Inventory ManagementInventory Management

Introduction Introduction Sanjay Choudhari

Indian Institute of Management Indore

Importance of Inventory Importance of Inventory

Importance of Inventory Importance of Inventory

Balance the advantages and disadvantages of small and large inventories

Pressures for small inventories Inventory holding cost Cost of capital Storage and handling costs Taxes, insurance, and shrinkage

Importance of Inventory Importance of Inventory

Pressures for large inventories Customer service Ordering cost Setup cost Labor and equipment utilization Transportation cost Payments to suppliers

Reasons for Holding InventoryReasons for Holding Inventory

To meet anticipated customer demand To protect against stock outs To take advantage of economic order

cycles To maintain independence of operations To allow for smooth and flexible

production operations To guard against price increases

In Short,In Short,

Buffer against uncertainty in…..Buffer against uncertainty in…..

Supply (Raw material inventories)

Production process ( Work in process inventories)

&

Demand (Finished good inventories)

Type of Inventory Type of Inventory

Process stage

Demand Type Others

Raw Materials WIP Finished Goods

Independent Dependent

Spares Consumable

Purpose

CycleSafetySeasonalPipeline

Independent Demand(demand for item is independent of demand for any other item)

Dependent Demand(demand for item is dependent upon the demand for some other item)

Independent vs. Dependent Independent vs. Dependent DemandDemand

Independent vs. Dependent Independent vs. Dependent Demand..Demand..

ItemMaterials With

Independent Demand

Materials WithDependent Demand

DemandSource

Company Customers Parent Items

MaterialType

Finished Goods WIP & Raw Materials

Method ofEstimatingDemand

Forecast & BookedCustomer Orders

Calculated

PlanningMethod

EOQ & ROP MRP

Inventory Type : Purpose Inventory Type : Purpose • Seasonal stocks

– These are accumulated to absorb seasonal fluctuations in supply or demand.

• Cycle stocks– Due to fixed transportation and handling charges or

set up requirements, it is economical to order or produce large quantities at a time.

• Safety stocks– These are built as a hedge against uncertainties in

supply or demand.

• Pipeline stocks– Inventories in-transit.

ABC AnalysisABC Analysis

Stock-keeping units (SKU) Identify the classes so management can

control inventory levels A Pareto chart

10 20 30 40 50 60 70 80 90 100

Percentage of SKUs

Per

cen

tag

e o

f d

oll

ar v

alu

e

100 —

90 —

80 —

70 —

60 —

50 —

40 —

30 —

20 —

10 —

0 —

Class C

Class A

Class B

ABC AnalysisABC Analysis

ABC ProblemABC Problem

Booker’s Book Bindery divides SKUs into three classes, according to their dollar usage.

Calculate the usage values of the following SKUs and determine which is most likely to be classified as class A.

SKU Number Description Quantity Used per Year

Unit Value ($)

1 Boxes 500 3.00

2 Cardboard (square feet)

18,000 0.02

3 Cover stock 10,000 0.75

4 Glue (gallons) 75 40.00

5 Inside covers 20,000 0.05

6 Reinforcing tape (meters)

3,000 0.15

7 Signatures 150,000 0.45

ABC ProblemABC Problem

SKU Number Description

Quantity Used per

Year

Unit Value ($)

Annual Dollar Usage ($)

1 Boxes 500 3.00 = 1,500

2 Cardboard (square feet)

18,000 0.02 = 360

3 Cover stock 10,000 0.75 = 7,500

4 Glue (gallons) 75 40.00 = 3,000

5 Inside covers 20,000 0.05 = 1,000

6 Reinforcing tape (meters)

3,000 0.15 = 450

7 Signatures 150,000 0.45 = 67,500

Total 81,310

ABC ProblemABC Problem

Percentage of SKUs

Pe

rce

nta

ge

of

Do

lla

r V

alu

e

100 –

90 –

80 –

70 –

60 –

50 –

40 –

30 –

20 –

10 –

0 –10 30 40 50 60 70 80 90 10020

Class C

Class A

Class B

Inventory Cost Inventory Cost

• Holding costs - associated with holding or “carrying” inventory over time

• Ordering costs - associated with costs of placing order and receiving goods

• Setup costs - cost to prepare a machine or process for manufacturing an order

• Shortage cost

Terms used in InventoryTerms used in Inventory

• Material cost = Ci (Average price paid per unit purchased is a key cost in

the lot-sizing decision )

• Fixed ordering cost = Co (Fixed ordering cost includes all costs that do

not vary with the size of the order but are incurred each time an order is

placed)

• Holding cost = CH = %*Ci (Holding cost is the cost of carrying one unit

in inventory for a specified period of time i.e. $ CH/Unit/Year)

• Quantity in a lot or batch size = Q (Quantity is either produced or

purchased at a time, EOQ* = Q* )

• Demand per unit time = D (i.e. Demand in one 1 year, d = average

demand per week, So, D = d *52 / year)

Inventory Cost Inventory Cost Holding Costs Holding Costs (CH)

• Obsolescence• Insurance• Extra staffing• Interest• Pilferage• Damage• Warehousing• etc.

Ordering Costs Ordering Costs (Co)

• Supplies• Forms• Order processing• Clerical support• etc.

• Clean-up costs• Re-tooling costs• Adjustment costs• etc.

Setup Costs Setup Costs (Cs)

Holding cost (CH)

• Cost of Capital

• Obsolescence cost

• Handling cost

Vary with quantity of product received , ZERO otherwise

• Occupancy cost

Vary with quantity of product stored, ZERO otherwise

• Miscellaneous costs

Theft, security, damage, tax, insurance

Inventory CostInventory Cost

Ordering cost (Co)

• Buyer time

Time of buyer for placing extra order, ZERO otherwise

Internet and communication has reduced this cost significantly

• Receiving costs

Administrative work such as purchase order matching with

updating inventory records

Quantity dependent should not be included here

• Transportation costs

Fixed cost should be included here

Inventory CostInventory Cost