Operations Management 9

MRP AND INVENTORY MANAGEMENT

 Learning Objectives
§ Explain what MRP is.
§ Describe the inputs, outputs, and nature of MRP processing.
§ Discuss the benefits and requirements of MRP.
§ Define the term inventory
§ List the major reasons for holding inventories;
§ Discuss periodic and perpetual review systems.
§ Discuss the objectives of inventory management.
§ Describe the A-B-C approach and explain how it is useful.
§ Describe the basic EOQ model and its assumptions and solve
typical problems.
§ Describe the economic production quantity model and solve
typical problems.

9-2
 MRP

Material Requirements Planning

9-3
 MRP
Material Requirements Planning (MRP):

Computer-based information system that translates

master schedule requirements for end items into
time-phased requirements for subassemblies,
components, and raw materials.

9-4
§ Master Production Schedule (MPS)
§ is a timetable that specifies what is to be
made (ussually finished goods), when it is
needed and in what quantities.

9-5
 MRP
§ Material requirements planning (MRP): Computer-based
information system that translates master schedule requirements
for end items into time-phased requirements for
subassemblies, components, and raw materials.

Assembly diagram

9-6
 MRP
§ An MRP system is intended to simultaneously meet three
objectives:
§ Ensure raw materials are available for production and products
are available for delivery to customers.
§ Maintain the lowest possible material and product levels in
store
§ Plan manufacturing activities, delivery schedules and
purchasing activities.
§ MRP is designed to answer three questions:
§ What is needed?
§ How much is needed?
§ When is it needed?

9-7
Independent and Dependent Demand
Independent Demand

A Dependent Demand

B(4) C(2)

D(2) E(1) D(3) F(2)

Independent demand is uncertain.

Dependent demand is certain.

9-9
 Example
Independent Demand or
dependent demand?
Chair

Leg Back
Assembly Seat Assembly

Cross Side Cross Back

Legs (2)
bar Rails (2) bar Supports (3)

9-11
 Dependant Demand

§ Dependent demand: Demand for

items that are subassemblies or
component parts to be used in
production of finished goods.
§ Once the independent demand is
known, the dependent demand can be
determined.

9-12
 Overview of MRP
MRP Inputs MRP Processing MRP Outputs

Changes
Order releases
Master
schedule Planned-order
schedules
Primary
reports
Exception reports
Bill of Planning reports
materials MRP computer Secondary
Performance-
programs reports control
reports

Inventory
records Inventory
transaction
9-13
9-14
 MPR Inputs
§ Master Production Schedule
§ Time-phased plan specifying timing and
quantity of production for each end item.
§ Material Requirement Planning Process
u re
ru ct
S t
u ct
rod es
P e
e Tim
T r a d
Le

9-15
 Master Schedule
Master schedule: One of three primary inputs in
MRP; states which end items are to be produced,
when these are needed, and in what quantities.
Cumulative lead time: The sum of the lead times
that sequential phases of a process require, from
ordering of parts or raw materials to completion of
final assembly.

9-16
 Bill-of-Materials

Bill of materials (BOM): One of the three

primary inputs of MRP; a listing of all of the raw
materials, parts, subassemblies, and assemblies
needed to produce one unit of a product.
Product structure tree: Visual depiction of the
requirements in a bill of materials, where all
components are listed by levels.

9-17
Assembly diagram and product structure tree for chair assembly

9-18
 Product Structure Tree

Level Chair
0

1 Leg Back
Assembly Seat Assembly

Cross Side Cross Back

2 Legs (2)
bar Rails (2) bar Supports (3)

9-19
Product Structure Tree

9-20
A product structure tree is useful in illustrating how the BOM is
used to determine the quantities of each of the ingredients
(requirements) needed to obtain a desired number of end items.

a. Determine the quantities of B, C, D, E,

and F needed to assemble one X.
b. Determine the quantities of these
components that will be required to
assemble 10 Xs, taking into account the
quantities on hand (i.e., in inventory) of
various components:

9-21
Solution

9-22
Solution

9-23
 Inventory Records
§ One of the three primary inputs in MRP
§ Includes information on the status of
each item by time period

9-24
 Assembly Time Chart
Cumulative lead time
Leadtime

Assembly time chart showing material order

points needed to meet scheduled availability of
the end item
9-25
 MRP Processing
§ MPS
Week
Item 1 2 3 4 5 6 7 8 9 10
T 100

§ BOM § Inventory and lead time

Item T U V W X Y
Leadtime 1 2 2 3 1 1
(weeks)
Inventory 10 20 30 40 50 60
on hand

9-26
 MRP Processing
Item T U V W X Y
Leadtime 1 2 2 3 1 1
(weeks)
Inventory 10 20 30 40 50 60
on hand

Item Gross Inventory Net requirements Timing for Timing for order
requirement on hand order releases
s receipts
T 100 10 90 7 6

U 180 20 160 6 4

V 270 30 240 6 4

X 320 40 280 4 3

Y 480 50 430 4 3

W 640 60 580 4 1

9-27
§ MPS Exercise
Week
Item 1 2 3 4 5 6 7 8 9 10
A 50 60
B 200

A B
§ BOM
C(1) D(1)
C(1) E(1)

F(1) E(1)
F(1)

§ Inventory and lead time F(1)

Item A B C D E F
Leadtime (weeks) 2 1 3 2 1 1
Inventory on hand 0 0 60 300 0 50

Q: Develop MRP table for the next 8 weeks 9-28

 Solution
Item Gross Inventory on Net Timing for Timing for
requirements hand requirements order receipts order
releases
A 50 0 50 4 2

60 0 60 8 6

B 200 0 200 5 4

C 50 60 0 - -

200 10 190 4 1

60 0 60 6 3

D 200 300 0 - -

E 50 0 50 2 1

60 0 60 6 5

F 50 50 0 - -

60 0 60 5 4
9-29
§ MPS Homework
Week
Item 1 2 3 4 5 6 7 8 9 10
A 35 50
B 150

A B
§ BOM
C(1) D(1)
C(1) E(1)

F(1) E(1)
F(1)

§ Inventory and lead time F(1)

Item A B C D E F
Leadtime (weeks) 2 1 3 2 1 1
Inventory on hand 0 0 60 300 0 50

Q: Develop MRP table 9-30

 MRP Primary Reports
§ Planned orders - schedule indicating the amount
and timing of future orders.
§ Order releases - Authorization for the execution of
planned orders.
§ Changes - revisions of due dates or order quantities,
or cancellations of orders.

MRP Inputs MRP Processing MRP Outputs

Changes
Order releases
Master Planned-order
schedule schedules
Primary
reports Exception reports
Bill of Planning reports
MRP computer Secondary Performance-
materials
programs reports control
reports
Inventory
Inventory
records
transaction

9-31
 MRP Secondary Reports

§ Performance-control reports
§ Planning reports
§ Exception reports

9-32
 Benefits of MRP
§ Low levels of in-process inventories
§ Ability to track material requirements
§ Ability to evaluate capacity requirements
§ Means of allocating production time
§ Ability to easily determine inventory usage by
backflushing
§ Backflushing: Exploding an end item’s bill of
materials to determine the quantities of the
components that were used to make the item.
9-33
 Requirements of MRP

§ Computer and necessary software

§ Accurate and up-to-date
§ Master schedules
§ Bills of materials
§ Inventory records
§ Integrity of data

9-34
9-35
INVENTORY MANAGEMENT

9-36
 Why Hold Inventory?
§ Cover process time
§ Allow for uncoupling of processes
§ Anticipation / Speculation
§ Minimize control costs
§ Buffer against uncertainties
§ Demand
§ Supply
§ Delivery
§ Manufacturing/Processing

9-37
 Three Levels of Inventory Decisions
Strategic
§ Supply Chain Decisions
§ What are the potential alternatives to inventory?
§ How should the product be designed?
§ Deployment Decisions Tactical

§ What items should be carried as inventory?

§ In what form should they be maintained?
§ How much of each should be held and where?
§ Replenishment Decisions Operational
§ How often should inventory status be determined?
§ When should a replenishment decision be made?
§ How large should the replenishment be?
9-38
 Classification of Inventory
§ Financial / Accounting Categories
§ Raw Materials
§ Work in Process (WIP)
§ Components, Semi-Finished Goods
§ Finished Goods
• Functional Roles
§ Cycle Stock
§ Safety Stock
§ Pipeline Inventory
9-39
 Classification of Inventory
§ Cycle stock:
§ The amount of inventory needed to meet expected demand.
§ Safety stock:
§ Extra inventory carried to reduce the probability of a stockout
due to demand and/or lead time variability.
§ Pipeline Inventory
§ Transit stock, refers to the units which are in transit between
locations

9-40
 REQUIREMENTS FOR EFFECTIVE INVENTORY
MANAGEMENT
1. A system to keep track of the inventory on hand and on
order.
2. A reliable forecast of demand that includes an indication of
possible forecast error.
3. Knowledge of lead times and lead time variability.
4. Reasonable estimates of inventory holding costs, ordering
costs, and shortage costs.
5. A classification system for inventory items.
6. Inventory turnover Ratio of average cost of goods sold to
average inventory investment.

9-41
Inventory Counting Systems
§ Periodic system:
§ Physical count of items in inventory made
at periodic intervals (weekly, monthly)
§ Perpetual inventory system
§ System that keeps track of removals from
inventory continuously, thus monitoring
current levels of each item.

9-42
 Total Relevant Costs
TC = Purchase + Order + Holding + Shortage

Four Standard Cost Components

§ Purchase (Unit Value) Cost
§ Ordering (Set Up) Cost
§ Holding (Carrying) Cost
§ Shortage Cost

9-43
 Relevant Costs
§ Purchase (Unit Value) Costs c
§ is the amount paid to a vendor or supplier
to buy the inventory
§ Units?
§ $ / Unit
§ How do we determine this number?
§ purchase price vs. manufacturing cost
§ When is it relevant?
§ When purchase price differs with respect to
quantity or timing of order

9-44
 Relevant Costs
Ordering costs are the costs of ordering and receiving inventory.
§ vary with the actual placement of an order.
§ shipping costs,
§ determining how much is needed,
§ preparing invoices,
§ inspecting goods upon arrival for quality and quantity,
§ moving the goods to temporary storage.
§ Ordering costs are generally expressed as a fixed dollar amount
per order, regardless of order size.
Setup costs The costs involved in preparing equipment for a job
§ preparing equipment for the job by adjusting the machine,
changing cutting tools) are analogous to ordering costs.

9-45
 Relevant Costs
§ Holding, or carrying, costs relate to physically having items in
storage.
§ Costs include interest, insurance, taxes (in some states),
depreciation, obsolescence, deterioration, spoilage, pilferage,
breakage, tracking, picking, and warehousing costs (heat, light,
rent, security). They also include opportunity costs associated
with having funds that could be used elsewhere tied up in
inventory.
§ Holding costs are stated in either of two ways:
§ as a percentage of unit price or as a dollar amount per unit.
§ Typical annual holding costs range from 20 percent to 40 percent or more of
the value of an item.
to hold a $100 item in inventory for one year could cost from $20 to $40.

9-46
 Classification system
§ items held in inventory are not of equal importance in terms of
dollars invested, profit potential, sales or usage volume, or
stockout penalties.
§ The A-B-C approach classifies inventory items according to
some measure of importance:
§ annual dollar value (i.e., dollar value per unit multiplied by annual usage
rate),
§ and then allocates control efforts accordingly

9-47
Example

9-48
Solution

9-49
 EOQ
§ Economic order quantity (EOQ)
§ The order size that minimizes total annual
cost.
§ how much to order?

9-50
The inventory cycle: profile of inventory level over time

9-51
EOQ

*Excluding: Purchase cost and stockout

9-52
 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.

2DS 2( Annual Demand )(Order or Setup Cost )

Q OPT = =
H Annual Holding Cost

Reorder point R = Ld

9-53
Example

9-54
 example
§ Piddling Manufacturing assembles security monitors.
It purchases 3,600 black-and-white cathode ray tubes
a year at $65 each. Ordering costs are $31, and
annual carrying costs are 20 percent of the purchase
price. Compute the optimal quantity and the total
annual cost of ordering and carrying the inventory

9-55
example

9-56
 EPQ
§ Economic Production Quantity (EPQ)

Inventory Level

Production
portion of cycle
Demand portion of
cycle with no supply

Time

9-57
EPQ model’s assumptions

9-58
EPQ

9-59
EPQ

9-60
Example

9-61
Solution

9-62
Solution

9-63
9-64