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  • 1. Chapter 12 Inventory Management McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
  • 2. Inventory
    • Inventory
      • A stock or store of goods
    • Independent demand items
      • Items that are ready to be sold or used
  • 3. Types of Inventory
    • Raw materials and purchased parts
    • Work-in-process
    • Finished goods inventories or merchandise
    • Maintenance and repairs (MRO) inventory, tools and supplies
    • Goods-in-transit to warehouses or customers (pipeline inventory)
  • 4. Inventory Functions
    • Inventories serve a number of functions such as:
      • To meet anticipated customer demand
      • To smooth production requirements
      • To decouple operations
      • To protect against stockouts
      • To take advantage of order cycles
      • To hedge against price increases
      • To permit operations
      • To take advantage of quantity discounts
  • 5. Inventory Management
    • 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
  • 6. 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
  • 7. 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
  • 8. 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
  • 9. 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
  • 10. 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
  • 11. 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?
  • 12. How Much to Order: EOQ Models
    • The basic economic order quantity model
    • The economic production quantity model
    • The quantity discount model
  • 13. 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
  • 14. 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
  • 15. Total Annual Cost 12-
  • 16. 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
  • 17. 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.
  • 18. 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
  • 19. 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
  • 20. EPQ – Total Cost 12-
  • 21. EPQ 12-
  • 22. Quantity Discount Model
    • Quantity discount
      • Price reduction offered to customers for placing large orders
  • 23. Quantity Discounts 12-
  • 24. Quantity Discounts 12-
  • 25. 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
  • 26. Reorder Point: Under Certainty 12-
  • 27. 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
  • 28. Safety Stock 12- LT Time Expected demand during lead time Maximum probable demand during lead time ROP Quantity Safety stock
  • 29. 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
  • 30. 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
  • 31. 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-
  • 32. Reorder Point: Demand Uncertainty 12-
  • 33. Reorder Point: Lead Time Uncertainty 12-
  • 34. 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
  • 35. Fixed-Quantity vs. Fixed-Interval Ordering 12-
  • 36. FOI Model 12-
  • 37. 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-
  • 38. 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
  • 39. 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
  • 40. Stocking Levels 12- Service level S o Balance Point Quantity C s C e S o =Optimum Stocking Quantity