Presentation on theme: "Inventory Management for Independent Demand"— Presentation transcript:
1 Inventory Management for Independent Demand Chapter 12
2 Just-in-Time & Lean Systems MGMT 326Facilities& WorkDesignFoundationsof OperationsProducts &ProcessesQualityAssurancePlanning& ControlManagingProjectsManagingQualityManagingInventoryIntroductionLinearProgram-mingStrategyProductDesignStatisticalProcessControlCapacityand LocationProcessDesignFacilityLayoutJust-in-Time & Lean Systems
3 Chapter Outline Basic concepts ABC inventory analysis Inventory costs Objectives of inventory managementDependent and independent demandABC inventory analysisInventory costsItem costsHolding costsOrder or setup costsShortage costs
4 Chapter Outline (2) Inventory policy Fixed order quantity method Economic order quantity – the optimal fixed order quantityReorder pointReorder point when demand is constantReorder point when demand is variableEconomic production quantity – the optimal production quantity
5 Objectives of Inventory Management Maintain good customer serviceMinimize inventory investment, consistent with the required level of customer service
6 Types of Demand Dependent Demand Demand for raw materials, component parts, and subassemblies used to make a finished productBoth the amount of demand and the date required depend on the production schedule
7 Types of Demand (2) Independent Demand Any demand that is not used to meet a production schedule is called independent demandExamples of independent demand: finished goods; retail and distributor inventories; service inventories; maintenance, repair, and operating (MRO) inventoriesMRO includes fuels, repair parts, office supplies, cleaning supplies
8 Dependent and Independent Demand: Types of Inventory used to meet aproduction schedulein manufacturingIndependent demand:not used to meet a production scheduleManufacturerService CompanyRaw materialsFinished goodsRetail ordistributorinventoriesComponent partsMROWork-in-process(WIP)Service inventoriesMRO
9 ABC Inventory Analysis For an inventory item, the annual usage in dollars is(annual demand)x(cost per unit).Annual demand is also called annual usage in units.ABC inventory analysis divides inventory items into 3 categories:A items usually account for at least 60% of annual usage and should be controlled most closelyB items require a moderate level of control. A and B items should account for at least 80% of annual usage.C items require less control than other items. These items are those with the least usage that were not classified asA and B items
11 Steps in ABC Analysis Compute Annual Usage in Dollars for each item. Compute Total Annual Usage.Compute the percentage of Annual Usage for each item.Sort the list of items by the percentage of Annual Usage in Dollars, from largest to smallest.
12 Steps in ABC Analysis (2) Calculate the Cumulative Percentage of Annual Usage in Dollars for the first item, first 2 items, first 3 items, etc. For the last item, the cumulative % should be 100%.Using Cumulative % as a guide, assign the items to A, B, and C categories.
15 Relevant Inventory Costs Measurable Cost of Inventory =Order Costs forpurchased itemsORSetup Costs foritems made byyour companyShortage costs:Administrative& transportationcosts related toback ordersItem CostsHoldingCosts+++Shortages and back orders result in lost sales and lost goodwill. These costs are relevant but hard to measure.
16 Item CostsItem costsFor purchased items, the item cost is the purchase price, plus shippingFor work in process, the item cost is the cost of materials and labor used in the itemFor finished goods, the item cost is the cost of goods sold.
17 Inventory Holding Costs Inventory holding costs include capital costs, storage costs, and risk costsCapital costs:If inventory is financed with borrowed money, the capital cost is the interest rate paidIf inventory is financed from retained earnings, the capital cost is the opportunity cost of not putting the money into other investmentsStorage costs: the costs of space, people, and equipment used in inventory storage
18 Inventory Holding Costs (2) Risk costs: cost of taxes and insurance on inventory, damage, obsolescence, and theftInventory holding costs are usually computed as a percentage of item costs
19 Ordering and Setup Costs For purchased items, ordering costs are the fixed costs associated with placing an order with a supplierFor items made internally, setup costs are used instead of order costs. The setup cost is the cost of work that must be done before production actually begins.
20 Shortage CostsAdministrative and transportation costs related to back ordersLost good will and lost sales due to product shortages – hard to measure
21 Inventory Management Policies An inventory management policy should determineHow much to orderWhen to order
22 Fixed Order Quantity Method An inventory policy for independent demand. Based on the following rules:Order the same amount, Q, each timeQ is called the order quantityPlace an order when the amount in inventory gets down to the reorder point, RCompute Q and R for each item.
23 Fixed Order Quantity Method (2) Relevant Costs AssumeQuantity discounts are not availableOrders are placed early enough that shortages do not occurRelevant costsOrder costsInventory holding costs
24 Fixed Order Quantity Method (3) Annual Inventory Cost Figure 12.2, page 430Given:D = annual demand = 10,400Weekly demand = 200L = lead time = 1 weekQ = order quantity = 600Average inventory= (Q/2) = 600/2 = 300
25 Fixed Order Quantity Method (4) Notation Q = order quantityD = annual demand for the itemS = cost of placing one orderH = inventory holding cost per unit per year(commonly called holding cost)L = lead time (time between order placement and order receipt)R = reorder pointTC = annual cost of placing orders+ annual cost of holding inventory
26 Fixed Order Quantity Method (5) Costs Annual cost of placing orders =Annual cost of holding inventory =Total annual cost =
27 Economic Order Quantity The economic order quantity (EOQ) is the fixed order quantity (Q) that minimizes the total annual costs of placing orders and holding inventory (TC).
28 Economic Order Quantity Assumptions Demand (D) is known and constantH is known and constantOrder costs (S) are constantThe order quantity arrives in a single shipmentNo quantity discounts are availableAll demand will be met (no shortages)
29 We want to minimize TCD, S, and H are constant. TC is a function of Q.
30 Economic Order Quantity (3) Let Q* be the economic order quantity. ThenFor Q*, annual order cost = annual inventory cost
31 Simple Reorder Point Use this method when daily demand is constant. R = reorder pointd = daily demand (may have to compute this)L = lead time (Caution: if lead time is given in weeks, convert this to days. A week may be 5, 6, or 7 days).R = dL
32 Reorder Point with Safety Stock Safety stock (SS) is extra inventory that is kept to meet unexpected demand.Reorder point withoutsafety stockReorder pointwith safety stock
33 Reorder Point with Safety Stock (2) How much safety stock (SS) ? Service level is the probability of having enough inventory to meet demand during lead timeThe probability of a stockout is (1 - service level)Demand during lead time is normally distributed with mean and standard deviation sdL
34 Reorder Point with Safety Stock (2) How much safety stock (SS) ? z is the number of standard deviations required to meet the desired service levelSS = zsdLReorder point with safety stock: R = zsdL
35 Reorder Point with Safety Stock Example GivenD = annual demand = 10,000N = number of business days per year = 250The company operates 5 days per week= average daily demandsdL = standard deviation of demand during lead time = 20L = lead time = 1 weekService level = 96%Find: reorder point with safety stock: R = zsdL
36 Computing Reorder Point with Safety Stock If average daily demand ( ) is not given, compute it.Note: = D/N and D == 10,000/250 = 40If the lead time is given in weeks or months, compute lead time in days.L = 1 week = 1(5) = 5 daysNote: 1 week is the number of days per week that the company operates. This may be 5, 6, or 7.
37 Computing Reorder Point with Safety Stock (2) Find the z value for the service level (96%)Appendix B givesthis area.Probability ofa stockout =1 – servicelevel = 4%50%46%z
38 Computing Reorder Point with Safety Stock (3) Find the z value for the service level (96%) (cont.)(a) Write the service level as a decimal96% =(b) Subtract from the service level– =(c) Use the table in Appendix B, page 652, to find the area that is closest toThe closest area in the table is , which occurs when z = 1.75Use z = 1.75
39 Computing Reorder Point with Safety Stock (4) Compute RR = L+ zsdL= 40(5) (20) == 235Note: If the computation gives a fractional value, round up to nearest integer.Example: Computed R = R = 211
40 Economic Production Quantity Key question: How many units of a part or product should be made at one time?The economic production quantity (EPQ) is the production quantity (lot size) that minimizes the total annual cost of setups and holding inventory.
41 Economic Production Quantity (2) Notation Q = Amount to make (lot size)D = annual demand for the itemd = daily demand for the itemp = daily production rateS = cost of one setupH = inventory holding cost per unit per year(commonly called holding cost)TC = annual cost of setups+ annual cost of holding inventoryThe EPQ is the quantity that minimizes TC
42 Economic Production Quantity (3) Assumption: Daily demand < daily production.When the item is being made, some is sold or used tomake a product. The remainder goes into inventory.When production stops, the inventory is used untilthere is no inventory left. Then production resumes.Ending inventory= beginninginventory+ production- sales or usage
43 Economic Production Quantity (4) Length of production run = Q/pDuring production, d units are sold or used each day. (p – d) units go into inventory.Maximum inventory:Total cost:Economic productionquantity (EPQ):
44 EOQ vs. EPQ When to use economic order quantity (EOQ): Demand is independentCompute how much to order (order quantity)When to use economic production quantity (EPQ):Parts or products will be produced: demand is dependentCompute how much to make at one time (production lot size)