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Management has two basic functions concerning inventory:
Establish a system for tracking items in inventory
Make decisions about
When to order
How much to order
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Effective Inventory Management
Requires:
A system keep track of inventory
A reliable forecast of demand
Knowledge of lead time and lead time variability
Reasonable estimates of
holding costs
ordering costs
shortage costs
A classification system for inventory items
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Inventory Counting Systems
Periodic System
Physical count of items in inventory made at periodic intervals
Perpetual Inventory System
System that keeps track of removals from inventory continuously, thus monitoring current levels of each item
Two-bin system
Two containers of inventory; reorder
when the first is empty
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Inventory Counting Technologies
Universal product code (UPC)
Bar code printed on a label that has information about the item to which it is attached
Radio frequency identification (RFID) tags
A technology that uses radio waves to identify objects, such as goods in supply chains
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Demand Forecasts and Lead Time
Forecasts
Inventories are necessary to satisfy customer demands, so it is important to have a reliable estimates of the amount and timing of demand
Lead time
Time interval between ordering and receiving the order
Point-of-sale (POS) systems
A system that electronically records actual sales
Such demand information is very useful for enhancing forecasting and inventory management
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ABC Classification System
A-B-C approach
Classifying inventory according to some measure of importance, and allocating control efforts accordingly
A items (very important)
10 to 20 percent of the number of items in inventory and about 60 to 70 percent of the annual dollar value
B items (moderately important)
C items (least important)
50 to 60 percent of the number
of items in inventory but only
about 10 to 15 percent of the
annual dollar value
12- Annual $ value of items High Low Few Many Number of Items A C B
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Cycle Counting
Cycle counting
A physical count of items in inventory
Cycle counting management
How much accuracy is needed?
A items: ± 0.2 percent
B items: ± 1 percent
C items: ± 5 percent
When should cycle counting be performed?
Who should do it?
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How Much to Order: EOQ Models
The basic economic order quantity model
The economic production quantity model
The quantity discount model
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Basic EOQ Model
The basic EOQ model is used to find a fixed order quantity that will minimize total annual inventory costs
Assumptions
Only one product is involved
Annual demand requirements are known
Demand is even throughout the year
Lead time does not vary
Each order is received in a single delivery
There are no quantity discounts
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The Inventory Cycle 12- Profile of Inventory Level Over Time Quantity on hand Q Receive order Place order Receive order Place order Receive order Lead time Reorder point Usage rate Time
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Total Annual Cost 12-
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Goal: Total Cost Minimization 12- Order Quantity (Q) The Total-Cost Curve is U-Shaped Ordering Costs Q * Annual Cost ( optimal order quantity) Holding Costs
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Deriving EOQ
Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q.
The total cost curve reaches its minimum where the carrying and ordering costs are equal.
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Economic Production Quantity (EPQ)
Assumptions
Only one product is involved
Annual demand requirements are known
Usage rate is constant
Usage occurs continually, but production occurs periodically
The production rate is constant
Lead time does not vary
There are no quantity discounts
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EPQ: Inventory Profile 12- Q Q * I max Production and usage Production and usage Production and usage Usage only Usage only Cumulative production Amount on hand Time
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EPQ – Total Cost 12-
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EPQ 12-
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Quantity Discount Model
Quantity discount
Price reduction offered to customers for placing large orders
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Quantity Discounts 12-
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Quantity Discounts 12-
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When to Reorder
Reorder point
When the quantity on hand of an item drops to this amount, the item is reordered.
Determinants of the reorder point
The rate of demand
The lead time
The extent of demand and/or lead time variability
The degree of stockout risk acceptable to management
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Reorder Point: Under Certainty 12-
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Reorder Point: Under Uncertainty
Demand or lead time uncertainty creates the possibility that demand will be greater than available supply
To reduce the likelihood of a stockout, it becomes necessary to carry safety stock
Safety stock
Stock that is held in excess of expected demand due to variable demand and/or lead time
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Safety Stock 12- LT Time Expected demand during lead time Maximum probable demand during lead time ROP Quantity Safety stock
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Safety Stock?
As the amount of safety stock carried increases, the risk of stockout decreases.
This improves customer service level
Service level
The probability that demand will not exceed supply during lead time
Service level = 100% - Stockout risk
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How Much Safety Stock?
The amount of safety stock that is appropriate for a given situation depends upon:
The average demand rate and average lead time
Demand and lead time variability
The desired service level
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Reorder Point ROP Risk of stockout Service level Expected demand Safety stock 0 z Quantity z-scale The ROP based on a normal Distribution of lead time demand 12-
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Reorder Point: Demand Uncertainty 12-
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Reorder Point: Lead Time Uncertainty 12-
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How Much to Order: FOI
Fixed-order-interval (FOI) model
Orders are placed at fixed time intervals
Reasons for using the FOI model
Supplier’s policy may encourage its use
Grouping orders from the same supplier can produce savings in shipping costs
Some circumstances do not lend themselves to continuously monitoring inventory position
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Fixed-Quantity vs. Fixed-Interval Ordering 12-
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FOI Model 12-
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FOI Model OI * represents the optimal time between orders. Time-frame of interest is an appropriate period (e.g., days or weeks). This is usually based on the time-frame expressed by the average demand rate, d-bar. 12-
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Single-Period Model
Single-period model
Model for ordering perishables and other items with limited useful lives
Shortage cost
Generally, the unrealized profit per unit
C shortage = C s = Revenue per unit – Cost per unit
Excess cost
Different between purchase cost and salvage value of items left over at the end of the period
C excess = C e = Cost per unit – Salvage value per unit
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Single-Period Model
The goal of the single-period model is to identify the order quantity that will minimize the long-run excess and shortage costs
Two categories of problem:
Demand can be characterized by a continuous distribution
Demand can be characterized by a discrete distribution
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Stocking Levels 12- Service level S o Balance Point Quantity C s C e S o =Optimum Stocking Quantity