Engineering Production Management

INVENTORY MANAGEMENT

Introduction

 Inventory is present in all manufacturing process:

In Manufacturing inventory consists of the components that go make up the

product being manufactured.

In Service Inventory may be used as part of the service delivery system ( for

example disposable implements for a hospital operation ) or it may be part of the tangible

component of the service itself (for example the brochure for a car insurance policy)

 Inventory is important because although it is necessary for customer service it can also be

a major cost to the organization.

 Inventory Management can be considered part of materials management in a service or

manufacturing organization.

 Materials Management includes the acquiring of inventory, the organization movement

of the inventory and the assessment of when inventory should be ordered and the amount

of inventory that should be ordered.

 Inventory Management Systems calculate the volume and timing of independent

demand items. Independent Demand is when demand is not directly related to the

demand for any other inventory item.

Types of Inventory

 Inventory Classified by Location

  Inventory Classified by Type

Inventory Classified By Location

Inventory classified by location as raw materials (goods received from suppliers), work in

progress (at some point within the operation process ) or finished goods (goods ready for

dispatch to the customer).

The proportions between these inventory types will vary but it is estimated that generally

30% are raw materials, 40% work in progress and 30% finished goods.

1.A. Raw Materials Inventory

May be supplied in batches to secure quantity discounts and reduce material handling.

1.B. Work-In-Progress Inventory

May help uncouple production stages and provide greater flexibility in production

scheduling.

1.C. Finished Goods Inventory

 May be used to ensure that important inventory items are always available to the

customer or avoid disruption caused by changing production output levels.

Inventory Classified by Type

The type of inventory can also be used to provide a method of identifying why inventory

is being held and so suggest policies for reducing its level.

2.A. Buffer/Safety – this is used to compensate for the uncertainties inherent in the

timing or rate of supply and demand between two operational stages.

Safety Stock is often used to compensate for uncertainties in the timing of supplies form

supplier.

2.B. Cycle – if it is required to produce multiple products from one operation in batches,

there is need to produce enough to keep a supply while the other batches are being produced.

Cycle inventory can be reduced by reducing the batch size which in turn will depend on

reducing setup/ changeover times between batches.

2.C. Decoupling – this permit stages in the manufacturing process too be managed and

their performance measured independently, to run at their own speed and not match the rate of

processing of departments at different points in the process.

2.D. Anticipation – this includes producing to stock to anticipate an increase in demand

due to seasonal factors.

 2.E. Pipeline / Movement - this is the inventor needed to compensate for the lack of

stock while material is being transported between stages. For Example, the distribution time

from the warehouse to a retail outlet.

Managing Inventory

 One of the major issues in inventory management is the level of decentralization required

in inventory distribution.

 Decentralized facilities offer a service closer to the customer and thus should provide a

better service level in terms of knowledge of customer needs and speed of service.

 Centralization however, offers the potential for less handling of goods between service

points, less control costs and less overall inventory levels due to lower overall buffer

levels required.

The ABC Inventory Classification System

 One way of deciding the importance of inventory items and thus an appropriate inventory

management method for them is to use the ABC Classification System.

 The ABC Classification System sorts inventory items into groups depending on the

amount of annual expenditure they incur which will depend on the estimated number of

items used annually multiplied by unit cost

Example of an ABC Classification Table

Item Annual Expenditure Percentage Cumulative

 (Cost X usage) Expenditure Expenditure
(%) (%)
D-76 800 24.1 24.1
A-25 650 19.6 43.7
C-40 475 14.3 58.1
C-22 450 13.6 71.6
B-18 300 9.0 80.7
G-44 200 8.0 71.6
A-42 150 5.4 80.7
D-21 100 3.0 86.7
H-67 75 2.3 91.3
E-88 65 2.0 94.3
F-23 50 1.5 96.5
Total 3315 98.5
100.0

 As shown in the table, Following Pareto’s Law, it is found out that 10 to 20 % of the

items account for 60 – 80 % of annual expenditure. These items are called A items and

needs to be controlled closely to reduce overall expenditure. Forecasting techniques may

be used to improve the accuracy of demand of forecast for these items.

 The B items account for the next 20-30% of items and usually account for a similar

percentage of total expenditure.

 The C item represents the remaining 50-70% of items but only account for less than 25%

of the total expenditure.

Inventory Models
 Inventory Models are used to assess when inventory requires ordering and what quantity

should be ordered at that point in time.

A. First Order Quantity Inventory Systems

The order quantity is the same each time the order is placed, but the time between the

orders varies according to the rate of use of the inventory item.

When the inventory level has reduced to a certain amount, termed Reorder Point, an order

for further inventory is made.

B. The Reorder Point (ROP) Model

It identifies the time to order when the stock level drops to a predetermined amount.

Safety Stock is used in order to prevent stock-out occurring.

To calculate safety stock level of number of factors should be taken into account including:

 Cost due to stock-out

 Cost of holding safety stock

 Variability In the rate of demand

 Variability in delivery lead time

The reorder problem is one of determining level of safety stock that balances the expected

holding costs with cost of stock-out:

1. Constant Demand and Constant Lead Time

Assuming that the delivery lead time and demand rate are constant there is no risk of

stock-out, so no safety stock is required.

2. Variable Demand and Constant Lead Time

This model assumes that demand during the delivery lead time consists of a series of

independent daily demand and thus can be described by a normal distribution.

3. Constant Demand and Variable Lead Time

here the lead time variation is described by a normal distribution and thus the expected

lead time is normally distributed.

4. Variable Demand Rate and Variable Lead Time

When Both Demand rate and lead time are available, the expected demand during lead

time is the average daily demand multiplied by average lead time.

C. The Economic Order Quantity (EOQ) Model

it calculates the fixed inventory order volume required while seeking to minimize the

sum of the annual cost of holding inventory and annual costs of ordering inventory. The Model

makes a number od assumption including:

 Stable or constant demand

 Fixed and identifiable ordering cost

 The relationship between the cost of holding inventory and number of items held is linear
  The item cost does not vary with the order size

 Delivery lead time does not vary

 No quantity discounts are available

 Annual demand exists

Implementing Inventory Systems

 Inventory management can also be outsourced in this way and thus is sometimes referred

to as Vendor Managed Inventory.

 Example of this is when wholesalers hold stock for a number of retailers this allows the

retailers to focus on selling activities and order stock from the wholesaler as needed.