You are on page 1of 28

Supply Chain Management

Inventory Management and Control

Indian Institute of Management
Lucknow

ABC Analysis
• Divides inventory into three classes based on
annual monetary volume
• Class A - high annual rupee volume
• Class B - medium annual rupee volume
• Class C - low annual rupee volume

• Used to establish policies that focus on the few
critical parts and not the many trivial ones
1/13/2016

Supply Chain Management

2

ABC Analysis
Item
Stock
Number

Percent of
Number of
Items
Stocked

#10286

20%

Annual
Volume
(units)

x

Unit
Cost

=

Annual
Dollar
Volume

1,000

$ 90.00

$ 90,000

#11526

500

154.00

#12760

1,550

#10867

#10500

1/13/2016

30%

Percent of
Annual
Dollar
Volume

Class

38.8% 72%

A

77,000

33.2%

A

17.00

26,350

11.3%

B

350

42.86

15,001

6.4% 23%

B

1,000

12.50

12,500

5.4%

B

Supply Chain Management

3

ABC Analysis
Item
Stock
Number

Percent of
Number of
Items
Stocked

Annual
Volume
(units)

x

Unit
Cost

=

Annual
Dollar
Volume

Percent of
Annual
Dollar
Volume

Class

#12572

600

$ 14.17

$ 8,502

3.7%

C

#14075

2,000

.60

1,200

.5%

C

100

8.50

850

.4%

#01307

1,200

.42

504

.2%

C

#10572

250

.60

150

.1%

C

#01036

1/13/2016

50%

Supply Chain Management

5%

C

4

Percent of annual dollar usage

ABC Analysis

80
70
60
50
40
30
20
10
0









A Items

B Items
C Items
|

|

|

|

|

|

|

|

10

20

30

40

50

60

70

80

Percent of inventory items
1/13/2016

Supply Chain Management

|

|

90 100
Figure 11.2
5

Criteria other than annual rupee volume
• Anticipated engineering changes
• Delivery problems
• Quality problems
• High unit cost

1/13/2016

Supply Chain Management

6

ABC Analysis – Policy Implications
• Policies employed shouldy include
• More emphasis on supplier development for A
items
• Tighter physical inventory control for A items
• More care in forecasting A items

1/13/2016

Supply Chain Management

7

Record Accuracy

Accurate records are a critical ingredient in production
and inventory systems

Allow organization to focus on what is needed

Necessary to make precise decisions about ordering,
scheduling, and shipping

Incoming and outgoing record keeping must be
accurate

Stockrooms should be secure
1/13/2016

Supply Chain Management

8

Cycle Counting and PIC

Items are counted and records updated on a periodic basis

Often used with ABC analysis to determine cycle
Trained personnel audit inventory accuracy

Offers several advantages
• Eliminates shutdowns and interruptions
• Eliminates annual inventory adjustment
• Allows causes of errors to be identified and corrected
• Maintains accurate inventory records
1/13/2016

Supply Chain Management

9

Cycle Counting Example
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), and C items every six months (120 days)
Item
Class

Quantity

A

500

Each month

B

1,750

Each quarter

C

2,750

Every 6 months

Cycle Counting Policy

Number of Items
Counted per Day
500/20 = 25/day
25/day
1,750/60 = 29/day
29/day
2,750/120 = 23/day
23/day
77/day
77/
day

1/13/2016

Supply Chain Management

10

Exercise
Woodywood Furnitures has 5200 items in inventory. The owner
has identified that 9% items are in A category and 36% items are
in B category. She would like to establish a system in which all A
items are counted every 4 weeks, B items are counted every 13
weeks and C items are counted every 26 weeks. Calculate the
number of items to be counted each week.
5200 × 0.09 = 468

468 ÷ 4= 117

117A items per day

5200 × 0.36= 1872

1872 ÷ 13 = 144

144 B items per day

5200 × 0.55 = 2850

2860 ÷ 26 = 110

110 C items per day

371 items
1/13/2016

Supply Chain Management

11

Control of Service Inventories

Can be a critical component of profitability

Losses may come from shrinkage or pilferage

Applicable techniques include

Good personnel selection, training, and discipline

Tight control on incoming shipments

Effective control on all goods leaving facility

1/13/2016

Supply Chain Management

12

Independent vs Dependent Demand
• Independent demand - the demand for item is
independent of the demand for any other item
in inventory
• Dependent demand - the demand for item is
dependent upon the demand for some other
item in the inventory
1/13/2016

Supply Chain Management

13

Holding Costs
Category
Housing costs (including rent or depreciation,
operating costs, taxes, insurance)

Cost (and Range) as
a Percent of
Inventory Value

6% (3 - 10%)

Material handling costs (equipment lease or
depreciation, power, operating cost)

3% (1 - 3.5%)

Labour cost

3% (3 - 5%)

Investment costs (borrowing costs, taxes, and
insurance on inventory)
Pilferage, space, and obsolescence

11% (6 - 24%)
3% (2 - 5%)
26%

Overall carrying cost

Table 11.1
1/13/2016

Supply Chain Management

14

Inventory Models for Independent Demand
Need to determine when and how much to order
• Basic economic order quantity
• Production order quantity
• Quantity discount model

1/13/2016

Supply Chain Management

15

Assumptions in Basic EOQ Model
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 can be completely avoided
1/13/2016

Supply Chain Management

16

Inventory level

Inventory Usage Over Time

Order quantity
= Q (maximum
inventory
level)

Usage rate

Average
inventory on
hand
Q
2

Minimum
inventory

Time
Figure 11.3
1/13/2016

Supply Chain Management

17

Minimizing Costs
Objective is to minimize total costs

Annual cost

Curve for total
cost of holding
and setup

Table 11.4

1/13/2016

Holding cost
curve

Minimum
total cost

Setup (or order)
cost curve
Optimal order
quantity
Supply Chain Management

Order quantity

18

The EOQ Model
D
Annual setup cost = S Q

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)

=

Annual demand
Number of units in each order

=

D
(S)
Q

1/13/2016

Supply Chain Management

Setup or order
cost per order

19

The EOQ Model
D
Annual setup cost = S Q

Q
Q*
D
S
H

Q
Annual holding cost =
H
2

= 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 holding cost = (Average inventory level)
x (Holding cost per unit per year)
Order quantity
=
2
=
1/13/2016

(Holding cost per unit per year)

Q (H)
2
Supply Chain Management

20

The EOQ Model
D
Annual setup cost = S Q

Q
Q*
D
S
H

Annual holding cost = 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

Q
2

Optimal order quantity is found when annual setup cost
equals annual holding cost
D
Q
S =
H
Q
2
Solving for Q* 2DS = Q2H
Q2 = 2DS/H
Q* =
1/13/2016

2DS/H
Supply Chain Management

21

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

Q* =

2DS
H

Q* =

2(1,000)(10)
0.50

1/13/2016

= 40,000 = 200 units

Supply Chain Management

22

An EOQ Example
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 =
=
Order
quantity
Q*
orders
1,000
N=
= 5 orders per year
200

1/13/2016

Supply Chain Management

23

An EOQ Example
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
Number of working
Expected time
days per year
between orders = T =
N
T=

1/13/2016

250
5

= 50 days between orders

Supply Chain Management

24

An EOQ Example
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 annual cost = Setup cost + Holding cost
D
Q
TC =
S +
H
Q
2
1,000
200
TC =
($10) +
($.50)
200
2
TC = (5)($10) + (100)($.50) = $50 + $50 = $100
1/13/2016

Supply Chain Management

25

Robust Model
The EOQ model is robust because
• It works even if all parameters and assumptions
are not met
• The total cost curve is relatively flat in the area
of the EOQ

1/13/2016

Supply Chain Management

26

EOQ Robustness Example
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
D
Q
TC =
S +
H
Q
2
1,500
200
TC =
($10) +
($.50) = $75 + $50 = $125
200
2
Total annual cost increases by only 25%
1/13/2016

Supply Chain Management

27

...Example
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
TC =
S +
H
Q
2
1,500
244.9
TC =
($10) +
($.50)
244.9
2
TC = $61.24 + $61.24 = $122.48

1/13/2016

Supply Chain Management

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

28