pom - j. galván 1 production and operations management ch.13: inventory management

POM - J. GalvánPOM - J. Galván 11

PRODUCTION AND PRODUCTION AND OPERATIONS OPERATIONS

MANAGEMENTMANAGEMENT

Ch.13: Inventory ManagementCh.13: Inventory Management


Learning ObjectivesLearning Objectives

Explain what inventory isExplain what inventory is Explain how inventory is classifiedExplain how inventory is classified Explain ABC Analysis and Cycle Explain ABC Analysis and Cycle

CountingCounting Compare inventory modelsCompare inventory models Use inventory models to find how Use inventory models to find how

much and when to ordermuch and when to order

POM - J. GalvánPOM - J. Galván 33© 1998 by Prentice Hall, Inc.A Simon & Schuster Company

Upper Saddle River, N.J. 07458

Stock of materialsStock of materials Stored capacityStored capacity ExamplesExamples

© 1995 Corel Corp.

© 1995 Corel Corp.

What is Inventory?What is Inventory?


The Functions of InventoryThe Functions of Inventory Provide a stock of goods to meet anticipated Provide a stock of goods to meet anticipated

customer demand and provide a “selection” of customer demand and provide a “selection” of goodsgoods

Decouple suppliers from production and production Decouple suppliers from production and production from distributionfrom distribution

Allow one to take advantage of quantity discountsAllow one to take advantage of quantity discounts To provide a hedge against inflationTo provide a hedge against inflation To protect against shortages due to delivery To protect against shortages due to delivery

variationvariation To permit operations to continue smoothly with the To permit operations to continue smoothly with the

use of “work-in-process”use of “work-in-process”


Higher costsHigher costs• Item cost (if purchased)Item cost (if purchased)• Ordering (or setup) costOrdering (or setup) cost

Costs of forms, clerks’ wages etc.Costs of forms, clerks’ wages etc.• Holding (or carrying) costHolding (or carrying) cost

Building lease, insurance, taxes etc.Building lease, insurance, taxes etc.

Difficult to controlDifficult to control Hides production problemsHides production problems

Disadvantages of InventoryDisadvantages of Inventory


Types of InventoryTypes of Inventory

Raw materialRaw material Work-in-processWork-in-process Maintenance/repair/operating Maintenance/repair/operating

suppliessupplies Finished goodsFinished goods


Inventory

Process stage

Demand Type

Number & Value Other

Raw Material WIP

Finished Goods

Independent Dependent

A Items B Items C Items

Maintenance Dependent Operating

Inventory ClassificationsInventory Classifications


1 Run timeRun time: : Job is at machine and being worked onJob is at machine and being worked on2 Setup timeSetup time: Job is at the work station, and the work station is : Job is at the work station, and the work station is

being "setup."being "setup."3 Queue timeQueue time: Job is where it should be, but is not being : Job is where it should be, but is not being

processed because other work precedes it.processed because other work precedes it.4 Move timeMove time: The time a job spends in transit: The time a job spends in transit5 Wait timeWait time: When one process is finished, but the job is waiting : When one process is finished, but the job is waiting

to be moved to the next work area.to be moved to the next work area.6 OtherOther: : "Just-in-case" inventory."Just-in-case" inventory.

The Material Flow CycleThe Material Flow Cycle

OtherWaitTime

MoveTime

QueueTime

SetupTime

RunTimeInput

Cycle Time

Output


Divides on-hand inventory into 3 classesDivides on-hand inventory into 3 classes• A class, B class, C classA class, B class, C class

Basis is usually annual $ volumeBasis is usually annual $ volume• $ volume = Annual demand x Unit cost$ volume = Annual demand x Unit cost

Policies based on ABC analysisPolicies based on ABC analysis• Develop class A suppliers moreDevelop class A suppliers more• Give tighter physical control of A itemsGive tighter physical control of A items• Forecast A items more carefullyForecast A items more carefully

ABC AnalysisABC Analysis


0

20

40

60

80

100

0 50 100 150% of Inventory Items% of Inventory Items

% Annual $ Usage% Annual $ Usage

AA

BB CC

Class % $ Vol % ItemsA 80 15B 15 30C 5 55

Classifying Items as ABCClassifying Items as ABC

ABC AnalysisABC Analysis

10 20 30 40 50 60 70 80 90100

Percentage of items

Perc

en

tag

e o

f d

ollar

valu

e

100 —

90 —

80 —

70 —

60 —

50 —

40 —

30 —

20 —

10 —

0 —

Class CClass B

Class A


Physically counting a sample of Physically counting a sample of total inventory on a regular basistotal inventory on a regular basis

Used often with ABC classificationUsed often with ABC classification• A items counted most often (e.g., daily)A items counted most often (e.g., daily)

Cycle CountingCycle Counting


Advantages of Cycle CountingAdvantages of Cycle Counting Eliminates shutdown and interruption of Eliminates shutdown and interruption of

production necessary for annual production necessary for annual physical inventoriesphysical inventories

Eliminates annual inventory adjustmentsEliminates annual inventory adjustments Provides trained personnel to audit the Provides trained personnel to audit the

accuracy of inventoryaccuracy of inventory Allows the cause of errors to be Allows the cause of errors to be

identified and remedial action to be identified and remedial action to be takentaken

Maintains accurate inventory recordsMaintains accurate inventory records


Techniques for Controlling Techniques for Controlling Service Inventory Include:Service Inventory Include:

Good personnel selection, training, Good personnel selection, training, and disciplineand discipline

Tight control of incoming shipmentsTight control of incoming shipments Effective control of all goods leaving Effective control of all goods leaving

the facilitythe facility


Independent versus Independent versus Dependent DemandDependent Demand

Independent demand - demand for Independent demand - demand for item is independent of demand for item is independent of demand for any other itemany other item

Dependent demand - demand for Dependent demand - demand for item is dependent upon the demand item is dependent upon the demand for some other itemfor some other item


Holding, Ordering, and Setup CostsHolding, Ordering, and Setup Costs

Holding costs - associated with Holding costs - associated with holding or “carrying” inventory over holding or “carrying” inventory over timetime

Ordering costs - associated with costs Ordering costs - associated with costs of placing order and receiving goodsof placing order and receiving goods

Setup costs - cost to prepare a Setup costs - cost to prepare a machine or process for machine or process for manufacturing an ordermanufacturing an order


Holding CostsHolding Costs

ObsolescenceObsolescence InsuranceInsurance Extra staffingExtra staffing InterestInterest PilferagePilferage DamageDamage WarehousingWarehousing Etc.Etc.


Determining Inventory Holding Determining Inventory Holding CostsCosts

CategoryCategory

Housing costsHousing costs

Material handling Material handling costscosts

Labor cost from extra Labor cost from extra handlinghandling

Investment costsInvestment costs

Pilferage, scrap, and Pilferage, scrap, and obsolescenceobsolescence

Cost as aCost as a % of Inventory % of Inventory

ValueValue6%6%

(3 - 10%)(3 - 10%)

3%3%(1 - 3.5%)(1 - 3.5%)

3%3%(3 -(3 - 5%)5%)

11%11%(6 - 24%)(6 - 24%)

3%3%(2 - 5%)(2 - 5%)


Ordering CostsOrdering Costs

SuppliesSupplies FormsForms Order processingOrder processing Clerical supportClerical support Etc.Etc.


Setup CostsSetup Costs

Clean-up costsClean-up costs Re-tooling costsRe-tooling costs Adjustment costsAdjustment costs Etc.Etc.


Fixed order quantity Fixed order quantity modelsmodels• Economic order quantityEconomic order quantity• Production order quantityProduction order quantity• Quantity discountQuantity discount

Probabilistic modelsProbabilistic models Fixed order period modelsFixed order period models

Help answer the inventory planning questions!

Help answer the inventory planning questions!

© 1984-1994 T/Maker Co.

Inventory ModelsInventory Models


Known and constant demandKnown and constant demand Known and constant lead timeKnown and constant lead time Instantaneous receipt of materialInstantaneous receipt of material No quantity discountsNo quantity discounts Only order (setup) cost and holding Only order (setup) cost and holding

costcost No stockoutsNo stockouts

EOQ AssumptionsEOQ Assumptions


Order QuantityOrder Quantity

Annual CostAnnual Cost

Holding Cost Curve

Holding Cost Curve

Total Cost Curve

Total Cost Curve

Order (Setup) Cost CurveOrder (Setup) Cost Curve

Optimal Optimal Order Quantity (Q*)Order Quantity (Q*)

EOQ ModelEOQ ModelHow Much to Order?How Much to Order?


More units must be stored if more orderedMore units must be stored if more ordered

Purchase OrderDescription Qty.Microwave 1

Order quantityOrder quantity



Why Holding Costs IncreaseWhy Holding Costs Increase


Cost is spread over more unitsCost is spread over more units

Example: You need 1000 microwave ovens Example: You need 1000 microwave ovens





1 Order (Postage $ 0.32)1 Order (Postage $ 0.32) 1000 Orders (Postage $320)1000 Orders (Postage $320)



Why Order Costs DecreaseWhy Order Costs Decrease


EOQ ModelEOQ ModelWhen To OrderWhen To Order

Reorder Reorder Point Point (ROP)(ROP)

TimeTime

Inventory LevelInventory Level

AverageAverageInventory Inventory

(Q*/2)(Q*/2)

Lead TimeLead Time

Optimal Optimal Order Order QuantityQuantity(Q*)(Q*)


Deriving an EOQDeriving an EOQ

Develop an expression for setup or Develop an expression for setup or ordering costsordering costs

Develop an expression for holding Develop an expression for holding costcost

Set setup cost equal to holding costSet setup cost equal to holding cost Solve the resulting equation for the Solve the resulting equation for the

best order quantitybest order quantity


Optimal Order Quantity

Expected Number of Orders

Expected Time Between Orders Working Days / Year

Working Days / Year

= =× ×

= =

= =

=

= ×

Q*D SH

ND

Q*

TN

dD

ROP d L

2

DD = Demand per year = Demand per year

SS = Setup (order) cost per order = Setup (order) cost per order

HH = Holding (carrying) cost = Holding (carrying) cost

dd = Demand per day = Demand per day

LL = Lead time in days = Lead time in days

EOQ Model EquationsEOQ Model Equations


Answers how much to order and Answers how much to order and when to orderwhen to order

Allows partial receipt of materialAllows partial receipt of material• Other EOQ assumptions applyOther EOQ assumptions apply

Suited for production environmentSuited for production environment• Material produced, used immediatelyMaterial produced, used immediately• Provides production lot sizeProvides production lot size

Lower holding cost than EOQ modelLower holding cost than EOQ model

Production Order Quantity Production Order Quantity ModelModel


Reasons for Variability in ProductionReasons for Variability in Production Most variability is caused by tolerating waste or Most variability is caused by tolerating waste or

by poor management. Specific causes include:by poor management. Specific causes include: employees, machines, and suppliers produce employees, machines, and suppliers produce

units that do not conform to standards, are units that do not conform to standards, are late or are not the proper quantitylate or are not the proper quantity

engineering drawings or specifications are engineering drawings or specifications are inaccurateinaccurate

production personnel try to produce beforeproduction personnel try to produce beforedrawings or specifications are completedrawings or specifications are complete

customer demands are unknowncustomer demands are unknown


POQ Model Inventory LevelsPOQ Model Inventory Levels


TimeTimeSupply Supply BeginsBegins

Supply Supply EndsEnds

Production portion of cycleProduction portion of cycle

Demand portion of cycle with no Demand portion of cycle with no supplysupply


D = Demand per year

S = Setup cost

H = Holding cost

d = Demand per day

p = Production per day

POQ Model EquationsPOQ Model Equations

Optimal Order Quantity

Max. Inventory Level

Setup Cost

Holding Cost

= =-

= *

= *

=

QH*

dp

Q

DQ

S

p *1

(

0.5 * H * Q - dp

1

)- d

p1

( )

2*D*S

( )


Answers how much to order & Answers how much to order & when to orderwhen to order

Allows quantity discountsAllows quantity discounts• Reduced price when item is purchased Reduced price when item is purchased

in larger quantitiesin larger quantities• Other EOQ assumptions applyOther EOQ assumptions apply

Trade-off is between lower price & Trade-off is between lower price & increased holding costincreased holding cost

Quantity Discount ModelQuantity Discount Model


Lowest cost not in Lowest cost not in discount rangediscount range

Quantity Discount ModelQuantity Discount ModelHow Much to Order?How Much to Order?

Order Order QuantityQuantity

Total CostTotal Cost TC for TC for Discount 1Discount 1

Discount Discount Quantity 1Quantity 1

TC for TC for Discount 2Discount 2

TC for TC for Discount 3Discount 3

DiscountDiscount Quantity 2Quantity 2

Quantity OrderedQuantity Ordered

Price 1Price 1 Price 2Price 2 PricePrice 3 3


Answer how much & when to order Answer how much & when to order Allow demand to varyAllow demand to vary

• Follows normal distributionFollows normal distribution• Other EOQ assumptions applyOther EOQ assumptions apply

Consider service level & safety stockConsider service level & safety stock• Service level = Service level = 1 - Probability of stockout1 - Probability of stockout• Higher service level means more safety Higher service level means more safety

stockstock More safety stock means higher ROPMore safety stock means higher ROP

Probabilistic ModelsProbabilistic Models


Probabilistic ModelsProbabilistic ModelsWhen to Order?When to Order?

Reorder Reorder Point Point (ROP)(ROP)

XX

Safety Stock (SS)Safety Stock (SS)

TimeTime


OptimalOptimal Order Order

QuantityQuantity

Lead TimeLead Time

SSSS

ROPROP

Service Service LevelLevel P(Stockout)P(Stockout)

Place Place orderorder

Receive Receive orderorder

FreqFreq


Reorder Reorder Point Point

(ROP)(ROP)

X

Safety Stock (SS)Safety Stock (SS)

TimeTime


OptimalOptimalOrderOrderQuantityQuantity

SSSS

ROPROP

Service Service LevelLevel P(Stockout)P(Stockout)

FreqFreq

Lead TimeLead Time

Place Place orderorder

Receive Receive orderorder

Probabilistic ModelsProbabilistic ModelsWhen to OrderWhen to Order


Answers how much to orderAnswers how much to order Orders placed at fixed intervalsOrders placed at fixed intervals

• Inventory brought up to target amountInventory brought up to target amount• Amount ordered variesAmount ordered varies

No continuous inventory countNo continuous inventory count• Possibility of stockout between intervalsPossibility of stockout between intervals

Useful when vendors visit routinelyUseful when vendors visit routinely• Example: P&G representative calls every 2 Example: P&G representative calls every 2

weeksweeks

Fixed Period ModelFixed Period Model


TimeTime

Inventory LevelInventory Level Target maximumTarget maximum

PeriodPeriod PeriodPeriodPeriodPeriod

Fixed Period ModelFixed Period ModelWhen to Order?When to Order?

pom - j. galván 1 production and operations management ch.13: inventory management

Documents

hand inventory

inventory management

functions of inventory

case inventory

time queue time setup

use inventory models

compare inventory models

process slide