1. PRODUCTION AND OPERATIONS MANAGEMENT
Ch.13: Inventory Management
POM - J. Galván

2. Learning Objectives Explain what inventory is
Explain how inventory is classified
Explain ABC Analysis and Cycle Counting
Compare inventory models
Use inventory models to find how much and when to order
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3. What is Inventory? Stock of materials Stored capacity Examples
© 1995 Corel Corp.
© 1998 by Prentice Hall, Inc.
A Simon & Schuster Company
Upper Saddle River, N.J
© 1995 Corel Corp.
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4. The Functions of Inventory
Provide a stock of goods to meet anticipated customer demand and provide a “selection” of goods
Decouple suppliers from production and production from distribution
Allow one to take advantage of quantity discounts
To provide a hedge against inflation
To protect against shortages due to delivery variation
To permit operations to continue smoothly with the use of “work-in-process”
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5. 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
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6. Types of Inventory Raw material Work-in-process
Maintenance/repair/operating supplies
Finished goods
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7. Inventory Classifications
Process stage
Number & Value
Demand Type
Other
Raw Material WIP Finished Goods
A Items B Items C Items
Maintenance Dependent Operating
Independent Dependent
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8. The Material Flow Cycle
Other
Wait
Time
Move
Queue
Setup
Run
Input
Cycle Time
Output
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.
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9. 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
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10. Classifying Items as ABC20 40 60 80
100 50
150
% of Inventory Items
% Annual $ Usage A B C
Class
% $ Vol
% Items 15 30 5 55
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11. ABC Analysis Percentage of dollar value Percentage of items 100 — 90 —
80 —
70 —
60 —
50 —
40 —
30 —
20 —
10 —
0 —
Class C
Class B
Class A
Percentage of dollar value 10 20 30 40 50 60 70 80 90
100
Percentage of items

12. 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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13. 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
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14. 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
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15. 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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16. Holding, Ordering, and Setup 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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17. Holding Costs Obsolescence Insurance Extra staffing Interest Pilferage
Damage
Warehousing
Etc.
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18. Determining Inventory Holding Costs
Category
Housing costs
Material handling costs
Labor cost from extra handling
Investment costs
Pilferage, scrap, and obsolescence
Cost as a
% of Inventory Value 6%
(3 - 10%) 3%
( %)
(3 - 5%)
11%
(6 - 24%)
(2 - 5%)
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19. Ordering Costs Supplies Forms Order processing Clerical support Etc.
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20. Setup Costs Clean-up costs Re-tooling costs Adjustment costs Etc. 23
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21. 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!
© T/Maker Co.
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22. 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
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23. EOQ Model How Much to Order?
Annual Cost
Total Cost Curve
Holding Cost Curve
Order (Setup) Cost Curve
Order Quantity
Optimal Order Quantity (Q*)
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24. Why Holding Costs Increase
More units must be stored if more ordered
Purchase Order
Description
Qty.
Microwave
1000
Order quantity
Purchase Order
Description
Qty.
Microwave 1
Order quantity
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25. 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 $ 0.32)
1000 Orders (Postage $320)
Order quantity
1000
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26. Average Inventory (Q*/2)
EOQ Model When To Order
Reorder Point (ROP)
Time
Inventory Level
Average Inventory (Q*/2)
Lead Time
Optimal Order Quantity (Q*)
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27. 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
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28. 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
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29. 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
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30. Reasons for Variability in Production
Most variability is caused by tolerating 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
engineering drawings or specifications are inaccurate
production personnel try to produce before drawings or specifications are complete
customer demands are unknown
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31. POQ Model Inventory Levels
Time
Supply Begins
Supply Ends
Production portion of cycle
Demand portion of cycle with no supply
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32. POQ Model Inventory Levels
Inventory level with no demand
Max. Inventory Q·(1- d/p)
Production Portion of Cycle Q*
Time
Supply Begins
Supply Ends
Demand portion of cycle with no supply
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33. ( ) POQ Model Equations = - * Q H* d p D S 1 0.5 * H * Q 2*D*S
Optimal Order Quantity
Max.
Inventory
Level
Setup Cost
Holding Cost = - * Q H* d p D S 1 (
0.5 * H * Q )
2*D*S
D = Demand per year
S = Setup cost
H = Holding cost
d = Demand per day
p = Production per day
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34. 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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35. Quantity Discount Model How Much to Order?
Order Quantity
Total Cost
TC for Discount 1
Discount Quantity 1
TC for Discount 2
TC for Discount 3
Discount Quantity 2
Quantity Ordered
Price 1
Price 2
Price 3
Lowest cost not in discount range
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36. 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
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37. Probabilistic Models When to Order?
Service Level
Freq
Inventory Level
P(Stockout)
Optimal
Order Quantity X SS
Reorder Point (ROP)
ROP
Safety Stock (SS)
Place order
Receive order
Time
Lead Time
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38. Probabilistic Models When to Order
Reorder Point (ROP)
Safety Stock (SS)
Time
Inventory Level
Optimal
Order
Quantity SS
ROP
Service Level
P(Stockout)
Freq
Lead Time
Place order
Receive order
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39. 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
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40. Fixed Period Model When to Order?
Time
Inventory Level
Target maximum
Period
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