Managing  Independent  Inventory
Overview <ul><li>What is an inventory system and why hold stock? </li></ul><ul><li>Textbook prescriptions versus reality a...
What is an Inventory System? <ul><li>Inventory </li></ul><ul><li>the stock of any item or resource used in an organization...
Organisations, Roles, Methods and Systems? <ul><li>What type of organisations use  systematic  inventory management method...
Independent vs. Dependent Demand E(1) Independent Demand (not related to other items or final end-product) Dependent Deman...
Independent versus Dependent Demand Dependent demand Work in progress Components and raw materials Time Demand/usage Indep...
Why hold stock? <ul><li>Provide flexibility </li></ul><ul><ul><li>minimum delay in supplying customers </li></ul></ul><ul>...
Inventory Types <ul><li>Raw-materials,  components and sub-assemblies </li></ul><ul><li>Work-in-progress or in-transit </l...
Material-Flows Process From Suppliers To Customer Production Processes Inventory in transit Stores  warehouse Finished goo...
Stock : Input (Flow in), Storage (Holding) and Flow out (Usage) Supply Rate Inventory Level Rate of Demand (Usage) Stock L...
Costs of Inventory <ul><li>Ordering costs </li></ul><ul><ul><li>purchase order & office, shipping and/or set up  </li></ul...
Order Quantities & Reorder Points R = Reorder point L = Lead time L L q R Time No. of units on hand safety or buffer level...
Simple inventory system  Raise order for ROQ Orders MRP Check stock level Yes No Receive/inspect.  Accept into stock Send ...
Bin systems Two-Bin  - quantity stock in bin 2 = re-order level Full Empty Order one bin One-Bin (periodic check) Order en...
EOQ Aim = Cost Minimisation  Cost Holding + ordering costs = total cost curve.  Find  Q eoq  inventory order point to mini...
Calculate EOQ Q eoq   = 2DS H = 2(Annual Demand)(Order or set-up cost)  Annual Holding Cost Reorder point  R=DL D = Avg da...
EOQ Solution Q = 2DS H = 2(1,000 )(10) 2.50 = 89.443 units or  90 units   eoq d = 1,000 units p.a. 365 days p.a. = 2.74 un...
EOQ and ROQ example 2 Annual Demand = 10,000 units Days per year considered in average daily demand = 365 Cost to place an...
Total variable cost Find point of minimum TVc Avg.stock Demand 2 x unit cost x Hc% + Oc 1200 2 x £3 x 25% = £450 +  £10 On...
EOQ Table – minimum TVc Avg.stock x item £ x hc % Oc + Hc
Minimum point of Total Inventory Costs <ul><ul><li>EOQ =  </li></ul></ul><ul><ul><li>minimum TVc point  </li></ul></ul>Tot...
EOQ Example <ul><li>Cheapo Bags wants to calculate the EOQ for tapestry cloth used to produce hand bags.  </li></ul><ul><u...
Economic Order Quantity (EOQ) Assumptions <ul><li>Single product line </li></ul><ul><li>Demand rate: recurring, known,  co...
Order Point  with Safety Stock Units Days Safety Stock Actual lead time is 3 days! (at day 21) 2200 2000 Order Point 400 2...
Safety Stock and Re-order Levels <ul><ul><li>Reserve - buffer - cushion against uncertain demand (usage) & lead time.  </l...
How Much Safety Stock? Cost vs. safety level <ul><li>Depends on: </li></ul><ul><li>Uncertainty:  demand & lead time </li><...
Cost vs service level £ Service level 70 80 90 100  % Cost of better and  better service <ul><li>Cost of poor service (out...
Normal Distribution of Demand over Lead Time m = mean demand r  = reorder point s = safety stock frequency probability of ...
Service level protection <ul><li>Confidence of % non –stock out </li></ul><ul><li>K  = 2 for 97.5 confidence </li></ul><ul...
ROL AND Service Level Example <ul><ul><li>ROL = Average usage in lead time + Safety stock </li></ul></ul>( Avg.  usage … d...
Review Systems <ul><li>Top-up with regular review </li></ul><ul><ul><li>Stock not to exceed upper limit (perishables, corr...
Price discounts and staged deliveries <ul><li>Quantity Discounts, buying   frequency &  Oc, Hc </li></ul><ul><ul><li>more ...
Price-Break Model Assumptions similar to as EOQ model i = % of unit cost as carrying cost C = cost per unit “ C” varies fo...
Price-Break Example <ul><li>Brunel University can reduce ordering costs for photocopy paper by placing larger quantity ord...
Solution = 1,826 units 0.02(1.20) = iC 2DS D = 10,000 units Order cost (S) = £4 Put data into formula for each price-break...
U-shaped function True Q opt  values occur at the start of each price-break interval.The total annual cost function is a “...
Price-Break Solution Now apply the Q opt  values to total annual cost & identify the total cost for each price-break. TC(0...
Just-in-Time <ul><li>Accurate production & inventory information system </li></ul><ul><li>Highly efficient purchasing </li...
ABC - 20/80 Principle and Inventory Control <ul><li>Items not of equal importance: </li></ul><ul><ul><li>£ invested & prof...
Annual Usage by £ Value
ABC Chart 3 6 9 2 4 1 10 8 5 7 Item No. 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Percent Usage 0% 20% 40% 60% 80% 100% 120% C...
Stock Check <ul><li>Book stock vs physical stock </li></ul><ul><li>Stock valuation – wastage & shrinkage </li></ul><ul><li...
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    1. 1. Managing Independent Inventory
    2. 2. Overview <ul><li>What is an inventory system and why hold stock? </li></ul><ul><li>Textbook prescriptions versus reality and variety? </li></ul><ul><li>Independent versus Dependent Demand </li></ul><ul><li>Inventory types, flows, costs </li></ul><ul><li>Re-order quantities, EOQ & calculations </li></ul><ul><li>Safety stocks & service levels </li></ul><ul><li>Review systems </li></ul><ul><li>Discounts and staged deliveries </li></ul><ul><li>JIT </li></ul><ul><li>ABC Analysis </li></ul><ul><li>Stock taking </li></ul><ul><li>Make or buy </li></ul>
    3. 3. What is an Inventory System? <ul><li>Inventory </li></ul><ul><li>the stock of any item or resource used in an organization: raw materials, finished products, component parts, supplies and work-in-process. </li></ul><ul><li>An inventory system </li></ul><ul><li>policies and controls for monitoring levels of inventory </li></ul><ul><li>Information system that records transactions and enables analysis of stock requirements and levels/quantities, costs etc </li></ul>
    4. 4. Organisations, Roles, Methods and Systems? <ul><li>What type of organisations use systematic inventory management methods? </li></ul><ul><li>How are the methods manifested? </li></ul><ul><li>How is inventory management linked to </li></ul><ul><ul><li>aggregrate planning, buying for MRP, JIT, retail buying, sales systems, accounting practice? </li></ul></ul><ul><li>Who does it? </li></ul><ul><ul><li>buyers, store keepers, production planners, accountants? </li></ul></ul><ul><li>What manual & IT-based systems are involved? </li></ul><ul><ul><li>Stock cards, orders, delivery notes, GRNs, return advice notes, inventory module in integrated accounting packages, stock checks and auditing. </li></ul></ul><ul><li>Are textbook methods really used? How, where? </li></ul><ul><li>What is the clerical burden of inventory analysis and control? </li></ul>
    5. 5. Independent vs. Dependent Demand E(1) Independent Demand (not related to other items or final end-product) Dependent Demand (derived from component parts, sub-assemblies, raw materials, etc.)
    6. 6. Independent versus Dependent Demand Dependent demand Work in progress Components and raw materials Time Demand/usage Independent demand - finished goods - spare parts Time Demand/usage
    7. 7. Why hold stock? <ul><li>Provide flexibility </li></ul><ul><ul><li>minimum delay in supplying customers </li></ul></ul><ul><ul><li>a good range </li></ul></ul><ul><li>Protect against uncertainties </li></ul><ul><li>Enable economic purchasing </li></ul><ul><li>Anticipate changes in demand or supply </li></ul><ul><ul><li>Buffers to feed processes and enable efficient scheduling </li></ul></ul><ul><ul><li>Strategic stock holdings </li></ul></ul>
    8. 8. Inventory Types <ul><li>Raw-materials, components and sub-assemblies </li></ul><ul><li>Work-in-progress or in-transit </li></ul><ul><li>Finished-goods </li></ul><ul><ul><li>In the warehouse, awaiting shipment, in delivery vehicles, in tanks, on shelves, in the stores </li></ul></ul><ul><li>Strategic inventory </li></ul><ul><li>Scrap & re-work </li></ul>
    9. 9. Material-Flows Process From Suppliers To Customer Production Processes Inventory in transit Stores warehouse Finished goods WIP WIP Work in process
    10. 10. Stock : Input (Flow in), Storage (Holding) and Flow out (Usage) Supply Rate Inventory Level Rate of Demand (Usage) Stock Level
    11. 11. Costs of Inventory <ul><li>Ordering costs </li></ul><ul><ul><li>purchase order & office, shipping and/or set up </li></ul></ul><ul><li>Holding Costs </li></ul><ul><ul><li>tied up capital (item value), staff & equipment, obsolescence, perishability, shrinkage, insurance & security, m 2 - m 3 (rent/lease), audit. </li></ul></ul><ul><li>Cost of being out of stock, cancelling an order </li></ul><ul><li>Scrap and re-working </li></ul><ul><ul><li>annual costs </li></ul></ul><ul><ul><li>= holding cost factor % </li></ul></ul><ul><ul><li>average value of stockholding </li></ul></ul>e.g. 25% or 2p in £ per month of stock
    12. 12. Order Quantities & Reorder Points R = Reorder point L = Lead time L L q R Time No. of units on hand safety or buffer level Average stock q/2 q
    13. 13. Simple inventory system Raise order for ROQ Orders MRP Check stock level Yes No Receive/inspect. Accept into stock Send back? Part-delivery No Next Check point Yes No Yes <=ROL? Outstanding Order? Due now?
    14. 14. Bin systems Two-Bin - quantity stock in bin 2 = re-order level Full Empty Order one bin One-Bin (periodic check) Order enough to refill bin? <ul><li>ROQ Options </li></ul><ul><li>Keep order costs to a minimum? </li></ul><ul><li>Order one year's supply in one go? OR </li></ul><ul><li>Hand-to-mouth, once per week? </li></ul>
    15. 15. EOQ Aim = Cost Minimisation Cost Holding + ordering costs = total cost curve. Find Q eoq inventory order point to minimise total costs. Ordering Costs Holding Costs Q eoq Order Quantity (Q) Total Cost
    16. 16. Calculate EOQ Q eoq = 2DS H = 2(Annual Demand)(Order or set-up cost) Annual Holding Cost Reorder point R=DL D = Avg daily demand (constant) L = Lead time (constant) when to place an order. <ul><li>Exercise EOQ and reorder point? </li></ul><ul><li>Annual demand = 2,000 units </li></ul><ul><li>Days/year in average daily demand = 365 </li></ul><ul><li>Cost to place an order = £10 </li></ul><ul><li>Holding cost /unit p.a. = £2.50 </li></ul><ul><li>Lead time = 7 days </li></ul><ul><li>Cost per unit = £15 </li></ul>
    17. 17. EOQ Solution Q = 2DS H = 2(1,000 )(10) 2.50 = 89.443 units or 90 units eoq d = 1,000 units p.a. 365 days p.a. = 2.74 units/day Reorder point D L = 2.74 units/day = 19.18 or 20 for 7 day lead time EOQ order = 90 units. When only 20 units left, place next order for 90 units.
    18. 18. EOQ and ROQ example 2 Annual Demand = 10,000 units Days per year considered in average daily demand = 365 Cost to place an order = £10 Holding cost per unit per year = 10% of cost per unit Lead time = 10 days Cost per unit = £15 365.148 (366 units) = 1.50 2(10,000)(10) = H 2DS = Q eoq If lead time = 10 days, ROL= 273.97 = 274 units Place order for 366 units. When 274 left, place next order for 366. D = 10,000 units/year 365 days = 27.397 units/day
    19. 19. Total variable cost Find point of minimum TVc Avg.stock Demand 2 x unit cost x Hc% + Oc 1200 2 x £3 x 25% = £450 + £10 Once per year = £460 1200/52 2 x £3 x 25% = £9 + £510 Once per week = £519 approx
    20. 20. EOQ Table – minimum TVc Avg.stock x item £ x hc % Oc + Hc
    21. 21. Minimum point of Total Inventory Costs <ul><ul><li>EOQ = </li></ul></ul><ul><ul><li>minimum TVc point </li></ul></ul>Total variable costs Total Hc Total Oc EOQ* Order Size (Q) £ Costs
    22. 22. EOQ Example <ul><li>Cheapo Bags wants to calculate the EOQ for tapestry cloth used to produce hand bags. </li></ul><ul><ul><li>Last year demand = 10,000 metres (constant rate). </li></ul></ul><ul><ul><li>Value per metre of tapestry = £6.40 </li></ul></ul><ul><ul><li>Oc – each order = £250. </li></ul></ul><ul><ul><li>Hc = £1.20 per metre = 18.75% </li></ul></ul><ul><li>What is the EOQ? </li></ul>2 x 10,000 x £250 = 2042 metres £6.40 x 18.75%
    23. 23. Economic Order Quantity (EOQ) Assumptions <ul><li>Single product line </li></ul><ul><li>Demand rate: recurring, known, constant </li></ul><ul><li>Lead time: constant , known </li></ul><ul><li>No quantity discounts - stable unit cost </li></ul><ul><li>No stock-outs allowed </li></ul><ul><li>Items ordered/produced in a lot or batch </li></ul><ul><li>Batch received all at once </li></ul><ul><li>Holding cost is linear based on average stock level </li></ul><ul><li>Fixed order + set up cost </li></ul>
    24. 24. Order Point with Safety Stock Units Days Safety Stock Actual lead time is 3 days! (at day 21) 2200 2000 Order Point 400 200 0 18 21 Dip into safety stock
    25. 25. Safety Stock and Re-order Levels <ul><ul><li>Reserve - buffer - cushion against uncertain demand (usage) & lead time. </li></ul></ul><ul><ul><li>A basis for a &quot;2-bin&quot; system </li></ul></ul><ul><ul><li>Application to JIT? </li></ul></ul><ul><ul><li>EOQ assumes certain demand & lead time. If uncertain, then: </li></ul></ul><ul><ul><li>ROL = </li></ul></ul><ul><ul><li>Average usage in lead time + safety stock </li></ul></ul>(Avg. lead time x Avg. daily usage)
    26. 26. How Much Safety Stock? Cost vs. safety level <ul><li>Depends on: </li></ul><ul><li>Uncertainty: demand & lead time </li></ul><ul><li>cost of </li></ul><ul><ul><li>being out of stock </li></ul></ul><ul><ul><li>carrying inventory </li></ul></ul><ul><ul><li>increasingly better service </li></ul></ul><ul><li>Service level policy </li></ul><ul><li>% confidence of not hitting a stock-out situation </li></ul>
    27. 27. Cost vs service level £ Service level 70 80 90 100 % Cost of better and better service <ul><li>Cost of poor service (out-of-stock) </li></ul><ul><li>Loss of </li></ul><ul><li>part order </li></ul><ul><li>future order </li></ul><ul><li>customer goodwill </li></ul><ul><li>buying from non-regular sources </li></ul>0
    28. 28. Normal Distribution of Demand over Lead Time m = mean demand r = reorder point s = safety stock frequency probability of stock out demand over lead time service level probability m s r
    29. 29. Service level protection <ul><li>Confidence of % non –stock out </li></ul><ul><li>K = 2 for 97.5 confidence </li></ul><ul><li>K = 3 for 99.87 </li></ul><ul><ul><li>ROL = Average usage in lead time + Safety stock </li></ul></ul>(Avg. usage (day/week) x Avg. Lead time) K x stdev demand x Avg. lead time
    30. 30. ROL AND Service Level Example <ul><ul><li>ROL = Average usage in lead time + Safety stock </li></ul></ul>( Avg. usage … day/week x Avg. lead time) K x stdev demand x Avg. lead time <ul><ul><li>ROL = (250 per week x 4 weeks) + ( 2 x 50 x (4) ) = 1000 + 200 = 1200 </li></ul></ul>Stock falls to or below ROL & no order is outstanding? Place a new order for 1200. Service level @ 97.5%  stock-out for 1 in 40 reorder situations.
    31. 31. Review Systems <ul><li>Top-up with regular review </li></ul><ul><ul><li>Stock not to exceed upper limit (perishables, corrosives, limited capacity) </li></ul></ul><ul><ul><li>use with – regular review (continuous or periodic) </li></ul></ul><ul><li>Continuous review </li></ul><ul><ul><li>relax “constant demand” assumption </li></ul></ul><ul><ul><li>Continuous system to monitor “stock-on-hand” </li></ul></ul><ul><li>Periodic review </li></ul><ul><ul><li>Apply EOQ (demand constant + “no stock-out”) </li></ul></ul><ul><ul><li>orders must be placed at specified intervals. </li></ul></ul><ul><ul><li>Use when multiple, items ordered from same supplier (joint-replenishment) </li></ul></ul><ul><ul><li>inexpensive items </li></ul></ul>
    32. 32. Price discounts and staged deliveries <ul><li>Quantity Discounts, buying frequency & Oc, Hc </li></ul><ul><ul><li>more storage space </li></ul></ul><ul><ul><li>different payment terms </li></ul></ul><ul><ul><li>if demand changes – surplus stock </li></ul></ul><ul><li>Staged deliveries & EOQ? </li></ul><ul><ul><li>Extra delivery & handling cost? </li></ul></ul><ul><ul><li>Assumes constant order cost </li></ul></ul><ul><ul><li>Requires reliable deliveries & steady demand </li></ul></ul><ul><ul><li>JIT – collaborative supplier relationships </li></ul></ul><ul><ul><li>Affect on supplier (locate nearer customer?) </li></ul></ul>
    33. 33. Price-Break Model Assumptions similar to as EOQ model i = % of unit cost as carrying cost C = cost per unit “ C” varies for each price-break so apply the formula to each price-break cost value. Holding cost per annum 2(Demand p.a.)(Order or Setup-cost) = iC 2DS = Q OPT
    34. 34. Price-Break Example <ul><li>Brunel University can reduce ordering costs for photocopy paper by placing larger quantity orders. What is the optimal order quantity? </li></ul><ul><li>e-mail order cost = £4 </li></ul><ul><li>carrying cost % = 2% </li></ul><ul><li>Demand p.a. = 10,000 units? </li></ul>Quantity price breaks 0.98 4,000 or more 1.00 2,500 to 3,999 £1.20 0 to 2,499 Price/unit(£) Order Quantity(units) iC 2DS
    35. 35. Solution = 1,826 units 0.02(1.20) = iC 2DS D = 10,000 units Order cost (S) = £4 Put data into formula for each price-break of “C”. =2,000 = =2,020 4) 2(10,000)( = Carrying cost % (i) = 2% Cost per unit (C) = £1.20, £1.00, £0.98 Q opt 0 - 2499 Feasible 2500-3999 and 4000+ Not feasible Are Q opt values feasible for the price breaks? 2(10,000)(4) 0.02(1.00) 0.02(0.98) 2(10,000)(4)
    36. 36. U-shaped function True Q opt values occur at the start of each price-break interval.The total annual cost function is a “u” shaped function 0 1826 2500 4000 Order Quantity Total annual costs Price-breaks
    37. 37. Price-Break Solution Now apply the Q opt values to total annual cost & identify the total cost for each price-break. TC(0-2499)= (10000x1.20)+(10000/1826)x4+(1826/2)(0.02x1.20) = £12,043.82 TC(2500 -3999) = £10,041 TC(4000+) = £9,949.20 Least cost Q opt = 4000
    38. 38. Just-in-Time <ul><li>Accurate production & inventory information system </li></ul><ul><li>Highly efficient purchasing </li></ul><ul><li>Reliable suppliers </li></ul><ul><li>Efficient inventory-handling system </li></ul><ul><ul><li>approach to inventory management & control in which inventories are acquired & inserted in production at exact time when needed. </li></ul></ul><ul><li>Requirement </li></ul>
    39. 39. ABC - 20/80 Principle and Inventory Control <ul><li>Items not of equal importance: </li></ul><ul><ul><li>£ invested & profit potential </li></ul></ul><ul><ul><li>Sales/usage volume </li></ul></ul><ul><ul><li>stock-out penalties </li></ul></ul><ul><li>Control expensive items closely. </li></ul><ul><li>“ A” items – review frequently </li></ul><ul><li>Review “B” & “C” items frequently. </li></ul>0 15 45 100 Cumulative % 70 90 100 Cumulative Percentage of Inventory Value A B C Pareto - 20/80 Principle Identify inventory items based on % of total £ value. “A” items top 20 %, “B” next 40 %, &quot;C&quot; the lower 20%.
    40. 40. Annual Usage by £ Value
    41. 41. ABC Chart 3 6 9 2 4 1 10 8 5 7 Item No. 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Percent Usage 0% 20% 40% 60% 80% 100% 120% Cumulative % Usage Cumulative % A B C
    42. 42. Stock Check <ul><li>Book stock vs physical stock </li></ul><ul><li>Stock valuation – wastage & shrinkage </li></ul><ul><li>Audit stock security systems </li></ul><ul><li>Organising the stock check </li></ul><ul><li>Internal & external audit </li></ul><ul><ul><li>Segmentation of duties </li></ul></ul>

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