12-1 Managing Inventory and and Supply Chain Chapters 12 & 11

12-2 The Functions of Inventory  To ”decouple” or separate various parts of the production process.  To smooth production (link supply and demand).  To provide goods for customers (quick response).  To take advantage of quantity discounts.  Buy more to get a reduced price.  To hedge against inflation and upward price changes (speculation).  Buy more now if you think price will rise.

12-3  Sort products from largest to smallest annual $ volume.  Divide into A, B and C classes.  Focus on A products.  Develop class A suppliers more.  Give tighter physical control of A items.  Forecast A items more carefully.  Consider B products only after A products. ABC Analysis

% of Products Classifying Items as ABC A B C 0 Annual $ Usage (x1000) Class% $ Vol% Items A39% 12% (3/25) B52%40% (10/25) C9%48% (12/25)

12-5 Inventory Costs  Holding costs  Holding costs - Associated with holding or “carrying” inventory over time.  Ordering costs  Ordering costs - Associated with costs of placing order and receiving goods.  Setup costs  Setup costs - Cost to prepare a machine or process for manufacturing an order.  Stockout costs  Stockout costs - Cost of not making a sale and lost future sales.

12-6  How much to order (each time)?  100 units, 50 units, units, etc.  When to order?  Every 3 days, every week, every month, etc.  When only 5 items are left, when only 10 items are left, when only 20 items are left, etc.  Many different models can be used, depending on nature of products and demand. Inventory Questions

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J  Fixed order-quantity models  Economic order quantity  Production order quantity  Quantity discount  Probabilistic models  Fixed order-period models Help answer the inventory planning questions! © T/Maker Co. Inventory Models

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J Inventory Usage Over Time Time Inventory Level Average Inventory (Q*/2) 0 Minimum inventory Order quantity = Q (maximum inventory level) Usage Rate

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J 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

12-10 = ×× EOQ = Q* DS H 2 EOQ Total Cost Optimization Total Cost = D Q S + Q 2 H Take derivative of total cost with respect to Q and set equal to zero: Solve for Q to get optimal order size: D Q 2 S H = 0

12-11 Order Quantity Annual Cost Total Cost Curve EOQ Model is Robust Small variation in cost Large variation in order size

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J EOQ Model When To Order Reorder Point (ROP) Time Inventory Level Average Inventory (Q*/2) Lead Time Optimal Order Quantity (Q*)

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J 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

12-14  Safety stock is inventory held to protect against stockout.  Service level = 1 - Probability of stockout  Service level of 95% means 5% chance of stockout.  Higher service level means more safety stock.  More safety stock means higher ROP.  ROP = Expected demand during lead time + Safety stock Safety Stock & Service Level

12-15  Material is not received instantaneously.  For example, it is produced in-house.  Other EOQ assumptions apply.  Model provides production lot size (like EOQ amount) for one product.  Similar to EOQ with setup cost rather than order cost.  Lower holding cost than EOQ model Production Order Quantity Model

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J EOQ POQ Model When To Order Reorder Point (ROP) Time Inventory Level Average Inventory Lead Time Optimal Order Quantity (Q*)

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J POQ Model Inventory Levels Time Inventory Level Production Portion of Cycle Max. Inventory Q·(1- d/p) Q* Supply Begins Supply Ends Inventory level with no demand Demand portion of cycle with no supply

12-18 Optimal Production Run Size = Maximum inventory level = Q [1- (d/p)] D = Annual demand S = Setup cost per setup H = Holding (carrying) cost per unit per year d = Demand rate p = Production rate POQ Model Equations Total Cost = D Q S +S + Q 2 H [1-(d/p)] = ×× Q* DS H[1-(d/p)] 2 = H 2DS p-d p Given

 POQ provides product as it is being used  POQ has lower inventory costs and larger lots  Ideal is to provide product Just in Time  JIT requires higher quality confidence  JIT gives fast information on production problems EOQ vs POQ (ERS)--Buy vs Make

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J Operations Management Buy vs. Make with Lean Strategy (pdf)

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J  Planning, organizing, directing, & controlling flows of materials  Begins with raw materials  Continues through internal operations  Ends with distribution of finished goods  Involves everyone in supply-chain  Example: Your supplier’s supplier  Objective: Maximize value & lower waste Supply-Chain Management

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J Consumer Retailer Manufacturing Material Flow VISA ® Credit Flow Supplier Wholesaler Retailer Cash Flow Order Flow Schedules The Supply-Chain

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J Vendor Selection Rating Form

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J  Plans to help achieve company mission  Affect long-term competitive position  Strategic options  Many suppliers  Few suppliers  Keiretsu network  Vertical integration  Virtual company Plan © 1995 Corel Corp. Supply-Chain Strategies

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J Supply-Chain Strategies  Negotiate with many suppliers; play one supplier against another  Develop long-term “partnering” arrangements with a few suppliers who will work with you to satisfy the end customer  Vertically integrate; buy the actual supplier  Keiretsu - have your suppliers become part of a company coalition  Create a virtual company that uses suppliers on an as-needed basis.

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J  Many sources per item  Adversarial relationship  Short-term  Little openness  Negotiated, sporadic PO’s  High prices  Infrequent, large lots  Delivery to receiving dock © 1995 Corel Corp. Many Suppliers Strategy

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J  1 or few sources per item  Partnership (JIT)  Long-term, stable  On-site audits & visits  Exclusive contracts  Low prices (large orders)  Frequent, small lots  Delivery to point of use © 1995 Corel Corp. Few Suppliers Strategy

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J  Japanese word for ‘affiliated chain’  System of mutual alliances and cross-ownership  Company stock is held by allied firms  Lowers need for short-term profits  Links manufacturers, suppliers, distributors, & lenders  ‘Partnerships’ extend across entire supply chain Keiretsu Network Strategy

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J © 1995 Corel Corp. Virtual Company Strategy  Network of independent companies  Linked by technology  PC’s, faxes, Internet etc.  Each contributes core competencies  Typically provide services  Payroll, editing, designing  May be long or short-term  Usually, only until opportunity is met

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J Successful Supply-Chain Management Requires:  A mutual agreement on goals  Trust  Compatible organizational cultures  “Cooperative Game”

Other Inventory Models  Quantity Discounts  Fixed Order Interval  Single Period (perishable) 12-31

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J  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 Quantity Discount Model

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J Quantity Discount Schedule Discount Number Discount Quantity Discount (%) Discount Price (P) 10 to 999No discount$ ,000 to 1,9994$ ,000 and over5$4.75

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J Quantity Discount – How Much to Order

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J  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 Fixed Period Model

Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J Inventory Level in a Fixed Period System Various amounts (Q i ) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum ppp Q1Q1Q1Q1 Q2Q2Q2Q2 Q3Q3Q3Q3 Q4Q4Q4Q4 Target maximum Time On-Hand Inventory

Single period Model  Obsolescence and spoilage  Quantity to buy depends on balance of costs:  Costs of Shortage = lost opportunities for Profit  Selling price-cost of good  Costs of Excess = leftover product  Cost of good –salvage  Optimal amount = Q = d + Zsl * Sigma (d)  Optimal Service Level = SL = Cs / (Cs +Ce) 12-37