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Operations Management: Course Instructor: Mansoor Qureshi
Operations Management: Course Instructor: Mansoor Qureshi
Management
Topic – Inventory Management
Course Instructor:
Mansoor Qureshi
What is Inventory?
Inventory is basically a stock or store of goods which
can be accounted physically or information based. A
physical resource that a firm holds in stock with the intent
of selling it or transforming it into a more valuable state.
– Raw Materials
– Works-in-Process
– Finished Goods
– Maintenance, Repair
and Operating (MRO)
Why Hold Inventories (1)
• For economies of scale
– It may be economical to produce a relatively
large number of items in each production run
and store them for future use.
• Coping with uncertainties
– Uncertainty in demand
– Uncertainty in lead time
– Uncertainty in supply
• For speculation
– Purchase large quantities at current low
prices and store them for future use.
– Cope with labor strike
Why Hold Inventories (2)
• Transportation
– Pipeline inventories is the inventory moving
from point to point, e.g., materials moving
from suppliers to a plant, from one operation
to the next in a plant.
• Smoothing
– Producing and storing inventory in anticipation
of peak demand helps to alleviate the
disruptions caused by changing production
rates and workforce level.
• Logistics
– To cope with constraints in purchasing,
production, or distribution of items, this may
cause a system maintain inventory.
Why Hold Inventories (3)
• Finished Goods
– Essential in produce-to-stock positioning strategies
– Necessary in level aggregate capacity plans
– Products can be displayed to customers
• Work-in-Process
– Necessary in process-focused production
– May reduce material-handling & production costs
• Raw Material
– Suppliers may produce/ship materials in batches
– Quantity discounts and freight/handling $$ savings
The smoother your supply chain operates and the better you are able to forecast the less
inventory you have to hold, unless you gain some economies of scale in purchasing,
transportation and or manufacturing.
Vs
• Shortage and customer service costs – These are the costs realized
when demand of a product crosses the inventory for that item. As such
these costs are considered equal to the amount paid by the customer to
buy the product from other firms. Sometimes the problem assumed
serious measures due to loss of goodwill for the company which might
prove costly in the long run.
Inventory Costs
Procurement costs
• Order processing
• Shipping
• Handling
Carrying costs
• Capital (opportunity) costs
• Inventory risk costs
• Space costs
• Inventory service costs
Out-of-stock costs
• Lost sales cost
• Back-order cost
Information requirement
A system to keep track of items in inventory –
• What is on order
• What is on hand
• What is where
• How much is where
• What condition is it in
• EOQ
• ABC Analysis
Reorder Point
• Quantity to which inventory is allowed to drop
before replenishment order is made
ROP = D X LT
D = Demand rate per period
LT = lead time in periods
A Reorder Point System
Economic Order Quantity EOQ
A quantitative decision model based on the trade-off between annual
inventory holding costs and annual order costs.
Q2
C H UC O
2
2 UC O
Q
2
CH
2UC O
EOQ =
CH
EOQ Example
• Given:
– 25,000 annual demand
– $3 per unit per year holding cost
– $100 ordering costs
2(25,000)(100)
EOQ = 1291
3
EOQ Model
When To Order
Inventory Level
Optimal Average
Order Inventory
Quantity (Q*/2)
(Q*)
Reorder
Point
(ROP)
Time
Lead Time
EOQ Example
Given:
– 7,200 = Annual replenishment
– $3 = Per unit per year holding cost
– $100 = Ordering cost per order
– 20% = Annual Holding rate
– $20 per unit = Unit Purchase cost
– 6 days = Lead Time
– 360 = Days per year