Lecture Outline

w Elements of Inventory Management w Inventory Control Systems w Economic Order Quantity Models w Quantity Discounts w Reorder Point

What Is Inventory?
w Stock of items kept to meet future demand w Purpose of inventory management
n n

how many units to order when to order

Types of Inventory
w Raw materials w Purchased parts and supplies w Work-in-process (partially completed) products (WIP) w Items being transported w Tools and equipment

Two Forms of Demand

Dependent
Demand for items used to produce final products Tires stored at a Goodyear plant are an example of a dependent demand item

Independent
Demand for items used by external customers Cars, appliances, computers, and houses are examples of independent demand inventory

Inventory Costs
Carrying cost
cost of holding an item in inventory

Ordering cost
cost of replenishing inventory

Shortage cost
temporary or permanent loss of sales when demand cannot be met

Inventory Control Systems

Continuous system (fixed-orderquantity)
constant amount ordered when inventory declines to predetermined level

Periodic system (fixed-timeperiod)

order placed for variable amount after fixed passage of time

ABC Classification
w Class A
n n

5 15 % of units 70 80 % of value 30 % of units 15 % of value 50 60 % of units 5 10 % of

w Class B
n n

w Class C
n

ABC Classification: Example

PART 1 2 3 4 5 6 7 8 9 10 UNIT COST $ 60 350 30 80 30 20 10 320 510 20 ANNUAL USAGE 90 40 130 60 100 180 170 50 60 120

ABC Classification: Example (cont.)

PART TOTAL PART VALUE %UNIT COST OFANNUAL USAGE OF TOTAL % TOTAL VALUE QUANTITY % CUMMULATIVE

9 8 2 1 4 3 6 5 10 7

$30,600 1 16,000 2 14,000 3 5,400 4 4,800 5 3,900 3,600 6 3,000 CLASS 7 2,400 8 A 1,700 B 9 $85,400 C 10

35.9 6.0 $ 60 18.7 5.0 350 16.4 4.0 30 6.3 9.0 80 5.6 6.0 30 4.6 10.0 4.2 18.0 20 % OF TOTAL 3.5 13.0 ITEMS 10 VALUE 2.8 12.0 320 9, 8,2.0 2 71.0 17.0 1, 4, 3 16.5 510 6, 5, 10, 7 12.5 20

6.0 90 11.0 40 A 15.0 130 24.0 60 30.0 B 100 40.0 58.0 180 OF TOTAL % 71.0 QUANTITY 170 83.0 C 50 15.0 100.0 60 25.0 120 60.0
Example 10.1

Economic Order Quantity (EOQ) Models

w EOQ
n

optimal order quantity that will minimize total inventory costs

w Basic EOQ model w Production quantity model w w

Assumptions of Basic EOQ Model

Demand is known with certainty and is constant over time No shortages/stockouts are allowed Lead time for the receipt of orders is constant Order quantity is received all at once No quantity discounts Only order (setup) cost & holding cost

Inventory Order Cycle

Order quantity, Q

Reorder point, R

Inventory Level

Demand rate

Lead time Order Order placed receipt

Lead time Order Order placed receipt

Time

EOQ Model
Annual Cost

Order Quantity

EOQ Model
Annual Cost

Holding Cost

Order Quantity

EOQ Model
Annual Cost

Holding Cost Order (Setup) Cost Order Quantity

EOQ Model
Annual Cost Total Cost Curve Holding Cost Order (Setup) Cost Order Quantity

EOQ Model
Annual Cost Total Cost Curve Holding Cost Order (Setup) Cost Optimal Order Quantity (Q*) Order Quantity

EOQ Cost Model

Co - cost of placing order Cc - annual per-unit carrying cost D - annual demand Q - order quantity CoD Q CcQ 2

Annual ordering cost = Annual carrying cost =

CoD CcQ Total cost = Q + 2

EOQ Cost Model

Deriving Qopt TC = Co D Q + CcQ 2 Proving equality of costs at optimal point Co D Q Q2 = = CcQ 2 2CoD Cc 2CoD Cc

CoD Cc TC =- 2 + Q Q 2 0= Qopt = C0 D Q2 + Cc 2

2CoD Cc

Qopt =

EOQ Cost Model (cont.)

Annual cost ($) Slope = 0 Minimum total cost Cc Q Carrying Cost = 2 Total Cost

CoD Ordering Cost = Q Optimal order Qopt Order Quantity, Q

EOQ Example
Cc = $0.75 per yard Qopt = Qopt = 2CoD Cc
2(150)(10,000) (0.75)

Co = $150

D = 10,000 yards

CoD CcQ TCmin = + Q 2 TCmin =

(150)(10,000) (0.75)(2,000) + 2,000 2

Qopt = 2,000 yards

Orders per year = D/Qopt = 10,000/2,000 = 5 orders/year

TCmin = $750 + $750 = $1,500

Order cycle time = 311 days/(D/Qopt ) = 311/5 = 62.2 store days

Quantity Discounts
Price per unit decreases as order quantity increases
CoD CcQ TC= + + PD Q 2 where P = per unit price of the item D = annual demand

Quantity Discount Model (cont.)

ORDER SIZE 0 - 99 100 199 200+ PRICE $10 8 (d1) 6 (d2)

TC = ($10 ) TC (d1 = $8 ) TC (d2 = $6 )

Inventory cost ($)

Carrying cost

Ordering cost Q(d1 ) = 100 Qopt Q(d2 ) = 200

Quantity Discount: Example

QUANTITY 1 - 49 50 - 89 90+ Qopt = For Q = 72.5 TC= For Q = 90 PRICE $1,400 1,100 900 2 Co D Cc Co D Qopt = Co = $2,500 Cc = $190 per computer D = 200 2(2500)(200) = 72.5 PCs 190

CcQopt + 2 + PD = $233,784

CcQ CoD TC= + 2 + PD = $194,105 Q

Reorder Point
Level of inventory at which a new order is placed R = dL where d = demand rate per period L = lead time

Reorder Point: Example

Demand = 10,000 yards/year Store open 311 days/year Daily demand = 10,000 / 311 = 32.154 yards/day Lead time = L = 10 days R = dL = (32.154)(10) = 321.54 yards

Safety Stocks
Safety stock
buffer added to on hand inventory during lead time

Stockout
an inventory shortage

Service level
probability that the inventory available during lead time will meet demand

Variable Demand with a Reorder Point

Q

Inventory level

Reorder point, R

LT Time

LT

Reorder Point with a Safety Stock

Inventory level

Q
Reorder point, R

Safety Stock

LT Time

LT

EOQ Example

SaveMart needs 1000coffee makers per year. The cost of each coffee maker is Rs.78. Ordering cost is Rs.100per order. Carrying cost p.a. is 40%of per unit cost. Lead time is 5days. SaveMart is open 365 days/yr.

What is the optimal order quantity & ROP?

SaveMart ROP
EOQ = 80 coffeemakers
ROP = demand over lead time = daily demand x lead time (days) =dxl D = annual demand = 1000 Days / year = 365 Daily demand = 1000 / 365 = 2.74 Lead time = 5 days ROP = 2.74 x 5 = 13.7 => 14