PRODUCTION AND OPERATIONS MANAGEMENT Ch.13: Inventory Management POM - J. Galván

Learning Objectives Explain what inventory is Explain how inventory is classified Explain ABC Analysis and Cycle Counting Compare inventory models Use inventory models to find how much and when to order POM - J. Galván 4

What is Inventory? Stock of materials Stored capacity Examples © 1995 Corel Corp. © 1998 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle River, N.J. 07458 © 1995 Corel Corp. POM - J. Galván 7

The Functions of Inventory Provide a stock of goods to meet anticipated customer demand and provide a “selection” of goods Decouple suppliers from production and production from distribution Allow one to take advantage of quantity discounts To provide a hedge against inflation To protect against shortages due to delivery variation To permit operations to continue smoothly with the use of “work-in-process” POM - J. Galván 8

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 POM - J. Galván 9

Types of Inventory Raw material Work-in-process Maintenance/repair/operating supplies Finished goods POM - J. Galván 10

Inventory Classifications Process stage Number & Value Demand Type Other Raw Material WIP Finished Goods A Items B Items C Items Maintenance Dependent Operating Independent Dependent POM - J. Galván 11

The Material Flow Cycle Other Wait Time Move Queue Setup Run Input Cycle Time Output Run time: Job is at machine and being worked on Setup time: Job is at the work station, and the work station is being "setup." Queue time: Job is where it should be, but is not being processed because other work precedes it. Move time: The time a job spends in transit Wait time: When one process is finished, but the job is waiting to be moved to the next work area. Other: "Just-in-case" inventory. POM - J. Galván 12

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 POM - J. Galván 13

Classifying Items as ABC 20 40 60 80 100 50 150 % of Inventory Items % Annual $ Usage A B C Class % $ Vol % Items 15 30 5 55 POM - J. Galván 14

ABC Analysis Percentage of dollar value Percentage of items 100 — 90 — 80 — 70 — 60 — 50 — 40 — 30 — 20 — 10 — 0 — Class C Class B Class A Percentage of dollar value 10 20 30 40 50 60 70 80 90 100 Percentage of items

Cycle Counting Physically counting a sample of total inventory on a regular basis Used often with ABC classification A items counted most often (e.g., daily) POM - J. Galván 15

Advantages of Cycle Counting Eliminates shutdown and interruption of production necessary for annual physical inventories Eliminates annual inventory adjustments Provides trained personnel to audit the accuracy of inventory Allows the cause of errors to be identified and remedial action to be taken Maintains accurate inventory records POM - J. Galván 16

Techniques for Controlling Service Inventory Include: Good personnel selection, training, and discipline Tight control of incoming shipments Effective control of all goods leaving the facility POM - J. Galván 17

Independent versus Dependent Demand Independent demand - demand for item is independent of demand for any other item Dependent demand - demand for item is dependent upon the demand for some other item POM - J. Galván 18

Holding, Ordering, and Setup 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 POM - J. Galván 19

Holding Costs Obsolescence Insurance Extra staffing Interest Pilferage Damage Warehousing Etc. POM - J. Galván 20

Determining Inventory Holding Costs Category Housing costs Material handling costs Labor cost from extra handling Investment costs Pilferage, scrap, and obsolescence Cost as a % of Inventory Value 6% (3 - 10%) 3% (1 - 3.5%) (3 - 5%) 11% (6 - 24%) (2 - 5%) POM - J. Galván 21

Ordering Costs Supplies Forms Order processing Clerical support Etc. POM - J. Galván 22

Setup Costs Clean-up costs Re-tooling costs Adjustment costs Etc. 23 POM - J. Galván 23

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! © 1984-1994 T/Maker Co. POM - J. Galván 24

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 POM - J. Galván 25

EOQ Model How Much to Order? Annual Cost Total Cost Curve Holding Cost Curve Order (Setup) Cost Curve Order Quantity Optimal Order Quantity (Q*) POM - J. Galván 26

Why Holding Costs Increase More units must be stored if more ordered Purchase Order Description Qty. Microwave 1000 Order quantity Purchase Order Description Qty. Microwave 1 Order quantity POM - J. Galván 27

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 $ 0.32) 1000 Orders (Postage $320) Order quantity 1000 POM - J. Galván 28

Average Inventory (Q*/2) EOQ Model When To Order Reorder Point (ROP) Time Inventory Level Average Inventory (Q*/2) Lead Time Optimal Order Quantity (Q*) POM - J. Galván 29

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 POM - J. Galván 30

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 POM - J. Galván 31

Production Order Quantity Model Answers how much to order and when to order Allows partial receipt of material Other EOQ assumptions apply Suited for production environment Material produced, used immediately Provides production lot size Lower holding cost than EOQ model POM - J. Galván 32

Reasons for Variability in Production Most variability is caused by tolerating waste or by poor management. Specific causes include: employees, machines, and suppliers produce units that do not conform to standards, are late or are not the proper quantity engineering drawings or specifications are inaccurate production personnel try to produce before drawings or specifications are complete customer demands are unknown POM - J. Galván 33

POQ Model Inventory Levels Time Supply Begins Supply Ends Production portion of cycle Demand portion of cycle with no supply POM - J. Galván 34

POQ Model Inventory Levels Inventory level with no demand Max. Inventory Q·(1- d/p) Production Portion of Cycle Q* Time Supply Begins Supply Ends Demand portion of cycle with no supply POM - J. Galván 35

( ) POQ Model Equations = - * Q H* d p D S 1 0.5 * H * Q 2*D*S Optimal Order Quantity Max. Inventory Level Setup Cost Holding Cost = - * Q H* d p D S 1 ( 0.5 * H * Q ) 2*D*S D = Demand per year S = Setup cost H = Holding cost d = Demand per day p = Production per day POM - J. Galván 36

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 POM - J. Galván 37

Quantity Discount Model How Much to Order? Order Quantity Total Cost TC for Discount 1 Discount Quantity 1 TC for Discount 2 TC for Discount 3 Discount Quantity 2 Quantity Ordered Price 1 Price 2 Price 3 Lowest cost not in discount range POM - J. Galván 38

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 POM - J. Galván 39

Probabilistic Models When to Order? Service Level Freq Inventory Level P(Stockout) Optimal Order Quantity X SS Reorder Point (ROP) ROP Safety Stock (SS) Place order Receive order Time Lead Time POM - J. Galván 32 40

Probabilistic Models When to Order Reorder Point (ROP) Safety Stock (SS) Time Inventory Level Optimal Order Quantity SS ROP Service Level P(Stockout) Freq Lead Time Place order Receive order POM - J. Galván 41

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 POM - J. Galván 42

Fixed Period Model When to Order? Time Inventory Level Target maximum Period POM - J. Galván 43