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Session 6

Vinay Kumar Kalakbandi

Assistant Professor

Operations & Systems Area

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Operations Management - II Post Graduate Program 2015-17

Agenda

• Recap

• Project Briefing

• Quiz 1 briefing

• Inventory Management – Certainty

• Inventory Management – Uncertainty

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Inventory Management

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Why inventories?

• Economies of Scale

• Supply and Demand Uncertainty

• Volume Discounts/Impending Price Rise

• Long Lead Times and Quick Response to

Customer’s Demand

• To maintain independence of operations

• To allow flexibility in production scheduling

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Inventory

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Inventory is injurious to your health!

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Get Lean…Get healthy!

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Inventory turns!!!

• Sales/average inventory

• D/AI

• Low or high??

• What is AI/D?

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We want to turn our inventory

faster than our people

A quote by James D. Sinegal

Co-founder, Costco

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Independent – Dependent Demand

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Inventory classification

• Classification by form

– Raw Materials (RM)

– Work-in-Process (WIP)

– Finished Goods (FG)

• Classification by Life cycle

– Perishable

– Non-perishable

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Inventory classification by function

• Cyclic stock

– Ordering lot size/2

• Safety stock

– To protect against uncertainties

• Anticipation

– To absorb uneven rates of demand or supply

• Pipeline

– Scheduled receipts or open orders

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Quantity

Time

Safety stock

Cyclic Stock

Pipeline inventory

L

Cyclic, Pipeline and Safety Stocks

Cyclic inventory, pipeline inventory and safety stocks are critically linked to “how much” and “when” decisions in inventory planning

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Costs of Inventory

• Physical holding cost (out-of-pocket)

• Financial holding cost (opportunity cost)

• Transportation cost

• Ordering costs

• Low responsiveness – to demand/market changes

– to supply/quality changes

• Obsolescence

• Holding (or carrying) costs

• Fixed costs

• Shortage costs

• Inventory writedown

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Inventory Policy parameters

• WHEN to order?

• HOW MUCH to order?

• In WHAT FORM? (RM, WIP or FG)

• WHERE TO DEPLOY in the supply chain?

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Simplest case

• Perpetual inventory system

• Demand for the product is known constant and uniform throughout the period

• Lead time (time from ordering to receipt) is constant

• Replenishment is instantaneous

• Price per unit of product is constant

• Inventory holding cost is based on average inventory

• Ordering or setup costs are constant

• All demands for the product will be satisfied (no back orders are allowed)

• How would the inventory level look like?

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• What should be the ordering quantity (Q)?

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EOQ model

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Practical issues with the EOQ model

• It may not be possible to

– Order exactly Q*

– Estimate the parameters (D,S,H) accurately

– Instantaneous replenishment

– Price discounts

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Robustness of the EOQ model

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Incorporating Lead time

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Price Discounts

• Why do suppliers give price discounts?

• Compute Q* values

– From lowest price to the highest

– Until valid Q* is obtained

• Compute TRC at this Q* and each price break

above this Q*

• Choose the order quantity with least TC

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Further complications: Supply Chain

• D = 120,000 bottles/year

• For the Retailer

– S=$100; H= $0.6

• Retailer’s optimal lot size?

• For the Supplier

– S=$250; H=$0.4

• Supplier’s optimal lot size?

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Who is the focus?

We have three entities: supplier, retailer, the chain

• What is optimal for one need not be optimal for the others

• Price discounts can be used to make a lot size attractive for others

• But the issue remains – how to achieve the coordination?

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Reducing inventory

Type of inventory Primary Lever Secondary Lever

Cyclic Reduce Q Reduce ordering and setup

cost

Increase repeatability

Safety Stock Place orders closer to the

time when the must be

received

Improve forecasting

Reduce lead time

Reduce supply

uncertainties

Increase equipment and

labor buffers

Anticipation Vary the production rate

to follow the demand rate

Level out demand rates

Pipeline Cut production-

disitribution lead time

Forward positioning

Selection of suppliers and

carriers

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