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Inventory Management
Inventory: A quantity of goods/materials in the control of a firm and hold for a time in a relatively idle state awaiting its intend use or sale Inventory Management: To determine an optimal level of holding such idle resources through certain procedures/rules on the decisions of when/how much to order for procurement or production
Major objectives of inventory management: 1. Minimizing total inventory management cost under given constraints 2. Satisfying desired customer service level
Functions of Inventory
1. To prevent fluctuation in demand 2. To meet seasonal demand change 3. To protect variation in supply 4. To obtain economy of scale in procurement/production 5. To maintain independence of operations 6. To smooth production process 7. To provide flexibility for production planning and scheduling
Type of Inventory
Inventory types: 1. RM/purchased parts/subassemblies 2. Work-in-process 3. Finished goods
Inventory: Purposetheand Types material Purpose: Buffering against any uncertainty in work flow process from
purchasing to finished goods shipping through providing a buffer between successive work flow stages. Types: Operation Type Manufacturing Inventory Type Purchased RMs and Parts Buffered Flows Between Purchasing and manufacturing operations
Work-In-Process
Finished Goods Services Delivery: Supplies
Wholesale/ Retail
Inventory Management
Costs affected by inventory decisions
Ordering (or setup costs) Clerical costs Transportation and receiving costs Cost incurred in setting up production Order follow-up cost
Inventory holding cost Space costs Storage costs Cost of capital invested Insurance costs Taxes on investment values Costs of spoilage
Stockout or shortage costs Expediting costs Rush shipment costs Possible loss Loss of profit Potential loss of customer
Costs of purchased items on which price discounts are offered based on Total dollar values of purchase order for items
Inventory Costs
Interest or opportunity Cost Storage and Handling Costs Taxes, Insurance, and Shrinkage Customer Service Cost Ordering Cost/Setup Cost Labor and Equipment Cost Transportation Costs Payments to Suppliers
Customer Service: measured by the availability of items when needed a performance measure of inventory management Customer may be: purchaser of FG/distribution/another plant or shop where next operation is performed Customer Service Level: a target level for keeping initial delivery schedules and backorders
Service level: an inventory management performance criterion measured by ---the percentage of stock-out occurrence defined as service level=1-P(percentage of stock-out) Safety stock: a quantity of inventory which have been set aside to reduce the probability of stockout or to improve the service level.
ABC Analysis
100 90 Class A 80 70 60 50 40 30 20 10 0 10 Figure 15.2 20 30 40 50 60 70 80 90 100 Class B Class C
Percentage of items
The first step in categorizing the item is to estimate the dollar value of annual usage for each item (multiply the selling price by the estimated annual usage). Then, they should be arranged in descending order. The result of these two steps are:
Item Value of annual usage $56,125.00 30,000.00 28,072.00 18,400.00 12,800.00 10,880.00 6,825.00 5,250.00 4,200.00 3,157.50 Cumulative value of Cumulative percent annual usage of value of annual usage $ 56,125.00 31.9 % 86,125.00 49.0 A 114,197.00 65.0 132,597.00 75.5 145,397.00 82.7 156,277.00 88.9 B 163,352.00 92.8 168,352.00 95.8 C 172,552.00 98.2 175,709.50 100.0
2222 1001 5376 0053 4197 0070 4421 3080 3683 2121
Assume the wholesaler wants to construct the ABC classification with A items representing 75% of the sales, B using the table above the classification would be:
Item A 2222 1001 5376 0053 Item B 4197 0070 Item C 4421 3080 3683 2121
Types of Demand
Independent Demand
When items demand is influenced by market conditions and is not related to (i.e. independent of) production decisions for any other item Only end items can qualify in manufacturing Demand must be forecast (uncontrollable) When items demand derives from (i.e. depends on) the production decisions for its parent All intermediate and purchased items in manufacturing Demand should be derived (can be controlled)
Dependent Demand
Some items can be viewed as both independent and dependent demand items!
Single item inventory vs. multiple-item inventory Single stage inventory vs. multi-stage Static demand vs. dynamic demand Stochastic demand vs. determined demand
Periodical review at fixed time interval (T) Place an order at end of each period with a quantity that build On- Hand Inventory up to M
3. Hybrid System: Combination of Fixed Order Interval (T) and Reorder Point System (R) (Several Possible Combinations). 4. Time-Phased Order Point System: (MRP Application on Independent Demand Items) 5. Single-Period Model: for Perishable Items (Newspaper/ Flower)
Q 2
Figure 15.3
1 cycle
Time
Continuous Review
IP Order received Order received IP Order received
IP
Order received
On-hand inventory
OH
OH
OH
R
Order placed L TBO TBO Order placed L TBO Figure 15.7 Order placed L
Time
Order received
OH
IP
Order received Q3 OH
IP
Order received
Q1
IP1 IP3 IP2 Order placed
Q2
Order placed
L P
Figure 15.12
L P
Time
Protection interval
(d) Q R Q
SS= 0
LT LT LT
D= annual demand (expressed in units/ year) L= reorder lead time (expressed as a fraction of a year) S= ordering cost (expressed as $ per order) C= item cost (expressed in $ per unit) F= inventory holding cost fraction (expressed as a fraction of item cost per year) H= holding cost = (C*F) The total annual cost (TC) for a purchased item managed with a perpetual inventory system can be calculated as follows: TC= (cost of the item) + (ordering cost) + (inventory holding cost) D*C + ( Q/2)*H + (D/Q)*S
Total cost =
2000
Q D (H) + (S) 2 Q
Holding cost =
1000
Q (H) 2
Ordering cost =
0 | 50 | 100 | 150 | 200 | 250 | 300 | 350 | 400
D (S) Q
Figure 15.4
P. 15-15.
Problem: If lead time is one day and there are 250 working days during the year, what is the reorder point?
Solution: d= 120,000/250= 480, L=1, SS=0 R= d.L + SS= (480X1) + 0 = 480
Problem: What is the total annual cost of this reordering system? Solution: TC = D.C + (D/Q).S + (Q/2).H = (120,000)(0.3) + (120,000/1,483)1.65+(1483/2)X0.18 = $36,267
Assumptions
1. Demand rate is constant 2. No constraints on lot size 3. Only relevant costs are holding and ordering/setup 4. Decisions for items are independent from other items 5. No uncertainty in lead time or supply 6. One Time delivery.
2*D*S
Imax
Maximum inventory
pd
pd Q Imax = (p d) = Q p p
Time
Production and demand
Demand only
TBO
Figure E.1
P. 15-17.
A manufacturer of steel products uses a large, special bolt as a fastener in all products in a particular product line. The usage rate of this item is 2000 per day. There are 250 working days in the year.
It takes 30 minutes to prepare a manufacturing order for this bolt. The clerks make $5.00 per hour.
It takes one hour to change the tooling to begin a production run for the bolt. The setup personnel make $9.00 per hour. The production run is 5000 units per day. C=1.30; F=25%; H=(1.3x25%)=0.325; d= 2,000; D=2,000x250=500,000 Problem: What is the economic production quantity for this item assuming a manufacturing cost of $1.30 and an annual holding cost of 25% of the manufacturing cost? S: (0.5x5) + (1x9)= $11.50, P=5,000 EPQ= (2.D.S)x P/H.(P-d) = (2x500,000x11.50)x5,000/0.325X(5,000-2,000) 7,680
Problem: If lead time is 1.5 days, what is the reorder point? Solution: L= 1.5; SS=0 R = d.L +SS = 2,000X1.5+0 = 3,000
Periodic Systems
Periodic Systems
T= economic order interval = L= reorder lead time (expressed as a fraction of a year) S= ordering cost (expressed as a fraction of a year) D= annual demand (expressed in units/year) C= item cost (expressed in $ per unit) F= inventory holding cost fraction (expressed as a fraction of item cost per year) Order quantity = Q= d(L+T) + SS It = M- It (M= (Base-Level) = d(L+T) + SS It = [On-Hand] + [On-Order] [Back Order])
P. 15-19.
An auto parts store carrier a universal gasoline filter. The store sells 4000 units of this item annually. The cost of this filter from the supply house is $0.50 and the annual holding cost is 20% of the unit value. The cost of preparing a purchase order is $8.00. D=4,000; C=0.5; F=20%; H=0.5X0.2=0.1 Problem: If the store is open 51 weeks per year, how many weeks should there be between orders? S=$8.00 T= 2.S/H.D = 2x8/0.1x4,000 =0.2 (Years) x 51 =10.2 (Weeks)
Problems: If the lead time is one week, what is the quantity to be ordered if 110 units are currently on hand at the end of a reorder interval?
D=4,000/51=78, L=1; It=110, SS=0 Q=d(T+L)+SS-It =78(10.2+1)+0-110770 Problem: How many orders should be placed each year? N= 51/10.2 =5 (Orders)
Hybrid System
A hybrid inventory system has a combination of a fixed order interval and a fixed reorder point. Examples of hybrid systems are:
Place an order every 4 weeks unless the inventory drops below 100 units. Then, place the order immediately Place a order every 4 weeks unless the inventory on hand is more than 250 units. Then, wait another week to place the order
T=
EOQ =
EPQ=
2*S
H*D
2DS H
2*D*S H
Q = d* (L+T)+SS - It
( )
P P-d
Continuous Review (Q,R) System fixed-order quantity system for independent demand item:
When a withdrawal brings Inventory down to the reorder point (R), place an order for Q (fixed) units R= average demand during the lead time + safety stock (safety stock = z* L) Review the inventory every P time periods- place an order (Q) equal to (T-IP), where T is the target inventory. Here Q varies, and time between orders (TBO) is fixed. Same four assumptions, but again allow for uncertain demand.
Order Time
Initiated By Control Point Operating Cost Implementation Data Managing
Fixed at T (period)
Time triggered (when tT) Periodical review only Low Easy Easy and simple
Individual review frequencies Possible quantity discounts Lower, less-expensive safety stocks
Comparative Advantage of Two Systems Periodic review system Administration is convenient Standardized routes for transportation systems Easier to combine orders to same supplier May help with price break or paperwork May reduce suppliers shipping costs Continuous review system Tailoring Q to costs for each item Easier for quantity discounts or capacity limitations Less safety stock Hybrid systems Optional replenishment system Base stock system Special case of Q and P system Single- bin system Two- bin system
In the fixed order quantity system, the ordering process is trigged when the inventory level drops to a critical point the order point This starts the lead time the item--lead time is the time to complete all activities associated with placing filling and receiving the order. During the lead time customers continue to draw down the inventory so during this period that the inventory is vulnerable to stock-out ( run out of inventory) Customer service level is the probability that a stock out will not occur during the lead time (DDLT). The order point is set based on: the demand during lead time and the desired customer service level
Order point = expected demand + safety stock The amount of safety stock needed is based on the degree of uncertainty in the DDLT and the customer service level desired If there is variability in the DDLT the DDLT is expressed as a distribution discrete /continuous DDLT distribution is appropriate when the demand is very high.
Determine R and Safety Stock R = Average Demand during Lead Time + Safety Stock = d*L + SS SS = determined by desired Service Level (%) and Standard deviation of (d*L) = z*L Example: Service Level = 95% = 5% z = 1.96 = 1% z = 2.33 Given: (d*L) = 250 L = 22 = 1% z = 2.33 SS = z* L = 2.33*22 = 51 R = (d*L) + SS = 250 +51 = 301 ~300
Reorder point = ADDLT + SS = 250 + 51 = 301 boxes Average demand during lead time zL
Example 15.5
$ 3.00
If the order quantity: Q < 2000; pay 100/unit If the order quantity: Q > 2000; pay 80/unit
What is the most economic order quantity that minimizes the total cost?
2*10,000*2000
If you order (just) Q= 2000 to obtain the discount price ($80), Then H= C2*F= $80*0.20 = $16, with Q* = 2,000 TC= (10,000*80)+2000/2*16 + 10,000/2000*2000= 826,000 Savings: 1,028,284-826,000=$202.284
TC P1=100
unrational
P2=80
unattainable
1,414
2,000
PD for P = $4.00
PD for P = $3.50
PD for P = $3.00
Due to Square-Root effect, the EOQ model is relatively insensitive to small changes from model parameter. For change in the demand rate (D) or Order Cost (S): -D (or S) is the numerator, EOQ varies directly as the square root of D (or S) For Change in the holding cost (h): -H is in the denominator, so if H decreases, EOQ increases Errors in estimating D, H and S
Errors such as overestimating ordering cost may be offset by other errors such as overestimating holding cost. The square root also reduces the effect of errors. If one misses a cost or demand estimate by 10%, the effect on total cost is often undetectable