Operations ManagementInventory Management Chapter 9Prepared by: Shatina Saad @ FPP

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Outline Functions Of Inventory

Types Of Inventory

Inventory ManagementABC Analysis Record Accuracy Cycle Counting Control of Service Inventories

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Outline - Continued Inventory ModelsIndependent Versus Dependent Demand Holding, Ordering, And Setup Costs

Inventory Models For Independent DemandBasic Economic Order Quantity (EOQ) Model Minimizing Costs Reorder Points by: Shatina Saad @ PreparedProduction Order Quantity Model 9-3 FPP Quantity Discount Models

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Learning ObjectivesWhen you complete this chapter, you should be able to : Identify or Define:ABC analysis Record accuracy Cycle counting Independent and dependent demand Holding, Ordering, and Setup Costs

Describe or Explain:The functions of inventory and Preparedbasic Saad @ by: Shatina inventory models 9-4 FPPOPM 533

What is Inventory? Stock of materials Stored capacity Examples 1995 Corel Corp.

1984-1994 T/Maker Co. 1995 Corel Corp.

1984-1994 T/Maker Co.

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The Functions of Inventory To decouple or separate various partsof 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

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Types of Inventory Raw material (RM) Work-in-progress (WIP) Maintenance/repair/operating supply (MRO) Finished goods (FG)

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Disadvantages of Inventory Higher costs

Item cost (if purchased) Ordering (or setup) cost

Costs of forms, clerks wages etc. Building lease, insurance, taxes etc.

Holding (or carrying) cost

Difficult to control Hides production problems

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Inventory ClassificationsInventory 19841994 T/Maker Co.

Proces s stage

Numb er & Value

Dema nd Type Independ ent Depende nt9-9

Other

Raw A Material Items WIP B Finished Items Goods C Prepared by: Shatina Saad @ FPP Items

Maintena nce OperatingOPM 533

The Material Flow CycleOther Input Wait Time Move Time Q ueu e T ime Cycle Time Setup Time Run Time Output

1 Run time: Job is at machine and being worked on 2 Setup time: Job is at the work station, and the work station is being "setup." 3 Queue time: Job is where it should be, but is not being processed because other work precedes it. 4 Move time: The time a job spends in transit 5 Wait time: When one process is finished, but the job is waiting to be moved to the next work area. 6 Other: "Just-in-case" inventory.Prepared by: Shatina Saad @ FPP

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ABC Analysis Divides on-hand inventory into 3 classes

A class, B class, C class $ volume = Annual demand x Unit cost Develop class A suppliers more Give tighter physical control of A items Forecast A items more carefully

Basis is usually annual $ volume

Policies based on ABC analysis

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% Annual $ Usage100 80 60 40 20 0 0

Classifying Items as ABC

Class % $ Vol % Items A 80 15 B 15 30 C 5 55

A B C50 100OPM 533

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% of Inventory Items9-12

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)

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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 recordsPrepared by: Shatina Saad @ FPP

Advantages of Cycle Counting

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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

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Independent versus Dependent Demand Independent demand - demand for item is independent of demand for any other item Dependent demand - demand for item is dependent upon the demand for some other item

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Inventory Costs Holding costs - associated with holding or carrying inventory over time; e.g. obsolescence, insurance, extra staffing, interest, pilferage, damage, warehousing, etc. Ordering costs - associated with costs of placing order and receiving goods; eg. Supplies, forms, order processing, clerical support, etc. Setup costs - cost to prepare a machine or process for manufacturing an order; e.g. cleanup costs, re-tooling costs, adjustment costs, etc.

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Inventory Holding Costs (Approximate Ranges)CategoryHousing 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 Prepared by: Shatina Saad @ obsolescence FPP9-18

Cost as a % of Inventory Value6% (3 - 10%) 3% (1 - 3.5%) 3% (3 - 5%) 11% (6 - 24%) 3% (2 - 5%) 26%OPM 533

Inventory Models Fixed order-quantity models

Economic order quantity Production order quantity Quantity discount

Help answer the inventory planning questions!

Probabilistic models Fixed order-period models

1984-1994 T/Maker Co.

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1. 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

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Inventory Usage Over TimeInventory LevelOrder quantity =Q (maximum inventory level)

Usage Rate

Average Inventory (Q*/2)

Minimum inventor 0 y

Time9-21OPM 533

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EOQ Model How Much to Order?Annual Costve Cur t e Cos al urv C Tot ost C ng i old H

Minimu m total cost

Order (Setup) Cost Curve Optimal Order Quantity (Q*)Prepared by: Shatina Saad @ FPP

Order quantityOPM 533

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More units must be stored if more are ordered

Why Holding Costs Increase

Purchase Order Descriptio Qty. n Microwave 1

Purchase Order Descriptio Qty. n Microwave 1000

Order quantityPrepared by: Shatina Saad @ FPP

Order quantity9-23OPM 533

Why Order Costs DecreaseCost is spread over more unitsExample: You need 1000 microwave ovens1 Order (Postage $ 0.33)Purchase Order Description Qty. Microwave 1000

1000 Orders (Postage $330) PurchaseOrder Order PurchaseOrder Purchase Descriptio Qty. Qty. Purchase Order Descriptio Qty. Descriptio Microwave Description Qty. 1 nn Microwave 11 n Microwave 1 Microwave

Order quantityPrepared by: Shatina Saad @ FPP

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Deriving an EOQ1. Develop an expression for setup or ordering costs 2. Develop an expression for holding cost 3. Set setup cost equal to holding cost 4. Solve the resulting equation for the best order quantity

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EOQ Model EquationsH D Q* N

Optimal Order Quantity=Q* = 2 D S

xpected Number of OrdersN = =

Working Days /Year xpected Time Between Orders =T =

d=

D

Working Days /Year

ROP = d L

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D = Demand per year S = Setup (order) cost per order H = Holding (carrying) cost d = Demand per day L 9-26= Lead time in days OPM 533

The Reorder Point (ROP) CurveQ* Slope = units/day =d Inventory level (units)

ROP (Unit s)

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Lead time =L

Time (days)OPM 533

2. 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 modelPrepared by: Shatina Saad @ FPP

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Reasons for Variability in ProductionMost 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 u inaccurate engineering drawings or specifications u production personnel try to produce before drawings or specifications are complete u customer demands are unknownu

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Inventory Level

POQ Model Inventory LevelsProduction portion of cycle Demand portion of cycle with no supply

Supply Supply Begins EndsPrepared by: Shatina Saad @ FPP

Time9-30OPM 533

POQ Model Inventory Levels Inventory LevelInventory level with no demand Max. Inventory Q(1- d/p) Production Portion of Cycle

Q*

Supply Supply Begins EndsPrepared by: Shatina Saad @ FPP

Demand portion of cycle with no supply9-31

Time

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POQ Model Equations= Q* p =

Optimal Order Quantity

2*D*S d H* 1p

Maximum inventory level * =Q Setup Cost = D Q *S

( )1d p d p

( )D = Demand per year S = Setup cost H = Holding cost d = Demand per day OPM 533 p = Production

0.5 Holding Cost = * H * Q 1 Prepared by: Shatina Saad @ FPP

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Answers how much to order & when to order Allows quantity discounts

3. Quantity Discount Model

Reduced price when item is purchased in larger quantities Other EOQ assumptions apply

Trade-off is between lower price & increased holding cost

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Quantity Discount ScheduleDisco unt Numb 1 er 2 3 Discount Quantity 0 to 999 1,000 to 1,999 2,000 and over Discoun t (%) No discount 4 5 Discount Price (P) $5.00 $4.80 $4.75

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Quantity Discount How Much to Order

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