- Inventory Management, Supply Contracts and Risk Pooling
- logistics-note-1-1230494545269880-2 (1)
- Value & Atittude
- Ikea Inventory Control
- 11.1.1.7.1 ManufacturingAnalyticsProductGuide
- Operation
- ACMA- 5-6
- Could Demand-driven MRP Be the Solution We Have Been Looking For
- Dynamic Safety Stock Calculation and Integration With Planning
- 06-InventoryControl
- DSP - 01 - Inventory and Ordering
- Monitoring Inventory
- OPMA 5361 Chapter 14
- Inventories 1
- 1 Nov Inventory
- [object XMLDocument]
- 1. Introduction to OPM
- Basics of Supply Chain Managment (Lesson 4)
- Strobel Method - Safety Shoe Production
- Just in Time and Lean Production
- ABI301 Midterm Lecture Note
- Business Plan net on the go
- Economic Order Qty EOQ Points tauqeer
- operations management/logistics/warehousing
- LUMS Descon
- Director of Distribution/Logistics
- 7289 Nitie Strategy Mnagement RB Case
- Logistics
- IE503_LectureC2
- CIO or CTO or VP of IT or Director of IT
- Ch2Lecture Notes
- JSW11eTBChapter-01
- chaoter2
- Chpater 9 Outline
- Ch3Lecture Notes
- Chapter 15
- chapter 9
- Chapter 5
- Chapter 1
- Ch1Lecture Notes(2)
- Chapter 4
- Chapter 13
- chapter 9
- Chapter 14
- Chapter 4
- Chapter 15
- Chpater 9 Outline
- Chapter 14
- Chapter 1
- Chapter 5
- chaoter2
- Strategic Mgt Powerpoint Overview(2)

Graeme Warren

Copyright Graeme Warren 1

Introduction

• Inventory is a stock of goods.

• Management of inventories of independent

demand items, i.e., items that can be sold,

used, or are otherwise stand-alone in nature.

• Dependent demand items are components or

spare parts of independent demand items.

Coverage in Chapter 12.

Copyright Graeme Warren 2

Importance, Types of Inventory

• Effective management of inventory is essential. There are stock

outs, with lost sales and possibly lost customers if a firm has to little

inventory. Too much inventory is a waste and reduces the firm’s

financial performance. The inventory of some firms is huge,

representing a significant investment. For most merchandisers,

inventory is one of the largest assets. For some firms, having

enough inventory (and the right type of inventory in the right

locations) to enable its competitive priorities is essential.

• Inventory may be classified by type. The most important types are:

raw materials and purchased parts, partially finished goods (also

called work in process or work in progress (WIP)), finished goods,

spare parts and maintenance supplies, tools, miscellaneous

supplies. The text also includes pipeline inventory, i.e., goods in

transit, as a separate class of inventory, but these goods can be

otherwise classified as raw materials, purchased parts, finished

goods inventory, etc.

Copyright Graeme Warren 3

Functions of Inventory

• Satisfying anticipated customer demand.

• To smooth production of products that experience seasonal demand because

the firm cannot produce fast enough during the season.

• To decouple operations. The idea here is to prevent bottlenecks from being

idle due to disruptions at other machines through the use of inventory buffers.

Other strategies are available.

• To protect against stock outs. Safety stock is inventory carried to protect

against variability in demand and variability in delivery lead time.

• To exploit order cycles. Production or order quantities will generally be

optimized to balance ordering and carrying costs. The use of economic lot sizes

leads to order cycles or periodic orders.

• To beat price increases. The idea here is to stockpile in anticipation of a price

increase by a supplier.

• To permit operations. Every production system will have some work in process

(WIP). Inventory cannot be eliminated entirely.

• To exploit quantity discounts.

Copyright Graeme Warren 4

Objectives & Decisions

The objectives of inventory management are:

• To ensure that the level of customer service is

satisfactory. This involves having the right goods

available at the right location and the right time to

satisfy the customer.

• To balance order and carrying costs.

The two fundamental decisions that must be made in

inventory management are:

• The order size.

• The order timing.

Copyright Graeme Warren 5

Measures of Performance

• Inventory turnover, defined as follows:

=

Higher inventory turns are desirable. Inventory turns will vary by industry and profit

margin.

• Weeks of supply, defined as follows:

=

Generally speaking we want to minimize weeks of supply, but it cannot go to zero

(because we need some inventory to “lubricate” the production system).

• Inventory on hand.

Copyright Graeme Warren 6

Requirements for

Effective Inventory Management

• A system to track inventory levels (orders, backorders, and

inventory on hand). There are two basic types:

– Periodic systems, in which inventory is periodically counted for the

purpose of placing of orders. The main advantage of a periodic system

is that multiple orders can be placed at the same time, allowing for

efficient shipping.

– Perpetual systems, which track every addition to, and every removal

from inventory. When a target inventory is reached, an order is

automatically generated. Perpetual systems are easily implemented

using point-of-sale (POS) systems that can scan merchandise bar codes

or RFID tags.

• A forecast of demand, to include estimates of the mean and

standard deviation of demand per period.

• Estimates of the mean and standard deviation of delivery lead time,

per supplier, per item.

Copyright Graeme Warren 7

Requirements for Effective

Inventory Management contin.

• Estimates of the inventory carrying, ordering, and shortage costs.

– Carrying (a.k.a. holding) costs include the cost of storing inventory, including real-estate taxes,

insurance, lost interest on the value of the inventory, spoilage, pilferage, obsolescence,

warehousing costs, and material handling costs. According to the class text, annual carrying

costs range from 20% to 40% of the value of an item, depending upon the type of item.

– Ordering costs include the cost of placing an order, administration, setting up a production

facility to manufacture an order (if applicable), quality assurance, storage, and handling of the

order upon delivery.

– Shortage costs occur when there is a stock out. They are difficult to estimate and include loss

of a sale, loss of customer goodwill, and perhaps permanent loss of the customer.

• An inventory classification system that recognizes the relative importance of different items (or

stock-keeping units (SKUs). The ABC approach can be used, where

– Class A items (typically 60-70% of the value of the inventory, but usually only about 10-20% of

the total number of items in inventory) are “very important.”

– Class B items (typically 25-40% of the value of the inventory, and accounting for about 20-40%

of the total number of items in inventory) are “moderately important.”

– Class C items (typically only 10-15% of the value of the inventory, but as much as 60% of the

total number of items in inventory) are “least important.”

Copyright Graeme Warren 8

Mathematical Models

Prototype inventory models, namely:

• A continuous- (a.k.a. perpetual) review model.

and

• A periodic-review model.

We will not consider the EPQ model (p. 570-573)

or quantity discounts (p. 573-577).

Copyright Graeme Warren 9

Continuous-Review Model Regime

The operating regime for the continuous-review model is as follows:

• An order (for Q units) is placed whenever the quantity of inventory

on hand reaches the re-order point, R.

• The order quantity Q is fixed and the time between orders is

variable (an order is placed when the inventory hits the re-order

point).

• The order size Q is optimized to balance carrying and ordering

costs.

• Example: used by some to buy gas for their vehicle: they go to the

gas station when the amber light (the re-order point R has been

reached) comes on, and fill up their tanks (i.e., Q is a tank of gas).

• Observe that a continuous-review system is focused on each type of

inventory in isolation.

Copyright Graeme Warren 10

Periodic-Review Model Regime

The periodic-review model operates as follows:

• an order for a variable number of units is placed every

OI time units. The time between orders is therefore

fixed.

• Orders are placed for whatever is needed to restock to

a target inventory level.

• Notice that a periodic-review system can order

multiple product types whenever an order is placed.

• Many retail firms use periodic-review systems, placing

orders on a fixed weekly or biweekly basis for

numerous types of items from a supplier.

Copyright Graeme Warren 11

Contrast of Continuous-Review and

Periodic-Review Models

Continuous-review

model

Periodic-review

model

Time between orders

Variable

(order when inventory

reaches the re-order point)

Fixed

Order size

Fixed

Variable

(order whatever is needed

at the fixed order times)

Copyright Graeme Warren 12

Pros and Cons of Continuous-Review

and Periodic-Review Models

• Pros of the continuous-review system: total carrying and ordering costs

are minimized.

• Cons of the continuous-review system: the model does not factor

inventory monitoring costs in the calculation of the optimal order

quantity. Monitoring is required to determine when the re-order point is

reached. Continuous-review systems can be expensive to implement in

practice due to the cost of monitoring, and the cost of shipping a single

type of item. Applications are usually limited to high-value items.

Nevertheless, it is often useful to know what the economic order quantity

is to design alternative inventory management systems.

• Pros of periodic-review systems: the fixed order interval allows for

efficient and routine shipping of multiple item types. This is a significant

consideration when freight costs are high…

• Cons of periodic-review systems: safety stock has to be carried to protect

against stock outs. Recall that in the periodic review model that orders can

only be placed at fixed order intervals, exposing the firm to greater stock

out risk because it cannot order whenever it needs to.

Copyright Graeme Warren 13

Continuous-Review Model Math

The key parameters needed to operate a continuous review system are:

• The order size Q, which we’ll set equal to the economic order size, EOQ .

• The re-order point R.

The notation we’ll assume is as follows:

• H is the annual carrying cost (in $/unit/year).

• D is the annual demand (in units).

• S is the flat order cost (in $). Note that it does not depend upon the size of the order.

• Q is an order quantity (in units).

• EOQ is the optimal order quantity a.k.a. economic order quantity or EOQ (in units).

• TBO is the time between orders.

• C is the total cost (in $).

• R is the reorder point (in units).

• L is the delivery lead time.

•

**is the standard deviation of demand during the delivery lead time.
**

Copyright Graeme Warren 14

Continuous-Review Model Math contin.

Copyright Graeme Warren 15

TBO TBO TBO

Q

Q

R

ORDERS PLACED

time

Inventory

Continuous-Review Model Math contin.

=

2

+

**Copyright Graeme Warren 16
**

Order Quantity

Cost

Carrying Cost

Total Cost

Order Cost

EOQ

Continuous-Review Model Math contin.

=

2

−

2

= 0

2

2

= 2

−3

> 0

Celebrated EOQ formula:

=

2

**Copyright Graeme Warren 17
**

Continuous-Review Model Math contin.

Time between orders: = /

Reorder point: = . +

**where z=NORM.INV(1-ltsl,0,1)
**

Copyright Graeme Warren 18

Example 1

A company buys an item with a demand of 64 units/week. It costs $50 to order the item (irrespective of the

quantity ordered). Holding costs are $13/unit/year. The delivery lead time is 2 weeks and the standard

deviation of demand during the delivery lead time is 12 units. Suppose that a lead time service level of 95%

is desired. Assume 52 weeks per year. Design a continuous-review inventory strategy for this setting, and

compute the total annual carrying and holding costs.

Solution: for this problem we have = 64 × 52 = 3328 units, = $50, = $13 unit/year; = 2 weeks;

**= 12 units. For this data we compute the optimal order quantity:
**

=

2

=

2 64 × 52 50

13

= 160

We calculate z=NORM.INV(1-.95,0,1) = 1.645.

The re-order point is then:

= . +.

**= 64 × 2 + 1.645 × 12 = 128 +19.74 = 147.74
**

which we will round to 148 units. Note that the safety stock is 19.74 units.

The time between orders is TBO = EOQ/D = 160/(6452) = 0.048 years = 2.5 weeks.

The total annual order and holding costs of the system is:

=

2

+

=

160

2

13 +

3328

160

50 = 1,040 + 1,040 = $2,080/

Copyright Graeme Warren 19

Example 1 Visualization

Copyright Graeme Warren 20

Two- Bin System

• A two-bin system is an example

of a continuous-review system.

• The system works by storing

inventory in two bins. When a bin

is empty an order is placed. The

inventory in the second bin is

used while waiting for the order

to arrive.

• The amount of inventory in a bin

(and hence the order size) should

be EOQ.

• Reorder point R = EOQ.

Copyright Graeme Warren 21

This image was taken from the Geography project collection. See this

photograph's page on the Geography website for the photographer's

contact details. The copyright on this image is owned by Michael

Patterson and is licensed for reuse under the Creative Commons

Attribution-ShareAlike 2.0 license. Downloaded from WikiMedia

Commons.

Periodic-Review Model Math

The key parameters needed to operate a periodic-review

system are:

• The time between orders (OI), and

• The amount to order.

We assume the notation used for the continuous-review

model, adding the following:

• OI = time between orders (in days).

• A= the amount of inventory on hand at time of ordering (in

units).

• d = the mean demand per day (in units).

•

**= the standard deviation of daily demand (in units).
**

Copyright Graeme Warren 22

Periodic-Review Model Math contin.

Copyright Graeme Warren 23

Orders Placed

Order Interval (OI)

Time

Inventory

T

Periodic-Review Model Math contin.

Deciding the order interval:

• May be decided by supplier

• =

**Define the protection interval P as the sum of the order interval
**

and the delivery lead time, i.e.:

= +

The protection interval is so named because every order that is

placed has to cover demand until the next order can be placed

and delivered.

Copyright Graeme Warren 24

Periodic-Review Model Math contin.

The amount that must be ordered is the expected

demand during the protection interval, plus safety stock,

less the amount on hand at reorder time.

= . +

−

We assume that demand during the protection interval is

normally distributed. z is then the familiar deviate for

which the upper tail of the standard normal distribution is

1-pisl (where pisl is the desired protection interval service

level). That is, z=NORM.INV(1-pisl,0,1).

Copyright Graeme Warren 25

Example 2

A company buys an item with a demand of 64 units/week. It costs $50 to order the item (irrespective of the

quantity ordered). Holding costs are $13/unit/year. The delivery lead time is 2 weeks and the standard

deviation of daily demand is 2 units. Suppose that a protection interval service level of 99% is desired.

Assume 52 weeks per year. Design a periodic-review inventory strategy for this setting.

Solution: We have = 64 units; = 64 × 52 = 3328 units, = $50, = $13 unit/year; = 2 weeks;

**= 2 units. For this data we compute the optimal order quantity:
**

=

2

=

2 64 × 52 50

13

= 160

Suppose that the supplier is flexible and will deliver as requested. In this case we are able to calculate the

order interval (OI):

=

=

160

3328

= 0.048 years = 2.5 weeks

Then we have = + = 2.5 +2 = 4.5 weeks.

The amount to order, at the fixed re-order times (every 2.5 weeks) will be (assuming there are A units on

inventory on hand at that time):

= 64 4.5 + 2.326 2 4.5 − = 288 + 9.9 − ≈ 298 −

since z=NORM.INV(1-.99,0,1) = 2.326.

The target inventory level, which will be denoted by T, is 298 units.

Copyright Graeme Warren 26

Single-Period Model

• The single-period model is also called the newsvendor

problem.

• Informal description: a newsvendor must decide how many

papers to buy from the newspaper company. She faces the

challenge of buying too few and foregoing profit versus

buying too many, and having to throw away unsold

newspapers at the end of the day.

• Let’s throw in some numbers: suppose she can buy the

newspapers for $0.10, and sell them for $1.00. How many

should she buy at the start of the day assuming that

demand for the newspaper is normally distributed with a

mean of 100 newspapers and a standard deviation of 15

newspapers?

Copyright Graeme Warren 27

Single-Period Model

The single-period model generalizes (and is applicable) to any inventory

system in which products age, become obsolete, or otherwise unusable at the

end of the period. The class text identifies applications in bakeries, produce,

printed media, and seafood. It is precisely the fact that the product is

valueless at the end of the period that makes the inventory problem a single-

period problem.

Suppose the following notation:

•

ℎ

the shortage cost (i.e., the lost profit per unit =

Revenue/unit – Cost/unit)

•

**the excess cost (i.e., Cost/unit – Salvage cost/unit)
**

•

**mean period demand
**

•

**standard deviation of period demand
**

Copyright Graeme Warren 28

Single-Period Model

The service level is the probability that demand will not exceed the stocking level, and is calculated as

follows (details are beyond the scope of the course):

=

ℎ

ℎ

+

**The optimal stock level at the start of the period for which demand is assumed to be normally
**

distributed with a mean of

and a standard deviation of

**can be calculated using the Microsoft Excel
**

2010 formula =NORM.INV(Service Level,

,

)

We are now in a position to help out our newsvendor. In her problem

ℎ

=$1.00-$0.10=$0.90,

=$0.10,

=100, and

=15. So,

=

ℎ

ℎ

+

=

0.90

0.90 + 0.10

= 0.9

And so her optimal stocking level should be =NORM.INV(0.9, 100,15) = 119.2, or 119 newspapers!

Copyright Graeme Warren 29

Operations Strategy

• Inventory management processes offer

substantial scope for significant improvement

(because of the cost of maintaining inventory).

• The benefits accruing from lean initiatives,

improvement in supply chain management,

and the use of an IT system to track inventory

should be pursued.

Copyright Graeme Warren 30

FIN

Copyright Graeme Warren 31

- Inventory Management, Supply Contracts and Risk PoolingUploaded bydhiar
- logistics-note-1-1230494545269880-2 (1)Uploaded byMangesh_Kumar_6946
- Value & AtittudeUploaded byShantanu Datta
- Ikea Inventory ControlUploaded byAtefeh Molaie
- 11.1.1.7.1 ManufacturingAnalyticsProductGuideUploaded bySagar Naidu
- OperationUploaded byJojoPANG
- ACMA- 5-6Uploaded byapi-3716588
- Could Demand-driven MRP Be the Solution We Have Been Looking ForUploaded byclemen_ang
- Dynamic Safety Stock Calculation and Integration With PlanningUploaded byKathula Venkateswararao
- 06-InventoryControlUploaded bymoonight223344
- DSP - 01 - Inventory and OrderingUploaded byscribd1904
- Monitoring InventoryUploaded byAji thea
- OPMA 5361 Chapter 14Uploaded byKhurramSadiq
- Inventories 1Uploaded byhari178
- 1 Nov InventoryUploaded byrahul
- [object XMLDocument]Uploaded byradhika1991
- 1. Introduction to OPMUploaded bymoh4u
- Basics of Supply Chain Managment (Lesson 4)Uploaded byPharmacotherapy
- Strobel Method - Safety Shoe ProductionUploaded byMd Mustafa Hussain
- Just in Time and Lean ProductionUploaded byaghataimor
- ABI301 Midterm Lecture NoteUploaded byabhute
- Business Plan net on the goUploaded byVishal Gaonkar
- Economic Order Qty EOQ Points tauqeerUploaded byM.Tauqeer
- operations management/logistics/warehousingUploaded byapi-77739452
- LUMS DesconUploaded byYasir
- Director of Distribution/LogisticsUploaded byapi-78255546
- 7289 Nitie Strategy Mnagement RB CaseUploaded bySudipta Soumyadarshan
- LogisticsUploaded bySuyog_Pitale_6869
- IE503_LectureC2Uploaded byjay
- CIO or CTO or VP of IT or Director of ITUploaded byapi-78092081

- Ch2Lecture NotesUploaded bycooneyz1987
- JSW11eTBChapter-01Uploaded bycooneyz1987
- chaoter2Uploaded bycooneyz1987
- Chpater 9 OutlineUploaded bycooneyz1987
- Ch3Lecture NotesUploaded bycooneyz1987
- Chapter 15Uploaded bycooneyz1987
- chapter 9Uploaded bycooneyz1987
- Chapter 5Uploaded bycooneyz1987
- Chapter 1Uploaded bycooneyz1987
- Ch1Lecture Notes(2)Uploaded bycooneyz1987
- Chapter 4Uploaded bycooneyz1987
- Chapter 13Uploaded bycooneyz1987
- chapter 9Uploaded bycooneyz1987
- Chapter 14Uploaded bycooneyz1987
- Chapter 4Uploaded bycooneyz1987
- Chapter 15Uploaded bycooneyz1987
- Chpater 9 OutlineUploaded bycooneyz1987
- Chapter 14Uploaded bycooneyz1987
- Chapter 1Uploaded bycooneyz1987
- Chapter 5Uploaded bycooneyz1987
- chaoter2Uploaded bycooneyz1987
- Strategic Mgt Powerpoint Overview(2)Uploaded bycooneyz1987