1 inventory final
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Inventory Definition
A stock of items held to meet future demand Inventory-A physical resource that a firm holds in
stock with the intent of selling it or transforming itinto a more valuable state.
Inventory System- A set of policies and controlsthat monitors levels of inventory and determineswhat levels should be maintained, when stockshould be refilled, and how large orders should be
given to the purchased department.
Question: Goods vs Services?
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Def. - A physical resource that a firm holds in stock
with the intent of selling it or transforming it into a
more valuable state.Raw Materials
Works-in-Process
Finished Goods
Maintenance, Repair and Operating
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Opposing Views of InventoryWhy We Want to Hold Inventories
Why We Not Want to Hold Inventories
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Why We Want to Hold Inventories Improve customer service
Reduce certain costs such as
ordering costs stock out costs
acquisition costs
start-up quality costs
Contribute to the efficient and effective operation ofthe production system
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Why We Want to Hold Inventories
Finished Goods Essential in produce-to-stock positioning strategies Necessary in level aggregate capacity plans Products can be displayed to customers
Work-in-Process Necessary in process-focused production May reduce material-handling & production costs
Raw Material Suppliers may produce/ship materials in batches Quantity discounts and freight/handling $$ savings
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Why We Do Not Want to Hold
Inventories Certain costs increase such as
carrying costs
cost of customer responsiveness
cost of coordinating production
cost of diluted return on investment
reduced-capacity costs
large-lot quality cost
cost of production problems
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Types of Inventory
Inputs Raw Materials
Purchased parts
Maintenance and RepairMaterials
Outputs Finished Goods
Scrap and Waste
Process
In Process Partially CompletedProducts and
Subassemblies
(in warehouses, or in
transit)
(often on the factory
floor)
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Types of Inventory
Work in
process
Work in
process
Work in
process
Finished
goods
Raw
Materials
Vendors Customer
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Water Tank Analogy for Inventory
Supply Rate
Inventory Level
Demand Rate
Inventory Level
Buffers Demand Rate
from Supply Rate
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Independent and Dependent Demand
Inventory
Independent demand items demanded by external customers (Kitchen Tables)
Dependent demand
items used to produce final products (table top, legs,hardware, paint, etc.)
Demand determined once we know the type and numberof final products
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Independent and Dependent Demand
Inventory Management
Independent demand Uncertain / forecasted
Continuous Review / Periodic Review
Dependent demand Requirements / planned
Materials Requirements Planning / Just in Time
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Reasons To Hold Inventory
Meet variations in customer demand:Meet unexpected demandSmooth seasonal or cyclical demand
Pricing related:Temporary price discounts
Hedge against price increasesTake advantage of quantity discounts
Process & supply surprisesInternal upsets in parts of or our own processesExternal delays in incoming goods
Transit
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Reasons To NOT Hold Inventory Carrying cost
Financially calculable
Takes up valuable factory space
Especially for in-process inventory
Inventory covers up problems That are best exposed and solved
Driver for increasing inventory turns (finished goods) and leanproduction/Just in time for work in process
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Inventory Hides Problems
Poor
Quality
Unreliable
Supplier
Machine
BreakdownInefficient
Layout
Bad
Design
Lengthy
Setups
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To Expose Problems:
Reduce Inventory Levels
PoorQuality
Unreliable
Supplier
Machine
BreakdownInefficient
Layout
Bad
Design
LengthySetups
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Remove Sources of Problems and
Repeat the Process
PoorQuality
Unreliable
Supplier
Machine
BreakdownInefficient
Layout
Bad
Design
Lengthy
Setups
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Inventory Cost Structures
Ordering (or setup) cost Carrying (or holding) cost:
Cost of capital
Cost of storage
Cost of obsolescence, deterioration, and loss
Stock out cost
Item costs, shipping costs and other cost subject tovolume discounts
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Typical Inventory Carrying Costs
Housing cost:Building rent or depreciationBuilding operating costTaxes on buildingInsurance
Material handling costs:
Equipment, lease, or depreciationPowerEquipment operating cost
Manpower cost from extra handling and supervision
Investment costs:Borrowing costsTaxes on inventoryInsurance on inventory
Pilferage, scrap, and obsolescence
Overall carrying cost
6%
(3% - 10%)
3%(1% - 4%)
3%(3% - 5%)
10%(6% - 24%)
5%(2% - 10%)
(15% - 50%)
Costs as % ofInventory Value
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Inventory Management Systems
Functions of Inventory Management
Track inventory
How much to order
When to order Prioritization
Inventory Management Approach
EOQ
Continuous / Periodic
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ABC Prioritization Based on Pareto concept (80/20 rule) and
total usage in dollars of each item.
Classification of items as A, B, or C oftenbased on $ volume.
Purpose: set priorities for managementattention.
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10 20 30 40 50 60 70 80 90 100
Percentage of items
P
ercentage
ofd
ollarvalue
100
90
80
70
60
50
40
30
20
10
0
+Class C
Class A
+Class B
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ABC Chart For Previous Slide
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
3 6 9 2 4 1 10 8 5 7
Item No.
Percen
tUsage
0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
120.0%
Cumulativ
e%Usage
Percentage of Total Dollar Usage Cumulative Percentage
A B C
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Inventory Management ApproachesA-items
Track carefully (e.g. continuous review)
Sophisticated forecasting to assure correct levels
C-items
Track less frequently (e.g.periodic review) Accept risks of too much or too little (depending
on the item)
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VED Classification: The VED analysis is done todetermine the critically of an item and its effect on
production and other services. It is specially used for
classification of spare parts. If it is essential, then itis given E classification and if it is not so essential,
the part is given D classification. For v items, a
large stock of inventory is generally maintained,
while forD items, minimum stock is enough.
The different techniques of inventory control are:ABC - Always better control analysis.HML - High, Medium & Low analysis.VED - Vital, Essential & desirable analysis.SDE - Scare, difficult & easy to obtain analysis.FSN - Fast moving, slow moving & non moving analysis.EOQ - Economic order quantity analysis.
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HML Classification: (High, Medium & Low analysis)
The high, medium & low analysis is based on the unit value
not on the consumption value. The inventory order should
be/will be listed in descending order of unit value & it is up
to the management to fix limits for three categories.
SDE Analysis:
This analysis is based upon the availability of items & this
is useful in the context of scarcity of supply. This analysis
refers on S forScarce items
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Economic Order Quantity (EOQ)
Model
Demand rate D is constant, recurring, and known
Amount in inventory is known at all times
Ordering (setup) cost S per order is fixed
Lead time L is constant and known.
Unit cost C is constant (no quantity discounts)
Annual carrying cost is i time the average $ value of theinventory
No stockouts allowed.
Material is ordered or produced in a lot or batch andthe lot is received all at once
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EOQ Lot Size Choice
There is a trade-off between lot size andinventory level.
Frequent orders (small lot size): higher ordering
cost and lower holding cost.Fewer orders (large lot size): lower ordering cost
and higher holding cost.
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EOQ Inventory Order CycleDemand
rate
0 TimeLead
time
Lead
timeOrder
Placed
Order
Placed
Order
Received
Order
Received
I
nventory
L
evel
Reorder point, R
Order qty, Q
As Q increases, average
inventory level increases, but
number of orders placed
decreases
ave = Q/2
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Total Cost of Inventory
EOQ Model
A t I t M t Q ti f
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Answer to Inventory Management Questions for
EOQ Model
Keeping track of inventoryImplied that we track continuously
How much to order?Solve for when the derivative of total cost with respect to Q
= SD/Q2 + iC/2 = 0Q = sqrt ( 2SD/iC)
When to order?Order when inventory falls to the Reorder Point-level R so
we will just sell the last item as the new order comes in:R = DL
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Re-order Point ExampleDemand = 10,000 quantity /year
Lead time = L = 10 days
When inventory falls to R, we order so as not to run outbefore the new order comes in.
R = ?
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Re-order Point ExampleDemand = 10,000 quantity /year
Daily demand = 10,000 / 365 = 27.4 quantity /day
Lead time = L = 10 days
R = D*L = (27.4)(10) = 274 quantity
(usually can neglect issues of working days vs
weekends, etc.)
Dont forget to convert to consistent time units!
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EOQ SummaryHow much to order?
Q = sqrt(2DS/iC)
When to order?R = DL
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EOQ Exercise Now you do it See Excel Spreadsheet: Excel_Inv_Examples.xls, EOQ
tab
Compute the values of R and Q and compare to thesimulation
Next see what happens when you have volumediscounts (EOQ w Discount Tab)
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EOQ ExampleUnit Cost C $0.45 /unitHolding cost factori 25% /year
Ordering cost S $15.00 /order
Demand rate D 10000 units/yearLead time L 0.0192 year
Solutions:
Re-order point R units (rounded)Q = sqrt(2SD/(iC)) units (rounded)