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© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-1 Operations Management Inventory Management Chapter 12.

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Presentation on theme: "© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-1 Operations Management Inventory Management Chapter 12."— Presentation transcript:

1 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-1 Operations Management Inventory Management Chapter 12

2 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-2  Stock of materials  Stored capacity © 1995 Corel Corp. © 1984-1994 T/Maker Co. © 1995 Corel Corp. What is Inventory?

3 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-3 Types of Inventory  Raw material  Work-in-progress  Maintenance / repair / operating supplies  Finished goods

4 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-4 The Material Flow Cycle

5 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-5 The Functions of Inventory  To ”decouple” or separate various parts of the production process  To provide a stock of goods that will provide a selection for customers  To take advantage of quantity discounts  To hedge against inflation and upward price changes

6 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-6  Higher costs  Interest or opportunity costs  Holding (or carrying) costs – storage, handling, taxes, insurance, shrinkage  Ordering (or setup) costs  Risk of deterioration or obsolescence  Hides production problems  Yield / scrap variations  Unscheduled downtime Disadvantages of Inventory Total cost = 20% - 40% of inventory value / year

7 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-7 Pressures on inventory Pressure for lower inventory Inventory investment Inventory holding cost Pressure for higher inventory Customer service Other costs related to inventory

8 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-8 Different Views of Inventory Demand Type Independent Dependent Process stage Raw Material Work in Process Finished Goods Other Maintenance / Repair Operating Supplies Types of Inventory Cycle Pipeline Safety Stock Anticipation Annual $ Volume A B C

9 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-9 How Is Inventory Created?  Cycle Inventory – result of lot size  Pipeline Inventory – in transit  Safety Stock  Anticipation Inventory Pipeline inventory = D L = dL Average cycle inventory = Q + 0 2 Types of Inventory Cycle Pipeline Safety Stock Anticipation

10 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-10 Inventory Calculations We use 70 hypodermic needles a week. We buy them in lots of 280. It takes three weeks for order handling and shipment. Cycle inventory =Q/2 =280/2 =140 needles Pipeline inventory=D L =dL =(70 needles/week)(3 weeks) =210 drills Inventory Worksheets

11 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-11 Inventory Reduction Tactics  Cycle inventory  Pipeline inventory  Safety Stock  Anticipation inventory Reduce lot size Reduce lead time Various Reduce uncertainties

12 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-12  Divides on-hand inventory into three classes on the basis of annual dollar volume – A, B, and C  $ volume = Annual demand x Unit cost  Policies based on ABC analysis  Develop class A suppliers more  Maintain tighter physical control of A items  Forecast A items more carefully ABC Analysis Annual $ Volume A B C

13 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-13 ABC Analysis Class% $ Vol% Items A8020 B1530 C 550 % of Inventory Items 0 20 40 60 80 100 050100 % Annual $ UsageA B C

14 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-14  Fixed order-quantity models  Economic order quantity  Production order quantity  Quantity discount  Probabilistic models  Fixed order-period models Help answer the inventory planning questions! © 1984-1994 T/Maker Co. Inventory Models for Independent Demand

15 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-15  Objective: minimize (ordering cost + holding cost)  Assumptions:  Known and constant demand  Known and constant lead time  Instantaneous receipt of material  No quantity discounts  Only ordering / setup cost and holding cost  No stockouts EOQ – Economic Order Quantity

16 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-16 Inventory Usage Over Time Time Inventory Level Average Cycle Inventory 0 Q Usage Rate Q2Q2

17 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-17 EOQ Model How Much to Order? Order quantity (Q) Annual Cost Holding Cost Total Cost Ordering (Setup) Cost Optimal Order Quantity (Q*) Minimum total cost

18 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-18 More units must be stored if more are ordered Purchase Order DescriptionQty. Microwave 1 Order quantity Purchase Order DescriptionQty. Microwave 1000 Why Holding Costs Increase

19 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-19 Cost is spread over more units Example: You need 1000 microwave ovens Purchase Order DescriptionQty. Microwave1 Purchase Order DescriptionQty. Microwave1 Purchase Order DescriptionQty. Microwave1 Purchase Order DescriptionQty. Microwave 1 1 Order (Postage $ 0.33)1000 Orders (Postage $330) Order quantity Purchase Order Description Qty. Microwave 1000 Why Ordering Costs Decrease

20 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-20 EOQ Model – When to Order Time Inventory Level Average Cycle Inventory Q* Reorder Point (ROP) Lead Time

21 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-21 Optimal Order Quantity Expected Number of Orders Expected Time Between Orders Working Days/Year = =× = N = D Q*Q* Working Days/Year == T N d D ROPdL == ×× Q* DS H 2 D = Demand per year S = Setup (order) cost per order H = Holding (carrying) cost d = Demand per day L = Lead time in days EOQ Model Equations

22 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-22  Fixed order-quantity models  Economic order quantity  Production order quantity  Quantity discount  Probabilistic models  Fixed order-period models Help answer the inventory planning questions! © 1984-1994 T/Maker Co. Inventory Models for Independent Demand

23 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-23  Answers how much to order and when to order  Allows partial receipt of material  Other EOQ assumptions apply  Suited for production environment  Material produced, used immediately  Provides production lot size  Lower holding cost than EOQ model POQ – Production Order Quantity

24 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-24 EOQ POQ Model Time Inventory Level Both production and usage take place Usage only takes place Maximum inventory level

25 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-25  Fixed order-quantity models  Economic order quantity  Production order quantity  Quantity discount  Probabilistic models  Fixed order-period models Help answer the inventory planning questions! © 1984-1994 T/Maker Co. Inventory Models for Independent Demand

26 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-26 Quantity Discount Model  Answers how much to order & when to order  Allows quantity discounts  Other EOQ assumptions apply  Trade-off is between lower price & increased holding cost Discount Number Discount Quantity Discount (%) Discount Price (P) 10 to 999No discount$ 5.00 21,000 to 1,9994$ 4.80 32,000 and over5$ 4.75

27 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-27 Quantity Discount – How Much to Order

28 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-28  Fixed order-quantity models  Economic order quantity  Production order quantity  Quantity discount  Probabilistic models  Fixed order-period models Help answer the inventory planning questions! © 1984-1994 T/Maker Co. Inventory Models for Independent Demand

29 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-29  Answer how much & when to order  Allow demand to vary  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 Probabilistic Models X Service Level P(Stockout) Frequency

30 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-30 Probabilistic Models - When to Order? Reorder Point (ROP) X Safety Stock (SS) Time Inventory Level Lead Time SS ROP Service Level P(Stockout) Place order Receive order Frequency

31 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-31  Fixed order-quantity models  Economic order quantity  Production order quantity  Quantity discount  Probabilistic models  Fixed order-period models Help answer the inventory planning questions! © 1984-1994 T/Maker Co. Inventory Models for Independent Demand

32 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-32  Answers how much to order  Orders placed at fixed intervals  Inventory brought up to target amount  Amount ordered varies  No continuous inventory count  Possibility of stockout between intervals  Useful when vendors visit routinely  Example: Office Max representative calls every week Fixed Period (P) Systems

33 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-33 Inventory in a Fixed Period System Various amounts (Q i ) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum ppp Q1Q1Q1Q1 Q2Q2Q2Q2 Q3Q3Q3Q3 Q4Q4Q4Q4 Target maximum Time On-Hand Inventory

34 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-34 Comparison of Q and P Systems  Continuous Review System ( Q ) A system designed to track the remaining inventory of an item each time a withdrawal is made, to determine whether it is time to replenish  Periodic Review System ( P ) A system in which an item’s inventory position is reviewed periodically rather than continuously

35 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-35  Continuous Review System ( Q )  Individual review frequencies  Possible quantity discounts  Lower, less-expensive safety stocks  Periodic Review System ( P )  Convenient to administer  Orders may be combined  Inventory position only required at review Comparison of Q and P Systems

36 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-36 Inventory Measures Average inventory = $2 million Cost of goods sold = $10 million 52 business weeks per year = = 5 turns/year $10 million $2 million Inventory turns = = = 10.4 weeks $2 million ($10 million)/(52 weeks) Weeks of supply = Average inventory value Weekly sales (at cost) Annual sales (at cost) Average inventory value

37 © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-37 Summary  Functions of inventory – Inventory enables value creation for many processes  Costs of inventory  Different views of inventory  Inventory reduction tactics  ABC and EOQ are traditional tools used to manage inventory – still used in many circumstances  Continuous review system (Q) for high-value parts; Periodic review system (P) for some low value parts  Weeks of Supply and inventory turns are widely-used measures of inventory


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