12 – 1 Operations Management Chapter 12 – Inventory Management © 2006 Prentice Hall, Inc. PowerPoint presentation to accompany Heizer/Render Principles.

12 – 1

Operations ManagementOperations ManagementChapter 12 – Inventory ManagementChapter 12 – Inventory Management

© 2006 Prentice Hall, Inc.

PowerPoint presentation to accompanyPowerPoint presentation to accompany Heizer/Render Heizer/Render Principles of Operations Management, 6ePrinciples of Operations Management, 6eOperations Management, 8e Operations Management, 8e

12 – 2

What is Inventory?

Stock of items kept to meet future demand

One of the most expensive assets of many companies representing as much as 50% of total invested capital

Operations managers must balance inventory investment and customer service

12 – 3

Inventory Management

Purpose of inventory management addresses these two basic inventory issues:

How many units to order?

When to order?

12 – 4

Types of Inventory

Raw material Purchased but not processed

Work-in-process (WIP) Undergone some change but not completed

Maintenance/repair/operating (MRO) Necessary to keep machinery and processes

productive

Finished goods Completed product awaiting shipment

12 – 5

Inventory and SCM

Bullwhip effect Demand information is distorted as it moves

away from end-use customer Higher safety stock is stored to compensate

Seasonal or cyclical demand Inventory provides independence from

vendors Take advantage of price discounts Inventory provides independence between

stages and avoids work stoppages

12 – 6

Inventory Management

Questions that need to be answered to determine how an inventory management system should be built (welcome back OPIM 203)

These are only the starting point

How are inventory items classified?

How can accurate inventory records can be maintained?

12 – 7

ABC Analysis

Divides inventory into three classes based on annual dollar volume Class A - high annual dollar volume

Class B - medium annual dollar volume

Class C - low annual dollar volume

Used to establish policies that focus on the few critical parts and not the many trivial ones

12 – 8

ABC Analysis

A ItemsA Items

B ItemsB ItemsC ItemsC Items

Pe

rce

nt o

f an

nua

l do

llar

usa

ge

80 80 –

70 70 –

60 60 –

50 50 –

40 40 –

30 30 –

20 20 –

10 10 –

0 0 – | | | | | | | | | |

1010 2020 3030 4040 5050 6060 7070 8080 9090 100100

Percent of inventory items Figure 12.2Figure 12.2

12 – 9

ABC Analysis

Other criteria than annual dollar volume may be used Anticipated engineering changes

Delivery problems

Quality problems

High unit cost

12 – 10

Record Accuracy Accurate records are a critical ingredient

in production and inventory systems

Allows organization to focus on what is needed

Necessary to make precise decisions about ordering, scheduling, and shipping

Incoming and outgoing record keeping must be accurate

Stockrooms should be secure

Losses may come from pilferage

12 – 11

Independent Versus Dependent Demand

Independent demand - the demand for item is independent of the demand for any other item in inventory

Dependent demand - the demand for item is dependent upon the demand for some other item in the inventory

12 – 12

Inventory Costs

Holding cost - the cost of holding or “carrying” inventory over time

Ordering cost - the cost of placing an order and receiving goods

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

Shortage cost – temporary or permanent loss of sales when demand cannot be met

12 – 13

Holding Costs

Category

Cost (and Range) as a Percent of Inventory Value

Housing costs (including rent or depreciation, operating costs, taxes, insurance)

6% (3 - 10%)

Material handling costs (equipment lease or depreciation, power, operating cost)

3% (1 - 3.5%)

Labor cost 3% (3 - 5%)

Investment costs (borrowing costs, taxes, and insurance on inventory)

11% (6 - 24%)

Pilferage, space, and obsolescence 3% (2 - 5%)

Overall carrying cost 26%

Table 12.1Table 12.1

12 – 14

Inventory Models for Independent Demand

Basic economic order quantity

Production order quantity

Quantity discount model

Need to determine when and how Need to determine when and how much to ordermuch to order

12 – 15

Basic EOQ Model

1. Demand is known, constant, and independent

2. Lead time is known and constant

3. Receipt of inventory is instantaneous and complete

4. Quantity discounts are not possible

5. Only variable costs are setup and holding

6. Stockouts can be completely avoided / No shortages allowed

Important assumptionsImportant assumptions

12 – 16

Inventory Usage Over Time

Figure 12.3Figure 12.3

Order Order quantity = Q quantity = Q (maximum (maximum inventory inventory

level)level)

Inve

nto

ry le

vel

Inve

nto

ry le

vel

TimeTime

Usage rateUsage rate Average Average inventory inventory on handon hand

QQ22

Minimum Minimum inventoryinventory

12 – 17

Minimizing Costs

Objective is to minimize total costsObjective is to minimize total costs

Table 11.5Table 11.5

An

nu

al c

ost

An

nu

al c

ost

Order quantityOrder quantity

Curve for total Curve for total cost of holding cost of holding

and setupand setup

Holding cost Holding cost curvecurve

Setup (or order) Setup (or order) cost curvecost curve

Minimum Minimum total costtotal cost

Optimal Optimal order order

quantityquantity

12 – 18

The EOQ Model

QQ = Number of pieces per order= Number of pieces per orderQ*Q* = Optimal number of pieces per order (EOQ)= Optimal number of pieces per order (EOQ)DD = Annual demand in units for the Inventory item= Annual demand in units for the Inventory itemSS = Setup or ordering cost for each order= Setup or ordering cost for each orderHH = Holding or carrying cost per unit per year= Holding or carrying cost per unit per year

Annual setup cost Annual setup cost == ((Number of orders placed per yearNumber of orders placed per year) ) x (x (Setup or order cost per orderSetup or order cost per order))

Annual demandAnnual demand

Number of units in each orderNumber of units in each orderSetup or order Setup or order cost per ordercost per order

==

= (= (SS))DDQQ

Annual setup cost = SDQ

12 – 19

The EOQ Model

QQ = Number of pieces per order= Number of pieces per orderQ*Q* = Optimal number of pieces per order (EOQ)= Optimal number of pieces per order (EOQ)DD = Annual demand in units for the Inventory item= Annual demand in units for the Inventory itemSS = Setup or ordering cost for each order= Setup or ordering cost for each orderHH = Holding or carrying cost per unit per year= Holding or carrying cost per unit per year

Annual holding cost Annual holding cost == ((Average inventory levelAverage inventory level) ) x (x (Holding cost per unit per yearHolding cost per unit per year))

Order quantityOrder quantity

22= (= (Holding cost per unit per yearHolding cost per unit per year))

= (= (HH))QQ22

Annual setup cost = SDQ

Annual holding cost = HQ2

12 – 20

The EOQ Model

QQ = Number of pieces per order= Number of pieces per orderQ*Q* = Optimal number of pieces per order (EOQ)= Optimal number of pieces per order (EOQ)DD = Annual demand in units for the Inventory item= Annual demand in units for the Inventory itemSS = Setup or ordering cost for each order= Setup or ordering cost for each orderHH = Holding or carrying cost per unit per year= Holding or carrying cost per unit per year

Optimal order quantity is found when annual setup cost Optimal order quantity is found when annual setup cost equals annual holding costequals annual holding cost

Annual setup cost = SDQ

Annual holding cost = HQ2

DDQQ

SS = = HHQQ22

Solving for Q*Solving for Q*22DS = QDS = Q22HHQQ22 = = 22DS/HDS/H

Q* = Q* = 22DS/HDS/H

12 – 21

An EOQ Example

Determine optimal number of needles to orderDetermine optimal number of needles to orderD D = 1,000= 1,000 units unitsS S = $10= $10 per order per orderH H = $.50= $.50 per unit per year per unit per year

Q* =Q* =22DSDS

HH

Q* =Q* =2(1,000)(10)2(1,000)(10)

0.500.50= 40,000 = 200= 40,000 = 200 units units

12 – 22

An EOQ Example

Determine optimal number of needles to orderDetermine optimal number of needles to orderD D = 1,000= 1,000 units units Q* Q* = 200= 200 units unitsS S = $10= $10 per order per orderH H = $.50= $.50 per unit per year per unit per year

= N = == N = =Expected Expected number of number of

ordersorders

DemandDemandOrder quantityOrder quantity

DDQ*Q*

N N = = 5= = 5 orders per year orders per year 1,0001,000200200

12 – 23

An EOQ Example

Determine optimal number of needles to orderDetermine optimal number of needles to orderD D = 1,000= 1,000 units units Q*Q* = 200= 200 units unitsS S = $10= $10 per order per order NN = 5= 5 orders per year orders per yearH H = $.50= $.50 per unit per year per unit per year

= T == T =Expected Expected

time between time between ordersorders

Number of working Number of working days per yeardays per year

NN

T T = = 50 = = 50 days between ordersdays between orders250250

55

12 – 24

An EOQ Example

Determine optimal number of needles to orderDetermine optimal number of needles to orderD D = 1,000= 1,000 units units Q*Q* = 200= 200 units unitsS S = $10= $10 per order per order NN = 5= 5 orders per year orders per yearH H = $.50= $.50 per unit per year per unit per year TT = 50= 50 days days

Total annual cost = Setup cost + Holding costTotal annual cost = Setup cost + Holding cost

TC = S + HTC = S + HDDQQ

QQ22

TC TC = ($10) + ($.50)= ($10) + ($.50)1,0001,000200200

20020022

TC TC = (5)($10) + (100)($.50) = $50 + $50 = $100= (5)($10) + (100)($.50) = $50 + $50 = $100