2 *** Important note ***Since the text contains advanced materials on inventory management, which will confuse you, do not refer to the text.Notations and method should be used consistently as this slides do.
3 Types of Inventory Inventory: supply of items held to meet demand SuppliersSuppliersMROMRORaw MaterialRaw MaterialComponentsComponentsMaintenance, repair &Maintenance, repair &operating suppliesoperating suppliesWork inWork inProcess (WIP)Process (WIP)FinishedFinishedGoods (FGI)Goods (FGI)TransportationDistributionDistributionCustomersCustomers7–3
4 Inventory Control Objectives We need to answer the following questions in order to balance supply and demand, and balance costs and service levels.When do I order?How much do I order?Where do I deploy the inventory?How much?Where?When?14–4
5 Functions of Inventory To meet anticipated demandTo smooth production requirementsTo decouple operationsTo protect against stock-outs
6 Functions of Inventory (Cont’d) To help hedge against price increasesTo permit operations through WIPTo take advantage of quantity discounts
7 Disadvantages of Inventories Difficult to ControlDetermining optimal amountsStorage and maintenanceHandling inventory is a non-value addedactivity
8 Inventory ManagementIndependent Demand: demand is beyond control of the organizationDependent Demand: demand is driven by demand of another item14–8
9 Inventory Counting Systems Periodic inventory SystemPhysical count of items made at periodic intervalsPerpetual Inventory System System that keeps track of inventory continuously, thus monitoring current levels of each item
10 Bullwhip EffectInventory oscillations become progressively larger looking backward through the supply chain
11 Managing Inventory Across the Supply Chain Collaborative planning, forecasting and replenishment (CPFR): supply chain partners sharing informationVendor-managed Inventory (VMI): the vendor is responsible for managing inventory for the customerVendor monitors and replenishes inventory balancesCustomer saves holding costsVendor has higher visibility of inventory usage
12 Inventory Management in the supply chain : Example (Wal-Mart) P&G:Cross-docking:
13 Managing Inventory – ABC Analysis ABC analysis: ranking inventory by importancePareto’s Law: small percentage of items have a large impact profit100958050CItemsBItemsAItemsCumulativePercentageof RevenueCumulative Percentage of Items7–13
14 Financial Impact of Inventory Set-up (Ordering)CostPurchased items: placing and receiving ordersHolding (Carrying ) CostsOpportunity cost (including cost of capital)Storage and warehouse managementTaxes and insuranceObsolescence, spoilage, & shrinkageMaterial handling, tracking and managementOrdering costCarrying cost7–1414
15 Total Inventory CostsTotal Inventory Costs: sum of all relevant annual inventory costs. i.e. total set-up cost + total holding cost.14–15
16 TIC = annual ordering cost + annual carrying cost Total Inventory CostsTIC = annual ordering cost + annual carrying cost= (D/Q)(S) + (Q/2)(IC)N = D/QA = Q/2Where:N = orders per year A = average inventory levelD = annual demand S = order cost per orderQ = order quantity C = unit costI = % carrying cost per year14–16
17 Total Inventory CostsNote that frequently holding cost is given as a single number meaning H = ICExample: H =$2/item/year14–17
18 N = D/Q = 3000 / 500 = 6 order per year Total Inventory CostsIf we need 3,000 units per year at a unit price of $20 and we order 500 each time, at a cost of $50 per order with a carrying cost of 20%, what is the TIC?N = D/Q = 3000 / 500 = 6 order per yearA = Q/2 = 500 / 2 = 250 average inventoryTIC = ordering cost + carrying cost= S (D/Q) + (IC)(Q/2)= $50 (3000/500) + ($20*0.20)*(500/2) = $1,300Where:N = D/Q Q = A = Q/ C = $20D = 3, S = $ I= 0.2014–18
19 N = D/Q = 3000 / 200 = 15 order per year Total Inventory CostsIf we need 3,000 units per year at a units price of $20 and we order 200 each time, at a cost of $50 per order with a carrying cost of 20%, what is the TIC?N = D/Q = 3000 / 200 = 15 order per yearA = Q/2 = 200 / 2 = 100 average inventoryTIC = ordering cost + carrying cost= S (D/Q) + ( IC )(Q/2)= 50 (3000/200) + ($20*0.20)*(200/2) = $1,150Where:N = D/Q Q = A = Q/ C = $20D = 3, S = $ I = 0.20Example 14-214–19
20 Economic Order Quantity (EOQ) Economic Order Quantity (EOQ): minimizes total acquisition costs; point at which holding and orders costs are equalHow much to orderD = Annual DemandS= Ordering costI= Percent of unit costC = Unit costH= IC= holding cost of itemper year14–20
23 Economic Order Quantity (EOQ) If we need 3,000 units per year at a unit price of $20, at a cost of $50 per order with a carrying cost of 20%, what is lowest TIC order quantity?D = 3,000S= $50C = $20I = 20%Example 14-314–23
24 EOQ Example What is the optimal order quantity? Example : D=48,000 units/yearS= $20/orderI= 18%, c=$100
25 EOQ theorem Example : D=12,000 units/year S= $60/order, H= $10/unit/yearQ= order quantity,Q*=optimal order quantityWhat is the optimal order quantity?
26 Production Order Quantity Model = POQ ModelIt is also called Economic Production Quantity Model= EPQ Model
27 POQ Model ■ Suited for Production Environment ■ Provides Production lot size
28 POQ Model Equations D= Demand per year S= Setup cost H=Holding cost Let,D= Demand per yearS= Setup costH=Holding costd=demand per dayp=production per day
29 POQ Model Equations ■ Optimal order quantity or production lot size ■ Max. Inventory level■ Setup cost■ Holding cost
30 Production Order Quantity S= $2,000I= 25%C = $10d = 2,000p = 5,000Example 14-614–30
31 POQ Example■ The Watkins Chemical Company produces a chemical compound that is used as a lawn fertilizer. The compound can be produced at a rate of 10,000 pounds per day. Demand for the compound is 0.6 million pounds per year. The fixed cost of setting up for a production run of the chemical is $1,500, and the variable cost of production is $3.50 per pound. The company uses an annual interest rate of 22% to account for the cost of capital, and the annual costs of storage and handling of the chemical amount to 12% of the value. Assume that there are 250 working days in a year. What is the optimal lot size, maximum inventory level, and total cost?
33 Quantity Discount Models Material cost:Total material cost is affected by the Discount (%)Unit cost if first $5.00, then $4.80,and finally $4.756-33
34 Quantity Discount Models Total Cost Curves for each of the 3 discount plans6-34
35 All-Units quantity discounts 1. Consider the all-units quantity discount schedule below.Units Ordered Price Per Unit EOQ at that Price$$$$$≥ $What are the possible optimal order quantities?
36 Steps for Solving Quantity Discount Compute EOQ for each discount price:If EOQ < discount minimum level, let Q = minimum.For each EOQ or minimum Q, compute total cost:TC = DC + (D/Q)(S) + (Q/2)(H)Choose the lowest cost quantity from all levels.Q*=IC2DS6-36
37 All-Units quantity discounts A supplier for Lower Florida Keys Health Systemhas introduced all-units quantity discountsto encourage larger order quantitiesof a special catheter. The price schedule is:Order Quantity Price per Unit$60.00$58.80500 or more $
38 All-Units quantity discounts The firm estimates that its annual demandfor this item is 936 units, its setup cost is $45 per order, and its annual holding cost is 25% of the catheter’s unit price.What’s the best order size?
40 All-Units quantity discounts Total cost for the quantity discount case:
41 Homework problems for ch 14 Problem 1. The I-75 Carpet Discount store in Washington stocks carpet in its warehouse and sells it through an adjoining showroom. The store keeps several brands and styles of carpet in stock; however, its biggest selling item is Super Shag carpet. The store wants to determine the optimal order size and total inventory cost for this brand of carpet given an estimated annual demand of 10,000 yards of carpet, annual carrying cost of $0.765 per yard, and an ordering cost of $150.a) Decide the optimal order quantityb) Calculate the minimum total annual inventory cost
42 Homework problems for ch 14 Problem 2. Ashlee’s Beach Chairs company produces upscale beach chairs. Annual demand for the chairs is estimated at 18,000 units. The frames are made in batches before the final assembly process. Ashlee’s frame department can produce 2,500 frames per month. The setup cost is $800 per order, and the annual holding cost is $18 per unit. The company operates 20 days per month.a) Determine the optimal lot sizeb) Calculate the total holding costc) Calculate maximum inventory level
43 Homework problems for ch 14 Problem 3. Sharp inc, a company that markets painless hypodermic needles to hospitals, would like to reduce its inventory cost by determining the optimal number of hypodermic needles to obtain per order. The annual demand is 1,000 units; the holding cost per unit per year is $0.5. The inventory manager of Sharp inc, calculated the optimal order quantity of 200 units.a) What is the ordering cost per order in the companyb) What is the total ordering cost?
44 Homework problems for ch 14 Problem 4 . A produce distributor uses 800 packing crates a month, which it purchases at a cost of $10 each. The manager has assigned an annual carrying cost of 35 percent of the purchase price per crate. Ordering costs are $28 each time. Currently the manager orders once a month. How much could the firm save annually in ordering and carrying costs by using the EOQ?
45 Homework problems for ch 14 Problem 5. Ross White’s machine shop uses 2,500 brackets during the course of a year, and this usage is relatively constant throughout the year. These brackets are purchased for $15 each. The holding cost per bracket per year is 10% of the unit cost and the ordering cost per order is $ There are 250 working days per year.a) What is EOQ?b) In minimizing cost, how many orders would be made each year?c) What would be the total annual inventory cost?(i.e. addition of total ordering and holding cost)
46 Homework problems for ch 14 Problem 6. A hospital buys disposable surgical packages from Pfishier, Inc. Pfisher’s price schedule is $50.25 per package on order of 1 to 199 packages, and $49.00 per packages on orders of 200 or more packages. Ordering cost is $64 per order, and annual holding cost is 20 percent of the per-unit purchase price. Annual demand is 490 packages. What is the best purchase quantity?