inventory management

Facts on Inventory Management

INVENTORY MANAGEMENT

The senior executives of “Alpha Numerics” were having their annual retreat to review accomplishments of the past year and to discuss major policy issues for the coming year. As was the norm, the retreat was held at a small hotel in the mountains of Pennsylvania, well removed from the company’s actual manufacturing facility.

INVENTORY MANAGEMENT: A SHORT STORY

The first day’s meeting had gone well, but in the early evening, after dinner, the subject of inventory control and the number of shortages that had occurred over the past year came up for discussion.

The Vice-President of engineering suggested that, as a solution to the shortage problem, purchasing should order all of the projected material requirements a the beginning of the year.


The Vice-President was so taken aback by this suggestion that, to the amazement of the others in the room, he leaped onto the conference table and shouted out, “Inventory is evil!” He turned to the President and said,

“If we were to follow this suggestion, Mr. President, do you have an extra 25,000 square feet of warehouses space where we can store the material?”


The President shook his head. “and do you, Mr. Vice-President of Finance, have an extra $5 million dollars to buy all this material?” The Vic-President of Finance similarly shook his head.

“And are you, Mr. Vice-President of Marketing, going to provide me with a perfect forecast of he products we expect to sell for he next year?”

The Vice-President of Marketing said, ”No, of course . That would be impossible.”


And turning to the VP of Engineering who made the initial proposal, he said, “and you’ll keep the same designs in he coming year without many any changes, won’t you?” The VP of Engineering said, ”that would be very unrealistic. ”All of the individuals in the room then looked up to the VP of Manufacturing still standing on the conference table and said, “we see what you mean. Inventory is indeed evil!”


Inventory Management: (Continued)Learning Objectives: After this chapter, you should

be able to;• Define the term inventory and list the major reasons for

holding inventories;• Contrast independent and dependent demand;• List the main requirements for effective inventory

management;• Discuss the objectives of inventory management;• Describe the basic EOQ model and its assumptions and

solve typical problems;• Describe the economic run size model and solve typical

problems;• Describe the quantity discount model and solve typical

problems.

Good Inventory Management is essential to the successful operation of most organization for a number reasons;

The amount of money inventory represents;

The impact that inventories have on the daily operations of an organization

Q- trigger!Q- trigger!What is lacking is an understanding of

* What needs to be done and * How to do it!

Inventory Management: (Continued)

INTRODUCTIONAn Inventory is a stock or sore of goods;* Firms typically stock hundreds or

thousands of items in inventory; ranging from small things such as pencil, paper clips, screw, nuts, and bolts to large items such as machines, trucks, construction equipment and airplanes.

Dependent Demand* Items in inventory that are

subassemblies or components parts to be used in the production of finished goods

Independent Demand* Items are the finished goods of other end

items.


Inventories are vital part of business. Not only are they necessary for operations, but also they contribute to customer satisfaction.

Q-Trigger* A typical firm probably has about 30% of

is current assets and perhaps as much as 90% of is working capital invested in inventory.

* A typical manufacturing firm carries different types of inventories, including the following;

Raw materials and purchased parts;Partially completed goods, called

work-in-process (WIP);


Finished goods inventories (manufacturing firms) or merchandise (retail stores);

Replacement parts, tools and supplies;

Goods-in-transition warehouse or customers.

Service firms do not carry these types of inventories, although hay do carry inventories of supplies and equipment.


FUNCTIONS OF INVENTORY:

To meet anticipated demand;To smooth production requirements;To decouple components of he

production-distribution system;To protect against stock-outs;To take advantage of order cycles;To hedge against price increases or

to take advantage of quantity discounts;To permit operations.


Requirements for effective inventory management;

* A system to keep track of the inventory on hand and on hand and on order;

* A reliable forecast of demand that includes an indication of possible forecast error;

* Knowledge of lead times and lead time variability;

* Reasonable estimates of inventory holding costs, ordering costs, and shortage

costs;* A classification system for inventory

items.


INVENTORY COUNTING SYSTEMS* Perpetual Inventory System – a system that keeps track of removals from inventory continuously, thus monitoring current levels of each item;* Two- bin System – two containers of inventory; reorder when the first is empty;* Universal Product Code – bar code printed on a label that has information about the item to which it is attached.


DEMAND FORECAST AND LEAD TIME INFORMATIONInventories are used to satisfy demand

requirements, so it is essential to have reliable estimates of the amount and timing of demand. COST INFORMATION

Holding or Carrying Costs – relate to physically having items in storage. Costs include interest, insurance, taxes, depreciation, obsolescence, deterioration, spoilage, pilferage, breakage, and warehousing costs.

Ordering Costs – are the costs of ordering and receiving inventory. These include determining how much is needed, preparing invoices, inspecting goods upon arrival for quality and quantity, and moving the goods to temporary storage


Q-TRIGGERWhat levels should be maintained?When stock should be replenished, and;How large orders should be?


Assumptions of the basic EOQ model1. Only one product is involved;2. Annual demand requirements are known;3. Demand is spread evenly throughout the year

so that the demand rate is reasonable constant;4. Lead time does not vary;5. Each order is received in a single delivery;6. There are no quantity discounts.


IE 11. A local distributor for a national tire company

expects to sell approximately 9,600 steel-belted radial tires of a certain size and tread design next year. Annual carrying costs are $16 per tire, and ordering costs are $75. The distributor operates 288 days a year.

a. What is the EOQ?b. How many times per year does the store

reorder?c. What is the length of an order cycle?

2. Piddling Manufacturing assembles television sets. It purchases 3,600 black-and-white picture tubes a year at $65 each. Ordering costs are $31, and annual carrying costs are 20 percent of the purchase price. Compute the optimal quantity and the total annual cost ordering and carrying the inventory.

IE 2

EOQ with Non-instantaneous ReplenishmentThe basic EOQ model assumes that each order is delivered at a single point in time. In some instances, however, such as when a firm is both a producer and user or when deliveries are spread over time, inventories tend to build gradually instead of instantaneously.

3. A toy manufacturer uses a 48,000 rubber wheels per year for its popular dump truck series. The firm makes its own wheels, which it can produce at a rate of 800 per day. The toy trucks are assembled uniformly over the entire year. Carrying cost is &1 per wheel. Setup cost for a production run of wheels is $45. The firm operates 240 days per year. Determine each of the following:

a. Optimal run sizeb. Minimum total annual cost for carrying and setupc. Cycle time for the optimal run sized. Run time

IE 3

Quantity Discounts are price reductions for large orders offered to customers to induce them to buy in large quantities.

• If quantity discounts are offered, the customer must weigh the potential benefits of reduced purchase price and fewer orders that will result from buying in large quantities against the increase in carrying costs caused by higher average inventories.

• The buyer’s goal with quantity discounts is to select the order quantity that will minimize total cost, where total cost is the sum of carrying cost, ordering cost, and purchasing cost.

IE 4

4. The maintenance department of a large hospital uses about 816 cases of liquid cleanser annually. Ordering costs are $12, carrying costs are $4 per case a year, and the new price schedule indicates that orders of less than 50 cases will cost $20 per case, 50 to 79 cases will cost $18 per case, 80 to 99 cases will cost $17 per case, and larger orders will costs $16 per case. Determine the optimal order quantity and the total cost.

Inventory Management: Illustrative Examples

When carrying costs are expressed as a percentage of price, determine the best purchase quantity with the following procedure;

• Beginning with the lowest price, compute the EOQs for each price range until a feasible EOQ is found;

• If the EOQ for the lowest price is feasible, it is the optimal order quantity. If the EOQ is not the lowest price range, compare the total cost at the price break for all lower prices with the total cost of the largest feasible EOQ. The quantity that yields the lowest total cost is the optimum.

IE 5

• Surge Electric uses 4,000 toggle switches a year. Switches are priced as follows: 1 to 499, 90 cents each; 500 to 999, 85 cents each; and 1,000 or more, 82 cents of purchase prices per unit on an annual basis. Determine the optimal order quantity and the total annual cost.

When to Reorder with EOQ OrderingEOQ models answer the question of how

much to order, but not the question of when to order. The latter is the function of models that identify the reorder point (ROP) in terms of quantity: the reorder point occurs when the quantity on hand drops to a predetermined amount. The amount that generally includes expected demand during lead time and perhaps an extra cushion of stock, which serves to reduce the probability of experiencing a stock-out during lead time.

The basic concern of the manager is to place an order when the amount of inventory on hand is sufficient to satisfy demand during the time it takes to receive that order. There are four determinants of the reorder point quantity;

1. The rate of demand;2. The length of lead time;3. The extent of demand and/or lead time

variability;4. The degree of stock-out risk acceptable to

management.

6. Tingly takes Two-a-Day vitamins, which are delivered to his home by a route man seven days after an order is called in. At what point should Tingly telephone his order in?

Safety Stock – a stock that is held in excess of expected demand rate due to

variable demand rate and/or lead time.

Service Level – Probability that demand will not exceed supply during lead time.

IE 6

The amount of safety stock that is appropriately for a given situation depends on the following factors;

1. The average demand rate and average lead time.

2. Demand and lead time variability.

3. The desired service level.

7. Suppose that the manager of a construction supply house determined from the historical records that the lead time demand for sand averages 50 tons. In addition, suppose the manager determined that demand during lead time could be described by a normal distribution that has a mean of 50 tons and a standard deviation of 5 tons. Answer these questions, assuming that the manager is willing to accept a stock-out risk of no more than 3 percent.

a. What value of z is appropriate?b. How much safety stock should be held?c. What reorder point should be used?

IE 7

8. A restaurant uses an average of 50 jars of a special sauce each week. Weekly usage of sauce has a standard deviation of 3 jars. The manager is willing to accept no more than a 10 percent risk of a stock-out during lead time, which is two weeks. Assume the distribution of usage is normal.

a. Which formula is appropriate to this situation?b. Determine the value of z.c. Determine the ROP.

IE 8

1. The housekeeping department of a motel uses approximately 400 washcloths per day. The actual amount tends to vary with the number of guests on any given night. Usage can be approximated by a normal distribution that has a mean of 400 and a standard deviation of 9 washcloths per day. A linen supply company delivers towels and washcloths with a lead time of three days. If the motel policy is to maintain a stock-out risk of 2 percent, what is the minimum number of washcloths that must be on hand at reorder time, and how much of that amount can be considered safety stock?

IE 9

2. The motel in the preceding example uses approximately 600 bars of soap each day, and this tends not to vary by more than a few bars either way. Lead time for soap delivery is normally distributed with a

mean of six days and standard deviation of two days. A service level of 90 percent is

desired. Find the ROP.

IE 10

3. The motel replaces broken glasses at a rate of 25 per day. In the past, this quantity has tended to vary normally and have a standard deviation of 3 glasses per day. Glasses are ordered from a Cleveland supplier. Lead time is normally distributed with an average of 10 days and a standard deviation of 2 days. What ROP should be used to achieve a service level of 95 percent?

IE 10

4. The manager of a store that sells office supplies has decided to set an annual service level of 96 percent for a certain model of telephone answering equipment. The store sells approximately 300 of this model a year. Holding cost is $5 per unit annually, ordering cost is $25, σdLT= 7.stock of the chemical?

a. What average number of units short per year will be consistent with the specified annual service level?b. What average number of units short per cycle will provide the desired annual service level?c. What lead time service level is necessary for the 96 percent annual service level?

IE 11

IE 13

5. A lab orders a number of chemicals from the same supplier every 30 days. Lead time is 5 days. The assistant manager of the lab must determine how much of one of these chemicals to order. A check of stock revealed that eleven 25-ml jars are on hand. Daily usage of the chemical is approximately normal with a mean of 15.2 ml per day and standard deviation of 1.6 ml per day. The desired service level for this chemical is 95 percent.How many bottles of the chemical should be ordered?What is the average amount of safety

IE #14: Shortages & SL

The manager of a store that sells office supplies has decided to set an annual service level of 96 percent for a certain model of telephone answering equipment. The store sells approximately 300 of this model a year. Holding cost is $5 per unit annually, ordering cost is $25, and σdLT = 7.

a. What average number of units short per year will be consistent with the specified annual service level?

b. What average number of units short cycle will provide the desired annual service level?

c. What lead time service level is necessary for the 96 percent annual service level?

IE #15A lab orders a number of chemicals

from the same supplier every 30 days. Lead time is 5 days. The assistant manager of the lab must determine how much of one of these chemicals to order. A check of stock revealed that eleven 25-ml jars are on hand. Daily usage of the chemical is approximately normal with a mean

Of 15.2 ml per day and a standard deviation of 1.6 ml per day. The desired service level for this chemical is 95 percent.

a.How many bottles of the chemical should be ordered?

b.What is the average amount of safety stock of the chemical?

IE #16Sweet cider is delivered weekly to Pappy’s

Produce Stand. Demand varies uniformly between 300 liters and 500 liters per week. Pappy pays 20 percent per liter for the cider and charges 80 cents per liter for it. Unsold cider has no salvage value and cannot be carried over into the next week due to spoilage. Find the optimal stocking level and its stock-out risk for that quantity.

IE #17Pappy’s Stand also sells a blend of

cherry juice and apple cider. Demand for the blend is approximately normal with a mean of 200 liters per week and a standard deviation of 10 liters per week. Cs = 60 cents per liter, and

Ce = 20 cents per liter. Find the optimal stocking level for the apple-cherry blend.

Materials Materials Requirements Requirements

PlanningPlanning

Materials Materials Requirements Requirements

PlanningPlanning

A Short Story FMC Corporation is a $3.75 billion

global producer of food machinery, chemicals, and defense equipment. Already skilled at producing high-quality, low-cost products, the company now wants to take advantage of emerging worldwide markets while being its customers’ best supplier.

A Short Story (cont’d)To do that, FMC plans to supply the

sales force with up-to-date information about the markets, the company’s product lines, and product availability across their plants. This will allow the sales force to access current information from 112 plants in 20 countries.

A Short Story (cont’d)In addition, sales representatives

will be given tools to analyze available inventory, capacity, cost, and currency considerations in order to achieve the most favorable economics in delivering products to customers. But first, FMC needs to get the right information from the company’s multiple ManMan MRP II

A Short Story (cont’d)Systems from the The Ask Cos.

Currently, FMC is working with Ask to develop the capabilities to support its goals.

Customer service is the primary focus at Dow Corning Corporation. The company has launched 30 cross-functional teams across five of its eight divisions. These teams are

A Short Story (cont’d)Working to change Dow’s operational

processes, work flows, and the way people perform to increase customer satisfaction and reduce consumption.

Of utmost importance is shortening the time-to-market of new products and placing operational activities, such as order entry, into the hands of customers. Key to these plans is

A Short Story (cont’d)An EDI system for the entire supply

chain. Dow also plans to replace its 20-year old, in-house-developed MRP II system with an advanced system that can balance its production resources across all of its divisions.

Today, MRP systems, in part or in whole, are used in manufacturing firms both large and small. The reason is that MRP is a logical and readily understandable approach.

Learning Objectives

• Describe the conditions under which MRP is most appropriate;

• Describe the inputs, outputs, and nature of MRP processing;

• Discuss the benefits and requirements of MRP.

Chapter Outline• MRP Inputs• MRP Processing• Other Considerations• Capacity Requirements Planning• Solved Problems• Problems

OverviewMaterials Requirements Planning

(MRP) is a computer-based information system designed to handle ordering and scheduling of dependent demand inventories.

Historically, ordering and scheduling of assembled products suffered from two difficulties.

Overview (Cont’d)

One was the enormous task of setting up schedules, keeping track of large numbers of parts and components, and coping with schedule and order changes.

MRP Inputs1. The Master ScheduleOne of three primary inputs; states

which end items are to be produced, when these are needed, and in what quantities.

2. Bill-of-MaterialsA listing of all of the raw materials,

parts, subassemblies, and assemblies needed to produce one unit of a product.

MRP Inputs3. The Inventory Records FileIncludes information on the status of

each item by time period.

Example #1

Use the information presented;a.Determine the quantities of B, C,

D, E, and F needed to assemble one X.

b.Determine the quantities of these components that will be required to assemble 200 Xs.

Example #1: Solutiona.

Component

Qty

B 2 Bs per X 2

D 3 Ds per B x 2 Bs per X

6

E 4 Es per D x 3 Ds per B x 2 Bs per X

24

E 1 E per B x 2 Bs per X 2

C 1 C per X 1

E 2 Es per C x 1 C per X 2

F 2 Fs per C x 1 C per X 2

Example #1: Solution

b. In order to assemble 200 units of X., the quantities of each component must be multiplied by 200. Hence, there must be 200(2) = 400 Bs, 200(6) = 1,200 Ds, 200(28) = 5,600 Es and so on…

MRP Processing• Gross RequirementsTotal expected demand for an item or

raw material in a time period.• Scheduled ReceiptsOpen orders scheduled to arrive from

vendors or elsewhere in the pipeline.• Projected on handExpected amount of inventory that will

be on hand at the beginning of each time period.

MRP Processing• Net requirementsThe actual amount needed in each time

period.• Planned-order receiptsQuantity expected to be received by the

beginning of the period in which it is shown.

• Planned-order releasesPlanned amount to order in each time

period; planned-order receipts offset by lead time

Example #2A firm that produces wood shutters and bookcases has

received two orders for shutters: one for 100 shutters and one for 150 shutters. The 100-unit order is due for delivery at the start of week 4 of the current schedule, and the 150-unit order is due for delivery at the start of week 4 of the current schedule, and the 150-unit order is due for delivery at the start of week 8. Each shutter consists of four slatted wood sections and two frames. The wood sections are made by the firm, and fabrication takes one week. The frames are ordered, and lead time is two weeks. Assembly of the shutters requires one week. There is a scheduled receipt of 70 wood sections in week.

1. Determine the size and timing of planned-order releases necessary to meet delivery requirements under each of these conditions.

• Lot-for-lot ordering• Lot-size ordering with a lot size of 320 units for frames and 70

units for wood sections.

MRP OutputsMRP systems have the ability to

provide management with a fairly broad range of outputs. These are often classified as primary reports, which are the main reports, and secondary reports, which are optional outputs.

MRP Outputs (Cont’d) Primary Reports

• Planned ordersSchedule indicating the amount and

timing of future orders.• Order releasesAuthorization for the execution of

planned orders.• ChangesRevisions of due dates or order

quantities, or cancellations or orders.

MRP Outputs (Cont’d) Secondary Reports

• Performance –control reportsEvaluation of system operation,

including deviations from plans and cost information.

• Planning reportsData useful for assessing future

material requirements.• Exception reportsData on any major discrepancies

encountered.

Other Considerations• Safety Stock• Lot Sizing• Lot-for-lot Ordering• Economic Order Quantity Model• Fixed-Period Ordering• Part-Period Model

Example #3Use the part-period method to determine

order sizes for this demand schedule:Setup cost is $80 per run for this item,

and unit holding cost is $.95 per period.

Period

1 2 3 4 5 6 7 8Demand

60 40 20 2 30 - 70 50

Cum. Dem.

60 100 120 122 152 152 222 272

Example #2: Solution1. First compute the EPP:

EPP=$80/$.95=84.21

Period Lot Size

Extra Invty carrie

d

Periods

Carried

Part Period

s

Cum. Part

Periods

1 60 0 0 0 0

100 40 1 40 40

120 20 2 40 80

122 2 3 6 86

5 30 0 0 0 0

100 70 2 140 140

50 0 0 0 0

Capacity Requirements Planning

The process of determining short-range capacity requirements.

• Load reportsDepartment or work center reports

that compare known and expected future capacity requirements with projected capacity availability.

Benefits and Requirements of MRP

• Low levels of in-process inventories;• The ability to keep track of material

requirements;• The ability to evaluate capacity

requirements generated by a given master schedule;

• A means of allocating production time.

Example #3The following product structure tree

indicates the components needed to assemble one unit of product W. Redraw the tree so that it conforms to low-level coding. Then determine the quantities of each component needed to assemble 100 units of W.

Example #4The following product structure tree

indicates the components needed to assemble one unit of product W. Redraw the tree so that it conforms to low-level coding. Then determine the quantities of each component to assemble 100 units of W.

Example #4 W

C(4)B (2)A

D(2) E E(2) F D(3) G(2)

D

Example #4Level Item (1 W)

Qty(100 W)

Qty

0 W 1

1 A 1

B 2

C 4

2 E 5

F 2

G 8

3 D 22

Example #5The product structure tree for end item E

follows. The manager wants to know the material requirements for ordered part R that will be needed to complete 120 units of E by the start of week 5. Lead times for items are one week for level 0 items, one week for level 1 items, and two for level 2 items. There is a scheduled receipt of 60 units of M at the end of week 1 and 100 units of R at the start of week 1. lot-for-lot ordering is used. (Solution in Excel)

Example #6Given the following production

schedule in units and the production standards for labor and machine time for this products, determine the labor and machine capacity requirements for each week. Then compute the percent utilization of labor and machines in each week if labor capacity is 200 hours per week and machine capacity is 250 hours per week

Example #6Production schedule:

Week 1 2 3 4

Quantity 200 300 100 150

Standarda time:

Labor .5 hours/unit

Machine 1.0 hours/unit

Example #6 (solution)

Week 1 2 3 4

Quantity 200 300 100 150

Labor hours

100 150 50 75

Machine hours

200 300 100 150

Week 1 2 3 4

Labor 50% 75% 25% 37.5%

Machine 80% 120% 40% 60%

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