Inventory Control Workshop Series

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Basics of Inventory Management

By Anthony D. Wilbon, Ph.D.

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Workshop Objectives

Provide a basic description of the

Define various methods of
inventory management

functions of inventory management

Discuss real world applications of

inventory management
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Workshop Topics

Inventory Management Systems Costs Associated with Inventory

Systems

Quantitative Methods of Inventory

Management

Material Requirements Planning

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What Is Inventory Management?

The set of policies and controls that

monitor levels of inventory and determines What levels should be maintained When stock should be replenished How large orders should be.

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Objectives of Inventory Management Systems

Inventory management is needed to

Provide optimum customer service Minimize the inventory investment Maximize the productivity of the operations.

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Elements of Inventory Management Systems

Inputs

Must forecast demand for products accurately Must establish policies for inventory management Must have an accurate assessment of lead times

Continuous monitoring of customer service levels and investments in inventory

Outputs

Managing vendors Management of excess stock Implement plans for ordering and replenishing

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Types of Inventory

The stock of any item or resource

used in an organization Raw materials Work-in-process Maintenance, repair, operating supply Finished goods

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Reasons for Holding Inventory

To provide a hedge against upward price changes in materials (e.g., inflation)

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To provide a stock of goods that will provide a selection for customers

To take advantage of discounts available through buying in large quantities To protect against uncertainty
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Inventory Costs

Holding costscarrying or storing inventory over time

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Ordering costsplacing orders and receiving goods into the firm

Setup costspreparing the system for creating an order Additional costs include

Shortage or stockout costs Purchase or item costs Transportation costs

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Disadvantages of Inventory

Maintaining large inventory is

difficult to control problems

Large inventory levels conceal other

Product life cycles are becoming
shorter increasing the likelihood of product obsolescence
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The high costs of inventory storage

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ABC Analysis

A method for grouping items by

dollar volume to identify those items to be monitored closely

Follows the Pareto principle Divides on-hand inventory into

three classes A class, B class, C class
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ABC Analysis

(continued)

Basis is usually annual $ volume $ volume = annual demand unit cost

A items: high dollar volume (15%) B items: moderate dollar volume (35%) C items: low dollar volume (50%)

Set strategies from ABC analysis to better forecast, tighten control, and develop closer relationships with class A suppliers

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ABC Exercise

ABC_CLASS_APICS[1].pdf

Carl Bork is opening a small automotive supply firm. There are many items of varying costs associated with carrying the inventory. Since Carl is just starting the business, his time is limited and he can not spend it monitoring all items in his inventory. He has classified the items according to how much he has spent on them and the demand. Use ABC analysis to classify the items into three categories.
Item Number H101 D203 F234 J232 S322 Annual Demand 50 25 15 65 75 Unit Cost 450 250 20 400 150

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ABC Solution
Item Number H101 D203 F234 J232 S322 Annual Demand 50 25 15 65 75 Unit Cost 450 250 20 400 150 Demand Cost 22500 6250 300 26000 11250 Classification A B C A B

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Cycle Counting

ABC_CLASS_APICS[1].pdf

A process of physically counting

some of total inventory on a regular basis

When used with ABC analysis,

count the A items most often. For example, A items get counted daily,
B items get counted weekly, C items are counted monthly.

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Inventory Management Models

Two primary models

Fixed order models
A system where the order quantity remains constant but the time between orders varies

Fixed time period models

A system where the time period between orders remains constant but the order quantity varies
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How Much to Order at One Time

Objectives: Minimize sum of all costs involved Decision rules for determining what lot size to order at one time:

Maximize customer service

Lot-for-lot
Fixed order quantity (FOQ) Economic order quantity (EOQ)

Order n periods of supply

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Fixed Order Quantity Models

Economic order quantity Quantity discount Safety stock and reorder point
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Fixed Order Quantity Model Assumptions

Demand for the product is known, constant, and uniform throughout the period The time from ordering to receipt (aka lead time) is known and constant Price per unit of product is constant (no quantity discounts)

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Ordering or setup costs are constant

No back orders or stockouts
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Primary Questions for Inventory Systems

How much to order? When to order?

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How Much to Order

Annual Costs Total Cost Curve

Holding Cost Curve

Order/Setup Cost Curve

Optimal Order Quantity
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Order Quantity
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When to Order
Inventory Levels Optimal Order Quantity

0
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Time
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Economic Order Quantity Model

EOQ Calculation in 13 min. - How to Calculate Economic Order Quantity Model or EOQ Model - YouTube

Optimal order quantity = Q =

2DS H

Expected number of orders = N = D/Q Expected time between orders = T = Reorder point (ROP) = d x L, where d =
Reorder Point Calculation in 7 minutes: ROP - YouTube

working days/year N D working days/year

Where: D = Demand per year S = Setup (order) cost per order H = Holding costs per unit per year d = Demand per day L = Lead time in days

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Basic Economic Order Quantity Model

Total annual cost =
Annual item cost + Annual ordering cost + Annual holding cost

TC = PD + D S + Q H Q 2
TC D P Q S H
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= = = = = =

Total annual cost Annual demand in units Price or cost per unit Quantity to be order Setup or ordering cost Annual holding cost per unit
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EOQ Exercise
Charles Ross is developing an inventory system for his new firm that sells robotic pet dogs. He estimates that the annual demand for his product is 3000 units. The cost of each dog is $100 and the holding cost is $5. Charles performed further analysis and determined that the order (setup) costs will be approximately $20 per order. It will take about 5 days for an order to arrive from the supplier. With EOQ analysis, he is now ready to develop an inventory system that will give him the lowest total cost. Using the EOQ formulas, calculate all of the necessary functions for his system.
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EOQ Solution
Q= 2DS H = 2300020 = 154.9 or 155 dogs 5

Number of orders per year = D/Q = 3000/155 = 19.35 or 19 orders Assuming 250 business days per year: Optimal number of days between orders = 250/19 = 13.15 or 13 days Total annual inventory costs TC = PD + DS + QH Q 2 = 1003000 + 300020 155 2 + 1555

TC = 300,000 + 387.1 + 387.5 = $300,774.6 Reorder point (ROP) = D L = 3000/250 5 = 60 dogs

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Quantity Discount Model

Allows quantity discounts

Vendor provides a reduced price when item is purchased in larger quantities

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Other EOQ assumptions apply

Must balance the trade-off between

Lower item price resulting from the discount
Increased cost of holding more inventory
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Quantity Discount Exercise

Spartan Sweaters, Inc., is a retailer in Flint, Michigan. The store specializes in sweaters but also sells other college-related paraphernalia. The specialty of the store, the letter sweater, costs $45. There is an annual demand of 5000. The owner of the store has determined that the order (setup) cost is $10 per order and the holding cost is $7.

The owner is considering a new supplier for the sweaters whereby each sweater would only cost $40. However, to receive the discount the store would have to buy 7000 at a time. Should the owner use the new supplier and take the discount.
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Quantity Discount Solution

Q= 2DS H = 2500010 7 = 119.52 or 120 sweaters

Total annual inventory costs TC = PD + DS + QH Q 2 = 455000 + 500010 120 + 1207 2

TC = 225,000 + 416.67 + 420 = $225,836.67 Recalculate total cost considering the discounted price and that you have to order a larger amount to get the discount. TC = PD + DS + QH Q 2 = 405000 + 500010 + 70007 7000 2

TC = 200,000 + 7.143 + 24500 = $224,507.14

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Stockouts

Issues with stock levels

replenish the item

Uncertainty in product demand Variability in the lead time required to

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These issues raise possibility of a stockout.

Management concern is maintaining a desirable level of service to provide its customers.

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Safety Stock and Reorder Point

From previous discussions we know

Reorder point = ROP = DL ROP = DL + safety stock

Where D = daily demand and L = order lead time

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If we include safety stock, we get The amount of safety stock depends on the cost of running out of stock and the holding costs for that additional inventory

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Stockout Costs
Annual stockout costs = (the sum of the units short)
(the probability of demand) (the stockout costs/unit) (the number of orders per year)

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Safety Stock Exercise

Cuddle Bears has determined that the reorder point for its teddy bears is 40 units without safety stock. The holding cost per bear per year is $3. The costs associated with running out of stock due to lost sales is $50 per bear. The optimal number of orders per year is 10. Demand during the reorder period follows the following probability.
Demand during Reorder Period 20 30 40 50 60
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Probability

0.2 0.2 0.2 0.2 0.2

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How much safety stock should Cuddle Bears maintain?

Safety Stock Solution

The safety stock with the lowest total cost is 20 bears. Therefore, Cuddle Bears should change its reorder point to 40 + 20 = 60 bears.
Safety Stock 20 10 0 Additional Holding Cost 20(3) = $60 10(3) = $30 $0 Stockout Cost $0 10(.2)(50)(10) = $1000 10(.2)(50)(10) + 20(.2)(60)(10) = $3400 Total Cost $60 $1030 $3400

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Independent and Dependent Demand

The EOQ model assumes that Often the real world suggests

demand for one item is independent of the demand for another item.
demand for one item depends on another. For example, demand for microchips is

dependent on demand for computers, cell phones, etc.

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Dispatching Rules First come, first served (FCFS) Earliest job due date (EDD) Earliest operation due date (ODD) Shortest process time (SPT) Critical ratio (CR) Jobs are performed in order received Jobs are performed according to end-item due dates Jobs are performed according to operation due dates Jobs are sequenced according to process time Jobs are sequenced using an index of relative priority of orders at a work center
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Material Requirements Planning

http://www.youtube.com/watch?v=dujJR6ep1vo&feature=related

A set of techniques that uses bill of material data, inventory data, and the master production schedule to calculate requirements for materials.
APICS Dictionary, 10th edition
Whats its IIS?http://www.youtube.com/watch?v=-rzdwHgZIaE&feature=related
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Material Requirements Planning

Use of dependent models such as

MRP requires knowledge of What is to be made and when What is in stock and what is on order Lead times.

A major input to MRP and plans at

the end-item level is the master production schedule.
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Master Production Schedule (MPS)

Specifies what is to be made and when

Corresponds with production plan which includes

Overall level of output Financial plans Customer demand Inventory fluctuations Supplier performance

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Tells us what is required to satisfy demand and meet the production plan

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MRP Structure

Often computerized Requires MPS, bill of material,

inventory purchase records, and lead times for each item as input provide plans and advice for when and how much to order
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Output is a series of reports that

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MRP Benefits

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Enhances inventory planning and scheduling Assists in meeting delivery schedules

Reduces inventory levels

Increases customer satisfaction

Allows faster response times for management

Reduces idle time
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MRP Program Output

Output Reports

Primary reports
Planned orders Order release notices Changes in due dates Cancellations or suspensions of open orders Inventory status data

Secondary reports
Planning reports Performance reports Exception reports
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Balancing Real Decisions and Mathematical Models

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Costs are difficult to measure

Demand is not constant

Lack of focus on lot sizing and inventory control

Need to focus on reducing setup costs to reduce EOQs and total costs
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Balancing Real Decisions and Mathematical Models (continued)

Determining Realistic Costs

Accounting data is usually expressed in

averages; marginal costs are needed to determine proper lot sizes. constant.

Carrying and ordering costs are not

Some costs (e.g., obsolescence) are
subjective.
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Balancing Real Decisions and Mathematical Models (cont.)

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Inventory Accuracy

Shrinkage, misidentification, and misplaced items create inventory inaccuracies.

Average amount of inventory relative to annual sales is decreasing. Firms are focusing on reducing setup and order costs, resulting in smaller economic order quantities. Firms are working more closely with vendors to reduce product throughput times and, consequently, lead times.

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References

APICSThe Performance Advantage

CPIM and CIRM course material Production and Inventory Management Journal Internet Sources (e.g., Center for Inventory Management, www.centerforinventorymanagement.org)
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Additional Reference Sources

APICS (800) 444-APICS (2742) or (703) 354-8851 APICS Online Bookstore www.apics.org/Bookstore/default.htm APICS International Conference and Exposition

APICS SM SIG WorkshopInventory Essentials for Small Manufacturers

Web Sites
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