Operations

Management
Inventory Management
 What is Inventory?
 Stock of materials
 Stored capacity © 1995
Corel Corp.

 Examples

© 1984-1994 T/Maker Co. © 1984-1994 T/Maker Co.

© 1995 Corel Corp.
 Types of Inventory

Raw material
Work-in-progress
Maintenance/repair/operating supply
Finished goods
 Disadvantages of Inventory

 Higher costs
 Item cost (if purchased)
 Ordering (or setup) cost
 Costs of forms, clerks’ wages etc.
 Holding (or carrying) cost
 Building lease, insurance, taxes etc.

 Difficult to control
 Hides production problems
 Effective Inventory Management
 Requires:
1. A system keep track of inventory
2. A reliable forecast of demand
3. Knowledge of lead time and lead time variability
4. Reasonable estimates of
 holding costs
 ordering costs
 shortage costs
5. A classification system for inventory items

13-5
 Inventory Classifications

Inventory © 1984-1994
T/Maker Co.

Process Number & Demand

Other
stage Value Type

Raw Material WIP A Items Maintenance

Independent
Finished Goods B Items Dependent
Dependent
C Items Operating
 ABC Analysis

 Divides on-hand inventory into 3 classes

 A class, B class, C class

 Basis is usually annual $ volume

 $ volume = Annual demand x Unit cost
 Policies based on ABC analysis
 Develop class A suppliers more
 Give tighter physical control of A items
 Forecast A items more carefully
 Classification

Category % of volume % of value

A 10-20 70-85

B 20-30 10-25

C 60-70 5-15
 Classifying Items as ABC
% Annual $ Usage Class % $ Vol % Items
100 A 80 15
B 15 30
80
C 5 55
60
40
A
B
20 C
0
0 50 100
% of Inventory Items
 Cycle Counting

 Physically counting a sample of total inventory

on a regular basis
 Used often with ABC classification
 A items counted most often (e.g., daily)
 Advantages of Cycle Counting
Eliminates shutdown and interruption of production
necessary for annual physical inventories
Eliminates annual inventory adjustments
Provides trained personnel to audit the accuracy of
inventory
Allows the cause of errors to be identified and
remedial action to be taken
Maintains accurate inventory records
 Techniques for Controlling Service
Inventory Include:

Good personnel selection, training, and

discipline
Tight control of incoming shipments
Effective control of all goods leaving the facility
 Independent versus
Dependent Demand

 Independent demand - demand for item is

independent of demand for any other item
 Dependent demand - demand for item is
dependent upon the demand for some other
item
 Inventory Costs

 Holding costs - associated with holding or

“carrying” inventory over time
 Ordering costs - associated with costs of placing
order and receiving goods
 Setup costs - cost to prepare a machine or
process for manufacturing an order
 Holding Costs
Obsolescence
Insurance
Extra staffing
Interest
Pilferage
Damage
Warehousing
Etc.
 Ordering Costs

Supplies
Forms
Order processing
Clerical support
Etc.
 Setup Costs

Clean-up costs
Re-tooling costs
Adjustment costs
Etc.
 Inventory Models

 Fixed order-quantity models Help

Helpanswer
answerthe
the
inventory
inventoryplanning
planning
 Economic order quantity questions!
questions!
 Production order quantity
 Quantity discount

 Probabilistic models
 Fixed order-period models
© 1984-1994
T/Maker Co.
 EOQ Assumptions

 Known and constant demand

 Known and constant lead time
 Instantaneous receipt of material
 No quantity discounts
 Only order (setup) cost and holding cost
 No stockouts
 EOQ Model
How Much to Order?
Annual Cost

t Cu r ve
a l C os rve
To t C u
C o st
ol ding
H

Order (Setup) Cost Curve

Optimal Order Quantity

Order Quantity (Q*)
 Why Holding Costs Increase

 More units must be stored if more are ordered

Purchase Order Purchase Order

Description Qty. Description Qty.
Microwave 1 Microwave 1000

Order quantity Order quantity

 Why Order Costs Decrease
 Cost is spread over more units
Example: You need 1000 microwave ovens
1 Order (Postage $ 0.33) 1000 Orders (Postage $330)

Purchase Order PurchaseOrder

Purchase Order
Description PurchaseOrder
Description
Purchase OrderQty.
Qty. Description Qty.
Qty.
Microwave 1000 Description
Microwave Qty. 11
Description
Microwave
Microwave
Microwave 11
Order quantity
 Deriving an EOQ

Develop an expression for setup or ordering

costs
Develop an expression for holding cost
Set setup cost equal to holding cost
Solve the resulting equation for the best order
quantity
 EOQ Model
When To Order
Inventory Level
Optimal Average
Order Inventory
Quantity (Q*/2)
(Q*)

Reorder
Point
(ROP)

Time
Lead Time
 EOQ Model Equations
Optimal Order Quantity 2 ×D ×S
= Q* =
H
D
Expected Number of Orders =N =
Q*
Expected Time Between Orders Working Days / Year
=T =
N
D D = Demand per year
d =
Working Days / Year S = Setup (order) cost per order
H = Holding (carrying) cost
ROP = d × L d = Demand per day
L = Lead time in days
 Production Order Quantity Model
 Answers how much to order and when to order
 Allows partial receipt of material
 Other EOQ assumptions apply
 Suited for production environment
 Material produced, used immediately
 Provides production lot size

 Lower holding cost than EOQ model

 EOQ POQ Model
When To Order
Inventory Level
Optimal Average
Order Inventory
Quantity
(Q*)

Reorder
Point
(ROP)

Time
Lead Time
 Reasons for Variability in Production

 Most variability is caused by waste or by poor

management. Specific causes include:
 employees, machines, and suppliers produce units that do
not conform to standards, are late or are not the proper
quantity
 inaccurate engineering drawings or specifications
 production personnel try to produce before drawings or
specifications are complete
 customer demands are unknown
 POQ Model Inventory Levels
Inventory Level

Production portion of cycle

Demand portion of cycle with no supply

Supply Supply
Time
Begins Ends
 POQ Model Equations

= Q* = 2*D*S
Optimal Order Quantity
p
( )
H* 1 -
d
p

Maximum inventory level = Q* ( 1 -

d
p )
D D = Demand per year
Setup Cost = * S
Q S = Setup cost
H = Holding cost
Holding Cost = 0.5 * H * Q
( )
1-
d
p
d = Demand per day
p = Production per day
 Quantity Discount Model
 Answers how much to order &
when to order
 Allows quantity discounts
 Reduced price when item is purchased in larger
quantities
 Other EOQ assumptions apply
 Trade-off is between lower price & increased
holding cost
 Quantity Discount Model
How Much to Order?
Total
Cost Discount 1 Price Discount 2 Price
Initial Price
1
or
TC f unt is c ount
isco or D
No D TC f
2
c ount
is
for D
TC

Quantity which would

be ordered
Order
Quantity
Lowest cost not in Quantity to Quantity to
earn earn
discount range Discount 1 Discount 2
 Probabilistic Models

 Answer how much & when to order

 Allow demand to vary
 Follows normal distribution
 Other EOQ assumptions apply

 Consider service level & safety stock

 Service level = 1 - Probability of stockout
 Higher service level means more safety stock
 More safety stock means higher ROP
 Probabilistic Models
When to Order?
Frequency Service
Inventory Level
Level P(Stockout)

Optimal
Order
X
Quantity SS
ROP
Reorder
Point
(ROP)

Safety Stock (SS)

Place Receive Time
order Lead Time order
 Fixed Period Model
 Answers how much to order
 Orders placed at fixed intervals
 Inventory brought up to target amount
 Amount ordered varies

 No continuous inventory count

 Possibility of stockout between intervals
 Useful when vendors visit routinely
 Example: P&G representative calls every 2 weeks
 Discussion Questions
 Define the term inventory, list the major reasons for
holding inventories, and list the main requirements for
effective inventory management.
 Discuss the nature and importance of service inventories.
 Explain periodic and perpetual review systems.
 Explain the objectives of inventory management.
 Describe the A-B-C approach and explain how it is useful.
 Discussion Questions
 Describe the basic EOQ model and its assumptions.
 Describe the economic production quantity model.
 Describe the quantity discount model.
 Describe reorder point models.
 Describe situations in which the single period model would
be appropriate.
 Fixed Period Model
When to Order?
Inventory Level Target maximum

Time
Period Period Period