19 inventory

8/4/2019 19 Inventory

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INVENTORY

MANAGEMENT



Operations Management 2 Lally School of Management and Technology

Inventory Definition

A stock of items held to meetfuture demand




Types of Inventory

Inputs• Raw Materials• Purchased parts• Maintenance and

Repair Materials

Outputs• Finished Goods

• Scrap and Waste

Process

In Process• Partially CompletedProducts andSubassemblies

(in warehouses, or

“in transit”)

(often on the

factory floor)




Types of Inventory

Work in

process

Work in

process

Work in

process

Finished

goods

Raw

MaterialsVendors Customer




Water Tank Analogy for Inventory

Supply Rate

Inventory Level

Demand Rate

Inventory Level

Buffers Demand

Rate from Supply

Rate




Independent and Dependent DemandInventory

Independent demand – items demanded by external customers

(Tables)

Dependent demand – items used to produce final products (fans,

computers, LCD projectors, etc.)

– Demand determined once we know the typeand number of final products




Independent and Dependent DemandInventory Management

Independent demand – Uncertain / forecasted

– Continuous Review / Periodic Review

Dependent demand – “Requirements” / planned

– Materials Requirements Planning / Just in

Time




Reasons To Hold Inventory

Meet variations in customer demand:Meet unexpected demand

Smooth seasonal or cyclical demand

Pricing related:

Temporary price discountsHedge against price increases

Take advantage of quantity discounts

Process & supply surprises

Internal – upsets in parts of or our own processesExternal – delays in incoming goods

Transit




Reasons To NOT Hold Inventory

Carrying cost

Financially calculable

Takes up valuable factory space

Especially for in-process inventory

Inventory covers up “problems” …

That are best exposed and solved

Driver for increasing inventory turns (finishedgoods) and lean production/Just in time for work inprocess




Inventory Hides Problems

Poor

Quality

UnreliableSupplier

MachineBreakdown

InefficientLayout

BadDesign

Lengthy

Setups




Inventory Cost Structures

Ordering (or setup) cost

Carrying (or holding) cost:Cost of capital

Cost of storageCost of obsolescence, deterioration, and loss

Stock out cost

Item costs, shipping costs and other costsubject to volume discounts




Typical Inventory Carrying Costs

Housing cost:

Building rent or depreciationBuilding operating costTaxes on buildingInsurance

Material handling costs:Equipment, lease, or depreciation

PowerEquipment operating cost

Manpower cost from extra handling and supervision

Investment costs:

Borrowing costsTaxes on inventoryInsurance on inventory

Pilferage, scrap, and obsolescence

Overall carrying cost

6%

(3% - 10%)

3%(1% - 4%)

3%(3% - 5%)

10%

(6% - 24%)

5%(2% - 10%)

(15% - 50%)

Costs as % ofInventory Value




Inventory Management Systems

Functions of Inventory Management

– Track inventory

– How much to order

– When to order

Prioritization

Inventory Management Approach

– EOQ

– Continuous / Periodic




ABC Prioritization

Based on “Pareto” concept (80/20 rule)

and total usage in dollars of each item.

Classification of items as A, B, or C oftenbased on $ volume.

Purpose: set priorities for management

attention.




ABC Prioritization

„A‟ items: 20% of SKUs, 80% of dollars

„B‟ items: 30 % of SKUs, 15% of dollars

„C‟ items: 50 % of SKUs, 5% of dollars

Three classes is arbitrary; could be any

number. Percents are approximate.

Danger: dollar use may not reflect

importance of any given SKU!




ABC Analysis Example

10 20 30 40 50 60 70 80 90 100

Percentage of items

P

e r c e n t a g e

o f d o l l a r v a l u e

100 —

90 —

80 —

70 —

60 —

50 —

40 —

30 —

20 —

10 —

0 —

+Class C

Class A

+Class B




Annual Usage of Items by Dollar Value

Item

Annual Usage in

Units Unit Cost Dollar Usage

Percentage of Total Dollar

Usage

1 5,000 1.50$ 7,500$ 2.9%

2 1,500 8.00 12,000 4.7%

3 10,000 10.50 105,000 41.2%4 6,000 2.00 12,000 4.7%

5 7,500 0.50 3,750 1.5%

6 6,000 13.60 81,600 32.0%

7 5,000 0.75 3,750 1.5%

8 4,500 1.25 5,625 2.2%

9 7,000 2.50 17,500 6.9%

10 3,000 2.00 6,000 2.4%

Total 254,725$ 100.0%




ABC Chart For Previous Slide

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

3 6 9 2 4 1 10 8 5 7

Item No.

P e r c e n

t U s a g e

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

C u m u l a t i v

e % U s a g e

Percentage of Total Dollar Usage Cumulative Percentage

A B C




Inventory Management Approaches

A-items

– Track carefully (e.g. continuous review )

– Sophisticated forecasting to assurecorrect levels

C-items

– Track less frequently (e.g. periodic review )

– Accept risks of too much or too little(depending on the item)




Economic Order Quantity (EOQ)Model

Demand rate D is constant, recurring, and known

Amount in inventory is known at all times

Ordering (setup) cost S per order is fixed

Lead time L is constant and known. Unit cost C is constant (no quantity discounts)

Annual carrying cost is i time the average $ value ofthe inventory

No stockouts allowed. Material is ordered or produced in a lot or batch and

the lot is received all at once




EOQ Lot Size Choice

There is a trade-off between lot size andinventory level.

Frequent orders (small lot size): higher

ordering cost and lower holding cost.Fewer orders (large lot size): lower ordering

cost and higher holding cost.




EOQ Inventory Order Cycle

Demandrate

0 TimeLeadtime

Leadtime

OrderPlaced

OrderPlaced

OrderReceived

OrderReceived

I n v e n t o r y

L

e v e l

Reorder point, R

Order qty, Q

As Q increases, average

inventory level increases, but

number of orders placed

decreases

ave = Q/2




Total Cost of Inventory – EOQ Model

Answer to Inventory Management




Answer to Inventory ManagementQuestions for EOQ Model

Keeping track of inventoryImplied that we track continuously

How much to order?Solve for when the derivative of total cost with respect

to Q = 0: -SD/Q^2 + iC/2 = 0Q = sqrt ( 2SD/iC)

When to order?Order when inventory falls to the “Reorder Point-level”

R so we will just sell the last item as the new ordercomes in:R = DL




Re-order Point Example

Demand = 10,000 units/year

Lead time = L = 10 days

When inventory falls to R, we order so as notto run out before the new order comes in.

R = ?




Re-order Point Example

Demand = 10,000 units/year

Daily demand = 10,000 / 365 = 27.4 units/day

Lead time = L = 10 days

R = D*L = (27.4)(10) = 274 units

(usually can neglect issues of working days vs

weekends, etc.)

Don’t forget to convert to consistent time units!




EOQ Summary

How much to order?

Q = sqrt(2DS/iC)

When to order?R = DL




EOQ Exercise

Now you do it

See Excel Spreadsheet:Excel_Inv_Examples.xls, EOQ tab

Compute the values of R and Q andcompare to the simulation

Next see what happens when you havevolume discounts (EOQ w Discount Tab)




EOQ Example

Unit Cost C $0.45 /unit

Holding cost factor i 25% /yearOrdering cost S $15.00 /order

Demand rate D 10000 units/yearLead time L 0.0192 year

Solutions:

Re-order point R units (rounded)Q = sqrt(2SD/(iC)) units (rounded)

19 inventory

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