Operations

Management
Inventory Management
Chapter 9

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 Outline
♦ Functions Of Inventory
♦ Types Of Inventory
♦ Inventory Management
♦ ABC Analysis
♦ Record Accuracy
♦ Cycle Counting
♦ Control of Service Inventories

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 Outline - Continued
♦ Inventory Models
♦ Independent Versus Dependent
Demand
♦ Holding, Ordering, And Setup Costs

♦ Inventory Models For

Independent Demand
♦ Basic Economic Order Quantity
(EOQ) Model
♦ Minimizing Costs
♦ Reorder Points

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Quantity Model OPM 533
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♦ Quantity Discount Models
 Learning Objectives
When you complete this chapter,
you should be able to :
Identify or Define:
♦ ABC analysis
♦ Record accuracy
♦ Cycle counting
♦ Independent and dependent
demand
♦ Holding, Ordering, and Setup Costs

Describe or Explain:
♦ The functions of inventory and
Preparedbasic inventory
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 What is Inventory?
♦ Stock of materials
♦ Stored capacity © 1995
Corel Corp.

♦ Examples

© 1984-1994 T/Maker Co. © 1984-1994 T/Maker Co.

© 1995 Corel Corp.

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 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

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 Types of Inventory
♦ Raw material (RM)
♦ Work-in-progress (WIP)
♦ Maintenance/repair/operating supply
(MRO)
♦ Finished goods (FG)

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 Disadvantages of
Inventory
♦ Higher costs
♦ Item cost (if purchased)
♦ Ordering (or setup) cost
♦ Costs of forms, clerks’ wages etc.
♦ Holding (or carrying) cost
♦ Building lease, insurance, taxes etc.

♦ Difficult to control
♦ Hides production problems

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 Inventory
Classifications

Inventory © 1984-
1994
T/Maker Co.

Proces Numb Dema

Other
s er & nd
stage Value Type

Raw A
Independ Maintena
Material Items
ent nce
WIP B
Depende Operating
Finished Items
nt
Goods
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 The Material Flow Cycle
Other Wait Move Q Setup Run
Time Time ueu Time Time
Input e Output
T
ime
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.

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 ABC Analysis
♦ Divides on-hand inventory into 3 classes
♦ A class, B class, C class
♦ Basis is usually annual $ volume
♦ $ volume = Annual demand x Unit cost
♦ Policies based on ABC analysis
♦ Develop class A suppliers more
♦ Give tighter physical control of A items
♦ Forecast A items more carefully

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 Classifying Items as
ABC
% Annual $ Class % $ Vol % Items
Usage A 80 15
100
B 15 30
80
C 5 55
60
A
40
B
20 C
0
0 50 100
% of Inventory Items
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 Cycle Counting

♦ Physically counting a sample of total

inventory on a regular basis
♦ Used often with ABC classification
♦ A items counted most often (e.g., daily)

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 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

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 Techniques for
Controlling Service
Inventory Include:
♦ Good personnel selection, training, and
discipline
♦ Tight control of incoming shipments
♦ Effective control of all goods leaving the
facility

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 Independent versus
Dependent Demand
♦ Independent demand - demand for item
is independent of demand for any other
item

♦ Dependent demand - demand for item

is dependent upon the demand for some
other item

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 Inventory Costs
♦ Holding costs - associated with holding or
“carrying” inventory over time; e.g.
obsolescence, insurance, extra staffing,
interest, pilferage, damage, warehousing, etc.
♦ Ordering costs - associated with costs of
placing order and receiving goods; eg. Supplies,
forms, order processing, clerical support, etc.
♦ Setup costs - cost to prepare a machine or
process for manufacturing an order; e.g. clean-
up costs, re-tooling costs, adjustment costs, etc.

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 Inventory Holding Costs
(Approximate Ranges)
Cost as a
Category % of Inventory
Value
Housing costs (building rent,
6%
depreciation, operating (3 - 10%)
cost, taxes, insurance)
3%
Material handling costs (1 - 3.5%)
(equipment, lease or
depreciation, power, 3%
operating cost) (3 - 5%)
11%
Labor cost from extra handling
(6 - 24%)
Investment costs (borrowing 3%
costs, taxes, and insurance (2 - 5%)
on inventory) 26%
Pilferage, scrap, and
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obsolescence
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 Inventory Models
♦ Fixed order-quantity models Help answer
♦ Economic order quantity the inventory
♦ Production order quantity planning
questions!
♦ Quantity discount

♦ Probabilistic models
♦ Fixed order-period models

© 1984-1994
T/Maker Co.

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 1. 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

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 Inventory Usage Over
Time
Order quantity
Usage
=Q Average
(maximum Rate Inventory
Inventory Level

inventory (Q*/2)
level)

Minimum
inventor
0
y Time

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 EOQ Model
How Much to Order?
Annual Cost

C u r ve
C o st v e
al u r
Minimu
Tot o s tC
g C
m total ldin
H o
cost

Order (Setup) Cost Curve

Optimal Order
Order Quantity (Q*) quantity
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 Why Holding Costs
Increase
♦ More units must be stored if more are ordered

Purchase Order
Purchase Order Descriptio Qty.
Descriptio Qty. n
Microwave 1000
n
Microwave 1
Order
Order quantity
quantity
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 Why Order Costs
Decrease
Cost is spread over more units
Example: You need 1000 microwave ovens
1 Order (Postage $ 1000 Orders (Postage
0.33) $330)
Purchase Order PurchaseOrder
Purchase Order
Description Qty. Purchase
Descriptio
Purchase Order
Qty.
Order
Descriptio
Descriptio Qty.
Qty.1
Microwave 1000 nn
Microwave
Description Qty.
Microwave
n
Microwave 11
Microwave 1
Order
quantity
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 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

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 EOQ Model Equations
× ×
Optimal Order Quantity=Q* = 2 D S
H
D
=N =
xpected Number of Orders
Q*
Working Days /Year
xpected Time Between Orders =T =
N
D D = Demand per year
d=
Working Days /Year S = Setup (order) cost
per order
ROP = d × L H = Holding (carrying)
cost
d = Demand per day
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 The Reorder Point
(ROP) Curve
Q*

Slope = units/day
=d
Inventory level

ROP
(Unit
(units)

s)

Time
Lead time (days)
=L
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 2. Production Order
Quantity Model
♦ Answers how much to order and when to
order
♦ Allows partial receipt of material
♦ Other EOQ assumptions apply
♦ Suited for production environment
♦ Material produced, used immediately
♦ Provides production lot size

♦ Lower holding cost than EOQ model

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 Reasons for Variability in
Production
Most variability is caused by waste or by
poor management. Specific causes
include:
❑ employees, machines, and suppliers produce
units that do not conform to standards, are late
or are not the proper quantity
❑ inaccurate engineering drawings or
specifications
❑ production personnel try to produce before
drawings or specifications are complete
❑ customer demands are unknown

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 POQ Model Inventory
Levels
Inventory Level

Production portion
of cycle

Demand portion of cycle

with no supply

Time
Supply Supply
Begins Ends
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 POQ Model Inventory
Inventory Level
Levels
Inventory level with no demand

Production Max. Inventory

Portion of Q·(1- d/p)
Q*
Cycle

Time
Supply Supply Demand portion
Begins Ends of cycle with no
supply
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 POQ Model Equations

= Q* = 2*D*S
Optimal Order Quantity

( )
p d
H* 1-
p

= Q*
Maximum inventory level ( )
1-
d
p
D D = Demand per
Setup Cost = *S year
Q
S = Setup cost
Holding Cost =
0.5 * H * Q 1 -
( ) d
p
H = Holding cost
d = Demand per
day
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 3. 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

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 Quantity Discount
Schedule
Disco Discount Discoun Discount
unt Quantity t (%) Price (P)
Numb
1
er 0 to 999 No $5.00
discount
2 1,000 to 4 $4.80
1,999
3 2,000 and 5 $4.75
over

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 Quantity Discount –
How Much to Order

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