26. 7 – 26
Lecture todayLecture today
Why is inventory so bad?
Why hold inventory?
Where to hold inventory?
What are types of inventory to keep?
What are the inventory costs?
How much inventory to keep?
When to order & how much to order?
What do I need to know to make those
decisions?
27. 7 – 27
Inventory ManagementInventory Management
Inventory management is the planning and
controlling of inventories in order to meet the
competitive priorities of the organization.
Inventory management requires information
about expected demands, amounts on hand and
amounts on order for every item stocked at all
locations.
28. 7 – 28
Inventory BasicsInventory Basics
Inventory is created when the receipt of
materials, parts, or finished goods
exceeds their disbursement.
Inventory is depleted when their
disbursement exceeds their receipt.
An inventory manager’s job is to balance
the advantages and disadvantages of
both low and high inventories.
30. 7 – 30
Why hold Inventory?Why hold Inventory?
Customer Sales & Service: Avoid Retail
stock outs and thus customer goodwill
(Retailing)
Seasonal sales (Xmas trees)
Take advantage of quantity discounts
Balance process flow time
Uncertainty in supply and demand
Lead Time
Speculative inventory (wine, gold)
31. 7 – 31
Inventory atInventory at WALWAL--MARTMART
Making sure the shelves are stocked with tens of
thousands of items at their 5,379 stores in 10 countries is
no small matter for inventory managers at Wal-Mart.
Knowing what is in stock, in what quantity, and where it is
being held, is critical to effective inventory management.
With inventories in excess of $29 billion, Wal-Mart is
aware of the benefits from improved inventory
management.
They know that effective inventory management must
include the entire supply chain.
The firm is implementing radio frequency identification
(RFID) technology in its supply chain.
33. 7 – 33
Macro Inventory DecisionsMacro Inventory Decisions
Where do we hold inventory?
◦ Manufacturers and suppliers
◦ warehouses and distribution centers
◦ retailers
Types of Inventory to keep?
◦ raw materials
◦ WIP
◦ finished goods
34. 7 – 34
Micro Inventory DecisionsMicro Inventory Decisions
When to order items?
How much of each item to order?
How much safety stock to keep?
Objective: minimize overall cost of keeping
inventory!
35. 7 – 35
Relevant Costs in an Inventory SystemRelevant Costs in an Inventory System
Procurement costs
Ordering cost (administrative, inspection,
transportation etc.)
Holding costs
Maintenance and Handling
Taxes
Obsolescence
Stock-outs costs
Lost sales (Customer goodwill)
Backorders
36. 7 – 36
Relevant information to any inventoryRelevant information to any inventory
decisiondecision
Knowing how much demand there is
Knowing if this demand is fairly constant or
varies
Knowing what is in stock
Knowing where they exist in the supply chain
Knowing how long it will take to replenish
Knowing where it is going to be replenished from
37. 7 – 37
Frequently used inventory termsFrequently used inventory terms
Inventory lot size
Replenishment Lead time
Stock out
Reorder Point
Safety stock
38. 7 – 38
Thousands of items are held in inventory
by a typical organization, but only a
small % of them deserves management’s
closest attention and tightest control.
ABC analysis: The process of dividing
items into three classes, according to
their dollar usage, so that managers can
focus on items that have the highest
dollar value.
Knowing which Items are Critical
39. 7 – 39
ABC AnalysisABC Analysis
1010 2020 3030 4040 5050 6060 7070 8080 9090 100100
Percentage of itemsPercentage of items
PercentageofdollarvaluePercentageofdollarvalue
100100 —
9090 —
8080 —
7070 —
6060 —
5050 —
4040 —
3030 —
2020 —
1010 —
00 —
Class C
Class A
Class B
40. 7 – 40
Economic Order Quantity (EOQ) is the
lot size that minimizes total annual
inventory holding and ordering costs.
Assumptions of EOQ
1. The demand rate is constant and known with
certainty.
2. There are no constraints on lot size.
3. The only relevant costs are holding costs
and ordering/setup costs.
4. Decisions for items can be made
independently of other items.
5. Lead time is constant and known with
certainty.
Economic Order Quantity (EOQ)Economic Order Quantity (EOQ)
44. 7 – 44
Annualcost(dollars)Annualcost(dollars)
Lot Size (Lot Size (QQ))
Total Annual Cycle-Inventory CostsTotal Annual Cycle-Inventory Costs
Holding cost = (Holding cost = (HH))
QQ
22
Ordering cost = (Ordering cost = (SS))
DD
QQ
Total cost = (Total cost = (HH) + () + (SS))
DD
QQ
QQ
22
Q = lot size; C = total annual cycle-inventory cost
H = holding cost per unit; D = annual demand
S = ordering or setup costs per lot
45. 7 – 45
Costing out a Lot Sizing PolicyCosting out a Lot Sizing Policy
Bird feeder sales are 18 units per week, and the
supplier charges $60 per unit. The cost of placing an
order (S) with the supplier is $45.
Annual holding cost (H) is 25% of a feeder’s value,
based on operations 52 weeks per year.
Management chose a 390-unit lot size (Q) so that new
orders could be placed less frequently.
What is the annual cycle-inventory cost (C) of the
current policy of using a 390-unit lot size?
Museum of Natural History Gift Shop:
46. 7 – 46
Costing out a Lot Sizing PolicyCosting out a Lot Sizing Policy
What is the annual cycle-inventory cost (C) of the
current policy of using a 390-unit lot size?
D = (18 /week)(52 weeks) = 936 units H = 0.25 ($60/unit) = $15
C = $2925 + $108 = $3033
C = (H) + (S) = (15) + (45)
Q
2
D
Q
936
390
390
2
Museum of Natural History Gift Shop:
47. 7 – 47
30003000 —
20002000 —
10001000 —
00 —
| | | | | | | |
5050 100100 150150 200200 250250 300300 350350 400400
Lot Size (Q)
Annualcost(dollars)Annualcost(dollars)
Total costTotal cost
Holding costHolding cost
Ordering costOrdering cost
Current
cost
Current
Q
Lowest
cost
Best Q (EOQ)
Lot Sizing at the MuseumLot Sizing at the Museum
of Natural History Gift Shopof Natural History Gift Shop
48. 7 – 48
Computing the EOQComputing the EOQ
C = (H) + (S)
Q
2
D
Q
EOQ =
2DS
H
D = annual demand
S = ordering or setup costs per lot
H = holding costs per unit
D = 936 units
H = $15
S = $45
EOQ =
2(936)45
15
= 74.94 or 75 units
C = (15) + (45)
75
2
936
75
C = $1,124.10
Bird Feeders:
49. 7 – 49
Time Between OrdersTime Between Orders
Time between orders (TBO) is the average
elapsed time between receiving (or placing)
replenishment orders of Q units for a particular
lot size.
For the birdfeeder example, using an EOQ of 75
units.
TBOEOQ =
EOQ
D
TBOEOQ = = 75/936 = 0.080 year
EOQ
D
TBOEOQ = (75/936)(12) = 0.96 months
TBOEOQ = (75/936)(52) = 4.17 weeks
TBOEOQ = (75/936)(365) = 29.25 days
52. 7 – 52
In Class Example (In Class Example (continued)continued)
53. 7 – 53
In Class ExampleIn Class Example
continuedcontinued
54. 7 – 54
Understanding the Effect of ChangesUnderstanding the Effect of Changes
What happens if there is a change in the
Demand Rate (D)?
What happens if the Setup Costs (S)
changes?
What happens if the holding Costs (H)
change?
What happens if there are errors in
estimating D, H, and S?