2 Learning ObjectivesDefine the term inventory and list the major reasons for holding inventories; and list the main requirements for effective inventory management.Discuss the nature and importance of service inventoriesDiscuss periodic and perpetual review systems.Discuss the objectives of inventory management.Describe the A-B-C approach and explain how it is useful.
3 Learning ObjectivesDescribe the basic EOQ model and its assumptions and solve typical problems.Describe the economic production quantity model and solve typical problems.Describe the quantity discount model and solve typical problems.Describe reorder point models and solve typical problems.Describe situations in which the single-period model would be appropriate, and solve typical problems.
4 Independent demand is uncertain. Dependent demand is certain. InventoryIndependent DemandAB(4)C(2)D(2)E(1)D(3)F(2)Dependent DemandIndependent demand is uncertain. Dependent demand is certain.Inventory: a stock or store of goods
5 Inventory ModelsIndependent demand – finished goods, items that are ready to be soldE.g. a computerDependent demand – components of finished productsE.g. parts that make up the computer
6 Types of Inventories Raw materials & purchased parts Partially completed goods called work in progressFinished-goods inventories(manufacturing firms) or merchandise (retail stores)
7 Types of Inventories (Cont’d) Replacement parts, tools, & suppliesGoods-in-transit to warehouses or customers
8 Functions of Inventory To meet anticipated demandTo smooth production requirementsTo decouple operationsTo protect against stock-outs
9 Functions of Inventory (Cont’d) To take advantage of order cyclesTo help hedge against price increasesTo permit operationsTo take advantage of quantity discounts
10 Objective of Inventory Control To achieve satisfactory levels of customer service while keeping inventory costs within reasonable boundsLevel of customer serviceCosts of ordering and carrying inventoryInventory turnover is the ratio of average cost of goods sold to average inventory investment.
11 Effective Inventory Management A system to keep track of inventoryA reliable forecast of demandKnowledge of lead timesReasonable estimates ofHolding costsOrdering costsShortage costsA classification system
12 Inventory Counting Systems Periodic SystemPhysical count of items made at periodic intervalsPerpetual Inventory System System that keeps track of removals from inventory continuously, thus monitoring current levels of each item
13 Inventory Counting Systems (Cont’d) Two-Bin System - Two containers of inventory; reorder when the first is emptyUniversal Bar Code - Bar code printed on a label that has information about the item to which it is attached
14 Key Inventory TermsLead time: time interval between ordering and receiving the orderHolding (carrying) costs: cost to carry an item in inventory for a length of time, usually a yearOrdering costs: costs of ordering and receiving inventoryShortage costs: costs when demand exceeds supply
15 ABC Classification System Figure 12.1Classifying inventory according to some measure of importance and allocating control efforts accordingly.A - very importantB - mod. importantC - least importantAnnual$ valueof itemsABCHighLowPercentage of Items
16 Cycle Counting A physical count of items in inventory Cycle counting managementHow much accuracy is needed?When should cycle counting be performed?Who should do it?
17 Economic Order Quantity Models Economic order quantity (EOQ) modelThe order size that minimizes total annual costEconomic production modelQuantity discount model
18 Assumptions of EOQ Model Only one product is involvedAnnual demand requirements knownDemand is even throughout the yearLead time does not varyEach order is received in a single deliveryThere are no quantity discounts
19 Profile of Inventory Level Over Time The Inventory CycleFigure 12.2Profile of Inventory Level Over TimeQuantityon handQReceiveorderPlaceLead timeReorderpointUsagerateTime
20 Total Cost Annual carrying cost Annual ordering cost Total cost = + Q 2HDS+TC =
21 Cost Minimization Goal Figure 12.4CThe Total-Cost Curve is U-ShapedAnnual CostOrdering CostsOrder Quantity (Q)QO(optimal order quantity)
22 Deriving the EOQUsing calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q.
23 Minimum Total CostThe total cost curve reaches its minimum where the carrying and ordering costs are equal.Q2HDS=
24 Economic Production Quantity (EPQ) Production done in batches or lotsCapacity to produce a part exceeds the part’s usage or demand rateAssumptions of EPQ are similar to EOQ except orders are received incrementally during production
25 Economic Production Quantity Assumptions Only one item is involvedAnnual demand is knownUsage rate is constantUsage occurs continuallyProduction rate is constantLead time does not varyNo quantity discounts
27 Total Costs with Purchasing Cost AnnualcarryingcostPurchasingTC =+Q2HDSorderingPD
28 Total Costs with PD Figure 12.7 Cost EOQTC with PDTC without PDPDQuantityAdding Purchasing cost doesn’t change EOQ
29 Total Cost with Constant Carrying Costs Figure 12.9OCEOQQuantityTotal CostTCaTCcTCbDecreasingPriceCC a,b,c
30 When to Reorder with EOQ Ordering Reorder Point - When the quantity on hand of an item drops to this amount, the item is reorderedSafety Stock - Stock that is held in excess of expected demand due to variable demand rate and/or lead time.Service Level - Probability that demand will not exceed supply during lead time.
31 Determinants of the Reorder Point The rate of demandThe lead timeDemand and/or lead time variabilityStockout risk (safety stock)
32 Safety Stock Figure 12.12 Quantity Maximum probable demand LTTimeExpected demandduring lead timeMaximum probable demandROPQuantitySafety stockSafety stock reduces risk ofstockout during lead time
33 Reorder Point Figure 12.13 The ROP based on a normal Risk ofa stockoutService levelProbability ofno stockoutExpecteddemandSafetystockzQuantityz-scaleThe ROP based on a normalDistribution of lead time demand
34 Fixed-Order-Interval Model Orders are placed at fixed time intervalsOrder quantity for next interval?Suppliers might encourage fixed intervalsMay require only periodic checks of inventory levelsRisk of stockoutFill rate – the percentage of demand filled by the stock on hand
35 Fixed-Interval Benefits Tight control of inventory itemsItems from same supplier may yield savings in:OrderingPackingShipping costsMay be practical when inventories cannot be closely monitored
36 Fixed-Interval Disadvantages Requires a larger safety stockIncreases carrying costCosts of periodic reviews
37 Single Period ModelSingle period model: model for ordering of perishables and other items with limited useful livesShortage cost: generally the unrealized profits per unitExcess cost: difference between purchase cost and salvage value of items left over at the end of a period
38 Single Period Model Continuous stocking levels Identifies optimal stocking levelsOptimal stocking level balances unit shortage and excess costDiscrete stocking levelsService levels are discrete rather than continuousDesired service level is equaled or exceeded
39 Optimal Stocking Level Service level =CsCs + CeCs = Shortage cost per unit Ce = Excess cost per unitService LevelSoQuantityCeCsBalance point
40 Example 15 Ce = $0.20 per unit Cs = $0.60 per unit Service level = Cs/(Cs+Ce) = .6/(.6+.2)Service level = .75Service Level = 75%QuantityCeCsStockout risk = 1.00 – 0.75 = 0.25
41 Operations Strategy Too much inventory Wise strategy Tends to hide problemsEasier to live with problems than to eliminate themCostly to maintainWise strategyReduce lot sizesReduce safety stock