Inventory management


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Week 6 Inventory Management

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Inventory management

  1. 1. Inventory Management
  2. 2. Definitions Inventory-A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state. Inventory System- A set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be
  3. 3. Inventory Def. - A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state. Raw Materials Works-in-Process Finished Goods Maintenance, Repair and Operating (MRO)
  4. 4. Expensive Stuff The average carrying cost of inventory across all mfg.. in the U.S. is 30-35% of its value. What does that mean? Savings from reduced inventory result in increased profit.
  5. 5. Zero Inventory? Reducing amounts of raw materials and purchased parts and subassemblies by having suppliers deliver them directly. Reducing the amount of works-in process by using just-in-time production. Reducing the amount of finished goods by shipping to markets as soon as possible.
  6. 6. Inventory Positions in the Supply ChainRaw WorksMaterials Finished Finished in Goods Goods Process in Field
  7. 7. Reasons for Inventories Improve customer service Economies of purchasing Economies of production Transportation savings Hedge against future Unplanned shocks (labor strikes, natural disasters, surges in demand, etc.) To maintain independence of supply chain
  8. 8. Inventory and Value Remember this?  Quality  Speed  Flexibility  Cost
  9. 9. Nature of Inventory: AddingValue through Inventory Quality - inventory can be a “buffer” against poor quality; conversely, low inventory levels may force high quality Speed - location of inventory has gigantic effect on speed Flexibility - location, level of anticipatory inventory both have effects Cost - direct: purchasing, delivery, manufacturing indirect: holding, stockout. HR systems may promote this-3 year postings
  10. 10. Nature of Inventory:Functional Roles of Inventory Transit Buffer Seasonal Decoupling Speculative Lot Sizing or Cycle Mistakes
  11. 11. Design of Inventory Mgmt.Systems: Macro Issues Need for Finished Goods Inventories  Need to satisfy internal or external customers?  Can someone else in the value chain carry the inventory? Ownership of Inventories Specific Contents of Inventories Locations of Inventories Tracking
  12. 12. How to Measure Inventory The Dilemma: closely monitor and control inventories to keep them as low as possible while providing acceptable customer service. Average Aggregate Inventory Value: how much of the company’s total assets are invested in inventory? Ford:6.825 billion Sears: 4.039 billion
  13. 13. Inventory Measures Weeks of Supply  Ford: 3.51 weeks  Sears: 9.2 weeks Inventory Turnover (Turns)  Ford: 14.8 turns  Sears: 5.7 turns  GM: 8 turns  Toyota: 35 turns
  14. 14. Reasons Against Inventory Non-value added costs Opportunity cost Complacency Inventory deteriorates, becomes obsolete, lost, stolen, etc.
  15. 15. Inventory Costs Procurement costs Carrying costs Out-of-stock costs
  16. 16. Procurement Costs Order processing Shipping Handling Purchasing cost: c(x)= $100 + $5x Mfg. cost: c(x)=$1,000 + $10x
  17. 17. Carrying Costs Capital (opportunity) costs Inventory risk costs Space costs Inventory service costs
  18. 18. Out-of-Stock Costs Lost sales cost Back-order cost
  19. 19. Independent Demand Independent demand items are finished products or parts that are shipped as end items to customers. Forecasting plays a critical role Due to uncertainty- extra units must be carried in inventory
  20. 20. Dependent Demand Dependent demand items are raw materials, component parts, or subassemblies that are used to produce a finished product. MRP systems---next week
  21. 21. Design of Inventory Mgmt.Systems: Micro Issues Order Quantity Economic Order Quantity Order Timing  Reorder Point
  22. 22. Objectives of InventoryControl 1) Maximize the level of customer service by avoiding understocking. 2) Promote efficiency in production and purchasing by minimizing the cost of providing an adequate level of customer service.
  23. 23. Balance in Inventory Levels When should the company replenish its inventory, or when should the company place an order or manufacture a new lot? How much should the company order or produce? Next: Economic Order Quantity
  24. 24. Models for Inventory Management:EOQ EOQ minimizes the sum of holding and setup costs Q = 2DCo/Ch D = annual demand Co = ordering/setup costs Ch = cost of holding one unit of inventory
  25. 25. Seatide EOQ = 2DCo/Ch D = annual demand = 6,000 Co = ordering/setup costs = $60 Ch = cost of holding one unit of inventory $3.00 x 24% = .72 720,000 2 x 6,000 x 60 .72 1,000 .72
  26. 26. Marginal Analysis Holding Costs$ Ordering Costs Units
  27. 27. Reorder Point Quantity to which inventory is allowed to drop before replenishment order is made Need to order EOQ at the Reorder Point: ROP = D X LT D = Demand rate per period LT = lead time in periods
  28. 28. Sawtooth Model level of inventory average inventoryunits Q t time
  29. 29. Q - System InventoryControl based on reorder point - When inventory is depleted to ROP, order replenishment of quantity EOQ.
  30. 30. Order Quantities when demand is smooth and continuous, can operate response- based system by determining  best quantity to replenish periodic demand (EOQ)  frequency of replenishment (ROP)  Reorder Point
  31. 31. Planning for Uncertainty changing lead times changing demand Uncertainty creeps in:  Plug in safety stockSafety stock - allows manager to determine the probability of stock levels - based on desired customer service levels
  32. 32. Inventory Model Under Uncertaintyreorder Qmpoint safety stock time
  33. 33. Models for Inventory Management:Quantity Discount Basically EOQ with quantity discounts To solve: 1. Write out the total cost equation 2. Solve EOQ at highest price and no discounts 3. If Qmin falls in a range with a lower price, recalculate EOQ assuming holding cost for that range. Call this Q2. 4. Evaluate the total cost equation at Q2 at the next highest price break point. OR Use a spreadsheet
  34. 34. P-SystemPeriodic Review Method an alternative to ROP/Q-system control is periodic review method Q-system - each stock item reordered at different times - complex, no economies of scope or common prod./transport runs P-system - inventory levels for multiple stock items reviewed at same time - can be reordered together higher carrying costs - not optimum, but more practical
  35. 35. Using P-System audit inventory level at interval (T) quantity to place on order is difference between max. quantity (M) and amount on hand at time of review management task - set optimal T and M to balance stock availability and cost In ABC analysis, which items would use P-system???
  36. 36. Types of Inventory Systems By Degree of Control required  often use grouping method, such as ABC
  37. 37. Classifying Inventory Items ABC Classification (Pareto Principle) A Items: very tight control, complete and accurate records, frequent review B Items: less tightly controlled, good records, regular review C Items: simplest controls possible, minimal records, large inventories, periodic review and reorder
  38. 38. Does ABC Classification MakeSense for an Assembler? i.e. – Gateway Computers
  39. 39. Planning Supply Chain ActivitiesAnticipatory - allocate supply to each warehouse based on the forecastResponse-based - replenish inventory with order sizes based on specific needs of each warehouse
  40. 40. Anticipatory InventoryControl determine requirements by forecasting demand for the next production run or purchase establish current on-hand quantities add appropriate safety stock based on desired stock availability levels and uncertainty demand levels determine how much new production or purchase needed (total needed - on-hand)
  41. 41. Response-Based System replenishment, production, or purchases of stock are made only when it has been signaled that there is a need for product downstream requires shorter order cycle time, often more frequent, lower volume orders determine stock requirements to meet only most immediate planning period (usually about 3 weeks)
  42. 42. Service Level Achieved•Item fill rate (IFR): the probability of fillingan order for 1 item from current stock expected number of units out of stock/year 1- total annual demand•Weighted Average Fill Rate (WAFR): multiplyIFR for each stock item on an order weightedby the ordering frequency for the item