Inventory Management

Inventory
Independent Demand

Dependent Demand

B(4)

C(2)

D(2)

E(1)

D(3)

F(2)

Independent demand is uncertain. Dependent demand is certain.

Inventory 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

Types of Inventories

Raw materials & purchased parts Partially completed goods called

work in progress

Finished-goods inventories
(manufacturing firms) or merchandise (retail stores)

Types of Inventories (Contd)

Replacement parts, tools, & supplies Goods-in-transit to warehouses or customers

Functions of Inventory

To meet anticipated demand To smooth production requirements To protect against stock-outs

Functions of Inventory (Contd)

To help hedge against price increases To permit operations

To take advantage of quantity discounts

Objective 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

Effective Inventory Management

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

Inventory Counting Systems

Periodic System
Physical count of items made at periodic intervals

Perpetual Inventory System

System that keeps track of removals from inventory continuously, thus monitoring current levels of each item

Inventory Counting Systems

(Contd)

Two-Bin System - Two containers of

inventory; reorder when the first is empty Universal Bar Code - Bar code printed on a label that has information about the item to which it is attached
0
214800 232087768

Key Inventory Terms

Lead time:

time interval between ordering and receiving the order

Holding (carrying) costs: cost to carry an

inventory

item in inventory for a length of time, usually a year

Ordering costs: costs of ordering and receiving

Shortage costs: costs when demand exceeds
supply

ABC Classification System

Classifying inventory according to some measure of importance and allocating control efforts accordingly.

A - very important B - mod. important C - least important

High

A B C
Low High

Annual $ value of items Low

Percentage of Items

Economic Order Quantity Models

Economic order quantity (EOQ) model

The order size that minimizes total annual cost

Economic production model

Quantity discount model

Assumptions of EOQ Model

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 Inventory Level = 0 when new order just arrived There are no quantity discounts

The Inventory Cycle

Q
Quantity on hand Profile of Inventory Level Over Time

Usage rate

Reorder point

Receive order

Place Receive order order

Place Receive order order

Time

Lead time

Total Cost
Annual Annual Total cost = carrying + ordering cost cost TC =

Q H 2

DS Q

Cost Minimization Goal

Q D TC H S 2 Q

Annual Cost

Ordering Costs
QO (optimal order quantity) Order Quantity (Q)

Minimum Total Cost

The total cost curve reaches its minimum where the Carrying Cost = Ordering Cost Q H 2 = DS Q

Deriving 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 OPT = 2DS = H 2( Annual Demand )(Order or Setup Cost ) Annual Holding Cost

Economic Production Quantity (EPQ)

Assumptions

Only one product is involved Annual demand requirements are known Usage rate is constant Usage occurs continually, but production occurs periodically The production rate is constant Lead time does not vary There are no quantity discounts
12-21

EPQ: Inventory Profile

Q Q* Imax
Production and usage Usage only Production and usage Usage only Production and usage

Cumulative production

Amount on hand

Time

12-22

Quantity Discount Model

Quantity discount

Price reduction offered to customers for placing large orders

Total Cost Carrying Cost Ordering Cost PurchasingCost Q D H S PD 2 Q where P Unit price

12-23

Quantity Discounts

12-24

Quantity Discounts

12-25

When to Reorder
with EOQ Ordering

Reorder Point - When the quantity on Safety Stock - Stock that is held in

hand of an item drops to this amount, the item is reordered 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.

Determinants of the Reorder Point

The rate of demand The lead time Demand and/or lead time variability Stockout risk (safety stock)

Safety Stock

reduce risk of stockout during lead time

Reorder Point
The ROP based on a normal Distribution of lead time demand
Service level Risk of a stockout Probability of no stockout Expected demand 0

ROP
Safety stock z

Quantity

z-scale

Single Period Model

Single period model: model for ordering
of perishables and other items with limited useful lives profits per unit

Shortage cost: generally the unrealized Excess cost: difference between

purchase cost and salvage value of items left over at the end of a period

Single Period Model

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

Optimal Stocking Level

Service level =

Cs Cs + Ce
Ce

Cs = Shortage cost per unit Ce = Excess cost per unit

Cs

Service Level

Quantity
Balance point
So

Example 15

Ce = $0.20 per unit Cs = $0.60 per unit Service level = Cs/(Cs+Ce) = .6/(.6+.2) Service level = .75
C e Cs

Service Level = 75%

Stockout risk = 1.00 0.75 = 0.25

Quantity

Operations Strategy

Too much inventory

Tends to hide problems Easier to live with problems than to eliminate them Costly to maintain Reduce lot sizes Reduce safety stock

Wise strategy