Inventory Management

1. Inventory Management 12 PowerPoint presentation to accompany Heizer and Render Operations Management, 10e Principles of Operations Management, 8e PowerPoint slides by Jeff Heyl

2. Outline • The Importance of Inventory • Functions of Inventory • Types of Inventory • Managing Inventory • ABC Analysis • Record Accuracy • Cycle Counting • Inventory Models • Independent vs. Dependent Demand • Holding, Ordering, and Setup Costs • Inventory Models for Independent Demand • The Basic Economic Order Quantity (EOQ) Model • Minimizing Costs • Reorder Points

3. Learning Objectives Conduct an ABC analysis Explain and use cycle counting Explain and use the EOQ model for independent inventory demand Compute a reorder point and safety stock

4. Amazon.com • Amazon.com started as a “virtual” retailer – no inventory, no warehouses, no overhead; just computers taking orders to be filled by others • Growth has forced Amazon.com to become a world leader in warehousing and inventory management

5. Inventory Management The objective of inventory management is to strike a balance between inventory investment and customer service

6. Functions of Inventory To decouple or separate various parts of the production process To decouple the firm from fluctuations in demand and provide a stock of goods that will provide a selection for customers To take advantage of quantity discounts To hedge against inflation

7. Types of Inventory • Raw material • Purchased but not processed • Work-in-process • Undergone some change but not completed • A function of cycle time for a product • Maintenance/repair/operating (MRO) • Necessary to keep machinery and processes productive • Finished goods • Completed product awaiting shipment

8. ABC Analysis • Divides inventory into three classes based on annual dollar volume • Class A - high annual dollar volume • Class B - medium annual dollar volume • Class C - low annual dollar volume • Used to establish policies that focus on the few critical parts and not the many trivial ones

9. 72% 23% ABC Analysis

10. 5% ABC Analysis

11. A Items 80 – 70 – 60 – 50 – 40 – 30 – 20 – 10 – 0 – Percent of annual dollar usage B Items C Items | | | | | | | | | | 10 20 30 40 50 60 70 80 90 100 Percent of inventory items ABC Analysis Figure 12.2

12. Cycle Counting • Items are counted and records updated on a periodic basis • Often used with ABC analysis to determine cycle • Has several advantages • Eliminates shutdowns and interruptions • Eliminates annual inventory adjustment • Trained personnel audit inventory accuracy • Allows causes of errors to be identified and corrected • Maintains accurate inventory records

13. Independent Versus Dependent Demand • Independent demand - the demand for item is independent of the demand for any other item in inventory • Dependent demand - the demand for item is dependent upon the demand for some other item in the inventory

14. Holding, Ordering, and Setup Costs • Holding costs - the costs of holding or “carrying” inventory over time • Ordering costs - the costs of placing an order and receiving goods • Setup costs - cost to prepare a machine or process for manufacturing an order

15. Basic EOQ Model Important assumptions Demand is known, constant, and independent Lead time is known and constant Receipt of inventory is instantaneous and complete Quantity discounts are not possible Only variable costs are setup and holding Stockouts can be completely avoided

16. Average inventory on hand Q 2 Usage rate Inventory level Minimum inventory 0 Time Inventory Usage Over Time Order quantity = Q (maximum inventory level) Figure 12.3

17. Total cost of holding and setup (order) Minimum total cost Holding cost Annual cost Setup (or order) cost Order quantity Optimal order quantity (Q*) Minimizing Costs Objective is to minimize total costs Table 12.4(c)

18. D Q Annual setup cost = S Annual demand Number of units in each order Setup or order cost per order = = (S) D Q 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 Annual setup cost = (Number of orders placed per year) x (Setup or order cost per order)

19. D Q Annual setup cost = S Annual holding cost = H Order quantity 2 = (Holding cost per unit per year) = (H) Q 2 Q 2 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 Annual holding cost = (Average inventory level) x (Holding cost per unit per year)

20. D Q Annual setup cost = S Annual holding cost = H Q 2 D Q S = H 2DS = Q2H Q2 = 2DS/H Q* = 2DS/H Q 2 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 Optimal order quantity is found when annual setup cost equals annual holding cost Solving for Q*

21. 2DS H Q* = 2(1,000)(10) 0.50 Q* = = 40,000 = 200 units An EOQ Example Determine optimal number of needles to order D = 1,000 units S = $10 per order H = $.50 per unit per year

22. Expected number of orders Demand Order quantity D Q* = N = = 1,000 200 N = = 5 orders per year 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

23. Number of working days per year N Expected time between orders = T = 250 5 T = = 50 days between 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

24. Q 2 D Q 200 2 TC = S + H 1,000 200 TC = ($10) + ($.50) 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 = (5)($10) + (100)($.50) = $50 + $50 = $100

25. Robust Model • The EOQ model is robust • It works even if all parameters and assumptions are not met • The total cost curve is relatively flat in the area of the EOQ

26. 1,500 units Q 2 D Q 200 2 TC = S + H 1,500 200 TC = ($10) + ($.50) = $75 + $50 = $125 An EOQ Example Management underestimated demand by 50% 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 increases by only 25%

27. 1,500 units 244.9 2 TC = ($10) + ($.50) Q 2 D Q TC = S + H 1,500 244.9 An EOQ Example Actual EOQ for new demand is 244.9 units D = 1,000 units Q* = 244.9 units S = $10 per order N = 5 orders per year H = $.50 per unit per year T = 50 days Only 2% less than the total cost of $125 when the order quantity was 200 TC = $61.24 + $61.24 = $122.48

28. Lead time for a new order in days ROP = Demand per day D Number of working days in a year d = Reorder Points • EOQ answers the “how much” question • The reorder point (ROP) tells “when” to order = d x L

29. Q* Slope = units/day = d Inventory level (units) ROP (units) Time (days) Lead time = L Reorder Point Curve Resupply takes place as order arrives Figure 12.5

30. D Number of working days in a year d = Reorder Point Example Demand = 8,000 iPods per year 250 working day year Lead time for orders is 3 working days = 8,000/250 = 32 units ROP = d x L = 32 units per day x 3 days = 96 units

31. Safety Stock • Purpose of Safety Stock • Needed when demand is variable • The level of safety stock is set based on the desired service level • Safety stock is needed to cover uncertainty during the lead-time

32. In-Class Problems from the Lecture Guide Practice Problems Problem 1: What are the appropriate ABC groups of inventory items?

33. In-Class Problems from the Lecture Guide Practice Problems Problem 3: Assume you have a product with the following parameters: Demand = 360 Holding cost per year = $1.00 per unit Order cost = $100 per order What is the EOQ? Problem 4: Given the data from Problem 3, and assuming a 300-day work year; how many orders should be processed per year? What is the expected time between orders? Problem 5: What is the total cost for the inventory policy used in Problem 3?

34. In-Class Problems from the Lecture Guide Practice Problems Problem 7: If demand for an item is 3 units per day, and delivery lead-time is 15 days, what should we use for a re-order point?