INVENTORY MANAGEMENT CONTROL

What Is Inventory?
Stock of items kept to meet future demand Purpose of inventory management
how many units to order? when to order?

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

Outputs
Finished Goods Scrap and Waste

PROCESS

(in warehouses, or in transit)

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

Water Tank Analogy for Inventory

Inventory Level Supply Rate

Inventory Level

Buffers Demand Rate from Supply Rate

Demand Rate

Two Forms of Demand

Dependent
Demand for items used to produce final products Tires stored at a Goodyear plant are an example of a dependent demand item Demand for items used by external customers Cars, appliances, computers, and houses are examples of independent demand inventory

Independent

Inventory Hides Problems

Bad Design

Lengthy Setups
Inefficient Layout

Poor Quality Machine Breakdown Unreliable Supplier

Inventory and Supply Chain Management problems

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 stop-pages

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

Typical Inventory Carrying Costs

Costs as % of Inventory Value
Housing cost: Building rent or depreciation Building operating cost Taxes on building Insurance 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 6% (3% - 10%)

3% (1% - 4%) 3% (3% - 5%) 10% (6% - 24%) 5% (2% - 10%) (15% - 50%)

INVENTORY CONTROL

Inventory control is concerned with minimizing the total cost of inventory. The three main factors in inventory control decision making process are: The cost of holding the stock (e.g., based on the interest rate). The cost of placing an order (e.g., for row material stocks) or the set-up cost of production. The cost of shortage, i.e., what is lost if the stock is insufficient to meet all demand. The third element is the most difficult to measure and is often handled by establishing a "service level" policy, e. g, certain percentage of demand will be met from stock without delay.

Inventory Control Systems

Continuous system (fixedorder-quantity)
constant amount ordered when inventory declines to predetermined level

Periodic system (fixed-timeperiod)

order placed for variable amount after fixed passage of time

Zero Inventory?

Reducing amounts of raw materials and purchased parts and subassemblies by having suppliers deliver them directly. Reducing the amount of works-in process by using just-in-time production. Reducing the amount of finished goods by shipping to markets as soon as possible.

How to Measure Inventory

The Dilemma: closely monitor and control inventories to keep them as low as possible while providing acceptable customer service. Average Aggregate Inventory Value: how much of the companys total assets are invested in inventory? Ford:6.825 billion Sears: 4.039 billion

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Inventory Measures
Weeks of Supply
Ford: 3.51 weeks Sears: 9.2 weeks

Inventory Turnover (Turns)

Ford: 14.8 turns Sears: 5.7 turns GM: 8 turns Toyota: 35 turns

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ABC CLASSIFICATION

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ABC Classification
The ABC Classification The ABC classification system is to grouping items according to annual sales volume, in an attempt to identify the small number of items that will account for most of the sales volume and that are the most important ones to control for effective inventory management.

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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

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ABC Classification: Example

PART
1 2 3 4 5 6 7 8 9 10

UNIT COST
$ 60 350 30 80 30 20 10 320 510 20

ANNUAL USAGE
90 40 130 60 100 180 170 50 60 120

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ABC Classification: Example (cont.)

PART TOTAL PART VALUE % OF TOTAL % OF TOTAL UNIT COSTQUANTITY % CUMMULATIVE ANNUAL USAGE VALUE

9 8 2 1 4 3 6 5 10 7

$30,600 1 16,000 2 14,000 3 5,400 4 4,800 5 3,900 3,600 6 CLASS 3,000 7 2,400 A 8 1,700 B 9 C $85,400

10

35.9 6.0 $ 60 18.7 5.0 350 16.4 4.0 30 6.3 9.0 80 5.6 6.0 30 4.6 10.0 4.2 % OF TOTAL 18.0 20 VALUE ITEMS 3.5 13.0 10 12.0 9, 8,2.8 2 71.0 320 17.0 1, 4,2.0 3 16.5 510 6, 5, 10, 7 12.5

20

6.0 90 11.0 40 A 15.0 130 24.0 60 30.0 B 100 40.0 % 58.0 180 OF TOTAL QUANTITY 71.0 170 C 83.0 50 15.0 100.0 25.0 60 60.0 120

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Example 10.1

ABC Analysis
Recognizes fact some inventory items are more important than others. Purpose of analysis is to divide all of company's inventory items into three groups: A, B, and C. Depending on group, decide how inventory levels should be controlled.

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Economic Order Quantity Model

Economic Order Quantity (EOQ) Models

EOQ
optimal order quantity that will minimize total inventory costs

Basic EOQ model Production quantity model

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

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 = 0: -SD/Q^2 + 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

The EOQ Model

Q = Number of pieces per order Q* = Optimal number of pieces per order (EOQ) D = Annual demand in units for the Inventory item S = Setup or ordering cost for each order H = Holding or carrying cost per unit per year

An EOQ Example
Determine optimal number of needles to order D = 1,000 units S = $10 per order H = $.50 per unit per year

Q* = Q* =

2DS H 2(1,000)(10) = 0.50 40,000 = 200 units

An EOQ Example
Determine optimal number of needles to order D = 1,000 units Q* = 200 units S = $10 per order H = $.50 per unit per year Expected Demand number of = N = = Order quantity orders

An EOQ Example
Determine optimal number of needles to order D = 1,000 units Q* = 200 units S = $10 per order N = 5 orders per year H = $.50 per unit per year Number of working Expected days per year time between = T = N orders

= 250/5 =50 days

An EOQ Example
Determine optimal number of needles to order D = 1,000 units Q* = 200 units S = $10 per order N = 5 orders per year H = $.50 per unit per year T = 50 days Total annual cost = Setup cost + Holding cost TC =

D Q* S + H Q* 2

= 5(10) + (200/2)(#50) = $100

Reorder Point
EOQ answers the how much question The reorder point (ROP) tells when to order

ROP =

Lead time for a Demand per day new order in days

=dxL
D d = Number of working days in a year

Reorder Point: Example

Demand = 10,000 kg/year Store open 311 days/year Daily demand = 10,000 / 311 = 32.154 kg/day Lead time = L = 10 days
R = dL = (32.154)(10) = 321.54 kg = 322 kg

Safety Stocks
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

Variable Demand with a Reorder Point

Q Inventory level

Reorder point, R

0 LT Time LT

Reorder Point with a Safety Stock

Inventory level

Q
Reorder point, R

Safety Stock

0 LT Time LT

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 (service factor) zd L = safety stock

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

Safety factor values for CSL

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Reorder Point for Variable Demand

The carpet store wants a reorder point with a 95% service level and a 5% stockout probability
d = 30 m per day L = 10 days d = 5 m per day For a 95% service level, z = 1.64 R = dL + z d L = 30(10) + (1.64)(5)( 10) Safety stock = z d L = (1.64)(5)( 10)

= 325.9 m

= 25.9 m