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Operations Management Inventory Management Chapter 12. Outline. GLOBAL COMPANY PROFILE: AMAZON.COM FUNCTIONS OF INVENTORY Types of Inventory INVENTORY MANAGEMENT ABC Analysis Record Accuracy Cycle Counting Control of Service Inventories . Outline - Continued. INVENTORY MODELS

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Operations ManagementInventory ManagementChapter 12

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Outline
Outline

  • GLOBAL COMPANY PROFILE: AMAZON.COM

  • FUNCTIONS OF INVENTORY

    • Types of Inventory

  • INVENTORY MANAGEMENT

    • ABC Analysis

    • Record Accuracy

    • Cycle Counting

    • Control of Service Inventories

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Outline continued
Outline - Continued

  • INVENTORY MODELS

    • Independent versus Dependent Demand

    • Holding, Ordering, and Setup Costs

  • INVENTORY MODELS FOR INDEPENDENT DEMAND

    • Basic Economic Order Quantity (EOQ) Model

    • Minimizing Costs

    • Reorder Points

    • Production Order Quantity Model

    • Quantity Discount Models

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Outline continued1
Outline - Continued

  • PROBABILISTIC MODELS WITH CONSTANT LEAD TIME

  • FIXED PERIOD (P) SYSTEMS

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


The functions of inventory
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


Types of inventory
Types of Inventory

  • Raw material

  • Work-in-progress

  • Maintenance/repair/operating supply

  • Finished goods

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


The material flow cycle
The Material Flow Cycle

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Disadvantages of inventory
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

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


The material flow cycle1
The Material Flow Cycle

Wait

Time

Queue

Time

Setup

Time

Run

Time

Move

Time

Other

Input

  • 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.

Output

Cycle Time

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Abc analysis
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

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Classifying items as abc

% Annual $ Usage

Class

% $ Vol

% Items

A

80

15

100

B

15

30

80

C

5

55

60

A

40

B

C

20

0

0

50

100

Classifying Items as ABC

% of Inventory Items

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Cycle counting
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)

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Advantages of cycle counting
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

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Techniques for controlling service inventory include
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

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Inventory costs
Inventory 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

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Holding carrying costs
Holding (Carrying) Costs

  • Obsolescence

  • Insurance

  • Extra staffing

  • Interest

  • Pilferage

  • Damage

  • Warehousing

  • Etc.

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Inventory holding costs approximate ranges

Category

Housing costs (building rent, depreciation, operating cost, taxes, insurance)

Material handling costs (equipment, lease or depreciation, power, operating cost)

Labor cost from extra handling

Investment costs (borrowing costs, taxes, and insurance on inventory)

Pilferage, scrap, and obsolescence

Overall carrying cost

Cost as a

% of Inventory Value

6%

(3 - 10%)

3%

(1 - 3.5%)

3%

(3 -5%)

11%

(6 - 24%)

3%

(2 - 5%)

26%

Inventory Holding Costs(Approximate Ranges)

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Ordering costs
Ordering Costs

  • Supplies

  • Forms

  • Order processing

  • Clerical support

  • Etc.

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Setup costs
Setup Costs

  • Clean-up costs

  • Re-tooling costs

  • Adjustment costs

  • Etc.

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Inventory models
Inventory Models

Help answer the inventory planning questions!

  • Fixed order-quantity models

    • Economic order quantity

    • Production order quantity

    • Quantity discount

  • Probabilistic models

  • Fixed order-period models

© 1984-1994 T/Maker Co.

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Eoq assumptions
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

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Inventory usage over time

Order quantity = Q (maximum inventory level)

Usage Rate

AverageInventory (Q*/2)

Inventory Level

Minimum inventory

0

Time

Inventory Usage Over Time

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Eoq model how much to order

Annual Cost

Total Cost Curve

Holding Cost Curve

Minimum total cost

Order (Setup) Cost Curve

Order quantity

Optimal Order Quantity (Q*)

EOQ ModelHow Much to Order?

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Why holding costs increase

Purchase Order

Description

Qty.

Microwave

1000

Order quantity

Why Holding Costs Increase

  • More units must be stored if more are ordered

Purchase Order

Description

Qty.

Microwave

1

Order quantity

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Why order costs decrease

1 Order (Postage $ 0.33)

1000 Orders (Postage $330)

Purchase Order

PurchaseOrder

Purchase Order

Purchase Order

Description

Qty.

Purchase Order

Description

Qty.

Description

Qty.

Description

Qty.

Microwave

1

Description

Qty.

Microwave

1000

Microwave

1

Microwave

1

Microwave

1

Order quantity

Why Order Costs Decrease

Cost is spread over more units

Example: You need 1000 microwave ovens

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Deriving an eoq
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

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Eoq model when to order

Inventory Level

AverageInventory (Q*/2)

Optimal Order Quantity(Q*)

Reorder Point (ROP)

Time

Lead Time

EOQ ModelWhen To Order

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Eoq model equations

×

×

2

D

S

Optimal Order Quantity

=

=

Q*

H

D

=

=

Expected Number of Orders

N

Q*

Working Days

/

Year

Expected Time Between Orders

=

=

T

N

D

D = Demand per year

S = Setup (order) cost per order

H = Holding (carrying) cost

d = Demand per day

L = Lead time in days

=

d

Working Days

/

Year

=

×

ROP

d

L

EOQ Model Equations

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


The reorder point rop curve

Q*

Slope = units/day = d

Inventory level (units)

ROP (Units)

Time (days)

Lead time = L

The Reorder Point (ROP) Curve

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Production order quantity model
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

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Eoq poq model when to order

Both production and usage take place

Usage only takes place

Maximum inventory level

Inventory Level

Time

EOQPOQ ModelWhen To Order

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Eoq poq model when to order1
EOQPOQ ModelWhen To Order

Inventory Level

AverageInventory

Optimal Order Quantity(Q*)

Reorder Point (ROP)

Time

Lead Time

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Reasons for variability in production
Reasons for Variability in Production

  • Most variability is caused by 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

    • inaccurate engineering drawings or specifications

    • production personnel try to produce before drawings or specifications are complete

    • customer demands are unknown

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Poq model inventory levels

Inventory Level

Production portion of cycle

Demand portion of cycle with no supply

Time

Supply Begins

Supply Ends

POQ Model Inventory Levels

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Poq model equations

d

-

p

POQ Model Equations

2*D*S

*

=

=

Q

Optimal Order Quantity

(

)

p

d

-

H*

1

p

)

(

*

Maximum inventory level

1

=

Q

D = Demand per year

S = Setup cost

H = Holding cost

d = Demand per day

p = Production per day

D

S

=

*

Setup Cost

Q

(

)

d

=

-

1

0.5 * H * Q

Holding Cost

p

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Quantity discount model
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

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Quantity discount schedule
Quantity Discount Schedule

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Quantity discount how much to order
Quantity Discount – How Much to Order

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Probabilistic models
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

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Probabilistic models when to order

Service Level

Frequency

Inventory Level

P(Stockout)

Optimal

Order Quantity

X

SS

ROP

Reorder Point (ROP)

Safety Stock (SS)

Place order

Receive order

Time

Lead Time

Probabilistic ModelsWhen to Order?

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Fixed period model
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

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Inventory level in a fixed period system

Target maximum

Q4

Q1

Q2

Q3

On-Hand Inventory

p

p

p

Time

Inventory Level 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

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


Fixed period model when to order

Inventory Level

Target maximum

Time

Period

Period

Period

Fixed Period ModelWhen to Order?

© 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458


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