11-1 Inventory Management
CHAPTER
7
Inventory/ Material
Management
Prepared by Şevkinaz Gümüşoğlu
using different references about POM
McGraw-Hill/Irwin Operations Management, Eighth Edition, by William J. Stevenson
Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
11-2 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
What Is Inventory?
Stock of items kept to meet future demand
Purpose of inventory management
how many units to order
when to order
11-3 Inventory Management
The Inventory Cycle Figure 1
Profile of Inventory Level Over Time
Quantity
on hand
Q
Receive
order
Place
order Receive
order Place
order
Receive
order
Lead time
Reorder
point
Usage
rate
Time
11-4 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
Types of Inventory
Raw materials
Purchased parts and supplies
Work-in-process (partially completed) products
(WIP)
Items being transported
Tools and equipment
11-5 Inventory Management
5
Inventory is a traditional topic in P/O Management. The
basic objective of inventory/material management has
traditionally been to keep inventory at desired level that
will meet product demand and also be cost effective.
Whether a company buys parts and products or produces
them, it is faced with decisions about inventory.
Inventories are present whenever the inputs and outputs of
a company are not used as soon as they become available. In general, most people think of inventory as a final product waiting to be sold to a retail customer. e.g. a new car, a can of ananas at a grocery store. This is of course one of its most important uses. Inventory can take on a number of different forms besides finished goods, such as raw materials, supplies, parts etc.
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Inventory can be defined as a stock of materials created to satisfy some eventual demand.
Inventories are idle resources of any kind that possesses economic value and held for future
use.
Inventory can be defined as a stock of
materials created to satisfy some eventual
demand.
Inventories are idle resources of any kind
that possesses economic value and held
for future use.
11-7 Inventory Management
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The major goal of any inventory control system is to discover
and maintain the best possible level of inventory in terms of both
units of product and least possible cost. As stated above, in
reaching this goal management seeks to avoid two common
pitfalls:
i. Management tries to avoid the problem inadequate levels of
inventory since too little inventory disrupts production and
may result in lost sales.
ii. The existence of too many inventories increases the risk of
obsolescence and creates unnecessary cost levels, both of
which are the utmost concern to management.
The best possible level of inventory is located somewhere
between these two extremes.
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To provide management with reasonable responses to the
preceding questions, the initial model is generally modified to
reflect operational situations. These modified models are then
used as a basis for answering three principal questions; which
constitute the purpose of inventory management:
1. When should an order be placed?
2. How much should be ordered?
3. What is the cost of inventory policy that has been selected?
In order to solve these problems we can use different type of models ;
Two bin system, single period system, EOQ etc.
11-9 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
Inventory and Quality Management
Customers usually perceive quality service as
availability of goods they want when they want
them
Inventory must be sufficient to provide high-
quality customer service in TQM
11-10 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
Inventory Control Systems
Continuous system (fixed-order-
quantity)
constant amount ordered when
inventory declines to
predetermined level
Periodic system (fixed-time-
period)
order placed for variable amount
after fixed passage of time
11-11 Inventory Management
11
One of the most important considerations of control is the
value of annual consumption of inventory /material items in a year.
Only a small number of inventory items consume a very large share of inventory consumption during the year.
A little larger number of inventory items covers a moderate share of annual inventory consumption.
A very large number of items just cover a very small share of annual inventory consumption.
These facts gave birth to the concept of ABC analysis.
We should use ABC Analysis especialy for
«Buy & Produce Decisions»
11-12 Inventory Management
ABC Inventory Classification
ABC classification is a method for determining level of control and frequency of review of inventory items
A Pareto analysis can be done to segment items into value categories depending on annual dollar volume
A Items – typically 20% of the items accounting for 80% of the inventory value-use Q system
B Items – typically an additional 30% of the items accounting for 15% of the inventory value-use Q or P
C Items – Typically the remaining 50% of the items accounting for only 5% of the inventory value-use P
11-13 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
ABC Classification
Class A
5 – 15 % of units
70 – 80 % of value
Class B
30 % of units
15 % of value
Class C
50 – 60 % of units
5 – 10 % of value
11-14 Inventory Management
11-15 Inventory Management
Policies For “A” group items
Develop class A suppliers more
Forecast A items more carefully
Purchasing department make maximum efforts to
expedite and delivery of these items
Purchase of these items in hands of top officials
The stock report of ‘A’ items should be sent more
frequently, say at least once in 15 days.
11-16 Inventory Management
Policies for “B” group items
Order quantities, re-order stocks and safety stock should
be fixed and revised for ‘B’ items at least one in every 4
to 6 months.
B items should be ordered less frequently than A items
11-17 Inventory Management
Policies for “C” group items
Large quantities can be brought at a time, as total
investment will be least.
Paper work can be reduced considerably if orders are
placed once or twice a year
The source of supply can be one or two based on their
reliability.
11-18 Inventory Management
Advantages of ABC Analysis
Helps to exercise selective control
Gives rewarding results quickly
Helps to point out obsolete stocks easily.
In case of “A” items careful attention can be paid at
every step such as estimate of requirements,
purchase, safety stock, receipts, inspections, issues,
etc. & close control is maintained.
In case of “C” items, recording & follow up, etc. may
be dispensed with or combined.
Helps better planning of inventory control
Provides sound basis for allocation of funds & human
resources.
11-19 Inventory Management
Disadvantages of ABC Analysis
Proper standardization & codification of inventory
items needed.
Considers only money value of items & neglects
the importance of items for the production
process or assembly or functioning.
Periodic review becomes difficult if only ABC
analysis is recalled.
When other important factors make it obligatory
to concentrate on “C” items more, the purpose of
ABC analysis is defeated.
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STEPS IN ABC ANALYSIS
The steps in computing ABC analysis are:
a Determine the annual usage in units for each item for the past one-year.
b. Multiply the annual usage quantity with the average unit price of each item to calculate the annual usage in US$ for each item.
c. Item with highest dollar usage annually is ranked first. Then the next lower annual usage item is listed till the lowest item is listed in the last.
d. Table 1 shows ranks of the items according to the annual usage in US$. for 10 items.
e. Arrange the items in the inventory by cumulative annual usage (dollars) and by cumulative percentage. Categorize the items in A, B , and C categories.
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TABLE 1: DETERMINATION OF
RANKS BY ANNUAL USAGE IN US$
Item # Average usage (units)
Unit cost (US$)
Annual usage (US$)
Rank
1 17 2.5
2 50 17
3 15 15
4 25 17
5 5 17
6 50 119
7 153 5
8 20 2.125
9 16 2.656
10 17 2.5
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TABLE 1: DETERMINATION OF
RANKS BY ANNUAL USAGE IN US$
Item # Average usage (units)
Unit cost (US$)
Annual usage (US$)
Rank
1 17 2.5 42.5
2 50 17 850
3 15 15 225
4 25 17 425
5 5 17 85
6 50 119 5950
7 153 5 765
8 20 2.125 42.5
9 16 2.656 42.5
10 17 2.5 42.5
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TABLE 1: DETERMINATION OF
RANKS BY ANNUAL USAGE IN US$
Item # Average usage (units)
Unit cost (US$)
Annual usage (US$)
Rank
A 17 2.5 42.5 8
B 50 17 850 2
C 15 15 225 5
D 25 17 425 4
E 5 17 85 6
F 50 119 5950 1
G 153 5 765 3
H 20 2.125 42.5 7
I 16 2.656 42.5 9
j 17 2.5 42.5 10
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TABLE 2:CATEGORIZING THE
ITEMS IN ABC RANKING
Item # Annual usage (US$)
Cumulative annual usage (US$)
Annual usage %
Category assigned
F 5950 5950
B 850 6800
G 765 7565
D 425 7990
C 225 8245
E 85 8330
H 42.5 8372.5
A 42.5 8415
j 42.5 8457.5
I 42.5 8500
Total 8500
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TABLE 2:CATEGORIZING THE
ITEMS IN ABC RANKING
Item # Annual usage (US$)
Cumulative annual usage (US$)
Annual usage %
Category assigned
6 5950 5950 70
2 850 6800 80
7 765 7565 89
4 425 7990 94
3 225 8245 97
5 85 8330 98
8 42.5 8372.5 98.5
1 42.5 8415 99
10 42.5 8457.5 99.5
9 42.5 8500 100
Total 8500
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TABLE 2:CATEGORIZING THE
ITEMS IN ABC RANKING
Item # Annual usage (US$)
Cumulative annual usage (US$)
Annual usage %
Category assigned
6 5950 5950 70 A
2 850 6800 80 B
7 765 7565 89 B
4 425 7990 94 C
3 225 8245 97 C
5 85 8330 98 C
8 42.5 8372.5 98.5 C
1 42.5 8415 99 C
10 42.5 8457.5 99.5 C
9 42.5 8500 100 C
Total 8500
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27
TABLE 3: ABC CATEGORY -
SUMMARY
category Item# % of items in inventory
$ in the category
% $ in the category
A 6 10 5950 70
B 2, 7 20 1615 19
C 1, 3, 4,5,8,9,10 70 935 11
Total 10 100 8500 100
11-28 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
ABC Classification: Example
1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120
PART UNIT COST ANNUAL USAGE
11-29 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
ABC Classification:
Example (cont.)
Example 10.1
1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120
PART UNIT COST ANNUAL USAGE TOTAL % OF TOTAL % OF TOTAL PART VALUE VALUE QUANTITY % CUMMULATIVE
9 $30,600 35.9 6.0 6.0
8 16,000 18.7 5.0 11.0
2 14,000 16.4 4.0 15.0
1 5,400 6.3 9.0 24.0
4 4,800 5.6 6.0 30.0
3 3,900 4.6 10.0 40.0
6 3,600 4.2 18.0 58.0
5 3,000 3.5 13.0 71.0
10 2,400 2.8 12.0 83.0
7 1,700 2.0 17.0 100.0
$85,400
A
B
C
% OF TOTAL % OF TOTAL CLASS ITEMS VALUE QUANTITY
A 9, 8, 2 71.0 15.0
B 1, 4, 3 16.5 25.0
C 6, 5, 10, 7 12.5 60.0
11-30 Inventory Management
Economic order quantity model
Economic production model
Quantity discount model
Some Basic Inventory Control Models
11-31 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
Economic Order
Quantity (EOQ) Models
EOQ
optimal order quantity that will
minimize total inventory costs
Basic EOQ model
Advance EOQ model ( back order
model, stockout model)
11-32 Inventory Management
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 Model
11-33 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
Inventory Order Cycle
Demand rate
Time Lead time
Lead time
Order placed
Order placed
Order receipt
Order receipt
Inven
tory
Level
Reorder point, R
Order quantity, Q
0
11-34 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
Inventory Costs
Carrying cost
cost of holding an item in inventory Ordering cost
cost of replenishing inventory Shortage cost
temporary or permanent loss of sales
when demand cannot be met
11-35 Inventory Management
Total Cost
Annual carrying cost
Annual ordering cost
Total cost = +
Q 2
Cc D Q
Co TC = +
TC= Total annual cost
Q= Order quantity in units
H or Cc = Holding (carrying )cost per unit
D= Annual Demand
S or Co = Ordering cost
11-36 Inventory Management
Cost Minimization Goal
Order Quantity
(Q)
The Total-Cost Curve is U-Shaped
Ordering Costs
QO
An
nu
al C
os
t
(optimal order quantity)
11-37 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
EOQ Cost Model
TC = + CoD
Q
CcQ
2
= + CoD
Q2
Cc
2
TC
Q
0 = + C0D
Q2
Cc
2
Qopt = 2CoD
Cc
Deriving Qopt Proving equality of costs at optimal point
= CoD
Q
CcQ
2
Q2 = 2CoD
Cc
Qopt = 2CoD
Cc
11-38 Inventory Management
EOQ MODEL EXAMPLE
A local distributor for a national tire company expects to
sell approximately 9600 steel-belted radial tires of a
certain size and tread design next year. Annual carrying
cost is $16 per tire, and ordering cost is $75. The
distributor operates 288 days a year.
D= 9600 H= $ 16 S= $ 75
a) What is the EOQ?
b) No. Of orders per year=D/Q=9600/300=32
tires 30016
2(9600)75
H
2DS = QOPT
11-39 Inventory Management
EOQ MODEL EXAMPLE
D= $ 9600 H= $ 16 S= $ 75
c) Length of order cycle= Q/D= 300/9600
=1/32 of a year*288 =9 work days.
d) Total Cost=Carrying cost+Ordering cost
=(Q/2)H+(D/Q)S
=(300/2)16+(9600/300)75
=2400+2400
=$ 4800
11-40 Inventory Management
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 Assumptions
11-41 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
Production Quantity Model (cont.)
Q(1-d/p)
Inventory
level
(1-d/p) Q
2
Time 0
Order
receipt period
Begin
order
receipt
End
order
receipt
Maximum
inventory
level
Average
inventory
level
11-42 Inventory Management
Economic Run (Batch) Size
p
QtimeRun
u
QtimeCycle
upMaximumI
SQDHI
CostSetupCostCarryingTC
up
p
H
DSQ
p
p
p
)(p
Qinventory
/2
2
p
max
maxmin
Qp= Optimum production quantity
H= Holding cost per unit
D= Annual Demand
S= Setup cost
P= Production or delivery rate
U= Usage rate
11-43 Inventory Management
Economic Run (Batch) Size Example
A toy manufacturer uses 48000 rubber wheels per year for its popular dump
truck series. The firm makes its own wheels, which it can produce at a rate of
800 per day. The toy trucks are assembled uniformly over the entire year.
Carrying cost is $ $1 per wheel a year. Setup cost for a production run of
wheels is $45. The firm operates 240 days per year.
D= 48000 S=$45 H=$1 per year wheels p=800 per day u= 48000 wheels
per 240 days or 200 wheels per day.
a) Optimal run size
b) Minimum total annual cost
wheelsup
p
H
DSQp 2400
200800
800
1
45)48000(22
1800$452400
48001
2
1800
2
1800)200800(800
2400)(
p
Q
maxmin
p
max
SQ
DH
ITC
wheelsupI
11-44 Inventory Management
Economic Run (Batch) Size Example
D= 48000 S=$45 H=$1 per year p=800 wheels per day u= 48000 wheels
per 240 days or 200 wheels per day.
c)
Thus, a run of wheels will be made every 12 days.
d)
Thus, each run will require three days to complete.
dayperwheelswheelsu
QtimeCycle
p 200/ 2400
daysdayperwheelswheelsp
QtimeR
p3 800/ 2400un
11-45 Inventory Management
Copyright 2006 John Wiley & Sons, Inc.
Safety Stocks
Safety stock
buffer added to on hand inventory during lead
time
Stockout
an inventory shortage
Service level
probability that the inventory available during lead
time will meet demand
