Chapter 6Quantity & Delivery

By: Paul Batchelor, Paige Frank, Matthew Johnson, Priscilla Mak, Missy McCormick

Why Do We Care?

• Continuous improvement and organizational goals drive management attitudes to quality, quantity and delivery

• Ch 5 – Quality

• Ch 6 – Quantity and Delivery

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Classification of Purchases

• Direct/Indirect Purchases• Types of Requirements

– i.e. raw materials, resale items, packaging, etc.

• Frequency of Purchase• Stock Items

– i.e. whether or not purchases are for stock replenishment

• Physical/Chemical Nature• Transport Type• Monetary Value – ABC Classification

PURCHASES

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

ABC Classification

• Concentrates efforts in the areas of highest payoff• Reduces paperwork and managerial effort, but

maintains a high service coverage• Steps:

1. Calculate purchase value (unit price x number of units)2. Classify the purchase value of each item into groups of high

annual purchase value (A), medium value (B), low value (C)3. Concentrate time and effort on A & B items versus on C items

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Forecasting

• Forecasts of usage, supply, market conditions, technology, price, etc., are always necessary to make good decisions

• Sales forecasts drive the need for raw materials, parts and subassemblies

Purchases

ABC

FORECASTING

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Review of Forecasting Techniques

• Qualitative Forecasting– Gathering opinions from a number of people– Delphi Technique

• Quantitative Forecasting– Using past data to predict the future– Causal Models– Time Series Forecasting

Purchases

ABC

FORECASTING

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Inventory

• Inventory policy has a great influence on purchase quantity decision

• Need to know:– How much to order– When to order– How much to carry

Purchases

ABC

Forecasting

INVENTORY

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Inventory Costs

• Main types of inventory costs– Carrying Costs

– Holding Costs

– Possession Costs

• Other costs– Ordering or Purchase Costs

– Setup Costs

– Stockout Costs

– Price Variation Costs

Purchases

ABC

Forecasting

INVENTORY

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Article: “Poor Inventory Control”

• Areas of investigation:– Bills of Material (BOM)– Receiving Policies– Do You Know Each Part’s ATP?– Engineering Changes– Scrap Reporting– Lead Times– Reorder Triggers– Warehouse Locator System

Purchases

ABC

Forecasting

INVENTORY

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Basic Elements of Carrying Costs

1) Capital Costs

2) Inventory Service Costs

3) Storage Space Costs

4) Inventory Risk Costs

• After carrying costs have been estimated, annual carrying costs can be calculated

Purchases

ABC

Forecasting

Inventory

CARRYING COSTS

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Inventory Carrying Costs

(CC per year) = (avg. inventory value) x (inventory CC as a % of

inventory value)

Avg. inv. value = (avg. inv. in units) x (material unit cost)

Purchases

ABC

Forecasting

Inventory

CARRYING COSTS

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Inventory Carrying Costs

CC = Q/2 x C x I

Where:

CC = carrying cost per year

Q = order quantity for the material

C = delivered unit cost of the material

I = inventory carrying cost for the material, as a % of inventory value

Purchases

ABC

Forecasting

Inventory

CARRYING COSTS

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Forms of Inventory

1) Raw Materials and Purchased Parts

2) Work In Process

3) Finished Goods

4) MRO Items

5) Resale Items

Purchases

ABC

Forecasting

Inventory

Carrying Costs

INVENTORY

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Functions of Inventory

• Roles of Inventory:– Transit or Pipeline Inventories– Cycle Inventories– Buffer/Safety Stocks– Anticipation Inventories– Decoupling Inventories

WHY??

Purchases

ABC

Forecasting

Inventory

Carrying Costs

INVENTORY

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Inventory Systems

• Inventory has costs associated with storage

• Systems developed to decrease stocks:– Just-in-time (JIT)– Kanban– Materials Resource Planning (MRP)

Purchases

ABC

Forecasting

Inventory

Carrying Costs

INVENTORY

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Just-in-Time (J.I.T.)

• What is it?• Goals• Integration with process and production

function– Layout– Automation– standardization

• Quality is the key!– 3 principles

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

J.I.T. Continued• Kanban systems

• What will J.I.T. accomplish?

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Dependent vs. Independent Demand

• Independent– Fixed-Quantity Model– Fixed-Period Model

• Dependent– MRP

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

DEMAND

Models

Service Levels

MRP

Game

Case 6-3

Fixed-Quantity Model

• Reorder when inventory drops to a reorder point

• Consider safety stock

• Calculations– Optimal Order Quantity (EOQ)– Reorder Point

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

MODELS

Service Levels

MRP

Game

Case 6-3

Fixed-Period Model

• Reorder only at review time

• Count inventory at the fixed interval period

• Inventory level should prevent stockouts

• Calculation:– Optimal Order Period

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

MODELS

Service Levels

MRP

Game

Case 6-3

Formula Variables

S = Order cost R = Annual demand K = Carrying cost percentage C = Purchase cost L = Lead time

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

MODELS

Service Levels

MRP

Game

Case 6-3

Example: Fixed-Quantity Model See pg 212-213 of text – Refer to handout

Given:

R = 900 units

K = 25 percent

L = 10 working days

C = $45 / unit

S = $50 / order

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

MODELS

Service Levels

MRP

Game

Case 6-3

Calculation

EOQ

Qopt = √ (2RS / KC)

Qopt = √ (2 * 900 * 50) / (25% * 45)

Qopt = 89 units

Reorder point

P = LR/250 Assume 250 working days

P = (10 * 900) / 250 = 36 units

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

MODELS

Service Levels

MRP

Game

Case 6-3

• Topt = (2S)/(RKC)

• Solution:– R = 900 units– C = $45 / unit– K = 25 percent– S = $50 / order

Example: Fixed-Period Model

Topt = (2S)/(RKC)

Topt = (2)(50)

(900)(0.25)(45)

Topt = 0.1

= 0.1*250 working days

= 25 reorder times per year

Note: 250/25 = 10 working days

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

MODELS

Service Levels

MRP

Game

Case 6-3

Example: Fixed-Period Model

• Reordering every 10 working days minimizes total costs– Carrying costs– Order costs

• Order must meet demand for 20 days:– Review period (10 working days)– Lead time (10 working days)

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

MODELS

Service Levels

MRP

Game

Case 6-3

Safety Stock and Service Levels

• Service Coverage– Percentage of requests that are immediately

served

• Stockout Costs– Loss of business due to running out of

inventory

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

SERVICE LEVELS

MRP

Game

Case 6-3

Safety Stock and Service Levels

• Critical Fractile = Cu/(Cu + Co)

• Where– Cu = the cost of understocking

– Co = the cost of overstocking

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

SERVICE LEVELS

MRP

Game

Case 6-3

Safety Stock and Service Levels

• Critical Fractile:– Difficult to determine– 95% or 19:1– Understocking is generally more costly than

overstocking• Exception: “bait and switch”

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

SERVICE LEVELS

MRP

Game

Case 6-3

MRP

• Used for dependent demand

• Goals of MRP:– Minimize inventory– Maintain high service coverage– Coordinate delivery schedules and

manufacturing and purchasing activities

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

Case 6-3

Case 6-3: Abbey Paquette

Abbey Paquette, Purchasing Agent for Pentz International, has been instructed by the new President to reduce annual inventory carry costs from two and a half million to zero by year end.

Upon further investigation, the firm’s database was filled with outdated, inaccurate information. Much of the inventory still on the system was not actually in stock.

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

CASE 6-3

Problems

Immediate Problem:– How to cut inventory carrying costs?

Basic Problems:– Lack of internal and external information systems– Poor inventory controls– Poor communication with employees

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

CASE 6-3

Analysis

• No system to classify inventory

• No knowledge of required inventory

• No forecasting

• May have resulted in unnecessary spending & stockout costs

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

CASE 6-3

Analysis

• No analysis/system to measure carrying costs– Goal: minimize total annual costs

– Timing considerations

– Obsolescence

• Tradeoff between different costs:– Inventory carrying costs vs. ordering costs

– Inventory carrying costs vs. stockout costs

– Inventory carrying costs vs. safety stock costs

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

CASE 6-3

Analysis

• Minimal supplier relationships– Inconsistent data

• Top management does not understand purchasing function

• Overabundance of small tasks minimizes time for strategy– Low level of automation

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

CASE 6-3

Analysis

• Current system of inventory tracking and control is not very useful or accurate

• Employees are not following the system and have not been properly trained on how to use the system

• The quality of the entire process is reduced without the problem being fixed

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

CASE 6-3

Alternatives1. Immediate reduction of inventory

• Goal: Zero inventory

• Refrain from reordering, until it is absolutely necessary

• Utilize J.I.T.

2. Gradual reduction of inventory• Goal: Some inventory

• Continue to reorder, but in smaller quantities

• May require improved supplier relationships

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

CASE 6-3

Class Discussion

• Split into 2 groups and prepare to defend why the following should be chosen:

Alternative #1 – Group A

Alternative #2 – Group B

Our Solution …Gradual Reduction of Inventory

(Alternative #1)

Implementation: Short TermTime frame: August to end of December

• Comprehensive Analysis – ABC classification– Supplier relations– EOQ Analysis

• Research information systems– MRP– EDI-INT– Barcode scanning

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

CASE 6-3

• Choosing information systems.– Consult other employees

• Meet with Isaac Chisholm – Explain issues with Zero inventory– Present the plan of action

Implementation: Short TermTime frame: August to end of December

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

CASE 6-3

Implementation: Medium Term Time frame: January to the end of December

• Get employee buy-in

• Implement new Information Systems– Barcode inventory management system– Internet-based EDI system

• Hire a consultant

• Train employee to do cycle counting

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

CASE 6-3

Implementation: Long Term Time frame: January and on

• Continue working with suppliers and employees to achieve a stockless inventory purchasing system– Use checks and balances– Generate feedback from employees

• Analyze the average carrying cost to determine the plan’s success

Purchases

ABC

Forecasting

Inventory

Carrying Costs

Inventory

JIT

Demand

Models

Service Levels

MRP

Game

CASE 6-3

QUESTIONS?

THANK YOU!