Managing Inventory and Supply Chain Chapters 12 & 11

12-1

The Functions of Inventory

To decouple or separate various parts of the production process. To smooth production (link supply and demand). To provide goods for customers (quick response). To take advantage of quantity discounts.

Buy more to get a reduced price.

To hedge against inflation and upward price changes (speculation).

Buy more now if you think price will rise.

12-2

ABC Analysis
Sort products from largest to smallest annual $ volume.
Divide into A, B and C classes.

Focus on A products.

Develop class A suppliers more. Give tighter physical control of A items.

Forecast A items more carefully.

Consider B products only after A products.

12-3

Classifying Items as ABC

Annual $ Usage (x1000)
100 80 60 40 20 0 0 20

Class A B C

% $ Vol % Items 39% 12% (3/25) 52% 40% (10/25) 9% 48% (12/25)

A B
40 60

C
80 100

% of Products
12-4

Inventory Costs
Holding costs - Associated with holding or carrying inventory over time.
Ordering costs - Associated with costs of placing order and receiving goods. Setup costs - Cost to prepare a machine or process for manufacturing an order. Stockout costs - Cost of not making a sale and lost future sales.
12-5

Inventory Questions
How much to order (each time)?

100 units, 50 units, 23.624 units, etc. Every 3 days, every week, every month, etc.

When to order?

When only 5 items are left, when only 10 items are left, when only 20 items are left, etc.

Many different models can be used, depending on nature of products and demand.
12-6

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

Help answer the inventory planning questions!

Probabilistic models Fixed order-period models

1984-1994 T/Maker Co.

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Inventory Usage Over Time

Order quantity = Q (maximum inventory level)
Usage Rate

Average Inventory (Q*/2)

Minimum inventory

Inventory Level 0 Time

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EOQ Model How Much to Order?

Annual Cost

Minimum total cost

Order (Setup) Cost Curve

Optimal Order Quantity (Q*)
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Order quantity

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EOQ Total Cost Optimization

Total Cost =

D Q S+ H Q 2

Take derivative of total cost with respect to Q and set equal to zero:

D 1 S+ H=0 Q2 2
Solve for Q to get optimal order size:

EOQ = Q* =

2 D S H
12-10

EOQ Model is Robust

Annual Cost

Small variation in cost

154.92
Large variation in order size
12-11

Order Quantity

EOQ Model When To Order

Inventory Level

Optimal Order Quantity (Q*) Reorder Point (ROP)

Average Inventory (Q*/2)

Time

Lead Time
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Probabilistic Models When to Order?

Inventory Level
Frequency

Service Level

P(Stockout)

Optimal Order Quantity

Reorder Point (ROP) ROP

SS

Safety Stock (SS) Place order Lead Time

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Receive order

Time

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Safety Stock & Service Level

Safety stock is inventory held to protect against stockout.

Service level = 1 - Probability of stockout

Service level of 95% means 5% chance of stockout.

Higher service level means more safety stock.

More safety stock means higher ROP.

ROP = Expected demand during lead time + Safety stock

12-14

Production Order Quantity Model

Material is not received instantaneously.

For example, it is produced in-house.

Other EOQ assumptions apply. Model provides production lot size (like EOQ amount) for one product. Similar to EOQ with setup cost rather than order cost.

Lower holding cost than EOQ model

12-15

EOQ POQ Model When To Order

Inventory Level

Optimal Order Quantity (Q*) Reorder Point (ROP)

Average Inventory

Time

Lead Time
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POQ Model Equations

D = Annual demand S = Setup cost per setup H = Holding (carrying) cost per unit per year d = Demand rate p = Production rate

Given

Optimal Production Run Size = Q* = Maximum inventory level = Q [1- (d/p)] Total Cost =

2 D S = H[1-(d/p)]

2DS H

p p-d

D Q S+ H [1-(d/p)] Q 2
12-18

EOQ vs POQ (ERS)--Buy vs Make

POQ provides product as it is being used POQ has lower inventory costs and larger lots Ideal is to provide product Just in Time JIT requires higher quality confidence JIT gives fast information on production problems

12-19

Operations Management
Buy vs. Make with Lean Strategy (pdf)
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Supply-Chain Management
Planning, organizing, directing, & controlling flows of materials
Begins with raw materials Continues through internal operations Ends with distribution of finished goods

Involves everyone in supply-chain

Example: Your suppliers supplier

Objective: Maximize value & lower waste

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The Supply-Chain
VISA

Material Flow

Credit Flow

Supplier
Supplier

Manufacturing

Retailer
Wholesaler

Consumer
Retailer Cash Flow

Schedules

Order Flow
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Vendor Selection Rating Form

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Supply-Chain Strategies
Plans to help achieve company mission Affect long-term competitive position Strategic options
Many suppliers Few suppliers Keiretsu network Vertical integration Virtual company

Plan

1995 Corel Corp.

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Supply-Chain Strategies
Negotiate with many suppliers; play one supplier against another Develop long-term partnering arrangements with a few suppliers who will work with you to satisfy the end customer Vertically integrate; buy the actual supplier Keiretsu - have your suppliers become part of a company coalition Create a virtual company that uses suppliers on an as-needed basis.

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Many Suppliers Strategy

Many sources per item Adversarial relationship Short-term Little openness Negotiated, sporadic POs High prices Infrequent, large lots Delivery to receiving dock
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Few Suppliers Strategy

1 or few sources per item Partnership (JIT) Long-term, stable On-site audits & visits Exclusive contracts Low prices (large orders) Frequent, small lots Delivery to point of use

1995 Corel Corp.

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Keiretsu Network Strategy

Japanese word for affiliated chain System of mutual alliances and cross-ownership

Company stock is held by allied firms

Lowers need for short-term profits

Links manufacturers, suppliers, distributors, & lenders

Partnerships extend across entire supply chain

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Virtual Company Strategy

Network of independent companies

Linked by technology

PCs, faxes, Internet etc.

Each contributes core competencies Typically provide services

Payroll, editing, designing

May be long or short-term

Usually, only until opportunity is met

1995 Corel Corp.

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Successful Supply-Chain Management Requires:

A mutual agreement on goals Trust Compatible organizational cultures
Cooperative Game

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Other Inventory Models

Quantity Discounts Fixed Order Interval Single Period (perishable)

12-31

Quantity Discount Model

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

Reduced price when item is purchased in larger quantities Other EOQ assumptions apply

Trade-off is between lower price & increased holding cost

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Quantity Discount Schedule

Discount Number 1 2 3 Discount Quantity 0 to 999 1,000 to 1,999 2,000 and over Discount (%) No discount 4 5 Discount Price (P) $5.00 $4.80 $4.75

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Quantity Discount How Much to Order

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Fixed Period Model

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 Example: P&G representative calls every 2 weeks
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Useful when vendors visit routinely

Inventory Level 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

Target maximum
Q1 Q2 Q4

On-Hand Inventory

Q3

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Single period Model

Obsolescence and spoilage Quantity to buy depends on balance of costs:

Costs of Shortage = lost opportunities for Profit

Selling price-cost

of good

Costs of Excess = leftover product

Cost of good salvage Optimal amount

= Q = d + Zsl * Sigma (d) Optimal Service Level = SL = Cs / (Cs +Ce)

12-37