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Inventory concept & need for inventory managementThe cost structure of Indian manufacturing plants showsthat materials constitute 66 percent of total costs, andmaterial processing overhead as 24 percent. This implies that management initiatives to controlmanufacturing costs need to focus on reduce materialcosts and overheads.Indian Manufacturing sector is facing stiff competitionfrom ASIAN market forcing it to be cost competitive in thefinal products and move towards mass customization .The challenge is to move from mass production culture tomass customization.
Traditional Manufacturing Process.Causal Diagram.
Why inventory problem Standardization Non standardization Variation Flow (Mass) Batch Job Project/ Turn Production production production key production MTS ETOStandard parts & Non standard low volumeHigh Volume
Toyota Production System.TPS works on the premise of eliminating waste andbeing flexible and open to change . It’s approach is toidentify and eliminate waste (non-value adding activities)through continuous improvement by flowing the product at thepull of the customer in pursuit of perfection.The Toyota Production System is a philosophy ofmanufacturing that was created by the Toyota Corporation.TPS, has become synonymous with Lean Manufacturing.TPS defined three types of waste: “Muda“( non value-addedwork), “Muri" (overburden) and “Mura“( unevenness). Byeliminating waste, overall quality can be improved andproduction time as well as cost can be reduced.
TPS defined three types of waste known as 3 M’s ofTPS.“Muda“( non value-added work)“Muri" (overburden) Excess inventory“Mura“( unevenness).By eliminating waste, overall quality can be improvedand production time as well as cost can be reduced.
Toyota Production System ( TPS) & 3 M’sAccording to TPS , there are seven types of wastes inproduction .1. Over-production2. Motion (of operator or machine)3. Waiting (of operator or machine)4. Conveyance,5. Processing itself6 .Inventory7. Correction (rework and scrap).Lean manufacturing aims to improve the manufacturingprocess by eliminating seven wastes in all their forms.
In business accounting , the Inventory turnover is a measure of the number oftimes inventory is sold or used in a time period ( year) . The equation for inventoryturnover equals the cost of goods sold divided by the average inventory . Inventoryturnover is also known as inventory turns, stock turn, stock turns, turns, andstock turnover.Inventory turn over = COGS Average inventoryAverage Inventory = Opening stock + closing stock 2A low turnover rate may point to overstockingThe purpose of increasing inventory turns is to reduce inventory for three reasons.Increasing inventory turns reduces holding cost . The organization spends lessmoney on rent, utilities, insurance, theft and other costs of maintaining a stock ofgood to be sold.It increases net income and profitability as long as the revenue from selling theitem remains constant.Items that turn over more quickly increase responsiveness to changes in customerrequirements while allowing the replacement of obsolete items.
D = 4,800 Annual DemandP = 40.00 Cost to Place an OrderV = 62.50 Value of one unit at CostC = 40% Annual Carrying Cost as a Percentage
Assumptions of the Simple EOQ Model1. Constant & Known rate of demand.2. Zero replenishment cycle or lead time.3. Fixed purchase price that is independent of the order quantity or time.4. Fixed transportation cost that is independent of the order quantity or time.5. No inventory in transit.6. Only one item in inventory, or at least no interaction among items.7. An infinite planning horizon.8. No limit on capital availability.
Inventory models to overcome the assumptions .Dimensions of inventory modelsDeterministic versus StochasticIndefinite versus finite planning horizonIndependent versus dependent demandSingle versus multiple:itemlocationechelon (interrelated locations)indenture (interrelated items)
MRP is an essential task for : Strategic inventory managementIn MRP decision, lot size has to be considered as it affects the productionschedule. However while doing so, set up cost need to be considered as itaffects the production cost.
Effects of Lot sizingLot-for-lot+ ”Preserves” the MPS quantities+ Suitable for JIT manufacturing+ Generates smooth requirements for material and capacity– No economic considerationsFixed order quantities– Lumps together requirements to large orders– Amplifies lumpiness through the BOM– Fluctuating material and capacity requirementsVariable quantity and cover-time+ Economic considerations considering discrete requirements- Estimation of cost parameters– Covering many periods net requirements tends to create amplified variability ofdemand for material and capacity
Inventory decision rules
Independent inventory Q,Rpolicy
What can happen: Q,R Policy . Demandduring lead time is greater than lead time
Demand during lead time is larger than order size.If ordered only when replenishment comes, inventory is depleted.Pink line when backorders, black when demand is lost.
Q,R Policy (amended with multiple R)
Inventory decision rulesQ is clear but S somewhat less clear. If we review inventory balancecontinuously, then when reorder point is reached and quantity Qordered, it will lead to an expected opening inventory of SHowever, if review is periodic, then the inventory can be more or lessbelow R, so S would be S = Q + (R-inventory).Policy Q,T is interesting. If demand during review T > Q, this policydoes not really work. Unless we decide that it is still Q that is orderedbut we can order or more times Q (n*Q).In practice, Q could be some physical logistics limit, like full truckloador a full pallet.In practice, S could be some periodic system, like shipping scheduleor production cycle.
Buffering techniquesSafety stockPhysical safety quantity. Used when quantity, demand or consumption isunreliableSafety lead timeSafety in time, order receipt before requirementUsed when lead times are stochasticExtends the lead timeHedgingSafety in order quantities used when yield is stochastic (e.g. scrap)Mainly used in master production schedulingSlack in the system (e.g. spare capacity)5. Some Safety Stock StrategiesSpecified fill rate (demand filled from stock) or Specified service level (probabilitya stock out will not occur)Maximize $ demand filled from a given investment.Set SS based on specified number of Sigmas (Std.Dev., MAD, etc.)Set SS based on specified time supply.Minimize shortage occurrences for a given investment (# of orders with aproblem.)Minimize transaction shortages for a given investment (# of problems in orders.)
Safety stock = Z*δdWhere– Z = value from the standard normal distribution– δd = standard deviation of demand during replenishment lead timeReorder Point = Z*δd + expected demand during lead timeExamples– Z(1,645) = 95%– Z(1,960) = 97,5 %– Z(3,090) = 99,9 %
Minor ProblemsIt calculates the probability of a stock out during replenishment leadtime, not customer service level measured as fill-rate. They are notthe same thing.What if delivery time is not certain but a variable, too?The formula applies only for normally distributed demand, not otherdemand distributions.How to incorporate demand forecasts?
If the LT distribution is binomial, then the joint distribution can be createdmanually.Bowersox gives a following approximate formula for calculating Z for variable leadtime situationjoint δ = √(t* δd 2+ d2* δt2Wheret = replenishment lead timeδt = replenishment lead time varianced = demand during average replensihment lead timeδd = demand variance during average replensihment lead time
Inventory independent on market Demand ( Mass production ) Q Q/2ROP Time Lead time D Lt = Av demand x LT Stock level = EOQ + DLt ( When supplier lead time not constant ) Stock level = EOQ + Dlt + variation in demand ( when demand fluctuates )
Cost trade off.When orders are placed more frequently, the ordering cost is high butcarrying cost lost is low , on the other hand if less frequent orders are placedordering cost will be low but carrying cost will be high. Total costCost Carrying cost Total cost Ordering cost Order Qty
Total no. of orders /year = D/ QAverage Inventory = Q/2Cost of ordering /year = D/Q x Co where Co is ordering cost per orderCarrying cost /year = Q/2 X Cc where Cc is carrying cost per unit per year Total cost is minimum when D/Q X Co = Q/2 X Cc Q2 = 2 X DX Co/ Cc EOQ= 2x D x Co Cc
Manufacturing model without shortage Items are produced & consumed simultaneously for a portion of the cycle time. The rate of consumption is uniform through out the year & cost of production remains same irrespective of production lot . I max = t p x ( P-D)Q Q = Pxtp , tp = Q/P D P = production rate D= consumption rate P P – D = inventory build up rate Q = Inventory at t1 tp Cycle 2 DXCs P EBQ = Ci ( P-D )
I max = t p x ( P-D) = Q/P x ( P-D) = Q x (1- D/P) Av annual Inv = Q/2 x ( 1- D/P) Av Annual Inv Cost = Q/2 x (1- D/P) Ci Annual set up cost = D/Q x C s Q/2 x(1-D/P) Ci = D/Q x Cs Q2 = 2 x D x Cs (P-D )Ci PEconomic 2x Dx C x P Q= sBatch Qty C i P-D
A manufacturing unit has annual demand of 10000 valves.Each valve costs Rs 32. The product engineeringdepartment estimates the setup cost as Rs 55 & holdingcost as 12.5 % of the valve. The production rate is uniformat 120 valve/day. Production happens for 250 days in ayear. Calculate optimal batch size & total inventory cost on the basis of optimal policy. Find the number of set ups on the basis of optimal batch . Ci= 12.5% of 32 = Rs 4 , D= 10000/250 = 40 units /day EBQ = 2 x 10000 x 55 ( 120/120-40) = 642 valves. 4 (10000/642)x 55 + 642/2 ( 120-40/120) x 4 856.8 + 856.35 = Rs 1713.15 /yr No of setups = 10000/ 642= 16 Approx
Inventory Control TechniquesInventory control techniques are used to prevent :1 financial leakage due o excessive stock & poor demand ,2 shortage of inventory3. Inventory Obsolescence Plan safety stock for critical & essential itemsBuild selective control on fast & slow moving inventory .Various Inventory control technique used are :ABC : Always Better ControlVED : Vital Essential & DesirableSDE : Scarce Difficulty & EasyFNSD Fast moving , Normal , Slow moving , Dead
ABC Classification 100 CLASS C 90 Low annual consumption value CLASS BUsage % Moderate annual Consumption value 70(InventoryValue ) CLASS A High annual consumption value items 0 10 30 100 % items
VED analysis : Vital : Without which production processwill come to halt. Essential : Non availability of such item will affectthe efficiency .Desirable : It is good if it is available , howeveralternate option can be done.SDE : Scarce ( Short supply ) Difficult ( Imported components ) easily ( Short lead time )
Purchase Inventory review system :Review process is administered on the basis of Fixedorder quantity ( Q system ) and fixed period quantitysystem . ( P system )In Q system , whenever the stock level reaches the RoL , order is placed for a fixed quantity of material .RoL is calculated as a sum of demand during the leadtime & variation in demand during lead time ( safetystock ) and average demand during delivery delays.( reserve stock )In p system , stock position is reviewed after every fixedperiod & order is placed according to stock position .
The goal of JIT in manufacturing organization is tocontinuously reduce the cost associated with requirementmaterial resource. Its objective is to achieve zero ( minimal )inventory through out the supply chain, hence implementgood material control. The goal of JIT process is to reduceexcess working capital held-up on account of material ,minimal inventory at WIP .The constraints for implementing JIT are :•Unpredictable quality of supply of material•Inability to hold tolerances.•Shortcoming in lead time. ( Erratic delivery )•Short supply of quantity of material•Inaccurate forecasting•Non standard materials being used ( Increased variety )•Last minute product changes.
Steps for implementing JIT in an organization.•Do detailed analysis of inventory requirement of all types at every stage ofproduction process.•Estimate the market fluctuations on account of price, supply , qualitydemand etc.•Identify reliable source of suppliers who are capable of supplying materialas when required.•Take supplier in to confidence & sensitize them the importance of JITinventory & build healthy business relationship with suppliers to have highcommitment & ownership . Use Value engineering approach.•Conduct periodic vendor appraisal & follow vendor rating system of evaluation.•Give instant feed back on the supply & suggest improvement steps.•Sign rate contract .• Use IT enabled ordering system , ERP .
Value Engineering or Value AnalysisIt is a technique of cost reduction and costprevention. It focuses on building necessaryfunctions at minimum cost with outcompromising on quality, reliability ,performance& appearance. It helps in identifying unnecessarycosts associated with any material , partcomponents or service by analysis of functionand efficiently eliminating them with outimpairing the quality functional reliability or itscapacity to provide service. It is a preventiveprocess.
When to apply VE1. Raw material cost increases suddenly .2. Vendors are unreliable & organization is highly dependent on a few select vendor .3. Cost of manufacturing is disproportionate to volume of production .Value analysis is done w.r.t cost associated at:• Cost Value (Labour , Material & overhead).• Use Value• Esteem Value ( Look & finish )• Performance Value ( Reliability , Safety , Service & Maintenance )
Value = Performance ( Utility) CostVendor analysis is done to minimize the cost incurred dueto a supplier Inefficiency or inability .Vendor cost to be considered are :•Opportunity loss due to poor quality ( High rejection cost )•leading to machine & labour idle time.•High re-work cost•Inconsistent lead time•Inability to meet the demand of the manufacturer•Poor Credit terms
Value engineering procedure:Constantly evaluate the inventory costs associated &benchmark against the best in practice.As & when the cost of manufacturing increasesdisproportionately, identify an alternate source for contractmanufacturing & monitor the quality & standards.Use more standard parts which can be sourced easilyDevelop more suppliers ( atleast 4 to5 for one part.) &minimize dependency on one supplier.Audit the supplier’s work premise & rate them on theperformance . Conduct quarterly vendor meet & share the highlights &concerns .
Material requirement planning (MRP )process. Batch production Turnkey production ExplodeDemand Analyze Requirement Demand intoaggregation Make or Buy Analysis bill of material ( BOM) decision Check Inventory Stock (Stocking Policy ) Make Buy N Y Raise Stock Raise production . Raise subcontract Purchase availability work order contract Indent
Make or Buy decision .Criteria of make : 1. Finished goods can be made cheaper by the firm. 2.Quality standardization can not be met by out side party. ( strict quality control. ) 3.Supply of the parts are unsteady ( Long lead time) 4.Capacity of production can be used for manufacturing some other part. ( Fixed cost) Buy : 1.Heavy investment in the facility 2.Parts are standard and available easily. 3.Demand of the components are seasonal . 4.Patent of some legal implications exists. 5.Cost of buying is less than manufacturing.
A firm has extra capacity which can be used for production of gears, whichthey have been buying form the market at Rs 300 per unit. If the firm makesgears , it incurs the following cost.Mat cost Rs 90/unit.Lab cost 120/unitOverhead Rs 30/unit . The annual fixed cost of production estimated is Rs240,000. Projected demand for next 24 months is 4000 units.Will it be profitable for the firm to manufacturer?The same capacity can be utilized for producing agri-equipment. In such casethere will be a saving of s 90,000. What should be the decision. Making /Buying gears VC/unit = ( Rs 90 + 120+ 30) = Rs 240 Total VC = 4000 X 240 = 9,60,000 Fixed cost = 2,40,000 Total cost = 12,00,000 Purchase cost = ( 4000 x Rs 300/unit ) = 12,00,000 Fixed cost = 2,40,000 Total cost = 14,40,000 Make gears Make Gears and Agri Equipment Rs 12,00,000 12,00,000 – 90,000 = 11,10,000
There are two machines to manufacture a particular product in a firm . Alternatively , they can also buy it from local market. The cost associated areas follows. The annual demand for the product is 10000 units. When would it be feasible for the firm to use process A & B . Cost ( Rs ) Machine A Machine B Buy FC/ Year 1,00,000 3,00,000 ----- VC/ unit 75 70 ----- Buy price / unit 80 Cost of Process A = 1,00,000 + 75 x 10000 = Rs 8,50,000 Cost of process B = 3,00,000 + 70 x 10000 = Rs 10,00,000 Cost of buying = 80 x 10000 = 8,00,000 Le t Q be the vol of production. For Process A 100000 + 75 Q =< 80 Q 100000 =< 5 Q 20000 units TC A >= TC B 100000 +75Q >= 300000 + 70Q 5Q>= 200000 = 40000 unitsWhen demand exceeds 20000 units , use process A & beyond 40000, use process B
Multi-echelon Distribution NetworkManaging inventory can be a daunting task for an enterprisewith tens of thousands of products that are located inhundreds of locations. The challenge is even greater when thelocations are situated in different tiers or echelons of theenterprise’s distribution network. In such multi-echelonnetworks, new product shipments are first stored at a regionalor central facility. These central facilities are the internalsuppliers to the customer-facing locations. This is a commondistribution model for many retail chains as well as for largedistributors and manufacturers. For example, a largepharmaceutical wholesaler’s distribution network consists ofone regional distribution center (RDC) and more than 30forward distribution centers (DCs).
Managing inventory in a multi-echelon network presentsmajor pitfalls.• End customer service failures occur even when in adequateinventory exists in the network.• Customer-facing locations experience undesirable stock outs, whileservice between echelons is more than acceptable.• External suppliers deliver unreliable performance, becausethey have received unsatisfactory demand projections.• Shortsighted internal allocation decisions are made for products withlimited availability.•The network carries excess inventory in the form of redundant safetystock.