1. Operations Management Inventory Management Chapter 12
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

2. What is Inventory? Stock of materials Stored capacity
© 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.
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© T/Maker Co.
© 1995 Corel Corp.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

3. Types of Inventory Raw material Work-in-progress
Maintenance / repair / operating supplies
Finished goods
It might be useful here to explicitly discuss the purpose of each type of inventory.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

4. 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.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

5. 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.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

6. Disadvantages of Inventory
Higher costs
Interest or opportunity costs
Holding (or carrying) costs – storage, handling, taxes, insurance, shrinkage
Ordering (or setup) costs
Risk of deterioration or obsolescence
Hides production problems
Yield / scrap variations
Unscheduled downtime
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.
Total cost = 20% - 40% of inventory value / year
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

7. Pressures on inventory
Pressure for lower inventory
Inventory investment
Inventory holding cost
Pressure for higher inventory
Customer service
Other costs related to inventory
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

8. Different Views of Inventory
Demand Type Independent Dependent
Types of Inventory Cycle Pipeline Safety Stock Anticipation
Annual $ Volume A B C
Process stage Raw Material Work in Process Finished Goods
Other Maintenance / Repair Operating Supplies
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

9. How Is Inventory Created?
Cycle Inventory – result of lot size
Pipeline Inventory – in transit
Safety Stock
Anticipation Inventory
Average cycle inventory =
Q + 0 2
Pipeline inventory = DL = dL
Types of Inventory Cycle Pipeline Safety Stock Anticipation
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

10. Inventory Calculations
We use 70 hypodermic needles a week. We buy them in lots of It takes three weeks for order handling and shipment.
Cycle inventory = Q/2
= 280/2
= 140 needles
Pipeline inventory = DL = dL
= (70 needles/week)(3 weeks)
= 210 drills
Inventory Worksheets
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

11. Inventory Reduction Tactics
Cycle inventory
Pipeline inventory
Safety Stock
Anticipation inventory
Reduce lot size
Reduce lead time
Reduce uncertainties
Various
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

12. ABC Analysis
Divides on-hand inventory into three classes on the basis of annual dollar volume – A, B, and C
$ volume = Annual demand x Unit cost
Policies based on ABC analysis
Develop class A suppliers more
Maintain tighter physical control of A items
Forecast A items more carefully
Annual $ Volume A B C
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?
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

13. ABC Analysis A B C Class % $ Vol % Items A 80 20 B 15 30 C 5 50
% of Inventory Items 20 40 60 80
100 50
% Annual $ Usage A B C
Are we back to Pareto analysis?
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

14. Inventory Models for Independent Demand
Fixed order-quantity 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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© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

15. EOQ – Economic Order Quantity
Objective: minimize (ordering cost + holding cost)
Assumptions:
Known and constant demand
Known and constant lead time
Instantaneous receipt of material
No quantity discounts
Only ordering / setup cost and holding cost
No stockouts
Students should be asked to consider the degree to which each of these assumptions is accurate.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

16. Inventory Usage Over Time
Inventory Level
Average Cycle Inventory Q
Usage Rate
Q 2
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.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

17. EOQ Model How Much to Order?
Order quantity (Q)
Annual Cost
Holding Cost
Total Cost
Ordering (Setup) Cost
Optimal Order Quantity (Q*)
Minimum total cost
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

18. Why Holding Costs Increase
More units must be stored if more are ordered
Purchase Order
Description
Qty.
Microwave 1
Order quantity
1000
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

19. Why Ordering 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
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

20. EOQ Model – When to Order
Time
Inventory Level
Average Cycle Inventory Q*
Reorder Point (ROP)
Lead Time
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.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

21. EOQ Model Equations = × N D Q* T d ROP L S H 2 Optimal Order Quantity
Expected Number of Orders
Expected Time Between Orders
Working Days /
Year = × N D Q* T d
ROP L S H 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.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

22. Inventory Models for Independent Demand
Fixed order-quantity 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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© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

23. POQ – Production Order Quantity
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.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

24. Both production and usage take place
EOQ POQ Model
Both production and usage take place
Usage only takes place
Maximum inventory level
Inventory Level
Time
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

25. Inventory Models for Independent Demand
Fixed order-quantity 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.
© T/Maker Co.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

26. Quantity Discount Model
Answers how much to order & when to order
Allows quantity discounts
Other EOQ assumptions apply
Trade-off is between lower price & increased holding cost
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
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

27. Quantity Discount – How Much to Order
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

28. Inventory Models for Independent Demand
Fixed order-quantity 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.
© T/Maker Co.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

29. Probabilistic Models Answer how much & when to orderX
Service Level
P(Stockout)
Frequency
Answer how much & when to order
Allow demand to vary
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.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

30. Probabilistic Models - When to Order?
Reorder Point (ROP) X
Safety Stock (SS)
Time
Inventory Level
Lead Time SS
ROP
Service Level
P(Stockout)
Place order
Receive order
Frequency
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J 32

31. Inventory Models for Independent Demand
Fixed order-quantity 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.
© T/Maker Co.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

32. Fixed Period (P) Systems
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: Office Max representative calls every week
This represents a model in which orders are based upon time, not the quantity needed. The following slide provides a graphical representation.
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

33. Inventory 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
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

34. Comparison of Q and P Systems
Continuous Review System (Q) A system designed to track the remaining inventory of an item each time a withdrawal is made, to determine whether it is time to replenish
Periodic Review System (P) A system in which an item’s inventory position is reviewed periodically rather than continuously
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

35. Comparison of Q and P Systems
Continuous Review System (Q)
Individual review frequencies
Possible quantity discounts
Lower, less-expensive safety stocks
Periodic Review System (P)
Convenient to administer
Orders may be combined
Inventory position only required at review
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

36. Inventory Measures Average inventory = $2 million
Cost of goods sold = $10 million
52 business weeks per year
= = weeks
$2 million
($10 million)/(52 weeks)
Weeks of supply =
Average inventory value
Weekly sales (at cost)
Annual sales (at cost)
Average inventory value
Inventory turns =
$10 million
$2 million
= = 5 turns/year
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J

37. Summary
Functions of inventory – Inventory enables value creation for many processes
Costs of inventory
Different views of inventory
Inventory reduction tactics
ABC and EOQ are traditional tools used to manage inventory – still used in many circumstances
Continuous review system (Q) for high-value parts; Periodic review system (P) for some low value parts
Weeks of Supply and inventory turns are widely-used measures of inventory
© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J