unit 12 inventory control

8/19/2019 Unit 12 Inventory Control

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Bangladesh Open University

Inventory Control

Unit Introduction

Inventory management is very important to both product and service oriented businesses. How much wealth to stock has been a puzzling question since man’seistence as an economic being. !hile the accumulation o" wealth has always been cheered# sub$ect to religious and moral constraints# the acquisition o" goods"or anticipated use is o" a peculiar nature. It is the stick that should be neither toolong nor too short # which %ing &olomon ordered his bird to "ind# and which#according to 'iddle (astern tale# the generations o" that bird are still looking "or in the trees. )hus in real business li"e situation raw materials must be scheduledand stock*piled "or the production# operating supplies must be delivered and placed on hand in the proper quantities "or the operation# large stocks o" materialsmust be kept to operate# maintain# and epand the etensive distribution system.I" proper materials are not available when needed# it will be di""icult to etendservices in a timely "ashion. )hese demand large volumes o" materials on hand toensure that there will be no shortage. )his will increase cost# but the customers pre"er low rates. )hus a proper balance must be struck to maintain proper inventory with the minimum "inancial impact on customers. )his demandsmaintaining stock keeping items at a level which is neither too much nor too lessand must be +ust*In*)ime ,+I)-. ocussing this the unit will cover the issues o" inventory concepts/ inventory control/ the operating doctrine o" inventory# +ust*In*)ime 'anagement ,+I)-

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Unit* 34 11


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Lesson One: Why-What-How Issues of Inventory

Lesson Objectives

5"ter completing this lesson you will be able to6

Understand the meaning o" inventory

Identi"y the reasons "or keeping inventory

(plain the and inventory system concepts

7iscuss how to control the inventory

8omments on the importance o" di""erent inventory

)he pressure "or operating capital has made business increasingly aware o" inventory as a "orm o" earning investment. )he basic problem o" inventory policyis to strike a balance between operating savings and costs o" capital requirementsassociated with larger stocks. &triking this balance is easier to say than to do.!hy are we always out o" stock9 5 complaint "rom a large number o" businessmen "aced with the dilemmas and "rustrations o" attempting

simultaneously to maintain stable operations# provide customers with adequateservice# and keep investment in stocks and equipment at reasonable levels. Inorder to get the answer to this question as a basis "or taking action# it is necessaryto step back and ask some rather di""erent kinds o" questions6

!hy do we have inventories9

!hat a""ects the inventory balances that we maintain9

How do these e""ects take place9

rom these questions a picture o" the inventory problems can be built up whichshows the in"luence on inventories and cost o" various alternative decisions#which the management may ultimately want to consider. Be"ore answering thesequestions let’s start de"ining inventory and understand di""erent types o"

inventory.

What is Inventory?

Inventory can be de"ined as idle resources awaiting activation. Inventory is madeo" all those items ready "or sale or o" items# which keep the process running.rom "irm’s point o" view# inventories represent an investment/ capital is requiredto store materials at any stage o" completion. Inventory is store o" goods andstocks. In manu"acturing# items in inventory are called stock*keeping items heldat a stock ,storage- point. &tock*keeping items usually are raw materials# work*in*process# "inished products and supplies stocked in order to meet an epecteddemand "or distribution in the "uture ,"igure 34.3.3-.

igure 34.3.36 7i""erent items o" inventory in manu"acturing kept in ware house

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Inventory is an idleresource "or later use.

Ware House

;aw materials↓

← !ork*in*processO""ice &urplus →

↑

inished goods


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(ven though inventory o" materials is an idle resource in the sense it is not meant"or immediate use. It is almost a necessity "or some inventories "or the smooth"unctioning o" an organization < manu"acturing or service. =et us take theeample o" a commercial bank with "ull*line services. )he typical individualaccount involves various transactions# such as# checking# savings# lock boes#

and loans. or the teller operation# the service is to convert labor and materialsinto money management. &uch materials as deposit slips# withdrawal slips# andloan payment coupons are more like operating supplies than raw materials. or the accounting operation# slips and coupons could be viewed as work*in*process#and money account statements awaiting mailing as "inished goods ,services-.

Tyes of Inventory

Inventory can be classi"ied into three di""erent categories6i. )ransaction inventoryii. &peculative inventoryiii. 0recautionary inventory

i. Transaction inventory6 It is "ormed basically o" those items# whichare mainly needed "or transaction# e.g.# transaction o" "inished saleable products or transaction o" raw materials.

a. 7e*linking 0roduction with 0urchasing 7epartment is one o" the"unctions o" this# i.e.# receipt o" raw material is stored in the "orm o" inventory and whenever production department needs raw materialit put indent to inventory organization rather than to purchasedepartment.

b. 7e*linking 0roduction with &ales Organization. &imilarly it delinkssales and production departments.

ii. !eculative inventory6 It is basically kept as a measure o" speculation o" increase in the price o" raw material or increases the sale

price o" "inished goods. It is generally resorted to be"ore the budget proposals.

iii. "recautionary inventory6 )he machines are to be kept running.)here may be breakdown o" machines at any time due to damage o" any part due to wear and tear. 5t that time it cannot be purchased immediately.)here"ore# such items# which are essential to keep the process running# areto be stored like machine parts# tools# etc. It is also called maintenancerepair and operation inventory.

Why Inventory?

5s noted# inventory is an idle resource "or later use. 5n idleness is alwaysassociated with a cost# maintaining inventories is epensive in terms o" theworking capital tied up in them# either directly or indirectly through alternativeuses o" the tied*up "unds. In addition# the process o" ordering goods# whether "rom an eternal supplier or "rom the "irm’s own production# is epensive due tothe costs arising "rom checking the actual levels o" stock# contacting suppliers#checking their products# and the applicable costs o" credit "acilities# shipping# and"orwarding. 5 parallel type o" cost# the set*up cost# arises in production*by*lot processes# where production is discontinuous and thus the equipment used# beingnot strictly specialized# needs ad$ustment and retooling "or every production run.Uncertainty has also its cost. Uncertainly regarding demand epectations and

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time lags between ordering and receiving# or starting a run and "inishing it#results in overages and shortages. )o these con"licting costs must be added thecost o" designing and handling inventory systems.

In some circles inventories are thought o" as a sign o" wealth# even ecessinventories in relation to the magnitude o" production and distribution "unction

are considered advantageous. On the other hand# the wise businessmen placemore emphasis on having working capital on the "orm o" cash and securities. Inrecent years a greater emphasis has been placed on having the means o" purchasing materials than having the materials themselves. (cessive inventorieshave been the reasons "or death o" many a business and very high inventorylevels has tipped the scale in our economy. inished product a"ter packaging are"irst stored and sent to the market as the need arises or orders are received. 5lsothe raw materials needed "or the "inished product cannot be directly "ed to the production department "rom the market. )hese have to be stored "irst a"ter procurement. )hese things put together give an idea o" storing these items. )his process o" storing is called inventory. )he "undamental reason "or carryinginventories is that are6

0hysically impossible "or each stock item to arrive eactly where and

when it is needed and (conomically impractical "or each stock item to arrive eactly where and

when it is needed.

(ven i" it were physically possible "or a supplier to deliver raw materials every"ew hours# "or eample# it could still be prohibitively epensive. )hemanu"acturer must there"ore keep etra supplies o" raw material inventory to usewhen they are needed in the conversion process. )he other reasons "or keepinginventories include6

a. #uffer stoc$ 6 Bu""er stock can be de"ined as the inventory against stock*outs "rom uncertain demand during lead*time. !hen demand is highly

variable# some protection is needed against the chances o" high stock*outcosts. In such cases inventory can be used as a buffer . =ikewise this also bu""ers against highly varied lead*time ,time between ordering andreceiving goods-.

b. %ecoulin&6 7ecoupling means breaking down operations apart so that oneoperation’s supply is separated "rom another’s supply. )hrough decoupling by procuring inventories separately# breakdowns# material shortages# or other production "luctuations at one stage o" operations do not cause anydisruption in later stages o" operation. 5lso through decoupling oneorganizational unit can schedule its operations independently. 7ecouplingthrough in*process inventory is common in automobile industry# where#engine build*up# seat assembly# body making# etc. are done separately ,in

many cases in distant locations-.

c. "roduction s'oothin&6 0roducts can be built during slack demand periods"or using in peak demand periods. )his will reduce high costs o" productionrate# work "orce level changes# set*up costs# etc. Inventories can help in this production leveling.

d. (aterials handlin&6 In some operations parts can be accumulated andstocked in container ,tote- boes or baskets and transported hand*$ack dollies ,wheelbarrow- or "orkli"t trucks much more economically than can be carried manually. )his is particularly true o" intermittent systems# since

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7ecoupling is breakingdown operations apartso that one operation’ssupply is separated"rom another’s su l .

(cessive inventories

have been the reasons"or death o" many a

business.


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they involve less automation o" material handling than do continuoussystems. In continuous manu"acturing# automated materials handlingsystems are designed to reduce overall handling costs# resulting in lesswork*in*process.

e. #ul$ urchase6 Bulk purchase gives quantity discount. )his also gives acost advantage o" materials inventories.

)vils of )*cess Inventory

rom the above discussion you can be well aware o" the importance o" inventoryand its management. But ecess inventory is no doubt an evil "or an organization.It blocks the money taking away opportunities "or the "irm. &ome o" the bad

impacts o" ecess inventory are mentioned below6

(ssential though they are# inventories also mean lock up capital o"

inventories# which could be invested in more pro"itable operations.

(cess inventory adds to the cost o" carrying the inventory more store

space# equipment and personnel# insurance# taes# pil"erage etc.

(cess inventory invites risk o" deterioration and obsolescence.

8hanges in the prices o" inventory materials sometime go un"avorable.

'aintenance o" cost money.

Inventory Control

Inventory constitutes one o" the most important elements o" any system dealing

with the supply# manu"acture and distribution o" goods and services. )he concepto" inventory control is very old but it came in light when . !. Harris publishedhis work on classical order size model. .(. ;aymond ,3?@3- and ;.'. !ilson,3?@A- etended this work. But only a"ter the second world war with thedevelopment o" operational research and computer technology that the theoreticalconcepts got a practical application. )he basic purpose o" inventory holdingstocks in a material "low system is to de*couple successive stages o" system.ollowing are important purpose o" inventory6

(istence o" time lags between manu"acturing and transport operations.

)he need to schedule various stages o" the system independently.

)he need to meet the "luctuation in demand and production rates.

)he need to maintain control over the quality o" the "inished production.

)he need to eercise in"luence over changes o" material prices

particularly basic raw materials.

)he inventory control mainly concerned with making optimum decision withrespect to the variables# which are sub$ect to control. Inventory control is a multi*item and multi*stage in nature. 5s noted inventory is an idle resource# which isuseable# has value and awaiting activation. )he idle resource may be men#money# materials# and plant acquisition. )he manpower# capital and plantacquisition problems are essentially control problems. Inventory controldetermines the levels o" composition o" inventories o" parts# materials and

Unit* 34 :

)he inventory controlmainly concerned withmaking optimumdecision with respect tothe variables# which aresub$ect to control.

+ctivity: 5ssume that you are the owner o" an eport quality man’sgarments manu"acture "irm. 7o you think "or your productsCinventory management issue’ should be a key success "actor9 !hyor why not9 7iscuss with your study partners.


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products that will protect most e""ectively the production# sales# and "inancialrequirements o" the business. 5 system o" production planning and control is notand end in itsel". It can only be $usti"ied because it ,a- provides the means "or e""ective coordination o" the 0roduction department with other departments o" the business/ and ,b- promotes e""ective shop operation through its control o" activities within the production department itsel".

+dvanta&es of inventory control

i. Introduction o" a proper inventory control system helps in keepingthe investment in the inventories as low as "easible.

ii. (nsures availability o" material by providing adequate productionagainst uncertainties o" supplies and consumption o" materials.

iii. 5llows "ull advantage o" economies o" bulk purchases andtransportation.

iv. ;educes changes o" going out o" stock.v. =eads to reduction in inventory levels.vi. ;eleases more o" capital "or other operations.vii. Increases pro"itability o" an organization.

viii. 5dequate customer service.i. 5dvantage o" price discounts by bulk purchasing.. 0roviding "leibility to allow changes in production lines due to

changes in demands or any other reason.

Which Inventory to )'hasi,e?

5s you can understand that all the items held in inventory are not o" equalimportance in terms o" monetary value# pro"it potential# sales or usage volume# or stock*out penalties. or eample# a retail store can have a lot o" items like# rice#sugar# butter# pencil batteries# etc. It would be unrealistic to devote equalattention to each o" these items. Instead# a more realistic and reasonable approachwould be to allocate control e""orts according to the relative importance o"

various items in inventory. Hence the question arises which inventory toemphasize9

+-#-C Classification

)he simple answer to this question is to apply the theory o" Vital Few and Trivial Many by Del"redo 0areto. !hen an organization’s inventory is listed by )akavalues# generally a small number o" items account "or a large )aka volume# and alarge number o" items "or a small )aka volume. In inventory management we"ocus this view by classi"ying the inventories into three categories 5# B and 8,igure 34.3.3-.

5n 5*grouping is made "or those "ew items with large )aka value/ a B*grouping"or items with moderate unit and )aka value/ and a 8*grouping "or the largenumber o" items accounting "or a small )aka value. )hus 5*group might contain#"or eample# about 32E o" the number o" items in the inventory costing about1*:E o" the total )aka usage/ B*group might contain# "or eample# about @Eo" the items costing about 42E o" the total )aka volume/ 8 group might contain#"or eample# about 22E o" the number o" items costing only about 3E o" thetotal )aka volume 34.3.3. )hese percentages vary "rom "irm to "irm# but in mostinstances a relatively small number o" items will account "or a large share o" thevalue or cost associated with an inventory.

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5*B*8 classi"ication o" inventory is listed bytaka values.


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3

>2

22

5 B 8

igure 34.3.36 5*B*8 classi"ication o" items

)hese items ,5*category- should receive relatively close attention through"requent reviews o" amounts on hand and control over withdrawals# where possible to make sure that customer service levels are attained. )he 8*itemsshould receive only loose control# whereas# the B*category should have controlsthat lie between the two etremes.

)*cetions to +-#-C classification

)here are "ew eceptions to 5B8 classi"ications. Items in 8 category can demandspecial emphasis i" they meet in any o" the "ollowing criteria6

'aterials critical to production

'aterials with short shel" lives

'aterials that are very large and bulky

Daluables materials sub$ect to pil"erage

'aterials with highly erratic lead*times

'aterials with highly erratic demand &tandard packaging# shipping# container# or vehicle size

Unit* 34 :4

Eo" total)akausage

32 A2 3

E o" items used

+ctivity: 8hose a medium or big in size departmental store "rom anysuper market. 8are"ully eamine its inventory management system. 7oyou think the store manager should take any "urther action,s- that will

hel himFher to increase er"ormance.


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uestions for discussion

3. Give speci"ic eamples o" each o" the "ollowing types o" inventories

,i- ;aw materials/ ,ii- !ork*in*process materials/ ,iii- O""ice supplies/ ,iv-inished goods.

4. !hat are the evils o" ecess inventory9 Give some eample with

respect o" Bangladesh scenario.@. ou are a manu"acturer o" a product. ou are using your own premises "or

holding the "inished goods. 7o you think it has a cost9 How will you calculate it9

A. ind the amount o" average inventory carried "or a "amily againsteach o" the "ollowing purchases "or a period o" one month. 'ake necessaryassumptions.

2. )he "amily consumes @ kg o" rice )k. 3:.. )hey purchase thewhole amount at the "irst day o" the month.

a. )he "amily consumes A kg o" sugar )k. @4.. )hey purchase therequired sugar two times a month at equal gap.

b. )he "amily purchases two bottles o" pickle , )k. 22. per bottle-.)hey purchase both the pickle bottles at the "irst day o" the month.

c. )he "amily makes weekly purchase o" one 4 gm packet o" butter ,)k. 2. per packet- "or weekly consumption.

d. )he "amily needs one 3>*slice packet o" bread , )k. 4. per packet- "or their break"ast everyday. )hey purchase it "rom the localgrocery every morning.

:. 5 "amily with three children and their parents is living at 7hanmondi. )heyhave a working maid living with them. Jormally at the beginning o" everymonth they make a shopping "or the whole month. )he shopping chart"ollows6

Ite' Unit "rice uantity Ite' Unit "rice uantity

;ice )k. 3>. @ kg 3. +elly )k. :1. @ bottles

lour )k. ?. 32 kg 33. )ooth pick )k. 34 3 packet

0ulses )k. @2 34 kg 34. Onion )k. 3A. : kg

0ickle )k. A4 4 bottles 3@. &alt )k. >. 2 kg

Biscuit )k. 4> A packet 3A. &pices )k. 44. 3 kg

0otato )k. ?. 1 kg 32. )ooth 0aste )k. @1. 4 pieces

&oap )k. 1. A pieces 31. Butter )k. 1A @ pieces

Oil )k. 32. 1 litre 3:. Hair Oil )k. 42 3 bottle

)ang )k. >2. 4 bottles 3>. 'atch bo )k. 3. 2 boes

)he "amily also subscribes two newspaper ,one Bengali and one (nglish- everyday# each costing )k. >.# which they sell at the end o" the month "or )k. 4A.

5lso they purchase two cans o" powder milk every month# one at the beginningand one hal"way through. (ach o" the cans costs Tk. 490. Considering abovemake an !C classification of the inventory items of the family.

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Lesson Two: The oeratin& %octrine

Lesson Objectives

5"ter completing this lesson you will be able to6

Understand the costs o" inventory

(plain the cost o" tradeo""

7iscuss the (conomic Order Kuantity ,(OK- model

Costs of Inventory

Operations managers must make two basic inventory policy decisions. )hese are6

i. !hen to reorder stock andii. How much stock to reorder

)hese decisions are re"erred to as the inventory control operating doctrine. Inoperating an inventory system managers should consider only those costs thatvary directly with the operating doctrine in deciding when and how much toreorder/ costs independent o" the operating doctrine are irrelevant. Basically#

there are "ive types o" relevant costs6

i. 8ost o" Item6 )he cost# or value# o" the item is usually its purchase price or the amount paid to the supplier "or the item.

ii. 0rocurement 8osts6 It is the cost o" placing a purchase order# or thesetup cost i" the item is manu"actured at the "acility.

iii. 8arrying 8ost6 8arrying or holding costs are the costs o" maintainingthe inventory warehouse and protecting the inventoried item. It iscalculated on the basis o" the percentage ,E- o" the average inventorycarried over a period o" time.

iv. &tock Out 8osts6 &tock out costs are associated with demand when

stocks have been depleted# take the "orm o" lost sales or backorder costs.v. 8ost O" Operating )he In"ormation 0rocessing &ystem6 !hether by

hand or by computer# someone must update records as stock levelschange. or systems in which inventory levels are not recorded daily# thecost is primarily incurred in obtaining accurate physical counts o" inventories.

Cost tradeoff

Our ob$ective in inventory control is to "ind the minimum cost operating doctrineover some planning horizon. !e need to consider all relevant costs# whichdiscussed in inventory cost. Using a one*year planning horizon# these costs can be epressed in a general cost equation6

L M M M

)cono'ic Order uantity (odels

In a continuous# or "ied*order*quantity# system when inventory reaches aspeci"ic level# re"erred to as the reorder point# a "ied amount is ordered. )hemost widely used and traditional means "or determining how much to order in acontinuous system is the (conomic Order Kuantity ,(OK- model# also re"erred to

Unit* 34 :A

)otal annualrelevant cost

)otal annualrelevant cost

8ost o"the item

0rocurement8ost

8arrying cost8ycle costBu""er cost

&tock*out cost=ost salesBack*orders

In the inventory systemmanagers shouldconsider only those

costs that var directl .


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as the economic lot*size model. )he earliest published deviation o" the basic(OK model "ormula occurred in 3?32 and is credited to ord Harris# anemployee at !esting*house. )he "unction o" the (OK model is to determine theoptimal order size that minimizes total inventory costs. )here are severalvariations o" the (OK model# depending on the assumptions made about theinventory system.

The #asic )O (odel

(OK is the optimal order quantity that will minimize total inventory costs. )hesimplest "orm o" the economic order quantity model on which all other modelversions are based is called the basic (OK model. It is essentially a single"ormula "or determining the optimal order size that minimizes the sum o" carrying costs and ordering costs. )he model "ormula is derived under a set o" simpli"ying and restrictive assumptions# as "ollows6

7emand is known with certainty and is relatively constant over a period

o" time. Jo shortage ,stock outs- is allowed.

=ead*time "or the receipt o" order is constant and independent o" demand. )he order quantity is received all at once.

igure 34.4.3 describes the continuous*inventory order cycle system inherent inthe (OK model. 5n order quantity# No# is received and is used up over time at aconstant rate. !hen the inventory level decreases to the reorder point# ; # a neworder is placed/ a period o" time# =# re"erred to as the lead"time# is required "or delivery.

)he order is received all at once $ust at the moment when demand depletes theentire stock o" inventory# thus allowing no shortages. )his cycle is repeated

continuously "or the same order quantity# reorder point and lead*time. 5s we haveseen that the economic order quantity is the order size that minimizes the sum o" carrying costs and order costs. )hese two costs react inversely to each other inresponse to an increase in the order size. 5s the order size increases# "ewer ordersare required# causing the cost to decline# whereas the average amount o" inventory on hand will increase# resulting in an increase in carrying costs. )hus#in e""ect# the optimal order quantity represents a compromise between these twocon"licting costs.

)he total annual ordering costs is computed by simply multiplying the cost per order# designated as C r # times the number o" orders per year. &ince annualdemand ,P- is assumed to be known and to be constant# the number o" orders will

be PFN# where N is the order size and

5nnual ordering cost L ,C r P- FN

)he only variable is this equation is N/ both C r and P are constant parameters.)hus# the relative magnitude o" the ordering cost is dependent upon the order size.

0roduction Operations 'anagement 0age* :2

(OK is the optimalorder quantity that willminimize totalinventor costs.


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)otal annual carrying cost is computed by multiplying the annual per unitcarrying cost ,E-# designated as 8c# times the average inventory level#determined by dividing the order size# N# by 4 ,NF4-6

5nnual carrying cost L 8c × ,8N- F4

)he total annual inventory cost ,)8- is simply the sum o" the ordering andcarrying costs6

)8 L C r × PFN M C c × C NF4

)hese three cost "unctions are shown in "igure 3.4. Jotice the inverse relationship between ordering cost and carrying cost# resulting in a conve total cost curve.

7i""erentiating the )8 curve with respect to N and equating it to Pero cancalculate the economic order quantity ,No-. By di""erentiating again with respectto we can check "or minima o" this cost curve. Hence#

.min##4

min

#4

B4

-4F,-F,

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4

4

imahencenumber #ositivea $

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d&

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ima for check to

'uantityorder economictheCC

% C $

C C

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% C C$ C

d&

d $ % C

d&

d

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dTC

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cr cr

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)he optimal order quantity occurs at the point in "igure 3.4 where the total costcurve is at a minimum# which also coincides eactly with the point where thecarrying cost curve intersects with the ordering cost curve. )his enables us todetermine the optimal value o" K by equating the two cost "unctions and solving"or K# as "ollows6

,C r P-FNo L ,C c 8No-F4

No 4 L ,4C r P-F,8C c-

c

r

o

CC

%C $

4=

or eample# the demand "or a product over a period o" one year is :2# units.)he unit cost o" the items is )k. 3. )he ordering cost and carrying costs are )k.3 and 32E o" the average carried inventory respectively. )he company policy isto place an arbitrary order o" 4# units each time an order is placed. ind the(OK9 &ee what a""ect the optimal order size has on current ordering and storagecosts9 Jow the (OK would be#

Unit* 34 :1


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units $ o

BBB#332.3B

3BBBB#:24=

×

××

=

I" we order 3# units each time we place an order# we will need to place :2orders per year# and our average inventory will be 2 units. Our total ordering

and storage cost will then be#

)otal ordering and storage cost L :2 × 3 M 2 × 3 × .32 L )k. 3#2

I" they "ollow current order policy#

)he order size L 4 units

5verage inventory L 3 units

Jo o" orders L @:.2 nos

)otal ordering and storage cost L @:.2 × 3 M 3 × 3 × .32

L )k. 3#>:2

Hence the optimal policy would save approimately )k. @:2

Lead Ti'e in %eter'inistic (odel

In (OK model we assumed that the lead*time is constant and independent o" demand. )his model can easily be ad$usted "or lead*times with certainty. !e cancalculate the reorder point ,;- as "ollows6

; L Bu""er stock M 7emand during lead time ,7=-L M ,=ead time-,7emandFunit time-L =d=

)he reorder point is now set and shown in "igure 3@.@. 5t ;# an order will be placed "or No units# which will arrive = units o" time later. 7uring the time between ordering and arrival# d= units per time unit# 7= in total unit will be

demanded# and inventory will be reduced accordingly.

No

Units ininventory

;

7=

= =

)ime

igure 34.4.36 the continuous*inventory order cycle system

or eample assume that 5 restaurant uses :@ dozens o" >*ounce paper cupsannually. )he cost per dozen o" these cups is )k.@.. )he ordering costs are)k.@:.2./ carrying costs are @E o" average carried inventory. 7elivery lead*time is known with certainty to be "ive days. (stablish the optimal operatingdoctrine.

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do(ensCC

%C $ )ere

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o :>??.::[email protected],BB.@B,

-2B.@:-,:@B,44# ≈===

;eorder point# ; L =d= L 2 × ,:@F@12- L 3 dozens

)he operating doctrine would be to order :> dozens when stocks on hand reaches3 dozens.

Usin& Co'uters to (ana&e Indeendent Inventory

8omputers can use data on receipts and withdrawals to maintain the amount o" stock on hand "or all the inventory items controlled by the computer system.8omputer companies and commercial so"tware companies o""er so"tware packages that will keep track o" the on*hand balance and per"orm other "unctions#such as reporting items that are below their reorder levels and recommending theeconomic quantity to buy or produce. )he computer may print a list each day#showing the items that need to be replenished. &ometimes pre"erred vendor

identi"ication "or each item is stored in the database# so the computer canautomatically prepare the purchase orders i" instructed to do so.

Use history can be used to calculate a "orecast o" the epected annual demand.(stimates o" the holding cost# setup cost# or order cost "or each item can be storedin the database# "rom which order quantity recommendations can be calculated.)he reorder level "or each item can be stored in the database# but o"ten only thelead*time and the desired service level are stored. )he program can compute thereorder level on the basis o" current estimates o" the average use rate and acalculation standard deviation or '57. )his type o" system maintains a largeamount o" data and per"orms numerous calculations to assist inventory managers.O" course# the system only makes recommendations# which can be overridden or

implemented according to the decisions o" the appropriate person.

)cono'ic Order uantity .)O/ relevant cost deter'ination

(OK is the quantity o" an inventory item to order so that total inventory costs areminimized over the "irm’s planning period. In"ormation required to determineoptimal order size are6

)he total unit to be used during a period

)he cost associate with placing an order# i.e.# ordering cost per order

)he cost o" holding one unit in inventory "or the entire period# i.e.#

carrying cost per unit per period.

Criteria for deter'inin& orderin& cost)he company in the purchasing o" raw materials incurs ordering costs. Includedin this cost are the processing and receiving costs incurred "or the each purchaseorder. %ey to recognizing ordering cost is to ask i" level o" this cost will change i" we place two orders instead o" one# i.e.# whether total cost "or a cost element willchange i" more than one order is placed. &uch as#

or making an order 'r. %amal needs to make a long distant telephone

call# which cost him )k. 34. 5s more is the number o" orders the moreis the cost arising "rom the telephone calls# e.g.# "or two orders it is )k.4A# "or @ orders it is )k. @1. Hence this is an ordering cost.

Unit* 34 :>

8omputer so"twarekeep track o" the

per"orm "unctions o" inventory that need theeconomic quantity to

buy or produce.


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5gain "or eample# let’s assume that 'r. %haleque has a quarterly

demand "or potatoes o" A2 kg "or his grocery business andtransportation cost is )k. 42 per kg. Jow i" only one order is placed thetransportation cost will be )k. 334#2. But i" 'r. %haleque places twoorders# then each time his cost will be )k. 21#42 without changing thetotal cost. 5s the total cost remains the same irrespective o" the number

o" orders this is not an eample o" ordering cost in this situation.

Criteria for deter'inin& carryin& cost

8arrying costs are those costs "or holding inventory. )hese costs generallyinclude insurance# personal property ta# cost o" storage space# breakage#obsolescence# and the rate o" return on the investment in inventory "orgone by thecompany. )he carrying cost can be epressed as cost per unit per year or as a percentage o" unit inventory value. %ey to re"erring a cost element as carryingcost i" the total cost "or that element vary with respect to average number o" unitsin inventory ,again not those costs that vary with the total number o" unitacquired-. )his time we have to ask whether total cost will change i" we increasethe average number o" units residing on inventory over the period by one unit.

)here"ore a cost "or having inventory may or may not be included in the carryingcost depending on whether its total "or the period depends on the averageinventory level. )his is why "ied cost should not be included in the decision process whether it is related to having inventory or not. 5s an eample assumethat rent "or inventorying bags o" potato may or may not be a carrying costdepending on whether total rent "or the period depends on average level o" inventory. ollowing table illustrates this with quarterly demand o" A2 bags.

0ent "ay'ent +&ree'ent 1o2 of

orders

+vera&e

inventory

0ent ay'ent for

The 3uarter

3. )aka 42 "or each bag

kept in inventory

3 442 A242L3342

4 3342 44242M44242 L3342

@. )aka 42 "or each unit in

the average inventory

3 442 44242L2142

4 3342 334242 L 4>342

Here under agreement 3 rent is not a carrying cost because the total rent payment"or the period is same even i" the average inventory level is changed. On theother hand under agreement 4# rent is a carrying cost as total payment o" rent "or the quarter is di""erent "or di""erent level o" average inventory. Hence we canconclude that all cost o" holding inventory is not relevant "or determiningcarrying cost. Only those costs o" inventory that in total "or the period varies withthe average inventoryForder size should be included under carrying cost.

0roduction Operations 'anagement 0age* :?

)he carrying cost can be epressed as cost per unit per year or as a

percentage o" unitinventory value.


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&chool o" Business

Lesson Three: 4ust-In-Ti'e Inventory !yste'

Lesson Objectives

5"ter completing this lesson you will be able to6 Understand the +ust*In*)ime ,+I)- inventory system

Identi"y the di""erent "eatures and building blocks o" +I) (plain the goal o" +I)

5nalyze the advantages and disadvantages o" +I)

7iscuss +I) in Bangladesh

What is 4ust-In-Ti'e .4IT/ inventory syste'

)arley"*avidson saw its commanding lead in heavyweight

motorcycle falter when #owerful +a#anese bikes a##eared in the

,.-. market. f )arley was to stay on the road/ the management

had to uncover the key element of +a#anese success. nitiallythey were baffled. )ondas motorcycle #lant in Maryville/ 1hio

was staffed by ,- workers/ 2ust like )arleys. t bought #arts

from ,- su##liers/ 2ust as )arley did. nd it had no clear

technological advantages. fter touring the #lant in Maryville/

they found what they were looking for. )onda turned out better motorcycles because of their +a#anese #roduction system/

s#ecifically "" the 2ust in time inventory control system.

)he term $ust*in

+I) is a manu"acturingsystem with the goal tooptimize processes and

procedures bycontinuously pursuingwaste reduction


17/23


than one $ob. In the United &tates# +I) was "irst adopted by the automobileindustry. =eading "irms in other industries < Nero# IB'# 5pple# Black R7ecker# and General (lectric# has picked up the concept to name $ust a "ew.

5eatures of 4IT

+I) manu"acturing is a broad philosophy o" continuous improvement# which

indicates three ma$or categories o" e""ort that are mutually supportive6

a. =ow Inventory b. 0eople Involvementc. )otal Kuality 8ontrol

a. Low inventory: CInventory is regarded as evil’ according to +I) philosophy. Its main purpose is to minimize the amount o" idle resources.)hat is why this e""ort is sometimes called zero inventory program o" stockless production.

b. "eole involve'ent: +I) has a strong management component. 'uch o" the success o" +I) can be traced to the "act that the companies that use ittrain the employees to have the appropriate skills# give them responsibility

and coordinate and motivate them. +I) philosophy o" continuousimprovement and minimization o" waste considers any activity that doesnot add value to the product or serve the customers in some way to bewaste. One "orm o" waste that is inconspicuous and di""icult to combat isthe under utilization o" human talent. +I) seeks to utilize more "ully thecreative talents o" the employees# suppliers# contractors# and others whomay contribute to the company’s improvement. +I) is a philosophy that cutsacross all phases o" the manu"acturing and marketing activities in anorganization. It is a strategy marked by an environment o" cooperation andcoordination between buyers and sellers. &hort*term relationships arereplaced by long*term commitments.

c. Total 3uality control: +I) interprets the term )otal Kuality 8ontrol as theachievement o" zero de"ect products that involves every department andevery employee o" the company. 5ccording to the philosophy# qualityshould be ensured at the source# that is quality should be assured "or everyset o" activities at the beginning level < automatically the output o" thecorresponding activities will be improved quality.

#uildin& #loc$s of 4IT

)he design and operation o" +I) ,igure [email protected] system provide the "oundation

"or accomplishing the a"oresaid goal. )he "oundation is made up o" "our building blocks. )hese blocks are6

a. "roduct desi&n : In product design# three elements are key to the +I)system < standard parts# modular design and quality. )he "irst two elementsrelate to speed and simplicity. Kuality is the sine qua non ,S!ithout whichnotQ- o" +I) because poor quality can create ma$or disruptions as the +I) isdesigned to gear up a smooth "low o" work/ the appearance o" problems dueto quality creates disruption in this "low.

0roduction Operations 'anagement 0age* >3

+I) is a philosophy thatcuts across all phases o" the manu"acturing andmarketing activities inan or anization.

+ctivity: How the +I) can help you to per"orm better with your 'B5 program o" Bangladesh Open University ,BOU-9


18/23

&chool o" Business

b. "rocess desi&n: &ome aspects o" process design are important "or +I)system6 small lot sizes# set up time reduction# manu"acturing cells# limitedwork in process# quality improvement# production "leibility and littleinventory storage.

c. "ersonnel 6 or&ani,ational ele'ents: )here are "ive elements o" personneland organization that are particularly important "or +I) system6 workers are

assets# cross*trained workers# continuous improvement# cost accounting andleadership F pro$ect management.

Ultimate goal

-u##orting goals

igure [email protected] Building blocks o" +I)

d. (anufacturin& lannin& and control: Under this# "ive elements are

considered vital6 level * loading# pull systems# visual record systems,%anban system-# close vendor relationships and reduced transaction processing.

The 4IT 7oal5 ma$or ob$ective o" +I) is to have only the right item at the right place at theright time# or to say it another way# to purchase and produce items only a shorttime be"ore they are needed so that work*in*process inventory is kept very low.)he practice not only reduces working capital requirements# it also reduces theneed "or "loor space and shortens the "low through time because materials spendvery little time in queues. )he ultimate goal o" +I) is a balanced system that is#one that achieves smooth# rapid "low o" materials through the system. )he goalsare6

(liminate disruptions

'ake the system "leible

;educe setup times and lead times

'inimize inventory investment

(liminate waste associated with queues

;eact "aster to demand changes

Uncover any quality problem

*isru#tions are occurred by a variety o" "actors# such as poor quality# equipment breakdowns# changes to the schedule# and late deliveries. )hese should be

Unit* 34 >4

(liminates disruptions ;educe setup (liminate waste

'ake the system "leible and lead times 'inimize inventories

+ #alanced

0aid 5low

+ #alanced

0aid 5low

a2 "roduct desi&n

&tandard parts'odular designKuality

b2 "rocess %esi&n

&mall lot size&etup time reduction'anu"acturing cells=imited work in

processKuality improvement0roduction "leibility=ittle inventory storage

c2 "ersonnel 6

or&ani,ational ele'ents

!orkers as assets8ross*trained workers8ontinuousimprovement8ost accounting=eadership F pro$ectmanagement

d2 (anufacturin&

"lannin& 8 control =evel loading0ull systemsDisual systems8lose vendorrelationships;educed transactions

5 ma$or ob$ective o" +I) is to have only theright item at the right

place at the right time.


19/23


eliminated as much as possible. 5 Fle&ible -ystem is one# which is robust enoughto handle a mi o" products# o"ten on a daily basis# and to changes in the level o" output while still maintaining balance and throughout speed. -etu# Time nd *eliveries ;ead Times prolong a process adding a value to the product. )hecontinuous process o" +I) reduces the disrupting setup times and the lead times#as net batch o" production is ready eactly when the preceding batch is

completed. nventory 3idle resources takes up space and adds cost to the system#which should be minimized. +I) can minimize the inventory a lot. 5s therequirements and the deliveries coincide# so no need o" storing "or the "uturerequirements.


20/23

&chool o" Business

;educed manu"actures lead times.

Greater "leibility in changing the production mi.

&moother productivity "low with "ewer disruptions caused by problems

due to quality# shorter setup times# and multi*skilled workers who canhelp each other and substitute "or others.

Increased productivity levels and utilization o" equipment.

!orker participation levels and utilization o" equipment.

!orker participation in problem solving.

0ressure to build good relationships with vendors.

;eduction in the need "or certain indirect labor# such as material

handlers.

4IT: + success story

)here are numerous success stories o" +I). 5 review o" success"ulimplementation in "ive U& companies showed an average lead*time reduction o" ?E. Inventory was reduced by @2 to :@E. 0urchase cost was reduced by 1 to33E. 5 "ew o" the more speci"ic eamples are enumerated "ollows.

)arley *avidson Case

Harley*7avidson# an eighty year old U& motorcycle manu"acturer# su""ered suchstrategic losses in 3?>3 and 3?>4 that the "uture o" the company was seriously inquestion. &ome o" the eternal problems were Honda# &uzuki# %awasaki# andamaha < "our +apanese competitors that had taken most o" the market. Harley E and warranty costs down by A1E. )he motorcycle part o" the company has been pro"itable since 3?>@. )hereason "or this dramatic turnaround is a company wide e""ort based on the +I)manu"acturing philosophy.

Chrysler Case

or 8hrysler# a car manu"acturing company# which has : percent o" its parts#made by outside suppliers# +I) is obviously quite critical. 8hrysler achieved a ?E reduction in inventory and an increase in average quarterly inventory turnover "rom 1.@> times to 3@.? times. 5 single corporation wide network connects8hrysler’s large and mid*sized computers "rom various vendors and givesengineering workstations access to the large computers. )his makes it easier totrans"er data "rom one system# stage o" production# or plant to another and"acilitates $ust*in*time inventory management.

-t. ;ukes )os#ital

Organizations that use +I) report enormous return on investment. &t. =uke’s(piscopal Hospital in Houston saved T3.2 million over three years when it closed

Unit* 34 >A

+ctivity: How the +I) can help the Bangladeshi manu"acturing "irm todo a better competition within the global environment9 (plain your arguments with taking eample "rom your chosen industry.


21/23


its enormous supplies warehouse and set up Sstockless distributionQ. ;ather thanstoring and handling thousands o" items# the hospital receives daily deliveries"rom Bater International ,the nation’s largest hospital supplier-# whosecomputers communicate directly with &t. =uke’s inventory management system.(ach day# Bater pulls together the materials needed and delivers them directly toeach area inside the hospital.

%rawbac$s of 4IT !yste'

5 recently published report in Business !eek by Brian 'illigan has stated6

5== Those who believe in the 3+T system say it eliminate

wastes and frees u# much needed s#ace that was once used to

house large chunks of inventory. !ut the system obviously has

some bugs in it/ and #urchasing managers say they need to beworked out. This is evident from the survey/ which re#orted that

4> of #artici#ants say = they are having efficiency #roblems.

==and #artial success can be very troublesome. The 4> who

re#ort +T"related efficiency #roblems say these #roblems can

'uickly become big #roblems when assembly lines are forced to

shut down.

-ome #urchasing managers say they have run into #roblems with

getting su##liers to kee# the needed stock ready to be delivered. n

fact/ ??> of the survey #artici#ants say missed su##ly deadlines

are a #roblem. Twenty one #ercent of those surveyed say su##ly

'uality is a #roblem. nd ??> say su##lier commitment is an area

that needs to be im#roved.6

+I) is not "ree "rom de"ects. )he potential shortcomings o" the system are as"ollows

+I) may result in increased worker idle time.

'ay decrease the production rate.

&low to react to changes in demand.

It ignores known in"ormation about "uture demand patterns.

7ecrease opportunity "or multiple sourcing.

&uppliers must react more quickly.

Improved reliability required o" suppliers.

The Instances of 5ailure

+I) makes manu"acturers more vulnerable to work stoppages at suppliers’ plantsand to delivery disruptions. 7uring the 3?? Ontario truckers’ dispute# tra""ic tie*ups at the 8anada*United &tates border caused big losses to manu"acturers andshowed them the importance o" keeping their supply routes open. +I) poses even bigger problems in international situations where supply channels are muchlonger.

0roduction Operations 'anagement 0age* >2

+I) may increaseworker idle time Rdecrease the production

+ctivity: 5sk your study partners to do a debate with you regardingthe advantages and disadvantages o" +I). 5"ter that make new list o"

advantages and disadvantages o" +I) and compare with the old one.


22/23

&chool o" Business

@eneral Motor ncident

In 3??1# a 3:*day strike by @ union employees at two o" General 'otor’s7ayton# Ohio brake plants made it drop the production o" 42# vehicles. )heresultant loss amounted to hundreds o" millions o" dollars and caused G' to layo"" 3:2# o" its employees.

Co'arison of 4IT and Traditional +roach

5actors 4IT Traditional +roach

Inventory5 liability. (very e""ort must beepended to do away with it.

5n 5sset. It protects against"orecast errors# machine problems# and late vendor deliveries.

=ot &izeImmediate needs only. 5 minimumreplenishment quantity is desired "or both manu"actured and purchased parts.

ormulas.

&etups 'ake them insigni"icant. )his requireseither etremely rapid change over tominimize the impact on production or the availability o" etra machines.

=ow priority issue. 'aimumoutput is the usual goal.

Kueues(liminate them. !hen problem occur#identi"y the causes and correct them.

Jecessary investment. Kueues permit "ollowing operations tocontinue in the event o" a problemwith "eeding operation.

Dendors8o*workers. 'ultiple deliveries "or allactive items are epected daily. )hevendor takes care o" the needs o" thecustomer# and the customer treats thevendor as an etension o" the "actory.

5dversaries. 'ultiple source arethe rule# and it’s typical to playthem o"" against each other.

Kuality Pero e""ects. I" quality is not 3 E# production is in $eopardy. )olerate some scram.

(quipment'aintenance

8onstant. 'achine breakdowns must be minimal. 5s required. Jot critical because o" queues.

It is not given that muchimportance.

=ead )imes%eep them short. )his simpli"ies the $ob o" marketing# purchasing# andmanu"acturing# as it reduces the need"or epanding.

)he longer the better. 'ost"oreman and purchasing agentswant more lead*time not less.

"lan for 4IT +dotion

or success"ul conversion and adoption# companies should adopt a care"ully planned approach that includes the "ollowing elements6

)op management must be sure about the commitment to the conversion

and necessary requirements.

'anagement must be sure about this involvement in the process and

must be known to its cost# duration to complete the conversion andepected results.

)hey should study their operations critically and decide the most critical

parts. )hey should have the support and cooperation o" the workers.

5rrange necessary training programs to make +I) a success.

Unit* 34 >1


23/23


)he workers must be "ully aware o" why +I) is desirable and also about

their $ob security. Once it is started# management should try to maintain the current system.

)hey should identi"y and solve eisting problems/ "ind out and enlist

potential workers.

4IT in #an&ladesh

)he development o" the +I) system in +apan was mainly due to the scarcity o" resources. )he same situation prevails in Bangladesh as we have very limitednatural resources# but comparatively greater human resources. )here"ore# +I)could be a very e""ective system "or a poor country like ours. But there are someconstraints in this regard. )hese might be#

)he most important problem in implementing +I) in Bangladesh is the

socio*cultural status. )he people are not accustomed to such culture o" being in time# which is a hindrance to +I) system. 'ore over# theeistence o" uncertain variables in Bangladesh is many ,i.e. hartals#tra""ic $ams-. &o accomplishing tasks in time is not at all epectable.

;aw materials "rom agricultural and seasonal products are not suitable"or steady production in small lots.

)he in"rastructure o" Bangladesh is not developed enough to distribute or

collect goods or raw materials in time according to their needs.

)o apply +I)# it requires strong discipline# reliable operating conditions#

and support o" the in"luential persons. )he communication system is alsonot o" higher technological. &o# the necessary materials# equipment andothers cannot arrive at the destination quite timely. )he practice o" getting compensation because o" the supplier’s delay is also not possiblein Bangladesh.

+I) becomes a "ailure story where a co*operative spirit between

management and workers is absent or little# which is "requent in our industries.

Buyers may not be willing to commit the resources necessary to help the

suppliers adopt the +I) system. )hey may be uneasy about long termcommitments to a seller.

&uppliers may not be "requent in small deliveries because it will be

di""icult i" they have other traditional buyers.

)he parties involved in this system need engineering and technological

changes resulting "rom continuing +I) improvements required by the buyer as well as the suppliers.

5s Bangladesh passes through the above constraints# the rate o" "ailure inapplying +I) is high here. 7espite some o" the "ertilizer companies use +I) tosome etent# "or eample# they use natural gas "rom pipeline and use it only attimes o" production# switching it o"" a"ter use. In the same manner# we can hopeto see the implementation o" +I) in other industries in the near "uture.

0eople o" Bangladeshare not accustomed tothe culture o" +I)#which is a constraint tothe s stem.

+ctivity: !ithin the present global competitive market do you think Bangladesh as a developing economy needs to consider +I)seriously9 !hy or why not9 +usti"y with good logic.

unit 12 inventory control

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