LEARNING OBJECTIVES ‘Nter completing this chante, students wil beable to: 1. Understand te importance of inventory contol and ABC analysis 2. Use the economic oder quantity (£09) to determine how much to order, 3. Compute the reorder point (ROP) in determining vnnen order mare inventory 4. Hance inventory problems that allow quantity iscounts or noninstartaneous recint. Rese {6-1 intoduetion 6.2 Importance of inventory Control 63. Inventory Decisions 6.4 Economie Order Quantity: Determining How Much to Oraer 65 Reorder Point: Determining When te Order 6.6 EOQ Without the instantaneous Recelpt Assumption 6.7 Quantity Discount Models Inventory Control Models 5. Understang the use of safety stock. 18. Deseribe the use of material requirements planning in soving dependentdemand inventory problems 7. Discuss ustinstime inventory concepts to reduce ventory levels and costs 18. Discuss enterprise resoure planning ystems. 6.8 Use of Safety Stock 6.9 Single Period Inventory Models 6.40 ABC Analysis: 6.14. Dependent Demand: The Case for Mater ments Planning 6.42 Jugtintime Inventory Cntr 6.43 Enterprise Resource Planning Recuire- Summary + Glossary + Key Equations + Solved Problems + Seif-Test + Discussion Questions and Problems + Internet Homework Problems + Case Std: Matin Pullin Bicycle Corporation + Toteret Case Stes + Bibliography ‘Appendix 6.1: Inventory Control wth QM for Windows 1954196 CHAPTER 6 + INVENTORY CONTROL MODELS 6.1. Introduction Inventory is one of the most expensive and important assets to many companies, representing as much as 50% of total invested eapital. Managers have long recognized that pood inventory ‘control is erucial. On one hand, a frm can ry to reduce costs by reducing on-hand inventory levels. On the other hand, customers become dissatisfied when fequent inventory outages, called stockouts, occur Thus, companies must make the balance between low and high inven tory levels. As you would expect, cost misimization isthe major factor in obtaining this delicate balance Inventory isany stored exurce Inventory is any stored resource thi is used to saity a current ora fare need, Raw mate that is usd to satya current rials, work-in-process and finished goods ae examples of inventory Inventory level for fs or future ned. ished goods ate a direct function of demand. When we determine the demand for completed ayaa ‘ 5 ais ‘ 3 pas 2 ' ——— ety monpoa odes Ano ning ot = (Naner of one plat pe yu) (Onking cox pe ode) nm demand Rarer tania * CONNEC tod) > ~2e, 2 ‘Ati holding or crying cst = (Avenglaventry) x (Caring peru py) wer guts ee GH (ary sont ero) 2 Se A rah ofthe hing cos he ring cos nd he al hes tw shown in Fp 63, ‘oc mest pint on ee coca xcs whet orig css a te eying cost Thu fo minnie oll oss givens suo th ode gun should osc Whee thse te cov el ricune 6.3 Total Cost as a Function of Order Quantity, usr202 CHAPTER 6 + INVENTORY CONTROL MODELS Wie derive the BOO equation by seting ordering cost equal to crying cast. ‘The otal anual inventory cst ‘sequal to ordering pls oling costs forthe simple EOQ model Finding the E0Q When the EOQ assumptions ae met, total ost is minimized when: Annual holding cost 26-2, FH Go Solving this for 0 gives the optimal order quanti Annual ordering cost ‘This optimal order qua by the following formula: “This BOQ isthe esis for many mote advanced models and some ofthese are discussed later in this eater, Economic Order Quantity (E€0Q) Model >. Annual ordering ost 6-2) cos = (62) @ Annual holding cost = 2c, we wo) ‘Sumco Pump Company Example Sumo, a company that sells pump housings to other manufacturers, would like to reduce its inenory cost by determining the optimal number of pump housings o obtain per ordee. The annual demand is 1,000 units, the ordering cost is $10 per order, and the average carrying cost per unit per years 0.50. Using these figures, ithe EOQ assumptions are met, we ea calulate the optimal numberof units per order: 200 its ‘The relevant otal annual inventory costs the sum ofthe ordering costs andthe carying costs: ‘Total annual cost = Order cost + Holding cost In terms ofthe variables inthe mode, the total cost (TC) can now be expressed as 6s)PROGRAM 6.18, Input Data and Excel QM Formulas for the Sumco Pump Company Example 164 ECONOMIC ORDER QUANTITY: DETERMINING HOW MUCHTO ORDER 203, “The alana ery os for Sums i compe Pe 42 re~Be,+ Se, Loon = 1) ~Boos) 50 + $50 = S100 "The numberof orders per year (D/O) is 5, and the average inventory (Q/2) is 100, ‘As you might expect, the ordering cost sequal to the carrying cost. You may wish to try Aitferent values for 0, such as 100 or 300 pumps. You wil find that the minimum total cost ‘occurs when Q is 200 units. The EOQ, O° is 200 puns, USING EXCEL QM FOR BASIC EO@ INVENTORY PROBLEMS The Sumnco Pump Company exam- ple, and a variety of other inventory problems we address inthis chapter, canbe easily solved using Excel QM. Program 6.1 shows the input data for Sumco and the Excel formulas ‘needed forthe OQ mode. Propram 6.1B contains the solution for this example, including the optimal order quantity, maximum inventory level, average inventory level, and the number of setups or arers. Purchase Cost of Inventory Items ‘Sometimes the total inventory cost expression is writen to ined the actual cost ofthe mate~ ‘il purchased. With the EOQ assumptions, the purchase cost doesnot depend onthe particular ‘onler policy found tobe optimal, because regardless of how many onder are placed each yea, ‘we sil incur the same annual purchase cost of D X C, where Cis the purchase cost per unit snd D isthe annual demand innit” 2 Suc Pump Company — roid Ou da 2 eee = ering ene ool pee 3 Sears ie ielgen be ey 2 unit price & availabe, itis entered here. ‘On input sewer, you may specify times _ C8 S| (eases aH ownors portage ofthe Sireuchenloon i perasteeney fs Saas fame a aoe Paieae ry (Catt ant purus) costs given bere) “ar inhchpr ne sche cin which cn fc oar pa ht ihn ay cu208 CHAPTER 6 + INVENTORY CONTROL MODELS PROGRAM 6.18 Excel QM Solution for the Sumco Pump Company Example 2 Sumco Pump Company 2 ventory Economic Order Quantity Model 7 bats @ Demand rate, ToK0] 9 Setupforder cost, 5 ad 40 Hldng cost, 5|(fixed amount) 11 UnitPrice,P 2 4 Resulte 11 (Optimal Order Guandiy 209] 15. Maximum inventory 200] 11 Average ievertory 109] 17 Number of Orders 5 19 folding cost 350.00 20 Setup cost $50.00 22 Unikeost $0.00 23 Total cont, T $200.0) 26 eis usefl to know how to caleulat the average inventory level in dollar terms when the brie per unit is given, This ean be dane a follows. With he variable O representing the quan tty of units ordered, and assuming @ unit cost of C, we can determine the average dolla value bf snventry svat = wo “This Formula is analogous to Fquation 6-1 Inventory carrying costs for many businesses and industries are also often expressed as an is the annual carrying cost anual percentage ofthe unit eost or price. When tis isthe cas, a new variable i introduced, percentage ofthe cost per unt. Let The the annual inventory boling charge a a percent of unit price or cost. Then the cost of ‘toring one unit of inventory forthe Year, Cis given by Cy = IC, wheee Cis the unit peice or ‘cost of an inventory item. Q* can be expressed, inthis ese, [oe 1 on Sensitivity Analysis with the E0Q Model “The EOQ model assumes that al input values are fixed and known with certnty. However, since these values ate often estimated or may change overtime tis important to understand165. REORDERPONT DETERMINING WHEN TO ORDER 205, how the order quantity might change if different input values are used. Determining he effects ofthese changes is called sensitivity analysis, “The EOQ formulas given a follows ‘Because of the square root in the formula any changes i the inputs (D, Cy) will est in relatively minor changes inthe optimal order quant. For example fC, were to increase by & fact of , the FOQ would ony increase by a factor of 2, Consider the Sumeo example just pee sented, Tae EOQ for this company i as fllows: In general, the EOQ changes by the square rot ofa change in any of the inputs &.5 Reorder Point: Determining When to Order ‘he reorder point (ROP) Aeterines when o order Inventory Is ound by malpying the daly demand times the lad tne in days [Now that we have decided how much to order, we lok atthe second inventory question: when ‘o ode. The ime been the placing and receipt ofan ores, ealled the lead time or dlivey ‘ime, is often afew days or even few wecks. Inventory most be available to meet the demand luring this ime, and this inventory can ether be on hand now or on order bat nt yet received ‘The total of these is called the inventory postion. Thus, the when ro onier decision is usually expressed in terms ofa reorder point (ROP), the inventory position at which an order should be placed, The ROP is given as ROP = (Demand per day) (Leadsime fora new order in days) =4xL os ‘gore 6.4 has two graphs showing the ROP. One ofthese ha relatively small reorder po while che othr has a telatively large reorder point. When the inventory position reaches the ROP, «new order should be placed. While waiting for tht onder o arrive the demand wil be ‘met with ether inventory curently on hand or with inventory tha already has ben ordered but will rive when the on-hand inventory falls to zero, Lets look a an example PROCOMP’S COMPUTER CHIP EXAMPLE Procomp's demand for computer chips is 8,000 per year The firm has a daily demand of 40 units and the order quantity i 400 units. Delivery of an ‘order akes thee working days. The eorder point for chips i calculated as follows ROP = x L = dOuniteperday X 3days 20.nits Hence, when the iaventory stock of chips drops to 120, an onder shouldbe placed. The order will ezive toe day ltr, just asthe firm's stock is depleted to 0, Since the order quantity is 400 units, the ROP is simply the on-hand inventory. This is the situation inthe fist graph in Figure 64. ‘Suppose the lad time for Procomp Computer Chips was 12 days instead of 3 days. The ee onder point would be: ROP = 40unitsperday % 12 days206 CHAPTER 6 + INVENTORY CONTROL MODELS FIGURE 6.4 Reorder Point Graphs Since the maximum on-hand inventory level is the order quantity of 400, an inventory positon ‘0 $80 would be Inventory position = (Inventory on hand) + (Inventory on oder) 4480 = 40 + 400 “Thus, a new order would have to be placed when the on-hand inventory fll to 80 while there ‘vas one other order in-raasit. The second graph in Figure 6. illustrates this type of situation. 6.6 _£0QWithout the Instantaneous Receipt Assumption The production run moe ‘liminates the ntantanous When a frm receives its inventory over a prio of time, a new mode! is needed that does not requite the instantaneous inventory recelpt assumption. This new model is applicable when inventory continuously flows or builds up over apeied of time after an order has ben placed or “when unis are produced and sod simultaneously. Under these circumstances, the daily demand. ‘ate mast he ten into account, Figure 65 shows inventory level asa function of ime, Beease this model is especially suited to the production environment, it is commonly called the ‘production run model. Inthe production process insead of having an ordering cos, hore willbe a senyp cost. This isthe cos of setting up the production facility to manufacture the desired product. It omally includes the salaries and wages of employees who are responsible for sting up the equipment, ‘enginecring and design costs of making the setup, paperwork, supplies, ilies, and soon. The ‘carrying cost per unit is composed of the same factors asthe uaditional EOQ model, although ‘he annaal earryng cost equation changes due toa change in average inventoryFIGURE 6.5 Inventory Control and ‘the Production Process Sofvng the production run ‘model neler setting setup costs ‘qual holding oss and Sling ford. ‘The maximum inventory evel Inthe production model less ‘han 166 FOO WITHOUT THE INSTANTANEOUS RECEIPT ASSUMPTION 207 lover Used Parco inventory Opes ‘Tree No Preducon Dag en Pens umng Ts Pa oe ~| me Invern Oye ‘The optimal production quantity can be derived by seting setup costs equal to holding cor carrying costs and solving forthe order quantity. Let's start by developing the expression for earrying cos. You should note, however, that making setup cost eq to carrying cost doesnot always guarantee optimal solutions for models more complex than the prodction run madel ‘Annual Carrying Cost for Production Run Model ‘As with the EOQ model, the carrying costs ofthe production ron mode! are ased onthe aver- fage inventory, and the average inventory is one-half the maximum inventory level. However, ‘nce the replenishment of inventory occurs over period of time and demand continues during this time, the maximum inventory willbe less than the order quantity Q. We ean develop the snnual carying or holding, cost expression using the following variables (Q = number of pieces per onder. or production in C= setup cos holding or carrying cost per unit per year daily production ate aly demand rte length of production run in days “The maximum inventory level sa fellows (Toul produced daring the production run) ~ (Tova used during production un) (Daily production rate) (Number of days of production) {Daily demand} (Number of dys of production) (rs) ~ (at) Since ‘otal produced = Q = pr, we know that 6»)208 CHAPTER 6 + INVENTORY CONTROL MODELS ere ithe formal forthe optimal production quantity Note the similar to the sie 00 Mode. and Annual holding cost = 0) Annual Setup Cost or Annual Ordering Cost When a produc is produced overtime, setup cost replaces ordering cost. Both ofthese are inde- pendent ofthe sizeof the oer and the size af the production ru, Tis eos i simply the aun her of orders (r production runs) times the ordering cost (setup cost). Tus, anal sanpcon = 2 (an 2 ny and > Annuat oxderingeost = 2 (613 peo = (i) Determining the Optimal Production Quantity ‘When the assumptions of the production run model are me, costs are minimized when the setup ost equals the holding cost, We can find the opimal quantity by setting these costs equal and Solving for . Thus, ‘Annual holding cost = Annu ef, 4), _D S(1-2)e.=2e, Solving this for 0, we gt the optimal production quantity (2") setup cost on) 1t should be noted that if he situation doesnot involve predueton but rather involves the receipt oF inventory over a period of time, this same model is appropriate, but C, replaces C, in the formals, Production Run Model amatg sou = 9 Aamateapon = Bo (= Optimal production quantity Q” ali > Brown Manufacturing Exampl Brown Manufacturing produces commercial eftigeration units in batches. The firm's estimated zmand forthe yea is 10,000 units. It costs about $100 to St up the manufacturing proces, and the carrying costs about SD eens per unit per year. When the pradicton process has been setup, 80 refrigeration units can be manufactured daily: The demand during the production period has traditionally been 60 unis each da. Brown operates its refigeration unit produetion sea 167 days per year. How many refigraton uit should Browa Manufacturing produce in166 FOO WITHOUT THE INSTANTANEOUS RECEIPT ASSUMPTION 209 cach batch? How long should the production pst ofthe eyele shown in Figure 6.5 last? Here is the solution ‘Annual demand = D = 10.00 ents Setup cost = C, = $100 Canying cost = Cy = $0.50 per unit peryear Daily production ate = p ~ SO unis diy Dally demandsate = d = 6Dunite daly ioe P= Ko | a Jo(i-4 V ° -_ Ew ag. ye asi mo V ost) ‘4000 nite 160" = 4000 units and we know thst 80 units canbe produced dy, he Ingth of ech po- «duction cyele will be Qjp ~ 4000/80 = 50 days. Thus, when Brown decides to produce te ftigeraton units, the equipment will beset upto manufacture the units fora 50-day time span ‘The number of production runs per year wil be D/Q = 10,000/:,000 = 2.5. This means that the average numberof production runs per yea is 25. Thee wil be 3 producti runs in one year with some inventory carried tothe next Yeas, so only 2 production runs are needed in the second yea USING EXCEL QM FOR PRODUCTION RUN MODELS ‘The Brown Manufacturing prodetion ran ‘model can also be solved using Excel QM. Program 6.2A contains the input dara andthe Exce! formulas fr tis problem, Program 6 28 provides the solution results, iclading the optimal pro- ction quantity, maximum inventory evel, average inventory level, and the numberof setups. PROGRAM 6.2A Excel QM Formulas and Input Data for the Brown Manufacturing Problem _—— ——=aj Prsicion Or Oar Enter the demand ae, setup cost and re Tou AVS TONNE ling cont Nonce he hcg ont SS Ie fad oar amour thr ta 9 a a percentage of he unit pee [i sancon 2 ‘a I Hvac Tate ona Exar daly produson at [ito anaes» c nd daly Geman ate. on Sar Ey fi: Caledate te opine! podcton avery Sanne jim la (Gate te anal hling cots bare on average ivertoy ay uncon iver arate anual senup cost sed onthe nonbe of sep,210 CHAPTER 6 + INVENTORY CONTROL MODELS Brown Mastotung PROGRAM 6.28 The Solution Results for the Brown ‘Manufacturing Problem Using Excel QM ay poser 8 las nsnstacies of ne appences rove nome tea of he apace at rue waranty One sich Fo tune 100 fmm abo 7000 eet par at ee edn thereat of applances, The anual aie ofthe prs te toys oe 7 min. re coer hare than 1200s levees that were pce hen see ess ere teed Ousted space on tere ves, on a0 409 pars vere Wpcaly cal on each ove, #0 sec person fred fo es an applance and not have neces pat Giava toca occured a specced vac made hate the onde deters a 0th he ea prion oul rn a {hte aptance doen a pst. Deding whch gars to cary was 9 pty fet probe, Apres war epun oi eter nay tec the {eran fr ats ad ey wth par shold be ct on toch ei, aly te wit was to edie Be ars eno Gn each ck as itera a cat ct than) Fortune 100 Firm Improves Inventory for Service Vehicles om Inventory: Cost vz Quantty ‘ e= fia er ag a2 rar Sn) the invent, However upon further ana, ae decid at the goa shoud be to mize the overall coxt—ncudng the ests of spacial deliveries of parts, resting the custome for the repair f the pat nae net intaly avaliable, and overall cu The projet team improved the orcastng stem used to project he rarer af parts needed an each vehicle. Asa el, {he actual numbe’ of parts cae on each vehiceereasad However the number of ist repairs nce Fem 85% (0 90% The ested ma savings of $3 millon pe yarn the cost these epaes. I aso improved custom satisfaction because the problem was fied without the sence person having ¢0 retum ascend ne Sere ae a Michel Garant Say Ane "A Mae ple ‘ecieae Reatmonry Ran foe Vou rs 6.7 Quantity Discount Models In developing the EOQ model camprions are met i we esumed that quanty discounts were not avilable. However, ‘many companies do oller quantity discounts, Ir such discount is possible, but all of the other possible to find the quantity tat minimizes the total inventory F0Q. ‘ost by using the FOQ model and making some adjustmentsTABLE 6.3 Quantity Discount Schedule ‘The veal objective ofthe ‘quantity discount mols 0 Ininimize total nventory costs, ‘ich now incl actual materia cost. 67 QUANTITY DIscoUNT MODELS 241 ‘When quantity discounts ae available, the purchase cost or matrial cost becomes ale- ‘vant cost, as it changes based onthe order quantity. The total relevant costs ae as Follows: Total ost = Material cost + Owing cost + Carying cost, De 2 Taaleot = ve +2, + (19 oor woe where D = annual demand in wits = ordering cost of each onder € = costper unit y= hong or carrying cost punt pe year Since holding cost pr wit per year i based onthe cost ofthe items, it is convenient to express ‘hiss Geete where 1 olding cost as percentage ofthe uniteost(C) Fr a specific purchase cost (C), given the assumptions we have made, ordering the EOQ will ‘minimize tral inventory costs. However, i the discount station, his quantity may aot be age ‘enough to qualify forthe dtcoun, so we must alto consider ordering this minmam quant for ‘he discount. Atypical quantity discount schedule is shown in Table 6.3, ‘As can be seen inthe table the normal cost forthe item is $5. When 1,000 1,999 units are ordered at one time, the cost per unit drops to $4.80, and whe the quantity ordered atone ‘ime is 2,000 units or more, the ost is $4.75 per unit. As always, management must decide ‘when and how much to order. But with quantity discounts, how does the manager make these decisions? ‘A with other inventory models discussed so fr, the overall objective willbe to minimize the oll cost Becaise the unit eot for the tied discount i Table 63s lowest, you might be ‘tempted to order 2,000 units or more to take advantage ofthe lower material cost. Placing an ‘order for that quantity with the greatest discount cos, however, might not minimize the ttl inventory cost. As the discount quantity goes up, the material cost goes down, but the carrying «ost increases because the ones are large, Thus, the major trade-off when considering quantity tiscounts i between the reduced material cos and the inceated carving cot. Figure 66 provides a graphical representation of he (ta est fr this station, Naice the cost curve drops considerably when the order quantity reaches the minimum fo each discount ‘With the specific costs inthis example, we see that the EOQ forthe second price category (1.000 = 0 = 1,999) is less than 1,000 units, Although the total cost forth EOQ is less than ‘he tol eos fr the FOQ withthe cost in eategory I the FOQ is wot large enough to obsain this Aiscount, Therefore the lowest posible total cost for this discount price acare a the minimum ‘quantity required to obtain the discount (Q ~ 1,000). The process for determining the mini ‘hum cost quantity inthis situations summarized in he following bo.212 CHAPTER 6 + INVENTORY CONTROL MODELS FIGURE 6.6 Total Cost Curve forthe Tota Quantity Discount Model cost $ ° Quantity Discount Model 1. For each discount price (©, compute BOQ = «| “7 2. I1LOQ « Minimum fr discount, adjust the quantity to Q » Minimum for discount 2 Fore EQ crate compute Talent = BC+ Be, « Sey 2 4, Choose the kest-cost quanti, Brass Department Store Example Let's see how this procedure can be applied by showing an exam le, Brass Department Store stocks toy race ars. Recely, the store was given a quanity discount schedule fr the eas: this ‘quantity discount schedule is show in Table 6 3. Ths, the normal est for the toy rae esis $5. erate | Lecco rots hs dvd an net requnts plang 0 opt to termi th runt ot sey Hock Seto cay frase pose ned ng on tthe oa of cerand ing te dete cone fan sce 2 espa end he eds a= fhe ed teh ocean te devas beeen the fort Sevand an heal nepy Tn em wa ees Sotho rth npr rand and poset wth desenamt dean “hood ABC cern tr was ie eter ‘ch ts ced eet td artista wre Sore bh fore dlr vohie andre ay aon Lucent Technologies Develops Inventory Requirements Planning System J to the Class A, 8, and C categories, 2D category was crested to Inlet were both ow doar ome an on ec i Asiple two‘ sate was used fr tes es In ere’ o gain aecoptorce ofthe I stm, business man ses rom a fonctions were nvvedin the proces, and he 3 fem was made Vanspatent so that eetyane understood the system Becase ofthe RP ston, ovealimvenory was edced by $85 millon, and tha serve eal was incensed by 20%. The success ofthe RP system Melped Lucent receve the Malcolm Bange Avardin 1902 (Strain Purp Goaher mo} 3 868 ustorsarerysToc 213 TABLE 6.4 Total Cost Computations for Brass Department Store ett itis MOL Re van a) 1 $500 700 2000 33000 350002570000 2 0 1000 om seo som 2472500 2 4s 2.00 aro ms sooo —244m2.50 or odes betwee 1,00 and 1,999 unis, the ui cost i $480, a for endes of 2000 oF mere unit te unit os $4.75.Furtheore the ordering cost is 49 per ode the annul demand 485,000 eae ears andthe inventory careyiag chee as a percentage of est is 20% oF 02. ‘What order quantiy wil minimize de otal iventory coat? “The fist sep it compute £00 for every discount in Tale 6.3, This is dove a follows frerescrcoy FQ = oaysooy_~ TOswseeroner B00 values are computed [COO ae carsperonder rm 2 NV (027(880) m= PeramOyy 800, = TREE = rcaperonr “Te secon tp sto js those quitties that ae below the allowable discount range. Since £00 ates areas 1209} is between 0 snd 55, doesnot hve to be jsed, BOQ is elw the allowable range of 1.0006 1999, and therefor, i mst be aust 0 1,000 units. The same isu for EOQs: ‘cmust be adjusted 2,000 unis. Afer this step, the fellowing oder quantities must be texted inthe total cont equi: a Q= 16 a ‘The tind step iso use Baton 6-14 ad comput ttl eos fo cah ofthe onder quantities. The total cont iscompued, ‘Thins accomplisid with the i of Table 6 “Te fourth step isto eet tht oder guy with he lowest tl cos Looking at able 6, youcan sc hat atone quan of 1,000 oy racecars minimizes the oa cost shuld be e- Crises Sized, however, that the tt est for odering 2000 cars is only shy qreatr tha he tal cos far ordering 1,000 cars. Ths, ifthe tid discount costs lowered to $4.65, for example, this ‘order quantity might beth one that minimizes the ttl ventory cost USING EXCEL QM FOR QUANTITY DISCOUNT PROBLEMS As seen inthe previous analysis, the quantity discount model is more complex than the inventory models discussed so far in this chapter, Fortunately, we can se he computer to simplify theealulations. Program 6.3A shows ‘the Excel formulas and input data needed for Excel QM forthe Brass Department Store prob- Tem, Program 6.38 provides the slution to this problem, including adjusted onder quantities and {otal coss foreach price break 6.8 _ Use of Safety Stock ‘Safety stock helps in avoiding ‘lockout ier tock hep onhand. ‘When the BOQ assumptions are met, tis possible to schedule orders to ative so that tockouts are completely avoided. However, ifthe demand or the lea time i uncer, the exact demand ‘uring the lead time (which i the ROP in the EOQ situation) wil ot be known with certainty ‘Therefor, to prevent stockouts, it is necessary to carry addtional inventory called safety stock.214 CHAPTER 6 + INVENTORY CONTROL MODELS PROGRAM 6.3A Excel QM's Formulas and the Input Data for the Brass Department Store Quantity Discount Problem —— M | Brass Department Store 7 , ii fSeamr foes aa [psa Sain.) Is = hes | A nents ls [ie e = = [icomeetn Sarmennen Sore acer eames eecaor Seeaan™ Sena [Bs greens apemete rao [gest Soo aa en Lr F aa eee Fy cose tel E Sea vary at mimes ta PROGRAM 6.38 SSS SS SS SS SS Excel QM's Solution to Brass Department Store the Brass Department Store Problem a Decors tine Eloi ro iD ‘When demand is unusually high during the lea time, you dip into the safety stock instead ‘encountering a stockow. Thus, the main purpose of safety stock sto avoid sockouts when the demand is higher than expected. Its use is showa in Figure 6.7. Note that although stocks can often be avoided by using safety stock, there is sill «chance that they may occur, The ‘demand may be so high that all the safety stocks used up and thus there ssl a stockout ‘One of he best ways to implement a safety stock policy sto adjust the reorder pont. nthe OQ situation where the demand and lead time are constant, the reorder point i simply theFIGURE 6.7 Use of Safety Stock ‘Safety stocks ncluded in the 68 ustorsirerYsToce 215 amount of inventory that would be wsed during the Lead ime (ie, the daily demand times the Tead time in days) This is assumed tobe known with certain, so there is no need to place an ‘onder when th inventory position i more than his. However, wien te daily demand or the lead ‘ime fuctute and are uncertain, the exact amouat of inventory chat willbe used during the lead time is uncertain, The average inventory usage during the lead time should be computed snd some safety stock shoul be added to this o avoid stockouts. The reorder point becomes ROP = (Average demand during lead time) + (Safty stock) ROP ~ (Average demand during lead time) + SS. (15) where SS = saferystock, porant factors in this decision aze the stockout cost andthe holding cos. The stockout cost ust- ally involves lost sales and lot goodwill, which resus in loss of fture sales. [olin cost is Tow while stockout cost is high, large amount of safety stock should be ested to avoid stock- ‘outs at cost ite to ear this, while stockous are expensive. On the other hand, stockout cos is low but holding costs high, a lower amount of safety stock would be prefered, a hav- nga stockout would ost very tle, but too mach safety sock wil elt in mae higher anna holding costs.216 CHAPTER 6 + INVENTORY CONTROL MODELS FIGURE 6. Safety Stock and the Normal Distribution How i the optimam stock evel determined? If demand fuctates while lad ime is eon stant, and if oth the stockout cost per unit and the holding cost pe unit are known, the use of & /payorticost table might be considered. With only s small numberof possible demand valves da ing the lead ime, a cos table could be constructed in which the different possible demand levels would be the states of nature, and che diffrent amounts of safety stock asthe alermatives. Using the techniques discussed in Chapter 3, the expected cost could be calsulate for each suety ‘Hock level an the minimum cost solution could be found. owever,a more general approach sto determine what service level is desired and then 10 find the safety sock level that would accomplish his. A prudent manager will look tthe Bold- ing cost and the stockout cost to help determine an appropriate service level. A service level indicates what percentage of the time customer demand is met. In eset words, the service evel isthe percentage of time that stockouts are avoided. Thus, Service level = 1 — Probability ofa sockout Probability ofastockout = 1 ~ Service evel Once the desired service level is established the amount of safety stock to cary ean be found ‘using the probability distribution of demand during the lead ime. SAFETY STOCK WITH THE NORMAL DISTRIBUTION Equation 6-15 provides the general formula ‘for determining the reorder point. When demand during the lead time is normally dstibuted, the reorder pint becomes ROP Average demand during leadtime) + Zor 16) where > number of standard deviations forgiven service level sra.x = standard deviation of demand during the ead time ‘Thus, the amount of safety stock i simply Zep The following example Looks at how to de- termine the appropiate safety stock level when demand during the lea time is aonmally dsb ted andthe mean and standard deviation ae known. HINSDALE COMPANY EXAMPLE ‘The Hinsdale Company aries a variety of electronic inventory items, and these ae typically identified by SKU. One particular item, SKU A337, has 2 de- ‘mand tat i normally distributed during the led time, with a mean of 350 units and a standard deviation of 10. Hinsdale wants to follow a policy that results in stockouts occurring only 5% of the time on any order. How mach safety stock Should be maintained and what isthe reorder point? Figure 6.8 helps visualize ths example68 ustorsirerysToce 247 From the normal distbution able (Appendix A) we have Z = 165: ROP = (Average demand ding lead time) + Zee 350 + 1.65(10) = 380 +165 = 366.5 wits or about 367 unis) So te eouder point is 46.5, and he safety sock is 165 nis. ‘CALCULATING LEAD TIME DEMAND AND STANDARD DEVIATION If the mean and standard devi- ston of demand during the lead time ste not known, they mis be clesatd fom historia de- ‘mand and lead time data Once these are found, Equation 6-16 can be used to find the safety ‘sock and onder point. Throughout his section, we assume th let ime is in days although ‘he sume procedure can be applied to weeks, month, or anyother ime period. We wll also as- sume thai demand Nuctsts, the distebution of demand each day is identical o and independ. cnt of demand on other days. Ir both daily demand and lad ime fluctuate, they are assumed to be independent also “There are three situation to consider In each of the following ROP forma, the average demanding the lead time i the Fst term and the safety stock (Zerg) isthe second tem 1, Demand is variable but lead time i constant: ROP = FL + Z(e4VE) ou) where = average daily demand standard deviation of daly demand ead time in days L 2. Demand is constant but lead imei variable: RoP = dE + Z(de,) (19) where T= average lead ime ‘01 = standard deviason of lead time d= dally demand 3. Roth demand and led ime ae variable Rop = ZZ + 2(VEeq + Fol) 9) [Notice thatthe third situation is the most general case andthe others canbe derived from that. either demand of lead time is constant, the standard deviation and variance for that would be O, and the average would just equal the constant amour. Ths, the formule for ROP in situation 3 an be simplified the ROP formula given for that situaon. HINSDALE COMPANY EXAMPLE, CONTINUED Hinsdale has decid to determine the sfey tock and ROP foe hee other tems: SKU FS402, SKU B7319, and SKU FO0OM, For SKU F402, the dally demand is normally dstibuted, with a mean of 15 units and 2 standard deviation of 3. Lead time i exaetly 4 days, Hinsdale wants fo maintain a 97% service level. What isthe reorder point and how much safety stock shouldbe carried?” From Appendix A, for a 97% service evel Z ~ LS. Since demand is variable but lead ‘ime is consti, ve find at + Z(o4vT) 60 + 1128 71.28 ROP 15(4) + L8B(3VF) = 15(4) + 1.88(6) So the average demand during the lead time is 60, and the safety stock is 11.28 unit For SKU B7319, the ily demand is constant at 25 uns per day, an the lead time is nor- ‘mally istribated, with & mean of 6 days anda standacd deviation of 3, Hinsdale wants to main {ain 298% service level on this particular product, What ste reorder point?218 (CHAPTER 6 + INVENTORY CONTROL MODELS From Appendix A, for a 98% service level Z = 205, Since demand is constant bat lad time i variable, we find RoP = a. + Z(da,) 50+ 15375 25(6) + 2.05(3)(25 303.75 150 + 205(75) So the average demand dung the lead time is 150, nd the safety stock is 156.09 unis, For SKU F900, the daily demand is normaly distributed, with a mean of 20 units and a standard deviation of 4, and the lead time is normally distribute, with a mean of $ days anda Standard deviation of 2: Hinsdale wants to maintain a 989% service level on this paricul prod et Wha he reorder point? From Appendix A fora 94% service level, = variable, we find Rop = JE + 2(VTeh = Fal) = (20)(5) + 155( VS + BOPP) = 100 +18 VTERD 100 + 1.55(4099) 55, Since both demand and ead time are 100 + 6353, = 1655 So the average demand during the lead time is 100, and the safety stock is 63.53 unt. A safety stock ee is determined As the sevice level increases, the safely stock increases at an inereasing rte. Table 6.5 for ech service evel iustrates how the safety stock level would change inthe Hinsdale Company (SKU A3378) TABLE 6.5 example for changes inthe sevice level. As the amount of safety stock inereats, the annual holding cosincreases as wel, CALCULATING ANNUAL HOLDING COST WITH SAFETY STOCK When the EOQ assumptions of constant demand and constant lead ime ate met, the average inventory is 0/2, and the annual holding costs (0/2)Cy. When safety stock i aried because demand fluctustes, he holding os for his safety stock is added othe holding cost ofthe regular inventory to get the total nual holding cost. f demand during the lead time is normaly dstribued and safety stock is used, the average inventory on the order quantity (Q) is sill Q/2, but the average amount of safety stock eaied is simply the amount ofthe safety stock (SS) and not one-half his amoust Since demand during the lead time is normally disebuted, there would be ines when inventory ‘usage during the lead time exceeded the expected amount and some safety stock would be used. ‘But itis just as likely thatthe inventory usage during the lad time Would be less than the Safety Stock for SKU ee) Ska Bit ° va va 999 an saFIGURE 6.9 Service Level Versus ‘Annual Carrying Costs Carrying cost increases at an increasing rate asthe service level increase. 68 ustorsirerysToce 219 expected stmount andthe ordet would arve while some regular inventory remained i addition ‘wal the safety stock, Tas, onthe average the company ould alway’ have this fll amount of safety stock in inventor, anda olding eost would apply toll of hs, From this we have “Total annul holding cost = Helin costo regula inventory + Holding costo fey tock tc = 2c, + (s5}¢, 620) where total ennual holding cost order quantity Dolding cost per wit peryear safety soc In the Hinsdale example for SKU A337, let's assume that the holding cost is $2 per unit per year. The amount of safety stock needed to achieve various service levels is shown in ‘Table 6.5. The holding cost forthe safety stock would be these amounts times $2 per unit. As illuswated in Figure 69, this holding cost wuld increase extremely rapidly once the serv- jee level reached 98. USING EXCEL QM FOR SAFETY STOCK PROBLEMS To use Excel QM to determine the safety stock and reorder point, select Excel QM from the Add-Ins tab and select Inventory—Reorder Poin/Safety Stock {normal distribution) Entec atte when the input window appears and click (OK. Program 6.4 shows the input sereen and formulas forthe Hinsdale Company examples. Program 648 preseas the outpt.220 CHAPTER 6 + INVENTORY CONTROL MODELS PROGRAM 6.4A Excel QM Formulas and Inputs Data for the Hinsdale Safety Stock Problem “The erage derend nd ands esti ding he eed ine oe rtered nee ovat I daly dear nora sited but ad ve conto, ‘he dese entered ere eed Une snomaly dsrbute, cots ‘scertered here lal demand is constant, ‘rer O forthe sanded evaton 2 ‘Sting icad ne wat = i Reeser anne Solon othe second Hindle, Se —— ‘cameo, were dy demand mes eee ear tment \ Fone Sad x Souion othe td Hina exo = sieve diy domond mes sorsar : ined ie me oma dred. 6.9 _Single-Period Inventory Models So far, we have considered inventory decisions in which demand continues inthe future, and future orders will be place far the same product. There are some products fr which a decision to moet the demand fora single time period is made, and items that donot sll during this time Petiod are of no value or havea greatly reduced value in the furure. For example, a daily news ‘per is worthless ater the next paper is available, Other examples inclide weekly magazines,{68 SINGLE-PeRIOD NVENTORY MODELS 221 programs printed for athletic evens, eetan prepared foods that havea shot fe, and some Sea ‘onal clothes tht ave greatly reduced value at the end ofthe season, This type of problem is ‘often called the news vendor problem ora single-petid inventory model. or example, large resturant might be able to stock from 20 to 100 cartons of doughnuts to mest a demand that anges from 20 to 100 cartons per day, While this could be modeled using payoff table (se Chapter 3), we would have to analyze 101 posible alternatives and states of ‘ruse, which would be quite tedious. A simpler approach fr this type of decison i to use mat- ‘inl, or incremental, aay, A decision-making approach using marginal profit and marginal loss is called marginal ‘analysis. Marginal profit (MP) ste aditional prot achieved if one aditional units stocked and sold. Marginal loss (ML) isthe los that occurs whea an additional units stocked but can- not be sold ‘When there are a manageable numberof alternatives an states of nature and we know the probabilities fr eah state of nature, marginal analysis with dserete distributions can be used ‘When there are avery large numberof possible alternatives and states of nature and the proba- bility aistribution ofthe states of nature ean be desribed with anormal disci, margin snalysis with the nom distebution are appropriate ‘Marginal Analysis with Discrete Distributions Finding inventory’ level withthe lowest cost is not cult when we follow the marginal analy- sis procedure. This approach says that we would stock an adsitional unt only if the expected ‘arginal profit fr that uit equals ar exceeds the expected marginal loss. This relationship is expressed symbolically a follows: ‘P= probability that demand willbe greater than or equal given supply (or the probabil- ity of sling atleast one addition unit) 1) = P~ probability that demand wil be less han supply (oe the probability that one a ‘on unit will nt set) ‘The expected margins! profit i found by molilying the probability that a given wait wil be sold by the marginal profit, PUMP. Similarly, de expected marginal loss is the probability of ‘ot selling the unit maltpied by the sarpinal loss, oe (1 — (ML) “The optimal decision rule ist stock the additional unit it P(e) = (1 = P)ML ‘With some basic mathematical manipulations, we can determine the evel of P for which ‘his relationship hod: (MP) = ML P(ML) (MP) + P(MIL) = ML P(MP + ML) = ML ML ares (2) In other words, a long as the probability of selling one more unt (P) is greater than or qual to ML/(MP + ML}, we would sock the additonal unit ‘Steps of Marginal Analysis with Discrete Di ML 1 Determine he value of ME 2. Construct probability table and add a cumulative proba tions for the problem. ity column. 4. Keep onderng inventory as long athe probability (P) of sling atleast one ational unit is rear than222 CHAPTER 6 + INVENTORY CONTROL MODELS TABLE 6.6 café du Donut’s obability Distribution + 00s 5 as 6 ois 5 2s ° oxo ” oa Tal 100 Café du Donut Example CCafé du Donut is «popular New Orleans dining spot onthe edge ofthe French Quarter. Its se aly is coffee and doughnuts; it buys the doughnuts fresh daly from a lage industeal bakery. ‘The café pays $4 for cach carton (containing two dozen doughnuts) delivered each morning ‘Any cartons nol soldat the end ofthe day are thrown away, fr they would nt be fresh enough to mest the caf’s standards. Ifa carton of doughnuts is sol, the total revenue is $6. Henee, the ‘marginal profit per earton of doughnuts is MP = Marginal profit “The marginal los is ML = $4 since the doughnuts cannot be returned or salvaged at days end From pat sles, the cafe's manager estimates thatthe daly demand wil follow the proba: bility distribution shown in Table 6.6. Tae manager then follows thee steps o find the optimal ‘number of ertos of doughnuts to order each day 6s: s2 Step 1. Determine the value of 7 forthe decison rule er peoMe_ st 4 SMe w ess post So the inventory stocking decision ru iso stock anadtionl unit it P = 0.67 Step 2. Add anew column to the table to reflect the probability that doughnut sles willbe at fact level or greater This is shown inthe right-hand column of Tabi 67, For example, the probability thar demand will be 4 cartons or greater is 1.00(= 00S + 015 + 0.15 + 1.20 + 025 + 0.10 + 0.10), Sinslaly, the probably that sales will be 8 cartons or pester i 045 (= 025 + 0.10 + 0.10): namely, the sum of probabilities fr sales of 8, 9, oF 10 earons. Stop 3. Keep ordering additonal canons as long asthe probability of selling atleast one !uddtional carton is greater than P, which isthe indifference probability. If Caé da Donut orders 6 cartons, marginal profits will sl be greater thn marginal lass since Pat6catons = 080 > 067 Marginal Analysis with the Normal Distribution When product demand or sales follow a normal distribution, which is @ common business situation, marginal analysis with the normal distribution ean be applied. Fist, we need to find four values:TABLE 6.7 Marginal Analysis for Café du Donut 58 SINGLE-PeRIOD INVENTORY MODELS 223. + 005 100 = 066 5 ous 095 = 066 6 ons 080 = 0.66 7 020 os 9 010 020 0 10 10 teat “Too 1 The average or mean sles forthe product, 2. The standard deviation of sles, @ 3. The marginal profit forthe product, MP 4. The marginal loss for the product, MI. ‘Once these uamttes are known, the process of finding the best stocking policy is somewhat Siilar to marginal analysis with discrete dstibutions. Welt X* ~ optimal sockng level ‘Steps of Marginal Analysis with the Normal Distribution ML, 1 Determine he vale of ea Lead Tne = * Wee Orde lose Es) eguted Dae [oo [so * [ovserretase [0] | ees Ls ‘Oraer Release | mo228 CHAPTER 6 + INVENTORY CONTROL MODELS TABLE 6.9 (On-Hand Inventory sing on-hand inventory to compute net requirements. FIGURE 6.18 Net Material Requirements Plan for 50 units of A. ° : : A : ‘imes) Production of 8 should be started in week 3, and C shouldbe stared in weak 4 (See the ‘order release for these items.) Working backward, the same computations canbe made forall, ‘the other items. The material requirements plan graphically reveals when esch tem should be red and competed in order to have 50 units of A at week 6, Now, anet requirements plan ‘ean be develope given the on-hand inventory in Table 69; here is how its dove. Using these data, we can develop a et materia quirements plan that inciides gross re= ‘guieements, on-hand inventory, net requiements,planned-order receipts, and planned-oede re leases foreach item. It is developed by beginning with A and working backward through the ‘othe items. Figure 6.14 shows het material requirements plan for product A.(611. DEPENDENT DEMAND: THE CASE FOR MATERIAL REQUIREMENTS PLANNING 228 ‘The not requitements plan is constructed like the pros requieements plan, Starting with item A, we work backward determining net requirements for ll tens. These computations are done by referring constantly to the structure tee and lead times, The gross requirements for A are SO units in week 6 Tem items are on hand, and thos the net requirements and planned-order {eceipt ate both 40 tems in week 6. Hecause of the one-week lead time, the planned-order release is 40 items in week 5. (See the arrow connecting the order receipt and order release.) ‘Look down column $ and efer tothe structure tee in igure 6.13, Eighty (2 X 40) items of B and 120 = 3 X 40 items of Care required in week Sin omer to havea total of 50 tems of A in ‘week 6, Te eter A inthe upper-right corer for tems Band C means tha his demand for and C was generated as a esl of the demand forthe parent, A. Now the same typeof analysis Js done for B and Co determine the net requirements for D,E, and F ‘Two or More End Products, So far, we have considered only one end product. For most manufacturing companies, there are ‘normally two or more end products that use some ofthe same parts or componens, All ofthe fend produc must be incorporated int a single net materi requirements plan Inthe MRP example just discussed, we developed a net material requirements plan for product A. Now, we show how to modify the net material requirements plan when a second end product is inoduced. Les call the second end product AA. ‘The material structure tre for pradvct AA is follows Pe Fe Let's assume that we need 10 units of AA. With this information we ean compute the gross requirements for AA: Pan D: 3X numberof AA's = 3X 1 Pat 2X numberof AA's = 2% 1 20 20 ‘To develop a net material requirements plan, we need to know the lead time for AA. Lets assume that it sone wock, We also astume that we neod ID units of AA in week 6 and that we Ihave no units of AA on hand Now, we ae ina position to modify the et material requirements plan for product Ato in- clude AA. This is done in Figute 6.15. ‘Look atthe top row ofthe figure. As you can se, we havea gross requirement of 10 uits of AA in week 6, We dan'thave ay units of AA oa and, so the net equrement is also 10 units SOFA, Hecause takes one Wook fo make AA, the order release of 10 sit of AA isin week 5 ‘This means tat we star mking AA in week Sand have the finished units n week 6. ‘Because we start making AA in week 5, we must have 30 units of D and 20 units of Fin ‘week 5. See the rows for D ana Fin Figure 6.15. The lead time for Dis one weak. Thus, we must iv the order release in week 4 to have the Finished units of D in week S. Note that theze was no Javentory on hand for D in Week 5. The orginal 10 uit of inventory of D were usd in week S ‘omake B, which was subsequenly used to make A. We also need to have 20 units of Fin week 50 produce 10 units of AA by week 6. Again, we have no on-hand inventory of Fin week 5 ‘The original S units were used in week 4 to make C, which wa subsequently used to make A. “The lea time for Fi three weeks. Thus, the order release for 20 units of F must be in week 2 (See the F row in Figure 615) “This example shows how the inventory requirements of two products can be refiected inthe same net material requirements plan. Some manufeturing companies can have more than 100 fend products that must be coordinated inthe same net material requirements plan, Alsough ‘uch a situation ean be very complicated, the same principles we used inthis example are230 CHAPTER 6 + INVENTORY CONTROL MODELS FIGURE 6.15 Net Material Requirements Plan, Including AA ‘employed. Remember that computer programs have been developed to handle lage and com- plex manufacturing operations. In adition to using MRP to handle end products and finished goods, MRP can also be used to handle spare parts and components. This is important because most manufacturing compa nice sell spare part and components for maintenance. A net material requirements plan should also reflect these spare parts and component 6.12 _Just-in-Time Inventory Control With 07; inventory arrives just bore itisneeed. ‘During the past wo decades, there has been a red to make the manufacturing process mare ef ficient One objective is to have less in-process inventory on hand. This i known as JIT inven ‘ory. With this approach inventory arrives just in time tobe used during the manufacturing ‘process to produce subparts, assembles, or finished goods. One technique of implementing TT is 4 manual procedare called Kanban. Kanban in Japanese means “ear” With a dual-eandFIGURE 6.16 ‘The Kanban System (612 JUSTINSTIME NENTORY CONTROL 231 container contin 4 1 Proaiear ‘Strape User "wee Nel nes 2 2 -anban system, ther is a conveyance Kanban, or C-kanban, and production kanban, or P- ‘Kanban. Tae kasban system is very simple. Here is how it works: Four Steps of Kanban 1. A user takes a container of pans or inventory along with is accompanying C-kanban to his ‘chee work area. When there ate no mae pists ofthe contain is emp, the uses tur the empy container along wi the C-kanbun othe produce area 2, Atte producer area, thee i fll container of parts along with a P-anban, The wser detaches the P-kanban from the fll container of parts. Then the user takes the ful container ‘of parts alongwith the orginal C-anbaa back to his or er area for immediate us. 3 The detached P-Aanban goes back to the produce are along wih the empty conaies, The -kanban sa signal that new puts are tobe manufacue or that new parts ze to be placed into the container When the contin i filed, the P-kanban is tached to the container 4. Ths process repeats itself during the typical workday. The dua-card kanban system i shown in Figure 6.16, ‘As shown in Figure 6.16, fll containers long with hex Cann go from the storage ara ‘oa user area ypically on a manufacturing line, Dating the production process prt in the container are used up. When the container i empty, the empty container along withthe same ‘Cann goes back tothe storage area Here, the user picks up anew all onan The Pann ‘rom the fll container i removed and sent back othe production area along withthe empty container to be refilled ‘At minim, two containers ae required using the Kanban system. One containers used atthe user area, and another containe is being refilled for face use. In ealiy, there ae usually ‘more than two containers. This is how inventory conto s accomplished. Inventory managers ‘an introduce addtional containers and their asocited P-kanbans into the system. In similar fasion, the inventory mage can remove containers andthe P-kanbans to hve her conta over inventory buldups. In addition to being a simple, easy-to-implement system, the kanban system can also be very effective in controlling inventory costs and in uncovering production ottenecks.Inven- ‘ory arrives atthe user area or on the manufacturing line jst when itis needed. Inventory does ‘ot builé up unnecessarily, clutering the production line or adding to unnecessary inventory expense, The kanban system reuces inventory levels and makes fora more effective operation. Wis like puting he production line onan inventory dit. Like any die, the inventory diet i= posed by the kanban system makes the production operation more sieamlined, Furthermore, production bottlenecks and problems ean be uncovered. Maay production managers remove ‘Containers and their associated Pana fom the Kanban sytem in oder to “starve” the pro ‘decom ine to uncover botlenecks und potential problems In implementing & kanhan system, nomber of work ules or Kanban cules are normally ‘implemented. One typicel kanban rule is that no containers are filled without the appropiate kann. Another re that each container must hold exally the specified numberof pts oF inventory items. These and similar rules make the production process more efficient Only those pars that are actually needed are prvtced, The production department Joes not produce inven- ‘ory justo keep busy. It produces inventory or parts only When they are needed in the user area fron a actual manufacturing ine232 (CHAPTER 6 + INVENTORY CONTROL MODELS 6.13 _ Enterprise Resource Planning (Over the years, MRP bas evolved to include ao oly the materials required in production, bat also the labor hous, materia ost, and other resources related to production. When approached in this fashion, the term MRP II is often used, and the word resource replaces the word requirements, As his concept evolved and sophisticated computer software programs were de- ‘elope, these ystems were ealed enterprise resource planning (ERP) ste, "The objective of an ERP system isto reduce costs y integrating all of the operations of & fim, Tis stars wit the supplier ofthe materials needed and flows through the organization include invoicing the customer ofthe Final product. Data are entered once into a database, and then these data ean be quickly an easily accessed by aayone in the orgenization, This benefits not only the Functions related to plansing and managing inventory, but also other business ‘processes such as accounting, inane, and human esoutes "The benefits ofa well-developed ERP system are reduced transaction costs and increased speed and accuracy of information, However, there are drawbacks as wel, The software i ex pensive to buy and cosy to customize. The implementation of an ERP system may require a company to change its aormal operations, and employees ae often resistant co change. Al, trainin employees on the use of the new software canbe expensive ‘There ate many ERP systoms available. The most common ones ae fom the firms SAP, Oraie, People Soft, Haan and JD Edwards, Even small ystems can cost hundreds of thousands of dollars. The large systems can cost hundreds of ‘Summary of dollars, ‘This chapter introduces the fundamentals of inventory contol theory, We show thatthe two most important problems are (1) how much to order and 2) when to onde. ‘We investigate the economic order quantity, which deter ‘mines how much onde, abd the corde pont, which dete mines when to order. In addition, we explore the use of Sensitivity analysis to determine what happens computations ‘when one or more ofthe values used i one of the equations changes. ‘The basic EOQ inventory model presented in this chapter ‘makes 2 number of assumptions: (1) known and constant de ‘mand and ead times, (2) instantaneous receipt of inventory. 3) ‘no quantity discounts, (4) a stockouss o shortages, and (5) the only variable evsts are ordering costs and carrying costs. If ‘hese assumptions are valid, the EOQ inventory model pro vides optimal solutions. On the ather hand, i these assunp- {dons do not hold, the base EOQ model does not apply. In these Glossary cases, more complex model are need, including the produc tion run, quantity discount, and safety stock models, When the laventory item is for use in a single time perio, the marginal analysis approach i sed, AUC analysis is used to determine ‘which items represen the greatest potential inventory cox these items ean be more careflly managed, ‘When the demand for inventory is not independent ofthe demand for another product, a technigue sue as MRP is ‘needed, MRP can be used to determine the gross and net mate Fil requtements for products. Computer software i necessary to implement major inventory systems including MRP systems successfully. Today, many companies are using ERP software to integrate al ofthe opcations within a fim, including inven ‘ory, accounting, finance, and human resources TT can lower inventory levels, reduce costs, end make a manufacturing process more efficient, Kanban, 2 Japanese wont ‘meaning "ear"is one way to implement the IT approach [ABC Analysis An analysis that divides inventory into tree soups. Group A is more important than group, which is more important than group C. ‘Annual Setup Cost The costo setup the mantfactring or production process forthe production run model Average Inventory The everage inventory on hand. In this chapter the average inventory is 0/2 forthe BOQ model Bill of Materials (BOM) A list ofthe components in a prod- ‘et, witha description and the quantity required to make ‘one unit ofthat product. Economic Order Quantity (EOQ) The amount of inventory ‘ordered that will minimize the ttl iver cost. His a ‘alle the optimal order quantity, o O°,