Inventory Management

 Inventory is one of the most expensive assets of many companies.  It represents as much as 60% of total invested capital. Inventory Management

 Inventory is any stored resource that is used to satisfy a current or future need.  Raw materials, work-in-process, and finished goods are examples of inventory.

Why do we hold Inventory?  Improve customer service  Reduce certain costs such as ◦ ordering costs ◦ stockout costs ◦ acquisition costs  Contribute to the efficient and effective operation of the production system

Why we do not hold Inventory?  Certain costs increase such as ◦ Carrying costs, Handling cost ◦ Labor Cost ◦ Warehouse Cost ◦ Logistics Cost ◦ cost of return on investment ◦ reduced-capacity costs (Storage, warehouse) ◦ cost of production problems (Excess Inventory)

Two Fundamental Inventory Decisions  How much to order of each material when orders are placed with either outside suppliers or production departments within organizations  When to place the orders

Independent Demand Inventory Systems  Demand for an item carried in inventory is independent of the demand for any other item in inventory  Finished goods inventory is an example  Demands are estimated from forecasts and/or customer orders

Dependent Demand Inventory Systems  Items whose demand depends on the demands for other items  For example, the demand for raw materials and components can be calculated from the demand for finished goods  The systems used to manage these inventories are different from those used to manage independent demand items

Independent vs. Dependent Demand B(4)C(2) D(2)E(1) D(3)F(2) Dependent Demand (components) A Independent Demand (finished goods and spare parts)

Inventory Costs  Costs associated with ordering too much (represented by carrying costs)  Costs associated with ordering too little (represented by ordering costs)  These costs are opposing costs, i.e., as one increases the other decreases

Inventory Costs (continued)  The sum of the two costs is the total stocking cost (TSC)  This cost behavior is the basis for answering the first fundamental question: how much to order  It is known as the economic order quantity (EOQ)

Economic Order Quantities (EOQ)

Behavior of EOQ Systems  As demand for the inventoried item occurs, the inventory level drops  When the inventory level drops to a critical point, the order point, the ordering process is triggered  The amount ordered each time an order is placed is fixed or constant  When the ordered quantity is received, the inventory level increases

inventory cost Service level 100% Reorder point should balance the risks of stockouts against costs of overstocking Company needs to balance ordering costs vs inventory carrying costs Inventory v/s Service levels

Economic Order Quantities  Typical assumptions made ◦ annual demand (D), carrying cost (C) and ordering cost (S) can be estimated ◦ average inventory level is the fixed order quantity (Q) divided by 2 which implies  no safety stock  orders are received all at once  demand occurs at a uniform rate  no inventory when an order arrives

Example of EOQ Zartex Co. produces fertilizer to sell to wholesalers. One raw material – calcium nitrate – is purchased from a nearby supplier at $22.50 per ton. Zartex estimates it will need 5,750,000 tons of calcium nitrate next year. The annual carrying cost for this material is 40% of the acquisition cost, and the ordering cost is $595. a) What is the most economical order quantity? b) How many orders will be placed per year?

 Economical Order Quantity (EOQ) D = 5,750,000 tons/year C =.40(22.50) = $9.00/ton/year S = $595/order EOQ= √2DS/C EOQ=√2( )(595)/9.00 (27, ) tons per order

ABC Classification of Inventory  Typical observations ◦ A small percentage of the items (Class A) make up a large percentage of the inventory value ◦ A large percentage of the items (Class C) make up a small percentage of the inventory value  These classifications determine how much attention should be given to controlling the inventory of different items

Copyright 2006 John Wiley & Sons, Inc.18  Class A ◦ 5 – 15 % of units ◦ 70 – 80 % of value  Class B ◦ 30 % of units ◦ 15 % of value  Class C ◦ 50 – 60 % of units ◦ 5 – 10 % of value ABC Classification

Copyright 2006 John Wiley & Sons, Inc.21 1$ PARTUNIT COSTANNUAL USAGE Supply Chain Management

Copyright 2006 John Wiley & Sons, Inc.22 Example $ PARTUNIT COSTANNUAL USAGE TOTAL% OF TOTAL% OF TOTAL PARTVALUEVALUEQUANTITY% CUMMULATIVE 9$30, , , , , , , , , , $85,400 AB C % OF TOTAL CLASSITEMSVALUEQUANTITY A9, 8, B1, 4, C6, 5, 10, Supply Chain Management

 In ABC classification, items kept in inventory are not of equal importance in terms of: ◦ dollars invested ◦ profit potential ◦ sales or usage volume ◦ stock-out penalties

Dynamics of Inventory Planning  Continually review ordering practices and decisions  Modify to fit the firm’s demand and supply patterns  Constraints, such as storage capacity and available funds, can impact inventory planning  Computers and information technology are used extensively in inventory planning