149155708 Inventory Management (1)

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Inventory Management I



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 andcontrols that monitors levels of inventory anddetermines what levels should be maintained,when stock should be replenished, and howlarge orders should be



Inventory

Def. - A physical resource that a firm holds instock 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)



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.



Zero Inventory? Reducing amounts of raw materials and

purchased parts and subassemblies byhaving suppliers deliver them directly.

Reducing the amount of works-in process by using just-in-time production.

Reducing the amount of finished goods byshipping to markets as soon as possible.



Inventory Positions in the

Supply Chain

Raw

MaterialsWorks

in

Process

Finished

Goods

Finished

Goods

in Field



Reasons for Inventories Improve customer service

Economies of purchasing

Economies of production

Transportation savings

Hedge against future

Unplanned shocks (labor strikes, naturaldisasters, surges in demand, etc.)

To maintain independence of supply chain



Inventory and Value Remember this?

Quality

Speed

Flexibility

Cost



Nature of Inventory: Adding

Value through Inventory Quality - inventory can be a “buffer” against poor

quality; conversely, low inventory levels may forcehigh quality

Speed - location of inventory has gigantic effect onspeed

Flexibility - location, level of anticipatory inventoryboth have effects

Cost - direct: purchasing, delivery, manufacturing

indirect: holding, stockout.

HR systems may promote this-3 year postings



Nature of Inventory:

Functional Roles of Inventory Transit

Buffer

Seasonal

Decoupling

Speculative Lot Sizing or Cycle

Mistakes



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 theinventory?

Ownership of Inventories

Specific Contents of Inventories

Locations of Inventories

Tracking



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 assetsare invested in inventory?

Ford:6.825 billion

Sears: 4.039 billion



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



Reasons Against Inventory Non-value added costs

Opportunity cost

Complacency

Inventory deteriorates, becomesobsolete, lost, stolen, etc.



Inventory Costs Procurement costs

Carrying costs

Out-of-stock costs



Procurement Costs Order processing

Shipping

Handling

Purchasing cost: c(x)= $100 + $5x

Mfg. cost: c(x)=$1,000 + $10x



Carrying Costs Capital (opportunity) costs

Inventory risk costs

Space costs

Inventory service costs



Out-of-Stock Costs Lost sales cost

Back-order cost



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



Dependent Demand Dependent demand items are raw

materials, component parts, or

subassemblies that are used to producea finished product.

MRP systems---next week



Design of Inventory Mgmt.

Systems: Micro Issues Order Quantity

Economic Order Quantity

Order Timing Reorder Point



Objectives of Inventory

Control 1) Maximize the level of customer

service by avoiding understocking.

2) Promote efficiency in production andpurchasing by minimizing the cost ofproviding an adequate level of customer

service.



Balance in Inventory Levels When should the company replenish its

inventory, or when should the company

place an order or manufacture a newlot?

How much should the company order or

produce? Next: Economic Order Quantity



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



Seatide EOQ = 2DCo /Ch

D = annual demand = 6,000

Co = ordering/setup costs = $60Ch = cost of holding one unit of inventory

$3.00 x 24% = .72

2 x 6,000 x 60

.72

720,000.72 1,000



Holding

Costs

OrderingCosts

Marginal Analysis

Units

$



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 LTD = Demand rate per period

LT = lead time in periods



level of inventory average

inventory

unitsQ

t time

Sawtooth Model



based on reorder point - Wheninventory is depleted to ROP, order

replenishment of quantity EOQ.

Q - System Inventory

Control



when demand is smooth andcontinuous, can operate response-

based system by determining best quantity to replenish periodic demand

(EOQ)

frequency of replenishment (ROP) Reorder Point

Order Quantities



changing lead times

changing demand

Uncertainty creeps in: Plug in safety stock

Safety stock - allows manager to

determine the probability of stock levels- based on desired customer servicelevels

Planning for Uncertainty



Inventory Model Under

Uncertainty

reorder Q m

point

safety stock

time



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 thatrange. Call this Q2.

4. Evaluate the total cost equation at Q2 at the nexthighest price break point.

OR Use a spreadsheet



an alternative to ROP/Q-system control isperiodic review method

Q-system - each stock item reordered atdifferent times - complex, no economies ofscope or common prod./transport runs

P-system - inventory levels for multiple stockitems reviewed at same time - can bereordered together

higher carrying costs - not optimum, but

more practical

P-System

Periodic Review Method



audit inventory level at interval (T)

quantity to place on order is difference

between max. quantity (M) and amounton 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???

Using P-System



Types of Inventory Systems

By Degree of Control required

often use grouping method, such as ABC



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, minimalrecords, large inventories, periodic reviewand reorder



Does ABC Classification Make

Sense for an Assembler? i.e. – Gateway Computers

Pl i S l Ch i A ti iti



Planning Supply Chain Activities

Anticipatory - allocate supply to eachwarehouse based on the forecast

Response-based - replenish inventorywith order sizes based on specificneeds of each warehouse



determine requirements by forecastingdemand for the next production run orpurchase

establish current on-hand quantities add appropriate safety stock based on

desired stock availability levels anduncertainty demand levels

determine how much new production orpurchase needed (total needed - on-hand)

Anticipatory Inventory

Control



replenishment, production, or purchases ofstock are made only when it has been

signaled that there is a need for productdownstream

requires shorter order cycle time, often morefrequent, lower volume orders

determine stock requirements to meet onlymost immediate planning period (usuallyabout 3 weeks)

Response-Based System



Service Level Achieved

1- expected number of units out of stock/year

total annual demand

•

Item fill rate (IFR): the probability of fillingan order for 1 item from current stock

•Weighted Average Fill Rate (WAFR): multiply

IFR for each stock item on an order weighted by the ordering frequency for the item

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