Operations Management Chapter 4 – Inventory Management PowerPoint presentation to accompany Heizer/Render Principles of Operations Management, 7e Operations Management, 9e

The Functions of Inventory To ”decouple” or separate various parts of the production process To provide a stock of goods that will provide a “selection” for customers To take advantage of quantity discounts To hedge against inflation and upward price changes If this course is the first exposure of students to manufacturing, it might be useful to discuss the decoupling function. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Types of Inventory Raw material Work-in-progress Maintenance/repair/operating supply Finished goods It might be useful here to explicitly discuss the purpose of each type of inventory. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Disadvantages of Inventory Higher costs Item cost (if purchased) Ordering (or setup) cost Costs of forms, clerks’ wages etc. Holding (or carrying) cost Building lease, insurance, taxes etc. Difficult to control Hides production problems Of the items listed on this slide, the least obvious to most students is the manner in which inventory can be used to hide production problems. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

ABC Analysis Divides on-hand inventory into 3 classes A class, B class, C class Basis is usually annual $ volume $ volume = Annual demand x Unit cost Policies based on ABC analysis Develop class A suppliers more Give tighter physical control of A items Forecast A items more carefully It might be helpful here to discuss some of the differences in the ways we would manage items in the three different levels. What actions would we actually take in managing A versus in managing C? Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Classifying Items as ABC 20 40 60 80 100 50 % Annual $ Usage A B C Class % $ Vol % Items 15 30 5 55 Are we back to Pareto analysis? % of Inventory Items Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Inventory Costs Holding costs - associated with holding or “carrying” inventory over time Ordering costs - associated with costs of placing order and receiving goods Setup costs - cost to prepare a machine or process for manufacturing an order Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Holding (Carrying) Costs Obsolescence Insurance Extra staffing Interest Pilferage Damage Warehousing Etc. You might ask students if they can identify an industry for which the cost of obsolescence is particularly important. Is the number of such industries likely to grow or decline? The same question could be asked regarding pilferage. The question could be asked in a more general manner: Are there industries for which one or another of the areas listed is of particular or unusual importance? Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Inventory Holding Costs (Approximate Ranges) Cost as a % of Inventory Value 6% (3 - 10%) 3% (1 - 3.5%) (3 - 5%) 11% (6 - 24%) (2 - 5%) 26% Category Housing costs (building rent, depreciation, operating cost, taxes, insurance) Material handling costs (equipment, lease or depreciation, power, operating cost) Labor cost from extra handling Investment costs (borrowing costs, taxes, and insurance on inventory) Pilferage, scrap, and obsolescence Overall carrying cost Note that this slide suggest holding costs are, on average, about 26% of the inventory value Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Ordering Costs Supplies Forms Order processing Clerical support Etc. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Setup Costs Clean-up costs Re-tooling costs Adjustment costs Etc. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Inventory Models Fixed order-quantity models Probabilistic models Economic order quantity Production order quantity Quantity discount Probabilistic models Fixed order-period models Help answer the inventory planning questions! This slide simply introduces some of the available models. Additional details are provided in subsequent slides. © 1984-1994 T/Maker Co. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

EOQ Assumptions Known and constant demand Known and constant lead time Instantaneous receipt of material No quantity discounts Only order (setup) cost and holding cost No stockouts Students should be asked to consider the degree to which each of these assumptions is accurate. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Inventory Usage Over Time Inventory Level Average Inventory (Q*/2) Minimum inventory Order quantity = Q (maximum inventory level) Usage Rate One should link this model to the assumptions. You should also explore, at least briefly, how this picture would change if the assumptions were not met. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

EOQ Model How Much to Order? Order quantity Annual Cost Holding Cost Curve Total Cost Curve Order (Setup) Cost Curve Optimal Order Quantity (Q*) Minimum total cost Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Why Holding Costs Increase More units must be stored if more are ordered Purchase Order Description Qty. Microwave 1000 Order quantity Purchase Order Description Qty. Microwave 1 Order quantity Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Why Order Costs Decrease Cost is spread over more units Example: You need 1000 microwave ovens Purchase Order Description Qty. Microwave 1 1 Order (Postage $ 0.33) 1000 Orders (Postage $330) Order quantity 1000 Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Deriving an EOQ Develop an expression for setup or ordering costs Develop an expression for holding cost Set setup cost equal to holding cost Solve the resulting equation for the best order quantity Students may find it helpful if you actually go through each of these steps - at least through writing the equation, and setting setup cost equal to holding cost. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

EOQ Model When To Order Inventory Level Time Average Inventory (Q*/2) Reorder Point (ROP) Time Inventory Level Average Inventory (Q*/2) Lead Time Optimal Order Quantity (Q*) One should link this model to the assumptions. You should also explore, at least briefly, how this picture would change if the assumptions were not met. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

EOQ Model Equations = × Q* D S H N T d ROP L 2 Optimal Order Quantity Expected Number of Orders Expected Time Between Orders Working Days / Year = × Q* D S H N T d ROP L 2 D = Demand per year S = Setup (order) cost per order H = Holding (carrying) cost d = Demand per day L = Lead time in days For some students, it is most important at this point to explain in detail the meaning and significance of each equation. It might be helpful to actually work through a numerical example. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

The Reorder Point (ROP) Curve Q* ROP (Units) Slope = units/day = d Lead time = L Time (days) Inventory level (units) Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Quantity Discount Model Answers how much to order & when to order Allows quantity discounts Reduced price when item is purchased in larger quantities Other EOQ assumptions apply Trade-off is between lower price & increased holding cost Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Quantity Discount Schedule Discount Number Discount Quantity Discount (%) Discount Price (P) 1 0 to 999 No discount $5.00 2 1,000 to 1,999 4 $4.80 3 2,000 and over 5 $4.75 Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Quantity Discount – How Much to Order Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Probabilistic Models Answer how much & when to order Allow demand to vary Follows normal distribution Other EOQ assumptions apply Consider service level & safety stock Service level = 1 - Probability of stockout Higher service level means more safety stock More safety stock means higher ROP One point to stress here is that this is simply an extension of the original EOQ model where we are now allowing the demand to vary. Students should become accustomed to seeking such extensions as the need arises. The next slide presents a graphical view of this model. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Probabilistic Models When to Order? Reorder Point (ROP) Optimal Order Quantity X Safety Stock (SS) Time Inventory Level Lead Time SS ROP Service Level P(Stockout) Place order Receive order Frequency Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 32

Fixed Period Model Answers how much to order Orders placed at fixed intervals Inventory brought up to target amount Amount ordered varies No continuous inventory count Possibility of stockout between intervals Useful when vendors visit routinely Example: P&G representative calls every 2 weeks This represents a model in which orders are based upon time, not the quantity needed. The following slide provides a graphical representation. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Inventory Level in a Fixed Period System Various amounts (Qi) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum p Q1 Q2 Q3 Q4 Target maximum Time On-Hand Inventory Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Fixed Period Model When to Order? Time Inventory Level Target maximum Period Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5e, and Operations Management, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458