2009 South-Western, a part of Cengage Learning MANAGING INVENTORIES CHAPTER 12 DAVID A. COLLIER AND JAMES R. EVANS OM 2 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Can you cite any experiences in which the lack of appropriate inventory at a retail store has caused you as the customer to be dissatisfied?
Inventory is any asset held for future use or sale. The expenses associated with financing and maintaining inventories are a substantial part of the cost of doing business (i.e., cost of goods sold). Inventory Management involves planning, coordinating, and controlling the acquisition, storage, handling, movement, distribution, and possible sale of raw materials, component parts and subassemblies, supplies and tools, replacement parts, and other assets that are needed to meet customer wants and needs. Chapter 12 Managing Inventories
3 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Basic Inventory Concepts Raw materials, component parts, subassemblies, and supplies are inputs to manufacturing and service-delivery processes. Work-in-process (WIP) inventory consists of partially finished products in various stages of completion that are awaiting further processing. Finished goods inventory is completed products ready for distribution or sale to customers. Chapter 12 Managing Inventories 4 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Basic Inventory Concepts Cycle inventory (order or lot size inventory) is inventory that results from purchasing or producing in larger lots than are needed for immediate consumption or sale. Safety stock inventory is an additional amount of inventory that is kept over and above the average amount required to meet demand. Chapter 12 Basic Inventory Concepts 5 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Inventory managers deal with two fundamental decisions: 1. When to order items from a supplier or when to initiate production runs if the firm makes its own items 2. How much to order or produce each time a supplier or production order is placed Chapter 12 Managing Inventories 6 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Inventory Management Decisions & Costs Four categories of inventory costs: Ordering costs or setup costs are incurred as a result of the work involved in placing purchase orders with suppliers or configuring tools, equipment, and machines within a factory to produce an item. Inventory-holding costs or inventory- carrying costs are the expenses associated with carrying inventory. Chapter 12 Managing Inventories 7 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Inventory Management Decisions & Costs Shortage costs or stockout costs are the costs associated with a SKU being unavailable when needed to meet demand. Unit cost is the price paid for purchased goods or the internal cost of producing them. Chapter 12 Managing Inventories 8 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning
Characteristics of Inventory Systems Number of items: each item is identified by its stock-keeping unit (SKU). A stock-keeping unit (SKU) is a single item or asset stored at a particular location. Maintaining data integrity on thousands of SKUs is difficult but must be done. The quality of inventory model decisions is related to the quality of information used in the model(s). Chapter 12 Managing Inventories
9 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Nature of Demand Independent demand is demand for an SKU that is unrelated to the demand for other SKUs and needs to be forecast. Dependent demand is demand directly related to the demand for other SKUs and can be calculated without needing to be forecast. Deterministic demand is when uncertainty is not included in its characteristics. Stochastic demand incorporates uncertainty by using probability distributions. Static demand is stable demand. Dynamic demand varies over time. Chapter 12 Managing Inventories
10 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Characteristics of Inventory Systems Number of time periods in planning horizon: short or long planning horizon such as days, weeks, months, quarters, and years. Size of time periods: hours, days, weeks, months, quarters. The lead time is the time between placement of an order and its receipt.
Chapter 12 Managing Inventories
11 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Characteristics of Inventory Systems A stockout is the inability to satisfy demand for an item. When a stockout happens, the item is either back-ordered or a sale is lost. A backorder occurs when a customer is willing to wait for an item. A lost sale occurs when the customer is unwilling to wait and purchases the item elsewhere. Chapter 12 Managing Inventories 12 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Inventory Management Infrastructure ABC inventory (Pareto) analysis gives managers useful information to identify the best methods to control each category of inventory (see Exhibits 12.2 to 12.4). A vital few SKUs represent a high percentage of the total dollar inventory value. Chapter 12 ABC Inventory Analysis 13 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning ABC Inventory (Pareto) Analysis A items account for a large dollar value but relatively small percentage of total items (e.g., 10% to 30 % of items, yet 60% to 80% of total dollar usage). C items account for a small dollar value but a large percentage of total items (e.g., 5% to 15% of items, yet about 50% of total dollar usage). These can be managed using automated computer systems. B items are between A and C. Chapter 12 ABC Inventory Analysis 14 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning In a fixed quantity system (FQS), the order quantity or lot size is fixed; the same amount, Q, is ordered every time. The process of triggering an order is based on the inventory position. Inventory position (IP) is the on-hand quantity (OH) plus any orders placed but which have not arrived (scheduled receipts, or SR), minus any backorders (BO). IP = OH + SR BO [12.1] Chapter 12 Managing Inventories
15 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Fixed Quantity System When inventory falls at or below a certain value, r, called the reorder point, a new order is placed. Reorder point depends on the lead time and nature of demandoftentimes, the reorder point is selected using the average demand during the lead time ( L ). r = L = (d) (L) [12.2] Where d is average demand per unit of time and L is the lead time expressed in the same units of time. Chapter 12 Managing Inventories 16 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Exhibit 12.6 Fixed Quantity System (FQS) under Stable Demand 17 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning The Economic Order Quantity (EOQ) model is a classic economic model developed in the early 1900s that minimizes total cost, which is the sum of the inventory-holding cost and the ordering cost. Cost of storing one unit in inventory for the year (denoted by C h ), is given by C h = (I) (C ), where I is annual inventory-holding charge, C is unit cost of the inventory item, and Q is the number of units in inventory. Chapter 12 Managing Inventories [12.4] annual inventory holding cost average inventory annual holding cost per unit = ( )
= 1
2
QC h
( ) 18 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Optimal Order Quantity: order quantity that minimizes the total cost.
Q* is the quantity that minimizes the total cost and is known as the economic order quantity, or EOQ. Chapter 12 Managing Inventories
Q* =
2DC o
C h
[12.7] 19 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Only a single item (SKU) is considered. The entire order quantity (Q) arrives in the inventory at one time. No physical limits are placed on the size of the order quantity, such as shipment capacity or storage availability. Only two types of costs are relevant order/setup and inventory holding costs. Chapter 12 Key Assumptions of the EOQ Model 20 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning No stockouts are allowed. The demand for the item is deterministic and continuous over time. This means that units are withdrawn from inventory at a constant rate proportional to time. For example, an annual demand of 365 units implies a monthly demand of 365/12 and a daily demand of one unit. Lead time is constant. Chapter 12 Key Assumptions of the EOQ Model (continued) 21 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Exhibit 12.9 Chart of Holding, Ordering, and Total Costs
22 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Fixed Period Systems An alternative to a fixed order quantity system is a fixed period system (FPS)sometimes called a periodic review systemin which the inventory position is checked only at fixed intervals of time, T, rather than on a continuous basis. Two principal decisions in a FPS: 1. The time interval between reviews (T), and 2. The replenishment level (M) Chapter 12 Managing Inventories 23 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Fixed Period Systems (no uncertainty) Economic time interval: T = Q*/D [12.11] Optimal replenishment level: M = d (T + L) [12.12] Where d = average demand per time period L = lead time in the same time units M = demand during the lead time plus review period Chapter 12 Managing Inventories
24 OM, Ch. 12 Managing Inventories 2009 South-Western, a part of Cengage Learning Single-Period Inventory Model Applies to inventory situations in which one order is placed for a good in anticipation of a future selling season where demand is uncertain. At the end of the period, the product has either sold out or there is a surplus of unsold items to sell for a salvage value. Sometimes called a newsvendor problem, because newspaper sales are a typical example of the single-period inventory problem. Chapter 12 Special Models for Inventory Management