (Cont’d)Functions of Inventory (Cont’d)
To take advantage of order cycles
To help hedge against price increases
To permit operations
To take advantage of quantity discounts
12-10
Objective of Inventory ControlObjective of Inventory Control
To achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds
Level of customer service
Costs of ordering and carrying inventory
Inventory turnover is the ratio ofaverage cost of goods sold toaverage inventory investment.
12-11
A system to keep track of inventory
A reliable forecast of demand
Knowledge of lead times
Reasonable estimates of Holding costs
Ordering costs
Shortage costs
A classification system
Effective Inventory ManagementEffective Inventory Management
12-12
Inventory Counting SystemsInventory Counting Systems
Periodic SystemPhysical count of items made at periodic intervals
Perpetual Inventory System System that keeps track of removals from inventory continuously, thus monitoringcurrent levels of each item
12-13
Inventory Counting Systems Inventory Counting Systems (Cont’d)(Cont’d)
Two-Bin System - Two containers of inventory; reorder when the first is empty
Universal Bar Code - Bar code printed on a label that hasinformation about the item to which it is attached 0
214800 232087768
12-14
Lead time: time interval between ordering and receiving the order
Holding (carrying) costs: cost to carry an item in inventory for a length of time, usually a year
Ordering costs: costs of ordering and receiving inventory
Shortage costs: costs when demand exceeds supply
Key Inventory TermsKey Inventory Terms
12-15
ABC Classification SystemABC Classification System
Classifying inventory according to some measure of importance and allocating control efforts accordingly.
AA - very important
BB - mod. important
CC - least important
Figure 12.1
Annual $ value of items
AA
BB
CC
High
Low
Low HighPercentage of Items
12-16
Cycle CountingCycle Counting
A physical count of items in inventory
Cycle counting management
How much accuracy is needed?
When should cycle counting be performed?
Who should do it?
12-17
Economic order quantity (EOQ) model
The order size that minimizes total annual cost
Economic production model
Quantity discount model
Economic Order Quantity ModelsEconomic Order Quantity Models
12-18
Only one product is involved
Annual demand requirements known
Demand is even throughout the year
Lead time does not vary
Each order is received in a single delivery
There are no quantity discounts
Assumptions of EOQ ModelAssumptions of EOQ Model
12-19
The Inventory CycleThe Inventory CycleFigure 12.2
Profile of Inventory Level Over Time
Quantityon hand
Q
Receive order
Placeorder
Receive order
Placeorder
Receive order
Lead time
Reorderpoint
Usage rate
Time
12-20
Total CostTotal Cost
Annualcarryingcost
Annualorderingcost
Total cost = +
TC = Q2
H DQ
S+
12-21
Cost Minimization GoalCost Minimization Goal
Order Quantity (Q)
The Total-Cost Curve is U-Shaped
Ordering Costs
QO
An
nu
al C
os
t
(optimal order quantity)
TCQH
D
QS
2
Figure 12.4C
12-22
Deriving the EOQDeriving the EOQ
Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q.
Q = 2DS
H =
2(Annual Demand)(Order or Setup Cost)
Annual Holding CostOPT
12-23
Minimum Total CostMinimum Total Cost
The total cost curve reaches its minimum where the carrying and ordering costs are equal.
Q2
H DQ
S=
12-24
Production done in batches or lots Capacity to produce a part exceeds the
part’s usage or demand rate Assumptions of EPQ are similar to EOQ
except orders are received incrementally during production
Economic Production Quantity (EPQ)Economic Production Quantity (EPQ)
12-25
Only one item is involved Annual demand is known Usage rate is constant Usage occurs continually Production rate is constant Lead time does not vary No quantity discounts
Economic Production Quantity Economic Production Quantity AssumptionsAssumptions
12-26
Economic Run SizeEconomic Run Size
QDS
H
p
p u0
2
12-27
Total Costs with Purchasing CostTotal Costs with Purchasing Cost
Annualcarryingcost
PurchasingcostTC = +
Q2
H DQ
STC = +
+Annualorderingcost
PD +
12-28
Total Costs with PDTotal Costs with PDC
ost
EOQ
TC with PD
TC without PD
PD
0 Quantity
Adding Purchasing costdoesn’t change EOQ
Figure 12.7
12-29
Total Cost with Constant Carrying Total Cost with Constant Carrying Costs Costs
OC
EOQ Quantity
To
tal C
os
t
TCa
TCc
TCbDecreasing Price
CC a,b,c
Figure 12.9
12-30
When to Reorder with EOQ When to Reorder with EOQ OrderingOrdering
Reorder Point - When the quantity on hand of an item drops to this amount, the item is reordered
Safety Stock - Stock that is held in excess of expected demand due to variable demand rate and/or lead time.
Service Level - Probability that demand will not exceed supply during lead time.
12-31
Determinants of the Reorder Determinants of the Reorder PointPoint
The rate of demand The lead time Demand and/or lead time variability Stockout risk (safety stock)
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Safety StockSafety Stock
LT Time
Expected demandduring lead time
Maximum probable demandduring lead time
ROP
Qu
an
tity
Safety stock
Figure 12.12
Safety stock reduces risk ofstockout during lead time
12-33
Reorder PointReorder Point
ROP
Risk ofa stockout
Service level
Probability ofno stockout
Expecteddemand Safety
stock0 z
Quantity
z-scale
Figure 12.13
The ROP based on a normalDistribution of lead time demand
12-34
Orders are placed at fixed time intervals Order quantity for next interval? Suppliers might encourage fixed
intervals May require only periodic checks of
inventory levels Risk of stockout Fill rate – the percentage of demand
filled by the stock on hand
Fixed-Order-Interval ModelFixed-Order-Interval Model
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Tight control of inventory items Items from same supplier may yield
savings in: Ordering Packing Shipping costs
May be practical when inventories cannot be closely monitored
Fixed-Interval BenefitsFixed-Interval Benefits
12-36
Requires a larger safety stock Increases carrying cost Costs of periodic reviews
Fixed-Interval DisadvantagesFixed-Interval Disadvantages
12-37
Single period model: model for ordering of perishables and other items with limited useful lives
Shortage cost: generally the unrealized profits per unit
Excess cost: difference between purchase cost and salvage value of items left over at the end of a period
Single Period ModelSingle Period Model
12-38
Continuous stocking levels
Identifies optimal stocking levels
Optimal stocking level balances unit shortage and excess cost
Discrete stocking levels
Service levels are discrete rather than continuous
Desired service level is equaled or exceeded
Single Period ModelSingle Period Model
12-39
Optimal Stocking LevelOptimal Stocking Level
Service Level
So
Quantity
Ce Cs
Balance point
Service level =Cs
Cs + CeCs = Shortage cost per unitCe = Excess cost per unit
12-40
Example 15Example 15
Ce = $0.20 per unit Cs = $0.60 per unit Service level = Cs/(Cs+Ce) = .6/(.6+.2) Service level = .75
Service Level = 75%
Quantity
Ce Cs
Stockout risk = 1.00 – 0.75 = 0.25
12-41
Too much inventory Tends to hide problems Easier to live with problems than to
eliminate them Costly to maintain
Wise strategy Reduce lot sizes Reduce safety stock
Operations StrategyOperations Strategy
