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1 Learning Objectives: Understand the practical aspects of various inventory systems Identify the major factors affecting inventory system performance Understand how to calculate the optimal order quantity in various circumstance IES 303 Chapter 15: Inventory Management Supplement E Week 13 February 2, 2006

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2 Inventory Management Inventory : Stock of items held to meet future demand Determine the amount of inventory to keep in stock Inventory management answers two questions: _________________________ ________________ or ________________ (EOQ) _________________________

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3 Physical Types of Inventory Raw materials Purchased parts and supplies Labor In-process (partially completed) products Component parts Tools, machinery, and equipment Reasons to Hold Inventory Meet unexpected demand Smooth seasonal or cyclical demand Meet variations in customer demand Take advantage of price discounts Quantity discounts

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4 Pressures for Low Inventories When keeping inventory, there are always some cost incurred ________ ___________________________ The variable cost of keeping items on hand $/ unit-period Inventory holding cost generally includes: _________________________

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5 Pressures for High Inventories Customer service Ordering cost ($ / order) Setup cost Transportation cost Payment to suppliers Labor and equipment utilization

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6 Types of Inventory Cycle Inventory Safety stock inventory Anticipation inventory Pipeline inventory

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7 Inventory Reduction Approach Cycle Inventory Safety stock inventory Anticipation inventory Pipeline inventory

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8 ABC Analysis Class A 5 – 15 % of units 70 – 80 % of value Class B 30 % of units 15 % of value Class C 50 – 60 % of units 5 – 10 % of value

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9 ABC Analysis Percentage of items Percentage of dollar value — — — — — — — — — — 0 0 — Figure 15.2 Class C Class A Class B

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10 Economic Order Quantity (EOQ) EOQ: the lot size or order size that minimizes total annual inventory holding and ordering cost Total inventory cost = Holding cost (HC) + ordering cost (OC) Assumptions for Basic EOQ Model ____________________________________________

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11 Basic EOQ Model Cycle Inventory Levels Time Lead time Order placed Order receipt Inventory Level Order quantity, Q 0

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12 Basic EOQ Model Graphs of Annual Holding, Ordering, and Total Costs Annual cost (dollars) Lot Size (Q) Figure 15.4 Holding cost (HC) Ordering cost (OC) Total cost = HC + OC

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13 Basic EOQ Model Derivation of total annual inventory cost and economic order quantity order quantity functions Q = order size (units) D = annual demand (units/year) S = ordering cost per order ($/order) H = annual per unit carrying cost ($/unit)

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14 Basic EOQ Model Ex 1:Carpet Sell The I-75 Carpet store stocks carpet in its warehouse and sells it through a showroom. The store keeps several brands and styles of carpet in stock; however, its bigger seller is the BIG C 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, an annual carrying cost of $0.75 per yard, and an ordering cost of $150. The store would like to know the number of orders that will be made annually and the time between orders given that the store is open every except Sunday, Thanksgiving Day and Christmas Day.

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15 EOQ Sensitivity Analysis Use estimates of relevant costs Ignore uncertainty in demand What happen if the holding / ordering cost is off by 20%, 30%? Consider 4 cases of variations of the model parameters. 1. Both ordering and carrying costs are 10% less than the original estimates 2. Both are 10% higher 3. Ordering cost is 10% higher and carrying cost is10% lower 4. Ordering cost is 10% lower and carrying cost is 10% higher Determine EOQ in each case. Remark on the sensitivity of Q on the estimated total cost.

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16 Basic Types of Inventory Control System Continuous review system ________________________ The ordering interval may not be consistent Manager has direct control Periodic review System (P) ________________________ No direct control Tend to have higher inventory to prevent stockout

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17 Continuous review system Figure 15.7 Time On-hand inventory R TBO L TBO L TBO L Orderreceived Orderreceived Q OH OrderplacedIPOrderreceived Q OH Orderplaced IP Orderreceived OrderplacedIPQ OH

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18 Continuous review system Selecting Reorder Point When demand is certain Reorder point (R) = demand during lead time When demand is uncertain Reorder point (R) = Avg demand during lead time + Safety stock

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19 Variable Demand Safety Stocks Safety stock ________________ ________________ Stockout an inventory shortage Service level ________________ Variable Demand with Reorder Point Reorder point, R Q LT Time LT Inventory level 0

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20 Variable Demand Safety Stocks Prevent stockout under uncertain demand Reorder point, R Q LT Time LT Inventory level 0 Safety Stock

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21 Reorder Point for a Service Level Probability of meeting demand during lead time = service level Probability of a stockout R Safety stock Demand z t L Average demand during lead time

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22 Reorder Point with Variable Demand Reorder point with safety stock Service level = probability of NO stockout

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23 Variable Demand Ex 2: PM computer PM Computers assembles microcomputers from generic components. It purchases its color monitors from a manufacturer in Taiwan. There is a long lead time of 25 days. Daily demand is normally distributed with a mean of 2.5 monitors and a standard deviation of 1.2 monitors. Determine the safety stock and reorder point corresponding to a 90% service level

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24 Periodic Review System (P system) Figure PP Time On-hand inventory T Q1Q1Q1Q1 Orderplaced L Orderplaced Orderreceived Orderreceived Orderplaced Q2Q2Q2Q2 Q3Q3Q3Q3 Orderreceived OH LL Protection interval IP 1 IP 3 IP 2 IPIPIP OH

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25 Special Inventory Model Noninstantaneous Replenishment Production and demand Demand only TBO Production quantity Demand during production interval Maximum inventory On-hand inventory Q Time I max p – d Figure E.1

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26 Special Inventory Model Noninstantaneous Replenishment I max = (p – d) = Q ( ) QpQp p – d p C = (H) + (S) I max 2 DQDQ C = ( ) + (S) DQDQ Q p – d 2 p ELS = p p – d 2DS H

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27 Noninstantaneous Replenishment Ex 3: Cheese Maker The Wood Valley Dairy makes cheese to supply to stores in its area. The dairy can make 250 lbs of cheese per day, and the demand at area stores is 180 lbs per day. Each time the dairy makes cheeses, it costs $125 to set up the production process. The annual cost of carrying a pound of cheese is $12. Determine the followings: - The optimal order size and the minimum total annual inventory cost - Length of time to receive an order, production run - Number of orders per year - Maximum inventory level

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28 Special Inventory Model Quantity Discount Price discount for higher quantity orders Include the purchase price in EOQ model P = Unit price of item Q opt Carrying cost Ordering cost Inventory cost ($) Q( P 1 ) = 100 Q(P 2 ) = 200 TC ( P 2 = $6 ) TC ( P 1 = $8 ) TC = ($10 )

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29 Quantity Discount Ex 4: Sweatshirt in bookstore The UW bookstore purchases sweatshirts with school logo from a vendor. The vendor sells the sweatshirts to the store for $38 a piece. The cost to bookstore for placing an order is $120, and the annual carrying cost is 25% of the cost of sweatshirt sweatshirts are estimated to be sold during the year. The vendor has offered the bookstore the following volume discount: What is an optimal order quantity? Order SizeDiscount and up 0% 2% 4% 5%

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