1. Inventory Management McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter 13: Learning Objectives You should be able to: 1.Define the term inventory, list the major reasons for holding inventories, and list the main requirements for effective inventory management 2.Discuss the nature and importance of service inventories 3.Explain periodic and perpetual review systems 4.Explain the objectives of inventory management 5.Describe the A-B-C approach and explain how it is useful 6.Describe the basic EOQ model and its assumptions and solve typical problems 7.Describe the economic production quantity model and solve typical problems 8.Describe the quantity discount model and solve typical problems 9.Describe reorder point models and solve typical problems 10.Describe situations in which the single-period model would be appropriate, and solve typical problems 13-2 Student Slides

3. Inventory – A stock or store of goods Independent demand items – Items that are ready to be sold or used Inventories are a vital part of business: (1) necessary for operations and (2) contribute to customer satisfaction A “typical” firm has roughly 30% of its current assets and as much as 90% of its working capital invested in inventory 13-3 Student Slides

4. Inventory Management Management has two basic functions concerning inventory: 1.Establish a system for tracking items in inventory 2.Make decisions about When to order How much to order Student Slides 13-4

5. Inventory Counting Systems Periodic System Physical count of items in inventory made at periodic intervals Perpetual Inventory System System that keeps track of removals from inventory continuously, thus monitoring current levels of each item An order is placed when inventory drops to a predetermined minimum level – Two-bin system » Two containers of inventory; reorder when the first is empty Student Slides 13-5

6. Inventory Costs Purchase cost The amount paid to buy the inventory Holding (carrying) costs Cost to carry an item in inventory for a length of time, usually a year Ordering costs Costs of ordering and receiving inventory Setup costs The costs involved in preparing equipment for a job Analogous to ordering costs Shortage costs Costs resulting when demand exceeds the supply of inventory; often unrealized profit per unit 13-6 Student Slides

7. Deriving EOQ Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q. The total cost curve reaches its minimum where the carrying and ordering costs are equal. 13-7 Student Slides

8. 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 1.The rate of demand 2.The lead time 3.The extent of demand and/or lead time variability 4.The degree of stockout risk acceptable to management Student Slides 13-8

9. Reorder Point: Under Certainty Student Slides 13-9

10. 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 Student Slides 13-10

11. How Much Safety Stock? The amount of safety stock that is appropriate for a given situation depends upon: 1.The average demand rate and average lead time 2.Demand and lead time variability 3.The desired service level Student Slides 13-11

12. Reorder Point: Demand Uncertainty Note: If only demand is variable, then 13-12 Student Slides

13. How Much to Order: FOI Fixed-order-interval (FOI) model – Orders are placed at fixed time intervals Reasons for using the FOI model – Supplier’s policy may encourage its use – Grouping orders from the same supplier can produce savings in shipping costs – Some circumstances do not lend themselves to continuously monitoring inventory position Student Slides 13-13

14. FOI Model Student Slides 13-14

15. Operations Strategy Improving inventory processes can offer significant cost reduction and customer satisfaction benefits – Areas that may lead to improvement: Record keeping – Records and data must be accurate and up-to-date Variation reduction – Lead variation – Forecast errors Lean operations Supply chain management Student Slides 13-15