2004 by Prentice Hall, Inc., Upper Saddle River, N.J.
07458
12-1
Operations
Management
Inventory Management
Chapter 12
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-2
Stock of materials
Stored capacity
1995 Corel Corp.
1984-1994 T/Maker Co. 1984-1994 T/Maker Co.
1995
Corel Corp.
What is Inventory?
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-3
Types of Inventory
Raw material
Work-in-progress
Maintenance / repair / operating supplies
Finished goods
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-4
The Material Flow Cycle
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-5
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
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-6
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
Disadvantages of Inventory
Total cost = 20% - 40% of inventory value / year
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-7
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. 07458
12-8
Different Views of Inventory
Demand Type
Independent
Dependent
Process stage
Raw Material
Work in Process
Finished Goods
Other
Maintenance / Repair
Operating Supplies
Types of Inventory
Cycle
Pipeline
Safety Stock
Anticipation
Annual $ Volume
A
B
C
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-9
How Is Inventory Created?
Cycle Inventory result of lot size
Pipeline Inventory in transit
Safety Stock
Anticipation Inventory
Pipeline inventory = DL = dL
Average cycle inventory =
Q + 0
2
Types of Inventory
Cycle
Pipeline
Safety Stock
Anticipation
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-10
Inventory Calculations
We use 70 hypodermic needles a week.
We buy them in lots of 280. It takes three
weeks for order handling and shipment.
Cycle inventory = Q/2
= 280/2
= 140 needles
Pipeline inventory = D
L
= dL
= (70 needles/week)(3 weeks)
= 210 drills
Inventory Worksheets
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-11
Inventory Reduction Tactics
Cycle inventory
Pipeline inventory
Safety Stock
Anticipation inventory
Reduce lot size
Reduce lead time
Various
Reduce uncertainties
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-12
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
ABC Analysis
Annual $ Volume
A
B
C
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-13
ABC Analysis
Class % $ Vol % Items
A 80 20
B 15 30
C 5 50
% of Inventory Items
0
20
40
60
80
100
0 50 100
% Annual $ Usage
A
B
C
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-14
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 for
Independent Demand
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-15
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
EOQ Economic Order Quantity
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-16
Inventory Usage Over Time
Time
I
n
v
e
n
t
o
r
y
L
e
v
e
l
Average
Cycle
Inventory
0
Q
Usage Rate
Q
2
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-17
EOQ Model
How Much to Order?
Order quantity (Q)
Annual Cost
Ordering (Setup) Cost
Optimal
Order Quantity (Q*)
Minimum
total cost
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-18
More units must be stored if more are ordered
Purchase Order
Description Qty.
Microwave 1
Order quantity
Purchase Order
Description Qty.
Microwave 1000
Why Holding Costs Increase
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-19
Cost is spread over more units
Example: You need 1000 microwave ovens
Purchase Order
Description Qty.
Microwave 1
Purchase Order
Description Qty.
Microwave 1
Purchase Order
Description Qty.
Microwave 1
Purchase Order
Description Qty.
Microwave
1
1 Order (Postage $ 0.33) 1000 Orders (Postage $330)
Order quantity
Purchase Order
Description
Qty.
Microwave
1000
Why Ordering Costs Decrease
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-20
EOQ Model When to Order
Time
Inventory Level
Average
Cycle
Inventory
Q*
Reorder
Point
(ROP)
Lead Time
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-21
Optimal Order Quantity
Expected Number of Orders
Expected Time Between Orders
Working Days / Year
=
=
=
N =
D
Q
*
Working Days / Year
= =
T
N
d
D
ROP d L
= =
Q*
D 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
EOQ Model Equations
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-22
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 for
Independent Demand
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-23
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
POQ Production Order Quantity
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-24
EOQ POQ Model
Time
I
n
v
e
n
t
o
r
y
L
e
v
e
l
Both production
and usage take
place
Usage only takes
place
Maximum
inventory
level
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-25
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 for
Independent Demand
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-26
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. 07458
12-27
Quantity Discount How Much to Order
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-28
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 for
Independent Demand
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-29
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
Probabilistic Models
X
Service
Level
P(Stockout)
F
r
e
q
u
e
n
c
y
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-30
Probabilistic Models - When to Order?
Reorder
Point
(ROP)
X
Safety Stock (SS)
Time
I
n
v
e
n
t
o
r
y
L
e
v
e
l
Lead Time
SS
ROP
Service
Level
P(Stockout)
Place
order
Receive
order
F
r
e
q
u
e
n
c
y
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-31
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 for
Independent Demand
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-32
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
Fixed Period (P) Systems
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-33
Inventory 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
p p p
Q
1
Q
2
Q
3
Q
4
Target maximum
Time
O
n
-
H
a
n
d
I
n
v
e
n
t
o
r
y
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-34
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 items inventory position is
reviewed periodically rather than continuously
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-35
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
Comparison of Q and P Systems
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-36
Inventory Measures
Average inventory = $2 million
Cost of goods sold = $10 million
52 business weeks per year
= = 5 turns/year
$10 million
$2 million
Inventory turns =
= = 10.4 weeks
$2 million
($10 million)/(52 weeks)
Weeks of supply =
Average inventory value
Weekly sales (at cost)
Annual sales (at cost)
Average inventory value
2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458
12-37
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