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Attribution Non-Commercial (BY-NC)

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Presented By:

Priyanka Gupta (2010PMM124) Anupama Kumari (2009PMM119)

Inventory Fundamentals

What is inventory? Materials & supplies that a business carries either for sale or to provide inputs to the production process Those stocks or items used to support production (raw materials and WIP), supporting activities (maintenance, repair, & operating supplies), & customer service (finished goods & spare parts)

Raw materials Work-in-process (WIP) Raw and in-process (RIP) Finished goods Distribution inventories Maintenance, repair, & operational supplies (MROs)

Inventory Objectives

Inventories must be coordinated to meet three conflicting objectives: Maximize customer service Minimize plant operation costs Minimize inventory investment

Inventory Costs

Inventory management costs

Item costs Carrying costs Ordering costs Stockout costs

Capacity-related costs

Functions of Inventories

Inventory serves as a buffer between: supply & demand customer demand & finished goods

requirements for an operation & the output from the preceding operation

Aggregate inventory management (AIM) is concerned with managing inventories according to their classifications (raw material, work-in-process, finished goods, etc.) & the function they perform AIM is financially oriented & concerned w/ costs & benefits of carrying the classifications of inventories

AIM involves Flow & kind of inventory needed Supply & demand patterns Functions inventory performs Objectives of inventory management Costs associated w/ inventory

It is a technique developed for handling EOQs in a aggregate and dealing with the problem of constraint of EOQ equation. It provides a means to calculate directly the proper lot size for a family of items to meet some constraints. Then limit order quantities are calculated with the help of formulas A &B Limit formula A = Ccb = Cca = ( Hb/ha)2 Limit formula B = M = Ha/Hb

Where Hb = Total set up hours for present quantities. Ha = Total set up hours for trial order quantities. Cca = Inventory carrying cost for trial order quantities. Ccb = Inventory carrying cost used for limit order quantities.

Example

D=10000 S=$125 I=0.25 C=$10 what is the trial lot size? Solution: QT= (2DS/Ic) = (2*10000*125/0.25*10) =1000 Setup in the year= D/Q=10

If Limit order quantity QL=2000 QL= (2DS/ILc) = (2*10000*125/IL*10)=2000 IL=6.25% Relationship between the trial and the limit lot size QL=M*QT

Where M= (IT/IL) 2000=M*1000 M=2 We have HT=Di *hi/QTi; HL=Di *hi/QLi Also M=HT/HL= (IT/IL)

Example

The two item in our inventory have been managed in a seat of the pants fashion for several years. The following table shows the current situation: Item Annual Usage D 10000 5000 Setup Unit Hours Cost of per item c order h 2 10 3 15 Present Yearly Order Setup Quantit Hours H y Q 769 13*2=26 1667 3*3=9

A B

Total

Current setup costs=$62.50 HL=35hours, IT=35% How can this situation be handled using LIMIT?

35

Item A B

Total 49 M=HT/HL=1.4 QL=M*QT =1.4*QT This leads us directly to the LIMIT order quantities:

Item A B Total LMIT Quantity QL 1.4*845=1183 1.4*598=837 Approximately Yearly Setup Hours HL 17 18 35

Inventry limit carrying percentage IL= IT(HL/HT)^2=0.35(35/49)^2=0.1786 Lot size QP-A QP-B 769 1667 845 598 1183 837 Annual Holding Annual Setup Cost ($) Cost ($) 687 2233 1625 563 Total Relevant Costs ($) 2312 2796

Exchange curve

Aggregate Annual Setup Cost ($) Optimal,given I=35%

3100

QT (1556,3047)

2600

(2177,2177)

2100

(2920,2188)

QP

QL

(2920,1623)

1600 QR 1500 1700 1900 2100 2300 2500 2700 2900 3100 3300 3500

Lagrange Multipliers

The method of Lagrange multipliers gives a set of necessary conditions to identify optimal points of equality constrained optimization problems. This is done by converting a constrained problem to an equivalent unconstrained problem with the help of certain unspecified parameters known as Lagrange multipliers.

16

The classical problem formulation minimize f(x1, x2, ..., xn) Subject to h1(x1, x2, ..., xn) = 0

can be converted to minimize L(x, l) = f(x) - l h1(x) where L(x, v) is the Lagrangian function l is an unspecified positive or negative constant called the Lagrangian Multiplier

New problem is: minimize L(x, l) = f(x) - l h1(x) Suppose that we fix l = l* and the unconstrained minimum of L(x; l) occurs at x = x* and x* satisfies h1(x*) = 0, then x* minimizes f(x) subject to h1(x) = 0. Trick is to find appropriate value for Lagrangian multiplier l. This can be done by treating l as a variable, finding the unconstrained minimum of L(x, l) and adjusting l so that h1(x) = 0 is satisfied.

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Method

1. Original problem is rewritten as: minimize L(x, l) = f(x) - l h1(x) 2. Take derivatives of L(x, l) with respect to xi and set them equal to zero.

If there are n variables (i.e., x1, ..., xn) then you will get n equations with n + 1 unknowns (i.e., n variables xi and one Lagrangian multiplier l)

3. Express all xi in terms of Langrangian multiplier l 4. Plug x in terms of l in constraint h1(x) = 0 and solve l. 5. Calculate x by using the just found value for l. Note that the n derivatives and one constraint equation result in n+1 equations for n+1 variables!

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Multiple constraints

The Lagrangian multiplier method can be used for any number of equality constraints. Suppose we have a classical problem formulation with k equality constraints minimize f(x1, x2, ..., xn) Subject to h1(x1, x2, ..., xn) = 0 hk(x1, x2, ..., xn) = 0 This can be converted in minimize L(x, l) = f(x) - lT h(x) where lT is the transpose vector of Lagrangian multpliers and has length k

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In closing

Lagrangian multipliers are very useful in sensitivity analyses (see Section 5.3) Setting the derivatives of L to zero may result in finding a saddle point. Additional checks are always useful. Lagrangian multipliers require equalities. So a conversion of inequalities is necessary. Kuhn and Tucker extended the Lagrangian theory to include the general classical single-objective nonlinear programming problem: minimize f(x) Subject to gj(x) 0 for j = 1, 2, ..., J hk(x) = 0 for k = 1, 2, ..., K x = (x1, x2, ..., xN) 21

Example

Suppose that we have a profit function and Max f(x,y)=x+3y Subject to g(x,y)=x2+y2-10=0 Specify the minimization problem with the help of lagrngian function

Solution

Examine the profit line: =x+3y In terms of y y=(/3)-(1/3)x slope=-1/3 dy/dx=-1/3

also g(x,y) solve in terms of x y 2=10-x 2 y=10-x 2 dy/dx=-(x/y) equating the slope of the profit line and the constraint line gives -(1/3)=-(x/y) y=3x; but y2=10-x2 x=1 and y=3

Conclusion profit are maximized at (x,y)=(1,3) with profit of x+3y=10. Lagrange multiplier technique: L(x,y,)=f(x,y)+ g(x,y)(the Lagrange function) Lx=fx+gx=0 =-(fx/gx) Ly=fy+gy=0 =-(fy/gy) Thus fx/gx=fy/gy fx/fy=gx/gy =dx/dy L(x,y,)=x+3y-(x2+y2-10)

Lx=1-2x=0 Ly=3-2y=0 L=x2+y2-10=0 solve for : =(1/2x)=(3/2y) y=3x also y=10-x 2 3x=10-x 2 x=1, y=3 gives profit f(1,3)=1+3*3=10 for minimize the total setup costs (D1S1/Q1)+(D2S2/Q2) =(10000*125/Q1)+(5000*187.5/Q2)

subject to an inventory investment constraint Q1*(I c1)/2+ Q2*(I c2)/2=2920 Q1*0.1786*10/2+ Q2*0.1786*15/2 apply Lagrange function L=(D1S1/Q1)+(D2S2/Q2)+[Q1*(I c1)/2+ Q2*(I c2)/2] diff with respect to Q1,Q2 and we obtain L/ Q1= D1S1/Q1^2+( I c1)/2=0 L/ Q2= D2S2/Q2^ 2+( I c2)/2=0 L/ =Q1*(I c1)/2+ Q2*(I c2)/2=2920 solve eq we obtain =0.555 Q1=1587 Q2=1122

minimum value of inventory holding costs as Q1*h1/2+ Q2*h2/2 =(1587*10*0.1786)/2+(1122*15*0.1786)/2 =2920 setup cost are (D1S1/Q1)+(D2S2/Q2) =10000*125/1587+5000*187.50/1122 =1624

Reality customers are not conveniently located

next to the factory. Often inventory must stored in several locations. The main issues are : 1. Where to have warehouses and what to stock. 2. How to replace stocks, given the answer to the first issue.

6 7

4 3 2 1

Coalescent systems: have material coming together into one end

item.

3 2 1

Fill rate : fill rate or percent unit service, gives the average fraction of unit demand satisfied from stock on hand. Fills: number of unit demanded and satisfied per unit time. Fills =fill rate * demand Expected number of backorder: is the time weighted average number of backorders outstanding at a stocking location. Including times of zero backorders, this measures depends on fill rate. Expected number of backorder= expected delay*demand rate Expected delay : average time necessary to satisfy a unit of demand .

Inventory holding cost. Setup costs and ordering costs. Stockout cost. System stability costs : cost associated with

overreaction to changes demand rates.

Example:D(annual demand)=1000 Q(order quantity)=100 B(maximum back order)=10 what is the expected number of back orders.

Solution: Average back order positon= B/2=10/2=5 Percentage time when back otders are possible =B/Q=10/100= 0.1 expected number of back orders= (B/Q)*(B/2)=0.1*5=0.5

Example:D(annual demand)=1000 Q(order quantity)=100 B(maximum back order)=50what is the expected delay or the average time to satisfy a unit demand. Working days=250

Centralization of inventories

Order decision rules and safety stock rules together to demonstrate their combined pressure to centralize inventories. TRC=(DS/Q)+(Qh/2)+h(SS)

D=annual demand S=setup cost Q=ordered quantity h=holding cost/unit/year. = standard deviation of lead time.

k= number of standard deviation of lead time demand used to determine safety stock. SS= safety stock. TRC=total relevant cost. SS=k Q=(2DS/h) TRC=(2ShD)+hk

N=stocking point. Di=annual demand. i=standard deviation The decentralized relevant cost would be N TRC={(2Sh D i )} + {hk i}

N

i 1

i 1

Assuming that h and k , we could centralize these inventories at one location. Ignoring transportation costs, the total relevant costs would be TRC=(2Sh)D+hk where N D =( D ) Di i 1

N i 1 i

Example: two inventory locations have annual demands and costs shown. S h D k D 100 10 1000 1.64 50 31.62 100 10 1000 1.64 50 44.72

The decentralized system is given by N N TRC={(2Sh Di)} + {hk i} i 1 i 1 TRC ={(2*100*10(1000+2000))} + {10*1.64(50+50)} =5054 The centralized system is given by TRC=(2Sh)Di+hk = ( 1 *1 + 2 *2 ) =70.7 TRC ={(2*100*10(3000))} + {10*1.64(70.7)} =3609

Set aggregate service level objectives for all items at an echelon. e.g. The objectives at the main distribution center might be 95% service, interpreted as a 95% fill rate. With n items in the inventory, the problem can be stated as follows: minimize (unit value on the item i)(safety stock on the item i) Subjected to (item demand rate/aggregate demand rate)(item fill rate)0.95

n i 1

n i 1

Multiechelon systems

Sometimes called Differentiated distribution or item decomposition systems, focus on effective safety stock. Applied to low demand rate items because mathematics of system is complex.

Destination

Origin

Origins

Destination

Origins destination

Origins destination

consolidated terminal

Multiple origins and multiple destinations. When multiple sources shipment to several destinations, however solving these problem becomes hopelessly difficult to solve This type of problem becomes manageable if we assume that all origins ship their products to a single consolidated terminal and that all items are distributed to destination as demanded from the consolidated terminal.

Formulas:

S

I(

ic (

d ijk)50

k k ijk

Qic=

p d d

i k

)

ijk

ck (

d ijk)50

i k ijk ijk

Qcj =

I (

p d / d

k

where dijk= quantity of demand from origin i for destination j for product k Pk= price/unit of k j Di,k= demand at source i for item k from all destinations j= d ijk Sic= cost of load from source i to consolidation terminal c

Sck = cost of load from consolidation terminal c to destinations k Wic=capacity of vehicle from source i to consolidation terminal c Wck=capacity of vehicle from consolidation terminal c to destinations k Tic=lead time/travel time from source i to consolidation terminal c Tck=lead time/travel time from consolidation terminal c to destinations k Fic= total quantity of items flowing per period from source i to consolidation terminal j k = d ijk Fcj= total quantity of items flowing per period from consolidation terminal c to destinations k = i k

ijk

I = inventory carrying percentage. The shippping quantity from source i to consolidation terminal c is given by min[Qic,Wic] The shippping quantity from consolidation terminal c to destinations is given by min[Qcj,Wcj]

Example: The demand for the products at destination 1 and 2 and source of these are presented in the table. The capacity of vehicles, relevant setup costs, lead time between locations, and other pertinent data in tables. Assume that the inventory carrying charges amount to 20% and that the firm operates fifty periods (weeks) per year. Find the economical quantity to ship from each source to the terminal and from the terminal each destination. Destination demand and origin capacity demand / period at

Product 1 2 3 4 Cost per unit 20 25 25 30 Destination1 8 6 5 6 Destination2 4 10 8 8 Source location 1 1 2 2

From to Setup cost Vehicle capacity Lead time (days) Source 1 terminal 45 150 4 Source 2 terminal 25 200 2 Terminal destination 1 30 150 3 Terminal destination 2 35 100 4

Step1:calculate the total annual demand for items 1 and 2 formula=[ d ] *50 [8+6+4+10]*50=1400 Eq1 Step2:calculate the average cost per part at source1. Formula= p d / d [(12*20)+(16*25)]/28=22.86 Eq2 Step3: Calculate the economical shipment quantity flowing from source 1 to the consolidated terminal. Qic=[{ S ( d )*50 }/{I( p d / d )}] Eq3 Q1c=[(45*1400)/(0.20*22.86)]=118 Find the minimum of Q1c and W1c. S1c=min[118,150]

j k ijk j k j k k ijk ijk

ic

ijk

ijk

ijk

Step5: calculate the quantities of individual items 1 and 2 flowing from origin 1 to the consolidated terminal. Q1c1=( ( S d ) / d ) =(118*12)/28=51 Q1c2=(118*16)/28=67 Step6: repeat the calculation for source 2. following the same procedure, we obtain the quantities of individual items 3 and 4 flowing from 2 to the consolidated terminal. Q2c=78 S2c=min[78,200]=78 Q2c3= (78*3)/27=38 Q2c4=(78*14)/27=40

j j k 1c 1 j1 ijk

The same procedure can be followed to obtain the shipment quantities from the consolidation terminal to destination 1 and 2, respectively. Step1: calculate the total annual demand for al items at destination1. [ d ]*50 [8+6+5+6]*50=1250 Step2:calculate the average cost per part at destination 1. [ p d / d ] [(20*8)+(25*6)+(25*5)+(30*6)]/25=24.6 Step3:calculate the economical shipment quantity for the total flow from the consolidation terminal to detination. Qcj= [{ S ( d ) 50 }/{I( p d / d )}]

i k ijk i k i k k ijk ijk i k i k i k ck ijk k ijk ijk

Qc1= [(30*1250)/(0.2*24.6)]=87.3 Step4: find minimum of Qc1 and Wc1 Sc1=min[87.3,150]=87.3 Step5:calculate the quantities of individual items 1 through 4 flowing the consolidated terminal to terminal 1. i i k Qc11=(Sc1 d i11) /( d i1k ) =(88*8)/25=28 Qc12=(88*6)/25=21 Qc13=(88*5)/25=18 Qc14=(88*6)/25=21 Step6:repeat the calculation for destination 2. following the same procedure, we obtain the quantities of items 1 through 4 from the consolidation terminal to terminal2.

Qc2= 102 Sc2=min[102,100]=100 Qc21= (Sc2 d ) /( d =(100*4)/30=13 Qc22 =(100*10)/30=33 Qc23 =(100*8)/30=27 Qc24 =(100*8)/30=27

i i k i 21

i 2k

))

References

PRODUCTION,PLANNING AND INVENTORY CONTROL

--S.L. NARASIMHAN --D.W. McLEAVEY --P.J. BILLINGTON (PRENTICE HALL OF INDIA PRIVATE LIMITED)

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