11-1 Inventory Management

CHAPTER
11
Inventory
Management
11-2 Inventory Management
Supply
Sources:
plants
vendors
ports
Regional
Warehouses:
stocking
points
Field
Warehouses:
stocking
points
Customers,
demand
centers
sinks
Production/
purchase
costs
Inventory &
warehousing
costs
Transportation
costs
Inventory &
warehousing
costs
Transportation
costs
11-3 Inventory Management
Inventory
Where do we hold inventory?
Suppliers and manufacturers
warehouses and distribution centers
retailers
Types of Inventory
WIP
raw materials
finished goods
Why do we hold inventory?
Economies of scale
Uncertainty in supply and demand
Lead Time, Capacity limitations

11-4 Inventory Management
Goals:
Reduce Cost, Improve Service
By effectively managing inventory:
Xerox eliminated $700 million inventory from
its supply chain
Wal-Mart became the largest retail company
utilizing efficient inventory management
GM has reduced parts inventory and
transportation costs by 26% annually
11-5 Inventory Management
Goals:
Reduce Cost, Improve Service
By not managing inventory successfully
In 1994, IBM continues to struggle with shortages in
their ThinkPad line (WSJ, Oct 7, 1994)
In 1993, Liz Claiborne said its unexpected earning
decline is the consequence of higher than anticipated
excess inventory (WSJ, July 15, 1993)
In 1993, Dell Computers predicts a loss; Stock plunges.
Dell acknowledged that the company was sharply off in
its forecast of demand, resulting in inventory write
downs (WSJ, August 1993)
11-6 Inventory Management
Independent Demand
A
B(4) C(2)
D(2) E(1) D(3)
F(2)
Dependent Demand
Independent demand is uncertain.
Dependent demand is certain.
Inventory: a stock or store of goods
11-7 Inventory Management
Types of Inventories
Raw materials & purchased parts
Partially completed goods called
work in progress
Finished-goods inventories
(manufacturing firms)
or merchandise
(retail stores)
11-8 Inventory Management
Types of Inventories (Contd)
Replacement parts, tools, & supplies
Goods-in-transit to warehouses or customers
11-9 Inventory Management
Functions of Inventory
To meet anticipated demand
To smooth production requirements
To decouple operations
To protect against stock-outs
11-10 Inventory Management
Functions of Inventory (Contd)
To take advantage of order cycles
To help hedge against price increases
To permit operations
To take advantage of quantity discounts
11-11 Inventory Management
Objective of Inventory Control
To achieve satisfactory levels of customer
service while keeping inventory costs within
reasonable bounds
Level of customer service
Costs of ordering and carrying inventory
11-12 Inventory Management
A system to keep track of inventory
A reliable forecast of demand
Knowledge of lead times
Reasonable estimates of
Holding costs
Ordering costs
Shortage costs
A classification system
Effective Inventory Management
11-13 Inventory Management
Inventory Counting Systems
Periodic System
Physical count of items made at periodic
intervals
Perpetual Inventory System
System that keeps track
of removals from inventory
continuously, thus
monitoring
current levels of
each item
11-14 Inventory Management
Inventory Counting Systems (Contd)
Two-Bin System - Two containers of
inventory; reorder when the first is empty
Universal Bar Code - Bar code
printed on a label that has
information about the item
to which it is attached
0
214800 232087768
11-15 Inventory Management
Lead time: time interval between ordering
and receiving the order
Holding (carrying) costs: cost to carry an
item in inventory for a length of time,
usually a year
Ordering costs: costs of ordering and
receiving inventory
Shortage costs: costs when demand exceeds
supply
Key Inventory Terms
11-16 Inventory Management
ABC Classification System
Classifying inventory according to some
measure of importance and allocating control
efforts accordingly.
A - very important
B - mod. important
C - least important
Figure 11.1
Annual
$ value
of items
A
B
C
High
Low
Few
Many
Number of Items
11-17 Inventory Management
Cycle Counting
A physical count of items in inventory
Cycle counting management
How much accuracy is needed?
When should cycle counting be performed?
Who should do it?
11-18 Inventory Management
Economic order quantity model
Economic production model
Quantity discount model
Economic Order Quantity Models
11-19 Inventory Management
Only one product is involved
Annual demand requirements known
Demand is even throughout the year
Lead time does not vary
Each order is received in a single delivery
There are no quantity discounts

Assumptions of EOQ Model
11-20 Inventory Management
The Inventory Cycle
Figure 11.2
Profile of Inventory Level Over Time
Quantity
on hand
Q
Receive
order
Place
order
Receive
order
Place
order
Receive
order
Lead time
Reorder
point
Usage
rate
Time
11-21 Inventory Management
Total Cost
Annual
carrying
cost
Annual
ordering
cost
Total cost = +
Q
2
H
D
Q
S
TC =
+
11-22 Inventory Management
Cost Minimization Goal
Order Quantity
(Q)
The Total-Cost Curve is U-Shaped
Ordering Costs
Q
O
A
n
n
u
a
l

C
o
s
t

(optimal order quantity)
TC
Q
H
D
Q
S
2
Figure 11.4C
11-23 Inventory Management
Deriving the EOQ
Using calculus, we take the derivative of the
total cost function and set the derivative
(slope) equal to zero and solve for Q.
Q =
2DS
H
=
2( Annual Demand )(Order or Setup Cost )
Annual Holding Cost
OPT
11-24 Inventory Management
Minimum Total Cost
The total cost curve reaches its minimum
where the carrying and ordering costs are
equal.


Q =
2DS
H
=
2( Annual Demand )(Order or Setup Cost )
Annual Holding Cost
OPT
11-25 Inventory Management
Production done in batches or lots
Capacity to produce a part exceeds the parts
usage or demand rate
Assumptions of EPQ are similar to EOQ
except orders are received incrementally
during production
Economic Production Quantity (EPQ)
11-26 Inventory Management
Only one item is involved
Annual demand is known
Usage rate is constant
Usage occurs continually
Production rate is constant
Lead time does not vary
No quantity discounts
Economic Production Quantity Assumptions
11-27 Inventory Management
Economic Run Size
Q
DS
H
p
p u
0
2

11-28 Inventory Management

Total Costs with Purchasing Cost
Annual
carrying
cost
Purchasing
cost
TC = +
Q
2
H
D
Q
S
TC =
+
+
Annual
ordering
cost
PD +
11-29 Inventory Management
Total Costs with PD
C
o
s
t

EOQ
TC with PD
TC without PD
PD
0
Quantity
Adding Purchasing cost
doesnt change EOQ
Figure 11.7
11-30 Inventory Management
Total Cost with Constant Carrying Costs
OC
EOQ
Quantity
T
o
t
a
l

C
o
s
t

TC
a
TC
c
TC
b
Decreasing
Price
CC
a,b,c
Figure 11.9
11-31 Inventory Management
When to Reorder with EOQ Ordering
Reorder Point - When the quantity on hand
of an item drops to this amount, the item is
reordered
Safety Stock - Stock that is held in excess of
expected demand due to variable demand
rate and/or lead time.
Service Level - Probability that demand will
not exceed supply during lead time.
11-32 Inventory Management
Determinants of the Reorder Point
The rate of demand
The lead time
Demand and/or lead time variability
Stockout risk (safety stock)
11-33 Inventory Management
Safety Stock
LT
Time
Expected demand
during lead time
Maximum probable demand
during lead time
ROP
Q
u
a
n
t
i
t
y

Safety stock
Figure 11.12
Safety stock reduces risk of
stockout during lead time
11-34 Inventory Management
Reorder Point
ROP
Risk of
a stockout
Service level
Probability of
no stockout
Expected
demand
Safety
stock
0 z
Quantity
z-scale
Figure 11.13
The ROP based on a normal
Distribution of lead time demand
11-35 Inventory Management
Orders are placed at fixed time intervals
Order quantity for next interval?
Suppliers might encourage fixed intervals
May require only periodic checks of
inventory levels
Risk of stockout

Fixed-Order-Interval Model
11-36 Inventory Management
Tight control of inventory items
Items from same supplier may yield savings
in:
Ordering
Packing
Shipping costs
May be practical when inventories cannot be
closely monitored

Fixed-Interval Benefits
11-37 Inventory Management
Requires a larger safety stock
Increases carrying cost
Costs of periodic reviews
Fixed-Interval Disadvantages
11-38 Inventory Management
Single period model: model for ordering of
perishables and other items with limited
useful lives
Shortage cost: generally the unrealized
profits per unit
Excess cost: difference between purchase
cost and salvage value of items left over at
the end of a period
Single Period Model
11-39 Inventory Management
Continuous stocking levels
Identifies optimal stocking levels
Optimal stocking level balances unit shortage
and excess cost
Discrete stocking levels
Service levels are discrete rather than
continuous
Desired service level is equaled or exceeded
Single Period Model
11-40 Inventory Management
Too much inventory
Tends to hide problems
Easier to live with problems than to eliminate
them
Costly to maintain
Wise strategy
Reduce lot sizes
Reduce safety stock
Operations Strategy
11-41 Inventory Management
Gortrac Manufacturing
GTS3
Inventory/Assessment/Reduction
11-42 Inventory Management
Materials
PS7
Washburn Guitars