Inventory Management I

1
Inventory Management I
2
Definitions

• Inventory-A physical resource that a firm holds
  in stock with the intent of selling it or
  transforming it into a more valuable state.
  
• Inventory System- A set of policies and controls
  that monitors levels of inventory and determines
  what levels should be maintained, when stock
  should be replenished, and how large orders
  should be

3
Inventory

• Def. - A physical resource that a firm holds in
  stock with the intent of selling it or
  transforming it into a more valuable state.
  
• Raw Materials
• Works-in-Process
• Finished Goods
• Maintenance, Repair and Operating (MRO)

4
Expensive Stuff

• The average carrying cost of inventory across all
  mfg.. in the U.S. is 30-35 of its value.
  
• What does that mean?
• Savings from reduced inventory result in
  increased profit.

5
Zero Inventory?

• Reducing amounts of raw materials and purchased
  parts and subassemblies by having suppliers
  deliver them directly.
  
• Reducing the amount of works-in process by using
  just-in-time production.
  
• Reducing the amount of finished goods by shipping
  to markets as soon as possible.

6
Inventory Positions in the Supply Chain
Raw Materials
Works in Process
Finished Goods
Finished Goods in Field
7
Reasons for Inventories

• Improve customer service
• Economies of purchasing
• Economies of production
• Transportation savings
• Hedge against future
• Unplanned shocks (labor strikes, natural
  disasters, surges in demand, etc.)
  
• To maintain independence of supply chain

8
Inventory and Value

• Remember this?
• Quality
• Speed
• Flexibility
• Cost

9
Nature of Inventory Adding Value through
Inventory

• Quality - inventory can be a buffer against
  poor quality conversely, low inventory levels
  may force high quality
  
• Speed - location of inventory has gigantic effect
  on speed
  
• Flexibility - location, level of anticipatory
  inventory both have effects
  
• Cost - direct purchasing, delivery,
  manufacturing
  
• indirect holding, stockout.
• HR systems may promote this-3 year postings

10
Nature of InventoryFunctional Roles of Inventory

• Transit
• Buffer
• Seasonal
• Decoupling
• Speculative
• Lot Sizing or Cycle
• Mistakes

11
Design of Inventory Mgmt. Systems Macro Issues

• Need for Finished Goods Inventories
• Need to satisfy internal or external customers?
• Can someone else in the value chain carry the
  inventory?
  
• Ownership of Inventories
• Specific Contents of Inventories
• Locations of Inventories
• Tracking

12
How to Measure Inventory

• The Dilemma closely monitor and control
  inventories to keep them as low as possible while
  providing acceptable customer service.
  
• Average Aggregate Inventory Value how much of
  the companys total assets are invested in
  inventory?
  
• Ford6.825 billion
• Sears 4.039 billion

13
Inventory Measures

• Weeks of Supply
• Ford 3.51 weeks
• Sears 9.2 weeks
• Inventory Turnover (Turns)
• Ford 14.8 turns
• Sears 5.7 turns
• GM 8 turns
• Toyota 35 turns

14
Reasons Against Inventory

• Non-value added costs
• Opportunity cost
• Complacency
• Inventory deteriorates, becomes obsolete, lost,
  stolen, etc.

15
Inventory Costs

• Procurement costs
• Carrying costs
• Out-of-stock costs

16
Procurement Costs

• Order processing
• Shipping
• Handling
• Purchasing cost c(x) 100 5x
• Mfg. cost c(x)1,000 10x

17
Carrying Costs

• Capital (opportunity) costs
• Inventory risk costs
• Space costs
• Inventory service costs

18
Out-of-Stock Costs

• Lost sales cost
• Back-order cost

19
Independent Demand

• Independent demand items are finished products or
  parts that are shipped as end items to
  customers.
  
• Forecasting plays a critical role
• Due to uncertainty- extra units must be carried
  in inventory

20
Dependent Demand

• Dependent demand items are raw materials,
  component parts, or subassemblies that are used
  to produce a finished product.
  
• MRP systems---next week

21
Design of Inventory Mgmt. Systems Micro Issues

• Order Quantity
• Economic Order Quantity
• Order Timing
• Reorder Point

22
Objectives of Inventory Control

• 1) Maximize the level of customer service by
  avoiding understocking.
  
• 2) Promote efficiency in production and
  purchasing by minimizing the cost of providing an
  adequate level of customer service.

23
Balance in Inventory Levels

• When should the company replenish its inventory,
  or when should the company place an order or
  manufacture a new lot?
  
• How much should the company order or produce?
• Next Economic Order Quantity

24
Models for Inventory ManagementEOQ

• EOQ minimizes the sum of holding and setup costs
• Q 2DCo/Ch
• D annual demand
• Co ordering/setup costs
• Ch cost of holding one unit of inventory

25
Seatide

• EOQ 2DCo/Ch
• D annual demand 6,000
• Co ordering/setup costs 60
• Ch cost of holding one unit of inventory
• 3.00 x 24 .72
• 2 x 6,000 x 60
• .72

720,000 .72
1,000
26
Marginal Analysis
Holding Costs

Ordering Costs
Units
27
Reorder Point

• Quantity to which inventory is allowed to drop
  before replenishment order is made
  
• Need to order EOQ at the Reorder Point
• ROP D X LT
• D Demand rate per period
• LT lead time in periods

28
Sawtooth Model
level of inventory
average
inventory
units Q t
time
29
Q - System Inventory Control

• based on reorder point - When inventory is
  depleted to ROP, order replenishment of quantity
  EOQ.
  

30
Order Quantities

• when demand is smooth and continuous, can operate
  response-based system by determining
  
• best quantity to replenish periodic demand (EOQ)
• frequency of replenishment (ROP)
• Reorder Point

31
Planning for Uncertainty

• changing lead times
• changing demand
• Uncertainty creeps in
• Plug in safety stock
• Safety stock - allows manager to determine the
  probability of stock levels - based on desired
  customer service levels

32
Inventory Model Under Uncertainty
reorder Qm point
safety stock
time
33
Models for Inventory ManagementQuantity
Discount

• Basically EOQ with quantity discounts
• To solve
• 1. Write out the total cost equation
• 2. Solve EOQ at highest price and no discounts
• 3. If Qmin falls in a range with a lower price,
  recalculate EOQ assuming holding cost for that
  range. Call this Q2.
  
• 4. Evaluate the total cost equation at Q2 at the
  next highest price break point.
  
• OR Use a spreadsheet

34
P-SystemPeriodic Review Method

• an alternative to ROP/Q-system control is
  periodic review method
  
• Q-system - each stock item reordered at different
  times - complex, no economies of scope or common
  prod./transport runs
  
• P-system - inventory levels for multiple stock
  items reviewed at same time - can be reordered
  together
  
• higher carrying costs - not optimum, but more
  practical

35
Using P-System

• audit inventory level at interval (T)
• quantity to place on order is difference between
  max. quantity (M) and amount on hand at time of
  review
  
• management task - set optimal T and M to balance
  stock availability and cost
  
• In ABC analysis, which items would use P-system???

36
Types of Inventory Systems

• By Degree of Control required
• often use grouping method, such as ABC

37
Classifying Inventory Items

• ABC Classification (Pareto Principle)
• A Items very tight control, complete and
  accurate records, frequent review
  
• B Items less tightly controlled, good records,
  regular review
  
• C Items simplest controls possible, minimal
  records, large inventories, periodic review and
  reorder

38
Does ABC Classification Make Sense for an
Assembler?

• i.e. Gateway Computers

39
Planning Supply Chain Activities
Anticipatory - allocate supply to each warehouse
based on the forecast Response-ba
sed - replenish inventory with order sizes based
on specific needs of each warehouse
40
Anticipatory Inventory Control

• determine requirements by forecasting demand for
  the next production run or purchase
  
• establish current on-hand quantities
• add appropriate safety stock based on desired
  stock availability levels and uncertainty demand
  levels
  
• determine how much new production or purchase
  needed (total needed - on-hand)

41
Response-Based System

• replenishment, production, or purchases of stock
  are made only when it has been signaled that
  there is a need for product downstream
  
• requires shorter order cycle time, often more
  frequent, lower volume orders
  
• determine stock requirements to meet only most
  immediate planning period (usually about 3 weeks)

42
Service Level Achieved

• Item fill rate (IFR) the probability of
  filling
  
• an order for 1 item from current stock

1- expected number of units out of stock/year
total annual demand

• Weighted Average Fill Rate (WAFR) multiply
• IFR for each stock item on an order weighted
• by the ordering frequency for the item