Ch10 Invent Manag

Chapter 10
Inventory Management
To Accompany Russell and Taylor, Operations Management, 4th Edition, 2003 Prentice-Hall, Inc. All rights reserved. To Accompany Russell and Taylor, Operations Management, 4th Edition, 2003 Prentice-Hall, Inc. All rights reserved.
Inventory
Stock of items held to meet future demand Inventory management answers two questions
How much to order When to order
To Accompany Russell and Taylor, Operations Management, 4th Edition, 2003 Prentice-Hall, Inc. All rights reserved.
Types of Inventory
Raw materials Purchased parts and supplies Labor In-process (partially completed) products In Component parts Working capital Tools, machinery, and equipment
Reasons to Hold Inventory

Meet unexpected demand Smooth seasonal or cyclical demand Meet variations in customer demand Take advantage of price discounts Hedge against price increases Quantity discounts
Two Forms of Demand

Dependent
Items used to produce final products
Independent
Items demanded by external customers
Inventory Costs
Carrying Cost
Cost of holding an item in inventory
Ordering Cost
Cost of replenishing inventory
Shortage Cost
Temporary or permanent loss of sales when demand cannot be met
Inventory Control Systems

Continuous system (fixed-order(fixed-orderquantity)
Constant amount ordered when inventory declines to predetermined level
Periodic system (fixed-time-period) (fixed-time Order placed for variable amount after fixed passage of time
ABC Classification System

Demand volume and value of items vary Classify inventory into 3 categories, typically on the basis of the dollar value to the firm
CLASS A B C PERCENTAGE OF UNITS 5 - 15 30 50 - 60 PERCENTAGE OF DOLLARS 70 - 80 15 5 - 10
ABC Classification
PART 1 2 3 4 5 6 7 8 9 10 UNIT COST $ 60 350 30 80 30 20 10 320 510 20 ANNUAL USAGE 90 40 130 60 100 180 170 50 60 120
Example 10.1
ABC Classification
PART TOTAL PART VALUE % OF TOTAL % OF TOTAL UNIT COSTQUANTITY % CUMMULATIVE ANNUAL USAGE VALUE
9 8 2 1 4 3 6 5 10 7
9 $85,400 10
$30,600 1 16,000 2 14,000 3 5,400 4 4,800 5 3,900 3,600 6 3,000 7 2,400 8 1,700
35.9 $ 60 18.7 350 16.4 30 6.3 80 5.6 30 4.6 4.2 20 3.5 10 2.8 320 2.0
510 20
6.0 5.0 4.0 9.0 6.0 10.0 18.0 13.0 12.0 17.0
90 40 130 60 100 180 170 50 60 120
6.0 11.0 15.0 24.0 30.0 40.0 58.0 71.0 83.0 100.0
Example 10.1
ABC Classification
9 8 2 1 4 3 6 5 10 7
9 $85,400 10
$30,600 1 16,000 2 14,000 3 5,400 4 4,800 5 3,900 3,600 6 3,000 7 2,400 8 1,700
35.9 $ 60 18.7 350 16.4 30 6.3 80 5.6 30 4.6 4.2 20 3.5 10 2.8 320 2.0
510 20
6.0 5.0 4.0 9.0 6.0 10.0 18.0 13.0 12.0 17.0
90 A 40 130 60 B 100 180 170 C 50 60 120
6.0 11.0 15.0 24.0 30.0 40.0 58.0 71.0 83.0 100.0
Example 10.1
ABC Classification
9 $30,600 1 8 16,000 2 2 14,000 3 1 CLASS 5,400 4 4 4,800 A 5 3 3,900 B 6 6 3,600 C 5 3,000 7 10 2,400 8 7 1,700
9 $85,400 10
35.9 6.0 $ 60 18.7 5.0 350 16.4 % OF TOTAL 4.0 30 6.3 ITEMS VALUE9.0 80 5.6 6.0 9, 8, 2 4.6 30 71.0 10.0 1, 4, 3 4.2 18.0 20 16.5 6, 5, 10, 7 12.5 3.5 13.0 10 2.8 12.0 320 2.0 17.0
510 20
6.0 90 11.0 A 40 % OF 15.0 130 TOTAL 24.0 QUANTITY 60 30.0 B 15.0 100 40.0 58.0 180 25.0 60.0 71.0 170 C 83.0 50 100.0 60 120
Example 10.1
ABC Classification
100 80
C B A
% of Value
60 40 20 0|
| 20
| 40
| 60
| 80
| 100
% of Quantity
Assumptions of Basic EOQ Model

Demand is known with certainty and is constant over time No shortages are allowed Lead time for the receipt of orders is constant The order quantity is received all at once
The Inventory Order Cycle

Order quantity, Q Inventory Level Reorder point, R
Time
Figure 10.1
The Inventory Order Cycle

Order quantity, Q Inventory Level
Demand rate
Reorder point, R
Figure 10.1
Lead time Order Order placed receipt
Lead time Order Order placed receipt
Time
EOQ Cost Model

Co - cost of placing order Cc - annual per-unit carrying cost perD - annual demand Q - order quantity CoD Annual ordering cost = Q C cQ Annual carrying cost = 2 C cQ CoD Total cost = + 2 Q
EOQ Cost Model

CDeriving Q D - annual demand o - cost of placing order Proving equality of opt Cc - annual per-unit carrying cost costsorder quantity perQ - at optimal point C cQ C oD TC = + 2 Q CoD C cQ Annual ordering cost = = Q 2 C oD Cc xTC = + Q2 2 xQ C cQ 2CoD 2 = Annual carrying cost = Q 2 C0D Cc Cc 0= + Q2 2 C cQ CoD 2CoD Total cost = + 2 Qopt = Q 2CoD Cc Qopt = Cc
EOQ Cost Model

Annual cost ($)
Order Quantity, Q
Figure 10.2
EOQ Cost Model

Annual cost ($)
CoD Ordering Cost = Q Order Quantity, Q

Figure 10.2
EOQ Cost Model

Annual cost ($) CcQ Carrying Cost = 2
CoD Ordering Cost = Q Order Quantity, Q

Figure 10.2
EOQ Cost Model

Annual cost ($) Slope = 0 Minimum total cost CcQ Carrying Cost = 2 Total Cost
CoD Ordering Cost = Q Optimal order Qopt

Figure 10.2
Order Quantity, Q
EOQ Example
Cc = $0.75 per yard Qopt = Qopt = 2CoD Cc
2(150)(10,000) (0.75)
Co = $150
D = 10,000 yards
CoD CcQ TCmin = + Q 2 TCmin

(150)(10,000) (0.75)(2,000) = + 2 2,000
Qopt = 2,000 yards
TCmin = $750 + $750 = $1,500
Order cycle time = 311 days/(D/Qopt) days/(D Orders per year = D/Qopt = 311/5 = 10,000/2,000 = 62.2 store days = 5 orders/year
Example 10.2
EOQ with Noninstantaneous Receipt

Inventory level Maximum inventory level Average inventory level Q(1-d/p) (1-d/p)
Q (1-d/p) (1-d/p) 2
0 Time
Figure 10.3

Inventory level Maximum inventory level Average inventory level Q(1-d/p) (1-d/p)
Q (1-d/p) (1-d/p) 2
0 Order receipt period Begin End order order receipt receipt Time
Figure 10.3

p = production rate Maximum inventory level = Q - Q d p =Q1- d p Q d Average inventory level = 12 p CoD CcQ d TC = Q + 2 1 - p
d = demand rate
2CoD Qopt = d Cc 1 p
Production Quantity
Cc = $0.75 per yard Co = $150 d = 10,000/311 = 32.2 yards per day 2CoD Qopt = Cc 1 - d p = D = 10,000 yards p = 150 yards per day
2(150)(10,000) 32.2 0.75 1 150 = 2,256.8 yards
CoD CcQ d TC = Q + 2 1 - p
= $1,329
2,256.8 Q Production run = = = 15.05 days per order 150 p

Example 10.3
Production Quantity
Cc = $0.75 per yard Co = $150 d = 10,000/311 = 32.2 yards per day 2CoD D = 10,000 yards p = 150 yards per day
2(150)(10,000) 10,000 = 2,256.8 yards D Qopt = = d Number of production runs = = 32.2 = 4.43 runs/year Cc 1 0.75Q1 - 2,256.8 150 p d 32.2 MaximumC Q inventory level = Q 1 = 2,256.8 1 CoD c d p 150 TC = Q + 2 1 - p = $1,329 = 1,772 yards 2,256.8 Q Production run = = = 15.05 days per order 150 p
Example 10.3
Quantity Discounts
Price per unit decreases as order quantity increases
CcQ CoD TC = + + PD 2 Q where P = per unit price of the item D = annual demand
Quantity Discounts
Price per unit decreases as order quantity increases
CcQ CoD TC = + + PD 2 Q where ORDER SIZE P = per unit price- of the item 0 99 D = annual demand 100 - 199 200+ PRICE $10 8 (d1) 6 (d2)
Quantity Discount Model

Inventory cost ($)
Figure 10.4

TC = ($10 ) TC (d1 = $8 ) Inventory cost ($) TC (d2 = $6 )
Carrying cost
Ordering cost Q(d1 ) = 100 Qopt Q(d2 ) = 200
Figure 10.4

TC = ($10 ) TC (d1 = $8 ) Inventory cost ($) TC (d2 = $6 )
Carrying cost
Ordering cost Q(d1 ) = 100 Qopt Q(d2 ) = 200
Figure 10.4
Quantity Discount
QUANTITY 1 - 49 50 - 89 90+ Qopt = For Q = 72.5 PRICE $1,400 1,100 900 2CoD = Cc Co = $2,500 Cc = $190 per computer D = 200
2(2500)(200) = 72.5 PCs 190
CcQopt CoD TC = + 2 + PD = $233,784 Qopt C cQ CoD TC = + 2 + PD = $194,105 Q

For Q = 90
Example 10.4
When to Order
Reorder Point is the level of inventory at which a new order is placed R = dL where d = demand rate per period L = lead time
Reorder Point Example

Demand = 10,000 yards/year Store open 311 days/year Daily demand = 10,000 / 311 = 32.154 yards/day Lead time = L = 10 days R = dL = (32.154)(10) = 321.54 yards
Example 10.5
Safety Stocks
Safety stock
buffer added to on hand inventory during lead time
Stockout
an inventory shortage
Service level
probability that the inventory available during lead time will meet demand
Variable Demand with a Reorder Point

Q Inventory level
Reorder point, R
0
Figure 10.5
Time
Variable Demand with a Reorder Point

Q Inventory level
Reorder point, R
0
Figure 10.5
LT Time
LT
Reorder Point with a Safety Stock

Inventory level Q
Reorder point, R
Safety Stock
0
Figure 10.6
LT Time
LT
Reorder Point With Variable Demand

R = dL + zWd L
where d = average daily demand L = lead time Wd = the standard deviation of daily demand z = number of standard deviations corresponding to the service level probability zWd L = safety stock
Reorder Point for a Service Level

Probability of meeting demand during lead time = service level
Probability of a stockout
Safety stock zWd L dL Demand R
Figure 10.7
Reorder Point for Variable Demand

The carpet store wants a reorder point with a 95% service level and a 5% stockout probability
d = 30 yards per day L = 10 days Wd = 5 yards per day For a 95% service level, z = 1.65 R = dL + z Wd L = 30(10) + (1.65)(5)( 10) = 326.1 yards
Example 10.6
Safety stock = z Wd L = (1.65)(5)( 10) = 26.1 yards
Order Quantity for a Periodic Inventory System

Q = d(tb + L) + zWd where d tb L Wd zWd = average demand rate = the fixed time between orders = lead time = standard deviation of demand tb + L - I
tb + L = safety stock I = inventory level

FixedFixed-Period Model with Variable Demand

d Wd tb L I z = 6 bottles per day = 1.2 bottles = 60 days = 5 days = 8 bottles = 1.65 (for a 95% service level) tb + L - I 60 + 5 - 8
Q = d(tb + L) + zWd = 397.96 bottles
= (6)(60 + 5) + (1.65)(1.2)

Ch10 Invent Manag

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Ch10 Invent Manag

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Chapter 10

Reasons to Hold Inventory

Two Forms of Demand

Inventory Control Systems

ABC Classification System

90 40 130 60 100 180 170 50 60 120

90 A 40 130 60 B 100 180 170 C 50 60 120

Assumptions of Basic EOQ Model

The Inventory Order Cycle

The Inventory Order Cycle

Lead time Order Order placed receipt

Lead time Order Order placed receipt

EOQ Cost Model

EOQ Cost Model

EOQ Cost Model

EOQ Cost Model

CoD Ordering Cost = Q Order Quantity, Q

EOQ Cost Model

CoD Ordering Cost = Q Order Quantity, Q

EOQ Cost Model

CoD Ordering Cost = Q Optimal order Qopt

CoD CcQ TCmin = + Q 2 TCmin

Qopt = 2,000 yards

TCmin = $750 + $750 = $1,500

EOQ with Noninstantaneous Receipt

EOQ with Noninstantaneous Receipt

EOQ with Noninstantaneous Receipt

2(150)(10,000) 32.2 0.75 1 150 = 2,256.8 yards

2,256.8 Q Production run = = = 15.05 days per order 150 p

Quantity Discount Model

Quantity Discount Model

Ordering cost Q(d1 ) = 100 Qopt Q(d2 ) = 200

Quantity Discount Model

Ordering cost Q(d1 ) = 100 Qopt Q(d2 ) = 200

2(2500)(200) = 72.5 PCs 190

CcQopt CoD TC = + 2 + PD = $233,784 Qopt C cQ CoD TC = + 2 + PD = $194,105 Q

Reorder Point Example

Variable Demand with a Reorder Point

Variable Demand with a Reorder Point

Reorder Point with a Safety Stock

Reorder Point With Variable Demand

Reorder Point for a Service Level

Safety stock zWd L dL Demand R

Reorder Point for Variable Demand

Safety stock = z Wd L = (1.65)(5)( 10) = 26.1 yards

Order Quantity for a Periodic Inventory System

tb + L = safety stock I = inventory level

FixedFixed-Period Model with Variable Demand

Q = d(tb + L) + zWd = 397.96 bottles

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