20-1McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

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Chapter 20

Production and Inventory Control

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Key Concepts

• The Fundamentals of Production Planning

• Modern Production Planning Systems

» Aggregate Planning and Master Scheduling

» Material Requirements Planning

» Capacity Requirements Planning

• Evolution of MRP and MRP II Systems

• Impact on Purchasing and Supply

• Just-In-Time Production Planning

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Key Concepts• The Functions of Inventories

» Definition of Inventories

» Inventory Analysis

• Costs Associated with Inventories» Carrying Costs

» Acquisition Costs

» Economic Order Quantity

• Types of Inventory Control Systems» Cyclical or Fixed Order Interval System

» The Just-In-Time (JIT) Approach

» Material Requirements Planning (MRP) System

» Order Point or Fixed Order Quantity System

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The Fundamentals of Production Planning

• Five general activities

» Preliminary Planning

» Aggregate Scheduling

» Detailed Production Scheduling

» Release and Dispatching of Orders

» Progress Surveillance and Correction

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Modern Production Planning Systems• Aggregate Planning and Master Scheduling

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Materials Requirements Planning

• Output of the MRP System» Current order releases to purchasing (or to previously

selected suppliers) with due date requirements.

» Planned order releases to purchasing for ensuing periods (considering inventory balance, scheduled requirements, and lead-time requirements).

» Current and planned order releases for in-house production, with completion date requirements.

» Feedback to the master production scheduler in case operating changes or supplier performance has produced material availability problems.

» With revised output from the master production schedule, the MRP system will re-plan and schedule the material requirements.

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FIGURE 20-3 A typical MRP planning record.

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MRP Logic and Format

• The essence of the MRP-based approach to materials planning and control is based on three fundamental concepts

» Dependent Demand

» Inventory/open order netting

» Time Phasing

• MRP systems rely on

» An accurate master schedule

» Absolute accuracy of all inventory counts

» Up to date bills of materials

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Capacity Requirement Planning• Based on machine availability in shop

• Requires:» Shop routing data

» Work center status data

• Variables manipulated by system and planners to achieve balanced schedule:» Alternative routings

» Personal reallocation

» Use of overtime

» Inventory-level variations

» Use of alternative tooling

» Use of subcontracting-outsourcin

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Evolution of MRP and MRP II Systems

• First significant use in early 1970’s

• Evolved from tool to order material to tool to schedule and reschedule use of shop capacity as well.

• MRP II has expanded to include the financial nature.

• MRP II also allows for viewing outcomes to proposed operating change.

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Impact on Purchasing and Supply

• Use of MRP systems have allowed the buyer to have greater impact on and access to the materials/production planning process.

• It allows the suppliers to have more accurate, reliable information of the buyers’ requirements.

• The buyer-supplier relationship becomes closer and more cooperative through this information sharing.

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Just-In-Time Production Planning• Inventory is undesirable because:

» It hides quality problems

» It hides production inefficiencies and productivity problems

» It adds unnecessary costs to the production operation-carrying costs of approximately 25 to 35 percent of the inventory value per year.

• The basic operating plan is to gear production and final assembly as closely to sales demand as possible in order to pull material through the system, reducing inventory levels.

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A Just-In-Time Illustration

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Characteristics of successful JIT operations• The JIT concept is most applicable to

manufacturing operations that pro duce a relatively small number of different products in at least a quasi-continuous environment.

• Product demand must be reasonably predictable, and requirements must be generated accurately. A closed loop MRP system can be used to do this, but typically the master production schedule must be smoothed on a daily basis.

• Statistical process control typically is used in both the buyer's and suppliers' organizations to ensure tight control of material and production quality. This is vital to the functioning of the low-float, small-volume, rel atively smooth-flowing operation.

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Characteristics of successful JIT operations• Production operation setup requirements must be able to

be reduced to relatively short times. Most firms target for tool changes and equipment setups of less than ten minutes. Without this capability, small-batch and smooth-flow production of different models or different products cannotbe accomplished efficiently.

• Purchasing must be able to reduce materials replenishment lead times. This usually is accomplished by reducing the four major elements of lead time—internal paperwork and ordering time, supplier queue and manufacturing time, transportation time requirements, and incoming receiving and inspection requirements.

• Successful JIT operation suppliers must be able to be flexible to meet the buying firm's stringent, short-fused material requirements—and they must be reliable to the nth degree.

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ERP Systems

• Enterprise Resource Planning (ERP) systems have evolved from the MRP II systems.

• ERP systems go well beyond the scope of production and inventory planning.

• ERP systems are used for cycle time reductions, better financial management, and to facilitate linkage to e-commerce systems.

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The Functions of Inventories

• Inventories allow for smooth and efficient operations of manufacturing organizations.

• Inventories allow additional flexibility for suppliers in planning, producing, and delivering parts.

• Inventories help balance the firm’s supply with the market forces of demand.

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Definition of Inventories

• Classifications of inventories

» Production inventories

» MRO inventories

» In-process inventories

» Finished goods inventories

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Inventory Analysis• Inventory management requires

cataloging all inventory part numbers, quantities, and values.

• Inventory management involves analysis of cataloged inventory.» ABC Analysis; The 80-20 rule

» Based on the Pareto principle

• ABC Analysis provided a basis on which to allocate funds and time of personnel in order to refine control over individual inventory items.

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Graphic analysis of production and MRO inventories

• ABC Analysis

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Dependent and Independent Demand

• Dependent Demand

» Use directly dependent on scheduled production of a larger component or parent product.

• Independent Demand

» Use is not driven by a bill of material or production schedule.

» MRO items have independent demand

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Costs Associated with Inventories

• Carrying Costs 1. Opportunity cost of invested funds 12-20%

2. Insurance costs 2- 4%

3. Property taxes 1- 3%

4. Storage costs 1- 3%

5. Obsolescence and deterioration 4-10%

Total carrying costs 20-40%

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Relationship of Inventory Related Costs to Inventory Level

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Acquisition Costs• Costs related to generating, processing and

handling an order.» A certain portion of wages and operating expenses of such

departments as purchasing and supply, production control, receiving, inspection, stores, and accounts payable—those departments whose personnel devote time to the generation and handling of the order

» The cost of supplies such as engineering drawings, envelopes, stationery, and forms for purchasing, production control, receiving, accounting, and so forth

» The cost of services such as computer time, telephone, fax machines, telegraph, and postage expended in procuring material

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Economic Order Quantity Concept (EOQ)• The appropriate order quantity that tends to

minimize all the costs associated with the order – carrying costs, acquisition costs, and the cost of the material.

• EOQ where AC=incremental acquisition costs; CC=incremental carrying costs; TC=total incremental costs.

EOQ

Ann

ual inc

remen

tal c

ost

Order or delivery quantity

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Weaknesses of the EOQ Formula

• It is NOT fully compatible with MRP and JIT

• All demand inputs are yearly estimates so the output is just an estimate.

• Only incremental costs are appropriate, that is, the cost of the next setup, the cost of the next purchase order preparation, the cost of the next stored unit (warehouse cost).

• Most users of this technique erroneously use “average costs”, which destroys the logic. Until you need to build a new warehouse, there is no increase in “sunk” warehouse cost as inventory increases.

• For inventory that moves from location to location, one set of costs does not apply.

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Weaknesses of the EOQ Formula

• The carrying costs are usually badly overstated, based on broad “industry averages” and often on pure estimates just short of guesses.

• Purchase ordering costs for long-term contracts are one-shot expenses. Release costs, especially by computer, would be or are fractions of a cent or for a FAX, perhaps $1.00. Repeat purchase orders for the same material would be nominal.

• Few firms have accurate studies of carrying cost to hold inventory beyond the cost of capital of the material. This cost could never be much more beyond the going commercial loan rates and the average rate of return of the firm. Thus, figures of 25-35% are suspect

• The opportunity cost aspect of EOQ rests on gigantic assumptions such as storage costs. Most warehouses are on the books at sunk costs with zero alternative use in the short term.

• EOQ assumes constant demand for the next year, hardly ever true.

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Types of Inventory Control Systems

• Cyclical or Fixed Order Interval System

• The Just-In-Time (JIT) Approach

• Materials Requirements Planning (MRP) System

• Order Point or Fixed Order Quantity System

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Cyclical or Fixed Order Interval System

• A time-based operation involving scheduled periodic reviews of stock levels of inventory items.

• Restock quantity placed to cover needs until next review.

• A items reviewed weekly, B items reviewed monthly, C items reviewed quarterly or semiannually.

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The Just-In-Time (JIT) Approach

• Inventories in the system maintained at minimal levels.

• Efforts should initially be placed on the A items.

• Many JIT materials are delivered directly to the production operation.

• The goal is to get supplier deliveries scheduled weekly – more often if possible.

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Materials Requirements Planning (MRP) System

• Through the bill of materials explosion and aggregation process, the production planning part of the MRP system generates on a weekly basis the projected materials requirements for all the finished products.

• The MRP system is designed for use with dependent demand items (production materials).

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Order Point or Fixed Order Quantity System

• Each item has its own unique optimum order quantity.

• The system requires two things for each inventory item

» A predetermination of an order point

» A predetermination of a fixed quantity to be ordered each time.

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Concluding Remarks• Production and Inventory management have

undergone change.

• New systems have increased the sophistication of the planning and control capabilities.

• Due to evolving product lines and the increasing technical nature of materials today, controlling inventories has become very difficult.

• Because effective inventory management can greatly impact profitability, top management should formulate policies and operating plans for controlling inventory.