1. Operations Management Inventory Management Chapter 12
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2. Outline GLOBAL COMPANY PROFILE: AMAZON.COM FUNCTIONS OF INVENTORY
Types of Inventory
INVENTORY MANAGEMENT
ABC Analysis
Record Accuracy
Cycle Counting
Control of Service Inventories
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3. Outline - Continued INVENTORY MODELS
Independent versus Dependent Demand
Holding, Ordering, and Setup Costs
INVENTORY MODELS FOR INDEPENDENT DEMAND
Basic Economic Order Quantity (EOQ) Model
Minimizing Costs
Reorder Points
Production Order Quantity Model
Quantity Discount Models
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4. Outline - Continued PROBABILISTIC MODELS WITH CONSTANT LEAD TIME
FIXED PERIOD (P) SYSTEMS
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5. Learning Objectives
When you complete this chapter, you should be able to :
Identify or Define:
ABC analysis
Record accuracy
Cycle counting
Independent and dependent demand
Holding, Ordering, and Setup Costs
Describe or Explain:
The functions of inventory and basic inventory models
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6. AMAZON.com
Jeff Bezos, in 1995, started AMAZON.com as a “virtual” retailer – no inventory, no warehouses, no overhead; just a bunch of computers.
Growth forced AMAZON.com to excel in inventory management!
AMAZON is now a worldwide leader in warehouse management and automation.
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7. Order Fulfillment at AMAZON
You order items;, computer assigns your order to distribution center [closest facility that has the product(s)]
Lights indicate products ordered to workers who retrieve product and reset light.
Items placed in crate with items from other orders, and crate is placed on conveyor. Bar code on item is scanned 15 times – virtually eliminating error.
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8. Order Fulfillment at AMAZON- Continued
Crates arrive at central point where items are boxed and labeled with new bar code.
Gift wrapping done by hand (30 packages per hour)
Box is packed, taped, weighed and labeled before leaving warehouse in a truck.
Order appears on your doorstep within a week
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9. What is Inventory? Stock of materials Stored capacity Examples
© 1995 Corel Corp.
While most students recognize inventory as a “stock of material,” the notion of inventory as a “stored capacity” probably merits explicit discussion.
© T/Maker Co.
© T/Maker Co.
© 1995 Corel Corp.
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10. 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.
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11. 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.
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12. The Material Flow Cycle
This slide illustrates the overall material flow cycle. You should stress the proportion of time material spends as inventory as opposed to being actually worked on; and note that this suggests effective inventory management and materials movement can reduce overall cycle time significantly.
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13. 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.
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14. Inventory Classifications
Process stage
Demand Type
Number & Value
Other
Raw Material
WIP
Finished Goods
Independent Dependent
A Items B Items C Items
Maintenance Operating
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15. The Material Flow Cycle
Wait
Time
Move
Time
Queue
Time
Setup
Time
Run
Time
Other
Input
Output
Cycle Time
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.
This slide provides a more detailed view of the material flow cycle. Students might be asked to comment on the impact of each element on the overall time. Questions such as:
- why do we need these times?
- how can they be reduced?
- would we wish to eliminate these elements entirely?
might be helpful.
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16. 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?
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17. Classifying Items as ABC20 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
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18. 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)
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19. 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
An element to stress about cycle counting is that it usually identifies problems and enables action to be taken in a reasonable amount of time.
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20. 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
Here you might ask students to consider the problem of inventory in organizations which provide primarily personal services (hospital, doctor, Merry Maids, college or university).
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21. 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
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22. 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
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23. 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?
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24. Inventory Holding Costs (Approximate Ranges)
Cost as a
% of Inventory Value 6%
(3 - 10%) 3%
( %)
(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
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25. Ordering Costs Supplies Forms Order processing Clerical support Etc.
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26. Setup Costs Clean-up costs Re-tooling costs Adjustment costs Etc.
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27. 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.
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28. 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.
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29. 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.
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30. 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
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31. 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
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32. 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
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33. 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.
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34. 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.
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35. 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.
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36. The Reorder Point (ROP) CurveQ*
ROP (Units)
Slope = units/day = d
Lead time = L
Time (days)
Inventory level (units)
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37. 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
One way to approach this is as an EOQ model with the instantaneous replenishment assumption relaxed. The following slide (EOQ Model modified to show changes for POQ) allows you to do this if you wish. Otherwise, skip it and move on.
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38. EOQ POQ Model When To Order
Time
Inventory Level
Both production and usage take place
Usage only takes place
Maximum inventory level
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39. EOQ POQ Model When To Order
Inventory Level
Average Inventory
Optimal Order Quantity (Q*)
Reorder Point (ROP)
Time
Lead Time
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40. Reasons for Variability in Production
Most variability is caused by 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
inaccurate engineering drawings or specifications
production personnel try to produce before drawings or specifications are complete
customer demands are unknown
You should either provide concrete examples of the causes noted, or ask that students do so.
You should also explicitly discuss the relevance of this variability to the POQ model.
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41. POQ Model Inventory Levels
Time
Supply Begins
Supply Ends
Production portion of cycle
Demand portion of cycle with no supply
Given that students recognize that production takes place for only a portion of the cycle, you might ask how one determines the appropriate length of the production period. If they understand the model, they will perceive that the production period is determined by the POQ.
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42. 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
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43. Maximum inventory level
POQ Model Equations
2*D*S
Optimal Order Quantity = Q * = ( ) p d H* 1 - p ( ) - d p
Maximum inventory level * = 1 Q
D = Demand per year
S = Setup cost
H = Holding cost
d = Demand per day
p = Production per day D = * S
Setup Cost
Here again, it may be helpful to actually go through a numerical example, but it will probably be necessary to explain in detail the meaning and significance of each equation Q ( ) d =
Holding Cost
0.5 * H * Q 1 - p
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44. 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
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45. 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
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46. Quantity Discount – How Much to Order
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47. 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.
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48. 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
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49. 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.
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50. 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
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51. Fixed Period Model When to Order?
Time
Inventory Level
Target maximum
Period
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