Gaafar 2005 Production Planning and Control- Inventory Management (1)

Production Planning and Control

Inventory Management
r. Lotfi K. Gaafar
Gaafar 2005 Production Planning and Control- Inventory Management (2)
Production Planning and Control
Demand
Iorecasting
Sales and
order entry
Customer
Production
Inventory
Vendors
Aggregate
planning
Inventory
management
Shipping
and
receiving
Materials
requirement
planning
Shop-Iloor
scheduling
and control
The Production Control System
Gaafar 2005 Production Planning and Control- Inventory Management (3)
Demand Management
Basic Problem: establish an interface between the customer and the plant
floor. that supports both competitive customer service and workable
production schedules.
Issues:
Customer Lead 1imes: shorter is more competitive.
Customer Service: on-time delivery.
Batching: grouping like product Iamilies can reduce lost capacity
due to setups.
Interface with Scheduling: customer due dates are are an
enormously important control in the overall scheduling process.
Gaafar 2005 Production Planning and Control- Inventory Management (4)
hy Manage Inventory?
Total $ investment on in inventories is $1.37 trillion (last
quarter oI 1999)
34 in ManuIacturing
26 in Retail
22 in holesale
8 in Farm
10 in Other
82% of the total
Gaafar 2005 Production Planning and Control- Inventory Management (5)
hy Manage Inventory?
In 1998, American companies spent $898 billion in logistics-related
activities (or 10.6 oI Gross Domestic Product).
Transportation 58
Inventory 38
Management 4
By eIIectively managing inventory:
Xerox eliminated $700 million inventory Irom its supply chain
al-Mart became the largest retail company utilizing eIIicient
inventory management
GM has reduced parts inventory and transportation costs by 26
annually
Gaafar 2005 Production Planning and Control- Inventory Management (6)
Supplv
Sources:
plants
endors
ports
Regional
\arehouses:
stocking
points
lield
\arehouses:
stocking
points
(ustomers.
demand
centers
sinks
Production
purchase
costs
Inentorv &
warehousing
costs
1ransportation
costs
Inentorv &
warehousing
costs
1ransportation
costs
Gaafar 2005 Production Planning and Control- Inventory Management (7)
hy Manage Inventory?
By not managing inventory successIully
In 1994, 'IBM continues to struggle with shortages in their
ThinkPad line (SJ, Oct 7, 1994)
In 1993, 'Liz Claiborne said its unexpected earning decline is the
consequence oI higher than anticipated excess inventory (SJ,
July 15, 1993)
In 1993, 'Dell Computers predicts a loss; Stock plunges. Dell
acknowledged that the company was sharply oII in its Iorecast oI
demand, resulting in inventory write downs (SJ, August 1993)
Gaafar 2005 Production Planning and Control- Inventory Management (8)
Inventory
here do we hold inventory?
suppliers and manuIacturers
warehouses and distribution centers
retailers
Types oI Inventory
IP and subassemblies
raw materials
Iinished goods
hy do we hold inventory? (Short answer)
Economies oI scale
Uncertainty in supply and demand
Gaafar 2005 Production Planning and Control- Inventory Management (9)
hy do we hold inventory?
Economies oI scale
Uncertainty in supply and demand
Speculation
Transportation
Smoothing production/purchasing
Logistics
Cost oI controlling inventory
Gaafar 2005 Production Planning and Control- Inventory Management (10)
Decisions to Make
e have to decide
How oIten we review the inventory
hen we should issue a (replenishment/production) order
How large the order should be
Gaafar 2005 Production Planning and Control- Inventory Management (11)
Characteristics oI Inv. Systems
Demand
Constant (level) or variable
Deterministic (known) or Stochastic (random or uncertain)
Lead Time
Review Time
Continuous or periodic review
Excess Demand
Backordered or lost
Changing inventory
Gaafar 2005 Production Planning and Control- Inventory Management (12)
Relevant Costs
Unit value or unit variable cost (c)
Cost oI making a part available Ior usage
Purchase Freight MIg. Costs
Usually diIIerent Irom 'accounting cost
Should include more than iust book value
Gaafar 2005 Production Planning and Control- Inventory Management (13)
Relevant Costs
Holding cost (cost oI carrying in inv.)
Opportunity costs oI the money tied to inventory ( ic), where i is
the available rate oI return on investment (may use IRR).
arehousing and Handling (cost oI providing space to store items,
counting and moving items in the warehouse)
Deterioration, damage, obsolescence
Insurance and taxes
: arehousing cost, $ per item per year
Gaafar 2005 Production Planning and Control- Inventory Management (14)
Relevant Costs
2
!nv.
Time, t
Avg. inv. level
Gaafar 2005 Production Planning and Control- Inventory Management (15)
Relevant Costs
Ordering or Setup Cost (P)
Fixed cost
Independent oI the size oI the replenishment or production
order
Ordering Iorms, phone calls, other communication costs, receiving,
inspection, cost oI interrupted production, opportunity cost oI lost
time, etc.
Gaafar 2005 Production Planning and Control- Inventory Management (16)
EOQ History
Introduced in 1913 by Ford . Harris, 'How Many Parts to Make
at Once
3terest o3 capital tied up i3 wages. material a3d overhead sets a
maximum limit to the qua3titv of parts which ca3 be profitablv
ma3ufactured at o3e time, 'set-up` costs o3 the iob fix the
mi3imum. Experie3ce has show3 o3e ma3ager a wav to determi3e
the eco3omical size of lots.
Early application oI mathematical modeling to ScientiIic
Management
Gaafar 2005 Production Planning and Control- Inventory Management (17)
EOQ Modeling Assumptions
1. !roduction is instantaneous there is no capacity constraint and
the entire lot is produced simultaneously.
2. Deliverv is immediate there is no time lag between production
and availability to satisIy demand.
3. Demand is deterministic there is no uncertainty about the
quantity or timing oI demand.
4. Demand is constant over time in Iact, it can be represented as a
straight line, so that iI annual demand is 365 units this translates
into a daily demand oI one unit.
5. A production run incurs a fixed setup cost regardless oI the
size oI the lot or the status oI the Iactory, the setup cost is constant.
6. !roducts can be analvzed singlv either there is only a single
product or conditions exist that ensure separability oI products.
Gaafar 2005 Production Planning and Control- Inventory Management (18)
EOQ Model
Time unit: one year
Total Cost setup cost opportunity cost arehousing cost, total
cost is calculated per unit.
Purchase Cost Constant
Opportunity cost is always based on average quantity
arehousing cost may be based on average quantity Ior mixed storage
areas, or on maximum quantity Ior dedicated storage.
Goal: Find the order quantity that minimizes total costs
General Equation
, %
"
%"
"
!
%
avg
Ior dedicated storage
,
) (
"
%"
"
!
%
avg

Ior mixed storage

Gaafar 2005 Production Planning and Control- Inventory Management (19)
EOQ Model
Inventory
Order
Quantity
"
Assumptions:
No Stockouts
Order when no inventory
Order size determines policy
Avg. Inventory ("
avg
)
"
avg
"/2
Gaafar 2005 Production Planning and Control- Inventory Management (20)
EOQ Model
0
20
40
60
80
100
120
140
160
0 500 1000 1500
Order Quantity
C
o
s
t
Total Cost
Order Cost
Holding Cost
"7timal "91e9
Ouantity, O*
Gaafar 2005 Production Planning and Control- Inventory Management (21)
EOQ Model
) (
2
*

!
" EO"

By diIIerentiation:
, %
"
%"
"
!
%
avg
Ior dedicated storage
,
) (
"
%"
"
!
%
avg

Ior mixed storage

) 2 (
2
*

!
" EO"

Ior dedicated storage
Ior mixed storage
Gaafar 2005 Production Planning and Control- Inventory Management (22)
EOQ Model
Example:
Zartex Co. produces Iertilizer to sell to wholesalers. One raw material
calcium nitrate is purchased Irom a nearby supplier at $22.50 per ton. Zartex
estimates it will need 5,750,000 tons oI calcium nitrate next year. The annual
carrying cost Ior this material is 40 oI the acquisition cost, and the ordering
cost is $595.
a) hat is the most economical order quantity?
b) How many orders will be placed per year?
c) How much time will elapse between orders?
Gaafar 2005 Production Planning and Control- Inventory Management (23)
EOQ Model
Tradeoff between set-up costs and holding costs when determining order
quantity. In Iact, we order so that these costs are equal per unit time
Total Cost is not particularly sensitive to the optimal order quantity
Order Quantity 50 80 90 100 110 120 150 200
Cost Increase 125 103 101 100 101 102 108 125
Gaafar 2005 Production Planning and Control- Inventory Management (24)
EOQ Observations
Batching causes inventory (i.e., larger lot sizes translate into more
stock).
Under speciIic modeling assumptions the lot size that optimally
balances holding and setup costs is given by the square root Iormula:
Total cost is relatively insensitive to lot size (so rounding Ior other
reasons, like coordinating shipping, may be attractive).
cc
!
"
2
*

carrying cost (cc) or cc 2

Gaafar 2005 Production Planning and Control- Inventory Management (25)
EOQ Trade-oII
Two interpretations:
II you order more (larger Q), you incur higher inventory cost, but
less setup cost
II you order less Irequently, you incur larger inventory cost, but
less setup cost
The trade-oII is not linear!
Gaafar 2005 Production Planning and Control- Inventory Management (26)
Economic ManuIacturing Quantity (EMQ)
hat happens when there is Iinite production rate?
A: production rate (in units per year)
A~D (demand rate per year). hy?
hat happens iI you keep producing?
The inventory will keep growing Iorever with a rate oI A-D.
There are many possible scenarios. The common two are:
A: Start producing " when inventory reaches zero.
B: Start producing a batch oI " so that the quantity is Iinished when
the previous batch is consumed.
Gaafar 2005 Production Planning and Control- Inventory Management (27)
EMQ- Scenario A
T
A T
C
Sta9t
P9o1.
!nv
Time
O
Sto7
P9o1.
Sta9t
P9o1.
Start producing " when inventory reaches zero at the rate oI parts per
time unit. Consumption is continuous at the rate oI parts per time unit
until inventory reaches zero, at which time production starts again.
O
N
( 1 |
2 2
" "
"

avg
Gaafar 2005 Production Planning and Control- Inventory Management (28)
EMQ- Scenario A
)( / ( 1 )| (
2
*

!
" EO"


By diIIerentiation:
, %
"
%"
"
!
%
avg
Ior dedicated storage
,
) (
"
%"
"
!
%
avg

Ior mixed storage

)( / ( 1 )| 2 (
2
*

!
" EO"


Ior dedicated storage
Ior mixed storage
Gaafar 2005 Production Planning and Control- Inventory Management (29)
EMQ- Scenario B
T
A
T
Sta9t
P9o1.
!nv
Time
O
Sto7
P9o1.
Sta9t
P9o1.
Start producing a batch oI ". at the rate oI parts per time unit, so that the
quantity is Iinished when the previous batch is consumed. Consumption is
continuous at the rate oI parts per time unit. Inventory never reaches
zero. "

is the minimum inventory level.

O
N
( 1 |
2 2
" " "
"

avg

O
N
Gaafar 2005 Production Planning and Control- Inventory Management (30)
EMQ- Scenario B
)( / ( 1 )| (
2
*

!
" EO"


By diIIerentiation:
, %
"
%"
"
!
%
avg
Ior dedicated storage
,
) (
"
%"
"
!
%
avg

Ior mixed storage

)( / ( 1 )| 2 (
2
*

!
" EO"


Ior dedicated storage
Ior mixed storage
Gaafar 2005 Production Planning and Control- Inventory Management (31)
Resource Constrained Multiple Product Systems
Another EOQ assumption:
Even iI you have multiple items to worry, you can analyze them
separately
hat happens iI the items share capacitated resources?
Budget
Machines
Personnel
Space, etc.
Gaafar 2005 Production Planning and Control- Inventory Management (32)
MedEquip Example Costs
1000 racks per year
c $250
! $500 (estimated Irom supplier`s pricing)
cc (0.1)($250) 10 $35 per unit per year
cc
!
"
2
*

169
35
) 1000 )( 500 ( 2
*
"
Gaafar 2005 Production Planning and Control- Inventory Management (33)
Costs in EOQ Model
Gaafar 2005 Production Planning and Control- Inventory Management (34)
Dynamic Lot Sizing
Another EOQ assumption:
Demand is constant over time
Dynamic Lot Sizing relaxes this assumption
Demand is changing over time
But demand in each period is known (so still deterministic).
Gaafar 2005 Production Planning and Control- Inventory Management (35)
Dynamic Lot Sizing
Examples:
MRP
Firm orders and contracts Ior Iuture periods
Seasonal demand patterns
Demand with trend (increasing or decreasing over time)
Gaafar 2005 Production Planning and Control- Inventory Management (36)
Example:
Other data
Beginning inventory: 0
Setup cost: $150
Inventory carrying cost: $2 per unit per period
Week 1 2 3 4 5 6 7 8 9 10
Demand 10 15 12 16 15 12 18 14 22 16
Dynamic Lot Sizing
Gaafar 2005 Production Planning and Control- Inventory Management (37)
Issues:
Determine a planning horizon
Calculate total cost over the planning horizon
Implementing decisions over time
Rolling horizon concept
Discrete demand vs. Continuous demand
Discrete Replenishments vs. Any-time replenishments
Dynamic Lot Sizing
Gaafar 2005 Production Planning and Control- Inventory Management (38)
Quick Solutions
Order every period exactly as much as you need
Lot-Ior-Lot
Determine a Iixed order quantity and order when you need to order (i.e.,
when on-hand inventory is less than the next period`s demand)
Example: EOQ
Order constant time-supply (i.e., order the amount suIIicient to cover total
demand in next three months)
Dynamic Lot Sizing
Gaafar 2005 Production Planning and Control- Inventory Management (39)
Lot-Ior-lot solution:
Dynamic Lot Sizing
Total Cost 150 10 * 150 $1650
!eriod 1 2 3 4 5 6 7 8 9 10 Total
Demand 10 15 12 16 15 12 18 14 22 16 150
Order 10 15 12 16 15 12 18 14 22 16 150
Beginning . 10 15 12 16 15 12 18 14 22 16 150
End . 0 0 0 0 0 0 0 0 0 0 0
Holding Cost 10 15 12 16 15 12 18 14 22 16 150

Gaafar 2005 Production Planning and Control- Inventory Management (40)
Other heuristics:
EOQ as a Time Supply
Periodic Order Quantity (POQ)
Part-Period Balancing (PPB)
Silver-Meal (or Least Period Cost)
Dynamic Lot Sizing
Gaafar 2005 Production Planning and Control- Inventory Management (41)
Example
Calculate EOQ:
Average demand per week
Holding cost per unit per week
EOQ
Total Holding and Setup Cost
Dynamic Lot Sizing
43 . 47
2
) 15 )( 150 ( 2 2
*

cc
!
"
Week 1 2 3 4 5 6 7 8 9 10
Demand 10 15 12 16 15 12 18 14 22 16
Gaafar 2005 Production Planning and Control- Inventory Management (42)
Dynamic Lot Sizing- EOQ
!eriod 1 2 3 4 5 6 7 8 9 10 Total
Demand 10 15 12 16 15 12 18 14 22 16 150
Order 48 48 48 48 192
Beginning . 48 38 23 59 43 28 64 46 32 58
End . 38 23 11 43 28 16 46 32 10 42
Holding Cost 86 61 34 102 71 44 110 78 42 100 642

Total Cost 642 4 * 150 $1242
Gaafar 2005 Production Planning and Control- Inventory Management (43)
Dynamic Lot Sizing - POQ
Periodic Order Quantity
Calculate EOQ using Average Demand
Calculate Time Supply and round it to the nearest integer
In each replenishment, order to cover that many periods` demand
Fixed order interval, but diIIerent quantity in each replenishment
Gaafar 2005 Production Planning and Control- Inventory Management (44)
Dynamic Lot Sizing - POQ
!eriod 1 2 3 4 5 6 7 8 9 10 Total
Demand 10 15 12 16 15 12 18 14 22 16 150
Order 37 43 54 16 150
Beginning . 37 27 12 43 27 12 54 36 22 16
End . 27 12 0 27 12 0 36 22 0 0
Holding Cost 64 39 12 70 39 12 90 58 22 16 422

Total Cost 422 4 * 150 $1022
Gaafar 2005 Production Planning and Control- Inventory Management (45)
Dynamic Lot Sizing - PPB
Part-Period Balancing
Select the number oI periods covered by the replenishment such
that the total inventory carrying costs are as close as possible to the
setup cost.
Gaafar 2005 Production Planning and Control- Inventory Management (46)
Dynamic Lot Sizing - PPB
!eriod 1 2 3 4 5 6 7 8 9 10 Total
Demand 10 15 12 16 15 12 18 14 22 16 150
Order 37 43 54 16 150
Beginning . 37 27 12 43 27 12 54 36 22 16
End . 27 12 0 27 12 0 36 22 0 0
Holding Cost 64 39 12 70 39 12 90 58 22 16 422

Total Cost 422 4 * 150 $1022
Gaafar 2005 Production Planning and Control- Inventory Management (47)
Dynamic Lot Sizing - SM
Silver-Meal (SM) Heuristic
Minimize total relevant costs per unit time Ior the duration oI the
replenishment quantity.
Replenishment quantity Q should last Ior an integer number oI periods:
cover the total demand in periods 1 through T (decision variable T)
Min (Setup Cost Inv Cost through T) / T
Q D
1
. D
T
Total Relevant Cost through T: TRC(T)
Select T such that TRC(T)/T is minimized.
Gaafar 2005 Production Planning and Control- Inventory Management (48)
Dynamic Lot Sizing - SM
!eriod 1 2 3 4 5 6 7 8 9 10 Total
Demand 10 15 12 16 15 12 18 14 22 16 150
Order 37 43 32 38 150
Beginning . 37 27 12 43 27 12 32 14 38 16
End . 27 12 0 27 12 0 14 0 16 0
Holding Cost 64 39 12 70 39 12 46 14 54 16 366

Total Cost 366 4 * 150 $966