Inventory Management

Chapter 13 Inventory Management
Lecture Outline
Elements of Inventory Management Inventory Control Systems Economic Order Quantity Models Quantity Discounts Reorder Point Order Quantity for a Periodic Inventory System
Copyright 2011 John Wiley & Sons, Inc.
13-2
What Is Inventory?
Stock of items kept to meet future demand Purpose of inventory management
how many units to order when to order
13-3
Supply Chain Management

Bullwhip effect
demand information is distorted as it moves away from the end-use customer higher safety stock inventories to are stored to compensate
Seasonal or cyclical demand Inventory provides independence from vendors Take advantage of price discounts Inventory provides independence between stages and avoids work stoppages
13-4
Quality Management in the Supply Chain

Customers usually perceive quality service as availability of goods they want when they want them Inventory must be sufficient to provide highquality customer service in QM
13-5
Types of Inventory
Raw materials Purchased parts and supplies Work-in-process (partially completed) products (WIP) Items being transported Tools and equipment
13-6
Two Forms of Demand

Dependent
Demand for items used to produce final products Tires for autos are a dependent demand item
Independent
Demand for items used by external customers Cars, appliances, computers, and houses are examples of independent demand inventory
13-7
Inventory Costs
Carrying cost
cost of holding an item in inventory
Ordering cost
cost of replenishing inventory
Shortage cost
temporary or permanent loss of sales when demand cannot be met
13-8
Inventory Control Systems

Continuous system (fixed-order-quantity)
constant amount ordered when inventory declines to predetermined level
Periodic system (fixed-time-period)

order placed for variable amount after fixed passage of time
13-9
ABC Classification
Class A
5 15 % of units 70 80 % of value
Class B
30 % of units 15 % of value
Class C
50 60 % of units 5 10 % of value
13-10
ABC Classification
PART UNIT COST ANNUAL USAGE
1 2 3 4 5 6 7 8 9 10
$ 60 350 30 80 30 20 10 320 510 20
90 40 130 60 100 180 170 50 60 120
13-11
ABC Classification
PART TOTAL VALUE % OF TOTAL VALUE % OF TOTAL QUANTITY % CUMMULATIVE
9 8 2 1 4 3 6 5 10 7
$30,600 16,000 14,000 5,400 4,800 3,900 3,600 3,000 2,400 1,700
35.9 18.7 16.4 6.3 5.6 4.6 4.2 3.5 2.8 2.0
6.0 5.0 4.0 9.0 6.0 10.0 18.0 13.0 12.0 17.0
A B C
6.0 11.0 15.0 24.0 30.0 40.0 58.0 71.0 83.0 100.0
$85,400
Example 10.1
Copyright 2011 John Wiley & Sons, Inc. 13-12
ABC Classification
% OF TOTAL VALUE
71.0 16.5 12.5
CLASS A B C
ITEMS 9, 8, 2 1, 4, 3 6, 5, 10, 7
% OF TOTAL QUANTITY
15.0 25.0 60.0
Example 10.1
Economic Order Quantity (EOQ) Models

EOQ
optimal order quantity that will minimize total inventory costs
Basic EOQ model Production quantity model
13-14
Assumptions of Basic EOQ Model

Demand is known with certainty and is constant over time No shortages are allowed Lead time for the receipt of orders is constant Order quantity is received all at once
13-15
Inventory Order Cycle

Order quantity, Q Inventory Level
Demand rate
Average inventory
Q 2
Reorder point, R
Lead time Order Order placed receipt
Lead time Order Order placed receipt
Time
13-16
EOQ Cost Model

Co - cost of placing order Cc - annual per-unit carrying cost Annual ordering cost = Annual carrying cost = Total cost = C oD + Q D - annual demand Q - order quantity CoD Q CcQ 2 CcQ 2
13-17
EOQ Cost Model

Deriving Qopt CoD CcQ TC = + Q 2 CoD Cc TC = Q2 + 2 Q C0D Cc 0 = Q2 + 2
Proving equality of costs at optimal point

C oD CcQ = Q 2 Q2 2C o D = Cc 2C o D Cc
Qopt =
2C o D Cc
Qopt =
13-18
EOQ Cost Model

Annual cost ($) Slope = 0 Minimum total cost Total Cost
CcQ Carrying Cost = 2
CoD Ordering Cost = Q
Optimal order Qopt
Order Quantity, Q
13-19
EOQ Example
Cc = $0.75 per gallon Co = $150 D = 10,000 gallons
Qopt =
Qopt =
2CoD Cc
2(150)(10,000) (0.75)
CoD CcQ TCmin = + Q 2
TCmin
(150)(10,000) (0.75)(2,000) = + 2,000 2
Qopt = 2,000 gallons

Orders per year = D/Qopt = 10,000/2,000 = 5 orders/year
TCmin = $750 + $750 = $1,500

Order cycle time = 311 days/(D/Qopt) = 311/5 = 62.2 store days
13-20
Production Quantity Model

Order is received gradually, as inventory is simultaneously being depleted
AKA non-instantaneous receipt model assumption that Q is received all at once is relaxed
p - daily rate at which an order is received over time, a.k.a. production rate d - daily rate at which inventory is demanded
13-21

Inventory level Maximum inventory level Average inventory level
Q(1-d/p)
Q (1-d/p) 2
0 Order receipt period Begin End order order receipt receipt Time
13-22

p = production rate d = demand rate
Maximum inventory level = Q - Q d p

=Q1- d p Average inventory level = Q 12
2CoD Qopt = d Cc 1 p
d p
CoD CcQ d TC = Q + 2 1 - p
13-23

Cc = $0.75 per gallon Co = $150 d = 10,000/311 = 32.2 gallons per day D = 10,000 gallons p = 150 gallons per day
2C o D Qopt = Cc 1 - d p =
2(150)(10,000) 32.2 0.75 1 150 = 2,256.8 gallons
CoD CcQ d TC = Q + 2 1 - p
= $1,329
2,256.8 Q Production run = = = 15.05 days per order 150 p


Number of production runs = 10,000 D = = 4.43 runs/year 2,256.8 Q d p 32.2 150
Maximum inventory level = Q 1 -
= 2,256.8 1 -
= 1,772 gallons
13-25
Solution of EOQ Models With Excel
The optimal order size, Q, in cell D8
13-26
Solution of EOQ Models With Excel
The formula for Q in cell D10
=(D4*D5/D10)+(D3*D10/2)*(1-(D7/D8))
=D10*(1-(D7/D8))
13-27
Solution of EOQ Models With OM Tools
13-28
Quantity Discounts
Price per unit decreases as order quantity increases
CoD CcQ TC = + + PD Q 2
where
P = per unit price of the item D = annual demand
13-29
Quantity Discount Model

ORDER SIZE 0 - 99 100 199 200+ PRICE $10 8 (d1) 6 (d2)
TC = ($10 ) TC (d1 = $8 ) TC (d2 = $6 )
Inventory cost ($)
Carrying cost
Ordering cost Q(d1 ) = 100 Qopt

Q(d2 ) = 200
13-30
Quantity Discount
QUANTITY 1 - 49 50 - 89 90+ Qopt = PRICE $1,400 1,100 900 2C o D = Cc Co = $2,500 Cc = $190 per TV D = 200 TVs per year
2(2500)(200) = 72.5 TVs 190
For Q = 72.5
CcQopt Co D TC = + 2 + PD = $233,784 Qopt
For Q = 90
CcQ CoD TC = + 2 + PD = $194,105 Q

13-31
Quantity Discount Model With Excel
=IF(D10>B10,D10,B10)
=(D4*D5/E10)+(D3*E10/2)+C10*D5
13-32
Reorder Point
Inventory level at which a new order is placed
R = dL
where
d = demand rate per period L = lead time
13-33
Reorder Point
Demand = 10,000 gallons/year Store open 311 days/year Daily demand = 10,000 / 311 = 32.154 gallons/day Lead time = L = 10 days R = dL = (32.154)(10) = 321.54 gallons
13-34
Safety Stock
Safety stock
buffer added to on hand inventory during lead time
Stockout
an inventory shortage
Service level
probability that the inventory available during lead time will meet demand P(Demand during lead time <= Reorder Point)
13-35
Variable Demand With Reorder Point

Q
Reorder point, R
Inventory level
0 LT Time LT
13-36
Reorder Point With Safety Stock

Inventory level
Reorder point, R
Safety Stock
LT
Time
LT
13-37
Reorder Point With Variable Demand

R = dL + zd L
where d = average daily demand L = lead time d = the standard deviation of daily demand z = number of standard deviations corresponding to the service level probability zd L = safety stock
13-38
Reorder Point For a Service Level

Probability of meeting demand during lead time = service level
Probability of a stockout
Safety stock
zd L dL Demand R
13-39
Reorder Point For Variable Demand

The paint store wants a reorder point with a 95% service level and a 5% stockout probability
d = 30 gallons per day L = 10 days d = 5 gallons per day For a 95% service level, z = 1.65 R = dL + z d L Safety stock = z d L
= 30(10) + (1.65)(5)( 10)

= 326.1 gallons
= (1.65)(5)( 10)
= 26.1 gallons
13-40
Determining Reorder Point with Excel
The reorder point formula in cell E7
13-41
Order Quantity for a Periodic Inventory System

Q = d(tb + L) + zd tb + L - I
where
d tb L d zd = average demand rate = the fixed time between orders = lead time = standard deviation of demand
tb + L = safety stock I = inventory level
13-42
Periodic Inventory System
13-43
Fixed-Period Model With Variable Demand

d d tb L I z = 6 packages per day = 1.2 packages = 60 days = 5 days = 8 packages = 1.65 (for a 95% service level)
Q = d(tb + L) + zd
tb + L - I
60 + 5 - 8
= (6)(60 + 5) + (1.65)(1.2) = 397.96 packages
13-44
Fixed-Period Model with Excel
Formula for order size, Q, in cell D10
13-45
Copyright 2011 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in section 117 of the 1976 United States Copyright Act without express permission of the copyright owner is unlawful. Request for further information should be addressed to the Permission Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information herein.
13-46

Inventory Management

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Chapter 13 Inventory Management

Copyright 2011 John Wiley & Sons, Inc.

Copyright 2011 John Wiley & Sons, Inc.

Supply Chain Management

Copyright 2011 John Wiley & Sons, Inc.

Quality Management in the Supply Chain

Copyright 2011 John Wiley & Sons, Inc.

Copyright 2011 John Wiley & Sons, Inc.

Two Forms of Demand

Copyright 2011 John Wiley & Sons, Inc.

Copyright 2011 John Wiley & Sons, Inc.

Inventory Control Systems

Periodic system (fixed-time-period)

Copyright 2011 John Wiley & Sons, Inc.

Copyright 2011 John Wiley & Sons, Inc.

$ 60 350 30 80 30 20 10 320 510 20

90 40 130 60 100 180 170 50 60 120

Copyright 2011 John Wiley & Sons, Inc.

Economic Order Quantity (EOQ) Models

Basic EOQ model Production quantity model

Copyright 2011 John Wiley & Sons, Inc.

Assumptions of Basic EOQ Model

Copyright 2011 John Wiley & Sons, Inc.

Inventory Order Cycle

Lead time Order Order placed receipt

Lead time Order Order placed receipt

Copyright 2011 John Wiley & Sons, Inc.

EOQ Cost Model

Copyright 2011 John Wiley & Sons, Inc.

EOQ Cost Model

Proving equality of costs at optimal point

Copyright 2011 John Wiley & Sons, Inc.

EOQ Cost Model

CcQ Carrying Cost = 2

CoD Ordering Cost = Q

Optimal order Qopt

Copyright 2011 John Wiley & Sons, Inc.

CoD CcQ TCmin = + Q 2

(150)(10,000) (0.75)(2,000) = + 2,000 2

Qopt = 2,000 gallons

TCmin = $750 + $750 = $1,500

Production Quantity Model

Copyright 2011 John Wiley & Sons, Inc.

Production Quantity Model

Copyright 2011 John Wiley & Sons, Inc.

Production Quantity Model

Maximum inventory level = Q - Q d p

Copyright 2011 John Wiley & Sons, Inc.

Production Quantity Model

2(150)(10,000) 32.2 0.75 1 150 = 2,256.8 gallons

2,256.8 Q Production run = = = 15.05 days per order 150 p

Production Quantity Model

Maximum inventory level = Q 1 -

Copyright 2011 John Wiley & Sons, Inc.

Solution of EOQ Models With Excel

The optimal order size, Q, in cell D8

Copyright 2011 John Wiley & Sons, Inc.

Solution of EOQ Models With Excel

The formula for Q in cell D10

Copyright 2011 John Wiley & Sons, Inc.

Solution of EOQ Models With OM Tools

Copyright 2011 John Wiley & Sons, Inc.

Copyright 2011 John Wiley & Sons, Inc.