Inventory management 091104161506 Phpapp02

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Inventory Management

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DSC 335 Roadmap

Operations Strategy

Process Management

Process strategy/analysis

Capacity analysis/planning

Quality management

Lean systems

Supply Chain Mgmt.

Supply chain dynamics

Inventory management

Case: Kristen’s Cookie

Case: Blanchard

Littlefield Game 1

Littlefield Game 2

Case: A Pain in Chain

Beer game

Decision Making Tools

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Inventory

Definition: the stock of any item or resource used in an organization

In the forms of Raw materials & component parts Work in process Finished products Replacement parts, tools, & supplies Goods-in-transit to warehouses or customers

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Inventory Example – a PC Manufacturer

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How Much Inventory We Need to Manage

In 2006 (nation-wide), the monthly average inventory is Retail: $ 486 B Wholesale: $ 381 B Manufacturing: $ 470 B Total: $1,337 B

6DSC 335, Fall 2009 data from finance.yahoo.com

Inventory

($million)% in Current Assets % in Total Assets

Wal-Mart 32,191 73.46% 23.30%

Target 7,797 50.80% 20.59%

Bestbuy 3,338 41.80% 28.14%

Amazon 877 26.00% 20.10%

Exxon Mobil 9,321 12.71% 4.47%

Boeing 8,105 35.27% 15.65%

GM 21,394 34.44% 4.56%

Ford 10,271 16.32% 3.72%

Toyota 13,799 15.10% 5.64%

Cisco 1,371 5.34% 3.17%

Solectron 1,516 34.84% 28.22%

Dell 576 3.25% 2.49%

Apple 270 1.86% 1.57%

HP 7,750 16.06% 9.45%

Inventory in Balance Sheets

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Pressure to Cut Inventory

0

30

60

90

120

1980 1985 1990 1995 2000 2004

Wal-Mart Kmart Target

Days of Inventory

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Sun’s Incentive Compensation to Boost Supply-Chain Performance

Bob Ferrari, a former employee of Sun Microsystems, says Sun is on the cutting edge of incentive compensation. Within Ferrari’s business unit at Sun, compensation metrics was weighted toward the supply chain. “On-time delivery, inventory turns, and customer satisfaction were all tied into pay,” Ferrari says.

– Jennifer Caplan, CFO.com

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Why Hold Inventory?

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Why Not to Hold Inventory?

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Cost of Holding Inventories

Annual holding cost of inventory is 30 to 35% of its value! This means: Retail: $ 486 B Wholesale: $ 381 B Manufacturing: $ 470 B Total: $1,337 B

Total inventory holding cost

= $ 1,337 B * 30% = $ 400 Billion !!

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Inventory Control

Managerial Objectives for Inventories Minimize the investment/cost tied in inventories. Meet the inventory availability needs of customers.

Inventory control answers two questions. How much to order? When to order?

Coping with uncertainty is challenging. Forecast demand and lead times. Sets stock availability levels (service levels).

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Economic Order Quantity (EOQ) Model

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Economic Order Quantity (EOQ) Model

Key Assumption 1 : All aspects are known with certainty Constant demand stream (No demand variability) Constant setup cost per order (independent of size of order) Constant annual holding cost per unit Constant lead time (= zero in the basic setting)

Instant replenish No backorders are allowed

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Managerial Questions

1. When to order/produce (assuming zero lead time)? When your inventory reaches zero

2. How much to order/produce? Let’s see…

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How Much Should We Order?

Holding cost Order setup cost Purchase cost

Large order size

Small order size

Time

Inventory

Inventory

Large order size

Small order size

Time

Slope = Demand rate

High

Low

Low

High

Same

Same

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Economic Order Quantity (EOQ) Model

Data (inputs to the model)

D = Demand rate (units / yr)

c = Cost of purchasing or producing a unit ($ / unit)

S = Setup cost or per order or per production run ($)

H = Annual holding cost per unit of inventory ($ / (unit•yr))

H is often taken as a percentage of the unit cost:

H = ic, where i is annual percentage holding cost

Decision: Q = Quantity of an order (units)

Objective: To minimize the total cost

Let’s see how to compute the total cost …

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Total Cost (TC)

Number of orders per year = D / Q ( / yr)

Annual ordering cost = (D / Q) S ($ / yr)

Average inventory = Q / 2 (units)

Annual holding cost = (Q / 2) H ($ / yr)

Annual purchase cost = c D ($ / yr)

Slope = D (units/year)Inventory

Q

Time

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Inventory Management at South Face

Here are some facts about The South Face retail shop:

D: 1200 jackets / year

S: $2,000

c: $200 per jacket

i: 25% / year

What order size (Q) would you recommend for The South Face ?

retailerwarehouse

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The South FaceNumber of units Number of Annual Annual Annualper order/batch Batches per Setup Cost Holding Cost Total Cost

Q Year: D/Q $ $ $50100150200250260270280290300310320330340350400500600700

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The South FaceNumber of units Number of Annual Annual Annualper order/batch Batches per Setup Cost Holding Cost Total Cost

Q Year: D/Q $ $ $50 24 48000100 12 24000150 8 16000200 6 12000250 4.8 9600260 4.6 9231270 4.4 8889280 4.3 8571290 4.1 8276300 4 8000310 3.9 7742320 3.75 7500330 3.6 7273340 3.5 7059350 3.4 6857400 3 6000500 2.4 4800600 2 4000700 1.7 3429

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The South FaceNumber of units Number of Annual Annual Annualper order/batch Batches per Setup Cost Holding Cost Total Cost

Q Year: D/Q $ $ $50 24 48000 1250100 12 24000 2500150 8 16000 3750200 6 12000 5000250 4.8 9600 6250260 4.6 9231 6500270 4.4 8889 6750280 4.3 8571 7000290 4.1 8276 7250300 4 8000 7500310 3.9 7742 7750320 3.75 7500 8000330 3.6 7273 8250340 3.5 7059 8500350 3.4 6857 8750400 3 6000 10000500 2.4 4800 12500600 2 4000 15000700 1.7 3429 17500

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The South FaceNumber of units Number of Annual Annual Annualper order/batch Batches per Setup Cost Holding Cost Total Cost

Q Year: D/Q $ $ $50 24 48000 1250 49250100 12 24000 2500 26500150 8 16000 3750 19750200 6 12000 5000 17000250 4.8 9600 6250 15850260 4.6 9231 6500 15731270 4.4 8889 6750 15639280 4.3 8571 7000 15571290 4.1 8276 7250 15526300 4 8000 7500 15500310 3.9 7742 7750 15492320 3.75 7500 8000 15500330 3.6 7273 8250 15523340 3.5 7059 8500 15559350 3.4 6857 8750 15607400 3 6000 10000 16000500 2.4 4800 12500 17300600 2 4000 15000 19000700 1.7 3429 17500 20929

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The South FaceNumber of units Number of Annual Annual Annualper order/batch Batches per Setup Cost Holding Cost Total Cost

Q Year: D/Q $ $ $50 24 48000 1250 49250100 12 24000 2500 26500150 8 16000 3750 19750200 6 12000 5000 17000250 4.8 9600 6250 15850260 4.6 9231 6500 15731270 4.4 8889 6750 15639280 4.3 8571 7000 15571290 4.1 8276 7250 15526300 4 8000 7500 15500310 3.9 7742 7750 15492320 3.75 7500 8000 15500330 3.6 7273 8250 15523340 3.5 7059 8500 15559350 3.4 6857 8750 15607400 3 6000 10000 16000500 2.4 4800 12500 17300600 2 4000 15000 19000700 1.7 3429 17500 20929

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Ordering Cost

QOPT (optimal order quantity) Q

Q DTC = H+ S

2 QHolding cost

SQD

H2Q

Cost

Lowest Cost

Finding the Optimal Q (EOQ)

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Calculating EOQ

The EOQ formula:

# orders / year =

Time between orders

EOQ = 2DSH

TBOEOQ = EOQD

DEOQ

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Example: Application 12.1

Suppose that you are reviewing the inventory policies on an $80 item stocked at a hardware store. The current policy is to replenish inventory by ordering in lots of 360 units. Additional information is:

D = 60 units per week, or 3,120 units per year

S = $30 per order

H = 25% of selling price, or $20 per unit per year

What is the EOQ?

EOQ = =2DS

H= 97 units2(3,120)(30)

20

SOLUTION

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Current Policy EOQ Policy

(cont’d)

What is the total annual cost of the current policy (Q = 360), and how does it compare with the cost with using the EOQ?

Q = 360 units Q = 97 units

C = 3,600 + 260

C = $3,860

C = (360/2)(20) + (3,120/360)(30)

C = 970 + 965

C = $1,935

C = (97/2)(20) + (3,120/97)(30)

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(cont’d)

What is the time between orders (TBO) for the current policy and the EOQ policy, expressed in weeks?

TBO360 =

TBOEOQ =

(52 weeks per year) = 6 weeks360

3,120

(52 weeks per year) = 1.6 weeks97

3,120

SOLUTION

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Notes on EOQ

EOQ is driven by cost minimization Holding cost + Setup cost

Total cost curve is fairly flat near the optimal point EOQ is “robust”, i.e, some errors in parameters estimation will not lead to large cost increase.

At EOQ, Holding cost = Ordering cost Is that always true if holding cost or setup cost take different

forms? Not necessarily.

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Managerial Insights – Sensitivity Analysis

TABLE 12.1 | SENSITIVITY ANALYSIS OF THE EOQ

Parameter EOQ Parameter Change

EOQ Change

Comments

Demand ↑ ↑ Increase in lot size is in proportion to the square root of D.

Order/Setup Costs ↓ ↓

Weeks of supply decreases and inventory turnover increases because the lot size decreases.

Holding Costs ↓ ↑ Larger lots are justified when holding

costs decrease.

2DSH

2DSH

2DSH

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Slope= D (units/yr)= d (units/day)

Q

Time

ReorderPoint (ROP)

Receive order

Placeorder

Receive order

Lead time:L (days)

Reorder Point: ROP = dL

What Happens When Lead Time > 0?

Reminder: Keep time units consistent!

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A cloth item is held in stock at a retail store, c = $0.1 per yard; H = $0.75 per yard/yr; S= $150 per order; D = 10,000 yards/yr. What’s the EOQ? Note: There are 311 operating days per year for the store

Exercise

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(cont’d) When to Order?

Reorder Point (R): level of inventory at which to place a replenishment order

R = d x L

d = demand rate per period , L = lead time

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What if demand is uncertain? – Inventory Control Systems

Continuous review (Q) system Also known as Reorder Point (ROP) system Constant amount ordered when inventory declines to

predetermined level Fixed-order-quantity system and

Fixed-time-period system (Periodic review) Order placed for a variable amount after fixed passage of time