The document discusses various topics related to materials management and inventory control. It defines key inventory terms like raw materials, work-in-process inventory, finished goods, and more. It describes the functions and types of inventory as well as costs associated with inventory like holding costs. The document also covers inventory management techniques like ABC analysis for classifying inventory items and cycle counting to periodically count inventory levels.

1. POM 370
Materials Management
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2. Materials Management
Importance
 Component of cost of goods sold (COGS)
 Labor component of COGS declining
 Significant increase in cost of materials
 Direct
 Indirect (overhead)
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3. Materials Management
Enterprise
Finished-goods
Orders
Purchasing
Storage
Raw-material
Customers
Storage
Suppliers
Transformation
Distribution
Receiving
Processes
In-process
Storage
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4. 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
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5. Inventory
What is inventory?
 Stock of materials
 Stored Capacity
 Examples:
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6. Inventory
Functions of inventory:
 To meet anticipated customer demand
 To decouple suppliers – production –
distribution
 To take advantage of quantity discounts
 To hedge against inflation & price increases
 To protect against delivery variations
 To avoid production disruptions through use
of Work-In-Process (WIP)
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7. Inventory
Negative aspects of inventory:
 Large inventories hide operational problems
 Financial cost in carrying excess inventories
 Risk of damage to goods held in inventory
 Risk of product obsolescence
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8. Inventory
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
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9. Inventory
Examples:
 Raw material
 Iron ore – steel mill
 Flour – bakery
 Work-in-process
 Radiator – auto manufacturer
 Draft contract – attorney
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10. Inventory
Examples:
 Maintenance / repair / operating supplies
(MRO)
 Lubricating oil – machine shop
 Soap and shampoo – hotel
 Finished goods
 Candy bar – confectioner
 Policy – insurance company
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11. Inventory
Transformation Process
Raw Finished
Materials goods
Vendors Work in Customers
process
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12. Water Tank Analogy
Inventory Level
Supply Rate
Inventory Level
Demand Rate
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13. ABC Analysis
 How inventory items can be classified
 How accurate inventory records can be
maintained
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14. 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
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15. ABC Analysis
% Annual $ Usage Class % $ Vol % Items
100 A 80 15
B 15 30
80
C 5 55
60
40
A
B
20 C
0
0 50 100
% of Inventory Items
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16. ABC Analysis
Percent of Percent of
Item Number Annual Annual Annual
Stock of Items Volume Unit Dollar Dollar
Number Stocked (units) x Cost = Volume Volume Class
#10286 20% 1,000 $ 90.00 $ 90,000 38.8% 72% A
#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
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17. ABC Analysis
Percent of Percent of
Item Number Annual Annual Annual
Stock of 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
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18. 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
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19. ABC Analysis
 Other criteria than annual dollar volume may
be used
 Key accounts
 Anticipated engineering changes
 Delivery problems
 Quality problems
 High unit cost
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20. 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
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21. Cycle Counting
 Items are counted and records updated on a
periodic basis
 Often used with ABC analysis to determine
cycle
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22. Cycle Counting
 Has several advantages
 Eliminates shutdowns and interruptions
 Eliminates annual inventory adjustment
 Trained personnel audit inventory accuracy
 Allows causes of errors to be identified and
corrected
 Maintains accurate inventory records
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23. Cycle Counting
5,000 items in inventory, 500 A items, 1,750 B items, 2,750 C
items
Policy is to count A items every month (20 working days), B
items every quarter (60 days), and C items every six months
(120 days)
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
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24. Control of Service Inventories
 Can be a critical component of profitability
 Losses may come from shrinkage or pilferage
 Applicable techniques include
 Good personnel selection, training, and
discipline
 Tight control on incoming shipments
 Effective control on all goods leaving facility
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25. Control of Service Inventories
 Shrinkage
 Unaccounted retail inventory between receipt
and sale
 Due to damage, theft and sloppy paperwork
 Theft also known as pilferage
 Accounts for 1% to 3% of sales
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26. Control of Service Inventories
 Controls
 Good personnel selection, training, and
discipline
 Tight control of incoming shipments
 Effective control of all goods leaving the
facility
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27. Types of Demand
 Independent demand - the demand for item is
independent of the demand for any other
item in inventory
 Refrigerator – goods
 Hamburger – services
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28. Types of Demand
 Dependent demand - the demand for item is
dependent upon the demand for some other
item in the inventory
 Ice maker – goods
 Ketchup – services
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29. Materials Costs
 Holding costs - associated with holding or
“carrying” inventory over time
 Setup costs - associated with costs of placing
order and receiving goods
 Out-of-stock costs - cost of back order and cost
of lost sales
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30. Holding Costs
 Obsolescence
 Insurance
 Extra staffing
 Cost of money (opportunity costs)
 Pilferage
 Damage
 Warehousing
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31. Holding Costs
Cost (and Range) as a
Percent of Inventory
Category Value
Housing costs (including rent or depreciation, operating 6% (3 - 10%)
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, and 11% (6 - 24%)
insurance on inventory)
Pilferage, space, and obsolescence 3% (2 - 5%)
Overall carrying cost 26%
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32. Setup Cost
 Supplies
 Forms
 Order processing
 Clerical support
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33. Independent Demand Models
 Fixed order-quantity models
 Economic order quantity (EOQ)
 Production order quantity Help answer the
Help answer the
(POQ) inventory planning
inventory planning
questions!
questions!
 Quantity discount
 Probabilistic models
 Fixed order-period models
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34. EOQ Model
EOQ assumptions:
 Known and constant demand
 Known and constant lead time
 Instantaneous receipt of material
 No quantity discounts
 Only order (setup) cost and holding cost
 No stockouts
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35. EOQ Model
EOQ inventory over time:
Order quantity = Q Usage Rate
(maximum Average
inventory level) Inventory
(Q*/2)
Inventory Level
Minimum
inventory
0 Time
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36. EOQ Model
EOQ Order Quantity:
Annual Cost
ve
os t Cur
Total C Curv
e
t
Minimum Cos
total cost Ho lding
Order (Setup) Cost Curve
Optimal Order quantity
Order Quantity (Q*)
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37. D
Annual setup cost = S
Q
EOQ Model
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
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38. D
Annual setup cost = S
Q
EOQ Model Annual holding cost =
Q
H
2
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 holding cost = (Average inventory level)
x (Holding cost per unit per year)
Order quantity
= (Holding cost per unit per year)
2
Q
= (H)
2
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39. EOQ Model
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
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
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40. EOQ Model - Example
Determine optimal number of needles to order
D = 1,000 units
S = $10 per order
H = $.50 per unit per year
2DS
Q* =
H
2(1,000)(10)
Q* = = 40,000 = 200 units
0.50
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41. EOQ Model - Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year
Expected Demand D
number of = N = =
orders Order quantity Q*
1,000
N= = 5 orders per year
200
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42. EOQ Model - 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
42

43. EOQ Model - 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
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44. POQ Model
 Answers how much to order and when to
order
 Allows partial receipt of material
 Other EOQ assumptions apply
 Suited for production environment
 Material produced, used immediately
 Provides production lot size
 Lower holding cost than EOQ model
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45. Quantity Discount Model
 Answers how much to order & when to order
 Allows quantity discounts
 Reduced price when item is purchased in
larger quantities
 Other EOQ assumptions apply
 Trade-off is between lower price & increased
holding cost
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46. Probabilistic Model
 Answer how much & when to order
 Allow demand to vary
 Follows normal distribution
 Other EOQ assumptions apply
 Consider service level & safety stock
 Service level = 1 - Probability of stockout
 Higher service level means more safety stock
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47. Fixed Period Model
 Answers how much to order
 Orders placed at fixed intervals
 Inventory brought up to target amount
 Amount ordered varies
 No continuous inventory count
 Possibility of stockout between intervals
 Useful when vendors visit routinely
 Example: Paul Mitchell representative calls on
salon every two weeks
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