Inventory Management: OP 2202: Introduction To Operations Management

OP 2202: Introduction to Operations
Management
Inventory Management
Anupam Das, PhD

OP 2202: Introductions to Operations Management
Lesson 14, Page 2
Outline for the Week 14

 GLOBAL COMPANY PROFILE: AMAZON.COM
 FUNCTIONS OF INVENTORY
 Types of Inventory
 INVENTORY MANAGEMENT
 ABC Analysis Record Accuracy
 Cycle Counting
 Control of Service Inventories
 INVENTORY MODELS
 Independent versus Dependent Demand
 Holding, Ordering, and Setup Costs
 INVENTORY MODELS FOR INDEPENDENT DEMAND
 Basic Economic Order Quantity (EOQ) Model
 Minimizing Costs
 Reorder Points
 Production Order Quantity Model
 Quantity Discount Models
 PROBABILISTIC MODELS WITH CONSTANT LEAD TIME
 FIXED PERIOD (P) SYSTEMS
Anupam Das, PhD
Lesson 14, Page 3
AMAZON.com
• Jeff Bezos, in 1995, started AMAZON.com
as a “virtual” retailer – no inventory, no
warehouses, no overhead; just a bunch of
computers.
• Growth forced AMAZON.com to excel in
inventory management!
• AMAZON is now a worldwide leader in
warehouse management and automation.
Anupam Das, PhD

Lesson 14, Page 4
Order Fulfillment at AMAZON

1. You order items;, computer assigns your order to
distribution center [closest facility that has the
product(s)]
2. Lights indicate products ordered to workers who
retrieve product and reset light.
3. Items placed in crate with items from other orders, and
crate is placed on conveyor. Bar code on item is
scanned 15 times – virtually eliminating error.
4. Crates arrive at central point where items are boxed
and labeled with new bar code.
5. Gift wrapping done by hand (30 packages per hour)
6. Box is packed, taped, weighed and labeled before
leaving warehouse in a truck.
7. Order appears on your doorstep within a week
Anupam Das, PhD

Lesson 14, Page 5
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.
Anupam Das, PhD

Lesson 14, Page 6
The Functions of Inventory
• To ”decouple” or separate various parts

of the production process
• To provide a stock of goods that will
provide a “selection” for customers
• To take advantage of quantity discounts
• To hedge against inflation and upward
price changes
Anupam Das, PhD

Lesson 14, Page 7
Types of Inventory
• Raw material
• Work-in-progress
• Maintenance/repair/operating supply
• Finished goods
Anupam Das, PhD

Lesson 14, Page 8
The Material Flow Cycle
Anupam Das, PhD

Lesson 14, Page 9
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
Anupam Das, PhD

Inventory Classifications
Lesson 14, Page 10
Inventory © 1984-1994
T/Maker Co.
Process Number & Demand

Other
stage Value Type
Raw Material A Items

Independent Maintenance
WIP B Items
Dependent Operating
Finished Goods C Items
Anupam Das, PhD

Lesson 14, Page 11
The Material Flow Cycle
Other Wait Move Queue Setup Run

Input Time Time Time Time Time Output
Cycle Time
1 Run time: Job is at machine and being worked on

2 Setup time: Job is at the work station, and the work
station is being "setup."
3 Queue time: Job is where it should be, but is not being
processed because other work precedes it.
4 Move time: The time a job spends in transit
5 Wait time: When one process is finished, but the job is
waiting to be moved to the next work area.
6 Other: "Just-in-case" inventory.
Anupam Das, PhD
Lesson 14, Page 12
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
Anupam Das, PhD

Lesson 14, Page 13
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
Anupam Das, PhD

Lesson 14, Page 14
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)
Anupam Das, PhD

Lesson 14, Page 15
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
Anupam Das, PhD

Techniques for Controlling Service Inventory
Lesson 14, Page 16
Include:
• Good personnel selection, training, and

discipline
• Tight control of incoming shipments
• Effective control of all goods leaving the
facility
Anupam Das, PhD

Independent versus Dependent Demand

Lesson 14, Page 17
• 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
Anupam Das, PhD

Lesson 14, Page 18
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
Anupam Das, PhD

Lesson 14, Page 19
Holding (Carrying) Costs

• Obsolescence
• Insurance
• Extra staffing
• Interest
• Pilferage
• Damage
• Warehousing
• Etc.
Anupam Das, PhD

Inventory Holding Costs (Approximate Ranges)

Lesson 14, Page 20
Cost as a
Category % of Inventory Value
6%
Housing costs (building rent, (3 - 10%)
depreciation, operating cost, taxes,
insurance) 3%
(1 - 3.5%)
Material handling costs (equipment, lease
or depreciation, power, operating cost) 3%
(3 - 5%)
Labor cost from extra handling
11%
(6 - 24%)
Investment costs (borrowing costs, taxes,
and insurance on inventory) 3%
(2 - 5%)
Pilferage, scrap, and obsolescence 26%
Overall carrying cost
Anupam Das, PhD

Ordering Costs
Lesson 14, Page 21
• Supplies
• Forms
• Order processing
• Clerical support
• Etc.
Anupam Das, PhD

Setup Costs
Lesson 14, Page 22
• Clean-up costs
• Re-tooling costs
• Adjustment costs
• Etc.
Anupam Das, PhD

Lesson 14, Page 23
Inventory Models
• Fixed order-quantity models
Help answer the
– Economic order quantity inventory planning
– Production order quantity questions!
– Quantity discount
• Probabilistic models
• Fixed order-period models
Anupam Das, PhD

Lesson 14, Page 24
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
Anupam Das, PhD

Inventory Usage Over Time

Lesson 14, Page 25
Order quantity = Q Usage Rate

(maximum inventory Average
level) Inventory
(Q*/2)
Inventory Level
Minimum
inventory 0
Time
Anupam Das, PhD

Lesson 14, Page 26
EOQ Model, How Much to Order?
Annual Cost
t Curve
C os
To ta
l
Curve
Minimum C ost
total cost old ing
H
Order (Setup) Cost Curve
Optimal Order quantity

Order Quantity (Q*)
Anupam Das, PhD

Lesson 14, Page 27
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
Anupam Das, PhD

Lesson 14, Page 28
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
Anupam Das, PhD

Lesson 14, Page 29
Deriving an EOQ
1. Develop an expression for setup or
ordering costs
2. Develop an expression for holding cost
3. Set setup cost equal to holding cost
4. Solve the resulting equation for the best
order quantity
Anupam Das, PhD

Lesson 14, Page 30
EOQ Model, When To Order
Inventory Level
Optimal Average
Order Inventory
Quantity (Q*/2)
(Q*)
Reorder
Point
(ROP)
Time
Lead Time
Anupam Das, PhD

Lesson 14, Page 31
EOQ Model Equations
Optimal Order Quantity 2 ×D ×S

= Q* =
H
Expected Number of Orders =N =
D
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
Anupam Das, PhD

Lesson 14, Page 32
The Reorder Point (ROP) Curve
Q*
Slope = units/day = d
Inventory level (units)
ROP
(Units)
Time (days)
Lead time = L
Anupam Das, PhD

Lesson 14, Page 33
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
Anupam Das, PhD

Lesson 14, Page 34
EOQ POQ Model, When To Order
Both production
and usage take Usage only takes
Maximum place
place
inventory
level
Inventory Level
Time
Anupam Das, PhD

Lesson 14, Page 35
EOQ POQ Model, When To Order
Inventory Level
Optimal Average
Order Inventory
Quantity
(Q*)
Reorder
Point
(ROP)
Time
Lead Time
Anupam Das, PhD

Lesson 14, Page 36
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
Anupam Das, PhD

Lesson 14, Page 37
POQ Model Inventory Levels

Inventory Level
Production portion of cycle
Demand portion of cycle with no supply
Supply Supply
Time
Begins Ends
Anupam Das, PhD

Lesson 14, Page 39
POQ Model Equations
= Q* = 2*D*S
Optimal Order Quantity
( )
p d
H* 1 -
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
Anupam Das, PhD

Lesson 14, Page 40
Quantity Discount Model

• Answers how much to order &
when to order
• Allows quantity discounts
– Reduced price when item is purchased in
larger quantities
• Trade-off is between lower price &
increased holding cost
Anupam Das, PhD

Lesson 14, Page 41
Quantity Discount Schedule
Discount Discount Discount Discount

Number Quantity (%) Price (P)
1 0 to 999 No $5.00
discount
2 1,000 to 1,999 4 $4.80
3 2,000 and over 5 $4.75
Anupam Das, PhD

Quantity Discount – How Much to Order

Lesson 14, Page 42
Anupam Das, PhD

Lesson 14, Page 43
Probabilistic Models
• Answer how much & when to order
• Allow demand to vary
– Follows normal distribution
• Consider service level & safety stock
– Service level = 1 - Probability of stockout
– Higher service level means more safety stock
• More safety stock means higher ROP
Anupam Das, PhD

Probabilistic Models. When to Order?

Lesson 14, Page 44
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
Anupam Das, PhD

Lesson 14, Page 45
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
Anupam Das, PhD

Lesson 14, Page 46
Inventory Level in a Fixed Period System

Various amounts (Qi) are ordered at regular time intervals (p)
based on the quantity necessary to bring inventory up to
target maximum
Target maximum
Q1 Q2 Q4
On-Hand Inventory
Q3
p p p
Time
Anupam Das, PhD

Lesson 14, Page 47
Fixed Period Model. When to Order?

Inventory Level Target maximum
Time
Period Period Period
Anupam Das, PhD

Inventory Management: OP 2202: Introduction To Operations Management

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OP 2202: Introduction to Operations

Anupam Das, PhD

Outline for the Week 14

Anupam Das, PhD

Order Fulfillment at AMAZON

Anupam Das, PhD

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

Anupam Das, PhD

The Functions of Inventory

• To ”decouple” or separate various parts

Anupam Das, PhD

Anupam Das, PhD

The Material Flow Cycle

Anupam Das, PhD

Anupam Das, PhD

Process Number & Demand

Raw Material A Items

Anupam Das, PhD

The Material Flow Cycle

Other Wait Move Queue Setup Run

1 Run time: Job is at machine and being worked on

Anupam Das, PhD

Classifying Items as ABC

% Annual $ Usage Class % $ Vol % Items

Anupam Das, PhD

• Physically counting a sample of total

Anupam Das, PhD

Advantages of Cycle Counting

Anupam Das, PhD

• Good personnel selection, training, and

Anupam Das, PhD

Independent versus Dependent Demand

• Independent demand - demand for item

Anupam Das, PhD

• Holding costs - associated with holding

Anupam Das, PhD

Holding (Carrying) Costs

Anupam Das, PhD

Inventory Holding Costs (Approximate Ranges)

Overall carrying cost

Anupam Das, PhD

Anupam Das, PhD

Anupam Das, PhD

Anupam Das, PhD

Anupam Das, PhD

Inventory Usage Over Time

Order quantity = Q Usage Rate

Anupam Das, PhD

EOQ Model, How Much to Order?

Order (Setup) Cost Curve

Optimal Order quantity

Anupam Das, PhD

Why Holding Costs Increase

Purchase Order Purchase Order

Anupam Das, PhD

Why Order Costs Decrease

Purchase Order PurchaseOrder

Anupam Das, PhD

Anupam Das, PhD

EOQ Model, When To Order

Anupam Das, PhD

EOQ Model Equations

Optimal Order Quantity 2 ×D ×S