Inventory

12 Management

PowerPoint presentation to accompany

Heizer and Render
Operations Management, 10e
Principles of Operations Management, 8e

PowerPoint slides by Jeff Heyl

© 2011 Pearson Education, Inc. publishing as Prentice Hall 12 - 1

 Inventory
Inventory is the stocks of goods or materials that are
on hand for future use. In general, inventory means
the stocks related to the production or business.

Inventory Control
Inventory control may be defined as a scientific
method of finding out how much stock should be
maintained in order to meet production demand and
can be able to provide right type of material at right
time in right quantities and competitive cost.

12 - 2
 Inventory Management

The objective of inventory

management is to strike a balance
between inventory investment and
customer service

12 - 3
 Importance of 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

12 - 4
 Functions of Inventory
1. To meet expected demand
2. To decouple or separate various parts of the
production process.
3. To decouple the firm from fluctuations in
demand and provide a stock of goods that will
provide a selection for customers.
4. To take advantage of quantity discounts.
5. To hedge against inflation.
6. Increase cash flow and profitability.

12 - 5
 Types of Inventory
 Raw material
 Purchased but not processed
 Work-in-process
 Undergone some change but not completed
 A function of cycle time for a product
 Maintenance/Repair/Operating (MRO)
 Necessary to keep machinery and processes
productive
 Finished goods
 Completed product awaiting shipment
12 - 6
 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

12 - 7
 Managing Inventory

1. How inventory items can be classified

2. How accurate inventory records can
be maintained

12 - 8
 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 and not the many
trivial ones

12 - 9
 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

12 - 10
 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%

12 - 11
Percent of annual dollar usage ABC Analysis
A Items
80 –
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

12 - 12
 ABC Analysis

 Other criteria than annual dollar

volume may be used
 Anticipated engineering changes
 Delivery problems
 Quality problems
 High unit cost

12 - 13
 ABC Analysis

 Policies employed may include

 More emphasis on supplier development
for A items
 Tighter physical inventory control for A
items
 More care in forecasting A items

12 - 14
 Record Accuracy
 Accurate records are a critical ingredient in
production and inventory systems
 Allows organization to focus on what is needed
 Necessary to make precise decisions about
ordering, scheduling, and shipping
 Incoming and outgoing record keeping must be
accurate
 Stockrooms should be secure

12 - 15
 Cycle Counting
 Items are counted and records updated on a
periodic basis
 Often used with ABC analysis
to determine cycle
 Has several advantages
1. Eliminates shutdowns and interruptions
2. Eliminates annual inventory adjustment
3. Trained personnel audit inventory accuracy
4. Allows causes of errors to be identified and corrected
5. Maintains accurate inventory records

12 - 16
 Cycle Counting Example

Item Number of Items

Class Quantity Cycle Counting Policy Counted per Day
A 500 Each month 500/20 = 25/day
B 1,750 Each quarter 1,750/60 = 29/day
C 2,750 Every 6 months 2,750/120 = 23/day
77/day

12 - 17
12 - 18
12 - 19
 Holding, Ordering, and
Setup Costs
 Holding costs - the costs of holding or
“carrying” inventory over time
 Ordering costs - the costs of placing an
order and receiving goods
 Setup costs - cost to prepare a machine
or process for manufacturing an order

12 - 20
 Holding Costs
Cost (and range)
as a Percent of
Category Inventory Value
Housing costs (building rent or 6% (3 - 10%)
depreciation, operating costs, taxes,
insurance)
Material handling costs (equipment lease or 3% (1 - 3.5%)
depreciation, power, operating cost)
Labor cost 3% (3 - 5%)
Investment costs (borrowing costs, taxes, 11% (6 - 24%)
and insurance on inventory)
Pilferage, space, and obsolescence 3% (2 - 5%)
Overall carrying cost 26%

12 - 21
 Holding Costs
Cost (and range)
as a Percent of
Category Inventory Value
a b ly d e p e n di ng
Housing costs (building rent ornsider
o 6% (3e-s10%)
n g c o s t s v a ry c
i n te r e s t ra t .
Holdi
depreciation, operating
s s ,
costs,
l o c a taxes,
t io n , and t ech
insurance)
t he b u si n e so m e h i g h
on a t e r th a n 1 5%, 4 0 %- .3.5%)
ra l ly g r e grea t e r t ha n
Gene
Material handling costs
ld
(equipment
in g c o s t s lease or 3% (1
depreciation, ave hooperating
items hpower, cost)
Labor cost 3% (3 - 5%)
Investment costs (borrowing costs, taxes, 11% (6 - 24%)
and insurance on inventory)
Pilferage, space, and obsolescence 3% (2 - 5%)
Overall carrying cost 26%

12 - 22
 Inventory Models for
Independent Demand
Need to determine when and how much to order

1. Basic economic order quantity (EOQ)

2. Production order quantity (POQ)
3. Discount order quantity (DOQ)

12 - 23
 Basic EOQ Model
Important assumptions

1. Demand is known, constant, and independent

2. Lead time is known and constant
3. Receipt of inventory is instantaneous and complete
4. Quantity discounts are not possible
5. Only variable costs are setup and holding
6. Stockouts can be completely avoided

12 - 24
 Inventory Usage Over Time

Usage rate Average

Order inventory
quantity = Q
Inventory level

on hand
(maximum
inventory Q
level) 2

Minimum
inventory

0
Time

12 - 25
 Minimizing Costs
Objective is to minimize total costs
Total cost of
holding and
setup (order)

Minimum
total cost
Annual cost

Holding or
Carrying cost

Setup (or order)

cost
Optimal order Order quantity
quantity (Q*)

12 - 26
 The EOQ Model
Annual setup cost =
D
Q
S

Q = Number of pieces per order

Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year

Annual setup cost = (Number of orders placed per year)

x (Setup or order cost per order)

Annual demand Setup or order

=
Number of units in each order cost per order

= D (S)
Q

12 - 27
 The EOQ Model
Annual setup cost =
D
Q
S
Q
Q = Number of pieces per order Annual holding cost = H
2
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year

Annual holding cost = (Average inventory level)

x (Holding cost per unit per year)

Order quantity
= (Holding cost per unit per year)
2

= Q (H)
2

12 - 28
 The EOQ Model
Annual setup cost =
D
Q
S
Q
Q = Number of pieces per order Annual holding cost = H
2
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year

Optimal order quantity is found when annual setup cost

equals annual holding cost

D Q
S = H
Q 2
Solving for Q*
2DS = Q2H
Q2 = 2DS/H
Q* = 2DS/H
12 - 29
 An EOQ Example

2DS
Q* =
H
2(1,000)(10)
Q* = = 40,000 = 200 units
0.50

12 - 30
 An EOQ Example

Expected Demand D
number of = N = =
orders Order quantity Q*
1,000
N= = 5 orders per year
200

12 - 31
 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year

Number of working
Expected days per year
time between = T =
orders N
250
T= = 50 days between orders
5

12 - 32
 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days

Total annual cost = Setup cost + Holding cost

D Q
TC = S + H
Q 2
1,000 200
TC = ($10) + ($.50)
200 2
TC = (5)($10) + (100)($.50) = $50 + $50 = $100

12 - 33
12 - 34
 An EOQ Example
Management underestimated demand by 50%
D = 1,000 units 1,500 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days

D Q
TC = S + H
Q 2
1,500 200
TC = ($10) + ($.50) = $75 + $50 = $125
200 2

Total annual cost increases by only 25%

12 - 35
 An EOQ Example
Actual EOQ for new demand is 244.9 units
D = 1,000 units 1,500 units Q* = 244.9 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days

D Q
TC = S + H
Q 2 Only 2% less
1,500 244.9 than the total
TC = ($10) + ($.50) cost of $125
244.9 2
when the
TC = $61.24 + $61.24 = $122.48 order quantity
was 200
12 - 36
 Reorder Points
 EOQ answers the “how much” question
 The reorder point (ROP) tells “when” to
order
Demand Lead time for a
ROP = per day new order in days
=dxL
D
d = Number of working days in a year

12 - 37
 Reorder Point Curve
Q*
Inventory level (units)

Resupply takes place as order arrives

Slope = units/day = d

ROP
(units)

Time (days)
Lead time = L
12 - 38
 Reorder Point Example
Demand = 8,000 iPods per year
250 working day year
Lead time for orders is 3 working days

D
d=
Number of working days in a year
= 8,000/250 = 32 units

ROP = d x L
= 32 units per day x 3 days = 96 units

12 - 39
Production Order Quantity
Model
 Used when inventory builds up
over a period of time after an
order is placed
 Used when units are produced
and sold simultaneously

12 - 40
 Production Order Quantity
Model
Part of inventory cycle during
which production (and usage)
is taking place
Inventory level

Demand part of cycle

with no production
Maximum
inventory

t Time

12 - 41
 Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days

Annual inventory Holding cost

= (Average inventory level) x
holding cost per unit per year

Annual inventory
= (Maximum inventory level)/2
level

Maximum Total produced during Total used during

= –
inventory level the production run the production run

= pt – dt

12 - 42
 Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days

Maximum Total produced during Total used during

= –
inventory level the production run the production run
= pt – dt
However, Q = total produced = pt ; thus t = Q/p

Maximum Q Q d
inventory level = p –d =Q 1–
p p p

Maximum inventory level Q d

Holding cost = (H) = 1– H
2 2 p
12 - 43
 Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
D = Annual demand

Setup cost = (D/Q)S

1
Holding cost = 2 HQ[1 - (d/p)]
1
(D/Q)S = 2 HQ[1 - (d/p)]
2DS
Q =
2
H[1 - (d/p)]

2DS
Q*p =
H[1 - (d/p)]
12 - 44
Production Order Quantity
Example
D = 1,000 units p = 8 units per day
S = $10 d = 4 units per day
H = $0.50 per unit per year

2DS
Q* =
H[1 - (d/p)]

2(1,000)(10)
Q* = = 80,000
0.50[1 - (4/8)]
= 282.8 or 283 hubcaps
12 - 45
 Production Order Quantity
Model
Note:
D 1,000
d=4= =
Number of days the plant is in operation 250

When annual data are used the equation becomes

2DS
Q* =
annual demand rate
H 1–
annual production rate

12 - 46
 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

12 - 47
 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

Table 12.2

12 - 48
 Quantity Discount Models
Steps in analyzing a quantity discount
1. For each discount, calculate Q*
2. If Q* for a discount doesn’t qualify,
choose the smallest possible order size
to get the discount
3. Compute the total cost for each Q* or
adjusted value from Step 2
4. Select the Q* that gives the lowest total
cost
12 - 49
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
Order quantity
12 - 50
 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)
12 - 51
 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
12 - 52
 Quantity Discount Example
Annual Annual Annual
Discount Unit Order Product Ordering Holding
Number Price Quantity 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

12 - 53
12 - 54
12 - 55
12 - 56
12 - 57
12 - 58
12 - 59
12 - 60
12 - 61
12 - 62
12 - 63
12 - 64
12 - 65
12 - 66
12 - 67
12 - 68
12 - 69
12 - 70
12 - 71
12 - 72
12 - 73
12 - 74