INVENTORY MANAGEMENT

IMPORTANCE OF MATERIALS
MANAGEMENT
Profit
ROI =
Total Assets (TA)

Profit x Sales
Sales TA ( FA+CA)
= 1- total costs = T.O of Total assets
Sales
Materials account for nearly 50% of total costs
Inventory accounts for nearly 75% of CA
 CLASSIFICATION OF
MATERIALS
Materials

Indirect Direct Project

FG
materials materials Materials
-MRP/MRP-2 -Network
General -JIT based
Spares
stores approach
-Replenishment systems
-ROL system
-Periodic review system
-Selective control methods
 INVENTORY PLANNING

Inventory planning and control

Deciding desirable levels
Monitoring the actuals and taking appropriate
preventive and corrective action
Inventory level decisions
Based on relevant cost considerations
Inventory carrying costs
Ordering costs
Stockout costs
TWO FUNDAMENTAL DECISIONS
IN VENTORY PLANNING

1.How much to order each time?

2 When to order?

Behaviour of relevant costs

2400
1200
1200 600
0 0
*As lot sisze increases, Inventory carrying costs
and ordering costs decrease
* As Inventory level decreases, stockout costs increase.
 ROL SYSTEM(Perpetual
Review system)-
Parameters to be decided
Decide fixed order quantity (=Q units)
Based on ABC Analysis
Using EOQ formula
Decide re-order level (ROL)
= Average lead time consumption
+ Safety stock
How the system works?
Update stock level after each issue
If stock level < or equal to ROL,
place order =Q units, otherwise, do not order
 ABC -ANALYSIS

Items are classified in to three categories

based on their annul consumption value
A category : small % of items(roughly 10%)
accounting for very high consumption value(
nearly 75%)
B category : Items with moderate consumption
value
C category : Large % of items (say 75%)
accounting for small % (say 10%) of value.
ORDERING POLICY BASED ON
ABC ANALYSIS

Ordering policy for different categories:

A category : small lot size( say 15 days- 1
month)- more frequent ordering
B category: Moderate lot size(2-3 months)
C category : Large lot size (6- 12 months)
Stock level in ROL system:
Average stock level = Q/2 +safety stock
Maximum sock = Q + safety stock
Minimum stock = safety stock
SAFETY STOCK DECISIONS
TYPE OF ANALYSIS TO BE DONE:
1. Lead time consumption analysis
-Average and S.D
2. ABC analysis

Steps in safety stock policy decision

1 Decide the service level policy for each category
2. Decide the safety stock in terms of number of SDs
for a given service level (SS = k*SD)
Category Servicelevel
A 90%
B 95%
C 99% k value increases with
service level
 PERIODIC REVIEW SYSTEM
-Parameters to be decided

Review period : Monthly, quarterly etc.,

Maximum stock level(MSL)
MSL = Avg.. Consn.(RP+LT)+ safety stock
Order quantity at each review period (OQ)
OQ = MSL- Stock balance(on hand+on order)
Features:
Order quantity varies
Ordering frequency fixed
PERIODIC REVIEW SYSTEM
-Graphical representation

300 MSL =300

OQ =50
OQ =100 OQ
SOH=250
200 =150
S.O.H

SOH=150
100

APR JUL OCT JAN

 EOQ With
Noninstantaneous Receipt
Inventory
level
Maximum
inventory level
Q(1-d/p)
Begin
Order
Average
receip inventory level
Q
(1-d/p) t
2

0
End Time
Order Order
receipt
receipt period
1998 by Prentice-Hall Inc
Russell/Taylor Oper Mgt 2/e Ch 12 - 15
 EOQ With
Noninstantaneous Receipt

p = production rate Q d
Max inv level = Q - d Q 1-
d = demand rate p p
1 d Q d
Avg inv level = Q 1- 1-
2 p 2 p
CoQ d
Total carrying cost = 1-
2 p
CoD CoQ d
TC 1-
Q 2 p
2CoD
Qopt
d
Cc 1-
p

Ch 12 - 16
 Production Quantity Example

CC = $0.75 per yard CO = $150 D = 10,000 yards

d = 10,000/311 = 32.2 yards per day p = 150 yards per day
2CoD CoD CoQ d
Qopt TCmin 1-
d Q 2 p
Cc 1-
p (150)(10,000) (0.75)2,256.8 32.2
1-
2(150)(10,000) 2,256.8 2 150

32.2 $1,329
0.75 1-
150
Production run = Q/p=2,256.8/150=15.05 yards
= 2,256.8 yards Number of production runs = D/Q=10,000/2,256.8 = 4.43
d 32.2
Max inv level = Q 1- 2,256.8 1- 1722
, yards
p 150

Ch 12 - 17
Single-Period Model: Newsvendor
Used to order perishables or other items with
limited useful lives.
Fruits and vegetables, Seafood, Cut flowers.
Blood (certain blood products in a blood bank)
Newspapers, magazines,
Unsold or unused goods are not typically carried
over from one period to the next; rather they are
salvaged or disposed of.
Model can be used to allocate time-perishable
service capacity.
Two costs: shortage (short) and excess (.
 Single-Period Model
Shortage or stockout cost may be a charge for loss
of customer goodwill, or the opportunity cost of lost
sales (or customer!):
Cs = Revenue per unit - Cost per unit.
Excess cost applies to the items left over at end of
the period, which need salvaging
Ce = Original cost per unit - Salvage value per
unit.
 The Single-Period Model:
Newsvendor

How do I know what service level is the best one,

based upon my costs?
Answer: Assuming my goal is to maximize profit (at least
for the purposes of this analysis!) I should satisfy SL
fraction of demand during the next period (DDLT)
If Cs is shortage cost/unit, and Ce is excess cost/unit,
then

Cs
SL
C s Ce
Single-Period Model for Normally
Distributed Demand
Computing the optimal stocking level differs slightly
depending on whether demand is continuous (e.g. normal)
or discrete. We begin with continuous case.
Suppose demand for apple cider at a downtown street stand
varies continuously according to a normal distribution with
a mean of 200 liters per week and a standard deviation of
100 liters per week:
Revenue per unit = $ 1 per liter
Cost per unit = $ 0.40 per liter
Salvage value = $ 0.20 per liter.
Single-Period Model for Normally
Distributed Demand
Cs = 60 cents per liter
Ce = 20 cents per liter.
SL = Cs/(Cs + Ce) = 60/(60 + 20) = 0.75

To maximize profit, we should stock enough product to

satisfy 75% of the demand (on average!), while we
intentionally plan NOT to serve 25% of the demand.
The folks in marketing could get worried! If this is a
business where stockouts lose long-term customers, then
we must increase Cs to reflect the actual cost of lost
customer due to stockout.
Single-Period Model for Continuous
Demand

demand is Normal(200 liters per week, variance = 10,000 liters2/wk)

so = 100 liters per week
Continuous example continued:
75% of the area under the normal curve must be to the
left of the stocking level.
Appendix shows a z of 0.67 corresponds to a left area
of 0.749
Optimal stocking level = mean + z () = 200 + (0.67)(100)
= 267. liters.
Single-Period & Discrete Demand: Lively
Lobsters
Lively Lobsters (L.L.) receives a supply of fresh, live
lobsters from Maine every day. Lively earns a profit of
$7.50 for every lobster sold, but a day-old lobster is worth
only $8.50. Each lobster costs L.L. $14.50.
(a) what is the unit cost of a L.L. stockout?
Cs = 7.50 = lost profit
(b) unit cost of having a left-over lobster?
Ce = 14.50 - 8.50 = cost salvage value = 6.
(c) What should the L.L. service level be?
SL = Cs/(Cs + Ce) = 7.5 / (7.5 + 6) = .56 (larger Cs
leads to SL > .50)
Demand follows a discrete (relative frequency) distribution
as given on next page.
 SPARE PARTS-SPECIAL
PROBLEMS

Excessive range
Uncertainty regarding timing and quantity
Problems in procurement
Manufacturers dumping excessive parts
Long lead time
Difficulty in supply when models change
Spurious parts in circulation in market
Problems of stocking and preservation
Problems of management attitude
TYPES OF SPARE PARTS

Insurance spare parts

Rotable spare parts
Operational/consumable spare parts
Insurance spare parts
Highly critical, highly reliable and costly parts
and assemblies of an equipment
Ex: Propeller in a ship, Grinder in a cement unit
Always one unit to be kept as a stand-by.
 TYPE OF SPARE PARTS
(Continued)
Rotable parts :
Parts which can be repaired and used
again
Repair shop facility should be available
nearby
Adequate stocks(floats) should be kept to
take care of requirements during repair
cycle time
Operational spare parts
ROL system to be adopted
Safety stock is a more important decision
SAFETY STOCK DECISION
FOR SPARE PARTS

Type of analysis to be made

Lead time consumption analysis-average/SD
ABC analysis
VED analysis (Criticality analysis)
Steps in safety stock decision
Decide the service levels to be provided based
on ABC/VED analysis
Decide SS units in terms of no. of SDs for a given
service level
SERVICE LEVEL POLICY

V E D
(%) Safety stock =
A 90 75 50 k(SD of LT consumption)
B 95 90 75

C 99 95 90

Service 50 75 80 85 90 95 98 99 99.8
level (%)
k value 0 0.7 0.8 1.0 1.3 1.7 2.1 2.3 3.1
 SELECTIVE CONTROL ANALYSIS

Classification Criteria Uses

ABC analysis Annual consn. -.Order quantity decision

Value - Safety stock decision
-Delegation & control
VED analysis Criticality -.Safety stock for spares
- Control

FSN analysis Movement - Disposal decision

- Physical storage
XYZ analysis Stock value -Disposal
-Stock verification
 DIRECT MATERIALS
-Planning and control systems

Distinguishing features of indirect and direct

materials
MRP system framework
BOM and MPS formats
Inputs and outputs in MRP system
Problems in MRP system
MRP-2 system enhancements
 Independent demand (Inventory).
Dependent demand (MRP)

Independent Demand is usually

for end products (forecasted, uncertain)

X Dependent Demand (MRP can

back-figure release times given
due dates for independent demands)
B(2) C(1)
Independent
D(3) E(1) E(2) F(2)
AA Dependent

Figure 14-6 of Stevenson

d e

f1 f2 g1 g2
 FEATURES OF DIRECT VS
INDIRECT MATERIALS- Indirect

Independent continuous demand with

random variations
Future requirements can be forecasted from
past consumption data
Responsibility for planning and ordering can
rest with materials department
Coordination problems are less
Automatic replenishment system possible
 DISTINCTIVE FEATURES OF
DIRECT MATERIALS

Dependent demand and intermittent demand

Future requirements derived from MPS
Actions of all departments affect the
effectiveness of planning
Coordination problems are more
Hence integrated approach is a must
MRP SYSTEM-FRAMEWORK
Firm MPS Forecasts
orders

BOM Serv.spares.
Gross req.

Inv. Net req.

data

LT Orders
data

WO PO
BOM FOR PRODUCT P1

P1 Level 0
(Product)
Level 1
S1 S2
(1) Assembly (2)

C1 C2 C3
C3 C4 C5
(1) (4) (1) (2) (2) (1)
Level 2 (components)
MPS FOR PRODUCTS P1 AND
P2

-------------------------------------------
Week no6 7 8 9 10
-------------------------------------------

Product P1 50 100
Product P2. 70 80 25
--------------------------------------------
 Example of MRP Logic and
Product Structure Tree
Given the product structure tree for A and the lead time and demand
information below, provide a materials requirements plan that defines
the number of units of each component and when they will be needed.

Lead Times
Product Structure Tree for Assembly A A 1 day
B 2 days
A C 1 day
D 3 days
E 4 days
F 1 day
B(4) C(2)
Demand
Day 10 50 A
D(2) E(1) D(3) F(2) Day 8 20 B (Spares)
Day 6 15 D (Spares)
 36
Finally, repeating the process for all components, we have the
final materials requirements plan:
Day: 1 2 3 4 5 6 7 8 9 10
A Required 50
LT=1 Order Placement 50
B Required 20 200
LT=2 Order Placement 20 200
C Required 100
LT=1 Order Placement 100
D Required 55 400 300
LT=3 Order Placement 55 400 300
E Required 20 200
LT=4 Order Placement 20 200
F Required 200
LT=1 Order Placement 200

B(4) C(2)

D(2) E(1) D(3) F(2)

The McGraw-Hill Companies, Inc., 2001
 MRP Example
Item On-Hand Lead Time (Weeks)
X X 50 2
A 75 3
B 25 1
A(2) B(1) C 10 2
D 20 2

C(3) C(2) D(5)

Requirements include 95 units (80 firm orders and 15 forecast) of X in
week 10 plus the following spares:
Spares 1 2 3 4 5 6 7 8 9 10
A 12
B 7
C 10
D 15
 C Gross Requirements 45 36 64
LT=2 On-Hand=10 10
Net Requirements 35 36 64
Planned Order Receipt 35 36 64
Planner Order Release 35 36 64
D Gross Requirements 15 135
LT=2 On-Hand=20 15 5
Net Requirements 130
Planned Order Receipt 130
Planner Order Release 130

A(2) B(1)

C(3) C(2) D(5)

 Day: 1 2 3 4 5 6 7 8 9 10
X Gross Requirements 95
LT=2 On-Hand=50 50
Net Requirements 45
Planned Order Receipt 45
Planner Order Release 45
A Gross Requirements 90 12
LT=3 On-Hand=75 75
Net Requirements 15 12
Planned Order Receipt 15 12
Planner Order Release 15 12
B Gross Requirements 7 45
LT=1 On-Hand=25 7 18
Net Requirements 27
Planned Order Receipt 27
Planner Order Release 27
C Gross Requirements 45 36 54 10
LT=2 On-Hand=10 10
Net Requirements 35 36 54 10
Planned Order Receipt 35 36 54 10
Planner Order Release 35 36 54 10
D Gross Requirements 15 135
LT=2 On-Hand=20 15 5
Net Requirements 130
Planned Order Receipt 130
Planner Order Release 130
 MRP SYSTEM-INPUT/OUTPUT
Inputs Outputs

MPS Production schedules

BOM/Amendments /work orders for
internally produced
Inventory status data
items
Material transactions
Purchase schedules
Manufacturing lead /purchase orders for
time bought out items
Purchase lead times
 PROBLEM AREAS IN MRP
USAGE

Frequent changes in MPS

BOM not uo to-date
Incorrect stock status
Unrealistic lead times
Material codification errors
Quality problems
No rational lot size and SS policies
Coordination problems
Software/Computer problems
MRP-2 FRAMEWORK

BOM MPS Inventory

lead time

MRP

Revise Release of
MPS PO, WO
Routing
no files and
CRP resources
Is MPS feasible?
Final orders
 MRP-2 SYSTEM
INPUTS/OUTPUTS

MRP-2 Additional Input

Route sheets for all components (Set up time, operation
time, sequence of operations, preferred work center )
Work center-wise capacity available
MRP-2 Additional output
Work center-wise load projections
Direct labour hour requirements
 JUST-IN-TIME SYSTEM (JIT)

JIT system goal and philosophy

Seven sources of waste
JIT production concepts
JIT purchasing principles
JIT Components
Pull Vs Push system
Kanban system
 JUST IN TIME SYSTEMS
(JIT)

Goal:To produce only the needed item in the

needed quantity at required time.
To organize the supply system in such a way to
meet the demands as and when they occur.
Philosophy: JIT philosophy is based on
continuous improvement in and elimination
of wastes in all areas of the company
Identification of sources of waste, tracing their
root causes and taking long term actions for
eliminating them is the basic approach in JIT
system.
 TOYOTAS SEVEN
SOURCES OF WASTE

Inventory
Defective output
Re-processing
Waiting time
Down time of equipments
Transportation (Movement)
Unnecessary human motions
Inventory hides problems

Inventory Level

Rework
Set-up
costs
Scrap Unbalanced
line

Absenteeism
Late deliveries
COMPONENTS OF JIT-Improve
Flow through JIT production
system
Reduce set up times (SMDE)
Small batch production
Eliminate equipment problems (TPM)
Adopt flexible layout (GT)
Adopt PULl system of scheduling
Use Visual signals for control.(KANBAN)
Improve productivity
 COMPONENTS OF JIT
-JIT purchasing principles

Assure long term orders to suppliers

Prefer a single source
Consider supplier as ones own department
sitting outside..
Provide technical/ training support
Develop healthy buyer-seller relationships
Proximity is an advantage
 JIT COMPONENTS- Improve
Quality through TQM

TQM Principles(Quality Mindset)

Quality through Robust design principles
Quality through process control(SPC)
Quality circles
 PUSH VS PULL SYSTEM

Push system
Emphasizes non-stop adherence to a
predetermined production schedule derived from
anticipated demand for end products.
Each stage in the upstream process prepares a
schedule through backward scheduling and
strictly produces according to them.
After production according to the schedule is
completed, they are pushed through the system ,
even if the next process does not immediately
needs them.
 PULL VS PUSH SYSTEM
Pull system
Emphasizes simplicity, flexibility and close co
ordination among workers.
Though, final assembly schedules are prepared
still it is recognized that they may vary.
The upstream activities are geared to match the
final assembly needs for a limited range of
products.
The production in the upstream departments is
governed by what the down stream sections
need.
The sub-assemblies and parts are thus pulled
through the system by the actual end item
demand.
 KANBAN SYSTEM

Kanban in Japanese means a reminder card

Kanban card acts as a visual signal to trigger off
production in upstream departments in a Pull
system.
In this system, each section is expected to have a
small inventory of input, divided into small lots of 4
or 5 pieces. With each lot a card will be attached.
KANBAN SYSTEM (Continued)

When the down stream section draws a lot of input

from its stock for production to feed next section, the
attached card is removed and placed in an empty
container.
The upstream section regularly monitors the kanban
container and if cards are found then it initiates
production equal to the quantity indicated by the
number of cards
If no cards are found in the container the upstream
section will not produce anything .