Operations Management

Inventory ManagementChapter 12

OutlineGLOBAL COMPANY PROFILE: AMAZON.COMFUNCTIONS OF INVENTORYTypes of InventoryINVENTORY MANAGEMENTABC AnalysisRecord AccuracyCycle CountingControl of Service Inventories

Outline - ContinuedINVENTORY MODELSIndependent versus Dependent DemandHolding, Ordering, and Setup CostsINVENTORY MODELS FOR INDEPENDENT DEMANDBasic Economic Order Quantity (EOQ) ModelMinimizing CostsReorder PointsProduction Order Quantity ModelQuantity Discount Models

Outline - ContinuedPROBABILISTIC MODELS WITH CONSTANT LEAD TIMEFIXED PERIOD (P) SYSTEMS

Learning ObjectivesWhen you complete this chapter, you should be able to :Identify or Define:ABC analysisRecord accuracyCycle countingIndependent and dependent demandHolding, Ordering, and Setup CostsDescribe or Explain:The functions of inventory and basic inventory models

AMAZON.comJeff Bezos, in 1995, started AMAZON.com as a virtual retailer no inventory, no warehouses, no overhead; just a bunch of computers.Growth forced AMAZON.com to excel in inventory management!AMAZON is now a worldwide leader in warehouse management and automation.

Order Fulfillment at AMAZONYou order items;, computer assigns your order to distribution center [closest facility that has the product(s)]Lights indicate products ordered to workers who retrieve product and reset light.Items placed in crate with items from other orders, and crate is placed on conveyor. Bar code on item is scanned 15 times virtually eliminating error.

Order Fulfillment at AMAZON- ContinuedCrates arrive at central point where items are boxed and labeled with new bar code.Gift wrapping done by hand (30 packages per hour)Box is packed, taped, weighed and labeled before leaving warehouse in a truck.Order appears on your doorstep within a week

What is Inventory?Stock of materialsStored capacityExamples 1995 Corel Corp. 1984-1994 T/Maker Co. 1984-1994 T/Maker Co. 1995 Corel Corp.

The Functions of InventoryTo decouple or separate various parts of the production processTo provide a stock of goods that will provide a selection for customersTo take advantage of quantity discountsTo hedge against inflation and upward price changes

Types of InventoryRaw materialWork-in-progressMaintenance/repair/operating supplyFinished goods

The Material Flow Cycle

Disadvantages of InventoryHigher costsItem cost (if purchased)Ordering (or setup) costCosts of forms, clerks wages etc.Holding (or carrying) costBuilding lease, insurance, taxes etc.Difficult to controlHides production problems

Inventory Classifications

The Material Flow CycleRun time: Job is at machine and being worked onSetup time: Job is at the work station, and the work station is being "setup."Queue time: Job is where it should be, but is not being processed because other work precedes it.Move time: The time a job spends in transitWait time: When one process is finished, but the job is waiting to be moved to the next work area.Other: "Just-in-case" inventory.OtherWaitTimeMoveTimeQueueTimeSetupTimeRunTimeInputCycle TimeOutput

ABC AnalysisDivides on-hand inventory into 3 classesA class, B class, C classBasis is usually annual $ volume$ volume = Annual demand x Unit costPolicies based on ABC analysisDevelop class A suppliers moreGive tighter physical control of A itemsForecast A items more carefully

Classifying Items as ABC% of Inventory Items

Cycle CountingPhysically counting a sample of total inventory on a regular basisUsed often with ABC classificationA items counted most often (e.g., daily)

Advantages of Cycle CountingEliminates shutdown and interruption of production necessary for annual physical inventoriesEliminates annual inventory adjustmentsProvides trained personnel to audit the accuracy of inventoryAllows the cause of errors to be identified and remedial action to be takenMaintains accurate inventory records

Techniques for Controlling Service Inventory Include:Good personnel selection, training, and disciplineTight control of incoming shipmentsEffective control of all goods leaving the facility

Independent versus Dependent DemandIndependent demand - demand for item is independent of demand for any other itemDependent demand - demand for item is dependent upon the demand for some other item

Inventory CostsHolding costs - associated with holding or carrying inventory over timeOrdering costs - associated with costs of placing order and receiving goodsSetup costs - cost to prepare a machine or process for manufacturing an order

Holding (Carrying) CostsObsolescenceInsuranceExtra staffingInterestPilferageDamageWarehousingEtc.

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 costCost as a % of Inventory Value6%(3 - 10%)3%(1 - 3.5%)

3%(3 - 5%)

11%(6 - 24%)3% (2 - 5%)26%

Ordering CostsSuppliesFormsOrder processingClerical supportEtc.

Setup CostsClean-up costsRe-tooling costsAdjustment costsEtc.

Inventory ModelsFixed order-quantity modelsEconomic order quantityProduction order quantityQuantity discountProbabilistic modelsFixed order-period modelsHelp answer the inventory planning questions! 1984-1994 T/Maker Co.

EOQ AssumptionsKnown and constant demandKnown and constant lead timeInstantaneous receipt of materialNo quantity discountsOnly order (setup) cost and holding costNo stockouts

Inventory Usage Over Time

EOQ ModelHow Much to Order?

Why Holding Costs IncreaseMore units must be stored if more are orderedPurchase OrderDescriptionQty.Microwave1Order quantity

Why Order Costs DecreaseCost is spread over more unitsExample: You need 1000 microwave ovens

Deriving an EOQDevelop an expression for setup or ordering costsDevelop an expression for holding costSet setup cost equal to holding costSolve the resulting equation for the best order quantity

EOQ ModelWhen To Order

EOQ Model Equations

The Reorder Point (ROP) Curve

Production Order Quantity ModelAnswers how much to order and when to orderAllows partial receipt of materialOther EOQ assumptions applySuited for production environmentMaterial produced, used immediatelyProvides production lot sizeLower holding cost than EOQ model

EOQ POQ ModelWhen To Order

EOQ POQ ModelWhen To OrderReorder Point (ROP)TimeInventory LevelAverage InventoryLead TimeOptimal Order Quantity (Q*)

Reasons for Variability in ProductionMost 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 quantityinaccurate engineering drawings or specificationsproduction personnel try to produce beforedrawings or specifications are completecustomer demands are unknown

POQ Model Inventory Levels

POQ Model Inventory Levels

POQ Model EquationsD = Demand per yearS = Setup costH = Holding cost d = Demand per dayp = Production per dayOptimal Order QuantitySetup CostHolding Cost==-=*=*=QH*dpQDQSp*1(0.5 * H * Q -dp1)1()2*D*S()Maximum inventory level

Quantity Discount ModelAnswers how much to order & when to orderAllows quantity discountsReduced price when item is purchased in larger quantitiesOther EOQ assumptions applyTrade-off is between lower price & increased holding cost

Quantity Discount Schedule

Discount NumberDiscount QuantityDiscount (%)Discount Price (P)10 to 999No discount$5.0021,000 to 1,9994$4.8032,000 and over5$4.75

Quantity Discount How Much to Order

Probabilistic ModelsAnswer how much & when to order Allow demand to varyFollows normal distributionOther EOQ assumptions applyConsider service level & safety stockService level = 1 - Probability of stockoutHigher service level means more safety stockMore safety stock means higher ROP

Probabilistic ModelsWhen to Order?

Fixed Period ModelAnswers how much to orderOrders placed at fixed intervalsInventory brought up to target amountAmount ordered variesNo continuous inventory countPossibility of stockout between intervalsUseful when vendors visit routinelyExample: P&G representative calls every 2 weeks

Inventory Level in a Fixed Period SystemVarious amounts (Qi) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum

Fixed Period ModelWhen to Order?

While most students recognize inventory as a stock of material, the notion of inventory as a stored capacity probably merits explicit discussion.If this course is the first exposure of students to manufacturing, it might be useful to discuss the decoupling function.It might be useful here to explicitly discuss the purpose of each type of inventory.This slide illustrates the overall material flow cycle. You should stress the proportion of time material spends as inventory as opposed to being actually worked on; and note that this suggests effective inventory management and materials movement can reduce overall cycle time significantly.Of the items listed on this slide, the least obvious to most students is the manner in which inventory can be used to hide production problems.This slide provides a more detailed view of the material flow cycle. Students might be asked to comment on the impact of each element on the overall time. Questions such as: - why do we need these times? - how can they be reduced? - would we wish to eliminate these elements entirely?might be helpful.It might be helpful here to discuss some of the differences in the ways we would manage items in the three different levels. What actions would we actually take in managing A versus in managing C?Are we back to Pareto analysis?An element to stress about cycle counting is that it usually identifies problems and enables action to be taken in a reasonable amount of time.Here you might ask students to consider the problem of inventory in organizations which provide primarily personal services (hospital, doctor, Merry Maids, college or university).You might ask students if they can identify an industry for which the cost of obsolescence is particularly important. Is the number of such industries likely to grow or decline?The same question could be asked regarding pilferage.

The question could be asked in a more general manner: Are there industries for which one or another of the areas listed is of particular or unusual importance?Note that this slide suggest holding costs are, on average, about 26% of the inventory valueThis slide simply introduces some of the available models. Additional details are provided in subsequent slides.Students should be asked to consider the degree to which each of these assumptions is accurate.One should link this model to the assumptions. You should also explore, at least briefly, how this picture would change if the assumptions were not met.Students may find it helpful if you actually go through each of these steps - at least through writing the equation, and setting setup cost equal to holding cost.One should link this model to the assumptions. You should also explore, at least briefly, how this picture would change if the assumptions were not met.For some students, it is most important at this point to explain in detail the meaning and significance of each equation. It might be helpful to actually work through a numerical example.One way to approach this is as an EOQ model with the instantaneous replenishment assumption relaxed. The following slide (EOQ Model modified to show changes for POQ) allows you to do this if you wish. Otherwise, skip it and move on.You should either provide concrete examples of the causes noted, or ask that students do so.

You should also explicitly discuss the relevance of this variability to the POQ model.Given that students recognize that production takes place for only a portion of the cycle, you might ask how one determines the appropriate length of the production period. If they understand the model, they will perceive that the production period is determined by the POQ.Here again, it may be helpful to actually go through a numerical example, but it will probably be necessary to explain in detail the meaning and significance of each equation One point to stress here is that this is simply an extension of the original EOQ model where we are now allowing the demand to vary. Students should become accustomed to seeking such extensions as the need arises.

The next slide presents a graphical view of this model.32This represents a model in which orders are based upon time, not the quantity needed. The following slide provides a graphical representation.