Overview

Inventory (ABC & EOQ)

Inventory Functions and Types ABC Analysis & Cycle Counting Fixed Period System

MGNT 3430

EOQ Inventory Model

Inventory: Functions & Types

Expensive asset Functions
Buffer between demand and supply Decouple production processes Hedge against inflation Take advantage of quantity discounts

Overview
Inventory Functions and Types ABC Analysis & Cycle Counting Fixed Period System EOQ Inventory Model

Types
Raw material: unprocessed by the firm Work-in-process (WIP): partially transformed

ABC Analysis
Inventory Classification
ABC Analysis
Pareto principle Classify items as A, B or C
Annual dollar volume
Item Stock Numbe r #10286 #11526 #12760 #10867 #10500 #12572 #14075 #01036 #01307
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Percent of Number of Items Stocked 20%

Annual Volume (units) 1,000 500 1,550

Unit Cost $ 90.00 154.00 17.00 42.86 12.50 $ 14.17 .60 8.50 .42 .60

Annual Dollar Volume $ 90,000 77,000 26,350 15,001 12,500 $ 8,502 1,200 850 504 150

Percent of Annual Dollar Volume 38.8% 33.2% 11.3% 6.4% 5.4% 3.7% .5% .4% .2% .1% 5% 23 % 72 %

Class A A B B B C C C C
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Taking Inventory
Audit of what is in stock/storage Reconcile purchases and

usage

30%

350 1,000 600 2,000

On hand=Purchases - Usage

Cycle counting
Taking partial inventory daily Frequency of counting
A items most frequent C items least frequent

50%

100 1,200 250

#10572

Cycle Counting
5,000 items in inventory: 500 A items, 1,750 B items, 2,750 C items
Policy is to count: A items every month (20 working days) B items every quarter (60 days) C items every six months (120 days)
Item Class Quantity A B C 500 1,750 2,750 Cycle Counting Policy Each month Each quarter Every 6 months Number of Items Counted per Day 500/20 = 25/day 1,750/60 = 29/day 2,750/120 = 23/day
7 77/day

Overview
Inventory Functions and Types ABC Analysis & Cycle Counting Fixed Period System EOQ Inventory Model

Fixed-period system
Inventory counted at end of period Ordering policy is order up to type
Set target or par levels for each item

Costs of Inventory
Holding Costs
Housing/storage Material handling & labor Investment Shrinkage & obsolescence

Example: The GAP

Order amount (Q) = Target (On-hand inventory) - Earlier orders not yet received + Back orders
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Ordering / Setup Costs

Supplies, processing time, clerical support Machine preparation

Unit Costs
Purchase cost per item
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Overview
Inventory Functions and Types ABC Analysis & Cycle Counting Fixed Period System EOQ Inventory Model

Basic EOQ Model Important assumptions

1. Demand is known, constant, and independent 2. Lead time is known and constant 3. Receipt of inventory is instantaneous and complete 4. Quantity discounts are not possible 5. Only variable costs are setup and holding 6. Stockouts completely avoidable
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Inventory Usage Over Time

Minimizing Total Costs

Objective is to minimize total costs
Average inventory on hand Q 2

Inventory level

Order quantity = Q (maximum inventory level) Minimum inventory

Usage rate

Curve for total cost of holding and setup Minimum total cost Annual cost Holding cost curve

Time
Figure 12.3
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Setup (or order) cost curve Optimal order quantity Order quantity
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Table 11.5

EOQ Model
Q Q* D S H

Annual setup cost =

D S Q

EOQ Model
Q Q* D S H

= Number of pieces per order = Optimal number of pieces per order (EOQ) = Annual demand in units for the Inventory item = Setup or ordering cost for each order = Holding or carrying cost per unit per year Annual setup cost = (Number of orders placed per year) x (Setup or order cost per order)

= Number of pieces per order = Optimal number of pieces per order (EOQ) = Annual demand in units for the Inventory item = Setup or ordering cost for each order = Holding or carrying cost per unit per year

D S Q Q Annual holding cost = H 2 Annual setup cost =

Annual holding cost = (Average inventory level) x (Holding cost per unit per year) = Order quantity (Holding cost per unit per year) 2 Q (H) 2
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Annual demand Setup or order Number of units in each order cost per order = D (S) Q
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EOQ Model
Q Q* D S H

= Number of pieces per order = Optimal number of pieces per order (EOQ) = Annual demand in units for the Inventory item = Setup or ordering cost for each order = Holding or carrying cost per unit per year

D S Q Q Annual holding cost = H 2 Annual setup cost =

EOQ Example: optimal order quantity

Determine optimal number of needles to order D = 1,000 units S = $10 per order H = $.50 per unit per year

Optimal order quantity is found when annual setup cost equals annual holding cost D Q S = H Q 2 Solving for Q*

Q* =

2DS H Q* = 2(1,000)(10) 0.50 = 40,000 = 200 units

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2DS = Q2H Q2 = 2DS/H Q* = 2DS/H

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EOQ Example: # of orders/ year

Determine optimal number of needles to order D = 1,000 units Q* = 200 units S = $10 per order H = $.50 per unit per year Expected Demand D number of = N = = Q* Order quantity orders 1,000 N= = 5 orders per year 200
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EOQ Example: Order cycle length

Determine optimal number of needles to order D = 1,000 units Q* = 200 units S = $10 per order N = 5 orders per year H = $.50 per unit per year Expected time between = T = orders T= Number of working days per year N

250 = 50 days between orders 5

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EOQ example: Total Cost

Determine optimal number of needles to order D = 1,000 units Q* = 200 units S = $10 per order N = 5 orders per year H = $.50 per unit per year T = 50 days Total (relevant) annual cost = Setup cost + Holding cost D Q TC = S + H Q 2 TC = 1,000 200 ($10) + ($.50) 200 2

EOQ Example:New optimal order quantity

Determine optimal number of needles to order D = 1,500 units S = $10 per order H = $.50 per unit per year

Q* =

2DS H Q* = 2(1,500)(10) 0.50 = 60,000 = 244.9 units

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TC = (5)($10) + (100)($.50) = $50 + $50 = $100

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EOQ Robustness: New TC

Actual EOQ for new demand is 244.9 units D = 1,000 units 1,500 units Q* = 244.9 units S = $10 per order N = 5 orders per year H = $.50 per unit per year T = 50 days D Q S + H Q 2 1,500 244.9 TC = ($10) + ($.50) 244.9 2 TC = TC = $61.24 + $61.24 = $122.48

EOQ Robustness: 1st Q* but D=1500

Management underestimated demand by 50% D = 1,000 units 1,500 units Q* = 200 units S = $10 per order N = 5 orders per year H = $.50 per unit per year T = 50 days Q D S + H 2 Q 1,500 200 TC = ($10) + ($.50) = $75 + $50 = $125 200 2 TC = Total annual cost increases by only 25%

Only 2% less than the total cost of $125 when the order quantity was 200
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Robustness of EOQ

Homework
Discussion Questions
1, 3, 4

The EOQ model is robust

It works even if all parameters and assumptions are not met The total cost curve is relatively flat in the area of the EOQ

Problems
12.1, 12.4, 12.5, 12.8

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