Presentation on theme: "MANAGING INVENTORIES CHAPTER 12 DAVID A. COLLIER AND JAMES R. EVANS."— Presentation transcript:
1 MANAGING INVENTORIESCHAPTER 12DAVID A. COLLIER AND JAMES R. EVANS
2 12-1 Explain the importance of inventory, types of inventories, and key decisions and costs. Describe the major characteristics that impact inventory decisions.Describe how to conduct an ABC inventory analysis.Explain how a fixed-order-quantity inventory system operates, and how to use the EOQ and safety stock models.12-5 Explain how a fixed-period inventory system operates.12-6 Describe how to apply the single-period inventory model.
3 Chapter 12 Managing Inventories anana Republic is a unit of San Francisco’s Gap, Inc. and accounts for about 13 percent of Gap’s sales. As Gap shifted its product line to basics such as cropped pants, jeans, and khakis, Banana Republic had to move away from such staples and toward trends, trying to build a name for itself in fashion circles. But fashion items, which have a much shorter product life cycle and are riskier because their demand is more variable and uncertain, bring up a host of operations management issues. In one recent holiday season, the company had bet that blue would be the top-selling color in stretch merino wool sweaters. They were wrong. Marka Hansen, company president noted, “The No. 1 seller was moss green. We didn’t have enough.”
4 Chapter 12 Managing Inventories What do you think?Can you cite any experiences in which the lack of appropriate inventory at a retail store has caused you as the customer to be dissatisfied?
5 Inventory is any asset held for future use or sale. Objectives: Chapter 12 Managing InventoriesInventory is any asset held for future use or sale.Objectives:Maintain sufficient inventoryIncur lowest possible costInventory Management involves planning, coordinating, and controlling the acquisition, storage, handling, movement, distribution, and possible sale of raw materials, component parts and subassemblies, supplies and tools, replacement parts, and other assets that are needed to meet customer wants and needs.
6 Understanding Inventory Chapter 12 Managing InventoriesUnderstanding InventoryRaw materials, component parts, subassemblies, and supplies are inputs to manufacturing and service- delivery processes.Work-in-process (WIP) inventory consists of partially finished products in various stages of completion that are awaiting further processing.Finished goods inventory is completed products ready for distribution or sale to customers.Safety stock inventory is an additional amount of inventory that is kept over and above the average amount required to meet demand.
7 Exhibit 12.1Role of Inventory in the Value Chain
8 Managing Inventories in Global Supply Chains Chapter 12 Managing InventoriesManaging Inventories in Global Supply ChainsPurchasing, tracking, and managing such a variety of items in global supply chains requires good technology, processes, and information technology (IT) support.Purchasing must focus on global sourcing and total system cost; ensure quality, delivery performance, and technical support; and seek new suppliers and products and be able to evaluate their potential to the company.Environmentally Preferable Purchasing (EPP), or green purchasing, is the affirmative selection and acquisition of products and services that most effectively minimize negative environmental impacts over their life cycle of manufacturing, transportation, use, and recycling or disposal.
10 Inventory Management Decisions and Costs Chapter 12 Managing InventoriesInventory Management Decisions and CostsInventory managers deal with two fundamental decisions:When to order items from a supplier or when to initiate production runs if the firm makes its own itemsHow much to order or produce each time a supplier or production order is placed
11 Inventory Management Decisions and Costs Chapter 12 Managing InventoriesInventory Management Decisions and CostsFour categories of inventory costs:Ordering or setup costsInventory-holding costsShortage costsUnit cost of the stock-keeping units (SKUs)
12 Inventory Management Decisions & Costs Chapter 12 Managing InventoriesInventory Management Decisions & CostsOrdering costs or setup costs are incurred as a result of the work involved in placing purchase orders with suppliers or configuring tools, equipment, and machines within a factory to produce an item.Inventory-holding costs or inventory- carrying costs are the expenses associated with carrying inventory.
13 Inventory Management Decisions & Costs Chapter 12 Managing InventoriesInventory Management Decisions & CostsShortage costs or stockout costs are the costs associated with a SKU being unavailable when needed to meet demand.Unit cost is the price paid for purchased goods or the internal cost of producing them.
14 Inventory Characteristics Chapter 12 Managing InventoriesInventory CharacteristicsNumber of items: each item is identified by a unique identifier, called a stock-keeping unit (SKU).A stock-keeping unit (SKU) is a single item or asset stored at a particular location.
15 Inventory Characteristics Chapter 12 Managing InventoriesInventory CharacteristicsNature of Demand:Independent demand is demand for an SKU that is unrelated to the demand for other SKUs and needs to be forecast.Dependent demand is demand directly related to the demand for other SKUs and can be calculated without needing to be forecast.Demand can either be constant (deterministic) or uncertain (stochastic)Static demand is stable demand.Dynamic demand varies over time.
16 Inventory Characteristics Chapter 12 Managing InventoriesInventory CharacteristicsNumber and Duration of Time Periods:Single periodMultiple time periodsLead Time:The lead time is the time between placement of an order and its receipt.
17 Inventory Characteristics Chapter 12 Managing InventoriesInventory CharacteristicsStockouts:A stockout is the inability to satisfy demand for an item.A backorder occurs when a customer is willing to wait for an item.A lost sale occurs when the customer is unwilling to wait and purchases the item elsewhere.
19 ABC Inventory Analysis Chapter 12 ABC Inventory AnalysisABC Inventory AnalysisABC inventory analysis categorizes SKUs into three groups according to their total annual dollar usage“A” items account for a large dollar value but a relatively small percentage of total items“C” items account for a small dollar value but a large percentage of total items“B” items are between A and C
20 ABC Inventory (Pareto) Analysis Chapter 12 ABC Inventory AnalysisABC Inventory (Pareto) Analysis“A” items account for a large dollar value but relatively small percentage of total items (e.g., 10% to 30 % of items, yet 60% to 80% of total dollar value).“C” items account for a small dollar value but a large percentage of total items (e.g., 50% to 60% of items, yet about 5% to 15% of total dollar value). These can be managed using automated computer systems.“B” items are between A and C.
21 Solved Problem Exhibit 12.2 Excel ABC Template Before SortingExhibit 12.2Solved ProblemThe data show projected annual dollar usage for 20 items. Exhibit 12.3 shows the data sorted, and indicates that about 70% of total dollar usage is accounted for by the first 5 items.
23 Exhibit 12.4ABC Histogram for the Results from Exhibit 12.3
24 Managing Fixed Quantity Inventory Systems Chapter 12 Managing InventoriesManaging Fixed Quantity Inventory SystemsIn a fixed quantity system (FQS), the order quantity or lot size is fixed; the same amount, Q, is ordered every time.The fixed order (lot) size, Q, can be a box, pallet, container, or truck load.Q does not have to be economically determined, as we will do for the EOQ model later.
25 Managing Fixed Quantity Inventory Systems Chapter 12 Managing InventoriesManaging Fixed Quantity Inventory SystemsThe process of triggering an order is based on the inventory position.Inventory position (IP) is the on-hand quantity (OH) plus any orders placed but which have not arrived (scheduled receipts, or SR), minus any backorders (BO).IP = OH + SR – BO [12.1]
26 Managing Fixed Quantity Inventory Systems Chapter 12 Managing InventoriesManaging Fixed Quantity Inventory SystemsWhen inventory falls at or below a certain value, r, called the reorder point, a new order is placed.The reorder point is the value of the inventory position that triggers a new order.
27 Exhibit 12.5Summary of Fixed Quantity System (FQS)
28 Exhibit 12.6Fixed Quantity System (FQS) under Stable Demand
29 Exhibit 12.7Fixed Quantity System (FQS) with Highly Variable Demand
30 Chapter 12 Managing Inventories The EOQ ModelThe Economic Order Quantity (EOQ) model is a classic economic model developed in the early 1900s that minimizes total cost, which is the sum of the inventory-holding cost and the ordering cost.
31 The EOQ Model Assumptions: Only a single item (SKU) is considered. Chapter 12 Managing InventoriesThe EOQ ModelAssumptions:Only a single item (SKU) is considered.The entire order quantity (Q) arrives in the inventory at one time.Only two types of costs are relevant—order/setup and inventory holding costs.No stockouts are allowed.The demand for the item is deterministic and continuous over time.Lead time is constant.
32 Chapter 12 Managing Inventories The EOQ ModelCycle inventory (also called order or lot size inventory) is inventory that results from purchasing or producing in larger lots than are needed for immediate consumption or sale.Average cycle inventory= (Maximum inventory + Minimum inventory)/2= Q/ [12.2]
33 Exhibit 12.8Cycle Inventory Pattern for the EOQ Model
34 The EOQ Model Inventory Holding Cost Chapter 12 Managing InventoriesThe EOQ ModelInventory Holding CostThe cost of storing one unit in inventory for the year, Ch, isCh = (I)(C) [12.3]whereI = annual inventory-holding charge expressed as a percent of unit costC = unit cost of the inventory item or SKU
35 ( ) The EOQ Model Annual inventory-holding cost is computed as: [12.4] Chapter 12 Managing InventoriesThe EOQ ModelAnnual inventory-holding cost is computed as:[12.4]annual inventoryholding costaverageinventoryannual holdingcost per unit=()12QCh
36 ( ) The EOQ Model Ordering Cost If D = annual demand and we order Q units each time, then we place D/Q orders/year.Annual ordering cost is computed as :()annual ordering cost=number oforders per yearcostper orderDCo[12.5]Qwhere C0 is the cost of placing one order
37 The EOQ Model TC 2 Q = QCh Co 1 + D [12.6] Total Annual Cost Chapter 12 Managing InventoriesThe EOQ ModelTotal Annual CostTotal annual cost is the sum of the inventory holding cost plus the order or setup cost:TC2Q=QChCo1+D[12.6]
38 √ The EOQ Model 2DCo Q* = [12.7] Ch Economic Order Quantity Chapter 12 Managing InventoriesThe EOQ ModelEconomic Order QuantityThe EOQ is the order quantity that minimizes the total annual costChQ* =√2DCo[12.7]
39 The EOQ Model Calculating the Reorder Point Chapter 12 Managing InventoriesThe EOQ ModelCalculating the Reorder PointThe reorder point, r, depends on the lead time and demand rate.Multiply the fixed demand rate d by the length of the lead time L (making sure they are expressed in the same units, e.g., days or months):r = Lead time demand = (demand rate)(lead time)= (d)(L) [12.8]
40 Solved Problem D = 24,000 cases per year. Co = $38 per order. Chapter 12 Managing InventoriesSolved ProblemD = 24,000 cases per year.Co = $38 per order.I = 18 percent.C = $12.00 per case.Ch = IC = $2.16.
41 Exhibit 12.9Excel Spreadsheet from EOQ Model Template
42 Safety Stock and Uncertain Demand in a Fixed Order Quantity System Chapter 12 Managing InventoriesSafety Stock and Uncertain Demand in a Fixed Order Quantity SystemWhen demand is uncertain, using EOQ based on the average demand will result in a high probability of a stockout.Safety stock is additional planned on-hand inventory that acts as a buffer to reduce the risk of a stockout.A service level is the desired probability of not having a stockout during a lead-time period.
44 Safety Stock and Uncertain Demand in a Fixed Order Quantity System Chapter 12 Managing InventoriesSafety Stock and Uncertain Demand in a Fixed Order Quantity SystemWhen a normal probability distribution provides a good approximation of lead time demand, the general expression for reorder point is r = mL + zsL [12.9] where mL = average demand during the lead time sL = standard deviation of demand during the lead time z = the number of standard deviations necessary to achieve the acceptable service level “zsL” represents the amount of safety stock.
45 Safety Stock and Uncertain Demand in a Fixed Order Quantity System Chapter 12 Managing InventoriesSafety Stock and Uncertain Demand in a Fixed Order Quantity SystemWe may not know the mean and standard deviation of demand during the lead time, but only for some other length of time, t, such as a month or year. Suppose that mt and st are the mean and standard deviation of demand for some time interval t, If the distributions of demand for all time intervals are identical to and independent of each other, thenmL = mtL [12.10]sL = st √L [12.11]
46 Chapter 12 Managing Inventories Solved ProblemSouthern Office Supplies, Inc. distributes laser printer paper.Ordering costs are $45.00 per order,One ream of paper costs $3.80,Annual inventory-holding cost rate is 20%.The average annual demand is 15,000 reams, or about 15,000/52 = per weekThe standard deviation of weekly demand is about 71The lead time from the manufacturer is two weeks.Inventory-holding cost is Ch = IC = 0.20($3.80) = $0.76 per ream per year.
47 Chapter 12 Managing Inventories Solved ProblemThe average demand during the lead time is (288.5)(2) = 577 reams,The standard deviation of demand during the lead time is approximately 71√2 = 100 reams.The EOQ model results in an order quantity of 1333, reorder point of 577, and total annual cost of $1,
48 Chapter 12 Managing Inventories Solved ProblemDesired service level of 95%, which results in a stockout of roughly once every 2 years. For a normal distribution, this corresponds to a standard normal z-value ofr = mL + zsL = 577 = 1.645(100) = 742 reamsThis policy increases the reorder point by 742 – 577 = 165 reams, which represents the safety stock.The cost of the additional safety stock is Ch times the amount of safety stock, or ($0.76/ream)(165 reams) = $
50 Managing Fixed Period Inventory Systems Chapter 12 Managing InventoriesManaging Fixed Period Inventory SystemsAn alternative to a fixed order quantity system is a fixed period system (FPS)—sometimes called a periodic review system—in which the inventory position is checked only at fixed intervals of time, T, rather than on a continuous basis.Two principal decisions in a FPS:The time interval between reviews (T), andThe replenishment level (M)
51 Managing Fixed Period Inventory Systems Chapter 12 Managing InventoriesManaging Fixed Period Inventory SystemsEconomic time interval: T = Q*/D [12.12]Optimal replenishment level without safety stock:M = d (T + L) [12.13]where d = average demand per time periodL = lead time in the same time unitsM = demand during the lead time plus review period
52 Exhibit 12.10Summary of Fixed Period Inventory Systems
53 Exhibit 12.11Operation of a Fixed Period Systems (FPS)
54 Managing Fixed Period Inventory Systems Chapter 12 Special Models for Inventory ManagementManaging Fixed Period Inventory SystemsUncertain DemandCompute safety stock over the period T + L.The replenishment level is computed as:M = mT+L + zσT+L [12.14]mT+L = mt (T + L) [12.15]σT+L = σt √T + L [12.16]
56 Single-Period Inventory Model Chapter 12 Special Models for Inventory ManagementSingle-Period Inventory ModelApplies to inventory situations in which one order is placed for a good in anticipation of a future selling season where demand is uncertain.At the end of the period, the product has either sold out or there is a surplus of unsold items to sell for a salvage value.Sometimes called a newsvendor problem, because newspaper sales are a typical example.
57 Single-Period Inventory Model Chapter 12 Special Models for Inventory ManagementSingle-Period Inventory ModelSolve using marginal economic analysis.cs = the cost per item of overestimating demand (salvage cost); this cost represents the loss of ordering one additional item and finding that it cannot be sold.cu = the cost per item of underestimating demand (shortage cost); this cost represents the opportunity loss of not ordering one additional item and finding that it could have been sold.The optimal order quantity Q* must satisfy:P (demand ≤ Q*) =cucu + cs[12.17]
58 Chapter 12 Managing Inventories Solved ProblemA buyer orders fashion swimwear about six months before the summer season.Each piece costs $40 and sells for $60.At the sale price of $30, it is expected that any remaining stock can be sold during the August sale.The cost per item of overestimating demand is equal to the purchase cost per item minus the August sale price per item:cs = $40 – $30 = $10.The per-item cost of underestimating demand is the difference between the regular selling price per item and the purchase cost per item; that is, cu = $60 – $40 = $20.
59 Solved Problem Exhibit 12.12 Probability Distribution for Single Period ModelSolved ProblemAssume that a uniform probability distribution rangingfrom 350 to 650 items describes the demand.
60 Solved Problem The optimal order size Q must satisfy: Chapter 12 Managing InventoriesSolved ProblemThe optimal order size Q must satisfy:P(demand ≤ Q*) = cu /(cu + cs)= 20/(20+10) = 2/3Because the demand distribution is uniform, the value of Q* is two-thirds of the way from 350 to 650. This results in Q* = 550.
61 Exhibit 12.15Excel Single Period Inventory Template
63 Hardy Hospital Case Study Chapter 12 Managing InventoriesHardy Hospital Case StudyWhat are good estimates of order cost and inventory holding cost? (State all assumptions and show all computations)What is the EOQ and reorder point for Strike Disinfectant given your answer to Question 1?Compute the total order and inventory holding costs for a Fixed Quantity System (FQS) and compare to their current order Q's. Can you save money by adopting a FQS?What are your final recommendations, including what you would recommend regarding regular and special orders, the state bidding system, and overall control of the university materials management system? Explain the reasoning for your recommendations.