Bus Adm 370 - Chp 12 Inventory Mgmt.

Inventory Inventory: A stock or store of goods. Inventory is created when

receiving rate exceeds usage rate

Inventory Management

incoming raw material exceeds production consumption production exceeds demand

Inventory can be measured in

physical units money

Inventory Examples
Manufacturing firms carry supplies of raw materials, purchased parts, finished items, spare parts, tools,....

What is Inventory Management?

Department stores carry clothing, furniture, stationery, appliances,... Hospitals stock drugs, surgical supplies, life-monitoring equipment, sheets, pillow cases,... Supermarkets stock fresh and canned foods, packaged and frozen foods, household supplies,... Software Companies Banks
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Bus Adm 370 - Chp 12 Inventory Mgmt.

INVENTORY INVENTORY
SINGLE Single STAGE stage MULTI Multi STAGE stage

Why might we want to build inventories?

INVENTORY
Raw material
a. Customer service: For customers that have immediate or seasonal demands, finished goods inventory can speed up delivery and reduce stockouts and backorders. b. Ordering costs: Costs associated with purchasing, follow-up, receiving, and paperwork are incurred each time an order is placed. By ordering in larger quantities, the resulting inventory provides a means of obtaining and handling materials in economic lot sizes. c. Setup costs: Production orders have similar costs associated with each setup, and machines may be unproductive for several hours each time the product is switched. > Labor and time to make changeover > May include scrap and rework 7

In process

INVENTORY
Independent demand Dependent demand Finished goods

INVENTORY
Seasonal stocks Cycle stocks Decoupling stocks

Why might we want to build inventories? (contd)

c. Stabilizing output rates: Inventories can be used to cover peaks in demand, level production activities, stabilize employment, and improve labor relations. d. Transportation costs: Transportation costs can be reduced by building inventories and shipping full truckloads. e. Quantity discounts. Ordering large quantities can provide a hedge against future price increases and provide a means to

Safety stocks

obtain quantity discounts.

Pipeline stocks
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Bus Adm 370 - Chp 12 Inventory Mgmt.

Why might we want to avoid inventories?

a. Collectively called inventory holding cost. The cost to keep an item on hand for a year typically ranges from 25 percent to 40 percent of the items value. b. Cost components Interest or opportunity cost of capital time value of money Storage and handlingwarehouse facilities and labor Taxes and insuranceusually proportional to inventory value Shrinkage - Pilferage - Obsolescence - Deterioration c. Masks quality problems we will look at this later in sessions on JIT
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Inventory Costs cont. b. Holding (carrying) cost: Physically holding item in storage. - Holding costs are stated in either way:
1. 2.

a percentage of unit price per unit of time a dollar amount per unit per unit of time

c. Shortage costs: Costs resulting when demand exceeds supply. - It is often difficult to quantify shortage costs.
One objective of Inventory Control is to minimize the sum of these costs by balancing them.
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Inventory Costs
a. (Fixed) ordering cost / Set up cost: Costs of ordering/producing and receiving inventory.
Cost of placing an order -- determine how much needed, typing up invoices, etc. Fixed ordering costs are generally expressed as a fixed dollar amount per order, independent of size of order.

Basic Inventory Management Questions

How much to order When to order?

a Unit ordering/production cost: cost of obtaining one unit of the inventory.

Unit price of the item Inspecting goods for quality and quantity, etc. Unit ordering costs are generally expressed as a dollar amount per unit.
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Purchase Order Description Qty. Microwave 1000

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Bus Adm 370 - Chp 12 Inventory Mgmt.

Inventory Counting Systems - Types

Periodic system: Physical count of items made at periodic intervals (weekly, monthly)
- Good: Economics of scale - Bad: Lack of control between reviews, carry extra stock to protect against shortages between reviews

Basic Economic Order Quantity Model (EOQ) Assumptions:

1. Ordering in batch from supplier. 2. Only one product is involved. 3. Constant demand rate. Demand is spread evenly
throughout the year.

Continuous (perpetual) system: System that keeps track of removals from inventory continuously, thus monitoring current levels of each item. Fixed quantity is ordered when a certain level is reached
- Good: keep constant count of inventory, fixed order quantity
-

4. Constant lead time. Lead time does not vary much for
a long enough time.

Bad: higher record keeping cost, periodic inventory counting is still required

Two-bin system: Two containers of inventory; reorder when the first is empty
- Good: simple, cheap, need not record each withdrawal - Bad: reorder card may not be turned in for some reasons
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5. Single delivery for each order. 6. A single flat unit price from the supplier.
Standard goods
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System Performance Measures for any Q

D = 400 units/year, H= 1.5 $/unit/year , S = $50 /order Q = 100 units
Average (cycle) inventory
Q 100 Q 50 2 2

Continuous (perpetual) System with Constant Demand and Lead Time EOQ (basic)

average (cycle) inventory =

100 Q ( )(1.5) $75 H 2 2

annual inventory holding cost

400 D 4 100 Q 400 D 50 200 S annual ordering cost = 100 Q

number of orders per year =

order cycle

length of order cycle =

100 1 Q year 400 4 D

annual total cost (C) = holding cost + ordering cost

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75 200 275

Q D H S 2 Q

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Bus Adm 370 - Chp 12 Inventory Mgmt.

System Operations and Cost Trade-off

D=400, h=1.5, S=50 Average (cycle) inv. number of orders / yr annual inv. holding cost annual ordering cost annual total cost Q=100 50 4 75 200 275 Q=200 100 2 150 100 250

Tradeoff: The higher Q, the higher inventory holding cost, but the lower ordering cost.

Question: Where to strike the balance? Whats best Q?

On-hand inventory On-hand inventory

Q=200

Q=100

Time (year)

Time (year)
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EOQ is the order quantity that minimizes the total cost

EOQ Model

How much to order?

Annual cost (dollars)
Total cost =
Q H 2

D S Q

Answer: 2 DS EOQ = H where D = annual demand, H = annual unit holding cost

Q H 2

Holding cost =
D S Q

When to order?
Instantaneous replenishment, i.e. lead time =0
Answer: when the inventory = 0

Ordering cost =

(Q*)

Constant replenishment lead time = L

Lot Size (Q) Answer ?

2 DS EOQ H

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Bus Adm 370 - Chp 12 Inventory Mgmt.

EOQ Model Reorder point (ROP)

Continuous System Uncertain Demand constant lead time = L

Let L = the time periods (say, days) for a replenishment order to arrive, d = demand per unit time period. When to order? Answer: when the on-hand inventory is equal to the reorder point: ROP = d*L ( = demand during lead time)
On-hand inventory
Order received Order placed

Order received

Order received Order received

Order received

On-hand inventory

Q
ROP
Order placed Order placed

Order placed

ROP
L L L L

Time
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Time

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Continuous System Uncertain Demand constant lead time = L

How much to order? Answer: EOQ = 2E ( D)S H where E[D] = average (expected) annual demand, H = annual unit holding cost When to order?
Reorder Point (ROP)?

Continuous (perpetual) System with Uncertain Demand and Constant Lead Time

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Bus Adm 370 - Chp 12 Inventory Mgmt.

Continuous Review Uncertain Demand constant replenishment lead time = L

What should be the reorder point (ROP) : If ROP = average (expected) demand during lead time, we have a 50% chance stocking out during the inventory cycle. So, to have a cycle-service level higher than 50%, we need a higher ROP. The part of ROP above the average demand during lead time is safety stock: ROP = average demand during lead time + safety stock Service Level = Prob. (demand is filled by on-hand inventory) =1-Prob(stockout)
Average demand during lead time Safety Stock

Cycle service level z

0.90 1.28

0.80 0.84

.9918 2.40

.999 3.08

Cycle-service level > 50% Probability of stock-out

ROP

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Calculation of Reorder Point (ROP)

If demand during lead time is Normal distributed with a mean (average) value of L and standard deviation of L , then the required safety stock for a given cycle-service level can be expressed as the number (z) of standard deviation; ROP = average demand during lead time + safety stock =

Calculation of

L + z L

where, z can be found from a Normal Distribution Table.

Cycle-service level

Often demand distribution data is not expressed in terms of replenishment lead time. Suppose we know that the demand per time period (say, week) is Normal distributed with a mean value of and a standard deviations of . The inventory replenishment lead time is L time periods. Then, the demand during lead time will be Normal distributed with a mean value of

L L
and standard deviation of L L

z L

ROP

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For case where lead time is also variable, refer page 566 of Stevenson

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