Inventory Management Chapter 13 Inventory Costs Purchase cost

Inventory Management Chapter 13

Inventory Costs • Purchase cost – The amount paid to buy the inventory • Holding (carrying) costs – Cost to carry an item in inventory for a length of time, usually a year • Interest, insurance, taxes (in some states), depreciation, obsolescence, deterioration, spoilage, pilferage, breakage, tracking, picking, and warehousing costs (heat, light, rent, workers, equipment, security). • Ordering costs – Costs of ordering and receiving inventory • determining how much is needed, preparing invoices, inspecting goods upon arrival for quality and quantity, and moving the goods to temporary storage. • Shortage costs – Costs resulting when demand exceeds the supply of inventory; often unrealized profit per unit MIS 373: Basic Operations Management 2

The Inventory Cycle Profile of Inventory Level Over Time Q Usage rate Quantity on hand Reorder point Receive order Place order Receive order Time Lead time MIS 373: Basic Operations Management 3

Total Annual Cost • Total Cost = Annual Holding Cost + Annual Ordering Cost Q D (TC) = H + S 2 Q Average number of units in inventory Number of orders where • Q = order quantity in units • H = holding (carrying) cost per unit, usually per year • D = demand, usually in units per year • S = ordering cost per order MIS 373: Basic Operations Management 4

Deriving EOQ • Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q. • The total cost curve reaches its minimum where the carrying and ordering costs are equal. MIS 373: Basic Operations Management 5

EPQ: Inventory Cycle Q Qp Production and usage Usage only Production and usage Cumulative production Imax Amount on hand Time Instructor Slides 13 -6

Time • Cycle time – The time between setups of consecutive runs • Run time – The production phase of the cycle

EPQ – Total Cost Instructor Slides 13 -8

EPQ Optimal Batch size a. k. a Economic Produciton Quantity (EPQ) Instructor Slides 13 -9

Quantity Discount Model • Quantity discount – Price reduction for larger orders offered to customers to induce them to buy in large quantities Instructor Slides 13 -10

Reorder-Point ROP = (Demand per day) * (Lead time for a new order in days) = d * L where d = (Demand per year) / (Number of working days in a year) Example: – Demand = 12, 000 i. Pads per year – 300 working day year – Lead time for orders is 3 working days In other words, the manager should place the order when only 120 units left in the inventory. d = 12, 000 / 300 = 40 units ROP = d * L = 40 units per day * 3 days of leading time = 120 units MIS 373: Basic Operations Management 11