1. 12-1 Managing Inventory and and Supply Chain Chapters 12 & 11

2. 12-2 The Functions of Inventory  To ”decouple” or separate various parts of the production process.  To smooth production (link supply and demand).  To provide goods for customers (quick response).  To take advantage of quantity discounts.  Buy more to get a reduced price.  To hedge against inflation and upward price changes (speculation).  Buy more now if you think price will rise.

3. 12-3  Sort products from largest to smallest annual $ volume.  Divide into A, B and C classes.  Focus on A products.  Develop class A suppliers more.  Give tighter physical control of A items.  Forecast A items more carefully.  Consider B products only after A products. ABC Analysis

4. 12-4 0 20 40 60 80 100 20 40 % of Products Classifying Items as ABC 60 80 100 A B C 0 Annual $ Usage (x1000) Class% $ Vol% Items A39% 12% (3/25) B52%40% (10/25) C9%48% (12/25)

5. 12-5 Inventory Costs  Holding costs  Holding costs - Associated with holding or “carrying” inventory over time.  Ordering costs  Ordering costs - Associated with costs of placing order and receiving goods.  Setup costs  Setup costs - Cost to prepare a machine or process for manufacturing an order.  Stockout costs  Stockout costs - Cost of not making a sale and lost future sales.

6. 12-6  How much to order (each time)?  100 units, 50 units, 23.624 units, etc.  When to order?  Every 3 days, every week, every month, etc.  When only 5 items are left, when only 10 items are left, when only 20 items are left, etc.  Many different models can be used, depending on nature of products and demand. Inventory Questions

7. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-7  Fixed order-quantity models  Economic order quantity  Production order quantity  Quantity discount  Probabilistic models  Fixed order-period models Help answer the inventory planning questions! © 1984-1994 T/Maker Co. Inventory Models

8. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-8 Inventory Usage Over Time Time Inventory Level Average Inventory (Q*/2) 0 Minimum inventory Order quantity = Q (maximum inventory level) Usage Rate

9. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-9 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

10. 12-10 = ×× EOQ = Q* DS H 2 EOQ Total Cost Optimization Total Cost = D Q S + Q 2 H Take derivative of total cost with respect to Q and set equal to zero: Solve for Q to get optimal order size: D Q 2 S + 1 2 H = 0

11. 12-11 Order Quantity Annual Cost Total Cost Curve 154.92 EOQ Model is Robust Small variation in cost Large variation in order size

12. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-12 EOQ Model When To Order Reorder Point (ROP) Time Inventory Level Average Inventory (Q*/2) Lead Time Optimal Order Quantity (Q*)

13. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-13 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

14. 12-14  Safety stock is inventory held to protect against stockout.  Service level = 1 - Probability of stockout  Service level of 95% means 5% chance of stockout.  Higher service level means more safety stock.  More safety stock means higher ROP.  ROP = Expected demand during lead time + Safety stock Safety Stock & Service Level

15. 12-15  Material is not received instantaneously.  For example, it is produced in-house.  Other EOQ assumptions apply.  Model provides production lot size (like EOQ amount) for one product.  Similar to EOQ with setup cost rather than order cost.  Lower holding cost than EOQ model Production Order Quantity Model

16. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-16 EOQ POQ Model When To Order Reorder Point (ROP) Time Inventory Level Average Inventory Lead Time Optimal Order Quantity (Q*)

17. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-17 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

18. 12-18 Optimal Production Run Size = Maximum inventory level = Q [1- (d/p)] D = Annual demand S = Setup cost per setup H = Holding (carrying) cost per unit per year d = Demand rate p = Production rate POQ Model Equations Total Cost = D Q S +S + Q 2 H [1-(d/p)] = ×× Q* DS H[1-(d/p)] 2 = H 2DS p-d p Given

19.  POQ provides product as it is being used  POQ has lower inventory costs and larger lots  Ideal is to provide product Just in Time  JIT requires higher quality confidence  JIT gives fast information on production problems 12-19 EOQ vs POQ (ERS)--Buy vs Make

20. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 11-20 Operations Management Buy vs. Make with Lean Strategy (pdf)

21. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 11-21  Planning, organizing, directing, & controlling flows of materials  Begins with raw materials  Continues through internal operations  Ends with distribution of finished goods  Involves everyone in supply-chain  Example: Your supplier’s supplier  Objective: Maximize value & lower waste Supply-Chain Management

22. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 11-22 Consumer Retailer Manufacturing Material Flow VISA ® Credit Flow Supplier Wholesaler Retailer Cash Flow Order Flow Schedules The Supply-Chain

23. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 11-23 Vendor Selection Rating Form

24. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 11-24  Plans to help achieve company mission  Affect long-term competitive position  Strategic options  Many suppliers  Few suppliers  Keiretsu network  Vertical integration  Virtual company Plan © 1995 Corel Corp. Supply-Chain Strategies

25. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 11-25 Supply-Chain Strategies  Negotiate with many suppliers; play one supplier against another  Develop long-term “partnering” arrangements with a few suppliers who will work with you to satisfy the end customer  Vertically integrate; buy the actual supplier  Keiretsu - have your suppliers become part of a company coalition  Create a virtual company that uses suppliers on an as-needed basis.

26. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 11-26  Many sources per item  Adversarial relationship  Short-term  Little openness  Negotiated, sporadic PO’s  High prices  Infrequent, large lots  Delivery to receiving dock © 1995 Corel Corp. Many Suppliers Strategy

27. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 11-27  1 or few sources per item  Partnership (JIT)  Long-term, stable  On-site audits & visits  Exclusive contracts  Low prices (large orders)  Frequent, small lots  Delivery to point of use © 1995 Corel Corp. Few Suppliers Strategy

28. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 11-28  Japanese word for ‘affiliated chain’  System of mutual alliances and cross-ownership  Company stock is held by allied firms  Lowers need for short-term profits  Links manufacturers, suppliers, distributors, & lenders  ‘Partnerships’ extend across entire supply chain Keiretsu Network Strategy

29. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 11-29 © 1995 Corel Corp. Virtual Company Strategy  Network of independent companies  Linked by technology  PC’s, faxes, Internet etc.  Each contributes core competencies  Typically provide services  Payroll, editing, designing  May be long or short-term  Usually, only until opportunity is met

30. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 11-30 Successful Supply-Chain Management Requires:  A mutual agreement on goals  Trust  Compatible organizational cultures  “Cooperative Game”

31. Other Inventory Models  Quantity Discounts  Fixed Order Interval  Single Period (perishable) 12-31

32. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-32  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 Quantity Discount Model

33. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-33 Quantity Discount Schedule Discount Number Discount Quantity Discount (%) Discount Price (P) 10 to 999No discount$5.00 21,000 to 1,9994$4.80 32,000 and over5$4.75

34. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-34 Quantity Discount – How Much to Order

35. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-35  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 Fixed Period Model

36. Transparenc y Masters to accompany Heizer/Rend er – Principles of Operations Managemen t, 5e, and Operations Managemen t, 7e © 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458 12-36 Inventory Level in a Fixed Period System Various amounts (Q i ) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum ppp Q1Q1Q1Q1 Q2Q2Q2Q2 Q3Q3Q3Q3 Q4Q4Q4Q4 Target maximum Time On-Hand Inventory

37. Single period Model  Obsolescence and spoilage  Quantity to buy depends on balance of costs:  Costs of Shortage = lost opportunities for Profit  Selling price-cost of good  Costs of Excess = leftover product  Cost of good –salvage  Optimal amount = Q = d + Zsl * Sigma (d)  Optimal Service Level = SL = Cs / (Cs +Ce) 12-37