1. 12 Inventory Management PowerPoint presentation to accompany
Heizer and Render
Operations Management, 10e
Principles of Operations Management, 8e
PowerPoint slides by Jeff Heyl
05: Ch12 - Inventory Management (MGMT3102: Fall13)

2. Outline The Importance of Inventory Managing Inventory
Functions of Inventory
Types of Inventory
Managing Inventory
ABC Analysis
Record Accuracy
Cycle Counting
Inventory Models
Independent vs. Dependent Demand
Holding, Ordering, and Setup Costs
Inventory Models for Independent Demand
The Basic Economic Order Quantity (EOQ) Model
Minimizing Costs
Reorder Points
05: Ch12 - Inventory Management (MGMT3102: Fall13)

3. Learning Objectives Conduct an ABC analysis
Explain and use cycle counting
Explain and use the EOQ model for independent inventory demand
Compute a reorder point and safety stock
05: Ch12 - Inventory Management (MGMT3102: Fall13)

4. Amazon.com
Amazon.com started as a “virtual” retailer – no inventory, no warehouses, no overhead; just computers taking orders to be filled by others
Growth has forced Amazon.com to become a world leader in warehousing and inventory management
05: Ch12 - Inventory Management (MGMT3102: Fall13)

5. Inventory Management
The objective of inventory management is to strike a balance between inventory investment and customer service
05: Ch12 - Inventory Management (MGMT3102: Fall13)

6. Functions of Inventory
To decouple or separate various parts of the production process
To decouple the firm from fluctuations in demand and provide a stock of goods that will provide a selection for customers
To take advantage of quantity discounts
To hedge against inflation
05: Ch12 - Inventory Management (MGMT3102: Fall13)

7. Types of Inventory Raw material Work-in-process
Purchased but not processed
Work-in-process
Undergone some change but not completed
A function of cycle time for a product
Maintenance/repair/operating (MRO)
Necessary to keep machinery and processes productive
Finished goods
Completed product awaiting shipment
05: Ch12 - Inventory Management (MGMT3102: Fall13)

8. ABC Analysis
Divides inventory into three classes based on annual dollar volume
Class A - high annual dollar volume
Class B - medium annual dollar volume
Class C - low annual dollar volume
Used to establish policies that focus on the few critical parts and not the many trivial ones
05: Ch12 - Inventory Management (MGMT3102: Fall13)

9. Percent of Number of Items Stocked Percent of Annual Dollar Volume
ABC Analysis
Item Stock Number
Percent of Number of Items Stocked
Annual Volume (units) x
Unit Cost =
Annual Dollar Volume
Percent of Annual Dollar Volume
Class
#10286
20%
1,000
$ 90.00
$ 90,000
38.8% A
#11526
500
154.00
77,000
33.2%
#12760
1,550
17.00
26,350
11.3% B
#10867
30%
350
42.86
15,001
6.4%
#10500
12.50
12,500
5.4%
72%
23%
05: Ch12 - Inventory Management (MGMT3102: Fall13)

10. Percent of Number of Items Stocked Percent of Annual Dollar Volume
ABC Analysis
Item Stock Number
Percent of Number of Items Stocked
Annual Volume (units) x
Unit Cost =
Annual Dollar Volume
Percent of Annual Dollar Volume
Class
#12572
600
$ 14.17
$ 8,502
3.7% C
#14075
2,000
.60
1,200
.5%
#01036
50%
100
8.50
850
.4%
#01307
.42
504
.2%
#10572
250
150
.1%
8,550
$232,057
100.0% 5%
05: Ch12 - Inventory Management (MGMT3102: Fall13)

11. ABC Analysis A Items 80 – 70 – 60 – Percent of annual dollar usage
80 –
70 –
60 –
50 –
40 –
30 –
20 –
10 –
0 –
| | | | | | | | | |
Percent of inventory items
A Items
B Items
C Items
Figure 12.2
05: Ch12 - Inventory Management (MGMT3102: Fall13)

12. Cycle Counting
Items are counted and records updated on a periodic basis
Often used with ABC analysis to determine cycle
Has several advantages
Eliminates shutdowns and interruptions
Eliminates annual inventory adjustment
Trained personnel audit inventory accuracy
Allows causes of errors to be identified and corrected
Maintains accurate inventory records
05: Ch12 - Inventory Management (MGMT3102: Fall13)

13. Independent Versus Dependent Demand
Independent demand - the demand for item is independent of the demand for any other item in inventory
Dependent demand - the demand for item is dependent upon the demand for some other item in the inventory
05: Ch12 - Inventory Management (MGMT3102: Fall13)

14. Holding, Ordering, and Setup Costs
Holding costs - the costs of holding or “carrying” inventory over time
Ordering costs - the costs of placing an order and receiving goods
Setup costs - cost to prepare a machine or process for manufacturing an order
05: Ch12 - Inventory Management (MGMT3102: Fall13)

15. Basic EOQ Model Important assumptions
Demand is known, constant, and independent
Lead time is known and constant
Receipt of inventory is instantaneous and complete
Quantity discounts are not possible
Only variable costs are setup and holding
Stockouts can be completely avoided
05: Ch12 - Inventory Management (MGMT3102: Fall13)

16. Inventory Usage Over Time
Inventory level
Time
Average inventory on hand Q 2
Usage rate
Order quantity = Q (maximum inventory level)
Minimum inventory
Figure 12.3
05: Ch12 - Inventory Management (MGMT3102: Fall13)

17. Total cost of holding and setup (order) Optimal order quantity (Q*)
Minimizing Costs
Objective is to minimize total costs
Annual cost
Order quantity
Total cost of holding and setup (order)
Setup (or order) cost
Minimum total cost
Optimal order quantity (Q*)
Holding cost
Table 12.4(c)
05: Ch12 - Inventory Management (MGMT3102: Fall13)

18. Number of units in each order Setup or order cost per order
The EOQ Model
Annual setup cost = S D Q
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year
Annual setup cost = (Number of orders placed per year)
x (Setup or order cost per order)
Annual demand
Number of units in each order
Setup or order cost per order =
= (S) D Q
05: Ch12 - Inventory Management (MGMT3102: Fall13)

19. The EOQ Model Q = Number of pieces per order
Annual setup cost = S D Q
Annual holding cost = H Q 2
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year
Annual holding cost = (Average inventory level)
x (Holding cost per unit per year)
Order quantity 2
= (Holding cost per unit per year)
= (H) Q 2
05: Ch12 - Inventory Management (MGMT3102: Fall13)

20. The EOQ Model 2DS = Q2H Q2 = 2DS/H Q* = 2DS/H
Annual setup cost = S D Q
Annual holding cost = H Q 2
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year
Optimal order quantity is found when annual setup cost equals annual holding cost D Q
S = H 2
Solving for Q*
2DS = Q2H
Q2 = 2DS/H
Q* = 2DS/H
05: Ch12 - Inventory Management (MGMT3102: Fall13)

21. An EOQ Example Q* = 2DS H Q* = 2(1,000)(10) 0.50 = 40,000 = 200 units
Determine optimal number of needles to order
D = 1,000 units
S = $10 per order
H = $.50 per unit per year
Q* =
2DS H
Q* =
2(1,000)(10)
0.50
= 40,000 = 200 units
05: Ch12 - Inventory Management (MGMT3102: Fall13)

22. Expected number of orders
An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year
= N = =
Expected number of orders
Demand
Order quantity D Q*
N = = 5 orders per year
1,000
200
05: Ch12 - Inventory Management (MGMT3102: Fall13)

23. Expected time between orders Number of working days per year
An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year
= T =
Expected time between orders
Number of working days per year N
T = = 50 days between orders
250 5
05: Ch12 - Inventory Management (MGMT3102: Fall13)

24. An EOQ Example Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days
Total annual cost = Setup cost + Holding cost
TC = S H D Q 2
TC = ($10) ($.50)
1,000
200 2
TC = (5)($10) + (100)($.50) = $50 + $50 = $100
05: Ch12 - Inventory Management (MGMT3102: Fall13)

25. Robust Model The EOQ model is robust
It works even if all parameters and assumptions are not met
The total cost curve is relatively flat in the area of the EOQ
05: Ch12 - Inventory Management (MGMT3102: Fall13)

26. An EOQ Example Management underestimated demand by 50%
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days
1,500 units
TC = S H D Q 2
TC = ($10) ($.50) = $75 + $50 = $125
1,500
200 2
Total annual cost increases by only 25%
05: Ch12 - Inventory Management (MGMT3102: Fall13)

27. An EOQ Example Actual EOQ for new demand is 244.9 units
D = 1,000 units Q* = units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days
1,500 units
TC = S H D Q 2
Only 2% less than the total cost of $125 when the order quantity was 200
TC = ($10) ($.50)
1,500
244.9 2
TC = $ $61.24 = $122.48
05: Ch12 - Inventory Management (MGMT3102: Fall13)

28. Lead time for a new order in days Number of working days in a year
Reorder Points
EOQ answers the “how much” question
The reorder point (ROP) tells “when” to order
ROP =
Lead time for a new order in days
Demand per day
= d x L
d = D
Number of working days in a year
05: Ch12 - Inventory Management (MGMT3102: Fall13)

29. Reorder Point Curve Q* Resupply takes place as order arrives
Inventory level (units)
Time (days) Q*
Resupply takes place as order arrives
Slope = units/day = d
ROP (units)
Lead time = L
Figure 12.5
05: Ch12 - Inventory Management (MGMT3102: Fall13)

30. Number of working days in a year
Reorder Point Example
Demand = 8,000 iPods per year
250 working day year
Lead time for orders is 3 working days
d = D
Number of working days in a year
= 8,000/250 = 32 units
ROP = d x L
= 32 units per day x 3 days = 96 units
05: Ch12 - Inventory Management (MGMT3102: Fall13)

31. Safety Stock Purpose of Safety Stock Needed when demand is variable
The level of safety stock is set based on the desired service level
Safety stock is needed to cover uncertainty during the lead-time

32. In-Class Problems from the Lecture Guide Practice Problems
Problem 1: What are the appropriate ABC groups of inventory items?
ABC Analysis
Stock Number
Annual $ Volume
Percent of Annual $ Volume
J24
12,500
46.2
R26
9,000
33.3
L02
3,200
11.8
M12
1,550
5.8
P33
620
2.3
T72 65
0.2
S67 53
Q47 32
0.1
V20 30
S = 100.0
ABC Groups
Class
Items
Annual Volume
Percent of $ Volume A
J24, R26
21,500
79.5 B
L02, M12
4,750
17.6 C
P33, T72, S67, Q47, V20
800
2.9
S = 100.0
05: Ch12 - Inventory Management (MGMT3102: Fall13)

33. In-Class Problems from the Lecture Guide Practice Problems
Assume you have a product with the following parameters:
Demand = 360
Holding cost per year = $1.00 per unit
Order cost = $100 per order
What is the EOQ?
Problem 4:
Given the data from Problem 3, and assuming a 300-day work year; how many orders should be processed per year? What is the expected time between orders?
Problem 5:
What is the total cost for the inventory policy used in Problem 3?
05: Ch12 - Inventory Management (MGMT3102: Fall13)

34. In-Class Problems from the Lecture Guide Practice Problems
If demand for an item is 3 units per day, and delivery lead-time is 15 days, what should we use for a re-order point?
ROP = Demand during lead-time = 3*15 = 45
05: Ch12 - Inventory Management (MGMT3102: Fall13)