11-1 Inventory Management 11-2 Inventory Management

CHAPTER
11
Operations Management
Inventory
William J. Stevenson
Management

8th edition
Operations Management, Eighth Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

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Types of Inventories
Inventory: a stock or store of goods Independent Demand
• Raw materials & purchased parts
• Partially completed goods called
A Dependent Demand
work in progress
• Finished-goods inventories
B(4) C(2)
• (manufacturing firms)
or merchandise
D(2) E(1) D(3) F(2) (retail stores)

Independent demand is uncertain.

Dependent demand is certain.
11-5 Inventory Management
Types of Inventories (Cont’
(Cont’d)
• Replacement parts, tools, & supplies
• Goods-in-transit to warehouses or customers
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Functions of Inventory (Cont’
(Cont’d)
• To take advantage of order cycles
• To help hedge against price increases
• To permit operations
• To take advantage of quantity discounts
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Functions of Inventory
• To meet anticipated demand
• To smooth production requirements
• To decouple operations
• To protect against stock-outs
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Objective of Inventory Control
• To achieve satisfactory levels of customer
service while keeping inventory costs within
reasonable bounds
• Level of customer service
• Costs of ordering and carrying inventory
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Effective Inventory Management Inventory Counting Systems

• A system to keep track of inventory • Periodic System

• A reliable forecast of demand Physical count of items made at periodic
• Knowledge of lead times intervals
• Perpetual Inventory System
• Reasonable estimates of System that keeps track
• Holding costs of removals from inventory
continuously, thus
• Ordering costs
monitoring
• Shortage costs current levels of
each item
• A classification system

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Inventory Counting Systems (Cont’

(Cont’d) Key Inventory Terms

• Two-Bin System - Two containers of • Lead time: time interval between ordering
inventory; reorder when the first is empty and receiving the order
• Universal Bar Code - Bar code • Holding (carrying) costs: cost to carry an
printed on a label that has item in inventory for a length of time,
information about the item usually a year
to which it is attached • Ordering costs: costs of ordering and

0
receiving inventory
• Shortage costs: costs when demand exceeds
214800 232087768 supply
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ABC Classification System Cycle Counting

Figure 11.1
Classifying inventory according to some • A physical count of items in inventory
measure of importance and allocating control
efforts accordingly. • Cycle counting management
• How much accuracy is needed?
A - very important
• When should cycle counting be performed?
B - mod. important
High
A • Who should do it?
C - least important Annual
$ value B
of items

Low C
Few Many
Number of Items

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Economic Order Quantity Models Assumptions of EOQ Model

• Economic order quantity model • Only one product is involved

• Economic production model • Annual demand requirements known
• Quantity discount model • Demand is even throughout the year
• Lead time does not vary
• Each order is received in a single delivery
• There are no quantity discounts
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The Inventory Cycle Total Cost

Figure 11.2

Profile of Inventory Level Over Time

Q Usage Annual Annual
Quantity rate Total cost = carrying + ordering
on hand cost cost
Q + DS
TC = H
Reorder 2 Q
point

Time
Receive Place Receive Place Receive
order order order order order
Lead time

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Cost Minimization Goal Deriving the EOQ

Figure 11.4C
Using calculus, we take the derivative of the
The Total-Cost Curve is U-Shaped
total cost function and set the derivative
Q D
TC = H+ S (slope) equal to zero and solve for Q.
Annual Cost

2 Q

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

Q OPT = =
H Annual Holding Cost

Ordering Costs

Order Quantity
QO (optimal order quantity)
(Q)
11-21 Inventory Management 11-22 Inventory Management

Minimum Total Cost Economic Production Quantity (EPQ)

The total cost curve reaches its minimum • Production done in batches or lots
where the carrying and ordering costs are • Capacity to produce a part exceeds the part’s
equal. usage or demand rate
• Assumptions of EPQ are similar to EOQ
2DS 2( Annual Demand )(Order or Setup Cost )
Q OPT = = except orders are received incrementally
H Annual Holding Cost
during production

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Economic Production Quantity Assumptions Economic Run Size

• Only one item is involved

• Annual demand is known

• Usage rate is constant 2DS p

• Usage occurs continually Q0 =
• Production rate is constant
H p− u
• Lead time does not vary

• No quantity discounts
11-25 Inventory Management 11-26 Inventory Management

Total Costs with Purchasing Cost Total Costs with PD

Figure 11.7

Cost
Annual Annual Adding Purchasing cost
TC = carrying + ordering + Purchasing
TC with PD
doesn’t change EOQ
cost cost cost

TC without PD
Q + DS + PD
TC = H
2 Q

PD

0 EOQ Quantity

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Total Cost with Constant Carrying Costs When to Reorder with EOQ Ordering
Figure 11.9
• Reorder Point - When the quantity on hand
TCa of an item drops to this amount, the item is
reordered
Total Cost

TCb
Decreasing
TCc Price • Safety Stock - Stock that is held in excess of
expected demand due to variable demand
rate and/or lead time.
CC a,b,c
• Service Level - Probability that demand will
OC
not exceed supply during lead time.

EOQ Quantity
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Determinants of the Reorder Point Safety Stock

Figure 11.12
• The rate of demand
• The lead time

Quantity
• Demand and/or lead time variability Maximum probable demand
during lead time
• Stockout risk (safety stock) Expected demand
during lead time

ROP

Safety stock reduces risk of Safety stock

stockout during lead time LT Time

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Reorder Point Fixed-

Fixed-Order-
Order-Interval Model
Figure 11.13

The ROP based on a normal

• Orders are placed at fixed time intervals
Distribution of lead time demand • Order quantity for next interval?

• Suppliers might encourage fixed intervals

Service level
Risk of
a stockout • May require only periodic checks of
Probability of
no stockout inventory levels
ROP Quantity • Risk of stockout
Expected
demand Safety
stock
0 z z-scale
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Fixed-
Fixed-Interval Benefits Fixed-
Fixed-Interval Disadvantages

• Tight control of inventory items • Requires a larger safety stock

• Items from same supplier may yield savings • Increases carrying cost
in: • Costs of periodic reviews
• Ordering
• Packing
• Shipping costs
• May be practical when inventories cannot be
closely monitored

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Single Period Model Single Period Model

• Single period model: model for ordering of • Continuous stocking levels

perishables and other items with limited
• Identifies optimal stocking levels
useful lives
• Shortage cost: generally the unrealized • Optimal stocking level balances unit shortage
profits per unit and excess cost

• Excess cost: difference between purchase • Discrete stocking levels

cost and salvage value of items left over at • Service levels are discrete rather than
the end of a period continuous
• Desired service level is equaled or exceeded
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Operations Strategy
CHAPTER
• Too much inventory
11
• Tends to hide problems
• Easier to live with problems than to eliminate Additional PowerPoint slides
them contributed by
• Costly to maintain Geoff Willis,
• Wise strategy University of Central Oklahoma.
• Reduce lot sizes
• Reduce safety stock

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Economic Production Quantity Gortrac Manufacturing

Production
Production

& Usage
& Usage

Usage
Usage

In
v en
t or
yL
ev
el

GTS3
Inventory/Assessment/Reduction
11-41 Inventory Management

Materials

PS7
Washburn Guitars