Inventory Management

Copyright 2009 John Wiley & Sons, Inc.

13-*Lecture OutlineElements of Inventory ManagementInventory Control SystemsEconomic Order Quantity ModelsQuantity DiscountsReorder PointOrder Quantity for a Periodic Inventory System

13-*What Is Inventory?Stock of items kept to meet future demandPurpose of inventory managementhow many units to orderwhen to order

13-*Inventory and Supply Chain ManagementBullwhip effectdemand information is distorted as it moves away from the end-use customerhigher safety stock inventories to are stored to compensateSeasonal or cyclical demandInventory provides independence from vendorsTake advantage of price discountsInventory provides independence between stages and avoids work stoppages

13-*Inventory and Quality Management in the Supply ChainCustomers usually perceive quality service as availability of goods they want when they want themInventory must be sufficient to provide high-quality customer service in QM

13-*Types of InventoryRaw materialsPurchased parts and suppliesWork-in-process (partially completed) products (WIP)Items being transportedTools and equipment

Types of InventorySeasonal Inventory: Seasonality in demand is absorbed using inventoryDecoupling Inventory: Complexity of production control is reduced by splitting manufacturing into stages and maintaining inventory between these stagesCyclic Inventory: Periodic replenishment causes cyclic inventory Pipeline Inventory: Exists due to lead timeSafety Stock: Used to absorb fluctuations in demand due to uncertainty

Inventory Planning Independent demand itemsFinished goods and spare parts typically belong to independent demand items in manufacturing organisations Two attributes characterize and distinguish independent demand items:Timing of demand: Independent demand items have a continuous demand Uncertainty of demand: There is considerable element of uncertainty in the demand in the case of independent demand items Inventory planning of independent demand items must address the following two key questions:How much? When?

QuantityTimeSafety stockCyclic StockPipeline inventoryLCyclic, Pipeline and Safety StocksA graphical illustrationCyclic inventory, pipeline inventory and safety stocks are critically linked to how much and when decisions in inventory planning

13-*Two Forms of DemandDependentDemand for items used to produce final products Tires stored at a Goodyear plant are an example of a dependent demand itemIndependentDemand for items used by external customersCars, appliances, computers, and houses are examples of independent demand inventory

13-*Inventory CostsCarrying costcost of holding an item in inventoryOrdering costcost of replenishing inventoryShortage costtemporary or permanent loss of sales when demand cannot be met

Costs in Inventory PlanningCarrying CostInterest for short-term borrowals for working capital Cost of stores and warehousing Administrative costs related to maintaining and accounting for inventory Insurance costs, cost of obsolescence, pilferage, damages and wastage All these costs are directly related to the level of inventory

Costs in Inventory PlanningOrdering CostSearch and identification of appropriate sources of supplyPrice negotiation, contracting and purchase order generationFollow-up and receipt of materialEventual stocking in the stores after necessary accounting and verification A larger order quantity will require less number of orders to meet a known demand and vice versa Cost of carrying and cost of ordering are fundamentally two opposing cost structures in inventory planning

Costs in Inventory PlanningShortage CostCosts arising out of pushing the order back and rescheduling the production system to accommodate these changes Rush purchases, uneven utilization of available resources and lower capacity utilization Missed delivery schedules leading to customer dissatisfaction and loss of good will The effects of shortage are vastly intangible, it is indeed difficult to accurately estimate

13-*Inventory Control SystemsContinuous system (fixed-order-quantity)constant amount ordered when inventory declines to predetermined levelPeriodic system (fixed-time-period)order placed for variable amount after fixed passage of time

Selective Control of InventoriesAlternative Classification SchemesABC Classification (on the basis of consumption value)XYZ Classification (on the basis of unit cost of the item)High Unit cost (X Class item)Medium Unit cost (Y Class item)Low unit cost (Z Class item)FSN Classification (on the basis of movement of inventory)Fast MovingSlow MovingNon-movingVED Classification (on the basis of criticality of items)VitalEssential DesirableOn the basis of sources of supplyImported Indigenous (National Suppliers)Indigenous (Local Suppliers)

13-*ABC ClassificationClass A5 15 % of units70 80 % of value Class B30 % of units15 % of valueClass C50 60 % of units 5 10 % of value

ABC ClassificationA graphical illustration

13-*ABC Classification: Example

13-*ABC Classification: Example (cont.)Example 10.1

13-*Economic Order Quantity (EOQ) ModelsEOQoptimal order quantity that will minimize total inventory costsBasic EOQ modelProduction quantity model

13-*Assumptions of Basic EOQ ModelDemand is known with certainty and is constant over timeNo shortages are allowedLead time for the receipt of orders is constantOrder quantity is received all at once

13-*Demand rateTimeLead timeLead timeOrder placedOrder placedOrder receiptOrder receiptInventory LevelReorder point, ROrder quantity, Q0Inventory Order CycleAverage inventory Q2

13-*EOQ Cost Model

13-*EOQ Cost Model

13-*EOQ Cost Model (cont.)

13-*EOQ ExampleOrders per year =D/Qopt=10,000/2,000=5 orders/yearOrder cycle time =311 days/(D/Qopt)=311/5=62.2 store days

13-*Production QuantityModelAn inventory system in which an order is received gradually, as inventory is simultaneously being depletedAKA non-instantaneous receipt modelassumption that Q is received all at once is relaxedp - daily rate at which an order is received over time, a.k.a. production rated - daily rate at which inventory is demanded

13-*Production Quantity Model (cont.)

13-*Production Quantity Model (cont.)

13-*Production Quantity Model: ExampleCc = $0.75 per gallonCo = $150D = 10,000 gallonsd = 10,000/311 = 32.2 gallons per dayp = 150 gallons per day

13-*Production Quantity Model: Example (cont.)

13-*Solution of EOQ Models with Excel

13-*Solution of EOQ Models with Excel (Cont)

13-*Solution of EOQ Models with OM Tools

13-*Quantity DiscountsPrice per unit decreases as order quantity increases

13-*Quantity Discount Model (cont.)

13-*Quantity Discount: ExampleCo =$2,500 Cc =$190 per TV D =200 TVs per year

13-*Quantity-Discount Model Solution with Excel

13-*Reorder PointLevel of inventory at which a new order is placed R = dLwhere

d = demand rate per periodL = lead time

13-*Reorder Point: ExampleDemand = 10,000 gallons/yearStore open 311 days/yearDaily demand = 10,000 / 311 = 32.154 gallons/dayLead time = L = 10 days

R = dL = (32.154)(10) = 321.54 gallons

13-*Safety Stocks Safety stockbuffer added to on hand inventory during lead timeStockout an inventory shortageService level probability that the inventory available during lead time will meet demand

13-*Variable Demand with a Reorder Point

13-*Reorder Point with a Safety Stock

13-*Reorder Point With Variable Demand

13-*Reorder Point for a Service Level

13-*Reorder Point for Variable DemandThe paint store wants a reorder point with a 95% service level and a 5% stockout probabilityFor a 95% service level, z = 1.65

13-*Determining Reorder Point with Excel

13-*Order Quantity for a Periodic Inventory System

13-*Periodic Inventory System

13-*Fixed-Period Model with Variable Demand

13-*Fixed-Period Model with Excel

****************************