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Inventory

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Operations Management 2 Lally School of Management and Technology

Inventory - I

Items from last class

What is inventory

Inventory Video

Inventory Cost Structure Basic Ideas for Managing Independent

Demand Inventory

Economic Order Quantity Exercise

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Operations Management 3 Lally School of Management and Technology

Inventory Definition

A stock of items held to meetfuture demand

Question: Goods vs Services?

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Types of Inventory

Inputs Raw Materials Purchased parts Maintenance and

Repair Materials

Outputs Finished Goods

Scrap and Waste

Process

In Process Partially CompletedProducts andSubassemblies

(in warehouses, or

in transit)

(often on the

factory floor)

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Types of Inventory

Work in

process

Work in

process

Work in

process

Finished

goods

Raw

MaterialsVendors Customer

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Operations Management 6 Lally School of Management and Technology

Water Tank Analogy for Inventory

Supply Rate

Inventory Level

Demand Rate

Inventory Level

Buffers Demand

Rate from Supply

Rate

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Operations Management 7 Lally School of Management and Technology

Independent and Dependent Demand

Inventory

Independent demand items demanded by external customers

(Kitchen Tables)

Dependent demand items used to produce final products (table

top, legs, hardware, paint, etc.)

Demand determined once we know the typeand number of final products

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Operations Management 8 Lally School of Management and Technology

Independent and Dependent Demand

Inventory Management

Independent demand Uncertain / forecasted

Continuous Review / Periodic Review

Dependent demand Requirements / planned

Materials Requirements Planning / Just in

Time

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Operations Management 9 Lally School of Management and Technology

Reasons To Hold Inventory

Meet variations in customer demand:Meet unexpected demand

Smooth seasonal or cyclical demand

Pricing related:

Temporary price discountsHedge against price increases

Take advantage of quantity discounts

Process & supply surprises

Internal upsets in parts of or our own processesExternal delays in incoming goods

Transit

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Operations Management 10 Lally School of Management and Technology

Reasons To NOT Hold Inventory

Carrying cost

Financially calculable

Takes up valuable factory space

Especially for in-process inventory

Inventory covers up problems

That are best exposed and solved

Driver for increasing inventory turns (finishedgoods) and lean production/Just in time for work inprocess

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Operations Management 11 Lally School of Management and Technology

Inventory Hides Problems

Poor

Quality

UnreliableSupplier

MachineBreakdown

InefficientLayout

BadDesign

Lengthy

Setups

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Operations Management 12 Lally School of Management and Technology

To Expose Problems:

Reduce Inventory Levels

PoorQuality

UnreliableSupplier

MachineBreakdown

InefficientLayout

BadDesign

LengthySetups

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Operations Management 13 Lally School of Management and Technology

Remove Sources of Problems

and Repeat the Process

PoorQuality

UnreliableSupplier

MachineBreakdown

InefficientLayout

BadDesign

LengthySetups

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Operations Management 14 Lally School of Management and Technology

Video

Inventory concepts that occur in thetextbook supply chain

Watch for:

Difference between independent anddependent demand inventory

How much and when to order

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Operations Management 15 Lally School of Management and Technology

Inventory Cost Structures

Ordering (or setup) cost Carrying (or holding) cost:

Cost of capital

Cost of storageCost of obsolescence, deterioration, and loss

Stock out cost

Item costs, shipping costs and other costsubject to volume discounts

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Operations Management 16 Lally School of Management and Technology

Typical Inventory Carrying Costs

Housing cost:

Building rent or depreciationBuilding operating costTaxes on buildingInsurance

Material handling costs:Equipment, lease, or depreciation

PowerEquipment operating cost

Manpower cost from extra handling and supervision

Investment costs:

Borrowing costsTaxes on inventoryInsurance on inventory

Pilferage, scrap, and obsolescence

Overall carrying cost

6%

(3% - 10%)

3%

(1% - 4%)

3%

(3% - 5%)

10%

(6% - 24%)

5%

(2% - 10%)

(15% - 50%)

Costs as % of

Inventory Value

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Operations Management 17 Lally School of Management and Technology

Inventory Management Systems

Functions of Inventory Management

Track inventory

How much to order

When to order

Prioritization

Inventory Management Approach

EOQ

Continuous / Periodic

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Operations Management 18 Lally School of Management and Technology

ABC Prioritization

Based on Pareto concept (80/20 rule)

and total usage in dollars of each item.

Classification of items as A, B, or C oftenbased on $ volume.

Purpose: set priorities for management

attention.

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Operations Management 19 Lally School of Management and Technology

ABC Prioritization

A items: 20% of SKUs, 80% of dollars

B items: 30 % of SKUs, 15% of dollars

C items: 50 % of SKUs, 5% of dollars

Three classes is arbitrary; could be any

number. Percents are approximate.

Danger: dollar use may not reflect

importance of any given SKU!

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Operations Management 20 Lally School of Management and Technology

ABC Analysis Example

10 20 30 40 50 60 70 80 90 100

Percentage of items

P

ercentage

ofd

ollarvalue

100

90

80

70

60

50

40

30

20

10

0

+Class C

Class A

+Class B

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Operations Management 21 Lally School of Management and Technology

Annual Usage of Items by Dollar Value

Item

Annual Usage in

Units Unit Cost Dollar Usage

Percentage ofTotal Dollar

Usage

1 5,000 1.50$ 7,500$ 2.9%

2 1,500 8.00 12,000 4.7%

3 10,000 10.50 105,000 41.2%4 6,000 2.00 12,000 4.7%

5 7,500 0.50 3,750 1.5%

6 6,000 13.60 81,600 32.0%

7 5,000 0.75 3,750 1.5%

8 4,500 1.25 5,625 2.2%

9 7,000 2.50 17,500 6.9%

10 3,000 2.00 6,000 2.4%

Total 254,725$ 100.0%

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Operations Management 22 Lally School of Management and Technology

ABC Chart For Previous Slide

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

3 6 9 2 4 1 10 8 5 7

Item No.

Percen

tUsage

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

Cumulativ

e%

Usage

Percentage of Total Dollar Usage Cumulative Percentage

A B C

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Operations Management 23 Lally School of Management and Technology

Inventory Management Approaches

A-items

Track carefully (e.g. continuous review)

Sophisticated forecasting to assurecorrect levels

C-items Track less frequently (e.g.periodic

review)

Accept risks of too much or too little(depending on the item)

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Operations Management 24 Lally School of Management and Technology

Economic Order Quantity (EOQ)

Model

Demand rate D is constant, recurring, and known

Amount in inventory is known at all times

Ordering (setup) cost S per order is fixed

Lead time L is constant and known. Unit cost C is constant (no quantity discounts)

Annual carrying cost is i time the average $ value ofthe inventory

No stockouts allowed. Material is ordered or produced in a lot or batch and

the lot is received all at once

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Operations Management 25 Lally School of Management and Technology

EOQ Lot Size Choice

There is a trade-off between lot size andinventory level.

Frequent orders (small lot size): higher

ordering cost and lower holding cost.Fewer orders (large lot size): lower ordering

cost and higher holding cost.

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Operations Management 26 Lally School of Management and Technology

EOQ Inventory Order Cycle

Demandrate

0 TimeLeadtime

Leadtime

OrderPlaced

OrderPlaced

OrderReceived

OrderReceived

Inventory

L

evel

Reorder point, R

Order qty, Q

As Q increases, average

inventory level increases, but

number of orders placed

decreases

ave = Q/2

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Total Cost of Inventory EOQ Model

Answer to Inventory Management

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Operations Management 28 Lally School of Management and Technology

Answer to Inventory Management

Questions for EOQ Model

Keeping track of inventoryImplied that we track continuously

How much to order?Solve for when the derivative of total cost with respect

to Q = 0: -SD/Q^2 + iC/2 = 0Q = sqrt ( 2SD/iC)

When to order?Order when inventory falls to the Reorder Point-level

R so we will just sell the last item as the new ordercomes in:R = DL

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Operations Management 29 Lally School of Management and Technology

Re-order Point Example

Demand = 10,000 yds/year

Lead time = L = 10 days

When inventory falls to R, we order so as notto run out before the new order comes in.

R = ?

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Operations Management 30 Lally School of Management and Technology

Re-order Point Example

Demand = 10,000 yds/year

Daily demand = 10,000 / 365 = 27.4 yds/day

Lead time = L = 10 days

R = D*L = (27.4)(10) = 274 yds

(usually can neglect issues of working days vs

weekends, etc.)

Dont forget to convert to consistent time units!

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EOQ Summary

How much to order?

Q = sqrt(2DS/iC)

When to order?R = DL

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Operations Management 32 Lally School of Management and Technology

EOQ Exercise

Now you do it

See Excel Spreadsheet:Excel_Inv_Examples.xls, EOQ tab

Compute the values of R and Q andcompare to the simulation

Next see what happens when you havevolume discounts (EOQ w Discount Tab)

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