Inventory Management

What is Inventory Management?

Inventory: A stock or store of goods. Firms typically stock many items in inventory. Many of the items a firm carries in inventory relate to the kind of business it engages in.

Independent demand is uncertain. Dependent demand is certain. Inventory Independent Demand A B(4) C(2) D(2) E(1) D(3) F(2) Dependent Demand Independent demand is uncertain. Dependent demand is certain. Inventory: a stock or store of goods

Independent demand – finished goods, items that are ready to be sold Inventory Models Independent demand – finished goods, items that are ready to be sold E.g. a computer Dependent demand – components of finished products E.g. parts that make up the computer

Examples Manufacturing firms carry supplies of raw materials, purchased parts, finished items, spare parts, tools,.... Department stores carry clothing, furniture, stationery, appliances,... Hospitals stock drugs, surgical supplies, life-monitoring equipment, sheets, pillow cases,... Supermarkets stock fresh and canned foods, packaged and frozen foods, household supplies,... Not all items in inventory are items to be sold.

The Nature and Importance of Inventories Inventories are a vital part of business Necessary for operations Contribute to customer satisfaction Inventories represent a significant portion of total assets Sale of merchandise (inventory) is a major source of revenues for retail and wholesale businesses

Types of Inventories Raw materials & purchased parts Partially completed goods called work in progress Finished-goods inventories (manufacturing firms) or merchandise (retail stores)

Types of Inventories (Cont’d) Replacement parts, tools, & supplies Goods-in-transit to warehouses or customers

Functions of Inventory To meet anticipated demand: Anticipation stock – average demand To smooth production requirements: Seasonal inventories To protect against stock-outs: Safety stock – uncertainty To take advantage of quantity discounts To help hedge against price increases 2. stock-up against seasonal demand 3. To decouple components of the production-distribution system, delay in one will not hinder the other. 4. safety stocks

Inadequate Control of Inventories Inadequate control of inventories can result in both under- and overstocking of items. Understocking (too few) results in missed deliveries, lost sales, dissatisfied customers, and production bottlenecks (idle workers or machines). Resulting underage cost. Overstocking (too many) ties up funds that might be more productive elsewhere. Resulting overage cost. In other words, the manager tries to achieve a balance in stocking. Goal: matching supply with demand!

Objective of Inventory Control To achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds Right goods, right place, right time, right quantity Inventory management has two main concerns Two fundamental decisions: When to order (timing) How much to order (size)

Performance Measures Performance measures used to judge the effectiveness of inventory management Customer satisfaction: the number and quantity of backorders, customer complaints. 2. Inventory turnover The higher, the better – more efficient use of inventory Desirable number of turns depend on industry and profit margin Indicate how many times a year the inventory is sold turnover 3. Days of inventory on-hand: the expected number of days of sales that can be supplied from existing inventory. Performance measures used to judge the effectiveness of inventory management:

Inventory Counting Systems Periodic System Physical count of items made at periodic intervals Perpetual Inventory System System that keeps track of removals from inventory continuously, thus monitoring current levels of each item

Inventory Counting Systems (Cont’d) Two-Bin System - Two containers of inventory; reorder when the first is empty Universal Bar Code - Bar code printed on a label that has information about the item to which it is attached 214800 232087768

Lead Time: Time interval between ordering and receiving the order 3. Lead Time Information Lead Time: Time interval between ordering and receiving the order - Lead time variability: the greater the potential variability, the greater the need for additional stock to reduce the risk of a shortage between deliveries

Ordering cost : Costs of ordering/producing and receiving inventory. 4. Inventory Costs Ordering cost : Costs of ordering/producing and receiving inventory. Eg. RM12 per order Unit ordering/production cost: cost of obtaining one unit of the inventory. Eg. RM 77 per item Buy stationary, Some raw materials – steel, nails, etc.

b. Holding (carrying) cost: Physically holding item in storage. 4. Inventory Costs cont. b. Holding (carrying) cost: Physically holding item in storage. interest insurance taxes depreciation obsolescence warehouse costs (heat, light, rent, security) opportunity costs Holding costs are stated in either way: a percentage of unit price a dollar amount per unit deterioration spoilage theft breakage Holding cost also include opportunity costs having funds tied up in inventory.

c. Shortage costs: Costs resulting when demand exceeds supply. 4. Inventory Costs cont. c. Shortage costs: Costs resulting when demand exceeds supply. Opportunity cost for not making a sale Loss of customer goodwill Lateness charges Cost of lost production It is often difficult to quantify shortage costs. One objective of Inventory Control is to minimize the sum of these costs by balancing them.

Replenishment Strategy -- EOQ (Basic)

Basic Economic Order Quantity Model (EOQ) Assumptions: 1. Ordering in batch from supplier. 2. Only one product is involved. 3. Constant demand rate. Demand is spread evenly throughout the year. 4. Constant lead time. Lead time does not vary much for a long enough time. 5. Single delivery for each order. 6. A single flat unit price from the supplier.

Profile of Inventory Level Over Time The Inventory Cycle Figure 11.2 Profile of Inventory Level Over Time Order/batch size Q Demand rate D Reorder point Time Receive order Place order Receive order Place order Receive order Order lead time Order cycle time

High average inventory Inventory Level vs. Order Frequency Small order Low average inventory Short order cycle time Large order High average inventory Long order cycle time

Now the Question is….. Economic order quantity (EOQ): The order size Q that minimizes total costs per unit time. Fixed ordering cost S IGD / order Unit ordering cost P IGD / unit ( P = unit price, assuming no other unit ordering cost component) Unit carrying cost H= h P IGD / time ( h = carrying cost rate for one IGD value of inventory/time) NO shortage cost here! Demand is a constant and it is always met.

H = rP = IGD80 * 0.2 = IGD16 /unit · yr Match! Example 2 Demand for a certain radial tires at a tire company is 800 units per month. Each tire costs the company IGD 80. Ordering costs are IGD 75, and the annual carrying costs are 20 percent of the purchase price. D = 800 * 12 = 9600 /yr S = IGD75 /order P = IGD80, r = 0.20 H = rP = IGD80 * 0.2 = IGD16 /unit · yr Match!

Solution to Example 2 1. How many tires should the manager order in each lot? 2. What is the company's average inventory of this tire? 3. How often will an order be placed (length of order cycle)?

Solution to Example 2 (Cont.) 4. How many times per year will an order be placed? 5. How much does the company spend annually on ordering costs? 6. How much does the company spend annually on holding (carrying) costs?

Solution to Example 2 (Cont.) 7. What is the total annual cost if the EOQ quantity is ordered? OR The ordering and carrying costs are equal at the EOQ