WHY INVENTORIES ARE NEEDED
To maintain independence of operations
To meet variations in demand
To allow production schedule flexibility
To provide a safeguard for variations in
raw materials deliveries
To take advantage of economic
purchase order size
2 (additional)
Inventory
Management
1
2
INVENTORY COSTS YOU
Holding or carrying costs
Ordering costs
Shortage and/or wrong inventory costs
INVENTORY MODELS
Independent versus Dependent Demand
Holding, Ordering, and Setup Costs
INVENTORY MODELS FOR INDEPENDENT
DEMAND
3
Basic Economic Order Quantity (EOQ) Model
Minimizing Costs
Reorder Points
Production Order Quantity Model
Quantity Discount Models
4
CAN YOU ….
AMAZON.com
Identify or Define:
Define:
Jeff Bezos,
Bezos, in 1995, started
AMAZON.com as a “virtual”
virtual” retailer –
no inventory, no warehouses, no
overhead; just a bunch of computers.
Growth forced AMAZON.com to excel in
inventory management!
AMAZON is now a worldwide leader in
warehouse management and
automation.
ABC analysis
Record accuracy
Cycle counting
Independent and dependent
demand
Holding, Ordering, and Setup Costs
Describe or Explain:
The functions of inventory and basic
inventory models
5
6
Order Fulfillment at AMAZON-
Order Fulfillment at AMAZON
1.
2.
3.
Continued
You order items;, computer assigns your
order to distribution center [closest facility
that has the product(s)]
Lights indicate products ordered to
workers who retrieve product and reset
light.
Items placed in crate with items from
other orders, and crate is placed on
conveyor. Bar code on item is scanned 15
times – virtually eliminating error.
7
4.
5.
6.
7.
Crates arrive at central point where items
are boxed and labeled with new bar
code.
Gift wrapping done by hand (30 packages
per hour)
Box is packed, taped, weighed and
labeled before leaving warehouse in a
truck.
Order appears on your doorstep within a
8
week
What is Inventory?
Stock of materials
Stored capacity
Examples
The Functions of Inventory
To ”decouple”
decouple” or separate various parts
of the production process
To provide a stock of goods that will
provide a “selection”
selection” for customers
To take advantage of quantity discounts
To hedge against inflation and upward
price changes
© 1995
Corel Corp.
© 1984-1994 T/Maker Co.
© 1984-1994 T/Maker Co.
© 1995 Corel Corp.
9
Types of Inventory
10
The Material Flow Cycle
Raw material
WorkWork-inin-progress
Maintenance/repair/operating supply
Finished goods
11
12
Disadvantages of Inventory
The Material Flow Cycle
Higher costs
Other
Input
Item cost (if purchased)
Ordering (or setup) cost
Wait
Time
Move
Time
Queue
Time
Setup
Time
Run
Time
Output
Cycle Time
Costs of forms, clerks’
clerks’ wages etc.
1
Holding (or carrying) cost
2
Building lease, insurance, taxes etc.
3
Difficult to control
Hides production problems
4
5
6
Run time: Job is at machine and being worked on
Setup time: Job is at the work station, and the work
station is being "setup."
Queue time: Job is where it should be, but is not being
processed because other work precedes it.
Move time: The time a job spends in transit
Wait time: When one process is finished, but the job is
waiting to be moved to the next work area.
Other:
Other: "Just"Just-inin-case" inventory or safety stock.
13
14
ABC Analysis
Classifying Items as ABC
Divides onon-hand inventory into 3 classes
A class, B class, C class
Class
A
B
C
% Annual $ Usage
100
80
Basis is usually annual $ volume
60
$ volume = Annual demand x Unit cost
B
20
Develop class A suppliers more
Give tighter physical control of A items
Forecast A items more carefully
% Items
15
30
55
A
40
Policies based on ABC analysis
% $ Vol
80
15
5
C
0
0
50
100
% of Inventory Items
15
16
Cycle Counting
Advantages of Cycle Counting
Eliminates shutdown and interruption of
production necessary for annual physical
inventories
Eliminates annual inventory adjustments
Provides trained personnel to audit the
accuracy of inventory
Allows the cause of errors to be identified
and remedial action to be taken
Maintains accurate inventory records
Physically counting a sample of total
inventory on a regular basis
Used often with ABC classification
A items counted most often (e.g., daily)
17
Techniques for Controlling
Service Inventory Include:
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Independent vs. Dependent Demand
Good personnel selection, training, and
discipline
Tight control of incoming shipments
Effective control of all goods leaving the
facility
19
Independent demand - demand for
item is independent of demand for any
other item
Dependent demand - demand for
item is dependent upon the demand for
some other item
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Holding (Carrying) Costs
Inventory Costs
Holding costs - associated with
holding or “carrying”
carrying” inventory over
time
Ordering costs - associated with costs
of placing order and receiving goods
Setup costs - cost to prepare a
machine or process for manufacturing
an order
Obsolescence
Insurance
Extra staffing
Interest
Pilferage
Damage
Warehousing
Etc.
21
Inventory Holding Costs
(Approximate Ranges)
Category
6%
(3 - 10%)
Material handling costs (equipment,
lease or depreciation, power,
operating cost)
3%
(1 - 3.5%)
Labor cost from extra handling
Investment costs (borrowing costs,
taxes, and insurance on inventory)
Pilferage, scrap, and obsolescence
Overall carrying cost
Ordering Costs
Cost as a
% of Inventory Value
Housing costs (building rent,
depreciation, operating cost, taxes,
insurance)
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3%
(3 - 5%)
Supplies
Forms
Order processing
Clerical support
Etc.
11%
(6 - 24%)
3%
(2 - 5%)
26%
23
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Setup Costs
Inventory Models
CleanClean-up costs
ReRe-tooling costs
Adjustment costs
Etc.
Fixed orderorder-quantity models
Economic order quantity
Production order quantity
Quantity discount
Help
Helpanswer
answerthe
the
inventory
inventoryplanning
planning
questions!
questions!
Probabilistic models
Fixed orderorder-period models
© 1984-1994
T/Maker Co.
25
Inventory Usage Over Time
Known and constant demand
Known and constant lead time
Instantaneous receipt of material
No quantity discounts
Only order (setup) cost and holding cost
No stockouts
27
Order quantity = Q
(maximum
inventory level)
Minimum
inventory
Inventory Level
EOQ Assumptions
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0
Usage Rate
Average
Inventory
(Q*/2)
Time
28
EOQ Model
How Much to Order?
Why Holding Costs Increase
Annual Cost
More units must be stored if more are
ordered
urve
ost C
C
l
a
t
urve
To
ost C
C
g
n
i
Hold
Minimum
total cost
Purchase Order
Description
Qty.
Microwave
1
Order (Setup) Cost Curve
Optimal
Order Quantity (Q*)
Order quantity
Order quantity
Purchase Order
Description
Qty.
Microwave
1000
Order quantity
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30
Why Order Costs Decrease
Deriving an EOQ
Cost is spread over more units
1.
Example: You need 1000 microwave ovens
1 Order (Postage $ 0.33)
1000 Orders (Postage $330)
Purchase Order
Description
Qty.
Microwave
1000
PurchaseOrder
Order
Purchase
Purchase
OrderQty.
Description
Purchase
Order
Description Qty.
Qty.
Description
Microwave Qty. 11
Description
Microwave
Microwave
Microwave
11
2.
3.
4.
Develop an expression for setup or
ordering costs
Develop an expression for holding cost
Set setup cost equal to holding cost
Solve the resulting equation for the
best order quantity
Order quantity
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32
EOQ Model
When To Order
EOQ Model Equations
Optimal Order Quantity
Inventory Level
Average
Inventory
(Q*/2)
Optimal
Order
Quantity
(Q*)
Expected Number of Orders
Expected Time Between Orders
Reorder
Point
(ROP)
d =
Working Days
ROP = d × L
Time
Lead Time
D
/ Year
2 ×D ×S
H
D
=N =
Q*
= Q* =
=T =
Working Days
/ Year
N
D = Demand per year
S = Setup (order) cost per order
H = Holding (carrying) cost
d = Demand per day
L = Lead time in days
33
The Reorder Point (ROP)
Curve
Production Order Quantity Model
Answers how much to order and when
to order
Allows partial receipt of material
Q*
Slope = units/day = d
Inventory level (units)
34
Other EOQ assumptions apply
ROP
(Units)
Suited for production environment
Material produced, used immediately
Provides production lot size
Lower holding cost than EOQ model
Time (days)
Lead time = L
35
36
Reasons for Variability in Production
Most variability is caused by waste or by
poor management. Specific causes
include:
employees, machines, and suppliers produce
units that do not conform to standards, are late
or are not the proper quantity
inaccurate engineering drawings or
specifications
production personnel try to produce before
drawings or specifications are complete
customer demands are unknown
37
Quantity Discount Schedule
Discount
Number
Discount
Quantity
Discount
(%)
Discount
Price (P)
1
0 to 999
No
discount
$5.00
2
1,000 to
1,999
4
$4.80
3
2,000 and
over
5
$4.75
Quantity Discount Model
Answers how much to order &
when to order
Allows quantity discounts
Reduced price when item is purchased in
larger quantities
Other EOQ assumptions apply
TradeTrade-off is between lower price &
increased holding cost
38
Probabilistic Models
Answer how much & when to order
Allow demand to vary
Follows normal distribution
Other EOQ assumptions apply
Consider service level & safety stock
Service level = 1 - Probability of stockout
Higher service level means more safety stock
More safety stock means higher ROP
39
40
Probabilistic Models
When to Order?
Inventory Level
Frequency
Service
Level
Fixed Period Model
P(Stockout)
Optimal
Order
Quantity
SS
Inventory brought up to target amount
Amount ordered varies
X
ROP
Reorder
Point
(ROP)
No continuous inventory count
Possibility of stockout between
intervals
Safety Stock (SS)
Place
order
Lead Time
Answers how much to order
Orders placed at fixed intervals
Receive
order
Useful when vendors visit routinely
Time
41
Example: P&G representative calls
every 2 weeks
42