Inventory

Inventory - I
Items from last class What is inventory Inventory Video Inventory Cost Structure Basic Ideas for Managing Independent Demand Inventory

Economic Order Quantity Exercise

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Inventory Definition

A stock of items held to meet future demand

Question: Goods vs Services?

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Types of Inventory
Inputs
Raw Materials Purchased parts Maintenance and Repair Materials

Process

Outputs
Finished Goods Scrap and Waste

(in warehouses, or in transit)

In Process
Partially Completed Products and (often on the Subassemblies factory floor)
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Types of Inventory
Work in process
Vendors

Raw Materials Work in process

Work in process

Finished Customer goods

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Water Tank Analogy for Inventory

Inventory Level Supply Rate

Inventory Level

Buffers Demand Rate from Supply Rate

Demand Rate
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Independent and Dependent Demand Inventory

Independent demand
items demanded by external customers (Kitchen Tables)

Dependent demand
items used to produce final products (table top, legs, hardware, paint, etc.) Demand determined once we know the type and number of final products

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Independent and Dependent Demand Inventory Management

Independent demand
Uncertain / forecasted Continuous Review / Periodic Review

Dependent demand
Requirements / planned Materials Requirements Planning / Just in Time

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Reasons To Hold Inventory

Meet variations in customer demand:

Meet unexpected demand Smooth seasonal or cyclical demand

Pricing related:
Temporary price discounts Hedge against price increases Take advantage of quantity discounts

Process & supply surprises

Internal upsets in parts of or our own processes External delays in incoming goods

Transit
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Reasons To NOT Hold Inventory

Carrying cost
Financially calculable

Takes up valuable factory space

Especially for in-process inventory

Inventory covers up problems

That are best exposed and solved
Driver for increasing inventory turns (finished goods) and lean production/Just in time for work in process

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Inventory Hides Problems

Bad Design

Lengthy Setups
Inefficient Layout

Poor Quality Machine Breakdown Unreliable Supplier

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To Expose Problems: Reduce Inventory Levels

Bad Design Lengthy Setups Inefficient Layout

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Poor Quality Machine Breakdown Unreliable Supplier

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Remove Sources of Problems and Repeat the Process

Poor Quality

Lengthy Setups

Bad Design

Inefficient Layout

Machine Breakdown

Unreliable Supplier

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Video
Inventory concepts that occur in the textbook supply chain Watch for:

Difference between independent and dependent demand inventory How much and when to order

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Inventory Cost Structures

Ordering (or setup) cost Carrying (or holding) cost:

Cost of capital Cost of storage Cost of obsolescence, deterioration, and loss

Stock out cost Item costs, shipping costs and other cost subject to volume discounts

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Typical Inventory Carrying Costs

Housing cost: Building rent or depreciation Building operating cost Taxes on building Insurance Material handling costs: Equipment, lease, or depreciation Power Equipment operating cost Manpower cost from extra handling and supervision Investment costs: Borrowing costs Taxes on inventory Insurance on inventory Pilferage, scrap, and obsolescence Overall carrying cost

Costs as % of Inventory Value 6% (3% - 10%)

3% (1% - 4%)

3% (3% - 5%) 10% (6% - 24%)

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5% (2% - 10%) (15% - 50%)

Inventory Management Systems

Functions of Inventory Management

Track inventory How much to order When to order

Prioritization Inventory Management Approach

EOQ Continuous / Periodic

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ABC Prioritization

Based on Pareto concept (80/20 rule) and total usage in dollars of each item. Classification of items as A, B, or C often based on $ volume.

Purpose: set priorities for management attention.

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ABC Prioritization

A items: 20% of SKUs, 80% of dollars B items: 30 % of SKUs, 15% of dollars C items: 50 % of SKUs, 5% of dollars Three classes is arbitrary; could be any number. Percents are approximate. Danger: dollar use may not reflect importance of any given SKU!

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ABC Analysis Example

100
90 Class A 80 70 60 50 40

+Class B

+Class C

Percentage of dollar value

30
20 10 0 10 20 30 40 50 60 70 80 90 100

Percentage of items
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Annual Usage of Items by Dollar Value

Percentage of Annual Usage in Total Dollar Units Unit Cost Dollar Usage Usage 5,000 $ 1.50 $ 7,500 2.9% 1,500 8.00 12,000 4.7% 10,000 10.50 105,000 41.2% 6,000 2.00 12,000 4.7% 7,500 0.50 3,750 1.5% 6,000 13.60 81,600 32.0% 5,000 0.75 3,750 1.5% 4,500 1.25 5,625 2.2% 7,000 2.50 17,500 6.9% 3,000 2.00 6,000 2.4% $ 254,725 100.0%
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Item 1 2 3 4 5 6 7 8 9 10 Total

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ABC Chart For Previous Slide

45.0% 40.0% 35.0% 120.0% 100.0%

Percent Usage

30.0% 25.0%

80.0% 60.0%

20.0% 15.0% 10.0% 20.0% 5.0% 0.0% 3 6 9 2 4 1 10 8 5 7 0.0% 40.0%

Item No. Percentage of Total Dollar Usage Cumulative Percentage

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Cumulative % Usage

Inventory Management Approaches

A-items
Track carefully (e.g. continuous review) Sophisticated forecasting to assure correct levels

C-items
Track less frequently (e.g. periodic review) Accept risks of too much or too little (depending on the item)

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Economic Order Quantity (EOQ) Model

Demand rate D is constant, recurring, and known Amount in inventory is known at all times Ordering (setup) cost S per order is fixed Lead time L is constant and known. Unit cost C is constant (no quantity discounts) Annual carrying cost is i time the average $ value of the inventory No stockouts allowed. Material is ordered or produced in a lot or batch and the lot is received all at once
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EOQ Lot Size Choice

There is a trade-off between lot size and inventory level.

Frequent orders (small lot size): higher ordering cost and lower holding cost. Fewer orders (large lot size): lower ordering cost and higher holding cost.

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EOQ Inventory Order Cycle

Demand rate Inventory Level Order qty, Q

ave = Q/2 Reorder point, R 0

As Q increases, average inventory level increases, but number of orders placed decreases Operations Management

Lead time Order Order Placed Received

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Lead Time time Order Order Placed Received

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Total Cost of Inventory EOQ Model

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Answer to Inventory Management Questions for EOQ Model

Keeping track of inventory
Implied that we track continuously

How much to order?

Solve for when the derivative of total cost with respect to Q = 0: -SD/Q^2 + iC/2 = 0 Q = sqrt ( 2SD/iC)

When to order?
Order when inventory falls to the Reorder Point-level R so we will just sell the last item as the new order comes in: R = DL

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Re-order Point Example

Demand = 10,000 yds/year Lead time = L = 10 days

When inventory falls to R, we order so as not to run out before the new order comes in. R=?

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Re-order Point Example

Demand = 10,000 yds/year Daily demand = 10,000 / 365 = 27.4 yds/day Lead time = L = 10 days

R = D*L = (27.4)(10) = 274 yds (usually can neglect issues of working days vs weekends, etc.)
Dont forget to convert to consistent time units!
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EOQ Summary
How much to order?
Q = sqrt(2DS/iC)

When to order?
R = DL

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EOQ Exercise
Now you do it See Excel Spreadsheet: Excel_Inv_Examples.xls, EOQ tab Compute the values of R and Q and compare to the simulation Next see what happens when you have volume discounts (EOQ w Discount Tab)

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EOQ Example
Unit Cost C Holding cost factor i Ordering cost S Demand rate D Lead time L Solutions: Re-order point R Q = sqrt(2SD/(iC)) $0.45 /unit 25% /year $15.00 /order 10000 units/year 0.0192 year

units (rounded) units (rounded)

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