OPERATIONS MANAGEMENT

SESSION-12
Inventory Management

Prepared by:
Dr Muhammad Asif Khan
 Inventory
 One of the most expensive assets of many
companies representing as much as 50% of
total invested capital
 Operations managers must balance inventory
investment and customer service
The Importance of Inventory
Main Focus on Inventory

Pressure for lower inventory

•Inventory investment
•Inventory holding cost

Pressure for higher inventory

•Customer service
•Other costs related to inventory
 What is Inventory?
Stock of materials
Stored capacity
© 1995
Corel Corp.

© 1984-1994 T/Maker Co. © 1984-1994 T/Maker Co.

© 1995 Corel Corp.
 Types of Inventory

 Raw material
 Work-in-progress
 Maintenance / repair / operating supplies
 Finished goods
 The Material Flow Cycle

Cycle time

95% 5%

Input Wait for Wait to Move Wait in queue Setup Run Output
inspection be moved time for operator time time
 The Functions of Inventory
1. Untuk memberikan stok barang guna mengantisipasi
permintaan yang akan muncul
2. Untuk menyelaraskan produksi dengan distribusi
3. Untuk mengambil keuntungan dari potongan jumlah;
pembeliaan jumlah besar dapat mengurangi biaya produksi
4. Untuk melakukan hedging (pemagaran) terhadap inflasi dan
perubahan harga
5. Untuk menghindari kekurangan stok karena faktor cuaca,
dan faktor lainnya
6. Untuk menjaga keberlangsungan proses produksi melalui
sistem “kerja-dalam-proses (work-in-process)”
 Disadvantages of Inventory
 Higher costs
 Interest or opportunity costs
 Holding (or carrying) costs – storage, handling, taxes,
insurance, shrinkage
 Ordering (or setup) costs
 Risk of deterioration or obsolescence
 Hides production problems
 Yield / scrap variations
 Unscheduled downtime

Total cost = 20% to 40% of inventory value / year

 Inventory Management

 How inventory items can be classified

 How accurate inventory records can be
maintained
 ABC Analysis
 Divides inventory into three classes based on
annual dollar volume
 Class A - high annual dollar volume
 Class B - medium annual dollar volume
 Class C - low annual dollar volume
 Used to establish policies that focus on the few
critical parts
 ABC Analysis
Percent of Percent of
Item Number of Annual Annual Annual
Stock Items Volume Unit Dollar Dollar
Number Stocked (units) x Cost = Volume Volume Class
#10286 20% 1,000 $ 90.00 $ 90,000 38.8% A
72%
#11526 500 154.00 77,000 33.2% A

#12760 1,550 17.00 26,350 11.3% B

#10867 30% 350 42.86 15,001 6.4% 23% B

#10500 1,000 12.50 12,500 5.4% B

 ABC Analysis
Percent of Percent of
Item Number of Annual Annual Annual
Stock Items Volume Unit Dollar Dollar
Number Stocked (units) x Cost = Volume Volume Class
#12572 600 $ 14.17 $ 8,502 3.7% C

#14075 2,000 .60 1,200 .5% C

#01036 50% 100 8.50 850 .4% 5% C

#01307 1,200 .42 504 .2% C

#10572 250 .60 150 .1% C

8,550 $232,057 100.0%

 ABC Analysis
A Items
80 –
Percent of annual dollar usage

70 –
60 –
50 –
40 –
30 –
20 – B Items
10 – C Items
0 – | | | | | | | | | |

10 20 30 40 50 60 70 80 90 100
Percent of inventory items
 ABC Analysis
 Other criteria than annual dollar volume may be
used
 Anticipated engineering changes
 Delivery problems
 Quality problems
 High unit cost
 Inventory Models for
Independent Demand
 Fixed order-quantity models
Help answer the
 Economic order quantity inventory planning
 Production order quantity questions!
 Quantity discount

 Probabilistic models
 Fixed order-period models
© 1984-1994
T/Maker Co.
 EOQ – Economic Order Quantity

 Objective:
minimize (ordering cost + holding cost)

 Assumptions:
 Known and constant demand
 Known and constant lead time
 Instantaneous receipt of material
 No quantity discounts
 Only ordering / setup cost and holding cost
 No stockouts
 Inventory Usage Over Time

Usage rate Average

Order quantity = inventory on
Q (maximum hand
inventory level)
Inventory level

Q
2

Minimum
inventory

0
Time
 Minimizing Costs
Objective is to minimize total costs
Curve for total cost
of holding and setup

Minimum total
cost

Holding cost
Annual cost

curve

Setup (or order) cost

curve

Optimal order Order quantity

Table 11.5 quantity (Q*)
 Why Holding Costs Increase
More units must be stored if more are ordered

Purchase Order Purchase Order

Description Qty. Description Qty.
Microwave 1 Microwave 1000

Order quantity
 Why Ordering Costs Decrease
Cost is spread over more units
Example: You need 1000 microwave ovens

1 Order (Postage $ 0.33) 1000 Orders (Postage $330)

Purchase Order PurchaseOrder

Purchase Order
Description PurchaseOrder
Description
Purchase OrderQty.
Qty. Description Qty.Qty.
Microwave 1000 Description
Microwave Qty. 11
Description
Microwave
Microwave
Microwave 11

Order quantity
 ECONOMIC ORDER QUANTITY (EOQ)
- Tujuan utama model EOQ adalah minimisasi biaya total
- Model EOQ berkaitan dengan kuantitas pemesanan yang paling
ekonomis
- Biaya yang relevan adalah biaya pemesanan dan penyimpanan
- Tingkat persediaan rata-rata pertahun diketahui sebagai fungsi
Q/2
Rumus:
Q (quantity) = jumlah barang setiap pemesanan
D (demand) = permintaan tahunan barang persediaan (dlm unit)
S (set up/ordering cost) = biaya pemesanan atau pemasangan
setiap pesanan
H (holding cost) = biaya penyimpanan/unit/tahun
Q* = jumlah optimal barang per pemesanan (EOQ)
1. Biaya pemesanan tahunan = [D/Q] (S)
2. Biaya penyimpanan tahunan = [Q/2] (H)
3. EOQ  nomor 1 = 2; Q* = √2DS/H
 MODEL EOQ … (lanjutan)
Contoh kasus: Permintaan tahunan boneka CV Toys adalah
1.000 unit; biaya pemesanan $10/pesanan; biaya
penyimpanan $0,50; hari kerja PT Y adalah 250 hari
kerja/tahun; lead time dari pemasok adalah 3 hari?

1. Q* = √2DS/H  √2 (1.000) (10) / (0,50) = √40.000 = 200

unit
2. Jumlah/tingkat pemesanan/tahun (N) = D/Q* = 1.000/200
= 5 kali pesanan/tahun
3. Jumlah waktu antar pesanan (jeda waktu pesanan) (T) =
jumlah hari kerja pertahun/N  250/5 = 50 hari. Setiap 50
hari kerja dilakukan pesanan 200 unit, sebanyak 5 kali
pesanan
4. Total biaya pemesanan (TC) model EOQ = [D/Q*] (S) +
[Q*/2] (H)  [1.000/200]($10) + [200/2]($0,50) = $100
 EOQ Model – When to Order

Inventory Level

Q*

Average Cycle
Inventory
Reorder
Point
(ROP)

Time
Lead Time
 MODEL EOQ : ROP … (lanjutan)
Contoh kasus: Permintaan tahunan boneka CV Toys
adalah 1.000 unit; biaya pemesanan $10/pesanan;
biaya penyimpanan $0,50; hari kerja PT Y adalah 250
hari kerja/tahun; lead time dari pemasok adalah 3
hari?

1. Q* = √2DS/H  √2 (1.000) (10) / (0,50) = √40.000 =

200 unit
2. Reorder point (ROP) = d (permintaan/hari) x L (lead
time pemesanan baru dalam hari). d = D/jumlah hari
kerja/tahun  d = 1.000/250 = 40 unit/hari. ROP = 40
x 3 = 120 unit. CV Toys harus melakukan pemesanan
ulang pada saat persediaan mencapai tingkat 120 unit
 Inventory Models for
Independent Demand
 Fixed order-quantity models
Help answer the
 Economic order quantity inventory planning
 Production order quantity questions!
 Quantity discount

 Probabilistic models
 Fixed order-period models
© 1984-1994
T/Maker Co.
 PRODUCTION ORDER QUANTITY (POQ)
 Model ini berguna ketika persediaan secara terus-menerus terbentuk
sepanjang waktu.
 Dalam model ini, tingkat produksi harian yang paling efisien (p) dan
tingkat permintaan harian atau tingkat penggunaan harian rata-rata (d)
dihitung

Rumus:
Q*p = √2DS/H [1-(d/p)]

Contoh kasus: Permintaan pelek racing setengah jadi PT Velk

Racing/tahun adalah 1.000 unit; permintaan harian rata-rata 6 unit;
produksi harian 8 unit; biaya pemesanan $10/unit; dan biaya
penyimpanan $0,50, tentukan jumlah unit maksimum/pemesanan

Q*p = √2(1.000)($10) /$0,50 [1-(6/8)] = 400 unit pelek

 Inventory Models for
Independent Demand
 Fixed order-quantity models
Help answer the
 Economic order quantity inventory planning
 Production order quantity questions!
 Quantity discount

 Probabilistic models
 Fixed order-period models
© 1984-1994
T/Maker Co.
 Quantity Discount Models
 Reduced prices are often available when larger
quantities are purchased
 Trade-off is between reduced product cost and
increased holding cost

Total cost = Setup cost + Holding cost + Product cost

D Q
TC = S+ H + PD
Q 2
 Quantity Discount Models

A typical quantity discount schedule

Discount Discount
Number Discount Quantity Discount (%) Price (P)
1 0 to 999 no discount $5.00
2 1,000 to 1,999 4 $4.80
3 2,000 and over 5 $4.75
 Quantity Discount Models
Total cost curve for discount 2
Total cost
curve for
discount 1
Total cost $

Total cost curve for discount 3

b
a Q* for discount 2 is below the allowable range at point a and must be
adjusted upward to 1,000 units at point b

1st price 2nd price

break break

0 1,000 2,000
Figure 12.7
Order quantity
 Quantity Discount Example
Calculate Q* for every discount 2DS
Q* =
IP

2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)

2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80)

2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75)
 Quantity Discount Example
Calculate Q* for every discount 2DS
Q* =
IP

2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)

2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80) 1,000 — adjusted
2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75) 2,000 — adjusted
 Quantity Discount Example
Discoun Order Annual Annual Annual
t Unit Quantit Product Ordering Holding
Number Price y Cost Cost Cost Total
1 $5.00 700 $25,000 $350 $350 $25,700

2 $4.80 1,000 $24,000 $245 $480 $24,725

3 $4.75 2,000 $23.750 $122.50 $950 $24,822.50

Table 12.3

Choose the price and quantity that gives the

lowest total cost
Buy 1,000 units at $4.80 per unit
 Inventory Models for
Independent Demand
 Fixed order-quantity models
Help answer the
 Economic order quantity inventory planning
 Production order quantity questions!
 Quantity discount

 Probabilistic models
 Fixed order-period models
© 1984-1994
T/Maker Co.
 Probabilistic Models
Service
Level P(Stockout)

Frequency
 Answer how much &
when to order X

 Allow demand to vary

 Other EOQ assumptions apply
 Consider service level & safety stock
 Service level = 1 – Probability of stockout
 Higher service level means more safety stock
 More safety stock means higher ROP
 Probabilistic Models - When to Order?
Service
Level P(Stockout)

Frequency
Inventory Level

X
SS
Reorder
ROP
Point
(ROP)

Safety Stock (SS)

Lead Time Time
Place Receive
order order
 Inventory Models for
Independent Demand
 Fixed order-quantity models
Help answer the
 Economic order quantity inventory planning
 Production order quantity questions!
 Quantity discount

 Probabilistic models
 Fixed order-period models
© 1984-1994
T/Maker Co.
 Fixed Period (P) Systems
 Answers how much to order
 Orders placed at fixed intervals
 Inventory brought up to target amount
 Amount ordered varies
 No continuous inventory count
 Possibility of stockout between intervals
 Useful when vendors visit routinely
 Example: Office Max representative calls every week
Inventory in a Fixed Period System
Various amounts (Qi) are ordered at regular time
intervals (p) based on the quantity necessary to
bring inventory up to target maximum

Target maximum

Q1 Q2 Q4
Q3
On-Hand Inventory

p p p

Time
 Comparison of Q and P Systems
 Continuous Review System (Q)
A system designed to track the remaining inventory
of an item each time a withdrawal is made, to
determine whether it is time to replenish

 Periodic Review System (P)

A system in which an item’s inventory position is
reviewed periodically rather than continuously
 Comparison of Q and P Systems
 Continuous Review System (Q)
 Individual review frequencies
 Possible quantity discounts
 Lower, less-expensive safety stocks

 Periodic Review System (P)

 Convenient to administer
 Orders may be combined
 Inventory position only required at review
 Inventory Measures
Average inventory = $2 million
Cost of goods sold = $10 million
52 business weeks per year

Average inventory value

Weeks of supply =
Weekly sales (at cost)
$2 million
= = 10.4 weeks
($10 million)/(52 weeks)

Annual sales (at cost)

Inventory turns =
Average inventory value
$10 million
= = 5 turns/year
$2 million
12-43
 Summary
 Functions of inventory –
Inventory enables value creation for many processes
 Costs of inventory
 Different views of inventory
 Inventory reduction tactics
 ABC and EOQ are traditional tools used to manage
inventory – still used in many circumstances
 Continuous review system (Q) for high-value parts;
Periodic review system (P) for some low value parts
 Weeks of Supply and inventory turns are widely-used
measures of inventory
12-44