Inventory Definition

A stock of items held to meet future demand Inventory-A physical resource that a firm holds in

stock with the intent of selling it or transforming it into a more valuable state. that monitors levels of inventory and determines what levels should be maintained, when stock should be refilled, and how large orders should be given to the purchased department.
Question: Goods vs Services?

Inventory System- A set of policies and controls

Def. - A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state. Raw Materials Works-in-Process Finished Goods Maintenance, Repair and Operating

Opposing Views of Inventory

Why We Want to Hold Inventories
Why We Not Want to Hold Inventories

Why We Want to Hold Inventories

Improve customer service
Reduce certain costs such as ordering costs stock out costs acquisition costs start-up quality costs Contribute to the efficient and effective operation of

the production system

Why We Want to Hold Inventories

Finished Goods
Essential in produce-to-stock positioning strategies Necessary in level aggregate capacity plans Products can be displayed to customers

Work-in-Process
Necessary in process-focused production May reduce material-handling & production costs

Raw Material
Suppliers may produce/ship materials in batches Quantity discounts and freight/handling $$ savings

Why We Do Not Want to Hold Inventories

Certain costs increase such as carrying costs cost of customer responsiveness cost of coordinating production cost of diluted return on investment reduced-capacity costs large-lot quality cost cost of production problems

Why We Do Not Want to Hold Inventories

Certain costs increase such as carrying costs cost of customer responsiveness cost of coordinating production cost of diluted return on investment reduced-capacity costs large-lot quality cost cost of production problems

Types of Inventory
Inputs
Raw Materials Purchased parts Maintenance and Repair Materials

Process

Outputs
Finished Goods Scrap and Waste

(in warehouses, or in transit)

In Process
Partially Completed Products and Subassemblies
(often on the factory floor)

Types of Inventory
Work in process
Vendors

Raw Materials Work in process

Work in process

Finished Customer goods

Water Tank Analogy for Inventory

Inventory Level Supply Rate

Inventory Level

Buffers Demand Rate from Supply Rate

Demand Rate

Independent and Dependent Demand Inventory

Independent demand items demanded by external customers (Kitchen Tables) Dependent demand items used to produce final products (table top, legs, hardware, paint, etc.) Demand determined once we know the type and number of final products

Independent and Dependent Demand Inventory Management

Independent demand Uncertain / forecasted Continuous Review / Periodic Review Dependent demand Requirements / planned Materials Requirements Planning / Just in Time

Reasons To Hold Inventory

Meet variations in customer demand:
Meet unexpected demand Smooth seasonal or cyclical demand

Pricing related:
Temporary price discounts Hedge against price increases Take advantage of quantity discounts

Process & supply surprises

Internal upsets in parts of or our own processes External delays in incoming goods

Transit

Reasons To NOT Hold Inventory

Carrying cost Financially calculable Takes up valuable factory space Especially for in-process inventory Inventory covers up problems That are best exposed and solved

Driver for increasing inventory turns (finished goods) and lean production/Just in time for work in process

Inventory Hides Problems

Bad Design

Lengthy Setups
Inefficient Layout

Poor Quality Machine Breakdown Unreliable Supplier

To Expose Problems: Reduce Inventory Levels

Bad Design Lengthy Setups Inefficient Layout Poor Quality Machine Breakdown Unreliable Supplier

Remove Sources of Problems and Repeat the Process

Poor Quality

Lengthy Setups

Bad Design

Inefficient Layout

Machine Breakdown

Unreliable Supplier

Inventory Cost Structures

Ordering (or setup) cost Carrying (or holding) cost: Cost of capital Cost of storage Cost of obsolescence, deterioration, and loss Stock out cost Item costs, shipping costs and other cost subject to

volume discounts

Typical Inventory Carrying Costs

Housing cost: Building rent or depreciation Building operating cost Taxes on building Insurance

Costs as % of Inventory Value 6% (3% - 10%)

Material handling costs: Equipment, lease, or depreciation Power Equipment operating cost Manpower cost from extra handling and supervision Investment costs: Borrowing costs Taxes on inventory Insurance on inventory Pilferage, scrap, and obsolescence Overall carrying cost

3% (1% - 4%)

3% (3% - 5%) 10% (6% - 24%) 5% (2% - 10%) (15% - 50%)

Inventory Management Systems

Functions of Inventory Management Track inventory How much to order When to order Prioritization Inventory Management Approach EOQ Continuous / Periodic

ABC Prioritization
Based on Pareto concept (80/20 rule) and total usage in dollars of each item.
Classification of items as A, B, or C often

based on $ volume.
Purpose: set priorities for management attention.

ABC Prioritization
A items: 20% of SKUs, 80% of dollars B items: 30 % of SKUs, 15% of dollars

C items: 50 % of SKUs, 5% of dollars

Three classes is arbitrary; could be any number.

Percents are approximate.

Danger: dollar use may not reflect importance of any given SKU!

100
90 Class A 80 70 60 50 40

+Class B

+Class C

Percentage of dollar value

30
20 10 0 10 20 30 40 50 60 70 80 90 100

Percentage of items

ABC Chart For Previous Slide

45.0% 40.0% 35.0% 120.0% 100.0% 80.0% 60.0% 20.0% 15.0% 10.0% 20.0% 5.0% 0.0% 3 6 9 2 4 1 10 8 5 7 0.0% 40.0%

Percent Usage

30.0% 25.0%

Item No. Percentage of Total Dollar Usage Cumulative Percentage

Cumulative % Usage

Inventory Management Approaches

A-items Track carefully (e.g. continuous review) Sophisticated forecasting to assure correct levels C-items Track less frequently (e.g. periodic review) Accept risks of too much or too little (depending on the item)

The different techniques of inventory control are: ABC - Always better control analysis. HML - High, Medium & Low analysis. VED - Vital, Essential & desirable analysis. SDE - Scare, difficult & easy to obtain analysis. FSN - Fast moving, slow moving & non moving analysis. EOQ - Economic order quantity analysis.
VED Classification: The VED analysis is done to determine the critically of an item and its effect on production and other services. It is specially used for classification of spare parts. If it is essential, then it is given E classification and if it is not so essential, the part is given D classification. For v items, a large stock of inventory is generally maintained, while for D items, minimum stock is enough.

HML Classification: (High, Medium & Low analysis)

The high, medium & low analysis is based on the unit value
not on the consumption value. The inventory order should be/will be listed in descending order of unit value & it is up to the management to fix limits for three categories. SDE Analysis: This analysis is based upon the availability of items & this is useful in the context of scarcity of supply. This analysis refers on S for Scarce items

Economic Order Quantity (EOQ) Model

Demand rate D is constant, recurring, and known Amount in inventory is known at all times Ordering (setup) cost S per order is fixed Lead time L is constant and known. Unit cost C is constant (no quantity discounts) Annual carrying cost is i time the average $ value of the inventory No stockouts allowed. Material is ordered or produced in a lot or batch and the lot is received all at once

EOQ Lot Size Choice

There is a trade-off between lot size and inventory level.
Frequent orders (small lot size): higher ordering cost and lower holding cost. Fewer orders (large lot size): lower ordering cost and higher holding cost.

EOQ Inventory Order Cycle

Demand rate Inventory Level Order qty, Q

ave = Q/2 Reorder point, R 0

As Q increases, average inventory level increases, but number of orders placed decreases

Lead time Order Order Placed Received

Lead Time time Order Order Placed Received

Total Cost of Inventory EOQ Model

Answer to Inventory Management Questions for EOQ Model

Keeping track of inventory
Implied that we track continuously

How much to order?

Solve for when the derivative of total cost with respect to Q = SD/Q2 + iC/2 = 0 Q = sqrt ( 2SD/iC)

When to order?
Order when inventory falls to the Reorder Point-level R so we will just sell the last item as the new order comes in: R = DL

Re-order Point Example

Demand = 10,000 quantity /year Lead time = L = 10 days

When inventory falls to R, we order so as not to run out before the new order comes in. R=?

Re-order Point Example

Demand = 10,000 quantity /year Daily demand = 10,000 / 365 = 27.4 quantity /day Lead time = L = 10 days

R = D*L = (27.4)(10) = 274 quantity (usually can neglect issues of working days vs weekends, etc.)
Dont forget to convert to consistent time units!

EOQ Summary
How much to order?
Q = sqrt(2DS/iC)

When to order?
R = DL

EOQyou do it Exercise Now

See Excel Spreadsheet: Excel_Inv_Examples.xls, EOQ

tab Compute the values of R and Q and compare to the simulation Next see what happens when you have volume discounts (EOQ w Discount Tab)

EOQ Example
Unit Cost C Holding cost factor i Ordering cost S Demand rate D Lead time L Solutions: Re-order point R Q = sqrt(2SD/(iC))

$0.45 /unit 25% /year $15.00 /order 10000 units/year 0.0192 year

units (rounded) units (rounded)