Inventory Management

1
Inventory Management

• Chapter 17

2
Topics

• Basic concepts.
• Management issues.
• Inventory-related costs.
• Economic order quantity model.
• Quantity discount model.
• Order timing decisions.
• Order quantity and reorder point interactions.
• Multi-item management.
• Multiple items from a single source.

3
Independent versus Dependent Demand

• Independent demand is for an item for which
  demand is influenced by factors outside of
  company decisions.
• Dependent demand is for an item for which demand
  is directly dependent on demand or requirement of
  another item.
• An item may have both independent and demand.

4
Functions of Inventory

• Transit stock (pipeline inventories) depends on
  the time to transport inventories between
  locations.
• Cycle stock order quantities larger than
  immediate requirementsthus satisfying multiple
  periods of demand.
• Safety stock provides protection against
  irregularities and uncertainties in supply or
  demand.
• Anticipation stock stock to meet demand in peak
  periods or special situations, e.g., planned
  shutdown.

5
Management Issues

• Routine inventory decisions
• How much to order (Q, S).
• When to order (R, T).
• Inventory system performance
• Inventory turnover.
• Customer service e.g, fill rate.
• Implementation - basic systems are in place
  before implementing advanced methods.

6
Inventory-related Costs

• Ordering costs - incurred each time a
  replenishment order is placed.
• Carrying costs - function of the items value and
  length of time its held in inventory.
• Cost of capital, opportunity cost.
• Taxes, insurance, inventory shrinkage, storage
  costs.
• Shortage and customer service costs - incurred
  when demand exceeds available supply.
• Loss of contribution margin and loss of good
  will.
• Tracking backorders.
• Customer service measures (surrogate for cost).

7
Economic Order Quantity Model (EOQ)

• TAC(A/Q)CP (Q/2)CH
• annual ordering cost annual carrying cost.

8
Quantity Discount Model

• TAC(v)A (A/Q)CP (Q/2)CH
• annual purchase cost annual ordering cost
  annual carrying cost
• Calculating the minimum-cost order quantity
• Calculate EOQ using minimum unit cost. If valid,
  this is the optimum Q.
• If invalid, calculate TAC using all break points.
• Calculate an EOQ for each item cost.
• Calculate TAC for each valid EOQ from step 3.
• Optimum Q is the lowest cost found in step 2 or
  step 4.

9
Order Timing Decisions

• Reorder point influenced by
• Demand rate.
• Lead time required for replenishment.
• Uncertainty in demand rate and replenishment
  time.
• Management policy on desired customer service
  level.
• Safety stock is added to the average demand
  during expected lead time to yield the reorder
  point (figure 17.7).

10
Safety Stock

• Stock-out probability - acceptable risk of
  stocking out during any given order replenishment
  order cycle (figure 17.8).
• R d Z?d
• Customer service level or fill rate- percentage
  of demand, measured in units, that can be
  supplied directly from inventory (figure 17.8).
• R d ?dE(Z)

11
Multi-item Management

• Single-criterion ABC analysis.
• Separate inventory items into three groupings
  based on annual cost-volume usage (unit cost x
  annual usage).
• A items high dollar usage (significant few).
• B items intermediate dollar usage.
• C items low dollar usage (trivial many).
• Commonly, a small percentage of items account for
  a large percentage of the annual cost volume
  usage.

12
Multi-item Management

• Multiple-criteria ABC analysis.
• Non-cost criterialead time, obsolescence,
  availability, substitutability, criticality.
• Inventory policies set for the established
  categories
• Inventory record verification.
• Order quantity.
• Safety stock.
• Classification of the item.

13
Multiple Items/Single Source

• Placing orders for several items provided by the
  same source can result in significant inventory
  cost savings.
• Individual item reorder points.
• Place order when an item reaches reorder point.
  Add other items using ratio of current on-hand
  plus on-order to the reorder point. Add until a
  total dollar value or weight is reached.
• Determine a joint EOQ, TBO.
• Methods economic dollar value order,
  simultaneous reorder point, full truckload.

14
Multiple Items/Single Source

• Group reorder pointsproviding a service level
  for the group.
• Sum individual reorder points.
• Convert item reorder points into dollars and sum.
• Base on periods (e.g., months) of supply.
• Place orders on a periodic basisbring inventory
  levels for each item to service level needed
  until the next order.

15
Concluding Principles

• The difference between dependent and independent
  demand must serve as the first basis for
  determining appropriate inventory management
  procedures.
• Organizational criteria must be clearly
  established before we set safety stock levels and
  measure performance.
• A sound basic independent demand system must be
  in place before we attempt to implement some of
  the advanced techniques presented here.

16
Concluding Principles

• Savings in inventory-related costs can be
  achieved by a joint determination of the order
  point and order quantity parameters.
• Combined ordering of several inventory items
  obtained from a single source can cut
  inventory-related costs.
• All criteria should be taken into account in
  classifying inventory items for management
  priorities.

17
Concluding Principles

• The policies developed for each ABC
  classification should be used to guide the
  classification of each item as well as to manage
  its inventories.
• Management must be sure the organization is
  prepared to take on advanced systems before
  attempting implementation.

18
Homework Assignment

• Problems 17.3 , 17.6, and 17.12
• Due Tuesday, November 26