Production Management

InventoryManagementInventory System Defined3Purposes of Inventory4Objective of Inventory ControlTo achieve satisfactory levels of customer service while keeping inventory costs within reasonable boundsLevel of customer serviceCosts of ordering and carrying inventoryE(1)Independent vs. Dependent DemandIndependent Demand (Demand not related to other items or the final end-product)Dependent Demand(Derived demand items for component parts, subassemblies, raw materials, etc.)6Inventory Planning

Finished goods and spare parts typically belong to independent demand items in manufacturing organisations Inventory planning of items must address the following two key questions:How much? When? Why Inventory is ImportantOn the balance sheet it represents about 30 to 50 % of the assets.

Ratios Inventory Turns is the ratio of the annual sales to the investment in inventoryFor ex, if the annual sales is 200 million and the average investment in inventory is 40 million then the ratio is 5. It shows how effectively inventory is used.Days of .supply is the ratio of inventory on hand to the avg daily usage.

Types Of Inventory: Raw materialWIP Finished goods. Distribution inventories MRO items (Maintenance, Repairs and Operational SuppliersSubstantial improvement in the productivity of inventory can be achieved by re-engineering supply chain processes.

Poor inventory management may lead to stock outs and hence cancellation of customers orders, overstocking leading to insufficient storage space and increase in the number and rupee value of obsolete products.

Consequently, inventory management has a large financial impact on the firm.

Investments blocked in inventory cannot be used to obtain other goods or assets that could improve the enterprise performance.

8Types of InventoryCycle Stock/ Lot size It is portion of inventory that depleted as customer orders come inand replenished as suppliers orders are received. Periodicreplenishment is required. Example hospital ordering 10000 syringes and daily use is 500. If Q is the order quantity per cycle then average inventory = Q/2

Transportation/Pipeline Inventory: Exists because of the time needed to move the goods from one location to another such as plant to distribution center called asPipeline or movement inventories.

Safety Stock is held to cover the unpredictable fluctuations in supply or demand or lead time, so that stock out will not happen.

QuantityTimeSafety stockCyclic StockPipeline inventoryLCyclic, Pipeline and Safety StocksA graphical illustrationCyclic inventory, pipeline inventory and safety stocks are critically linked to how much and when decisions in inventory planningTypes of InventoryAnticipation inventory / Seasonal these are built up in anticipation of a future demand for example, ahead of a peak selling season, promotion etc.

Dead stock- It is obsolete stock that part of the non moving inventory that is unlikely to be of any further use. Example electronics

Decoupling Inventory Complexity of production control is reduced by splitting manufacturing into stages and maintaining inventory between these stagesCosts in Inventory PlanningCarrying CostInterest for short-term borrowals for working capital Cost of stores and warehousing Administrative costs related to maintaining and accounting for inventory Insurance costs, cost of obsolescence, pilferage, damages and wastage All these costs are directly related to the level of inventory Costs in Inventory PlanningOrdering CostSearch and identification of appropriate sources of supplyPrice negotiation, contracting and purchase order generationFollow-up and receipt of materialEventual stocking in the stores after necessary accounting and verification A larger order quantity will require less number of orders to meet a known demand and vice versa Cost of carrying and cost of ordering are fundamentally two opposing cost structures in inventory planningCosts in Inventory PlanningShortage CostCosts arising out of rescheduling the production system to accommodate these changes Rush purchases, uneven utilisation of available resources and lower capacity utilisation Missed delivery schedules leading to customer dissatisfaction and loss of good will The effects of shortage are vastly intangible, it is indeed difficult to accurately estimate Total cost of carrying Total cost of ordering Sum of the two costsMinimum Cost EconomicOrder Qty.Level of InventoryCost of InventoryEOQ ModelA graphical representationInventory Control for deterministic demand: EOQ Model

Demand during the planning period = DOrder quantity = Q The cost of ordering per order = Inventory carrying cost per unit per unit time = The total ordering cost is given by

The average inventory carried by an organisation=The cost associated with carrying inventory =

Total cost of the plan = Total cost of carrying inventory + Total cost of orderingTC(Q)= + Inventory Control for deterministic demand: EOQ Model

Denoting EOQ by Q*, we obtain the expression of Q* as:

The optimal number of orders =

Time between orders =

Issues in using EOQ ModelModel assumptionsThe demand is known with certainty Demand is continuous over timeThere is an instantaneous replenishment of itemsThe items are sourced from an outside supplierAssumptions about order quantityThere are no restrictions in the quantity that we can orderThere are no preferred order quantities for the itemsNo price discount is offered when the order size is large Despite this, the EOQ model could be applied with suitable modifications because it is robust Q can be a minimum order quantity if EOQ value is lesserHave a preferred quantity based on truckload quantity, economies of scale, quantity discounts etcROPSSQLInventory LevelTimeSafety StockMean Demand during LT Inventory Position Physical InventoryContinuous Review (Q) SystemAn illustrationSSLInventory LevelTimeSafety Stock Inventory Position Physical InventoryR2R3RQRQ2RQ3ROrder Up to LevelSPeriodic Review (P) SystemAn illustrationBasic Fixed-Order Quantity Model and Reorder Point BehaviorR = Reorder PointQ = Economic Order QuantityL = Lead TimeLLQQQRTimeNumberof unitson hand10Use of Q and P systemsQ system is based on perpetual monitoringQ system is less responsive to demand changes when demand declines, the ROP moves to the right and system will continue to order even if demand is less, so carrying cost may riseIf demand increases, ROP will happen frequently and ordering cost will increaseAnother issue is ordering of multiple items A, B,C from the same supplier.P system overcomes limitation of Q system.Greater chances of linkage between MRP and planning system.For high value/ A class use P systemEOQ Example (1) Problem DataAnnual Demand = 1,000 unitsDays per year considered in average daily demand = 365Cost to place an order = $10Holding cost per unit per year = $2.50Lead time = 7 daysCost per unit = $15Given the information below, what are the EOQ and reorder point?14EOQ Example (1) Solution

In summary, you place an optimal order of 90 units. In the course of using the units to meet demand, when you only have 20 units left, place the next order of 90 units.15EOQ Example (2) Problem DataAnnual Demand = 10,000 unitsDays per year considered in average daily demand = 365Cost to place an order = $10Holding cost per unit per year = 10% of cost per unitLead time = 10 daysCost per unit = $15Determine the economic order quantity and the reorder point.16EOQ Example (2) Solution

Place an order for 366 units. When in the course of using the inventory you are left with only 274 units, place the next order of 366 units.17Inventory AnalysisProduct Classification Analysis (ABC)

Selective Control of InventoriesAlternative Classification SchemesABC Classification (on the basis of consumption value)XYZ Classification (on the basis of unit cost of the item)High Unit cost (X Class item)Medium Unit cost (Y Class item)Low unit cost (Z Class item)FSN Classification (on the basis of movement of inventory)Fast MovingSlow MovingNon-movingVED Classification (on the basis of criticality of items)VitalEssential DesirableOn the basis of sources of supplyImported Indigenous (National Suppliers)Indigenous (Local Suppliers)ABC ClassificationA graphical illustration

Inventory Planning & ControlChapter HighlightsA fixed order quantity (Q system) or continuous review system of inventory planning and control is useful for B class and C class items of inventory. A popular application of the continuous review system in organisations is the two-bin system. A fixed order interval or a periodic review system (P system) is useful for planning and control of high value and A class items. The P system is more responsive to changes in demand patterns than the Q system.Selective control of inventories is achieved through alternative classification methodologies. The ABC, VED and XYZ classifications are often used by organisations.Product Number

Sales (000)Percent of SalesCumulative Sales PercentCumulative Products PercentCategory

145,00030.030.05A

235,00023.353.310A

325,00016.770.015A

415,00010.080.020A

58,0005.385.325B

65,0003.388.730B

74,0002.791.335B

83,0002.093.340B

92,0001.394.745B

101,0000.795.350B

111,0000.796.055C

121,0000.796.760C

202500.2100.00100C