Inventory Management

EOQ

What is inventory?

Inventory is the raw materials, component parts, work-in-process, or finished products that are held at a location in the supply chain.

What is Inventory?
Stock of materials Stored capacity Examples
1995 Corel Corp.

1984-1994 T/Maker Co. 1995 Corel Corp. EOQ

1984-1994 T/Maker Co.

The Functions of Inventory

To decouple or separate various parts of the production process To provide a stock of goods that will provide a selection for customers To take advantage of quantity discounts To hedge against inflation and upward price changes

EOQ

Benefits of Inventory
Hedge against uncertain demand
Hedge against uncertain supply Economize on ordering costs Smoothing

To summarize, we build and keep inventory in order to match supply and demand in the most cost effective way.

Types of Inventory
Raw material Work-in-progress Maintenance/repair/operating supply Finished goods

EOQ

The Material Flow Cycle

EOQ

Disadvantages of Inventory
Higher costs
Item cost (if purchased) Ordering (or setup) cost

Costs of forms, clerks wages etc.

Building lease, insurance, taxes etc.

Holding (or carrying) cost

Difficult to control Hides production problems

EOQ

Inventory Classifications
Inventory
1984-1994 T/Maker Co.

Process stage

Number & Value

Demand Type

Other

Raw Material WIP Finished Goods

EOQ

A Items B Items C Items

Independent Dependent

Maintenance Operating

The Material Flow Cycle

Input Other Wait Time Move Time Queue Time Setup Time Run Time Output

Cycle Time

1 Run time: Job is at machine and being worked on 2 Setup time: Job is at the work station, and the work station is being "setup." 3 Queue time: Job is where it should be, but is not being processed because other work precedes it. 4 Move time: The time a job spends in transit 5 Wait time: When one process is finished, but the job is waiting to be moved to the next work area. 6 Other: "Just-in-case" inventory.
EOQ

Inventory Costs
Holding costs - associated with holding or carrying inventory over time Ordering costs - associated with costs of placing order and receiving goods Setup costs - cost to prepare a machine or process for manufacturing an order

EOQ

Economic Order Quantity - EOQ

Q* = 2SD H

Example: Assume a car dealer that faces demand for 5,000 cars per year, and that it costs $15,000 to have the cars shipped to the dealership. Holding cost is estimated at $500 per car per year. How many times should the dealer order, and what should be the order size?

2(15,000 )(5,000 ) Q 548 500

*

Holding (Carrying) Costs

Obsolescence Insurance Extra staffing Interest Pilferage Damage Warehousing Etc.

EOQ

Inventory Holding Costs (Approximate Ranges)

Category
Housing costs (building rent, depreciation, operating cost, taxes, insurance) Material handling costs (equipment, lease or depreciation, power, operating cost) Labor cost from extra handling Investment costs (borrowing costs, taxes, and insurance on inventory) Pilferage, scrap, and obsolescence Overall carrying cost
EOQ

Cost as a % of Inventory Value

6% (3 - 10%) 3% (1 - 3.5%) 3% (3 - 5%) 11% (6 - 24%) 3% (2 - 5%) 26%

Ordering Costs
Supplies Forms Order processing Clerical support Etc.

EOQ

Setup Costs
Clean-up costs Re-tooling costs Adjustment costs Etc.

EOQ

Inventory Models
Fixed order-quantity models
Economic order quantity Production order quantity Quantity discount

Help answer the inventory planning questions!

Probabilistic models Fixed order-period models

1984-1994 T/Maker Co.

EOQ

The Basic EOQ Model

The optimal order size, Q,

is to minimize the sum of carrying costs and ordering costs.

Assumptions and Restrictions: - Demand is known with certainty and is relatively constant over time. - No shortages are allowed. - Lead time for the receipt of orders is constant. (will consider later) - The order quantity is received all at once and instantaniously.

How to determine the optimal value (to p10) Q*?

18

The Basic EOQ Model

We assumed that, we will only keep half the inventory over a year then

The total carry cost/yr = Cc x (Q/2).Total order cost = Co x (D/Q) Then , Total cost
TC C D C Q = Q 2
o c

Finding optimal Q*

(to p11)

19

EOQ Assumptions
Known and constant demand Known and constant lead time Instantaneous receipt of material No quantity discounts Only order (setup) cost and holding cost No stockouts

EOQ

Inventory Usage Over Time

Order quantity = Q (maximum inventory level)

Usage Rate

Minimum inventory 0

Inventory Level

Average Inventory (Q*/2)

Time

EOQ

EOQ Model How Much to Order?

Annual Cost

Minimum total cost

Order (Setup) Cost Curve

Optimal Order Quantity (Q*)
EOQ

Order quantity

The Basic EOQ Model

To order inven

Total annual inventory cost is sum of ordering and Tocarrying keep inven cost: TC C D C Q Q 2
o c

Try to get this value

Figure 16.5 The EOQ cost model

23

Examples

(to p13)

If delivery is not instantaneous, but there is a lead time L: When to order? How much to order?
Order Quantity Q
Inventory

Lead Time Place order Receive order

Time

Why Holding Costs Increase

More units must be stored if more are ordered

Purchase Order Description Qty. Microwave 1

Purchase Order Description Qty. Microwave 1000

Order quantity
EOQ

Order quantity

Why Order Costs Decrease

Cost is spread over more units
Example: You need 1000 microwave ovens
1 Order (Postage $ 0.33)
Purchase Order Description Qty. Microwave 1000

1000 Orders (Postage $330)

Purchase Order Purchase Order Purchase OrderQty. Description Purchase Order Description Qty. Qty. Description Microwave Qty. 11 Description Microwave Microwave Microwave 11

Order quantity
EOQ

Deriving an EOQ
1. Develop an expression for setup or ordering costs 2. Develop an expression for holding cost 3. Set setup cost equal to holding cost 4. Solve the resulting equation for the best order quantity

EOQ

EOQ Model When To Order

Inventory Level
Optimal Order Quantity (Q*) Reorder Point (ROP) Average Inventory (Q*/2)

Lead Time
EOQ

Time

EOQ Model Equations

Optimal Order Quantity Expected Number of Orders

= Q* =

2 D S H D =N = Q*

Expected Time Between Orders

=T =

Working Days

/ Year

d =

D
Working Days / Year

ROP = d L
EOQ

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

The Reorder Point (ROP) Curve

Q*

Slope = units/day = d Inventory level (units)

ROP (Units)

Time (days)
Lead time = L
EOQ

Quantity Discount Model

Answers how much to order & when to order Allows quantity discounts

Reduced price when item is purchased in larger quantities Other EOQ assumptions apply

Trade-off is between lower price & increased holding cost

EOQ

Quantity Discount Schedule

Discount Number 1 2 3 Discount Quantity 0 to 999 1,000 to 1,999 2,000 and over Discount (%) No discount 4 5 Discount Price (P) $5.00 $4.80 $4.75

EOQ

Quantity Discount How Much to Order

EOQ

Probabilistic Models
Answer how much & when to order Allow demand to vary
Follows normal distribution Other EOQ assumptions apply

Consider service level & safety stock

Service level = 1 - Probability of stockout Higher service level means more safety stock

More safety stock means higher ROP

EOQ

Probabilistic Models When to Order?

Inventory Level
Frequency

Service Level

P(Stockout)

Optimal Order Quantity

Reorder Point (ROP) ROP

SS

Safety Stock (SS) Place order

EOQ

Lead Time

Receive order

Time

Fixed Period Model

Answers how much to order Orders placed at fixed intervals
Inventory brought up to target amount Amount ordered varies

No continuous inventory count

Possibility of stockout between intervals Example: P&G representative calls every 2 weeks

Useful when vendors visit routinely

EOQ

Inventory Level in a Fixed Period System

Various amounts (Qi) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum
Target maximum

On-Hand Inventory

Q1

Q2 Q3 p p p

Q4

Time
EOQ

Fixed Period Model When to Order?

Inventory Level
Target maximum

Period
EOQ

Period

Period

Time