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Inventory Management: Meeting Demand while Minimizing Costs

Learn about inventory management, types of inventory, reasons to hold inventory, inventory costs, and how to determine the optimal order size to minimize inventory costs.

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Inventory Management: Meeting Demand while Minimizing Costs

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  1. BUAD306 Chapter 13 - Inventory Management

  2. Everyday Inventory • Food • Gasoline • Clean clothes… What else?

  3. Inventory • Stock or quantity of items kept to meet demand • Takes on different forms • Final goods • Raw materials • Purchased/component parts • Labor • In-process materials • Working capital

  4. Types of Inventory • Static – only one opportunity to buy and sell units • Dynamic – ongoing need for units; reordering must take place

  5. Types of Demand • Dependent Demand • Items are used internally to produce a final product • Independent Demand • Items are final products demanded by external customers

  6. Reasons To Hold Inventory • To meet anticipated demand • To smooth production requirements • To decouple components of the production-distribution system • To protect against stock-outs • To take advantage of order cycles • To hedge against price increases or to take advantage of quantity discounts • To permit operations

  7. Inventory Costs • Carrying Costs - Storage, warehousing, insurance, security, taxes, opportunity cost, depreciation, etc. • Ordering Costs - Determining quantities needed, preparing documentation, shipping, inspection of goods, etc. • Stockout Costs – Temporary or permanent loss of sales / goodwill when demand cannot be met

  8. What if? • Operate 365 days/year • Demand = 1,000/day • Two scenarios for ordering supplies: • 1 x 365,000 • 365 x 1,000 What are the implications of each from a cost perspective?

  9. Inventory Management • Objective: To keep enough inventory to meet customer demand AND also be cost-effective • Goal: To determine the amount of inventory to keep in stock - how much to order AND when to order How much and when to order inventory?

  10. Inventory Management Requirements • A system to keep track of the inventory on hand and on order • A reliable forecast of demand • Knowledge of lead times • Reasonable estimates of inventory costs

  11. Inventory Control Systems • Control the level of inventory by determining how much to order and when • Continuous (Perpetual) Inventory System - a continual record of the inventory level for every item is maintained • Periodic Inventory System - inventory on hand is counted at specific time intervals

  12. 0 214800 232087768 Other Control Systems/Tools • Universal Product Codes (UPC) • RFID Tags • Two-Bin System – two containers of inventory; reorder when the first is empty

  13. Considerations • Lead Time • Time interval between ordering and receiving the order • Cycle Counting • Physical count of items in inventory • Usage Rate • Rate at which amount of inventory is depleted

  14. Inventory Cycle Profile of Inventory Level Over Time Q Usage rate Quantity on hand Reorder point Time Place order Place order Receive order Receive order Receive order Lead time

  15. Economic Order Quantity • The EOQ Model determines the optimal order size that minimizes total inventory costs

  16. 2DS H Optimal Order Quantity 2 (Annual Demand) (Order Cost) Q = = o Annual Holding Cost per unit Qo D Length of order cycle = D Qo # Orders / Year =

  17. Annual carrying cost Annual ordering cost Total cost = + Qo D S H TC = + 2 Qo Basic EOQ Model Where: Qo = Economic order quantity in units H = Holding (carrying) cost per unit D = Demand, usually in units per year S = Ordering cost

  18. Cost Minimization Goal The Total-Cost Curve is U-Shaped Annual Cost Carrying Costs Ordering Costs Order Quantity (Q) QO (optimal order quantity)

  19. EOQ Example 1 A local office supply store expects to sell 2400 printers next year. Annual carrying cost is $50 per printer, and ordering cost is $30. The company operates 300 days a year. A) What is the EOQ? B) How many times per year does the store reorder? C) What is the length of an order cycle? D) What is the total annual cost if the EOQ quantity is ordered?

  20. EOQ Example 2 A local electronics store expects to sell 500 flat-screen TVs each month during next year. Annual carrying cost is $60 per TV, and ordering cost is $50. The company operates 364 days a year. A) What is the EOQ? B) How many times per year does the store reorder? C) What is the length of an order cycle? D) What is the total annual cost if the EOQ quantity is ordered?

  21. Quantity Discounts • A price discount on an item if predetermined numbers of units are ordered TC = Carrying cost + Ordering cost + Purchasing cost = (Q / 2) H + (D / Q) S + PD where P = Unit Price

  22. Quantity Discount Example Campus Computers 2Go Inc. wants to reduce a large stock of laptops it is discontinuing. It has offered the University Bookstore a quantity discount pricing schedule as shown below. Given the discount schedule and its known costs, the bookstore wants to determine if it should take advantage of this discount or order the basic EOQ order size.

  23. EPQ – Economic Production Quantity (EOQ w/Incremental Replenishment) • Used when company makes its own product • Considers a variety of costs/terms: • Carrying Cost • Setup Cost (analogous to ordering costs) • Maximum and Average Inventory Levels • Economic Run Quantity • Cycle Time • Run Time

  24. EOQ with Incremental Replenishment (EPQ) • Definitions • S = Setup Cost • H = Holding Cost • Imax = Maximum Inventory • Iavg = Average Inventory • D = Demand/Year • p = Production or Delivery Rate • u = Usage Rate

  25. EOQ with Incremental Replenishment (EPQ)

  26. EPQ Assumptions • Only one item is involved • Annual demand is known • Usage rate is constant • Usage occurs continually, production periodically • Production rate is constant • Lead time doesn’t vary • No quantity discounts

  27. EPQ Example A toy manufacturer uses 48,000 rubber wheels per year for its product. The firm makes its own wheels, which it can produce at a rate of 800 per day. The toy trucks are assembled uniformly over the entire year. Carrying cost is $1 per wheel a year. Setup cost for a production run of wheels is $45. The firm operates 240 days per year. Determine the: • Optimal run size • Minimum total annual cost for carrying and setup • Cycle time for the optimal run size • Run time

  28. EPQ Example • Idle Time Calculation • Value for Production Planning • Value for “What If” Scenario

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