1. 12 Inventory Management PowerPoint presentation to accompany
Heizer and Render
Operations Management, Eleventh Edition
Principles of Operations Management, Ninth Edition
PowerPoint slides by Jeff Heyl
© 2014 Pearson Education, Inc.

2. Outline The Importance of Inventory Managing Inventory
Inventory Models for Independent Demand
EOQ Model
Safety Stock

3. Importance of inventory and its types

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

5. Importance of Inventory
One of the most expensive assets of many companies representing as much as 50% of total invested capital
Operations managers must balance inventory investment and customer service
Year
Ending
GDP
($ trillion)
Inventory
($ billion)
Inv. as a
% of GDP
1980
2.80
692
24.7%
1985
4.21
847
20.1%
1990
5.80
843
14.5%
1995
7.40
971
13.1%
2000
10.13
1180
11.6%
2005
12.90
1296
10.0%
2010
14.76
1416
9.6%

6. Types of Inventory Raw material Work-in-process (WIP)
Inputs
Transformation
Outputs
Raw material
Purchased but not processed
Work-in-process (WIP)
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

7. Types of Inventory Work-in-process (WIP)
Undergone some change but not completed
A function of cycle time for a product
Cycle time
95% 5%
Input Wait for Wait to Move Wait in queue Setup Run Output
inspection be moved time for operator time time

8. Managing inventory
ABC Analysis
Cycle Counting

9. Managing Inventory
How inventory items can be classified (ABC analysis)
How accurate inventory records can be maintained

10. Managing Inventory: Video
Inventory Control at Wheeled Coach
Cycle Counting: a process where each item in inventory is physically counted on a routine schedule
ABC analysis: the ranking of all items of inventory according to importance

11. 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

12. ABC Analysis Step 1: Determine annual usage/sales for each item
Step 2: Determine the percentage of the total usage/sale by item
Step 3: Rank the items from highest to lowest percentage
Step 4: Classify the items into ABC categories
Class A: 15% of item accounts for 70% - 80% of sales.
Class B: 30% of items accounts for 15% - 25% of sales
Class C: 55% of items accounts for 5% of sales

13. PERCENT OF NUMBER OF ITEMS STOCKED PERCENT OF ANNUAL DOLLAR VOLUME
ABC Analysis
ABC Calculation
(1)
(2)
(3)
(4)
(5)
(6)
(7)
ITEM STOCK NUMBER
PERCENT OF NUMBER OF ITEMS STOCKED
ANNUAL VOLUME (UNITS) x
UNIT COST =
ANNUAL DOLLAR VOLUME
PERCENT OF ANNUAL DOLLAR VOLUME
CLASS
#10286
20%
1,000
$ 90.00
$ 90,000
38.8% A
#11526
500
154.00
77,000
33.2%
#12760
1,550
17.00
26,350
11.3% B
#10867
30%
350
42.86
15,001
6.4%
#10500
12.50
12,500
5.4%
#12572
600
$ 14.17
$ 8,502
3.7% C
#14075
2,000
.60
1,200
.5%
#01036
50%
100
8.50
850
.4%
#01307
.42
504
.2%
#10572
250
150
.1%
8,550
$232,057
100.0%
72%
23% 5%

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

15. ABC Analysis Other criteria than annual dollar volume may be used
High shortage or holding cost
Anticipated engineering changes
Delivery problems
Quality problems

16. ABC Analysis Policies employed may include
More emphasis on supplier development for A items
Tighter physical inventory control for A items
More care in forecasting A items

17. ABC Analysis (Example 12.1)
Omega Corporation is a small manufacturer of computer connectors in Raleigh, North Carolina. The materials which go into a connector are summarized below:
Material
A-2
B-7
C-1
D-9
E-4
F-6
G-5
H-3
Annual usage
3,870
1,550
990
2,150
775
7,000
1,285
1,900
Unit cost ($)
0.25
0.66
7.01
12.30
8.90
0.13
5.74
15.06
Annual dollar volume ($)
3870 × 0.25 = 967.5
1550 × 0.66 = 1023
990 × 7.01 =
2150 × = 26445
775 × 8.90 =
7000 × 0.13 = 910
1285 × 5.74 =
1900 × = 28614

18. ABC Analysis (Example 12.1)
Material
H-3
D-9
G-5
C-1
E-4
B-7
A-2
F-6
Annual dollar volume ($)
28,614.0
26,445.0
7,375.9
6,939.9
6,897.5
1,023.0
967.5
910.0
Percent of annual dollar volume (%)
Class
36.14
33.40
9.32
8.77
8.71
1.29
1.22
1.15 A B C
69.54%
26.8%
3.66%
79,175.8

19. EX 1, Problem 12.2 (Page 507)
Boreki Enterprises has the following 10 items in inventory. Theodore Boreki asks you, a recent OM graduate, to divide these items into ABC classifications:
Item
Annual Demand
Cost/unit A2
3,000 50 B8
4,000 12 C7
1,500 45 D1
6,000 10 E9
1,000 20 F3
500 G2
300 H2
600 I5
1,750 J8
2,500 5

20. Cycle Counting
Items are counted and records updated on a periodic basis
Often used with ABC analysis
A items should be counted frequently
C items will be counted least frequently

21. Case Study
Why, in your opinion, is senior management so concerned about the “high” inventory levels at Champion Electric?
What would you suggest to Barb as steps to take in addressing the concerns of President Campos?

22. Case Study
Why, in your opinion, is senior management so concerned about the “high” inventory levels at Champion Electric?
High asset investments and high costs to the company through inventory carrying costs
Reduce profitability and have negative impact on the stockholders
Alternative uses of the investment:
paying off company debts
investing in other assets
paying a “special” dividend to stockholders

23. Case Study
2. What would you suggest to Barb as steps to take in addressing the concerns of President Campos?
Revisit its classification of inventory
If using an ABC analysis
Consider criteria other than volume
Marketing and operations people could work together to develop criteria related to importance of items to customers
Develop better accuracy in the inventory information system, such as, cycle counting

24. Inventory model
EOQ Model
Reorder Point
Safety Stock

25. Inventory Models
Final product, Chapter12
Inventory
Independent-demand Item: EOQ
Dependent-demand Item: MRP
Raw material, WIP, Chapter 14
Independent Demand: demand is beyond control of the organization
Dependent Demand: demand is driven by demand of another item

26. Inventory Models
We need to answer the following questions in order to balance supply and demand, and balance costs and service levels.
When do I order?
How much do I order?
How much?
When?

27. Inventory Models
Inventory Costs
Holding costs
Ordering / Setup costs

28. Inventory Models Holding (Carrying) Costs
Costs to carry an item in inventory for a length of time 28

29. Inventory Models Ordering and Set-up Cost
Order cost: the expenses of replenishing inventories
Costs to place and receive orders from suppliers
Shipping cost, preparing invoice, inspecting goods
Moving the goods to temporary storage
Setup cost: the expenses of changing over or rearranging a work center to get ready for production
Preparing equipment for the job by adjusting the machine, changing tools
Total annual order/setup cost varies with the number of orders 29

30. (maximum inventory level)
EOQ Model
Inventory Level
Usage rate
Order quantity = Q
(maximum inventory level)
Average inventory = Q 2
ROP
(Reorder point)
Time
Lead time = L
Order Cycle Time

31. EOQ Model Objective is to minimize total costs
Annual cost
Order quantity
Total cost of holding and setup (ordering)
Setup (or ordering) cost curve
Minimum total cost
Optimal order quantity (Q*)
Holding cost

32. EOQ Model How much to order
Economic Order Quantity (EOQ): minimizes total costs; point at which holding and orders costs are equal
How much to order
Q* = Optimum order quantity
D = Annual Demand
S = Ordering/setup cost
H = Holding/carrying cost

33. EOQ Model
Q = Order quantity
D = Annual Demand

34. EOQ Model Q = Order quantity D = Annual Demand S = Ordering/setup cost
H = Holding/carrying cost
P = Unit cost of product

35. EOQ Model (Example 12.2)
Sharp, Inc., a company that markets painless needles to hospitals, would like to reduce its inventory cost by determining the optimal number of hypodermic needles to obtain per order. The annual demand is 1000 units; the ordering cost is $10 per order; the carrying cost per unit per year is $0.5; and the unit price of product is $10. The number of working days per year is 250 days. In order to minimize the annual total cost,
(1) how many hypodermic needles should be ordered each time?
D = 1,000 units
S = $10 per order
H = $.50 per unit per year

36. EOQ Model (Example 12.2)
(2) how many orders should be placed per year?
D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year

37. EOQ Model (Example 12.2) (3) what is the expected time between orders?
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year
Number of working days per years = 250 days

38. EOQ Model (Example 12.2)
(4) how much is the optimal annual total inventory cost?
D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year
Total annual cost = Setup cost + Holding cost
TC = S H D Q* 2
TC = ($10) ($.50)
1,000
200 2
TC = (5)($10) + (100)($.50)
= $50 + $50
= $100

39. EOQ Model (Example 12.2)
(5) how much is the optimal annual total cost?
D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year
P = $10 per unit per product
Total annual cost = Setup cost + Holding cost + Product cost
TC = S H + PD D Q* 2
TC = ($10) ($.50) +(1000)($10)
1,000
200 2
TC = (5)($10) + (100)($.50) + (1000)($10)
= $50 + $50 + $10,000
= $10,100

40. (2) The number of purchase orders issued per year for CDs.
Example 12.3: A computer components manufacturer uses approximately 10,000 blank CDs annually. The CDs are used at a safety rate during the 250 workdays that the plant operates. The price of each blank CD is $7.00 and the annual carrying cost is $0.5 per unit per year. The ordering cost is $50. In order to minimize the annual total cost,
(1) The optimal order size each time the inventory needs to be replenished.
D = 10,000 per year
P = $7.00
H = $0.5 per unit per year
S = $50 per order
Available working days = 250 days
(2) The number of purchase orders issued per year for CDs.

41. (3) Annual ordering cost
D = 10,000 per year
P = $7.00
H = $0.5 per unit per year
S = $50 per order
Available working days = 250 days
Q* = 1415 units
(3) Annual ordering cost
(4) The number of workdays between each purchase order placed (order cycle time).
(5) Average inventory level of CDs

42. (6) Annual carrying (holding) cost
D = 10,000 per year
P = $7.00
H = $0.5 per unit per year
S = $50 per order
Available working days = 250 days
Q* = 1415 units
(7) Total inventory cost
(8) How much would the total inventory cost increase compared to (7) if the order quantity must be 1000 units because of a standard shipping container size?
Q = 1000 units
Difference in TIC = $750 - $706 = $44

43. EX1 in class: A PDA manufacturer, Assistants, Inc
EX1 in class: A PDA manufacturer, Assistants, Inc., uses approximately 28,800 microchips annually for Model #7346. The chips are used at a steady rate during the 250 workdays that the plant operates. The price of each chip is $10.00 and the annual holding (carrying) cost is $2.00 per unit per year. The ordering cost is $50. Answer the following questions.
What is the optimal order size each time the inventory needs to be replenished?
To assure accurate administrative records, a purchase order is given to the supplier each time the EOQ is ordered. How many purchase orders are issued per year for chips?
What is the annual ordering cost?
What is the number of workdays between each purchase order placed (length of order cycle)?
What is the average inventory level (quantity) of chips?
What is the annual carrying (holding) cost?
What are the total inventory costs?
How much would the total inventory cost (TIC) change if the order quantity must be 1500 units because of standard shipping container size?

44. EX2 in class: Northeastern Airlines has a need for about 1,350 new flight attendants per year as replacements for those who leave. Trainees are put through a training program, and the fixed cost of running one session of this program is $19,200. Any number of sessions can be run during the year, but they must be scheduled such that the company always has enough flight attendants. The cost of having excess attendants is simply the salary that they receive, which is $25,600 per year per attendant.
(1) How many flight trainees should be in each session to minimize Northeastern’s annual “inventory cost”?
(2) What is the optimal number of training sessions that Northeastern should run per year?
(3) What is the minimum annual “inventory” cost for the firm?

45. 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

46. Reorder Points EOQ answers the “how much” question
The reorder point (ROP) tells “when” to order
minimum level of on-hand inventory that triggers a replenishment
Lead time (L) is the time between placing and receiving an order
ROP =
Lead time for a new order in days
Demand per day
= d x L
Where d =
Demand per year
Number of working days in a year

47. Reorder Points (Example 12.4)
An apple distributor has a demand for 8,000 iPods per year. The firm operates a 250-day working year. On average, delivery of an order takes 3 working days. What is the reorder points (ROP)?
Demand = 8,000 iPods per year
250 working day year
Lead time for orders is 3 working days
d =
Demand per year
Number of working days in a year
= 8,000/250 = 32 units
ROP = d x L
= 32 units per day x 3 days = 96 units

48. EX3 in class
If you use 10 units per day, and the lead time for resupply is 9 days, how low can your inventory get before placing a new order?

49. Safety Stock ROP = d x L + ss
Used when demand is not constant or certain
Defined as extra units of inventory carried as protection against possible stockouts
Use safety stock to achieve a desired service level and avoid stockouts
ROP = d x L + ss

50. Safety Stock Inventory level Time Figure 12.8 Safety stock 16.5 units
ROP 
Place order
Figure 12.8
Inventory level
Time
Minimum demand during lead time
Maximum demand during lead time
Expected demand during lead time
ROP = safety stock of 16.5 = 366.5
Receive order
Lead time

51. Example 12.5: A computer components manufacturer uses approximately 10,000 blank CDs annually. The CDs are used at a safety rate during the 250 workdays that the plant operates. The price of each blank CD is $7.00 and the annual carrying cost is $0.5 per unit per year. The ordering cost is $50. The lead time for ordering these CDs is ten days. In addition, due to poor supplier delivery, the company has decided to maintain a safety stock of 1000 units.
(1) The optimal order size each time the inventory needs to be replenished.
D = 10,000 per year
P = $7.00
H = $0.5 per unit per year
S = $50 per order
L = 10 days
Safety stock = 1000 units
Available working days = 250 days

52. (3) Average inventory level of CDs
(2) Number of workdays between each purchase order placed (order cycle time).
D = 10,000 per year
P = $7.00
H = $0.5 per unit per year
S = $50 per order
L = 10 days
Safety stock = 1000 units
Available working days = 250 days
Q* = 1415 units
(3) Average inventory level of CDs
Since the safety stock is used, the average inventory level increases by the amount of safety stock

53. (4) Maximum inventory level of CDs
D = 10,000 per year
P = $7.00
H = $0.5 per unit per year
S = $50 per order
L = 10 days
Safety stock = 1000 units
Available working days = 250 days
Q* = 1415 units
The maximum inventory level increases by the amount of safety stock
(5) Reorder point in units

54. (6) Annual setup/Ordering cost
D = 10,000 per year
C = $7.00
H = $0.5 per unit per year
S = $50 per order
L = 10 days
Safety stock = 1000 units
Available working days = 250 days
Q* = 1415 units
Setup/Ordering cost does not change
(7) Annual carrying (holding) cost
Carrying cost increases
(8) Total inventory cost
When safety stock is used,
optimal holding cost ≠ optimal setup/carrying cost

55. Safety Stock
ROP = d  L + SS

56. EX4 in class: Texahoma State University's bookstore is in the process of establishing an inventory policy for notebook filler. Based on past experience, management knows that demand has been fairly constant at a rate of 30 packages per working day. The notebook filler can be purchased from Jungle Supplies for $1.6 a package. Jungle needs 9 working days' notice to ensure prompt service and will deliver the entire order at one point in time.
It takes a bookstore staff member, who earns $5.4 per hour, approximately 60 minutes to process a purchase order and set up the sales display after receiving the shipment; paper, postage, telephone, and fax cost an additional $0.6 per order to the set-up cost. Holding cost, which includes pilferage, deterioration, interest, and storage expenses, is estimated to be 12 percent of the price of the notebook filler. Texahoma State University is open 300 days per year and bookstore management's objective is to fully satisfy customer demand at the least cost. Assume that safety stock (SS) is 50 units.
(1) How low can the inventory get before the bookstore place an order for the notebook filler?
(2) How many notebook fillers should the bookstore order each time?
(3) What is the optimal annual total inventory cost?
(4) What is the optimal annual total cost?
(5) Suppose that, at present, the bookstore places an order for the notebook filler on a quarterly basis. By how much the annual total inventory cost may be reduced if the EOQ policy is followed?