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Homework (page 602): 13.5, 13.6, 13.19, 13.22, 13.34, 13.41

Homework (page 602):

13.5, 13.6, 13.19, 13.22, 13.34, 13.41

Types of Inventories Raw materials & purchased parts Partially completed goods called work in process
Types of Inventories
Raw materials & purchased parts
Partially completed goods called work in process
(WIP)
Finished-goods inventories (manufacturing firms) or
merchandise (retail stores)
Replacement parts, tools, & supplies
Goods-in-transit to warehouses or
customers (Pipeline inventory)
Inventory Counting Systems Periodic System
Inventory Counting Systems
Periodic System

Physical count of items made at periodic intervals

Perpetual Inventory System (Continual System)

System that keeps track of removals from inventory continuously, thus monitoring current levels of each item

System) System that keeps track of removals from inventory continuously, thus monitoring current levels of each
What Is Inventory? Three measures of process performance
What Is Inventory?
Three measures of process performance

Flow rate (throughput rate): the rate at which the process is delivering output Flow Time: the time it takes a flow unit to get through the process Inventory: The number of units contained within the process.

Little’s Law:

Average Inventory=average flow rate * average flow time

Inventory Turnover Inventory 1 Flow Time = Inventory turnover = Flow rate Flow time Inventory
Inventory Turnover
Inventory
1
Flow Time =
Inventory turnover =
Flow rate
Flow time
Inventory turnover is the ratio of annual
cost of goods sold to average inventory
investment.
The turnover ratio indicates how many
times a year the inventory is sold.
The higher the ratio, the better.
Inventory Counting Systems (Cont’d) Two-Bin System - Two containers of inventory; reorder when the first
Inventory Counting Systems (Cont’d)
Two-Bin System - Two containers of
inventory; reorder when the first is empty
(ROP: the amount contained in the 2 nd
bin)

Universal Bar Code - Bar code

printed on a label that has information about the item to which it is attached

0

214800 232087768
214800 232087768

Inventory Costs

Lead time: time interval between ordering and receiving the order

Holding (carrying) costs: cost to carry an item in

inventory for a length of time, usually a year.

Interest, insurance, depreciation, warehousing cost, deterioration, etc.

Ordering costs: costs of ordering and receiving inventory

Preparing invoices, shipping cost, inspecting goods upon arrival, etc.

Shortage costs: costs when demand exceeds supply

Opportunity cost of not making a sale, loss of customer goodwill, late charges.

 

ABC Classification System -Example

Item

Demand

Unit Cost

Dollar Value

Dollar Usuage

1

1,000

$4,300

$4,300,000

39.34%

2

5,000

$720

$3,600,000

32.94%

72.28%

3

1,900

$500

$950,000

8.69%

4

1,000

$710

$710,000

6.50%

5

2,500

$250

$625,000

5.72%

6

2,500

$192

$480,000

4.39%

25.30%

7

400

$200

$80,000

0.73%

8

500

$100

$50,000

0.46%

9

200

$210

$42,000

0.38%

10

1,000

$35

$35,000

0.32%

11

3,000

$10

$30,000

0.27%

12

9,000

$3

$27,000

0.25%

6.81%

   

Total

$10,929,000

 
Inventory Models
Inventory Models

Fixed order quantity models Economic order quantity Production order quantity Quantity discount

Probabilistic models

Fixed order interval models

Help Help answer answer the the inventory inventory planning planning questions! questions!
Help Help answer answer the the
inventory inventory
planning planning
questions! questions!
ABC Classification System Form of Pareto analysis (80/20 rule) Classifying inventory according to some measure
ABC Classification System
Form of Pareto analysis (80/20 rule)
Classifying inventory according to some
measure of importance, usually annual
dollar usage, and allocating control efforts
accordingly.
High
AA
AA - very important
Annual
BB - mod. important
$ volume
BB
of items
CC - least important
CC
Low
Few
Many
Number of Items
Basic Inventory Planning Questions
Basic Inventory Planning Questions

How much to order When to order?

Basic Inventory Planning Questions How much to order When to order? Purchase Order Description Qty. Microwave
Purchase Order Description Qty. Microwave 1000
Purchase Order
Description
Qty.
Microwave
1000
Economic Order Quantity (EOQ) Model

Economic Order Quantity (EOQ) Model

Inventory Cost Components
Inventory Cost Components

Purchase cost, P($/unit) Holding cost, H ($/unit/period) Ordering cost, S ($/order)

An EOQ System Order size=350 Usage rate=50/day Lead time=2 days InventoryInventory LevelLevel AverageAverage
An EOQ System
Order size=350
Usage rate=50/day
Lead time=2 days
InventoryInventory LevelLevel
AverageAverage
InventoryInventory (Q/2)(Q/2)
OrderOrder
QuantityQuantity
(Q)(Q)
((Q=350Q=350))
ReorderReorder
PointPoint
(ROP)(ROP)
12
14
ROP=100
5
7
TimeTime
(2 days’ supply)
LeadLead TimeTime
1 year AverageAverage Low Q InventoryInventory (Q/2)(Q/2) TimeTime Many orders produce a low average inventory
1 year
AverageAverage
Low Q
InventoryInventory (Q/2)(Q/2)
TimeTime
Many orders produce a low average inventory
High Q
AverageAverage
InventoryInventory (Q/2)(Q/2)
TimeTime
Few orders produce a high average inventory

Assumptions of EOQ Model

Assumptions of EOQ Model Known & constant demand Known & constant lead time Demand is even
Assumptions of EOQ Model Known & constant demand Known & constant lead time Demand is even

Known & constant demand Known & constant lead time Demand is even throughout the year Each order is received in a single delivery There are no quantity discounts No stockouts

EOQ Model Output Example

When the inventory of microwaves gets down to 15 units (reorder point), order 35 units (EOQ).

15 left
15
left
Purchase Order Description Qty. Microwave 35
Purchase Order
Description
Qty.
Microwave
35

EOQ Model: total cost (Carrying Cost + Ordering Cost)

AnnualAnnual CostCost TotalTotal CostCost CurveCurve HoldingHolding (Carrying)(Carrying) CostCost OrderOrder
AnnualAnnual CostCost
TotalTotal CostCost CurveCurve
HoldingHolding (Carrying)(Carrying) CostCost
OrderOrder (Setup)(Setup) CostCost
OrderOrder QuantityQuantity
OptimalOptimal
OrderOrder QuantityQuantity (Q*)(Q*)

Carrying costs are linearly related to order size Ordering costs are inversely and nonlinearly related to order size

Total Cost (Carrying Cost + Ordering Cost)

Annual

Total cost = carrying cost TC = H Q 2 Q D H = S
Total cost
=
carrying
cost
TC
=
H Q
2
Q
D
H
=
S
2
Q
2 DS
Q * =
H

+

+

Annual

ordering

cost

D Q S

EOQ Model: Example

You’re a buyer for Wal-Mart. Wal- Mart needs 1000 coffee makers per year. The cost of each coffee maker is $78. Ordering cost is $100 per order. Carrying cost is 40% of per unit cost. Lead time is 5 days. Wal-Mart is open 365 days/yr. What is the optimal order quantity & ROP?

D=1000/year

S=$100/order

H=0.4*78=$31.2/unit/year

What is the optimal order quantity & ROP ? D = 1 0 0 0 /

Sensitivity Analysis (Order Quantity)

A. As demand increases, EOQ increases in proportion of square root of D rather than in direct proportion to demand.

B. What if the optimal policy is followed, but values of D, S, or h are incorrectly specified?

Specifically, suppose we don’t know S, but rather only have

an estimate

quantity which is optimal with respect to the estimate:

ˆ

S . Given this estimate, we’d compute an order

ˆ

Q = optimal order quantity based on estimates

ˆ

Q =

ˆ 2 SD h
ˆ
2 SD
h

EOQ Model Equations

Optimal Order Quantity

=

*

=

=

2

D

S

Q

H

 

Number of Orders =

m

=

D

 

Q *

 

Expected Time Between Orders =

T

=

Q

*

D

 

*

 

Q

D

S

 

Q H

Total Cost (Carrying and Ordering Cost) =

2

 

H

+

=

 

Q

*

Total Annual Cost =

pD

+

Q

2

*

H

+

D

Q

*

S

DD== DemandDemand raterate (e.g.,(e.g., perper year)year) SS== SetupSetup (ordering)(ordering) costcost perper orderorder HH== HoldingHolding (carrying)(carrying) costcost

 

EOQ Solution

 

Optimal Order

   

Q * =

( )( 2 1000 )( 100 ) 2 ⋅ D ⋅ S = ( )(
( )(
2 1000
)(
100
)
2
D
S
=
(
)(
)
H
.40 78

= 80 units

Quantity:

   

Number of orders per year:

m

=

D

=

1000

=

12.5

13 (Orders)

80

 

*

Q

Length of order cycle:

T =

Q

=

80

=

0.08 (Year)

=

29.2 (Days)

D

1000

     
Daily usage:
Daily usage:

d =

1000

= 2.74 units/day

 
 

365

 

ROP = d.LT = (2.74)(5)= 13.7 units

Reorder Point: Total Cost:
Reorder Point:
Total Cost:

=(Q*/2)*H+(D/Q*)*S

=80/2*31.2+13*100=$2548

Inventory Turnover:

 

=1000/40=25

Sensitivity Analysis (Total Cost)
Sensitivity Analysis (Total Cost)
Sensitivity Analysis (Total Cost)

Total Cost is not particularly sensitive to the optimal order quantity

 
 

T

(

Q

)

=

Q

+

Q

*

)

T

(

Q

)

1 (
2

*

Q

Q

Order Quantity

50%

80%

 

90%

 

100%

110%

120%

150%

200%

Cost Increase 125% 103% 101% 100% 101% 102% 108% 125%
Cost Increase 125% 103% 101% 100% 101% 102% 108% 125%

EOQ “Zone”

AnnualAnnual CostCost TotalTotal CostCost CurveCurve Q*Q* OrderOrder QuantityQuantity
AnnualAnnual CostCost
TotalTotal CostCost CurveCurve
Q*Q*
OrderOrder QuantityQuantity

EOQ “Zone”

The total cost curve is relatively flat near the EOQ

Safety Stock InventoryInventory LevelLevel Maximum probable demand during lead time Expected demand during lead time
Safety Stock
InventoryInventory LevelLevel
Maximum probable demand during lead time
Expected demand during lead time
ROPROP
Safety Stock
LT
TimeTime
Place
Receive
order
order

ROP Example 1

Suppose that the manager of a construction supply house determined from historical record that demand for sand during lead time average 50 tons. In addition, suppose the manager determined that demand during lead time could be described by a normal distribution that has a mean of 50 tons and a standard deviation of 5 tons. Assuming that the manager is willing to accept a stockout risk of no more than 3%.

When to Reorder with EOQ Ordering Reorder Point (ROP) - When the quantity
When to Reorder with EOQ Ordering
Reorder Point (ROP) - When the quantity

on hand of an item drops to this amount, the item is reordered

Safety Stock(SS) - Stock that is held in excess of expected demand due to variable demand rate and/or lead time.

Service Level (SL)- Probability that demand will not exceed supply during lead time.

Reorder Point Under Uncertainty Service level Risk of a stockout Probability of no stockout ROP
Reorder Point Under Uncertainty
Service level
Risk of
a stockout
Probability of
no stockout
ROP
Expected
Quantity
demand
Safety
stock
0 z
z-scale
ROP=Expected demand during lead time+ Safety Stock
=Expected demand during lead time+
dLT
3% 5 50 z 0 z EXCEL: What value of z is appropriate? Z=1.88 =NORMSINV(0.97)
3%
5
50
z
0
z
EXCEL:
What value of z is appropriate?
Z=1.88
=NORMSINV(0.97)
How much safety stock should be held? zσ = 1.88*5 = 9.40 dLT What reorder
How much safety stock should be held?
= 1.88*5 = 9.40
dLT
What reorder point should be used?
ROP=50+9.40=59.40
Levers for Reducing Safety Inventory
Levers for Reducing Safety Inventory
Levers for Reducing Safety Inventory Reduce demand variability through improved forecasting. Reduce replenishment lead

Reduce demand variability through improved forecasting. Reduce replenishment lead time. Pool safety inventory for multiple locations or products through physical or virtual centralization. Exploit product substitution. Postpone product-differentiation processing until closer to the point of actual demand

Newsboy Model

Newsboy Model

The Single-period Model (Newsboy problem) Used to handle ordering of perishables and items that have
The Single-period Model (Newsboy
problem)
Used to handle ordering of perishables
and items that have a limited useful life.
(fashion and seasonal apparel, hotel
rooms, airline tickets)
Example:

Overbooking of airline flights Ordering of fashion items Any type of one-time order.

Uniform Distribution

A random variable (X) between some minimum (a) and maximum (b) value are equally likely.

X ~ u(a,b)

1

b a

SL
SL
SL

SL

SL
SL
SL
SL

a ROP

b

Newsboy Problem
Newsboy Problem

Example: On consecutive Sunday, Mac, the owner of a local newsstand, purchases a number of copies of the The Computer Journal. He pays 25 cents for each copy and sell each for 75 cents. Copies he has not sold during the week can be returned to his supplier for 10 cents each. The supplier is able to salvage the paper for printing future issues. Mac has kept careful records of the demand each week for the Journal. (This includes the number of copies actually sold plus the number of customer requests that could not be satisfied.)

Underage cost & Overage cost
Underage cost & Overage cost
Underage cost & Overage cost
 

Underage cost (Shortage cost ): the unrealized profit per unit.

 
C = u
C
=
u

Revenue per unit – Cost per unit

Overage cost (Excess cost): cost of overstocking

 

C

o

=

Original cost per unit – Salvage vale per unit

The Goal of Newsboy Model
The Goal of Newsboy Model
The Goal of Newsboy Model

To identify the order quantity, or stocking level, that will minimize the long-run excess and shortage costs. Demand could be continuous distribution or discrete distribution. Expected marginal benefit from raising order size=Expected marginal cost

 
 

(1-SL * )C u = SL * × C o

 
 

Service level (

SL

) =

 

C

u

 
 

C

u

+

C

o

Example Sweet cider is delivered weekly to Cindy’s Cider Bar. Demand varies uniformly between 300
Example
Sweet cider is delivered weekly to Cindy’s Cider
Bar. Demand varies uniformly between 300 and
500 liters per week. Cindy pays 20 cents per liter
for the cider and charges 80 cents per liter for it.
Unsold cider has no salvage value and can not be
carried over into the next week due to spoilage.
Find the optimal stocking level and its stockout
risks for that quantity.

C

o

C

u

= $0.20-$0=0.20 per unit

= $0.80-$0.20=0.60 per unit

If demand is normal distribution with a mean of 200 liters per week and a standard deviation of 10 liters per week.

75% 200 S o
75%
200 S
o

S

o = µ + zσ

=200+0.675*10

=206.75 liters

Continuous Stocking Level The service level is the probability that demand will not exceed the
Continuous Stocking Level
The service level is the probability that
demand will not exceed the stocking
level.

Service level (

SL

) =

 

C

u

 
 

C

u

+

C

o

 

(

S

o

)

Optimal stocking quantity determined

is then

∗ SL = C u = 0.6   = 0.75   C u + C

SL

=

C

u

=

0.6

 

=

0.75

 

C

u

+

C

o

0.6

+

0.2

75%

75%

300

S

o

S

o

=300+0.75(500-300)=450 liters

500

Discrete Stocking Level
Discrete Stocking Level

Computer service level Round-up rule: Whenever you are

looking up a target value in a table and

the target value falls between two entries, choose the entry that leads to the larger order quantity.

Example

Demand for long-stemmed red roses at a small flower shop can be approximated using a Poisson distribution that has a mean of four dozen per day. Profit on the roses is $3 per dozen. Leftover flowers are marked down and sold the next day at a loss of $2 per dozen. Assume that all marked-down flowers are sold. What is the optimal stocking level? What is the expected profit?

C

u

= $3

C

o

= $2

Example

A hotel near the university always fills up on the evening before football games. History has shown that when the hotel is fully booked, the number of last minute cancellations(no shows) is as follows.The average room rate is $80. When the hotel is overbooked, policy is to find a room in a near hotel and to pay for the room for the customer. This usually costs the hotel approximately $200 since rooms booked on such late notice are expensive. How many rooms should the hotel overbooked?

C

u

= $80

C

o

= $200

Demand(dozen/day)

Relative Frequency

Cumulative Frequency

0

0.018

0.018

1

0.074

0.092

2

0.146

0.238

3

0.196

0.434

4

0.195

0.629

5

0.156

0.785

 

SL

C

= u

3 =4 dozens

= 0.6

S

o

Expected Profit=-4*2*0.018+ [1*3-3*2]*0.074+

[2*3-2*2]*0.146+ [3*3-1*2]*0.196+

4*3*(1-0.434) =8.09

C

u

+ C

o

=

3

+ 2

Number of No-Shows Probability Cumulative Probability 0 0.05 0.05 1 0.08 0.13 2 0.1 0.23
Number of No-Shows
Probability
Cumulative Probability
0 0.05
0.05
1 0.08
0.13
2 0.1
0.23
3 0.15
0.38
4 0.2
0.58
5 0.15
0.73
6 0.11
0.84
7 0.06
0.9
8 0.05
0.95
9 0.04
0.99
10
0.01
1
C
80
u
SL
=
=
=
0.2857
C
+ C
200
+ 80
u
o
S
=3 rooms
o