Ch12 inventory

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 0745812-1

Operations Operations ManagementManagement

Inventory ManagementInventory ManagementChapter 12Chapter 12


Stock of materials Stored capacity

© 1995 Corel Corp.© 1984-1994 T/Maker Co. © 1984-1994 T/Maker Co.

© 1995 Corel Corp.

What is Inventory?What is Inventory?


Types of InventoryTypes of Inventory

Raw material Work-in-progress Maintenance / repair / operating supplies Finished goods


The Material Flow CycleThe Material Flow Cycle


The Functions of InventoryThe Functions of Inventory

To ”decouple” or separate various parts of the production process

To provide a stock of goods that will provide a selection for customers

To take advantage of quantity discounts To hedge against inflation and upward price

changes


Higher costs Interest or opportunity costs Holding (or carrying) costs – storage, handling, taxes,

insurance, shrinkage Ordering (or setup) costs

Risk of deterioration or obsolescence Hides production problems

Yield / scrap variations Unscheduled downtime

Disadvantages of InventoryDisadvantages of Inventory

Total cost = 20% - 40% of inventory value / yearTotal cost = 20% - 40% of inventory value / year


Pressures on inventoryPressures on inventory

Pressure for lower inventory

•Inventory investment

•Inventory holding cost

Pressure for higher inventory

•Customer service

•Other costs related to inventory


Different Views of InventoryDifferent Views of Inventory

Demand TypeDemand TypeIndependentIndependentDependentDependent

Process stageProcess stageRaw MaterialRaw MaterialWork in ProcessWork in ProcessFinished GoodsFinished Goods

OtherOtherMaintenance / RepairMaintenance / RepairOperating SuppliesOperating Supplies

Types of InventoryTypes of InventoryCycleCyclePipelinePipelineSafety StockSafety StockAnticipationAnticipation

Annual $ VolumeAnnual $ VolumeAABBCC


How Is Inventory Created?How Is Inventory Created?

Cycle Inventory – result of lot size

Pipeline Inventory – in transit

Safety Stock Anticipation Inventory

Pipeline inventory = DL = dL

Average cycle inventory = Q + 0

2

Types of InventoryTypes of InventoryCycleCyclePipelinePipelineSafety StockSafety StockAnticipationAnticipation


Inventory CalculationsInventory Calculations

We use 70 hypodermic needles a week. We buy them in lots of 280. It takes three weeks for order handling and shipment.

Cycle inventory = Q/2= 280/2= 140 needles

Pipeline inventory = DL = dL= (70 needles/week)(3 weeks)= 210 drills

Inventory WorksheetsInventory Worksheets


Inventory Reduction TacticsInventory Reduction Tactics

Cycle inventory

Pipeline inventory

Safety Stock

Anticipation inventory

Reduce lot size

Reduce lead time

Various

Reduce uncertainties


Divides on-hand inventory into three classes on the basis of annual dollar volume – A, B, and C $ volume = Annual demand x Unit cost

Policies based on ABC analysis Develop class A suppliers more Maintain tighter physical control of A items Forecast A items more carefully

ABC AnalysisABC Analysis

Annual $ VolumeAnnual $ VolumeAABBCC


ABC AnalysisABC Analysis

Class % $ Vol % ItemsA 80 20B 15 30C 5 50

% of Inventory Items

0

20

40

60

80

100

0 50 100

% Annual $ Usage

AABB

CC


Fixed order-quantity models Economic order quantity Production order quantity Quantity discount

Probabilistic models

Fixed order-period models

Help answer the inventory planning questions!


© 1984-1994 T/Maker Co.

Inventory Models forInventory Models forIndependent DemandIndependent Demand


Objective: minimize (ordering cost + holding cost)

Assumptions: Known and constant demand Known and constant lead time Instantaneous receipt of material No quantity discounts Only ordering / setup cost and holding cost No stockouts

EOQ – Economic Order QuantityEOQ – Economic Order Quantity


Inventory Usage Over TimeInventory Usage Over Time

Time

Inve

ntor

y Le

vel

Average Cycle

Inventory

0

Q

Usage Rate

Q2


EOQ ModelEOQ ModelHow Much to Order?How Much to Order?

Order quantity (Q)

Annual Cost

Holding CostTotal Cost

Ordering (Setup) Cost

Optimal Order Quantity (Q*)

Minimum total cost


More units must be stored if more are ordered

Purchase OrderDescription Qty.Microwave 1

Order quantity


Why Holding Costs IncreaseWhy Holding Costs Increase


Cost is spread over more unitsExample: You need 1000 microwave ovens




Purchase Order

Description Qty.Microwave 1

1 Order (Postage $ 0.33) 1000 Orders (Postage $330)

Order quantity


Why Ordering Costs DecreaseWhy Ordering Costs Decrease


EOQ Model – When to OrderEOQ Model – When to Order

Time

Inventory Level

Average Cycle

Inventory

Q*

Reorder Point (ROP)

Lead Time


Optimal Order Quantity

Expected Number of Orders

Expected Time Between Orders

Working Days / Year=

= ×

= N = DQ*

Working Days / Year= =TN

dD

ROP d L

= =× ×

Q*D SH

2

D = Demand per year

S = Setup (order) cost per order

H = Holding (carrying) cost

d = Demand per day

L = Lead time in days

EOQ Model EquationsEOQ Model Equations


Answers how much to order and when to order Allows partial receipt of material

Other EOQ assumptions apply

Suited for production environment Material produced, used immediately Provides production lot size

Lower holding cost than EOQ model

POQ – Production Order QuantityPOQ – Production Order Quantity


EOQ EOQ POQ ModelPOQ Model

Time

Inve

ntor

y Le

vel

Both production and usage take

place Usage only takes placeMaximum

inventory level


Quantity Discount ModelQuantity Discount Model

Answers how much to order & when to order Allows quantity discounts

Other EOQ assumptions apply Trade-off is between lower price & increased holding cost

Discount Number

Discount Quantity

Discount (%)

Discount Price (P)

1 0 to 999 No discount $ 5.00

2 1,000 to 1,999 4 $ 4.80

3 2,000 and over 5 $ 4.75


Quantity Discount – How Much to OrderQuantity Discount – How Much to Order


Answer how much & when to order

Allow demand to vary Other EOQ assumptions apply

Consider service level & safety stock Service level = 1 – Probability of stockout Higher service level means more safety stock More safety stock means higher ROP

Probabilistic ModelsProbabilistic Models

X

Service Level P(Stockout)

Freq

uenc

y


Probabilistic Models - When to Order?Probabilistic Models - When to Order?

Reorder Point

(ROP)

X

Safety Stock (SS)

Time

Inve

ntor

y Le

vel

Lead Time

SS

ROP

Service Level P(Stockout)

Place order

Receive order

Freq

uenc

y


Answers how much to order Orders placed at fixed intervals

Inventory brought up to target amount Amount ordered varies

No continuous inventory count Possibility of stockout between intervals

Useful when vendors visit routinely Example: Office Max representative calls every week

Fixed Period (P) SystemsFixed Period (P) Systems


Inventory in a Fixed Period SystemInventory in a Fixed Period System

Various amounts (Qi) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum

pp pp pp

QQ11 QQ22

QQ33

QQ44

Target maximum

Time

On-

Han

d In

vent

ory


Comparison of Comparison of QQ and and PP Systems Systems

Continuous Review System (Q)A system designed to track the remaining inventory of an item each time a withdrawal is made, to determine whether it is time to replenish

Periodic Review System (P) A system in which an item’s inventory position is reviewed periodically rather than continuously


Continuous Review System (Q) Individual review frequencies Possible quantity discounts Lower, less-expensive safety stocks

Periodic Review System (P) Convenient to administer Orders may be combined Inventory position only required at review

Comparison of Comparison of QQ and and PP Systems Systems


Inventory MeasuresInventory MeasuresAverage inventory = $2 millionCost of goods sold = $10 million52 business weeks per year

= = 5 turns/year$10 million

$2 million

Inventory turns =

= = 10.4 weeks$2 million

($10 million)/(52 weeks)

Weeks of supply =Average inventory value

Weekly sales (at cost)

Annual sales (at cost)

Average inventory value


SummarySummary Functions of inventory –

Inventory enables value creation for many processes Costs of inventory Different views of inventory Inventory reduction tactics ABC and EOQ are traditional tools used to manage

inventory – still used in many circumstances Continuous review system (Q) for high-value parts;

Periodic review system (P) for some low value parts Weeks of Supply and inventory turns are widely-used

measures of inventory

Ch12 inventory

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