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Inventory Management

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Inventory Management

CHAPTER

Operations Management

11

William J. Stevenson

Inventory Management

8th edition
McGraw-Hill/Irwin Operations Management, Eighth Edition, by William J. Stevenson Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

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Types of Inventories

Inventory: a stock or store of goods

Independent Demand

Dependent Demand

Raw materials & purchased parts Partially completed goods called work in progress

Finished-goods inventories

B(4)

C(2)

D(2)

E(1)

D(3)

F(2)

(manufacturing firms) or merchandise (retail stores)

Independent demand is uncertain. Dependent demand is certain.

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Types of Inventories (Contd) (Cont

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Functions of Inventory

Replacement parts, tools, & supplies Goods-in-transit to warehouses or customers

To meet anticipated demand To smooth production requirements To decouple operations To protect against stock-outs

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Functions of Inventory (Contd) (Cont

To take advantage of order cycles To help hedge against price increases To permit operations To take advantage of quantity discounts

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Objective of Inventory Control

To achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds

Level of customer service Costs of ordering and carrying inventory

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Effective Inventory Management

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Inventory Counting Systems

A system to keep track of inventory A reliable forecast of demand Knowledge of lead times Reasonable estimates of

Periodic System
Physical count of items made at periodic intervals

Perpetual Inventory System

System that keeps track of removals from inventory continuously, thus monitoring current levels of each item

Holding costs Ordering costs Shortage costs

A classification system

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Inventory Counting Systems (Contd) (Cont

Two-Bin System - Two containers of inventory; reorder when the first is empty Universal Bar Code - Bar code printed on a label that has information about the item to which it is attached

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Key Inventory Terms

214800 232087768

Lead time: time interval between ordering and receiving the order Holding (carrying) costs: cost to carry an item in inventory for a length of time, usually a year Ordering costs: costs of ordering and receiving inventory Shortage costs: costs when demand exceeds supply

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ABC Classification System

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Cycle Counting

Figure 11.1

Classifying inventory according to some measure of importance and allocating control efforts accordingly.

A physical count of items in inventory Cycle counting management

A - very important B - mod. important C - least important

How much accuracy is needed? When should cycle counting be performed? Who should do it?

High Annual $ value of items Low

A B C
Few Many

Number of Items

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Economic Order Quantity Models

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Assumptions of EOQ Model

Economic order quantity model Economic production model Quantity discount model

Only one product is involved Annual demand requirements known Demand is even throughout the year Lead time does not vary Each order is received in a single delivery There are no quantity discounts

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The Inventory Cycle

Profile of Inventory Level Over Time

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Total Cost

Figure 11.2 Q
Quantity on hand

Usage rate

Annual Annual Total cost = carrying + ordering cost cost TC = Q H 2 + DS Q

Reorder point

Receive order

Place Receive order order

Place Receive order order

Time

Lead time

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Cost Minimization Goal

The Total-Cost Curve is U-Shaped

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Deriving the EOQ

Figure 11.4C

Annual Cost

TC =

D Q H+ S 2 Q

Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q.

Q OPT =

2DS = H

2( Annual Demand )(Order or Setup Cost ) Annual Holding Cost

Ordering Costs
QO (optimal order quantity) Order Quantity (Q)

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Minimum Total Cost

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Economic Production Quantity (EPQ)

Production done in batches or lots Capacity to produce a part exceeds the parts usage or demand rate Assumptions of EPQ are similar to EOQ except orders are received incrementally during production

The total cost curve reaches its minimum where the carrying and ordering costs are equal.
Q OPT = 2DS = H 2( Annual Demand )(Order or Setup Cost ) Annual Holding Cost

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Economic Production Quantity Assumptions Only one item is involved Annual demand is known Usage rate is constant Usage occurs continually Production rate is constant Lead time does not vary No quantity discounts

Economic Run Size

Q0 =

p 2DS H p u

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Total Costs with Purchasing Cost

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Total Costs with PD

Adding Purchasing cost doesnt change EOQ

Figure 11.7

Annual Annual TC = carrying + ordering + Purchasing cost cost cost TC = Q H 2 + DS Q + PD

Cost

TC with PD

TC without PD

PD

EOQ

Quantity

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Total Cost with Constant Carrying Costs

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When to Reorder with EOQ Ordering

Figure 11.9

Total Cost

TCa TCb TCc

Decreasing Price

Reorder Point - When the quantity on hand of an item drops to this amount, the item is reordered Safety Stock - Stock that is held in excess of expected demand due to variable demand rate and/or lead time. Service Level - Probability that demand will not exceed supply during lead time.

CC a,b,c
OC

EOQ

Quantity

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Determinants of the Reorder Point

The rate of demand The lead time Demand and/or lead time variability Stockout risk (safety stock)

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Safety Stock

Figure 11.12
Quantity

Maximum probable demand during lead time Expected demand during lead time

ROP Safety stock reduces risk of stockout during lead time Safety stock
LT Time

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Reorder Point
The ROP based on a normal Distribution of lead time demand
Service level Risk of a stockout Probability of no stockout Expected demand 0

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Fixed-Order-Interval Model Fixed- Order-

Figure 11.13

ROP
Safety stock z

Quantity

Orders are placed at fixed time intervals Order quantity for next interval? Suppliers might encourage fixed intervals May require only periodic checks of inventory levels Risk of stockout

z-scale

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Fixed-Interval Benefits Fixed-

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Fixed-Interval Disadvantages Fixed-

Tight control of inventory items Items from same supplier may yield savings in:

Ordering Packing Shipping costs

Requires a larger safety stock Increases carrying cost Costs of periodic reviews

May be practical when inventories cannot be closely monitored

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Single Period Model

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Single Period Model

Single period model: model for ordering of perishables and other items with limited useful lives Shortage cost: generally the unrealized profits per unit Excess cost: difference between purchase cost and salvage value of items left over at the end of a period

Continuous stocking levels

Identifies optimal stocking levels Optimal stocking level balances unit shortage and excess cost

Discrete stocking levels

Service levels are discrete rather than continuous Desired service level is equaled or exceeded

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Operations Strategy

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Too much inventory

Tends to hide problems Easier to live with problems than to eliminate them Costly to maintain

CHAPTER

11

Wise strategy

Additional PowerPoint slides contributed by Geoff Willis, University of Central Oklahoma.

Reduce lot sizes Reduce safety stock

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Economic Production Quantity

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Gortrac Manufacturing

Production & Usage

Usage

Production & Usage

Usage

In v

en t

or yL

ev el

GTS3 Inventory/Assessment/Reduction

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Materials

PS7 Washburn Guitars