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1 12 Inventory Management PowerPoint presentation to accompany Heizer and Render Operations Management, 10e Principles of Operations Management, 8e PowerPoint slides by Jeff Heyl

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2 Outline The Importance of Inventory Functions of Inventory Types of Inventory Managing Inventory ABC Analysis Record Accuracy Cycle Counting Inventory Models Independent vs. Dependent Demand Holding, Ordering, and Setup Costs Inventory Models for Independent Demand The Basic Economic Order Quantity (EOQ) Model Minimizing Costs Reorder Points

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3 Learning Objectives 1.Conduct an ABC analysis 2.Explain and use cycle counting 3.Explain and use the EOQ model for independent inventory demand 4.Compute a reorder point and safety stock

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4 Amazon.com Amazon.com started as a “virtual” retailer – no inventory, no warehouses, no overhead; just computers taking orders to be filled by others Growth has forced Amazon.com to become a world leader in warehousing and inventory management

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5 Inventory Management The objective of inventory management is to strike a balance between inventory investment and customer service

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6 Functions of Inventory 1.To decouple or separate various parts of the production process 2.To decouple the firm from fluctuations in demand and provide a stock of goods that will provide a selection for customers 3.To take advantage of quantity discounts 4.To hedge against inflation

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7 Types of Inventory Raw material Purchased but not processed Work-in-process Undergone some change but not completed A function of cycle time for a product Maintenance/repair/operating (MRO) Necessary to keep machinery and processes productive Finished goods Completed product awaiting shipment

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8 ABC Analysis Divides inventory into three classes based on annual dollar volume Class A - high annual dollar volume Class B - medium annual dollar volume Class C - low annual dollar volume Used to establish policies that focus on the few critical parts and not the many trivial ones

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9 ABC Analysis Item Stock Number Percent of Number of Items Stocked Annual Volume (units)x Unit Cost= Annual Dollar Volume Percent of Annual Dollar VolumeClass # %1,000$ 90.00$ 90, %A # , %A #127601, , %B # % ,0016.4%B #105001, ,5005.4%B 72% 23%

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10 ABC Analysis Item Stock Number Percent of Number of Items Stocked Annual Volume (units)x Unit Cost= Annual Dollar Volume Percent of Annual Dollar VolumeClass # $ 14.17$ 8,5023.7%C #140752, ,200.5%C # % %C #013071, %C # %C 8,550$232, % 5%

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11 C Items ABC Analysis A Items B Items Percent of annual dollar usage 80 – 70 – 60 – 50 – 40 – 30 – 20 – 10 – 0 – |||||||||| Percent of inventory items Figure 12.2

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12 Cycle Counting Items are counted and records updated on a periodic basis Often used with ABC analysis to determine cycle Has several advantages 1.Eliminates shutdowns and interruptions 2.Eliminates annual inventory adjustment 3.Trained personnel audit inventory accuracy 4.Allows causes of errors to be identified and corrected 5.Maintains accurate inventory records

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13 Independent Versus Dependent Demand Independent demand Independent demand - the demand for item is independent of the demand for any other item in inventory Dependent demand Dependent demand - the demand for item is dependent upon the demand for some other item in the inventory

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14 Holding, Ordering, and Setup Costs Holding costs Holding costs - the costs of holding or “carrying” inventory over time Ordering costs Ordering costs - the costs of placing an order and receiving goods Setup costs Setup costs - cost to prepare a machine or process for manufacturing an order

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15 Basic EOQ Model 1.Demand is known, constant, and independent 2.Lead time is known and constant 3.Receipt of inventory is instantaneous and complete 4.Quantity discounts are not possible 5.Only variable costs are setup and holding 6.Stockouts can be completely avoided Important assumptions

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16 Inventory Usage Over Time Figure 12.3 Order quantity = Q (maximum inventory level) Usage rate Average inventory on hand Q 2 Minimum inventory Inventory level Time 0

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17 Minimizing Costs Objective is to minimize total costs Table 12.4(c) Annual cost Order quantity Total cost of holding and setup (order) Holding cost Setup (or order) cost Minimum total cost Optimal order quantity (Q*)

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18 The EOQ Model Q= Number of pieces per order Q*= Optimal number of pieces per order (EOQ) D= Annual demand in units for the inventory item S= Setup or ordering cost for each order H= Holding or carrying cost per unit per year Annual setup cost =(Number of orders placed per year) x (Setup or order cost per order) Annual demand Number of units in each order Setup or order cost per order = Annual setup cost = S DQDQ = (S) DQDQ

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19 The EOQ Model Q= Number of pieces per order Q*= Optimal number of pieces per order (EOQ) D= Annual demand in units for the inventory item S= Setup or ordering cost for each order H= Holding or carrying cost per unit per year Annual holding cost =(Average inventory level) x (Holding cost per unit per year) Order quantity 2 = (Holding cost per unit per year) = (H) Q2Q2 Annual setup cost = S DQDQ Annual holding cost = H Q2Q2

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20 The EOQ Model Q= Number of pieces per order Q*= Optimal number of pieces per order (EOQ) D= Annual demand in units for the inventory item S= Setup or ordering cost for each order H= Holding or carrying cost per unit per year Optimal order quantity is found when annual setup cost equals annual holding cost Annual setup cost = S DQDQ Annual holding cost = H Q2Q2 DQDQ S = H Q2Q2 Solving for Q* 2DS = Q 2 H Q 2 = 2DS/H Q* = 2DS/H

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21 An EOQ Example Determine optimal number of needles to order D = 1,000 units S = $10 per order H = $.50 per unit per year Q* = 2DS H Q* = 2(1,000)(10) 0.50 = 40,000 = 200 units

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22 An EOQ Example Determine optimal number of needles to order D = 1,000 units Q*= 200 units S = $10 per order H = $.50 per unit per year = N = = Expected number of orders Demand Order quantity DQ*DQ* N = = 5 orders per year 1,

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23 An EOQ Example Determine optimal number of needles to order D = 1,000 unitsQ*= 200 units S = $10 per orderN= 5 orders per year H = $.50 per unit per year = T = Expected time between orders Number of working days per year N T = = 50 days between orders 250 5

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24 An EOQ Example Determine optimal number of needles to order D = 1,000 unitsQ*= 200 units S = $10 per orderN= 5 orders per year H = $.50 per unit per yearT= 50 days Total annual cost = Setup cost + Holding cost TC = S + H DQDQ Q2Q2 TC = ($10) + ($.50) 1, TC = (5)($10) + (100)($.50) = $50 + $50 = $100

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25 Robust Model The EOQ model is robust It works even if all parameters and assumptions are not met The total cost curve is relatively flat in the area of the EOQ

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26 An EOQ Example Management underestimated demand by 50% D = 1,000 units Q*= 200 units S = $10 per orderN= 5 orders per year H = $.50 per unit per yearT= 50 days TC = S + H DQDQ Q2Q2 TC = ($10) + ($.50) = $75 + $50 = $125 1, ,500 units Total annual cost increases by only 25%

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27 An EOQ Example Actual EOQ for new demand is units D = 1,000 units Q*= units S = $10 per orderN= 5 orders per year H = $.50 per unit per yearT= 50 days TC = S + H DQDQ Q2Q2 TC = ($10) + ($.50) 1, ,500 units TC = $ $61.24 = $ Only 2% less than the total cost of $125 when the order quantity was 200

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28 Reorder Points EOQ answers the “how much” question The reorder point (ROP) tells “when” to order ROP = Lead time for a new order in days Demand per day = d x L d = D Number of working days in a year

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29 Reorder Point Curve Q*Q* ROP (units) Inventory level (units) Time (days) Figure 12.5 Lead time = L Slope = units/day = d Resupply takes place as order arrives

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30 Reorder Point Example Demand = 8,000 iPods per year 250 working day year Lead time for orders is 3 working days ROP = d x L d = D Number of working days in a year = 8,000/250 = 32 units = 32 units per day x 3 days = 96 units

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31 Safety Stock Purpose of Safety Stock Needed when demand is variable The level of safety stock is set based on the desired service level Safety stock is needed to cover uncertainty during the lead-time

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32 In-Class Problems from the Lecture Guide Practice Problems Problem 1: What are the appropriate ABC groups of inventory items? ABC Analysis Stock Number Annual $ Volume Percent of Annual $ Volume J2412, R269, L023, M121, P T S Q V S = 100.0

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33 In-Class Problems from the Lecture Guide Practice Problems Problem 3: Assume you have a product with the following parameters: Demand = 360 Holding cost per year = $1.00 per unit Order cost = $100 per order What is the EOQ? Problem 4: Given the data from Problem 3, and assuming a 300-day work year; how many orders should be processed per year? What is the expected time between orders? Problem 5: What is the total cost for the inventory policy used in Problem 3?

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34 In-Class Problems from the Lecture Guide Practice Problems Problem 7: If demand for an item is 3 units per day, and delivery lead-time is 15 days, what should we use for a re-order point?

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