1. Inventory BA 339 Mellie Pullman
3/31/2017
Inventory BA 339 Mellie Pullman

2. BA 339
3/31/2017

3. Inventory Definitions
BA 339
3/31/2017
Inventory Definitions
Inventory vs. Inventory system
Dependent vs. Independent environments
Types
Safety Stock
Anticipation Inventory
Hedge inventory (unusual events)
Transportation or Pipeline Inventory 3

4. Purposes of Inventory 1. Independence of operations. 2. Variation
BA 339
3/31/2017
Purposes of Inventory
1. Independence of operations.
2. Variation
Product demand
Material Delivery Time
3. Scheduling flexibility
4. Volume Discounts
5. Material price fluctuations 4

5. Inventory Costs Holding (or carrying) costs
BA 339
3/31/2017
Inventory Costs
Holding (or carrying) costs
Setup (or production change) costs
Ordering costs.
Shortage costs. 5

6. Inventory Systems Rules to manage inventory, specifically:
BA 339
3/31/2017
Inventory Systems
Rules to manage inventory, specifically:
timing (when to order)
sizing (how much to order)
Continuous Review or Fixed-Order Quantity Models (Q)
Event triggered (Example: running out of stock)
Periodic Review or Fixed-Time Period Models (P)
Time triggered (Example: Monthly sales call by sales representative) 7

7. Comparison of Periodic and Continuous Review Systems
BA 339
3/31/2017
Comparison of Periodic and Continuous Review Systems
Periodic Review
Fixed order intervals
Variable order sizes
Convenient to administer
Inventory position only required at review
Continuous Review
Varying order intervals
Fixed order sizes (Q)
Allows individual review frequencies
Possible quantity discounts
Lower, less-expensive safety stocks

8. BA 339
3/31/2017
Inventory costs
C = Unit cost or production cost: the additional cost for each unit purchased or produced.
H = Holding costs: cost of keeping items in inventory(cost of lost capital, taxes and insurance for storage, breakage, etc., handling and storing)
S = Setup or ordering costs: a fixed cost incurred every time you place an order or a batch is produced.

9. Total costs of carrying inventory
BA 339
3/31/2017
Total costs of carrying inventory
Assumptions
demand is constant and uniform throughout the period for your products (5 cases per day)
Price per unit is constant for the period ($16/case)
Inventory holding cost is based on an average cost.
Total Inventory Policy Cost annually = annual purchase cost + annual order cost + annual holding cost

10. BA 339
3/31/2017

11. Total cost of Inventory Policy
= annual purchase cost (annual demand * Cost/item) + annual order cost (annual # orders * Cost to order) + annual holding cost (average units held*cost to carry one unit)

12. Total Inventory Cost Equation
BA 339
3/31/2017
Total Inventory Cost Equation
D = yearly demand of units
C = cost of each unit
Q = quantity ordered
S = cost to place order
H = average yearly holding cost for each unit
= storage+interest*C
D/Q = number of orders per year
Q/2 = average inventory held during a given period
assuming with start with Q and drop to zero
before next order arrives (cycle inventory).

13. Deriving the EOQ : Economic Order Quantity
BA 339
3/31/2017
Deriving the EOQ : Economic Order Quantity
Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero

14. EOQ Model--Basic Fixed-Order Quantity Model (Q)
3/31/2017
EOQ Model--Basic Fixed-Order Quantity Model (Q)
R = Reorder point
Q = Economic order quantity
L = Lead time L Q R
Time
Number
of units
on hand

15. BA 339
3/31/2017
The Reorder Point
Reorder point = (average period demand)*Lead Time periods
= d * L

16. Another EOQ Example Annual Demand = 1,000 units
BA 339
3/31/2017
Another EOQ Example
Annual Demand = 1,000 units
Days per year considered in average daily demand = 365
Cost to place an order = $10
Holding cost per unit per year = $2.50
Lead time = 7 days
Cost per unit = $15
Determine the economic order quantity & reorder point.

17. BA 339
3/31/2017
Minor Deviations Here
What causes minor deviations from the ideal order size?
Assumptions behind the regular EOQ Model?

18. Variations in lead time
BA 339
3/31/2017
Variations in lead time
If we have variations in lead time, how should we change the reorder point so we rarely run out? Reorder Point = Average demand during lead time(d*L) + safety stock (Z* sL)
where: d = average daily (or weekly) demand L = Lead time (matching days or weeks) sL = standard deviation of demand during lead time. sD = standard deviation of demand (days or weeks).

19. Service Level or % of time inventory will meet demand during lead time
BA 339
Service Level or % of time inventory will meet demand during lead time
3/31/2017
Z Value
Resulting Service Level
1.28
90%
1.65
95%
2.33
99%
3.08
99.9%

20. Example Annual Demand = 1000 units
BA 339
3/31/2017
Example
Annual Demand = 1000 units
250 work days in the year d=1000/250 = 4 units/day
Q= 200 units L=9 days sL = 3 units
z=2 (97.7% likelihood that we won’t run out during lead time) Reorder point= d*L +z*sL = (4*9) + (2*3) = 42 units

21. P Method (periodic review)
BA 339
3/31/2017
P Method (periodic review)
You have a predetermined time (P) between orders (sales rep comes by every 10 days) or the average time between orders from EOQ = Q/D
How much should you order to bring inventory level up to some predetermined level, R where:
R = restocking level
Current Inventory position = IP
Order Quantity= R-IP

22. Restocking Level Needs to meet most demand situations
BA 339
3/31/2017
Restocking Level
Needs to meet most demand situations
R= Restocking level = Average demand during lead time & review period+ safety stock = mP+L + z* sP+L where: mP+L = average demand during lead time and review period z = # of standard dev from mean above the average demand (higher z is lower probability of running out). sRP+L = standard deviation of demand during lead time + review period

23. ABC Inventory Management
Based on “Pareto” concept (80/20 rule) and total usage in dollars of each item.
Classification of items as A, B, or C based on usage.
Purpose is to set priorities on effort used to manage different SKUs, i.e. to allocate scarce management resources.
SKU: Stock Keeping Unit

24. ABC Inventory Management
‘A’ items: 20% of SKUs, 80% of dollars
‘B’ items: 30 % of SKUs, 15% of dollars
‘C’ items: 50 % of SKUs, 5% of dollars
Three classes is arbitrary; could be any number.
Percents are approximate.
Danger: dollar use may not reflect importance of any given SKU!

25. Example of SKU list for 10 items
Annual Usage in Units
Unit Cost
Dollar Usage
Percentage of Total Dollar Usage 1
5,000 $
$ ,500
2.9% 2
1,500
8.00
12,000
4.7% 3
10,000
10.50
105,000
41.2% 4
6,000
2.00 5
7,500
0.50
3,750
1.5% 6
13.60
81,600
32.0% 7
0.75 8
4,500
1.25
5,625
2.2% 9
7,000
2.50
17,500
6.9% 10
3,000
2.4%
Total
$ 254,725
100.0%

26. ABC Chart for SKU List A B C

27. ABC Application Jewelry Store Fine Dining Restaurant Outdoor Retailer
Large Department Store