Inventory management

Presentation on:

“Inventory Management”

To hold or not to hold?

ObjectivesAppreciate the importance of effective inventory

management.

Understand the different reasons for holding inventory

and the different types of inventory

Describe the different costs of inventory.

Realize the significance of independent and dependent

demand in inventory control systems.

ObjectivesBe aware of the concept of Economic Order Quantity

and its limitations.

Describe the different inventory systems based on

independent demand.

Explain technologies as used for classifying and

controlling inventory.

IntroductionInventory-A physical resource that a firm holds in stock

with the intent of selling it or transforming it into a more

valuable state.

Inventory System- A set of policies and controls that

monitors levels of inventory and determines what levels

should be maintained, when stock should be replenished,

and how large orders should be placed.

Inventory One of the most expensive assets of many companies,

representing as much as 30-40% of total invested capital

Operations managers must balance inventory

investment and customer service

Inventory Management It is the planning and control of inventories (or stock) in

the transformation system of an organization in order to

meet customer demand while also being effective.

Key questions to answer1. What to stock?

2. How much to stock?

3. Where it should be located?

4. How much should be ordered?

Reasons for holding inventoryTo anticipate changes in customer demand.

To decouple (or uncouple) operations.

To protect against stock-outs due to uncertainties in

supply, demand and lead times.

To allow for transit and transit time.

As a hedge against price increases.

To minimize purchasing and inventory costs.

Types of inventoryRaw materials- all commodities, parts and

components.

MRO: Maintenance, Repairs and Operating Supplies

Work-in-Process

Finished Goods

The Costs of InventoryOrdering Costs (Including set-up costs)

Holding costs (Capital costs, Storage costs, Insurance

costs and obsolescence costs)

Stock-out costs (costs involved in dealing with stock-

outs)

Independent Demand vs. Dependent Demand

Inventory systems based on Independent Demand

Fixed-Order Quantity System (sometimes referred to as

EOQ or Q systems).

Fixed-time Period Systems(or Period Review system or

Fixed order interval or P systems).

The Economic Order Quantity (EOQ) Model

The EOQ is the order quantity that minimizes the

ordering cost and the holding cost of an item i.e.

minimizing the total costs in acquiring and holding

assets

Basic EOQ Model

1. Demand is known, constant, and independent2. Lead time is known and constant3. Receipt of inventory is instantaneous and

complete4. Quantity discounts are not possible5. Only variable costs are setup and holding6. Stock-outs can be completely avoided

Important assumptions

Inventory Usage Over Time

Order quantity = Q (maximum inventory level)

Inve

ntor

y le

vel

Time

Usage rate Average inventory on

handQ2

Minimum inventory

Minimizing CostsObjective is to minimize total costs

Annu

al c

ost

Order quantity

Curve for total cost of holding

and setup

Holding cost curve

Setup (or order) cost curve

Minimum total cost

Optimal order

quantity

The EOQ ModelQ = Number of pieces per orderQ* = Optimal number of pieces per order (EOQ)D = Annual demand in units for the Inventory itemS = Setup or ordering cost for each orderH = Holding or carrying cost per unit per year

Annual setup cost = DSQ

Annual holding cost = QH2

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

Annual demandNumber of units in each order

Setup or order cost per order

=

= (S)DQ

The EOQ ModelQ = Number of pieces per orderQ* = Optimal number of pieces per order (EOQ)D = Annual demand in units for the Inventory itemS = Setup or ordering cost for each orderH = Holding or carrying cost per unit per year

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

Order quantity2

= (Holding cost per unit per year)

= (H)Q2

Annual setup cost = DSQ

Annual holding cost = QH2

The EOQ ModelQ = Number of pieces per orderQ* = Optimal number of pieces per order (EOQ)D = Annual demand in units for the Inventory itemS = Setup or ordering cost for each orderH = Holding or carrying cost per unit per year

Annual setup cost = DSQ

Annual holding cost = QH2

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

DQ

S = HQ2

Solving for Q*2DS = Q2HQ2 = 2DS/H

Q* = 2DS/H

An EOQ ExampleDetermine optimal number of needles to orderD = 1,000 unitsS = $10 per orderH = $.50 per unit per year

Q* =2DS

H

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

0.50= 40,000 = 200 units

An EOQ ExampleDetermine optimal number of needles to orderD = 1,000 units Q* = 200 unitsS = $10 per orderH = $.50 per unit per year

= N = =Expected number

of ordersDemand

Order quantityD

Q*

N = = 5 orders per year 1,000200

An EOQ ExampleDetermine optimal number of needles to orderD = 1,000 units Q* = 200 unitsS = $10 per order N = 5 orders per yearH = $.50 per unit per year

= T =Expected time

between ordersNumber of working

days per yearN

T = = 50 days between orders2505

An EOQ ExampleDetermine optimal number of needles to orderD = 1,000 units Q* = 200 unitsS = $10 per order N = 5 orders per yearH = $.50 per unit per year T = 50 days

Total annual cost = Setup cost + Holding cost

TC = S + HDQ

Q2

TC = ($10) + ($.50)1,000200

2002

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

Robust Model

The EOQ model is robust

It works even if all parameters and

assumptions are not met

The total cost curve is relatively flat in

the area of the EOQ

Reorder Points EOQ answers the “how much”

question The reorder point (ROP) tells when

to orderROP =

Lead time for a new order in

days

Demand per day

= d x L

d = DNumber of working days in a year

Reorder Point CurveQ*

ROP (units)In

ven

tory

leve

l (u

nit

s)

Time (days)Lead time = L

Slope = units/day = d

Reorder Point Example

Demand = 8,000 DVDs per year250 working day yearLead time for orders is 3 working days

ROP = d x L

d = D

Number of working days in a year

= 8,000/250 = 32 units

= 32 units per day x 3 days = 96 units

Fixed-time Period (P) Systems Here the inventory levels are reviewed at fixed intervals.

Four of the original EOQ assumptions maintained

No constraints are placed on lot size

Holding and ordering costs

Independent demand

Lead times are certainOrder is placed to bring the inventory position up to the target

inventory level, T, when the predetermined time, P, has elapsed

Fixed-time Period System(P)

P P

T

L L L

Protection interval

Time

On

-han

d i

nve

nto

ry

IP3

IP1

IP2

OrderplacedOrderplaced

Orderplaced

Orderreceived

Orderreceived

Orderreceived

IP IPIP

OH OHQ1

Q2

Q3

P System When Demand Is Uncertain

Inventory Control Mechanism

Pareto Principle

80/20 rule

Based on the work of an economist & avid horticulturalist,

V. Pareto in late 19th century Italy.

80% of the land was owned by 20% of the people.

80% of the peas were produced by 20% of the pods

Applied to business by quality guru Dr. Juran

Pareto principle applied:

Applied to Meetings: 80% of decisions come from 20% of

meeting time.

Applied to product defects: 20% of the quality problems

cause 80% of the defects.

Applied to Salespeople: Roughly 20% of a sales force will

develop 80% of the annual results

Applied to Business Units: Roughly 20% of a company's

business units will produce 80% of the annual revenue.

Applied to time-management…

Moral of the Pareto principle

Find the significant 20%

Manage that 20%

Pareto principal + Inventory = ABC Analysis

“critical few and the trivial many”

Create a Pareto chart for the inventory dollars per year of

each item – dollar-volume

Generally the top 80% of dollars are from approximately 20%

of the items.

Categorize all items into

Class A items – top ~20% items by dollar-volume

Class B items

Class C items

ABC Analysis

10 20 30 40 50 60 70 80 90 100

Percentage of items

Per

cen

tag

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f d

oll

ar v

alu

e

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ABC Analysis

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Percentage of items

Per

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ABC Analysis

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Percentage of items

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ABC Analysis

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Percentage of items

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f d

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ABC Analysis

10 20 30 40 50 60 70 80 90 100

Percentage of items

Per

cen

tag

e o

f d

oll

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alu

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100 —

90 —

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Class C

Class A

Class B

ABC AnalysisPolicies based on ABC analysis

Develop Class A suppliers moreImplement tighter physical control of Class

A itemsForecast Class A items more carefullyModel inventory for Class A items

Cycle countingPhysically counting a sample of total inventory on

a regular basis

Used often with ABC classificationClass A items counted most often (e.g., daily)

Class B items counted less frequently (e.g. weekly)

Class C items counted least often (e.g. monthly)

Advantages of Cycle Counting

Eliminates shutdown and interruption of production

necessary for annual physical inventories

Eliminates annual inventory adjustments

Provides trained personnel to audit the accuracy of

inventory

Allows the cause of errors to be identified and

remedial action to be taken

Maintains accurate inventory records

Thank you