Inventory Management

Inventory Management

• Inventory is one of
the most
expensive assets
of many
companies.
•
• It represents as
much as 40% of
total invested
capital.
 Inventory Management
• Inventory is any stored resource that is used to
satisfy a current or future need.
• Raw materials, work-in-process, and finished
goods are examples of inventory.
• Two basic questions in inventory management
are
1.How much to order
2.When to order
Basic Functions of
Inventory
Types of Inventory
Holding and Ordering
Costs
 Lot Sizing
• “How many parts to make at once”
• Objective: Find optimum production
quantities
 TRADE -OFF
Meeting demand requirements
and
Set up, inventory, holding and back
order costs
 Techniques of Lot Sizing
I. LOT – FOR – LOT
– Produces exactly the required amount
each period
– Minimizes carrying cost
– Neglects set up costs and capacity
limitations


II.Economic Order Quantity

–
–
 Techniques of Lot Sizing
III.Least Total Cost
– Dynamic lot sizing method
– Compares carrying cost and Set
up(ordering) costs
– Selects the lot where the two are
almost equal


IV.Least Unit Cost

– Adds ordering and carrying cost to
each lot size and divides with the
number of units
– The lot with the lowest unit cost is
•
ABC Analysis
• ABC analysis divides on-hand inventory into
three classifications on the basis of dollar
volume.
• It is also known as Pareto analysis. (which is
named after principles dictated by Pareto).
• The idea is to focus resources on the critical
few and not on the trivial many.
• (Annual Dollar Volume of an Item) = (Its
Annual Demand) x (Its Cost per unit)
•
 ABC Analysis
Item Class Annual Dollar Total Inventory Costs Total Inventory items
Volume

Class A High 70% – 80% 15%

Class B Medium 15% - 25% 30%

Class C Low 5% 50% - 60%

ABC Analysis
ABC Analysis Uses
 Just-in-Time Inventory
•
• Just in Time Inventory is the minimum inventory
that is necessary to keep a system perfectly
running.
•
• With just in time (JIT) inventory, the exact
amount of items arrive at the moment they
are needed, Not a minute before OR not a
minute after.

 Achieving JIT Inventory
•
• To achieve JIT inventory, Managers should
Reduce the Variability caused by
some Internal and External Factors.
•
• Existence of Inventory hides the
variability. What causes variability?
 Just-in-Time Inventory

• Most Internal Variability is caused by tolerating

waste (inventory).
• Employees or machines produce units that
do not conform to standards which are
waste and cause variability.
• Engineering drawings are inaccurate,
resulting in loss of production and resulting
in Variability.
• Customer Demands may change due to some
External Factors (such as competitors’ actions
or promotions).
Just-in-Time Inventory
Just-in-Time Inventory
 Inventory Models

• Demand for an item is either dependent

on the demand for other items or it is
independent.
• For example, demand for refrigerator is
independent of the demand for cars.
• But, demand for auto tires is certainly
dependent on the demand of cars.
 Inventory Models

• In this section, we will deal with the

Independent Demand Situation.
• In the independent demand situation, we
should be interested in answering:
• a) When to place an order for an item,
and
• b) how much of an item to order.
Inventory Models
 EOQ Model -
•
Assumptions
Demand is known and constant.
• Lead time (the time between placement of
order and receipt of the order) is constant and
known.
• Orders arrive in one batch at a time, and they
arrive in one point in time.
• Quantity discounts are not possible.
• The costs include only setup cost (or ordering
cost when buying) and holding cost.
• Orders are always placed at the right times.
Therefore, stock outs (or shortages) can be
completely avoided.
 EOQ Model
Profile of Inventory Level Over Time
Q Usage
Quantity rate
on hand

Reorder
point

Time
Receive Place Receive Place Receive
order order order order order
Lead time
 EOQ Model
• Q = order quantity (That is also equal
to the Maximum Inventory)
• Minimum Inventory = 0
• When inventory level reaches 0, a
new order is placed and received.
 EOQ Model

• The objective of inventory models is to

minimize total cost.
• If we minimize the ordering and holding
costs, we will be able to minimize total
cost
 EOQ Model Curve

Q D
TC = H + S
Annual Cost

2 Q

Holding Cost

Ordering Costs

Q* (optimal order quantity)

Optimal order quantity (Q*) occurs at a point where ordering cost is equal
to the holding cost.
 EOQ Model - Equation
• We can write an equation for Q* as follows:
• There will be (D/Q) times of ordering in a whole
year.


Annual Ordering Cost = (D/Q) * S

Average Annual Holding Cost = (Average

Inventory) *H = (Q/2) * H


For Q*, Annual Setup Cost = Annual Holding

Cost
 (D/Q) * S = (Q/2) * H

 EOQ Model - Equation

2DS 2(Annual Demand)(Order or Setup Cost)

Q
 = =
* H Annual Holding Cost


Q* the Economic Order Quantity


 Example
• An Inventory model has the following
characteristics:
• Annual Demand (D) = 1000 units
• Ordering (Setup) cost (S)= $10 per order;
• Holding cost per unit per year (H) = $.50
• Assume that there are 270 working days in
a year (excluding holidays and
weekends).
 Example

1.EOQ, Q* = [2(1000)10 / .50]1/2 = 200 units

2.Expected number of orders placed during the
year (N) = D / Q* = 1000 / 200 = 5 times.
3.Expected time between orders (T) = (Working
days in a year) / N = 270 / 5 = 54 days.
4.Total Annual Cost = Annual Setup Cost +
Annual Holding Cost
 = DS / Q*+ (Q*)H / 2 = $100

 Reorder Point

• So far, we only decided how much to order

(That is Q*).
• Now, we should find what time to order.
• We assumed that firm will wait until its
inventory reaches to zero before placing an
order and the Orders will be received
immediately.
• However, there is a time between placement
and receipt of an order called the LEAD TIME
 Reorder Point

• Reorder Point” (ROP) is the time when the

order is to be placed.
• ROP (in units) = (Demand Per Day)* (Lead
time for a new order in days)
•
 ROP = d * L
Reorder Point
 Reorder Point
• When the inventory level reaches the ROP, a
new order is required.
• It will take a time that is equal to the Lead Time
(L) to receive the new order.
• Demand per day (d) = D / No. of working
days in a year
• This ROP equation assumes that demand is
uniform and constant.
• If this is not the case, an extra (safety) stock is
added (because of uncertainty).
 Reorder Point Example
• Annual demand for an item is D =
8000/year.
• This year there will be 200 working days
in a year.
• Delivery of an order for this item takes 3
working days (L = 3 days).
 Example
• Demand per day, d = 8000 / 200
 = 40 units/ day.
• ROP = d * L = 40 * 3
 = 120 units.
• When the inventory level becomes 120
units, an Order should be placed.
 Make/Buy decision
• Act of making a strategic choice
between producing an item
internally (in-house) or buying it
externally (from an outside
supplier)
• This analysis is conducted at two
levels
– Strategic level
– Operational level
 Make/Buy decision
• Variables considered at the strategic
level include analysis of the future,
as well as the current environment
– Government regulation
– Competing firms
– Market trends
• Operational level confines to the
operation of that particular
company
 Make/Buy decision
• Two most important factors to
consider in a make-or-buy decision
– Cost
– Availability of production capacity
 Factors that influence firms to
‘make’
• Cost considerations
• Desire to integrate plant operations
• Productive use of excess plant capacity
• Better quality control
• Design secrecy is required to protect
proprietary technology
• Unreliable and no competent suppliers
• Desire to maintain a stable workforce
• Quantity too small to interest a supplier
• Control of lead time, transportation, and
warehousing costs
• Greater assurance of continual supply
• Political, social and other reasons
 Factors that influence firms to
‘buy’
• Lack of expertise
• Suppliers' research and specialized know-
how exceeds that of the buyer
• cost considerations
• Small-volume requirements
• Limited production facilities or insufficient
capacity
• Indirect managerial control considerations
• Procurement and inventory considerations
• Brand preference
• Item not essential to the firm's strategy
 Questions to be answered
• Is this the organization’s core
competency?
• Could we be harmed by disclosing
proprietary information?
• What will be the impact on quality or
delivery?
• What additional risks would we be
facing?
• How irreversible is the decision?

 Cost considerations for “make"
analysis
• Incremental inventory-carrying costs
• Direct labor costs
• Incremental factory overhead costs
• Delivered purchased material costs
• Incremental managerial costs
• Any follow-on costs stemming from
quality and related problems
• Incremental purchasing costs
• Incremental capital costs

 Cost considerations for "buy"
analysis
• Purchase price of the part
• Transportation costs
• Receiving and inspection costs
• Incremental purchasing costs
• Any follow-on costs related to quality
or service

 Main factors to be
considered
• Volume
• Fixed costs associated with making
• Per-unit direct costs of making
• Per-unit landed cost from a supplier
 Costs to be calculated
• Cost To Buy, CTB = V * LC
– V = Volume
– LC = Supplier's Per Unit Landed Cost
• Cost To Make, CTM = FC + (PUDC *
V)
– FC = Fixed Costs (of making)
– PUDC = Per Unit Direct Cost (of
making)
• If CTM > CTB, it is more financially
desirable to buy and vice versa
Thank You!!!