scm inventory 21 oct bt

Inventory Management in Inventory Management in Supply ChainSupply Chain

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Supply Chain Management by R P Mohanty & S G Deshmukh © Biztantra NextBack

Importance of Inventory Management in the Supply Chain• Resource availability (such as that of finance and space) has forced management to consider how best to lower the levels of inventory within the supply chain management systems in order to maintain margins • The realization by many companies that a greater return-on-investment (ROI) can be obtained by developing the core business, and that investment in working capital items, such as inventory and debtors, returns far less in comparison to other initiatives. • The developments IT front provides a potential tool to reduce the inventory. Inventory and information can be traded. The better the information lower is the need for inventory. Information systems such as POS (point of sales), ERP (Enterprise Resource Planning systems) can significantly reduce the inventory.


Why inventory?

• Leverage economies of scale by producing in large volumes (typically unit costs are lowest when product is a manufactured in long production run at constant quantities).• Exploit economies of scale in purchase and transportation based on the notion that both product procurement and transportation costs will be reduced if lot sizes are large.• Inventory provides hedges against price changes: Especially In India, observe the tendency to hoard commodities in anticipation of price rise just before the budget (in the months of Jan/Feb, just before the financial budget). This suggests that volume purchases will minimize the impact of suppliers’ price increases. • Inventory protects against demand and lead-time uncertainties.


Tradeoff between Inventory &

service


Inventory

Type of demand Characteristics Inventory policy

Constant or uniform demand

Predictable high flow rates Minimum stock. Direct deliveries from suppliers.

Wavy pattern Slow moving flow rates, High critically. Perishable, Peaks are relative predictable

Minimize Inventory holding, building them only during peak demand period. Direct delivery from supplier where possible.

Sudden Upshot: Type (a)

High criticality, Low value, Long lead-time, Small physical size.

Hold high level of stock thereby allowing safety stock for delivery lead-time and demand fluctuations.

Sudden Upshot: Type (b)

Low criticality, High value, Bulky physical characteristics, Demand Peaks are relatively predictable.

Minimize stockholding, building them only during peak demand period. Direct delivery from supplier where possible.


Selective Inventory Control: Pareto Analysis or ABC analysis

Pareto analysis (sometimes referred to as the 80/20 rule and as ABC analysis) is a method of Pareto analysis (sometimes referred to as the 80/20 rule and as ABC analysis) is a method of classifying items, events, or activities according to their relative importance.

It is frequently used in inventory management where it is used to classify stock items into groups based on the total annual expenditure for, or total stockholding cost of, each item. Companies often concentrate on the high value/important items.

ABC analysis is used to prioritize the items.


Pareto (ABC) Analysis Vital few/ Trivial

many!

10 20 30 40 50 60 70 80 90 100

Percentage of items

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


Inventory Costs

Purchase orProduction

Cost of item

HoldingCosts

Ordering orSetupCost

Stock outCost

Total Inventory Cost


Inventory Decisions: How and

When

How many units should be ordered when an order is placed?

When should the order be placed?


Continuous Review (Q System)

On

-han

d i

nve

nto

ry

Time

Orderreceived

Orderreceived

Q Q

OH OH

Orderplaced

Orderplaced

IP IP

TBO

L

TBO

L

TBO

L

R

Orderreceived

Q

OH

Orderplaced

IP

Orderreceived


Uncertain Demand

Time

On

-han

d i

nve

nto

ry

Orderreceived

Q

OH

Orderplaced

Orderplaced

Orderreceived

IPIP

R

TBO1 TBO2 TBO3

L1 L2 L3

Q

Orderplaced

Q

Orderreceived

Orderreceived


Periodic Review Systems (P

System)

Time

On

-han

d i

nve

nto

ry

IP1

IP3

IP2

Orderreceived

Orderreceived

IP IP

OH OH

Orderplaced

Orderplaced

Q1Q2

Q3

L L LP P

Protection interval

T

Orderreceived

IP


EOQ Model

EOQ - Economic Order Quantity Model

Assumptions

- Delivery is immediate- There is no time lag between

purchasing and availability - lead time is

zero

- Demand is deterministic

- Demand is constant over a period of time

- We know how much will be demanded and when the

demand will occur

- There are no space/budget constraints

- No interaction of items

- A lot of items can be broken down into identifiable,

individual items.


EOQ Model

D = units of demand per year

c = unit item cost

A = Ordering cost for each order

H = cost to hold a unit in inventory for one year

Q = Order quantity


Example

Excel purchases a component part for one of their specialty assembly from an outside vendor

– Item cost Mu 1.20 each.

– Ordering cost : Mu 50

– Inventory Holding Rate : 25 %

– Average demand : 1600 units /week

– MU: Monetary Unit


Analysis

Average Weekly = 1600 units

Annual Demand = 52 weeks x 1600 = 83,200

Daily Demand = 83,200/365 = 228

How many to order and how often?

Option 1: Order every 4 days

Order 4 x 228 = 912 units

Number of Orders = 365/4 = 91.2


Inventory Option 1

900

600

300

0 0 2 4 6 8 10 12Working Day

Inve

nto

ry

Lev

elQ=912

Q/2 = 456Average Inv.

Maximum Inv.

Minimum Inv.


Costs

Holding Cost = H

Per Unit = (.25)(1.20) = Mu 0.30 = H

(note: annual per unit holding cost is 25% of price)

Annual Holding = (H) (Q/2)

Annual = (.30) (456 units) = Mu 136.80

Ordering Cost = A

Per Order = Mu 50.00 = A

Annual Ordering = (D/Q)A

Annual Cost = (91.2)(Mu 50) = Mu 4560

TC = (H) (Q/2) + (D/Q)A + c(D)

Holding Ordering Purchasing

= 136 + 4560 + 99840

TC = Mu 104,536


Finding a “better” choice for Q

Since the unit purchase cost, c, is a constant regardless of what we select for Q, it can be

ignored and we can deal only with the holding and ordering cost portion of total cost.

Thus for Q = 912 units


Inventory Cost Analysis

c = 1.2h = 0.3D = 83200A = 50

Order Quantity Orders Holding Cost Order Cost Total Cost500 166 75.00$ 8,320.00$ 8,395.00$ 1000 83 150.00$ 4,160.00$ 4,310.00$ 1500 55 225.00$ 2,773.33$ 2,998.33$ 2000 42 300.00$ 2,080.00$ 2,380.00$ 2500 33 375.00$ 1,664.00$ 2,039.00$ 3000 28 450.00$ 1,386.67$ 1,836.67$ 3500 24 525.00$ 1,188.57$ 1,713.57$ 4000 21 600.00$ 1,040.00$ 1,640.00$ 4500 18 675.00$ 924.44$ 1,599.44$ 5000 17 750.00$ 832.00$ 1,582.00$ 5500 15 825.00$ 756.36$ 1,581.36$ 6000 14 900.00$ 693.33$ 1,593.33$ 6500 13 975.00$ 640.00$ 1,615.00$ 7000 12 1,050.00$ 594.29$ 1,644.29$ 7500 11 1,125.00$ 554.67$ 1,679.67$


Inventory Costs Analysis

(Cont.)

$-

$1,000.00

$2,000.00

$3,000.00

$4,000.00

$5,000.00

$6,000.00

$7,000.00

$8,000.00

$9,000.00

500

2000

3500

5000

6500

8000

9500

Order Quantity

Co

st

Holding Cost

Order Cost

Total Cost

MinimumTotal Cost


Average Inventory Value vs Lots Per Year

0

1000

2000

3000

4000

5000

6000

7000

0 50 100 150 200

Lots Per Year

Ave

rag

e In

ven

tory

Val

ue

Inventory Costs Analysis

(Cont.)

Ave. Inv. Value = c (Q/2)


Solving for the Optimal Quantity

EOQ

H

2DA = Q*

5266.25 = .30

0)2(83200)(5 = Q*

TC = (Q/2)(H) + (D/Q)(S)

= (5266.25/2)(.30) + (83200/5266.25)50

= Mu 789.94 + Mu 789.94 = Mu 1579.88

EOQ=

EOQ=


Issue of Sensitivity

Inventory Costs are not particularly sensitive to small changes in lot size

Order Quantity Orders (Lots) Holding Cost Order Cost Total Cost5400 15 810.00$ 770.37$ 1,580.37$ 5350 16 802.50$ 777.57$ 1,580.07$ 5300 16 795.00$ 784.91$ 1,579.91$ 5250 16 787.50$ 792.38$ 1,579.88$ 5200 16 780.00$ 800.00$ 1,580.00$

EOQ = 5266 Total Cost = Mu 1579.88


Time Between Orders

T = Q* = EOQ = 5266.25 = .063 years D D 83200

T = .063 x 365 days = 23.1 days = 23 days

Thus inventory Model : Order 5266 units every 23rd Day


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scm inventory 21 oct bt

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