BUAD306 Chapter 13 - Inventory Management

Everyday Inventory Food Gasoline Clean clothes… What else?

Inventory Stock or quantity of items kept to meet demand Takes on different forms Final goods Raw materials Purchased/component parts Labor In-process materials Working capital

Inventory Static – only one opportunity to buy and sell units Dynamic – ongoing need for units; reordering must take place

Demand Dependent Demand Items are used internally to produce a final product Independent Demand Items are final products demanded by external customers

Reasons To Hold Inventory To meet anticipated demand To smooth production requirements To decouple components of the production- distribution system To protect against stock-outs To take advantage of order cycles To hedge against price increases or to take advantage of quantity discounts To permit operations

Inventory Costs Carrying Costs - Storage, warehousing, insurance, security, taxes, opportunity cost, depreciation, etc. Ordering Costs - Determining quantities needed, preparing documentation, shipping, inspection of goods, etc. Stockout Costs – Temporary or permanent loss of sales / goodwill when demand cannot be met

Inventory Management Objective: To keep enough inventory to meet customer demand AND also be cost-effective Goal: To determine the amount of inventory to keep in stock - how much to order AND when to order How much and when to order inventory?

Inventory Management Requirements A system to keep track of the inventory on hand and on order A reliable forecast of demand Knowledge of lead times Reasonable estimates of inventory costs A classification system for inventory items (ABC)

Inventory Control Systems Control the level of inventory by determining how much to order and when Continuous (Perpetual) Inventory System - a continual record of the inventory level for every item is maintained Periodic Inventory System - inventory on hand is counted at specific time intervals

Other Control Systems/Tools Universal Product Codes (UPC) RFID Tags Two-Bin System – two containers of inventory; reorder when the first is empty

Considerations Lead Time Time interval between ordering and receiving the order Cycle Counting Physical count of items in inventory Usage Rate Rate at which amount of inventory is depleted

Inventory Cycle Profile of Inventory Level Over Time Quantity on hand Q Receive order Place order Receive order Place order Receive order Lead time Reorder point Usage rate Time

Economic Order Quantity The EOQ Model determines the optimal order size that minimizes total inventory costs

Optimal Order Quantity Q = 2DS H = 2 (Annual Demand) (Order Cost) Annual Holding Cost per unit o QoDQoD Length of order cycle = DQoDQo # Orders / Year =

Basic EOQ Model Annual carrying cost Annual ordering cost Total cost =+ QoQo 2 H D QoQo S TC = + Where: Q o = Economic order quantity in units H = Holding (carrying) cost per unit D = Demand, usually in units per year S = Ordering cost

Cost Minimization Goal The Total-Cost Curve is U-Shaped Ordering Costs QOQO Order Quantity (Q) Annual Cost ( optimal order quantity) Carrying Costs

EOQ Example 1 A local office supply store expects to sell 2400 printers next year. Annual carrying cost is $50 per printer, and ordering cost is $30. The company operates 300 days a year. A) What is the EOQ? B) How many times per year does the store reorder? C) What is the length of an order cycle? D) What is the total annual cost if the EOQ quantity is ordered?

EOQ Example 2 A local electronics store expects to sell 500 flat-screen TVs each month during next year. Annual carrying cost is $60 per TV, and ordering cost is $50. The company operates 364 days a year. A) What is the EOQ? B) How many times per year does the store reorder? C) What is the length of an order cycle? D) What is the total annual cost if the EOQ quantity is ordered?

Quantity Discounts A price discount on an item if predetermined numbers of units are ordered TC = Carrying cost + Ordering cost + Purchasing cost = (Q / 2) H + (D / Q) S + PD where P = Unit Price

Quantity Discount Example Campus Computers 2Go Inc. wants to reduce a large stock of laptops it is discontinuing. It has offered the University Bookstore a quantity discount pricing schedule as shown below. Given the discount schedule and its known costs, the bookstore wants to determine if it should take advantage of this discount or order the basic EOQ order size. QuantityPrice 1 – 49$1, – 89$1, $800 Carrying Cost:$200 Ordering Cost$1,000 Annual Demand400 units

EPQ – Economic Production Quantity (OQ with Incremental Replenishment) Used when company makes its own product Considers a variety of costs/terms: Carrying Cost Setup Cost (analogous to ordering costs) Maximum and Average Inventory Levels Economic Run Quantity Cycle Time Run Time

EOQ with Incremental Replenishment (EPQ) Definitions S = Setup Cost H = Holding Cost I max = Maximum Inventory I avg = Average Inventory D = Demand/Year p = Production or Delivery Rate u = Usage Rate

EOQ with Incremental Replenishment Total Cost = Carrying Cost + Setup Cost (I max /2) H + (D/Q o ) S Economic run quantityQ o = 2DS/H * p/(p-u) Cycle time (time between runs) Q o /u Run time (production phase) Q o /p Maximum Inventory LevelI max = (Q o /p)(p-u) Average Inventory LevelI average = I max /2

Assumptions Only one item is involved Annual demand is known Usage rate is constant Usage occurs continually, production periodically Production rate is constant Lead time doesn’t vary No quantity discounts

EOQ Replenishment Example A toy manufacturer uses 48,000 rubber wheels per year for its product. The firm makes its own wheels, which it can produce at a rate of 800 per day. The toy trucks are assembled uniformly over the entire year. Carrying cost is $1 per wheel a year. Setup cost for a production run of wheels is $45. The firm operates 240 days per year. Determine the: Optimal run size Minimum total annual cost for carrying and setup Cycle time for the optimal run size Run time

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Other Considerations Safety Stock Reorder Point Seasonality

HW #13 A mail-order house uses 18,000 boxes a year. Carrying costs are $.60 per box per year and ordering costs are $96. The following price schedule is offered. Determine the EOQ and the # of orders per year. # BoxesUnit Price $ $ $ $1.10