Managing Independent Inventory

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Managing Independent Inventory
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Overview

• What is an inventory system and why hold stock?
• Textbook prescriptions versus reality and
  variety?
• Independent versus Dependent Demand
• Inventory types, flows, costs
• Re-order quantities, EOQ calculations
• Safety stocks service levels
• Review systems
• Discounts and staged deliveries
• JIT
• ABC Analysis
• Stock taking
• Make or buy

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What is an Inventory System?

• Inventory
• the stock of any item or resource used in an
  organization raw materials, finished products,
  component parts, supplies and work-in-process.
• An inventory system
• policies and controls for monitoring levels of
  inventory
• Information system that records transactions and
  enables analysis of stock requirements and
  levels/quantities, costs etc

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Organisations, Roles, Methods and Systems?

• What type of organisations use systematic
  inventory management methods?
• How are the methods manifested?
• How is inventory management linked to
• aggregrate planning, buying for MRP, JIT, retail
  buying, sales systems, accounting practice?
• Who does it?
• buyers, store keepers, production planners,
  accountants?
• What manual IT-based systems are involved?
• Stock cards, orders, delivery notes, GRNs, return
  advice notes, inventory module in integrated
  accounting packages, stock checks and auditing.
• Are textbook methods really used? How, where?
• What is the clerical burden of inventory analysis
  and control?

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Independent vs. Dependent Demand
Independent Demand (not related to other items or
final end-product)
Dependent Demand (derived from component parts,
sub-assemblies, raw materials, etc.)
E(1)
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Independent versus Dependent Demand
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Why hold stock?

• Provide flexibility
• minimum delay in supplying customers
• a good range
• Protect against uncertainties
• Enable economic purchasing
• Anticipate changes in demand or supply
• Buffers to feed processes and enable efficient
  scheduling
• Strategic stock holdings

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Inventory Types

• Raw-materials, components and sub-assemblies
• Work-in-progress or in-transit
• Finished-goods
• In the warehouse, awaiting shipment, in delivery
  vehicles, in tanks, on shelves, in the stores
• Strategic inventory
• Scrap re-work

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Material-Flows Process
Production Processes
Work in process
To Customer
Stores warehouse
Finished goods
WIP
From Suppliers
WIP
Inventory in transit
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Stock Input (Flow in), Storage (Holding) and
Flow out (Usage)
Inventory Level
Supply Rate
Stock Level
Rate of Demand (Usage)
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Costs of Inventory

• Ordering costs
• purchase order office, shipping and/or set up
• Holding Costs
• tied up capital (item value), staff equipment,
  obsolescence, perishability, shrinkage, insurance
  security, m2 - m3 (rent/lease), audit.
• Cost of being out of stock, cancelling an order
• Scrap and re-working

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Order Quantities Reorder Points
Average stock q/2
No. of units on hand
q
q
safety or buffer level
R
L
L
Time
R Reorder point L Lead time
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Simple inventory system
Next Check point
Orders MRP Check stock level
No
Yes
No
Yes
Yes
Receive/inspect. Accept into stock Send
back? Part-delivery
No
Raise order for ROQ
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Bin systems
Two-Bin - quantity stock in bin 2 re-order level
Order one bin
Full
Empty
One-Bin (periodic check)
Order enough to refill bin?

• ROQ Options
• Keep order costs to a minimum?
• Order one year's supply in one go? OR
• Hand-to-mouth, once per week?

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EOQ Aim Cost Minimisation
Holding ordering costs total cost curve.
Find Qeoq inventory order point to minimise
total costs.
Cost
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Calculate EOQ
2DS
2(Annual Demand)(Order or set-up cost)
Qeoq






H
Annual Holding Cost
when to place an order.
Reorder point RDL D Avg daily demand
(constant) L Lead time (constant)

• Exercise EOQ and reorder point?
• Annual demand 2,000 units
• Days/year in average daily demand 365
• Cost to place an order 10
• Holding cost /unit p.a. 2.50
• Lead time 7 days
• Cost per unit 15

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EOQ Solution
2DS
2(1,000 )(10)
Q







89.443 units or 90 units
eoq
H
2.50
1,000 units p.a.
d



2.74 units/day
365 days p.a.
Reorder point D L 2.74 units/day 19.18
or 20 for 7 day lead time
EOQ order 90 units. When only 20 units left,
place next order for 90 units.
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EOQ and ROQ example 2
Annual Demand 10,000 units Days per year
considered in average daily demand 365 Cost to
place an order 10 Holding cost per unit per
year 10 of cost per unit Lead time 10
days Cost per unit 15
2(10,000)(10)
2DS
365.148 (366 units)



Q
1.50
H
eoq
If lead time 10 days, ROL 273.97 274
units Place order for 366 units. When 274 left,
place next order for 366.
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Total variable cost
Avg.stock
Find point of minimum TVc
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EOQ Table minimum TVc
Avg.stock x item x hc
Oc Hc
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Minimum point of Total Inventory Costs
EOQ minimum TVc point
Total variable costs
Costs
Total Hc
Total Oc
EOQ
Order Size (Q)
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EOQ Example

• Cheapo Bags wants to calculate the EOQ for
  tapestry cloth used to produce hand bags.
• Last year demand 10,000 metres (constant rate).
• Value per metre of tapestry 6.40
• Oc each order 250.
• Hc 1.20 per metre 18.75
• What is the EOQ?

• 2 x 10,000 x 250

2042 metres
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Economic Order Quantity (EOQ) Assumptions

• Single product line
• Demand rate recurring, known, constant
• Lead time constant , known
• No quantity discounts - stable unit cost
• No stock-outs allowed
• Items ordered/produced in a lot or batch
• Batch received all at once
• Holding cost is linear based on average stock
  level
• Fixed order set up cost

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Order Point with Safety Stock
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Safety Stock and Re-order Levels

• Reserve - buffer - cushion against uncertain
  demand (usage) lead time.
• A basis for a "2-bin" system
• Application to JIT?
• EOQ assumes certain demand lead time. If
  uncertain, then
• ROL
• Average usage in lead time safety stock

(Avg. lead time x Avg. daily usage)
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How Much Safety Stock? Cost vs. safety level

• Depends on
• Uncertainty demand lead time
• cost of
• being out of stock
• carrying inventory
• increasingly better service
• Service level policy
• confidence of not hitting a stock-out situation

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Cost vs service level

• Cost of poor service (out-of-stock)
• Loss of
• part order
• future order
• customer goodwill
• buying from non-regular sources

Cost of better and better service
70
80
90
100
0
Service level
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Normal Distribution of Demand over Lead Time
m mean demand r reorder point s safety
stock
service level probability
frequency
probability of stock out
m
s
r
demand over lead time
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Service level protection
ROL Average usage in lead time Safety stock
(Avg. usage (day/week) x Avg. Lead time)
K x stdev demand x Avg. lead time

• Confidence of non stock out
• K 2 for 97.5 confidence
• K 3 for 99.87

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ROL AND Service Level Example
ROL Average usage in lead time Safety stock
(Avg. usage day/week x Avg. lead time)
K x stdev demand x Avg. lead time
ROL (250 per week x 4 weeks) ( 2 x 50 x (4)
) 1000 200 1200
Stock falls to or below ROL no order is
outstanding? Place a new order for 1200. Service
level _at_ 97.5 ? stock-out for 1 in 40 reorder
situations.
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Review Systems

• Top-up with regular review
• Stock not to exceed upper limit (perishables,
  corrosives, limited capacity)
• use with regular review (continuous or
  periodic)
• Continuous review
• relax constant demand assumption
• Continuous system to monitor stock-on-hand
• Periodic review
• Apply EOQ (demand constant no stock-out)
• orders must be placed at specified intervals.
• Use when multiple, items ordered from same
  supplier (joint-replenishment)
• inexpensive items

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Price discounts and staged deliveries

• Quantity Discounts, buying frequency Oc, Hc
• more storage space
• different payment terms
• if demand changes surplus stock
• Staged deliveries EOQ?
• Extra delivery handling cost?
• Assumes constant order cost
• Requires reliable deliveries steady demand
• JIT collaborative supplier relationships
• Affect on supplier (locate nearer customer?)

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Price-Break Model
Assumptions similar to as EOQ model
i of unit cost as carrying cost C cost per
unit
C varies for each price-break so apply the
formula to each price-break cost value.
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Price-Break Example

• Brunel University can reduce ordering costs for
  photocopy paper by placing larger quantity
  orders. What is the optimal order quantity?
• e-mail order cost 4
• carrying cost 2
• Demand p.a. 10,000 units?

Quantity price breaks
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Solution
Put data into formula for each price-break of C.
D 10,000 units Order cost (S) 4
Carrying cost (i) 2 Cost per unit (C)
1.20, 1.00, 0.98
Are Qopt values feasible for the price breaks?
2(10,000)(4)
2DS
2(10,000)(4)
2,000

1,826 units


0.02(1.00)
0.02(1.20)
iC
4)
2(10,000)(
2,020

0.02(0.98)
Qopt 0 - 2499 Feasible 2500-3999 and 4000 Not
feasible
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U-shaped function
True Qopt values occur at the start of each
price-break interval.The total annual cost
function is a u shaped function
Total annual costs
Price-breaks
0 1826 2500 4000
Order Quantity
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Price-Break Solution
Now apply the Qopt values to total annual cost
identify the total cost for each price-break.
TC(0-2499) (10000x1.20)(10000/1826)x4(1826/2)(0
.02x1.20) 12,043.82 TC(2500 -3999)
10,041 TC(4000) 9,949.20
Least cost Qopt 4000
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Just-in-Time
approach to inventory management control in
which inventories are acquired inserted in
production at exact time when needed. Requirement

• Accurate production inventory information
  system
• Highly efficient purchasing
• Reliable suppliers
• Efficient inventory-handling system

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ABC - 20/80 Principle and Inventory Control

• Items not of equal importance
• invested profit potential
• Sales/usage volume
• stock-out penalties
• Control expensive items closely.
• A items review frequently
• Review B C items frequently.

100
90
70
Cumulative Percentage of Inventory Value
C
B
A
0 15 45 100
Pareto - 20/80 Principle Identify inventory items
based on of total value. A items top 20 ,
B next 40 , "C" the lower 20.
Cumulative
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Annual Usage by Value
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ABC Chart
45
120
A
B
C
40
100
35
30
80
Cumulative
Cumulative Usage
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Percent Usage
60
20
15
40
10
20
5
0
0
3
6
9
2
4
1
10
8
5
7
Item No.
42
Stock Check

• Book stock vs physical stock
• Stock valuation wastage shrinkage
• Audit stock security systems
• Organising the stock check
• Internal external audit
• Segmentation of duties