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How can it be that mathematics, being after all a product of human thought independent of experience, is so admirably adapted to the objects of reality Albert Einstein. Importance of Inventory.

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How can it be that mathematics, being after all a product of human thought independent of experience, is so admirably adapted to the objects of reality

Albert Einstein

Importance of Inventory

A typical hospital spends about 20% of its budget on medical, surgical, and pharmaceutical supplies. For all hospitals it adds up to \$150billion annually.

The average inventory in US economy about \$1.13 trillion on \$9.66 trillion of sales. About \$430 billion in manufacturing, \$230 billion in wholesaler, \$411 billion in retail.

What happens when a company with a large Work In Process (WIP) and Finished Goods (FG) inventory finds a market demand shift to a new product? Two choices:

• Fire-sell all WIP and FG inventories and then quickly introduce the new product  Significant losses
• Finish all WIP inventory and sell all output before introducing the new product  Delay and reduced market response time

Inventory Classified

Inputs inventory

• Raw materials and Parts

In-process inventory

• Parts and products that are being processed
• Parts and products to decouple operations (line balancing inventory).
• Parts and products to take advantage of Economies of Scale (batch inventory).

Outputs inventory

• To meet anticipated customer demand (average inventory and safety stock).
• To smooth production while meeting seasonal demand (seasonal inventory).
• In transit to a final destination to fill the gap between production and demand lead times (pipeline inventory).

Inventory

Poor inventory management hampers operations, diminishes customer satisfaction, and increases operating costs.

A typical firm probably has tied in inventories about

• 30 percent of its Current Assets
• 90 percent of its Working Capital (Current Assets – Current Liabilities)

Understocking; lost sales, dissatisfied customers.

Overstocking; tied up funds (financial costs), storage and safe keeping (physicalcost), change in customer preferences (obsolescence cost).

One-Bin System (Periodic)

Order Enough to Refill Bin

Periodic Inventory [Counting] Systems

At the beginning of each period, the existing inventory level is identified and the additional required volume to satisfy the demand during the period is ordered.

The quantity of order is variable but the timing of order is fixed.

Re-Order Point (ROP) is defined in terms of time.

Physical count of items made at periodic intervals.

Disadvantage: no information on inventory between two counts.

Two-Bin System (Perpetual)

Order One Bin of Inventory

Empty

Full

Perpetual Inventory Systems

When inventory reaches ROP an order of EOQ (Economic Order Quantity) units is placed.

The quantity of order is fixed but the timing of order is variable.

ROP is defined in terms of quantity (inventory on hand).

Keeps track of removals from inventory continuously, thus monitoring current levels of each item.

A point-of-sales (POS) system record items at the time of sale.

A classification Approach: ABC Analysis

ABC Analysis in terms of dollars invested, profit potential, sales or usage volume, and stockout penalties. Perpetual for class A, Periodic for class C.

Group A: Perpetual

Group C: Periodic

The Basic Inventory Model: Economic Order Quantity

• Only one product
• Demand is known and is constant throughout the year
• Each order is received in a single delivery
• Lead time does not vary
• Two costs
• Ordering Costs: Costs of ordering and receiving the order
• Holding or Carrying Costs: Cost to carry an item in inventory for one year
• Unit cost of product is not incorporated because we assume it is fixed. It does not depends on the ordering policy.

The Basic Inventory Model

• Annual demand for a product is 9600 units.
• D = 9600
• Annual carrying cost per unit of product is \$16.
• H = 16
• Ordering cost per order is \$75.
• S = 75
• How much should we order each time to minimize our total cost?
• b) How many times should we order?
• c) What is the length of an order cycle (288 working days/year)?
• d) What is the total cost?
• Do NOT worry if you do not get integer numbers.

Ordering Cost

D = Demand in units / year

Q = Order quantity in units / order

Number of orders / year =

S = Order cost / order

Annual order cost =

Usage

rate

The Inventory Cycle

Quantity

on hand

Inventory

order

Time

When the quantity on hand is just sufficient to satisfy demand in lead time, an order for EOQ is placed

At the instant that the inventory on hand falls to zero, the order will be received (Screencam tutorial on DVD)

Q

Q/2

0

The Inventory Cycle

Inventory

Q = Order quantity

At the beginning of the period we get Q units.

At the end of the period we have 0 units.

Time

Time

Average Inventory / Period & Average Inventory / year

This is average inventory / period.

Average inventory / periodis also known as Cycle Inventory

What is average inventory / year ?

Inventory Carrying Cost

Q = Order quantity in units / order

Average inventory / year =

H = Inventory carrying cost / unit / year

Annual carrying cost =

2

DS

2

(

Annual Demand

)

(

Order or Setup Cost

)

EOQ

=

=

H

Annual Holding Cost

EOQ

EOQ is at the intersection of the two costs.

(Q/2)H = (D/Q)S

Q is the only unknown. If we solve it

Back to the Original Questions

• Annual demand for a product is 9600 units.
• D = 9600
• Annual carrying cost per unit of product is \$16.
• H = 16
• Ordering cost per order is \$75.
• S = 75
• a) How much should we order each time to minimize our total cost?
• b) How many times should we order?
• c) What is the length of an order cycle (288 working days/year)?
• d) What is the total cost?

How Many Times Should We Order?

Annual demand for a product is 9600 units.

D = 9600

Economic Order Quantity is 300 units.

EOQ = 300

Each time we order EOQ.

How many times should we order per year?

D/EOQ

9600/300 = 32

What is the Length of an Order Cycle?

Working Days = 288/year

9600 units are required for 288 days.

300 units is enough for how many days?

(300/9600)×(288) = 9 days

What is the Optimal Total Cost

The total cost of any policy is computed as:

The economic order quantity is 300.

This is optimal policy that minimizes total cost.

Centura Health Hospital

Centura Health Hospital processes a demand of 31200 units of IV starter kits each year (D=31200), and places an order of 6000 units at a time (Q=6000). There is a cost of \$130 each time an order is placed (S = \$130). Inventory carrying cost is \$0.90 per unit per year (H = \$0.90). Assume 52 weeks per year.

What is the average inventory?

Average inventory = Q/2 = 6000/2 = 3000

What is the total annual carrying cost?

Carrying cost = H(Q/2) = 0.9×3000=2700

How many times do we order?

31200/6000 = 5.2

What is total annual ordering cost?

Total ordering cost = S(D/Q)

Ordering cost = 130(5.2) = \$676

Assignment 12a.1

• A toy manufacturer uses approximately 32000 silicon chips annually. The Chips are used at a steady rate during the 240 days a year that the plant operates. Annual holding cost is 60 cents per chip, and ordering cost is \$24. Determine the following:
• a) How much should we order each time to minimize our total cost?
• b) How many times should we order?
• c) what is the length of an order cycle (working days 240/year)?
• d) What is the total cost?

Assignment 12a.2

• Victor sells a line of upscale evening dresses in his boutique. He charges \$300 per dress, and sales average 30 dresses per week. Currently, Vector orders 10 week supply at a time from the manufacturer. He pays \$150 per dress, and it takes two weeks to receive each delivery. Victor estimates his administrative cost of placing each order at 225. His inventory charring cost including cost of capital, storage, and obsolescence is 20% of the purchasing cost. Assume 52 weeks per year.
• Compute Vector’s total annual cost of inventory system (carrying plus ordering but excluding purchasing) under the current ordering policy?
• Without any EOQ computation, is this the optimal policy? Why?
• Compute Vector’s total annual cost of inventory system (carrying plus ordering but excluding purchasing) under the optimal ordering policy?
• What is the ordering interval under optimal ordering policy?
• What is average inventory and inventory turns under optimal ordering policy? Inventory turn = Demand divided by average inventory. Average inventory = Max Inventory divided by 2. Average inventory is the same as cycle inventory.

Assignment 12a.3

• Complete Computer (CC) is a retailer of computer equipment in Minneapolis with four retail outlets. Currently each outlet manages its ordering independently. Demand at each retail outlet averages 4,000 per week. Each unit of product costs \$200, and CC has a holding cost of 20% of the product cost per annum. The fixed cost of each order (administrative plus transportation) is \$900. Assume 50 weeks per year. The holding cost will be the same in both decentralized and centralized ordering systems. The ordering cost in the centralized ordering is twice of the decentralized ordering system.
• Decentralized ordering: If each outlet orders individually.
• Centralized ordering: If all outlets order together as a single order.
• Compute EOQ in decentralized ordering
• Compute the cycle inventory for one outlet and for all outlets.
• Compute EOQ in the centralized ordering
• Compute the cycle inventory for all outlets and for one outlet
• Compute the total holding cost + ordering cost (not including purchasing cost) for the decentralized policy
• Compute the total holding cost plus ordering cost for the centralized policy