Inventory Management

1. Inventory Management Chapter 17

2. Topics • Basic concepts. • Management issues. • Inventory-related costs. • Economic order quantity model. • Quantity discount model. • Order timing decisions. • Order quantity and reorder point interactions. • Multi-item management. • Multiple items from a single source.

3. Independent versus Dependent Demand • Independent demand is for an item for which demand is influenced by factors outside of company decisions. • Dependent demand is for an item for which demand is directly dependent on demand or requirement of another item. • An item may have both independent and demand.

4. Functions of Inventory • Transit stock (pipeline inventories): depends on the time to transport inventories between locations. • Cycle stock: order quantities larger than immediate requirements—thus satisfying multiple periods of demand. • Safety stock: provides protection against irregularities and uncertainties in supply or demand. • Anticipation stock: stock to meet demand in peak periods or special situations, e.g., planned shutdown.

5. Management Issues • Routine inventory decisions: • How much to order (Q, S). • When to order (R, T). • Inventory system performance: • Inventory turnover. • Customer service; e.g, fill rate. • Implementation - basic systems are in place before implementing advanced methods.

6. Inventory-related Costs • Ordering costs - incurred each time a replenishment order is placed. • Carrying costs - function of the item’s value and length of time it’s held in inventory. • Cost of capital, opportunity cost. • Taxes, insurance, inventory shrinkage, storage costs. • Shortage and customer service costs - incurred when demand exceeds available supply. • Loss of contribution margin and loss of good will. • Tracking backorders. • Customer service measures (surrogate for cost).

7. Economic Order Quantity Model (EOQ) • TAC=(A/Q)CP + (Q/2)CH • = annual ordering cost + annual carrying cost.

8. Quantity Discount Model • TAC=(v)A + (A/Q)CP + (Q/2)CH • =annual purchase cost + annual ordering cost + annual carrying cost • Calculating the minimum-cost order quantity: • Calculate EOQ using minimum unit cost. If valid, this is the optimum Q. • If invalid, calculate TAC using all break points. • Calculate an EOQ for each item cost. • Calculate TAC for each valid EOQ from step 3. • Optimum Q is the lowest cost found in step 2 or step 4.

9. Order Timing Decisions • Reorder point influenced by: • Demand rate. • Lead time required for replenishment. • Uncertainty in demand rate and replenishment time. • Management policy on desired customer service level. • Safety stock is added to the average demand during expected lead time to yield the reorder point (figure 17.7).

10. Safety Stock • Stock-out probability - acceptable risk of stocking out during any given order replenishment order cycle (figure 17.8). • R = d + Zd • Customer service level or fill rate- percentage of demand, measured in units, that can be supplied directly from inventory (figure 17.8). • R = d + dE(Z)

11. Multi-item Management • Single-criterion ABC analysis. • Separate inventory items into three groupings based on annual cost-volume usage (unit cost x annual usage). • A items: high dollar usage (significant few). • B items: intermediate dollar usage. • C items: low dollar usage (trivial many). • Commonly, a small percentage of items account for a large percentage of the annual cost volume usage.

12. Multi-item Management • Multiple-criteria ABC analysis. • Non-cost criteria—lead time, obsolescence, availability, substitutability, criticality. • Inventory policies set for the established categories: • Inventory record verification. • Order quantity. • Safety stock. • Classification of the item.

13. Multiple Items/Single Source • Placing orders for several items provided by the same source can result in significant inventory cost savings. • Individual item reorder points. • Place order when an item reaches reorder point. Add other items using ratio of current on-hand plus on-order to the reorder point. Add until a total dollar value or weight is reached. • Determine a joint EOQ, TBO. • Methods: economic dollar value order, simultaneous reorder point, full truckload.

14. Multiple Items/Single Source • Group reorder points—providing a service level for the group. • Sum individual reorder points. • Convert item reorder points into dollars and sum. • Base on periods (e.g., months) of supply. • Place orders on a periodic basis—bring inventory levels for each item to service level needed until the next order.

15. Concluding Principles • The difference between dependent and independent demand must serve as the first basis for determining appropriate inventory management procedures. • Organizational criteria must be clearly established before we set safety stock levels and measure performance. • A sound basic independent demand system must be in place before we attempt to implement some of the advanced techniques presented here.

16. Concluding Principles • Savings in inventory-related costs can be achieved by a joint determination of the order point and order quantity parameters. • Combined ordering of several inventory items obtained from a single source can cut inventory-related costs. • All criteria should be taken into account in classifying inventory items for management priorities.

17. Concluding Principles • The policies developed for each ABC classification should be used to guide the classification of each item as well as to manage its inventories. • Management must be sure the organization is prepared to take on advanced systems before attempting implementation.

18. Homework Assignment • Problems 17.3 , 17.6, and 17.12 • Due Tuesday, November 26