Unit III

Inventory Management
Inventory

 Inventory is the stock of any item

or resource used in an organization.

 Inventory system is the set of

policies and controls that monitor
levels of inventory and determine
what levels should be maintained,
when stock should be replenished
and how large orders should be.
 In a manufacturing organization,
inventory is classified into raw
materials, finished products,
component parts, supplies and
work-in-process.
 The basic purpose of inventory
analysis is:
 When items should be ordered.
 How large the order should be.
Objectives of Inventory Management

 To maintain independence of
operations
 A supply of materials at a work center
allows that center flexibility in
operations.
 A cushion of several parts within the
workstation can compensate shorter
performance times for longer
performance times.
 To meet variation in product
demand
 If the demand is known, it is possible
to produce the product to meet the
demand.
 Usually, however, demand is not
completely known and a safety or
buffer stock must be maintained to
absorb variation.
 To allow flexibility in production
scheduling
 A stock of inventory relieves the
pressure on the production system.
 It helps in better production planning
for smoother flow and lower-cost
operation through larger lot-size
production.
 To provide a safeguard for variation
in raw material delivery time
 When material is ordered from a
vendor, delays can occur for a variety
of reasons:
 A normal variation in shipping time.
 A shortage of material at the vendor’s
plant.
 An unexpected strike at the vendor’s plant.
 A shipment of incorrect or defective
material.
 To take advantage of economic
purchase order size
 Costs such as phone calls, postage
etc. are associated in placing an order.
 Shipping costs favour larger orders –
larger the shipment, lower the per unit
cost.
Inventory Costs

 Holding (carrying) costs.

 Includes costs for storage facilities,
handling, insurance, obsolescence,
depreciation.
 High holding costs tend to favour low
inventory levels.
 Set up costs
 Making each different product involves
obtaining the necessary materials,
arranging specific equipment setups
etc.
 Ordering costs
 These costs refer to the managerial
and clerical costs to prepare the
purchase or production order.

 Shortage costs
 When there is a shortage in the stock
of an item.
Independent versus Dependent
Demand

 In independent demand, the

demands for various items are
unrelated to each other.
 In dependent demand, the need for
any one item is a direct result of the
need for some other item.
Eg: Demand for cars is an independent
demand whereas demand for tyres is
dependent demand.
Factors affecting Inventory
Management/Control Policy

 Product design.
 Plant layout.
 Differentiation of the product at
various stages.
 Process capability and flexibility.
 Production capacity and Storage
facility.
 Quality requirements, shelf-life and
obsolescence risks.
 Changes in size and frequency of
orders.
 Unpredictability of sales.
 Amount of capital available for
stock.
Inventory Control techniques

 ABC Inventory Planning

 Focus on the most important items in
inventory.
 Pareto Principle (80:20 principle).
 20 percent of the people control 80
percent of the wealth.
 This logic of the few having the greatest
importance and the many having little
importance is termed the Pareto principle.
 ABC Classification:
 A items constitute roughly the top 15
percent of the items.
 B items the next 35 percent.
 C items the last 50 percent.
Annual usage of Inventory by value
Item number Annual Rupee Percentage of
Usage Total Value
22 Rs. 95,000 40.69%
68 75,000 32.13
27 25,000 10.71
03 15,000 6.43
82 13,000 5.57
54 7,500 3.21
36 1,500 0.64
19 800 0.34
23 425 0.18
41 225 0.10
Rs. 233,450 100%
ABC Grouping of Inventory Items
Classification Item Annual Percentage
Number Rupee of Total
Usage
A 22, 68 Rs. 170,000 72.9%
B 27, 03, 82 53,000 22.7
C 54, 36, 19, 10,450 4.4
23, 41
Rs. 233,450 100%
%
of
Total
inventory100
value 80
60
40 A
20 B

0 20 40 60 80 100
Percentage of total list of different stock items
 The purpose of classifying items into
groups is to establish the appropriate
degree of control over each item.
 For Eg: Class A items may be
controlled with weekly ordering.
 Class B biweekly.
 Class C monthly or bimonthly.
 Eg: In an automobile service station, Petrol
and diesel would be an A item. Tyres,
batteries, oil, grease may be B item. Wiper
blades, valve stems may be C items.
 VED Analysis
 Analysis for monitoring and control of
stores and spares inventory by
classifying them into 3 categories:
 Vital
 Essential
 Desirable
 Basis is criticality of inventories.
 It is specially used for classification of
spare parts.
 If a part is vital, it is given ‘V’
classification.
 If a part is essential, then it is given ‘E’
classification.
 If a part is not so essential, the part is
given ‘D’ classification.
 For ‘V’ items, a large inventory is
generally maintained.
 For ‘D’ items, minimum stock is enough.
 FSN analysis
 Classification is based on frequency of
Issues/Use.
 Fast moving (F)
 Items that are frequently issued i.e. more
than once a month.
 Slow moving (S)
 Items that are issued less than once a
month.
 Non-moving (N)
 Items that are not issued/used for more than
2 years.
 This classification helps spare parts
management in establishing most
suitable stores layout.
 Attention of the management is
focused on the Non-moving items to
enable decision as to whether they are
required in the future or they can be
salvaged.
 SED or SDE analysis
 Classification is based on the lead time
required to procure the spare part.
 Scarce (S)
 Items which are imported and those items
which require more than 6 months lead time.
 Difficult (D)
 Items which require more than a fortnight
but less than 6 months lead time
 Easily available (E)
 Items which are easily available i.e. less than
a fortnights’ lead time.
Multiperiod Inventory Systems

 Two types:
 Fixed-order quantity models (also
called economic order quantity, EOQ
and Q-model)
 Fixed-time period models (also called
periodic system, periodic review
system, fixed-order interval system
and P-model)
 Fixed-order quantity and Fixed-
Time period differences
Q-model P-model
FEATURE FIXED-ORDER FIXED-TIME PERIOD
QUANTITY MODEL MODEL
Order quantity Q-constant (the same q-variable (varies each
amount ordered each time order is placed)
time)
When to place order R- when inventory T- when the review
position drops to the period arrives
reorder level
Record-keeping Each time a withdrawal Counted only at review
or addition is made period
Size of inventory Less than fixed-time Larger than fixed-order
period model quantity model
Time to maintain Higher due to perpetual Lower
record-keeping
Type of items Higher-priced, critical or Not so important items
important items
Fixed-order quantity models

 Determines the specific point R, at

which an order will be placed and
the size of that order, Q.
 An order of size Q is placed when
the inventory available reaches the
point R.
 Inventory position is defined as the
on-hand plus on-order minus
backordered quantities.
Calculation

 Total annual cost = Annual

purchase cost + Annual ordering
cost + Annual holding cost
TC = DC + (D/Q)S + (Q/2)H
where,
TC = Total annual cost
D = Demand (annual)
C = Cost per unit
Q = Quantity to be ordered (the optimal
amount is termed the economic order
quantity (EOQ) or Qopt)
S = setup cost or cost of placing an order
R = Reorder point
L = Lead time
H = Annual holding and storage cost per
unit of average inventory
 Qopt = √(2DS/H)
 At Qopt, total cost is minimum.
 In this simple model, demand and lead
time are constant, hence, no safety
stock is necessary and the reorder
point, R is
 R = dL
where,
d = Average daily demand (constant)
L = Lead time in days (constant)
Question
 Find the economic order quantity and the
reorder point, given
Annual demand (D) = 1000 units
Average daily demand (d) = 1000/365
Ordering cost (S) = Rs. 5 per order
Holding cost (H) = Rs. 1.25 per unit per
year
Lead time (L) = 5 days
Cost per unit (C) = Rs. 12.5
What quantity should be ordered?
Solution

 The optimal order quantity is

Qopt = √(2DS/H)
= √(2x1000x5/1.25)
=√(8000) = 89.4 units
The reorder point is
R = dL = (1000/365)x 5
= 13.7 units
Hence, when the inventory position
drops to 14, place an order for 89
more units.
The total annual cost will be
TC = DC + (D/Q)S + (Q/2)H
= 1000x12.5 + (1000/89)x5
+ (89/2)x 1.25
= Rs. 12611.81
Fixed-order quantity model with
safety stock

 Safety stock
 It can be defined as the amount of
inventory carried in addition to the
expected demand
 The key difference is in computing
the reorder point. The order
quantity is the same in both cases.
Calculation

 The reorder point is

R = dL + z L
where
R = Reorder point in units
d = Average daily demand
L = Lead time in days (time between placing
an order and receiving the items
z = Number of standard deviations for a
specified service probability
L = Standard deviation of usage during Lead
time
Safety Stock = z L
Question

 Consider an economic order

quantity case where annual demand
D = 1000 units, economic order
quantity Q = 200 units, the desired
probability of not stocking out
P = .95, the standard deviation of
demand during lead time L = 25
units and lead time L = 15 days.
Determine the reorder point.
Assume that demand is over a 250-
work-day year.
Solution

 d = 1000/250 = 4 and L = 15 days

R = dL + z L = 4 (15) + z (25)
Here, z = 1.64 for P = 0.95
R = 4 (15) + 1.64 (25)
= 60 + 41 = 101 units
Hence, when the stock on hand
gets down to 101 units, order 200
more units.
Question
 Daily demand for a certain product is
normally distributed with a mean of 60 and
standard deviation of 7. The source of
supply is reliable and maintains a constant
lead time of six days. The cost of placing
the order is Rs. 10 and annual holding
costs are Rs. 0.50 per unit. There are no
stockout costs and unfilled orders are filled
as soon as the order arrives. Assume sales
occur over the entire 365 days of the year.
Find the order quantity and reorder point to
satisfy a 95 percent probability of not
stocking out during the lead time.
Solution

 d = 60, S = Rs. 10, =7 d

H = Rs. 0.50, D = 60(365), L = 6

Qopt = √(2DS/H) = √(2(60)365(10)/0.50)
= 936 units
L = √∑ d = √6 (7) = 17.15

For a probability of 95 percent, z = 1.64

To compute the reorder point, we need
to calculate the amount of product used
during the lead time and add this to the
safety stock.
R = dL + z L

= 60(6) + 1.64 (17.15)

= 388 units
Hence, an order for 936 units is placed
whenever the number of units remaining
in inventory drops to 388.
Fixed-Time period Model with
Safety Stock

 In a fixed-time period system,

reorders are placed at the time of
review (T) and the safety stock that
must be reordered is
Safety stock = z T+L
q = d (T+L) + z T+L – I
where,
q = Quantity to be ordered
T = The number of days between reviews
L = Lead time in days
d = Forecast average daily demand
z = Number of standard deviations
for a specified service probability
T+L = Standard deviation of demand over
the review and lead time
I = Current inventory level (includes items
on order)
Question

 Daily demand for a product is 10

units with a standard deviation of 3
units. The review period is 30 days
and lead time is 14 days.
Management has set a policy of
satisfying 98 percent of demand
from items in stock. At the
beginning of this review period,
there are 150 units in inventory.
How many units should be ordered?
Solution

 The quantity to order is

q = d (T+L) + z T+L –I
T+L = √∑ d = √(T+L) d

= √(30+14) (3)
= 19.90
The z value for P=0.98 is 2.05
q = d (T+L) + z T+L –I
= 10 (30+14) + 2.05(19.90)- 150
= 331 units
To ensure a 98 percent probability of not stocking
out, order 331 units at this review period.
Lead Time Reduction

 Lead time reduction leads to:

 The ability to quickly fill customer
orders that can’t be filled from stock.
 Reduction in the bullwhip effect.
 More accurate forecasts due to a
decreased forecast horizon.
 Reduction in finished goods inventory
levels.
 Many customers consider lead time
a very important criterion for
vendor selection.
 Distribution network designs should
make available the information
about the status of the entire
supply chain.
Just-In-Time (JIT)
 JIT is a Japanese management philosophy
which was developed in early 1970s.
 It was first developed within the Toyota
manufacturing plants by Taiichi Ohno as a
means of meeting consumer demand with
minimum delay.
 JIT based production system has the
capacity to strengthen the organization’s
competitiveness in the marketplace
substantially by reducing wastes and
improving product quality and efficiency
of production.
 As a philosophy, JIT’s primary goal is
the elimination of waste in the
production system.
 The overall goals of JIT is to eliminate
waste, to improve quality, to minimize
lead time, to reduce costs and to
improve productivity.
Key Elements of JIT

 Continuous Improvement.
 Attacking fundamental problems –
anything that does not add value to a
product or system.
 Quality control at source.
 Poka-yoke or Mistake Proofing.
 Preventative maintenance.
 Eliminating Waste or Muda.
 Overproduction.
 Waiting Time or Delay.
 Transportation.
 Processing.
 Inventory.
 Unnecessary movement.
 Product defects.
 Set-up time reduction
 JIT aims for single digit set-up time
(less than 10 minutes), which is done
through planning, processing and
product redesigning.
 Reduction in set-up time not only
increases flexibility, but also allows
smaller batches. Ideal batch size is 1.
 Reduction of lot sizes
(manufacturing and purchase)
 Reducing set up time allows
economical production of smaller lots.
 Close cooperation with suppliers is
necessary to achieve reductions in
order of lot sizes for purchased items.
 Reduction of lead times (production
and delivery)
 Production lead times can be reduced by
keeping machines closer, applying group
technology and also improving the
coordination and cooperation between
successive processes.
 Delivery lead times can be reduced
through close cooperation with suppliers,
possibly by inducing suppliers to locate
closer to the factory.
 Jidoka (automation)
 A Japanese term that means providing
automation with a human touch.
 It involves designing machines with
the autonomous capability, so that
workers can do more value added
work.
 Andon (trouble lights)
 A Japanese term that means “light”.
 In the Toyota production system,
Andon is a type of visual signal for an
employee, indicating that a problem
has occurred and cannot be resolved
without stopping the production
process.
 The signal gives a cue to initiate the
corrective action.
 Preventive maintenance
 To maintain equipment and prevent
breakdowns.
 Machines periodically undergo a
maintenance process to avoid big
machine failure.
 Flexible workforce
 Workers should be trained to operate
on several machines, to perform
maintenance tasks and to perform
quality inspections.
Kanban Production Control
Systems (Kanban Pull System)

 A Kanban control system uses a

signaling device to regulate JIT flows.
 Kanban means “sign” or “instruction
card” in Japanese.
 In a paperless control system,
containers can be used instead of
cards.
 The cards or containers make up the
Kanban pull system.
 The authority to produce or supply
additional parts comes from
downstream operations.
Withdrawal Kanban

Machine Storage
parts A
Storage
parts A Assembly
Center &B &B
line

Production Kanban

Flow of Two Kanbans

 Figure shows an assembly line that is
supplied with parts by a machine center.
 The machine center makes two parts, A and
B.
 These two parts are stored in containers that
are located next to the assembly line and
next to the machine center.
 Each container next to the assembly line has
a withdrawal kanban and each container next
to the machine center has a production
kanban.
 This is often referred to as a two-card kanban
system.
 When the assembly line takes the first part A
from a full container, a worker takes the
withdrawal kanban from the container and
takes the card to the machine center storage
area.
 In the machine center area, the worker finds
a container of part A, removes the production
kanban and replaces it with the withdrawal
kanban.
 Placement of this card on the container
authorizes the movement of the container to
the assembly line.
 The freed production kanban is placed on
a rack by the machine center, which
authorizes the production of another lot of
material.
 A similar process is followed for part B.
Determining the Number of
Kanbans Needed

 Setting up a kanban control system

requires determination of the number
of kanban cards (or containers)
needed.
 The number of kanban card sets is:

k = (Expected demand during lead time

+ safety stock) / Size of the container
= (DL(1+S)) / C
k = Number of kanban card sets
D = Average number of units
demanded over some time period
L = Lead time to replenish an order
S = Safety stock expressed as a
percentage of demand during the
Lead time
C = Container size
 Question. Items are made in batches
of 10 units. The converter cell can
respond to an order for a batch of
items in approximately 4 hours. The
fabrication cell averages approximately
8 assemblies per hour. Due to some
variability in the process, management
has decided to have safety stock
equivalent to 10 percent of the needed
inventory. How many kanban sets are
needed to manage the replenishment
of the items?
 Solution:
L = 4 hours
D = 8 per hour
S = 10% of the expected demand
C = 10 units
k = (DL(1+S)) / C
k = (8 x 4 (1+0.1)) / 10 = 35.2/10
= 3.52
Hence, we would need 4 kanban card
sets.
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