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DESCRIPTION
TRANSCRIPT
POM 370
Materials Management
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Materials Management
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Importance
Component of cost of goods sold (COGS)
Labor component of COGS declining
Significant increase in cost of materials Direct Indirect (overhead)
Materials Management
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Su
pp
liers
Cu
stom
ers
Enterprise
PurchasingOrders
Raw-material Storage
Receiving
Transformation Processes
In-process Storage
Distribution
Finished-goods
Storage
Inventory
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One of the most expensive assets of many companies representing as much as 50% of total invested capital
Operations managers must balance inventory investment and customer service
Inventory
What is inventory? Stock of materials Stored Capacity Examples:
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Inventory
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Functions of inventory: To meet anticipated customer demand To decouple suppliers – production –
distribution To take advantage of quantity discounts To hedge against inflation & price increases To protect against delivery variations To avoid production disruptions through use
of Work-In-Process (WIP)
Inventory
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Negative aspects of inventory:
Large inventories hide operational problems
Financial cost in carrying excess inventories
Risk of damage to goods held in inventory
Risk of product obsolescence
Inventory
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Types of Inventory: Raw material
Purchased but not processed Work-in-process
Undergone some change but not completed A function of cycle time for a product
Maintenance/repair/operating (MRO) Necessary to keep machinery and processes
productive Finished goods
Completed product awaiting shipment
Inventory
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Examples: Raw material
Iron ore – steel mill Flour – bakery
Work-in-process Radiator – auto manufacturer Draft contract – attorney
Inventory
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Examples: Maintenance / repair / operating supplies
(MRO) Lubricating oil – machine shop Soap and shampoo – hotel
Finished goods Candy bar – confectioner Policy – insurance company
Inventory
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VendorsVendors CustomersCustomers
Transformation ProcessTransformation Process
RawRawMaterialsMaterials
Work inWork inprocessprocess
Finished Finished goodsgoods
Water Tank Analogy
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Supply RateSupply RateInventory LevelInventory Level
Demand RateDemand Rate
Inventory LevelInventory Level
ABC Analysis
How inventory items can be classified
How accurate inventory records can be maintained
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ABC Analysis
Divides inventory into three classes based on annual dollar volume
Class A - high annual dollar volume
Class B - medium annual dollar volume
Class C - low annual dollar volume
Used to establish policies that focus on the few critical parts and not the many trivial ones
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ABC Analysis
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% of Inventory Items
0
20
40
60
80
100
0 50 100
% Annual $ Usage
AABB
CC
Class % $ Vol % ItemsA 80 15B 15 30C 5 55
ABC Analysis
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B5.4%12,50012.501,000#10500
B23%6.4%15,00142.8635030%#10867
B11.3%26,35017.001,550#12760
A33.2%77,000154.00500#11526
A72%38.8%$ 90,000$ 90.001,00020%#10286
Class
Percent of Annual Dollar
Volume
Annual Dollar
Volume=Unit Costx
Annual Volume (units)
Percent of Number of Items Stocked
Item Stock
Number
ABC Analysis
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C.1%150.60250#10572
C.2%504.421,200#01307
C5%.4%8508.5010050%#01036
C.5%1,200.602,000#14075
C3.7%$ 8,502$ 14.17600#12572
Class
Percent of Annual Dollar
Volume
Annual Dollar
Volume=Unit Costx
Annual Volume (units)
Percent of Number of Items Stocked
Item Stock
Number
ABC Analysis
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A ItemsA Items
B ItemsB ItemsC ItemsC Items
Pe
rce
nt
of
an
nu
al d
olla
r u
sa
ge
Pe
rce
nt
of
an
nu
al d
olla
r u
sa
ge
80 80 –
70 70 –
60 60 –
50 50 –
40 40 –
30 30 –
20 20 –
10 10 –
0 0 – | | | | | | | | | |
1010 2020 3030 4040 5050 6060 7070 8080 9090 100100
Percent of inventory itemsPercent of inventory items
ABC Analysis
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Other criteria than annual dollar volume may be used
Key accounts
Anticipated engineering changes
Delivery problems
Quality problems
High unit cost
ABC Analysis
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Policies employed may include
More emphasis on supplier development for A items
Tighter physical inventory control for A items
More care in forecasting A items
Cycle Counting
Items are counted and records updated on a periodic basis
Often used with ABC analysis to determine cycle
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Cycle Counting
Has several advantages Eliminates shutdowns and interruptions Eliminates annual inventory adjustment Trained personnel audit inventory accuracy Allows causes of errors to be identified and
corrected Maintains accurate inventory records
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Cycle Counting
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5,000 items in inventory, 500 A items, 1,750 B items, 2,750 C items
Policy is to count A items every month (20 working days), B items every quarter (60 days), and C items every six months (120 days)
77/day
2,750/120 = 23/dayEvery 6 months2,750C
1,750/60 = 29/dayEach quarter1,750B
500/20 = 25/dayEach month500A
Number of Items Counted per DayCycle Counting PolicyQuantity
Item Class
Control of Service Inventories
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Can be a critical component of profitability
Losses may come from shrinkage or pilferage
Applicable techniques include
Good personnel selection, training, and discipline
Tight control on incoming shipments
Effective control on all goods leaving facility
Control of Service Inventories
Shrinkage Unaccounted retail inventory between receipt
and sale Due to damage, theft and sloppy paperwork Theft also known as pilferage Accounts for 1% to 3% of sales
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Control of Service Inventories
Controls Good personnel selection, training, and
discipline Tight control of incoming shipments Effective control of all goods leaving the
facility
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Types of Demand
Independent demand - the demand for item is independent of the demand for any other item in inventory Refrigerator – goods Hamburger – services
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Types of Demand
Dependent demand - the demand for item is dependent upon the demand for some other item in the inventory Ice maker – goods Ketchup – services
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Materials Costs
Holding costs - associated with holding or “carrying” inventory over time
Setup costs - associated with costs of placing order and receiving goods
Out-of-stock costs - cost of back order and cost of lost sales
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Holding Costs
Obsolescence
Insurance
Extra staffing
Cost of money (opportunity costs)
Pilferage
Damage
Warehousing30
Holding Costs
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26%Overall carrying cost
3% (2 - 5%)Pilferage, space, and obsolescence
11% (6 - 24%)Investment costs (borrowing costs, taxes, and insurance on inventory)
3% (3 - 5%)Labor cost
3% (1 - 3.5%)Material handling costs (equipment lease or depreciation, power, operating cost)
6% (3 - 10%)Housing costs (including rent or depreciation, operating costs, taxes, insurance)
Cost (and Range) as a Percent of Inventory
ValueCategory
Setup Cost
Supplies
Forms
Order processing
Clerical support
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Independent Demand Models
Fixed order-quantity models Economic order quantity (EOQ) Production order quantity
(POQ) Quantity discount
Probabilistic models
Fixed order-period models
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Help answer the inventory planning questions!
Help answer the inventory planning questions!
Help answer the inventory planning questions!
Help answer the inventory planning questions!
EOQ Model
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 stockouts34
EOQ Model
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TimeTime
Inve
ntor
y Le
vel
Inve
ntor
y Le
vel
AverageAverageInventory Inventory
(Q*/2)(Q*/2)
0Minimum Minimum inventoryinventory
Order quantity = Q Order quantity = Q (maximum (maximum inventory level)inventory level)
Usage RateUsage Rate
EOQ inventory over time:EOQ inventory over time:
EOQ Model
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EOQ Order Quantity:EOQ Order Quantity:
Order quantity
Annual Cost
Holding Cost CurveTotal Cost Curve
Order (Setup) Cost Curve
Optimal Order Quantity (Q*)
Minimum total cost
EOQ Model
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Q = Number of pieces per order Q* = 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 = (Number of orders placed per year) x (Setup or order cost per order)
Annual demand
Number of units in each orderSetup or order cost per order
=
= (S)DQ
Annual setup cost Annual setup cost = = SSDDQQ
EOQ Model
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Q = Number of pieces per order Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the Inventory item S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year
Annual holding cost = (Average inventory level) x (Holding cost per unit per year)
Order quantity
2= (Holding cost per unit per year)
= (H)Q2
Annual setup cost Annual setup cost = = SSDDQQ
Annual holding cost Annual holding cost = = HHQQ22
EOQ Model
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Q = 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
Optimal order quantity is found when annual setup cost Optimal order quantity is found when annual setup cost equals annual holding costequals annual holding cost
DQ
S = HQ2
Solving for Q* 2DS = Q2HQ2 = 2DS/H
Q* = 2DS/H
EOQ Model - Example
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Determine 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
EOQ Model - Example
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Determine optimal number of needles to orderD = 1,000 units Q* = 200 unitsS = $10 per orderH = $.50 per unit per year
= N = =Expected number of
orders
DemandOrder quantity
DQ*
N = = 5 orders per year 1,000200
EOQ Model - Example
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Determine 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 orders
Number of working days per year
N
T = = 50 days between orders250
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Determine 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 orders
Number of working days per year
N= T =
Expected time between
orders
Number of working days per year
N
Number of working days per year
N
T = = 50 days between orders250
5T = = 50 days between orders250
5250
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EOQ Model - Example
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Determine 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 = (5)($10) + (100)($.50) = $50 + $50 = $100
TC = ($10) + ($.50)1,000200
2002
TC = ($10) + ($.50)1,000200
1,000200
2002
2002
TC = S + HDQ
Q2
TC = S + HDQDQ
Q2Q2
POQ 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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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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Probabilistic Model
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
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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
Useful when vendors visit routinely Example: Paul Mitchell representative calls on
salon every two weeks
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