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Inventory Control & Management

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Operations Management
Inventory Control & Management
OperationsManagement
InventorycontrolandManagement
Lecture 8
Lecture Outlines
Inventory Control & Management
 What is inventory?
 Why is inventory necessary?
 What are the advantages and disadvantages of
holding inventory?
 How much inventory should an operation hold?
 When should an operation replenish its inventory?
 How can inventory be controlled?
 Understand the strategic significance of
managing inventory
 Knowledge insights with quantity discounts (Piece
break model)
 EOQ for multiple items with resources constraints
OperationsManagement
InventorycontrolandManagement
Lecture 8
In general,
 Inventory is a list of items or goods;
 Inventory refers to the ‘materials in stock’;
 Stored accumulation of material resources in a
transformation system.
 For example, inventory in a library means the list of
books, journals, periodicals, furniture, fans, etc.
What is inventory?
A typical firm carries different inventories such as:
 raw materials and purchased parts;
 partially completed goods called work-in-process;
 finished-goods or merchandise in retail stores;
 replacement parts, tools, and supplies; and
 goods-in-transit to warehouses or customers
OperationsManagement
InventorycontrolandManagement
Lecture 8
• Inventory is the stock of any item or resource used in
an organization and can include: raw materials,
finished products, component parts, supplies, and
work-in-process items.
An inventory system is the set of policies and controls that
monitor levels of inventory and determines what levels should
be maintained, when stock should be replenished, and how
large orders should be
Firms invest 25-35 percent of assets in inventory but many do
not manage inventories well
What is inventory? Cont..
OperationsManagement
InventorycontrolandManagement
Lecture 8
• Fuel for the car Milk to drink
• Milk to sell Production with setups
• Motherboards to assemble computers
General concept:
Distribution, transports blood from blood centers to
hospitals in response to emergency requests.
Example:
But for blood services, such as Blood Bank Service:
Collection, involves recruiting and retaining blood
donors, encouraging them to attend donor sessions
1
2 Processing, blood down into its constituent parts
(red cells, platelets & plasma) blood-based products
3
What is inventory? Cont..
OperationsManagement
InventorycontrolandManagement
Lecture 8
 What business are we in? Is it manufacturing or assembly?
 To what extent does the firm want to own assets
throughout the supply chain?
 With which suppliers (and numbers of suppliers) does the
firm want to have for long-term relationships?
 What is the extent of the suppliers’ involvement?
The key questions in inventory control are:
What is inventory? Cont..
The basic questions are to solve in IC&M:
How much of the inventory is to be kept and /or
ordered?
When should this be done?
OperationsManagement
InventorycontrolandManagement
Lecture 8
Why is inventory necessary?
What is the purpose of holding stocks?
Basic question:
Find the answer: Inventories serve the following purposes:
To meet anticipated (predicted) demand.
Inventories are required to satisfy expected demand.
Examples: demand are electronic items, tools, clothing.
To smooth production requirements.
Meeting the seasonal and off-season demands to meet
overly high requirements during certain seasonal
periods. Example: fresh fruits, vegetables deal with
seasonal inventories; greeting cards, Christmas trees.
OperationsManagement
InventorycontrolandManagement
Lecture 8
To decouple components of the production-
distribution system.
Inventory buffers to continue temporarily while machine
breakdowns are resolved. Finished good inventories are
used to buffer sales.
Why is inventory necessary?
To protect against stock-outs.
Delayed deliveries and unexpected increases in demand
increase the risk of shortages. Delay can occur because
of weather conditions, traffic congestion, supplier
stock-outs, deliveries of wrong materials, quality
problems, etc.
OperationsManagement
InventorycontrolandManagement
Lecture 8
To buy and produce in economic lot size in order to
minimize purchasing and inventory costs.
To take advantage of order cycles.
Purchasing a larger quantities for quantity discounts in
unit price & due to discounts and lower transport cost.
To hedge against price increases.
To ensure against scarcity of materials.
To meet demands in unplanned shocks (labor strikes,
natural disasters, surges, flood, rushes, etc.)
To maintain customer-supplier–producer relationship.
Why is inventory necessary?
OperationsManagement
InventorycontrolandManagement
Lecture 8
Drawbacks of holding inventory
A number of negative aspects are:
×
ties up money, in the form of working capital;
×
incurs storage costs (leasing space, maintaining
appropriate conditions, etc.);
×
may become obsolete, can be damaged, or deteriorate,
lost, be expensive to retrieve, etc.;
×
could be as it gets hidden amongst other inventory;
×
might be hazardous to store (e.g., flammable solvents,
explosives, chemicals and drugs);
×
requiring special facilities and systems for safe handling;
×
uses space that could be used to add value;
×
involves administrative and insurance costs;
OperationsManagement
InventorycontrolandManagement
Lecture 8
Types of Inventories
Also called safety inventory, is to compensate for the
unexpected fluctuations in supply and demand.
For example, a retail seller, can never forecast
demand perfectly, even when it has a good idea of
the most likely demand level; order goods as there is
always a certain amount of most items in stock.
Depending on the supply and demand at different points
in any operation lead to five types of inventories are:
1. Buffer inventory,
2. Cycle inventory,
3. De-coupling inventory,
4. Anticipation inventory, and
5. Pipeline inventory.
Buffer
inventory
OperationsManagement
InventorycontrolandManagement
Lecture 8
One or more stages in the process cannot supply all
items it produces simultaneously, e.g., suppose a
baker makes three types of bread, each of which is
equally popular with its customers. Because of the
nature of the mixing and baking process, only one
kind of bread can be produced at any time.
Cycle
inventory
When an operation is designed to use a process
layout, transformed resources move intermittently
between specialized areas that comprise similar
operations. Each batch of work-in-progress
inventory joins a queue, awaiting its turn in the
schedule for the next processing stage.
De-
coupling
Inventory
Types of Inventories
OperationsManagement
InventorycontrolandManagement
Lecture 8
 Anticipation inventory can be used to cope with
seasonal demand.
 It is used to compensate for differences in the
timing of supply and demand.
 Most commonly used when demand fluctuations
are large but relatively predictable.
Anticipation inventory
 Pipeline inventory exists because material cannot be
transported instantaneously between the point of
supply and the point of demand.
 If a retail store orders a consignment of items from one of its suppliers, the
supplier will allocate the stock to the retail store in its own warehouse,
pack it, load it onto its truck, transport it to its destination, and unload it
into the retailer’s inventory.
Pipeline inventory
Types of Inventories
OperationsManagement
InventorycontrolandManagement
Lecture 8
Requirements for Effective Inventory
Inventory Control & Management
 A classification system for inventory items.
These requirements are:
A system to keep track of the inventory on hand and on order.
• Find out how much we have, and how much we should have
based on stock-level fluctuations, rate of demands, etc.
• Then take steps to close the gap between the two.
A reliable forecast of demand that includes an indication of
possible forecast error.
 Knowledge of lead times and lead time variability.
 Reasonable estimates of inventory holding costs, ordering
costs, and shortage costs.
OperationsManagement
InventorycontrolandManagement
Lecture 8
Inventory counting systems can be:
(i) periodic, or
(ii) perpetual.
Techniques of Effective Inventory
Inventory Counting System
A physical count of items in inventory is made at
periodic intervals (e.g., weekly, monthly) in order
to decide how much to order for each item.
Examples: A small retailer, placing orders for
many items at the same time.
Periodic
Inventory
There is a lack of control between reviews and
there is a need to protect against shortage
between review periods by carrying extra stock.
OperationsManagement
InventorycontrolandManagement
Lecture 8
Known as ‘continual system’ which keeps track of
removals from inventory on a continuous basis.
Periodic
Inventory
When the amount on hand reaches a predefined
minimum, a fixed quantity is ordered. This system
offers continuous monitoring and the setting of
optimal order quantity.
• There is an added cost for record keeping and
physical count is needed to verify inv. records.
• Discrepancy could occur due to errors, theft,
spoilage, and other factors.
• Examples: bank, supermarkets, pharmacy,
discount shops, and department stores etc.
Techniques of Effective Inventory
OperationsManagement
InventorycontrolandManagement
Lecture 8
 The items are divided into two bins: the first one is for
satisfying the current demand, while the second one is
to satisfy the demand during the replenishment period.
Techniques of Effective Inventory
Periodic inventory: A Two-bin System
 Very elementary and most commonly used system.
 It is also called the min-max system.
Items are withdrawn from bin-1 until its contents are exhausted;
then place an order using order card placed at bottom of first bin.
Bin-2Bin-1
Bin-2 contains enough stock to satisfy expected demand until the
order is filled, plus extra cushion of stock that reduces the chance
of stock-out if the order is late or if usage is greater than expected.
OperationsManagement
InventorycontrolandManagement
Lecture 8
 Reorder card may not be turned in for a
variety of reasons (e.g., misplaced, the
person responsible forgets to turn it in),
 Absence of adequate data on stock levels
and consumption rates.
 Affects the evaluation of batch sizes for
orders that can be reduced by slow,
medium, and fast moving.
Periodic inventory: A Two-bin System
Advantages:
Disadvantages:
 It is simple, reliable, and easy to explain
and operate,
 There is no need to record each
withdrawal from inventory.
Techniques of Effective Inventory
OperationsManagement
InventorycontrolandManagement
Lecture 8
 Based on periodic reordering of all items.
 With every cycle, stock of each item is brought up to its
level, which is dependent on the length of the cycle, the
replenishment period, and the consumption rate.
 Reorder quantity increases with cycle time if the
replenishment period and demand rate do not change.
Periodic inventory: Ordering cycle system
Techniques of Effective Inventory
 All orders for replenishment are issued at the same time.
 Ordering mechanism is regular and not subject to
sporadic arrivals of warning signals from the store.
 Usually more stock is held when this system is adopted
than with the 2-bin system.
Advantages
Disadvantage:
OperationsManagement
InventorycontrolandManagement
Lecture 8
1. Single cycle, or all items one cycle
2. Multicycle, or groupcycle
 Items are divided into groups and each group has
its own ordering cycle, independent of the other
groups.
 Groups are formed by selecting goods that to be
ordered from the same vendor or by taking items
with similar demand characteristics.
 This system is adopted when the stores have to
deal with a large number of items.
Following variations of ordering cycle system are possible:
Periodic inventory: Ordering cycle system
Techniques of Effective Inventory
 All the items are replenished in every cycle.
 Suitable when number of items is not too large.
 Differences in demand are not very significant.
 However, average stock level tends to increase
with the number of items.
Single cycle:
Multi cycle:
OperationsManagement
InventorycontrolandManagement
Lecture 8
 To satisfy the demands, it is essential to have reliable
estimates of demand, and the lead time (time between
submitting an order and receiving it).
 The greater the potential variability, the greater the
need for additional stock to reduce the risk of shortage
between deliveries.
Demand forecast & Lead time information
Quantity
on hand
Q
Receive
order
Place
order
Receive
order
Place
order
Receive
order
Lead time
Reorder
point
Usage
rate
Time
Profile of Inventory Level Over Time
Techniques of Effective Inventory
OperationsManagement
InventorycontrolandManagement
Lecture 8
 Consist of selective control methods based on Pareto 80-
20 principle, which states that there are a critical few
and trivial many.
 All items are classified into some broad groups on certain
basis and attention is paid to their control accordingly.
 Some of the popular control techniques are:
 ABC classification
 FSN classification
 VED classification
Inventory Control Techniques
Inventory can be controlled by these two techniques:
1. Qualitative techniques,
2. Quantitative techniques.
Qualitative Techniques:
OperationsManagement
InventorycontrolandManagement
Lecture 8
Can be split into two types depending on the demand
rate and the nature of demand:
• Deterministic models, and
• Probabilistic or non-deterministic models.
Qualitative Techniques:
Deterministic models
In this model, the demand of an item is known and fixed.
Probabilistic models
In this model, the demand of an item is not known and
called stochastic.
Inventory Control Techniques
OperationsManagement
InventorycontrolandManagement
Lecture 8
Inventory Control Techniques
 ABC stands for ‘always better control’.
 Items on hand are classified into A, B, and C types on
the basis of the value in terms of capital or annual
money usage (i.e., dollar value per unit × annual usage)
 Items with high value and low volume are kept in A-
type, items with low value and high volume are kept in
C-type, and the items with moderate value and
moderate volumes belong to the B-type.
 Attention is given based on the type sorted (A-type are
given the maximum, and so on while ordering,
 Three classes of items are called: A (very important), B
(moderately important), and C (least important).
ABC classification
OperationsManagement
InventorycontrolandManagement
Lecture 8
Inventory Control Techniques
 A items generally account
for about 15 - 20 % of items but about 60 – 70% of $ usage,
on the other end, C items might account for about 60% of
items but only about 10% of $ usage of an inventory.
 The actual number of categories varies from organization
to organization, depending on the extent to which a firm
wants to differentiate the control efforts.
Classifying inventory according to measure of importance:
A - very important
B - mod. important
C - least important
Annual
$ value
of items
A
B
C
High
Low
Low High% of Items
OperationsManagement
InventorycontrolandManagement
Lecture 8
A computer hardware company has organized its 10 items on an
annual dollar volume basis. Details like item numbers, their annual
demand, unit cost, annual dollar volume, and percentage of the total
represented by each item are shown in Table (R. N. Roy, A Modern
Approach to Operations Management, New Age International, pp. 106 .
Example: ABC Analysis
OperationsManagement
InventorycontrolandManagement
Lecture 8
Inventory Control Techniques
FSN Classification
 Items are classified according to the rate of consumption.
 Materials are fast (F), slow (S) and non-moving types (N).
 F-type materials get maximum attention, and N type get
minimum attention for their control and procurement.
Example: Let this concept in our kitchen, sorting all items
 F = Rice, salt, sugar, tea are consumed almost daily at
relatively faster rate and they need more attention.
 S = Fruit, dry fruits are consumed at a moderate speed
and need moderate attention.
 N = Medicine, shaving blades, cosmetics are consumed at
a very negligible rate and need less attention.
OperationsManagement
InventorycontrolandManagement
Lecture 8
VED Classification
 Materials are classified according to its criticality in the
production system. Thus, materials can be
 vital (V),
 essential (E), and
 desirable (D) types.
 Maximum attention is paid to procurement and control
of vital items and less to the desirable ones, and so on.
 It is so because the lack of vital items can bring the
production of the plant down and the plant is running
into losses.
 Example, 1000 items of a steel plant, V = 200—Much attention, E = 300—
Moderate attention, D = 500—Less attention is given to these items.
Inventory Control Techniques
OperationsManagement
InventorycontrolandManagement
Lecture 8
Every time an order is placed to replenish stock, a number
of transactions are needed which incur costs. These include
 the clerical tasks of preparing the order,
 the documentation associated to the order,
 arranging for the delivery to be made,
 arranging to pay the supplier for the delivery, and
 the general costs of keeping all the information.
 In addition, there could also be a ‘changeover’ cost
 to supply the items caused by the need to change.
Inventory Costs
Several types of costs are directly associated with order size.
These are:
1. Cost of Placing Order
OperationsManagement
InventorycontrolandManagement
Lecture 8
Sometimes, suppliers offer discounts on the normal
purchase price for large quantities; alternatively they
might impose extra costs for small orders.
2. Price discount Costs
The cost associated to failing to supply customers’ order
for a misjudge the order-quantity and inventory runs out.
The loss incur for both internal and external customers.
 For external, they may take their business elsewhere;
 For internal, stock-outs could lead to idle time at the
next process, inefficiencies and, eventually, again,
dissatisfied external customers.
3. Stock-out Costs
Inventory Costs
OperationsManagement
InventorycontrolandManagement
Lecture 8
The costs associated with physically storing the goods.
 Renting,
 heating and lighting the warehouse,
 insuring the inventory in special conditions,
 ensuring high security etc.
5. Storage Costs
4. Working Capital Costs
After receiving a replenishment order, the supplier will
demand payment for their goods. Eventually, there is a lag
between payment and receiving payment. The costs
associated with it are
(i) bank interest to pay the bank, and
(ii) the opportunity costs of not investing it elsewhere.
Inventory Costs
OperationsManagement
InventorycontrolandManagement
Lecture 8
When an order of large quantities is placed, this usually
results in stocked items spending a long time stored in
inventory. Then there is a risk that the items might either
become obsolete; for example: in the case of a change in
fashion, or deteriorate with age in the case of most
foodstuffs, medicines, biodegradable items etc.
6. Obsolescence Costs
7. Operating Inefficiency Costs
According to lean synchronization philosophies, high
inventory levels prevent us seeing the full extent of
problems within the operation.
Inventory Costs
OperationsManagement
InventorycontrolandManagement
Lecture 8
Inventory Control Techniques
A company orders from an outside supplier. The supplier
delivers to the purchasing plant precisely the quantity it
asks for; and it passes that stock onto its customers.
Deterministic model: Basic EOQ Model
• How much to produce in one time?
Materials can be either produced or purchased, but in both
situations, one needs to know the following:
• How much to procure (order) in one time?
The answer to these questions depends on the total-cost of
production or total cost of purchase of items: Then,
• What are the cost of production or purchase them?
OperationsManagement
InventorycontrolandManagement
Lecture 8
Inventory Control Techniques
 Economic order quantity (EOQ) model
The order size that minimizes total annual cost
 Economic Production Model
 Quantity Discount Model
Cycle Counting
Economic order quantity (EOQ) model
 Every time an order is placed, Q items are ordered.
Demand for the item is then steady and perfectly
predictable at a rate of D units per month.
 When demand is depleted, another order of Q items
instantaneously arrives, and so on.
OperationsManagement
InventorycontrolandManagement
Lecture 8
Inventory Control Techniques
Assumptions for EOQ
 Each order is received in a single delivery
 There are no quantity discounts
 Fixed set-up cost for each order, called order cost.
 Variable stock holding cost per unit per year.
 No safety stock is maintained.
This model makes the following assumptions:
 Only one product is involved
 Annual demand requirements known
 Demand is even throughout the year
 Lead time does not vary
OperationsManagement
InventorycontrolandManagement
Lecture 8
Inventory Control Techniques
To find out EOQ model,
holding costs are taken into account by including:
● working capital costs
● storage costs
● obsolescence risk costs.
Order costs are calculated by taking into account:
● cost of placing the order (including transportation)
● price discount costs.
EOQ Model
Holding costs = holding cost/unit × average inventory
= 𝑪 𝒉 ×
𝑸
𝟐Holding costs
Ordering costs = ordering cost × number of orders per period
= 𝑪 𝒐 ×
𝑫
𝑸
Ordering costs
OperationsManagement
InventorycontrolandManagement
Lecture 8
Inventory Control Techniques
The average inventory =
𝑸
𝟐
(because the two shaded areas are equal)
The time interval between deliveries =
𝑸
𝑫
Frequency of deliveries = reciprocal of time interval = 𝑫
𝑸
EOQ Model Cont….
Time
Inventory
level
Order
Quantity, Q Slope= demand rate
Instantaneous deliveries at a rate of 𝑫
𝑸 per period
Avg. Inv. 𝑸
𝟐
Steady and predictable demand
𝑸
𝑫
Fig. Inventory profiles chart the variation in inventory level, Ref. N. Slack, et. al.
OperationsManagement
InventorycontrolandManagement
Lecture 8
EOQ Model Cont….
From before:
Total cost = holding cost + order cost
The rate of change of total cost is given by the first differential
of Ct with respect to Q :
The lowest cost will occur when dCt/dQ = 0, that is:
where Qo = the EOQ. Rearranging this expression gives:
𝑪 𝒕 =
𝑪 𝒉 𝑸
𝟐
+
𝑪 𝒐 𝑫
𝑸
OperationsManagement
InventorycontrolandManagement
Lecture 8
Inventory Control Techniques
EOQ Model Cont….
Cost Minimization Goal
The Total-Cost Curve is U-Shaped
Ordering Costs
QO
AnnualCost
(optimal order quantity)
TC
Q
H
D
Q
S 
2
Order Quantity (Q)
Using the EOQ:
Time between orders =
Order frequency = per period
𝑬𝑶𝑸
𝑫
𝑫
𝑬𝑶𝑸
OperationsManagement
InventorycontrolandManagement
Lecture 8
EOQ Problems
A local distributor for a national tire company expects
to sell approximately 9,600 steel-belted radial tires
of a certain size and tread design next year. Annual
carrying cost is $16 per tire, and ordering cost is $75.
The distributor operates 288 days a year.
a. What is the EOQ?
b. How many times per year does the store reorder?
c. What is the length of an order cycle?
d. What is the total annual cost if the EOQ
quantity is ordered?
OperationsManagement
InventorycontrolandManagement
Lecture 8
OperationsManagement
InventorycontrolandManagement
Lecture 8
Piddling Manufacturing assembles security monitors. It
purchases 3,600 black-and-white cathode ray tubes a
year at $65 each. Ordering costs are $31, and annual
carrying costs are 20 percent of the purchase price.
Compute the optimal quantity and the total annual
cost of ordering and carrying the inventory.
Given that,
D = 3,600 CRT/yr
S = $ 31
H = $ 65 * 0.20
= $ 13
OperationsManagement
InventorycontrolandManagement
Lecture 8
Quantity discounts are price reductions for
larger orders offered to customers to induce
them to buy in large quantities.
If quantity discounts are offered, the buyer
must weigh the potential benefits of reduced
purchase price and fewer orders that will
result from buying in large quantities against
the increase in carrying costs caused by
higher average inventories.
Quantity Discounts
Chicago surgical
supply company
publishes the price list
OperationsManagement
InventorycontrolandManagement
Lecture 8
The buyer's goal with quantity discounts is to
select the order quantity that will minimize
total cost, where total cost is the sum of
carrying cost, ordering cost, and purchasing
(i.e., product) cost:
where, P = Unit price
Recall that in the basic EOQ model, determination
of order size does not involve the purchasing cost.
The rationale for not including unit price is that
under the assumption of no quantity discounts,
price per unit is the same for all order sizes.
OperationsManagement
InventorycontrolandManagement
Lecture 8
Comparison of TC curves for
constant carrying costs and
carrying costs that are a
percentage of unit costs
The total-cost curve with
quantity discounts is
composed of a portion of the
total-cost curve for each price
OperationsManagement
InventorycontrolandManagement
Lecture 8
The procedure for determining the overall EOQ
differs slightly, depending on which of these
two cases is relevant. For carrying costs that
are constant, the procedure is as follows:
1. Compute the common minimum point.
2. Only one of the unit prices will have the
minimum point in its feasible range since
the ranges do not overlap. Identify that
range.
 If the feasible minimum point is on the lowest
price range, that is the optimal order
quantity.
 If the feasible minimum point is in any other
range, compute the total cost for the
minimum point and for the price breaks of
all lower unit costs.

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Inventory Control & Management

  • 2. OperationsManagement InventorycontrolandManagement Lecture 8 Lecture Outlines Inventory Control & Management  What is inventory?  Why is inventory necessary?  What are the advantages and disadvantages of holding inventory?  How much inventory should an operation hold?  When should an operation replenish its inventory?  How can inventory be controlled?  Understand the strategic significance of managing inventory  Knowledge insights with quantity discounts (Piece break model)  EOQ for multiple items with resources constraints
  • 3. OperationsManagement InventorycontrolandManagement Lecture 8 In general,  Inventory is a list of items or goods;  Inventory refers to the ‘materials in stock’;  Stored accumulation of material resources in a transformation system.  For example, inventory in a library means the list of books, journals, periodicals, furniture, fans, etc. What is inventory? A typical firm carries different inventories such as:  raw materials and purchased parts;  partially completed goods called work-in-process;  finished-goods or merchandise in retail stores;  replacement parts, tools, and supplies; and  goods-in-transit to warehouses or customers
  • 4. OperationsManagement InventorycontrolandManagement Lecture 8 • Inventory is the stock of any item or resource used in an organization and can include: raw materials, finished products, component parts, supplies, and work-in-process items. An inventory system is the set of policies and controls that monitor levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be Firms invest 25-35 percent of assets in inventory but many do not manage inventories well What is inventory? Cont..
  • 5. OperationsManagement InventorycontrolandManagement Lecture 8 • Fuel for the car Milk to drink • Milk to sell Production with setups • Motherboards to assemble computers General concept: Distribution, transports blood from blood centers to hospitals in response to emergency requests. Example: But for blood services, such as Blood Bank Service: Collection, involves recruiting and retaining blood donors, encouraging them to attend donor sessions 1 2 Processing, blood down into its constituent parts (red cells, platelets & plasma) blood-based products 3 What is inventory? Cont..
  • 6. OperationsManagement InventorycontrolandManagement Lecture 8  What business are we in? Is it manufacturing or assembly?  To what extent does the firm want to own assets throughout the supply chain?  With which suppliers (and numbers of suppliers) does the firm want to have for long-term relationships?  What is the extent of the suppliers’ involvement? The key questions in inventory control are: What is inventory? Cont.. The basic questions are to solve in IC&M: How much of the inventory is to be kept and /or ordered? When should this be done?
  • 7. OperationsManagement InventorycontrolandManagement Lecture 8 Why is inventory necessary? What is the purpose of holding stocks? Basic question: Find the answer: Inventories serve the following purposes: To meet anticipated (predicted) demand. Inventories are required to satisfy expected demand. Examples: demand are electronic items, tools, clothing. To smooth production requirements. Meeting the seasonal and off-season demands to meet overly high requirements during certain seasonal periods. Example: fresh fruits, vegetables deal with seasonal inventories; greeting cards, Christmas trees.
  • 8. OperationsManagement InventorycontrolandManagement Lecture 8 To decouple components of the production- distribution system. Inventory buffers to continue temporarily while machine breakdowns are resolved. Finished good inventories are used to buffer sales. Why is inventory necessary? To protect against stock-outs. Delayed deliveries and unexpected increases in demand increase the risk of shortages. Delay can occur because of weather conditions, traffic congestion, supplier stock-outs, deliveries of wrong materials, quality problems, etc.
  • 9. OperationsManagement InventorycontrolandManagement Lecture 8 To buy and produce in economic lot size in order to minimize purchasing and inventory costs. To take advantage of order cycles. Purchasing a larger quantities for quantity discounts in unit price & due to discounts and lower transport cost. To hedge against price increases. To ensure against scarcity of materials. To meet demands in unplanned shocks (labor strikes, natural disasters, surges, flood, rushes, etc.) To maintain customer-supplier–producer relationship. Why is inventory necessary?
  • 10. OperationsManagement InventorycontrolandManagement Lecture 8 Drawbacks of holding inventory A number of negative aspects are: × ties up money, in the form of working capital; × incurs storage costs (leasing space, maintaining appropriate conditions, etc.); × may become obsolete, can be damaged, or deteriorate, lost, be expensive to retrieve, etc.; × could be as it gets hidden amongst other inventory; × might be hazardous to store (e.g., flammable solvents, explosives, chemicals and drugs); × requiring special facilities and systems for safe handling; × uses space that could be used to add value; × involves administrative and insurance costs;
  • 11. OperationsManagement InventorycontrolandManagement Lecture 8 Types of Inventories Also called safety inventory, is to compensate for the unexpected fluctuations in supply and demand. For example, a retail seller, can never forecast demand perfectly, even when it has a good idea of the most likely demand level; order goods as there is always a certain amount of most items in stock. Depending on the supply and demand at different points in any operation lead to five types of inventories are: 1. Buffer inventory, 2. Cycle inventory, 3. De-coupling inventory, 4. Anticipation inventory, and 5. Pipeline inventory. Buffer inventory
  • 12. OperationsManagement InventorycontrolandManagement Lecture 8 One or more stages in the process cannot supply all items it produces simultaneously, e.g., suppose a baker makes three types of bread, each of which is equally popular with its customers. Because of the nature of the mixing and baking process, only one kind of bread can be produced at any time. Cycle inventory When an operation is designed to use a process layout, transformed resources move intermittently between specialized areas that comprise similar operations. Each batch of work-in-progress inventory joins a queue, awaiting its turn in the schedule for the next processing stage. De- coupling Inventory Types of Inventories
  • 13. OperationsManagement InventorycontrolandManagement Lecture 8  Anticipation inventory can be used to cope with seasonal demand.  It is used to compensate for differences in the timing of supply and demand.  Most commonly used when demand fluctuations are large but relatively predictable. Anticipation inventory  Pipeline inventory exists because material cannot be transported instantaneously between the point of supply and the point of demand.  If a retail store orders a consignment of items from one of its suppliers, the supplier will allocate the stock to the retail store in its own warehouse, pack it, load it onto its truck, transport it to its destination, and unload it into the retailer’s inventory. Pipeline inventory Types of Inventories
  • 14. OperationsManagement InventorycontrolandManagement Lecture 8 Requirements for Effective Inventory Inventory Control & Management  A classification system for inventory items. These requirements are: A system to keep track of the inventory on hand and on order. • Find out how much we have, and how much we should have based on stock-level fluctuations, rate of demands, etc. • Then take steps to close the gap between the two. A reliable forecast of demand that includes an indication of possible forecast error.  Knowledge of lead times and lead time variability.  Reasonable estimates of inventory holding costs, ordering costs, and shortage costs.
  • 15. OperationsManagement InventorycontrolandManagement Lecture 8 Inventory counting systems can be: (i) periodic, or (ii) perpetual. Techniques of Effective Inventory Inventory Counting System A physical count of items in inventory is made at periodic intervals (e.g., weekly, monthly) in order to decide how much to order for each item. Examples: A small retailer, placing orders for many items at the same time. Periodic Inventory There is a lack of control between reviews and there is a need to protect against shortage between review periods by carrying extra stock.
  • 16. OperationsManagement InventorycontrolandManagement Lecture 8 Known as ‘continual system’ which keeps track of removals from inventory on a continuous basis. Periodic Inventory When the amount on hand reaches a predefined minimum, a fixed quantity is ordered. This system offers continuous monitoring and the setting of optimal order quantity. • There is an added cost for record keeping and physical count is needed to verify inv. records. • Discrepancy could occur due to errors, theft, spoilage, and other factors. • Examples: bank, supermarkets, pharmacy, discount shops, and department stores etc. Techniques of Effective Inventory
  • 17. OperationsManagement InventorycontrolandManagement Lecture 8  The items are divided into two bins: the first one is for satisfying the current demand, while the second one is to satisfy the demand during the replenishment period. Techniques of Effective Inventory Periodic inventory: A Two-bin System  Very elementary and most commonly used system.  It is also called the min-max system. Items are withdrawn from bin-1 until its contents are exhausted; then place an order using order card placed at bottom of first bin. Bin-2Bin-1 Bin-2 contains enough stock to satisfy expected demand until the order is filled, plus extra cushion of stock that reduces the chance of stock-out if the order is late or if usage is greater than expected.
  • 18. OperationsManagement InventorycontrolandManagement Lecture 8  Reorder card may not be turned in for a variety of reasons (e.g., misplaced, the person responsible forgets to turn it in),  Absence of adequate data on stock levels and consumption rates.  Affects the evaluation of batch sizes for orders that can be reduced by slow, medium, and fast moving. Periodic inventory: A Two-bin System Advantages: Disadvantages:  It is simple, reliable, and easy to explain and operate,  There is no need to record each withdrawal from inventory. Techniques of Effective Inventory
  • 19. OperationsManagement InventorycontrolandManagement Lecture 8  Based on periodic reordering of all items.  With every cycle, stock of each item is brought up to its level, which is dependent on the length of the cycle, the replenishment period, and the consumption rate.  Reorder quantity increases with cycle time if the replenishment period and demand rate do not change. Periodic inventory: Ordering cycle system Techniques of Effective Inventory  All orders for replenishment are issued at the same time.  Ordering mechanism is regular and not subject to sporadic arrivals of warning signals from the store.  Usually more stock is held when this system is adopted than with the 2-bin system. Advantages Disadvantage:
  • 20. OperationsManagement InventorycontrolandManagement Lecture 8 1. Single cycle, or all items one cycle 2. Multicycle, or groupcycle  Items are divided into groups and each group has its own ordering cycle, independent of the other groups.  Groups are formed by selecting goods that to be ordered from the same vendor or by taking items with similar demand characteristics.  This system is adopted when the stores have to deal with a large number of items. Following variations of ordering cycle system are possible: Periodic inventory: Ordering cycle system Techniques of Effective Inventory  All the items are replenished in every cycle.  Suitable when number of items is not too large.  Differences in demand are not very significant.  However, average stock level tends to increase with the number of items. Single cycle: Multi cycle:
  • 21. OperationsManagement InventorycontrolandManagement Lecture 8  To satisfy the demands, it is essential to have reliable estimates of demand, and the lead time (time between submitting an order and receiving it).  The greater the potential variability, the greater the need for additional stock to reduce the risk of shortage between deliveries. Demand forecast & Lead time information Quantity on hand Q Receive order Place order Receive order Place order Receive order Lead time Reorder point Usage rate Time Profile of Inventory Level Over Time Techniques of Effective Inventory
  • 22. OperationsManagement InventorycontrolandManagement Lecture 8  Consist of selective control methods based on Pareto 80- 20 principle, which states that there are a critical few and trivial many.  All items are classified into some broad groups on certain basis and attention is paid to their control accordingly.  Some of the popular control techniques are:  ABC classification  FSN classification  VED classification Inventory Control Techniques Inventory can be controlled by these two techniques: 1. Qualitative techniques, 2. Quantitative techniques. Qualitative Techniques:
  • 23. OperationsManagement InventorycontrolandManagement Lecture 8 Can be split into two types depending on the demand rate and the nature of demand: • Deterministic models, and • Probabilistic or non-deterministic models. Qualitative Techniques: Deterministic models In this model, the demand of an item is known and fixed. Probabilistic models In this model, the demand of an item is not known and called stochastic. Inventory Control Techniques
  • 24. OperationsManagement InventorycontrolandManagement Lecture 8 Inventory Control Techniques  ABC stands for ‘always better control’.  Items on hand are classified into A, B, and C types on the basis of the value in terms of capital or annual money usage (i.e., dollar value per unit × annual usage)  Items with high value and low volume are kept in A- type, items with low value and high volume are kept in C-type, and the items with moderate value and moderate volumes belong to the B-type.  Attention is given based on the type sorted (A-type are given the maximum, and so on while ordering,  Three classes of items are called: A (very important), B (moderately important), and C (least important). ABC classification
  • 25. OperationsManagement InventorycontrolandManagement Lecture 8 Inventory Control Techniques  A items generally account for about 15 - 20 % of items but about 60 – 70% of $ usage, on the other end, C items might account for about 60% of items but only about 10% of $ usage of an inventory.  The actual number of categories varies from organization to organization, depending on the extent to which a firm wants to differentiate the control efforts. Classifying inventory according to measure of importance: A - very important B - mod. important C - least important Annual $ value of items A B C High Low Low High% of Items
  • 26. OperationsManagement InventorycontrolandManagement Lecture 8 A computer hardware company has organized its 10 items on an annual dollar volume basis. Details like item numbers, their annual demand, unit cost, annual dollar volume, and percentage of the total represented by each item are shown in Table (R. N. Roy, A Modern Approach to Operations Management, New Age International, pp. 106 . Example: ABC Analysis
  • 27. OperationsManagement InventorycontrolandManagement Lecture 8 Inventory Control Techniques FSN Classification  Items are classified according to the rate of consumption.  Materials are fast (F), slow (S) and non-moving types (N).  F-type materials get maximum attention, and N type get minimum attention for their control and procurement. Example: Let this concept in our kitchen, sorting all items  F = Rice, salt, sugar, tea are consumed almost daily at relatively faster rate and they need more attention.  S = Fruit, dry fruits are consumed at a moderate speed and need moderate attention.  N = Medicine, shaving blades, cosmetics are consumed at a very negligible rate and need less attention.
  • 28. OperationsManagement InventorycontrolandManagement Lecture 8 VED Classification  Materials are classified according to its criticality in the production system. Thus, materials can be  vital (V),  essential (E), and  desirable (D) types.  Maximum attention is paid to procurement and control of vital items and less to the desirable ones, and so on.  It is so because the lack of vital items can bring the production of the plant down and the plant is running into losses.  Example, 1000 items of a steel plant, V = 200—Much attention, E = 300— Moderate attention, D = 500—Less attention is given to these items. Inventory Control Techniques
  • 29. OperationsManagement InventorycontrolandManagement Lecture 8 Every time an order is placed to replenish stock, a number of transactions are needed which incur costs. These include  the clerical tasks of preparing the order,  the documentation associated to the order,  arranging for the delivery to be made,  arranging to pay the supplier for the delivery, and  the general costs of keeping all the information.  In addition, there could also be a ‘changeover’ cost  to supply the items caused by the need to change. Inventory Costs Several types of costs are directly associated with order size. These are: 1. Cost of Placing Order
  • 30. OperationsManagement InventorycontrolandManagement Lecture 8 Sometimes, suppliers offer discounts on the normal purchase price for large quantities; alternatively they might impose extra costs for small orders. 2. Price discount Costs The cost associated to failing to supply customers’ order for a misjudge the order-quantity and inventory runs out. The loss incur for both internal and external customers.  For external, they may take their business elsewhere;  For internal, stock-outs could lead to idle time at the next process, inefficiencies and, eventually, again, dissatisfied external customers. 3. Stock-out Costs Inventory Costs
  • 31. OperationsManagement InventorycontrolandManagement Lecture 8 The costs associated with physically storing the goods.  Renting,  heating and lighting the warehouse,  insuring the inventory in special conditions,  ensuring high security etc. 5. Storage Costs 4. Working Capital Costs After receiving a replenishment order, the supplier will demand payment for their goods. Eventually, there is a lag between payment and receiving payment. The costs associated with it are (i) bank interest to pay the bank, and (ii) the opportunity costs of not investing it elsewhere. Inventory Costs
  • 32. OperationsManagement InventorycontrolandManagement Lecture 8 When an order of large quantities is placed, this usually results in stocked items spending a long time stored in inventory. Then there is a risk that the items might either become obsolete; for example: in the case of a change in fashion, or deteriorate with age in the case of most foodstuffs, medicines, biodegradable items etc. 6. Obsolescence Costs 7. Operating Inefficiency Costs According to lean synchronization philosophies, high inventory levels prevent us seeing the full extent of problems within the operation. Inventory Costs
  • 33. OperationsManagement InventorycontrolandManagement Lecture 8 Inventory Control Techniques A company orders from an outside supplier. The supplier delivers to the purchasing plant precisely the quantity it asks for; and it passes that stock onto its customers. Deterministic model: Basic EOQ Model • How much to produce in one time? Materials can be either produced or purchased, but in both situations, one needs to know the following: • How much to procure (order) in one time? The answer to these questions depends on the total-cost of production or total cost of purchase of items: Then, • What are the cost of production or purchase them?
  • 34. OperationsManagement InventorycontrolandManagement Lecture 8 Inventory Control Techniques  Economic order quantity (EOQ) model The order size that minimizes total annual cost  Economic Production Model  Quantity Discount Model Cycle Counting Economic order quantity (EOQ) model  Every time an order is placed, Q items are ordered. Demand for the item is then steady and perfectly predictable at a rate of D units per month.  When demand is depleted, another order of Q items instantaneously arrives, and so on.
  • 35. OperationsManagement InventorycontrolandManagement Lecture 8 Inventory Control Techniques Assumptions for EOQ  Each order is received in a single delivery  There are no quantity discounts  Fixed set-up cost for each order, called order cost.  Variable stock holding cost per unit per year.  No safety stock is maintained. This model makes the following assumptions:  Only one product is involved  Annual demand requirements known  Demand is even throughout the year  Lead time does not vary
  • 36. OperationsManagement InventorycontrolandManagement Lecture 8 Inventory Control Techniques To find out EOQ model, holding costs are taken into account by including: ● working capital costs ● storage costs ● obsolescence risk costs. Order costs are calculated by taking into account: ● cost of placing the order (including transportation) ● price discount costs. EOQ Model Holding costs = holding cost/unit × average inventory = 𝑪 𝒉 × 𝑸 𝟐Holding costs Ordering costs = ordering cost × number of orders per period = 𝑪 𝒐 × 𝑫 𝑸 Ordering costs
  • 37. OperationsManagement InventorycontrolandManagement Lecture 8 Inventory Control Techniques The average inventory = 𝑸 𝟐 (because the two shaded areas are equal) The time interval between deliveries = 𝑸 𝑫 Frequency of deliveries = reciprocal of time interval = 𝑫 𝑸 EOQ Model Cont…. Time Inventory level Order Quantity, Q Slope= demand rate Instantaneous deliveries at a rate of 𝑫 𝑸 per period Avg. Inv. 𝑸 𝟐 Steady and predictable demand 𝑸 𝑫 Fig. Inventory profiles chart the variation in inventory level, Ref. N. Slack, et. al.
  • 38. OperationsManagement InventorycontrolandManagement Lecture 8 EOQ Model Cont…. From before: Total cost = holding cost + order cost The rate of change of total cost is given by the first differential of Ct with respect to Q : The lowest cost will occur when dCt/dQ = 0, that is: where Qo = the EOQ. Rearranging this expression gives: 𝑪 𝒕 = 𝑪 𝒉 𝑸 𝟐 + 𝑪 𝒐 𝑫 𝑸
  • 39. OperationsManagement InventorycontrolandManagement Lecture 8 Inventory Control Techniques EOQ Model Cont…. Cost Minimization Goal The Total-Cost Curve is U-Shaped Ordering Costs QO AnnualCost (optimal order quantity) TC Q H D Q S  2 Order Quantity (Q) Using the EOQ: Time between orders = Order frequency = per period 𝑬𝑶𝑸 𝑫 𝑫 𝑬𝑶𝑸
  • 40. OperationsManagement InventorycontrolandManagement Lecture 8 EOQ Problems A local distributor for a national tire company expects to sell approximately 9,600 steel-belted radial tires of a certain size and tread design next year. Annual carrying cost is $16 per tire, and ordering cost is $75. The distributor operates 288 days a year. a. What is the EOQ? b. How many times per year does the store reorder? c. What is the length of an order cycle? d. What is the total annual cost if the EOQ quantity is ordered?
  • 42. OperationsManagement InventorycontrolandManagement Lecture 8 Piddling Manufacturing assembles security monitors. It purchases 3,600 black-and-white cathode ray tubes a year at $65 each. Ordering costs are $31, and annual carrying costs are 20 percent of the purchase price. Compute the optimal quantity and the total annual cost of ordering and carrying the inventory. Given that, D = 3,600 CRT/yr S = $ 31 H = $ 65 * 0.20 = $ 13
  • 43. OperationsManagement InventorycontrolandManagement Lecture 8 Quantity discounts are price reductions for larger orders offered to customers to induce them to buy in large quantities. If quantity discounts are offered, the buyer must weigh the potential benefits of reduced purchase price and fewer orders that will result from buying in large quantities against the increase in carrying costs caused by higher average inventories. Quantity Discounts Chicago surgical supply company publishes the price list
  • 44. OperationsManagement InventorycontrolandManagement Lecture 8 The buyer's goal with quantity discounts is to select the order quantity that will minimize total cost, where total cost is the sum of carrying cost, ordering cost, and purchasing (i.e., product) cost: where, P = Unit price Recall that in the basic EOQ model, determination of order size does not involve the purchasing cost. The rationale for not including unit price is that under the assumption of no quantity discounts, price per unit is the same for all order sizes.
  • 45. OperationsManagement InventorycontrolandManagement Lecture 8 Comparison of TC curves for constant carrying costs and carrying costs that are a percentage of unit costs The total-cost curve with quantity discounts is composed of a portion of the total-cost curve for each price
  • 46. OperationsManagement InventorycontrolandManagement Lecture 8 The procedure for determining the overall EOQ differs slightly, depending on which of these two cases is relevant. For carrying costs that are constant, the procedure is as follows: 1. Compute the common minimum point. 2. Only one of the unit prices will have the minimum point in its feasible range since the ranges do not overlap. Identify that range.  If the feasible minimum point is on the lowest price range, that is the optimal order quantity.  If the feasible minimum point is in any other range, compute the total cost for the minimum point and for the price breaks of all lower unit costs.