Inventory Management

Definition Purposes of inventory Inventory costs Inventory models o Economic Order Quantity o Quantity Discount

Definition Inventory -- stored resource (raw material, work-in-process, finished goods) that is used to satisfy present or future demand Inventory management -- determine how much to order? When to order? ABC Analysis -- classify inventory into 3 groups according to its annual dollar volume/usage Annual dollar volume = annual demand x cost An example: A B C Top 80% of total dollar volume Next 15% Next 5% Cost 200 200 800 100 200 Demand x Cost 10000 2000 80000 5000 3000 100000 % of total cost 10% 2% 80% 5% 3% Class B C A B C

Item# Annual Demand 234 170 222 410 160 Total Exercise Pg.541 Problem 13, 27 Purposes of inventory 50 10 100 50 15

1. Smooth-out variations in operation performances 2. Avoid stock out or shortage 3. Safeguard against price changes and inflation 4. Take advantage of quantity discounts Inventory costs 1. Holding or carrying costs: storage, insurance, investment, pilferage, etc. Annual holding cost = average inventory level x holding cost per unit per year = order quantity/2 x holding cost per unit per year

2. Setup or ordering costs: cost involved in placing an order or setting up the equipment to make the product Annual ordering cost = no. of orders placed in a year x cost per order = annual demand/order quantity x cost per order

EOQ (Economic Order Quantity) Model Assumptions 1. Order arrives instantly 2. No stockout 3. Constant rate of demand What is the order quantity such that the total cost is minimized? 1. Total cost = holding cost + ordering cost = (order quantity/2) x holding cost per unit per year + (annual demand/order quantity) x cost per order

2. Optimal order quantity (Q*) is found when annual holding cost = ordering cost

3. Number of orders = Annual Demand/Q*

4. Time between orders = No. of working days per year / number of orders 5. Reorder point = daily demand x lead time + safety stock Example: Given: Annual Demand = 60,000 Ordering cost = $25 per order Holding cost = $3 per item per year No. of working days per year = 240 Then, it can be computed: Q* = 1000 Total cost = $3000 Number of orders = 60000/1000 = 60 Time between orders = 240/60 = 4 days Daily demand = 60000/240 = 250 If lead time = 3 days (lead time < time between orders) Reorder point = (60000/240)x3=750 Reorder when inventory on hand = 750

If lead time = 5 days (lead time > time between orders) Reorder point = 250x5 = 1250 Reorder when inventory on hand = 1250-Q*=1250-1000=250

In class exercise Pg.540, Problems 10 Annual demand = 2000 Ordering cost = $10 Holding cost = $5 EOQ = sqrt(2*2000*10/5) = 89 Annual ordering cost = 2000/89*$10 = $223.6 Annual holding cost = 89/2*$5 = $223.6 Exercise Pg. 539, Problem 1, 7a

Quantity Discount Model 1. Total cost = holding + ordering + purchasing 2. Holding cost is a % of the purchasing cost Case 1 Annual Demand =100 per year Ordering cost = 45 per order Holding cost = 20% of cost of item Order quantity 50 or less 51 to 59 60 or more Cost per item $18 $16 $12

Should order 62 units Case 2 Same as case 1 except: Order quantity 50 or less 51 to 99 100 or more Cost per item $18 $16 $12 EOQ 50 54 62 Infeasible Remark

Need to compare: Total cost (Q=54) and Total cost (Q=100)

Total cost (Q=54) = (100/54)x45 + (54/2)x(0.2x16) + 16x100 =1780.53 Total cost (Q=100) = (100/100)x45 + (100/2)x(0.2x12) + 12x100 = 1425 Order 100 units Case 3 Same as case 1 except: Order quantity 55 or less 56 to 99 100 or more Cost per item $18 $16 $12 EOQ 50 54 62 Remark Feasible Infeasible Infeasible

Need to compare: Total cost (Q=50), Total cost (Q=56) and Total cost (Q=100) Total cost (Q=50) = (100/50)x45 + (50/2)x(0.2x18) + 18x100 = 1980 Total cost (Q=56) = (100/56)x45 + (56/2)x(0.2x16) + 16x100 =1781.16 Total cost (Q=100) = 1425 Order 100 units