1. CHAPTER
Inventory Management

2. After studying this chapter, you should be able to:
Objectives
1. Describe the traditional inventory management model.
2. Discuss JIT inventory management.
3. Explain the theory of constraints, and tell how it can be used to manage inventory.
After studying this chapter, you should be able to:

3. Inventory Costs
1. Ordering costs are the costs of placing and receiving an order.
2. Setup costs are the costs of preparing equipment and facilities so they can be used to produce a particular product or component.
3. Carrying costs are the costs of carrying inventory.

4. Traditional Reasons for Carrying Inventory
1. To balance ordering or setup costs and carrying costs.
2. To satisfy customer demand.
3. To avoid shutting down manufacturing facilities because of machine failure, defective parts, unavailable parts, or late delivery of parts.
4. To buffer against unreliable production processes.
5. To take advantage of discounts.
6. To hedge against future price increases.

5. The Appropriate Inventory Policy
Two Basic Questions Must be Addressed
How much should be ordered or produced?
When should the order be placed or the setup be performed?

6. The Traditional Inventory Model
Total Costs = Ordering costs + Carrying costs
TC = PD/Q + CQ/2
Where TC = The total ordering (or setup) and carrying costs
P = The cost of placing and receiving an order (or the cost of setting up a production run)
Q = The number of units ordered each time an order is placed
D = The known annual demand
C = The cost of carrying one unit of stock for one year 7

7. The Traditional Inventory Model
Economic order quantity (EOQ)
=  2PD/C
D = 10,000 units
Q = 1,000 units
P = $25 per order
C = $2 per unit

8. The Traditional Inventory Model
EOQ =  ($2 x $25 x 10,000)/2
EOQ =  250,000
EOQ = 500 units 8

9. Reorder Point Reorder point = Rate of usage x Lead time
Demand is Certain
Reorder point = Rate of usage x Lead time
Example: The producer uses 50 parts per day and that the lead time is 4 days.
Reorder point = 4 x 50 = 200 units
Thus, an order should be placed when inventory drops to 200 units.

10. Reorder Point Demand is Certain Inventory (units) (EOQ) 500 400 300
200
100
(ROP)
Days

11. Reorder Point
Safety Stock
If the refrigerator part was used at a rate of 60 parts a day instead of 50, the firm would use 200 parts after three and one-third days. The safety stock is determined as follows:
Maximum usage 60
Average usage 50
Difference 10
Lead time x4
Safety stock 40

12. Reorder Point ROP = (Average rate of usage x Lead time) + Safety stock
ROP = (50 x 4) + 40
ROP = 240 units

13. A Manufacturing Example
The manager of Benson Company is trying to determine the size of the production runs for the blade fabrication. The controller supplies the following information:
Average demand for blades 320 per day
Maximum demand for blades 340 per day
Annual demand for blades 80,000
Unit carrying cost $5
Setup cost $12,500
Lead time 20 days

14. A Manufacturing Example
EOQ =
2PD C 
2 x 80,000 x 2,500 = 5 
400,000,000 =
= 20,000 blades

15. A Manufacturing Example
Maximum usage 340
Average usage 320
Difference 20
Lead time x20
Total safety stock 400
Reorder point = (Average usage x Lead time) + Safety stock
= (320 x 20) + 400
= 6,800 units

16. Traditional Inventory Systems
Push-through system
Significant inventories
Large supplier base
Short-term supplier contracts
Departmental structure
Specialized labor
Centralized services
Low employee involvement
Supervisory management style
Acceptable quality level
Driver tracing dominates 11

17. Traditional Manufacturing LayoutB 
Welding Equipment
Department 3
Department. 1
Lathes
Abrasive Grinders A B
Department 2
Product A
Product B
Each process passes through departments that specialize in one process.
Finished Product A
Finished Product B

18. JIT Inventory Systems Pull-through system Insignificant inventories
Small supplier base
Long-term supplier contracts
Cellular structure
Multiskilled labor
Decentralized services
High employee involvement
Facilitating management style
Total quality control
Direct tracing dominates

19. JIT Inventory Systems JIT has two strategic objectives:
To increase profits
To improve a firm’s competitive positions

20. JIT Manufacturing Layout
Cell A
Cell B
Grinder
Grinder 
Welding 
Welding
Lathe
Product A
Lathe
Product B
Finished Product
Finished Product

21. JIT And Inventory Management
Setup and Carrying Costs: The JIT Approach
JIT And Inventory Management
JIT reduces the costs of acquiring inventory to insignificant levels by:
1. Drastically reducing setup time
2. Using long-term contracts for outside purchases
Carrying costs are reduced to insignificant levels by reducing inventories to insignificant levels

22. JIT And Inventory Management
Due Date Performance: The JIT Solution
JIT And Inventory Management
Lead times are reduced so that the company can meet requested delivery dates and to respond quickly to customer demand.
Lead times are reduced by:
reducing setup times
improving quality
using cellular manufacturing

23. Avoidance of Shutdown: The JIT Approach JIT And Inventory Management
Total preventive maintenance to reduce machine failures
Total quality control to reduce defective parts
Cultivation of supplier relationships to ensure availability of quality raw materials and subassemblies
The use of the Kanban system is also essential

24. What is the Kanban System?
A Card System is used to monitor work-in-process
A withdrawal Kanban
A production Kanban
A vendor Kanban 12

25. Withdrawal Kanban Item No.___________________ _____________
Item Name_________________ _____________
Computer Type_____________ _____________
Box Capacity_______________ _____________
Box Type__________________ _____________
15670T07
Processing Process
Circuit Board
CB Assembly
TR6547 PC 8
Subsequent Process C
Final Assembly 13

26. Production Kanban Item No.___________________ _____________
Item Name_________________ _____________
Computer Type_____________
Box Capacity_______________
Box Type__________________
15670T07
Process
Circuit Board
CB Assembly
TR6547 PC 8 C

27. Vendor Kanban Item No.___________________
Item Name_________________ _____________
Box Capacity_______________
Box Type__________________
Time to Deliver
Name of Supplier
15670T08
Name of Receiving Co.
Computer Casing
Electro PC
Receiving Gate 8 C 75
8:30 A.M., 12:30 P.M., 2:30 P.M.
Garry Supply

28. Kanban Process CB Stores Withdrawal Store (7) (1) Lot with P-Kanban
CD Assembly
(5) Attach
W-Kanban
(1) Remove
W-Kanban
Attach to
Post
(6) Signal
Remove
(4) P-Kanban
Attach to Post
CB Stores
(2), (3)
Production
Ordering Post
Withdrawal Post
Final Assembly 16

29. JIT’s Limitations
Time is required to build sound relationships with suppliers.
Sharp reductions in inventory buffers may cause a regimented workflow and high levels of stress among production workers.
The absence of inventory to buffer production interruptions.
Current sales are placed at risk to achieve assurance of future sales.

30. JIT And Inventory Management Discounts and Price Increases: JIT Purchasing Versus Holding Inventories
Careful vendor selection
Long-term contracts with vendors
Prices are stipulated (usually producing a significant savings)
Quality is stipulated
The number of orders placed are reduced

31. Theory of Constraints Three Measures of Organizational Performance
Throughput
Inventory
Operating expenses 17

32. Five Steps to Improve Performance
Theory of Constraints
Five Steps to Improve Performance
1. Identify the organization’s constraint(s).
2. Exploit the binding constraint(s).
3. Subordinate everything else to the decisions made in Step 2.
4. Elevate the binding constraint(s).
5. Repeat the process. 18

33. Drum-Buffer-Rope System
Materials
Rope
Initial Process
Process C
Process A
Final Process
Process B
Finished Goods
Drummer
Process
Time Buffer 19

34. Drum-Buffer-Rope System
Material for 12 Parts per Day (Part X: 6 and Part Y: 6)
Confer Company
Grinding Process
Rope
Time
12 Units
Part X
Buffer
12 Units
Part Y
DRUMMER
Drilling Process
Finished Goods
6 Units Part X per Day
6 Units Part Y per Day
Polishing Process

35. Chapter Nineteen
The End