reid & sanders, operations management © wiley 2002 independent demand inventory management 12 c...

Reid & Sanders, Operations Management© Wiley 2002

Independent Demand InventoryManagement 12

C H A P T E R


Learning Objectives

• Describe different types & uses of inventory

• Understand relevant inventory costs

• Calculate order quantities

• Evaluate different inventory policies

• Calculate appropriate safety stock policies

• Understand ABC inventory policies

• Compare cycle & periodic counting


Types of Inventory


Uses of Inventory

• Anticipation or seasonal inventory• Safety stock: buffer demand fluctuations• Lot-size or cycle stock: take advantage of

quantity discounts or purchasing efficiencies• Pipeline or transportation inventory• Speculative or hedge inventory• Maintenance, repair, and operating (MRO)

inventories


Objectives & Measures

• Provide desired customer service level:– Percentage of orders shipped on schedule– Percentage of lines shipped on schedule– Percentage of dollar volume shipped on schedule

• Provide for cost-efficient operations:– Total inventory-related costs

• Minimize inventory related investments:– Inventory turnover– Weeks (or days) of supply


Relevant Costs

• Item price• Holding costs

– Variable costs dependent upon the amount of inventory held (e.g.: capital & opportunity costs, storage & insurance, risk of obsolescence)

• Ordering & setup costs:– Fixed cost of placing an order (e.g.: clerical accounting &

physical handling) or setting up production (e.g.: lost production to change tools & clean equipment)

• Shortage costs:– Lost profit, expediting & back ordering expenses


Order Quantity Approaches

• Lot-for-lot: – Order exactly what is needed

• Fixed order quantity:– Order a predetermined amount each time

• Min-max system:– When inventory falls to a set minimum level, order up to

the predetermined maximum level

• Order enough for n periods• Periodic review:

– At specified intervals, order up to a predetermined target level


Periodic Review System

• Target inventory calculation:

• Order quantity calculation:

SSLRPdTI

OHTIQ


Fixed-Order Quantity Models

• Economic Order Quantity (EOQ)

• Economic Production Quantity (EPQ)

• Quantity Discount Model


EOQ Assumptions

• Demand is known & constant - no safety stock is required

• Lead time is known & constant• No quantity discounts are available• Ordering (or setup) costs are constant• All demand is satisfied (no shortages)• The order quantity arrives in a single

shipment


Inventory Profile


EOQ Total Costs

Total annual costs + annual ordering costs + annual holding costs


EOQ: Total Cost Equation

• Minimize the TC by ordering the EOQ:

H

QS

Q

DTCEOQ 2

H

DSEOQ

2


Simple Reorder Point

R = dL


EOQ Example


Solution


EPQ Assumptions

• Same as the EOQ except: inventory arrives in increments & is drawn down as it arrives


EPQ Equations

• Adjusted total cost:

• Maximum inventory:

• Adjusted order quantity:

H

IS

Q

DTC MAX

EPQ 2

p

dQIMAX 1

pd

H

DSEPQ

1

2


Quantity Discount Model Assumptions

• Same as the EOQ, except:– Unit price depends upon the quantity

ordered

• Adjusted total cost equation:

PDHQ

SQ

DTCQD

2


Quantity Discount Procedure

• Calculate the EOQ at the lowest price• Determine whether the EOQ is feasible at

that price – Will the vendor sell that quantity at that price

• If yes, stop – if no, continue• Check the feasibility of EOQ at the next

higher price• Continue to the next slide ...


QD Procedure

• Continue until you identify a feasible EOQ• Calculate the total costs (including purchase

price) for the feasible EOQ model• Calculate the total costs of buying at the

minimum quantity allowed for each of the cheaper unit prices

• Compare the total cost of each option & choose the lowest cost alternative


What if Demand is Uncertain?


Adding Safety Stock

• Order-cycle service level:– From a managerial standpoint, determine

the acceptable probability that demand during lead time won’t exceed on-hand inventory

– Risk of a stockout: 1 – (service level)


Adjusted ReorderPoint Equation

R = reorder point

d = average daily demand

L = lead time in days

z = number of standard deviations associated with desired service level

sigma = standard deviation of demand during lead time

dLzdLR


ABC Classification

• Pareto’s law:– Roughly 20% of inventories will account for 80% of

inventory value

• Divide inventories into A, B, and C categories based on value, risk, & other considerations– Use tight controls & frequent reviews for A items– Use normal methods to manage B items– Use simple, inexpensive systems with large safety

stocks to manage C items (just don’t run out)


Periodic versus Cycle Counting

• Periodic counting:– Take a periodic (often annual) physical

inventory to verify & update records

• Cycle counting:– Count specified items each day (mini

physical inventories)– Frequency with which each item is counted

depends upon its ABC classification


The End

Copyright © 2002 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United State Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

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