Learning Objectives • Define the term inventory and list the major reasons for holding inventories; and list the main requirements for effective inventory management. • Discuss the nature and importance of service inventories • Discuss the objectives of inventory management. • Describe the A-B-C approach and explain how it is useful.
Learning Objectives • Describe the basic EOQ model and its assumptions and solve typical problems. • Describe the economic production quantity model and solve typical problems. • Describe reorder point models and solve typical problems.
What is inventory? • Examples: • Parts in a factory • Paper towels in your cupboard • Customers on hold • Paperwork in secretary’s in-box • Not limited to physical products Inventory is DELAY in business process.
What is inventory? Within organization: Transformation Input Output • Raw materials • Materials received • Customers waiting in a bank • Paperwork in in-box • Work-in-Process • Semi-finished products • Customers at the counter • Paperwork on desk • Finished goods • Products waiting to be shipped • Customers leaving the bank • Paperwork in out-box Between organizations: Goods-in-transit
Types of Inventories • Raw materials & purchased parts • Partially completed goods called work in progress (WIP) • Finished-goods inventories (manufacturingfirms or merchandise, retail stores)
Types of Inventories (Cont’d) • Replacement parts, tools, & supplies • Goods-in-transit to warehouses or customers
Functions of Inventory • To meet anticipated demand (anticipation stock) • To maintain continuity of operations (buffer stock) • To protect against stock-outs, i.e. decrease the risk of shortages due to delayed delivery and unexpected increases in demand, (safety stock) • To take advantage of quantity discounts
Objective of Inventory Control • To achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds (limits), there are 2 concerns: • Level of customer service • Right goods (in sufficient quantities) • Right place • Right time • Costs of ordering and carrying inventory
Effective Inventory Management • A system to keep track of inventory • A reliable forecast of demand • Knowledge of lead times • Reasonable estimates of • Holding costs • Ordering costs • Shortage costs • A classification system
Inventory Tracking Systems • Periodic System Physical count of items made at periodic intervals • Perpetual Inventory System System that keeps track of removals from inventory continuously, thus monitoringcurrent levels of each item Perpetual = all-time, เป็นไปอย่างต่อเนื่อง ตลอดเวลา
0 214800 232087768 Inventory Tracking Systems (Cont’d) • Two-Bin System - Two containers of inventory; reorder when the first is empty • Universal Product Code (UPC) - Bar code printed on a label that hasinformation about the item to which it is attached
High A Annual $ value of items B C Low Low High Percentage of Items ABC Classification System Classifying inventory according to some measure of importance and allocating control efforts accordingly. A-very important B- mod. important C- least important
ABC Classification System A item is 10 -20% of the number of items but 60-70% of the annual dollarC item is 50-60% of the number of items but 10-15% of the annual dollarNormally, A items should receive close attention (frequent reviews) while C items should receive only loose control.
Cycle Counting • A physical count of items in inventory • Cycle counting management • How much accuracy is needed? (± 0.2% for A items, ± 1% B items, and ± 5% C items) • When should cycle counting be performed? • Who should do it?
Inventory Models • Independent demand – finished goods, items that are ready to be sold • E.g. a computer • Dependent demand – components of finished products • E.g. parts that make up the computer
Inventory Models Independent Demand Items Dependent Demand Items A C(2) B(4) D(2) E(1) D(3) F(2)
Economic Order Quantity Models • Economic order quantity (EOQ) model • The order size that minimizes total annual cost • Economic production model • Quantity discount model
Assumptions of EOQ Model • Only one product is involved • Annual demand requirements known • Demand is even throughout the year • Lead time does not vary • Each order is received in a single delivery • There are no quantity discounts
Profile of Inventory Level Over Time Q Usage rate Quantity on hand Reorder point Time Place order Receive order Receive order Receive order Place order Lead time The Inventory Cycle
The Inventory Cycle Large Q Small Q Time
Q D S H + 2 Q Total Cost Annual carrying cost Annual ordering cost Total cost = + TC =
Cost Minimization Goal The Total-Cost Curve is U-Shaped Annual Cost Ordering Costs Order Quantity (Q) QO (optimal order quantity)
Deriving the EOQ Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q.
Q D S H = 2 Q Minimum Total Cost The total cost curve reaches its minimum where the carrying and ordering costs are equal.
Economic Production Quantity (EPQ) • Production done in batches or lots • Capacity to produce a part exceeds the part’s usage or demand rate • Assumptions of EPQ are similar to EOQ except orders are received incrementally during production
Economic Production Quantity Assumptions • Only one item is involved • Annual demand is known • Usage rate is constant • Usage occurs continually • Production rate is constant • Lead time does not vary • No quantity discounts
EPQ: Inventory Profile Q Production and usage Usage only Production and usage Usage only Production and usage Q* Cumulative production Imax Amount on hand Time
Annual carrying cost Annual ordering cost Purchasing cost + TC = + Q D PD S H TC = + + 2 Q Total Costs with Purchasing Cost
Cost Adding Purchasing costdoesn’t change EOQ TC with PD TC without PD PD 0 Quantity EOQ Total Costs with PD
TCa TCb Total Cost Decreasing Price TCc CC a,b,c OC EOQ Quantity Total Cost with Constant Carrying Costs
When to Reorder • Reorder point • When the quantity on hand of an item drops to this amount, the item is reordered. • Determinants of the reorder point • The rate of demand • The lead time • The extent of demand and/or lead time variability • The degree of stockout risk acceptable to management
Reorder Point: Under Uncertainty • Demand or lead time uncertainty creates the possibility that demand will be greater than available supply • To reduce the likelihood of a stockout, it becomes necessary to carry safety stock • Safety stock • Stock that is held in excess of expected demand due to variable demand and/or lead time
Safety Stock Quantity Maximum probable demand during lead time Expected demand during lead time ROP Safety stock Time LT Safety stock reduces risk of stockout during lead time 12-40
Safety Stock? • As the amount of safety stock carried increases, the risk of stockout decreases. • This improves customer service level • Service level • The probability that demand will not exceed supply during lead time • Service level = 100% - Stockout risk 12-41
How Much Safety Stock? • The amount of safety stock that is appropriate for a given situation depends upon: • The average demand rate and average lead time • Demand and lead time variability • The desired service level
Reorder Point The ROP based on a normal Distribution of lead time demand Service level Risk of a stockout Probability of no stockout Quantity ROP Expected demand Safety stock 0 z z-scale
Fixed-Order-Interval Model • Orders are placed at fixed time intervals • Order quantity for next interval? • Suppliers might encourage fixed intervals • May require only periodic checks of inventory levels • Risk of stockout • Fill rate – the percentage of demand filled by the stock on hand
Fixed-Interval Benefits • Tight control of inventory items • Items from same supplier may yield savings in: • Ordering • Packing • Shipping costs • May be practical when inventories cannot be closely monitored