Operations Management Inventory Management Chapter 12 Transparency Masters

Operations Management Inventory Management Chapter 12 Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -1 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Outline ¨ GLOBAL COMPANY PROFILE: AMAZON. COM ¨ FUNCTIONS OF INVENTORY ¨ Types of Inventory ¨ INVENTORY MANAGEMENT ¨ ABC Analysis ¨ Record Accuracy ¨ Cycle Counting ¨ Control of Service Inventories Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -2 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Outline - Continued ¨ INVENTORY MODELS ¨ Independent versus Dependent Demand ¨ Holding, Ordering, and Setup Costs ¨ INVENTORY MODELS FOR INDEPENDENT DEMAND ¨ Basic Economic Order Quantity (EOQ) Model ¨ Minimizing Costs ¨ Reorder Points ¨ Production Order Quantity Model ¨ Quantity Discount 12 -3 Models Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Outline - Continued ¨ PROBABILISTIC MODELS WITH CONSTANT LEAD TIME ¨ FIXED PERIOD (P) SYSTEMS Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -4 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Learning Objectives When you complete this chapter, you should be able to : Identify or Define: ¨ ABC analysis ¨ Record accuracy ¨ Cycle counting ¨ Independent and dependent demand ¨ Holding, Ordering, and Setup Costs Describe or Explain: ¨ The functions of inventory and basic inventory models 12 -5 Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

AMAZON. com ¨ Jeff Bezos, in 1995, started AMAZON. com as a “virtual” retailer – no inventory, no warehouses, no overhead; just a bunch of computers. ¨ Growth forced AMAZON. com to excel in inventory management! ¨ AMAZON is now a worldwide leader in warehouse management and automation. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -6 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Order Fulfillment at AMAZON 1. You order items; , computer assigns your order to distribution center [closest facility that has the product(s)] 2. Lights indicate products ordered to workers who retrieve product and reset light. 3. Items placed in crate with items from other orders, and crate is placed on conveyor. Bar code on item is scanned 15 times – virtually eliminating error. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -7 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Order Fulfillment at AMAZON- Continued 4. Crates arrive at central point where items are boxed and labeled with new bar code. 5. Gift wrapping done by hand (30 packages per hour) 6. Box is packed, taped, weighed and labeled before leaving warehouse in a truck. 7. Order appears on 12 -8 your doorstep within a week Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

What is Inventory? ¨ Stock of materials ¨ Stored capacity ¨ Examples © 1995 Corel Corp. © 1984 -1994 T/Maker Co. © 1995 Corel Corp. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -9 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

The Functions of Inventory ¨ To ”decouple” or separate various parts of the production process ¨ To provide a stock of goods that will provide a “selection” for customers ¨ To take advantage of quantity discounts ¨ To hedge against inflation and upward price changes Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -10 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Types of Inventory ¨ Raw material ¨ Work-in-progress ¨ Maintenance/repair/operating supply ¨ Finished goods Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -11 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

The Material Flow Cycle Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -12 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Disadvantages of Inventory ¨ Higher costs Item cost (if purchased) ¨ Ordering (or setup) cost ¨ ¨ ¨ Costs of forms, clerks’ wages etc. Holding (or carrying) cost ¨ Building lease, insurance, taxes etc. ¨ Difficult to control ¨ Hides production problems Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -13 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Inventory Classifications Inventory Proces s stage Number & Value A Items B Items C Transparency Masters to accompany Heizer/Render – Principles of Operations Items Management, 5 e, and Operations Management, Deman d Type Raw Material WIP Finished Goods 7 e © 1984 -1994 T/Maker Co. Independen t Dependent 12 -14 Other Maintenanc e Operating © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

The Material Flow Cycle Input Other Wait Time Move Time Queu e Time Setup Time Run Time Output Cycle Time 1 Run time: Job is at machine and being worked on 2 Setup time: Job is at the work station, and the work station is being "setup. " 3 Queue time: Job is where it should be, but is not being processed because other work precedes it. 4 Move time: The time a job spends in transit 5 Wait time: When one process is finished, but the job is waiting to be moved to the next work area. 6 Other: "Just-in-case" inventory. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -15 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

ABC Analysis ¨ Divides on-hand inventory into 3 classes ¨ A class, B class, C class ¨ Basis is usually annual $ volume ¨ $ volume = Annual demand x Unit cost ¨ Policies based on ABC analysis Develop class A suppliers more ¨ Give tighter physical control of A items ¨ Forecast A items more carefully ¨ Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -16 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Classifying Items as ABC Class A B C % Annual $ Usage 100 80 60 % $ Vol 80 15 5 % Items 15 30 55 A 40 B 20 C 0 0 50 100 % of Inventory Items Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -17 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Cycle Counting ¨ Physically counting a sample of total inventory on a regular basis ¨ Used often with ABC classification ¨ A items counted most often (e. g. , daily) Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -18 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Advantages of Cycle Counting ¨ Eliminates shutdown and interruption of production necessary for annual physical inventories ¨ Eliminates annual inventory adjustments ¨ Provides trained personnel to audit the accuracy of inventory ¨ Allows the cause of errors to be identified and remedial action to be taken ¨ Maintains accurate inventory records Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -19 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Techniques for Controlling Service Inventory Include: ¨ Good personnel selection, training, and discipline ¨ Tight control of incoming shipments ¨ Effective control of all goods leaving the facility Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -20 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Independent versus Dependent Demand ¨ Independent demand - demand for item is independent of demand for any other item ¨ Dependent demand - demand for item is dependent upon the demand for some other item Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -21 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Inventory Costs ¨ Holding costs - associated with holding or “carrying” inventory over time ¨ Ordering costs - associated with costs of placing order and receiving goods ¨ Setup costs - cost to prepare a machine or process for manufacturing an order Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -22 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Holding (Carrying) Costs ¨ Obsolescence ¨ Insurance ¨ Extra staffing ¨ Interest ¨ Pilferage ¨ Damage ¨ Warehousing ¨ Etc. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -23 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Inventory Holding Costs (Approximate Ranges) Category Housing costs (building rent, depreciation, operating cost, taxes, insurance) Material handling costs (equipment, lease or depreciation, power, operating cost) Labor cost from extra handling Investment costs (borrowing costs, taxes, and insurance on inventory) Transparency Masters to accompany 12 -24 Pilferage, scrap, and obsolescence Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e Cost as a % of Inventory Value 6% (3 - 10%) 3% (1 - 3. 5%) 3% (3 - 5%) 11% (6 - 24%) 3% (2 - 5%) 26% © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Ordering Costs ¨ Supplies ¨ Forms ¨ Order processing ¨ Clerical support ¨ Etc. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -25 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Setup Costs ¨ Clean-up costs ¨ Re-tooling costs ¨ Adjustment costs ¨ Etc. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -26 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Inventory Models ¨ Fixed order-quantity models Economic order quantity ¨ Production order quantity ¨ Quantity discount ¨ Help answer the inventory planning questions! ¨ Probabilistic models ¨ Fixed order-period models © 1984 -1994 T/Maker Co. Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -27 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

EOQ Assumptions ¨ Known and constant demand ¨ Known and constant lead time ¨ Instantaneous receipt of material ¨ No quantity discounts ¨ Only order (setup) cost and holding cost ¨ No stockouts Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -28 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Inventory Usage Over Time Usage Rate Inventory Level Order quantity = Q (maximum inventory level) Minimum inventory 0 Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e Average Inventory (Q*/2) Time 12 -29 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

EOQ Model How Much to Order? Annual Cost ve r u t. C os ve C r l u a t t. C To s o g. C n i d Hol Minimu m total cost Order (Setup) Cost Curve Optimal Order Quantity (Q*) Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -30 Order quantity © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Why Holding Costs Increase ¨ More units must be stored if more are ordered Purchase Order Description Qty. Microwave 1000 Order quantity Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e Order quantity 12 -31 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Why Order Costs Decrease Cost is spread over more units Example: You need 1000 microwave ovens 1 Order (Postage $ 0. 33) 1000 Orders (Postage $330) Purchase Order Description Qty. Microwave 1000 Purchase. Order Description Qty. Purchase Description Qty. 1 Microwave Description Qty. Microwave 11 Microwave 1 Order quantity Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -32 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Deriving an EOQ 1. Develop an expression for setup or ordering costs 2. Develop an expression for holding cost 3. Set setup cost equal to holding cost 4. Solve the resulting equation for the best order quantity Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -33 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

EOQ Model When To Order Inventory Level Average Inventory (Q*/2) Optimal Order Quantity (Q*) Reorder Point (ROP) Time Lead Time Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -34 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

EOQ Model Equations 2 ×D ×S H D Expected Number of Orders =N= Q* Optimal Order Quantity = Q* = Expected Time Between Orders = T = Working Days / Year N d= D Working Days / Year ROP = d × L Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e D = Demand per year S = Setup (order) cost per order H = Holding (carrying) cost d = Demand per day L = Lead ©time in days 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 12 -35 07458

The Reorder Point (ROP) Curve Inventory level (units) Q* Slope = units/day = d ROP (Units) Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -36 Lead time = L Time (days) © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Production Order Quantity Model ¨ Answers how much to order and when to order ¨ Allows partial receipt of material ¨ Other EOQ assumptions apply ¨ Suited for production environment Material produced, used immediately ¨ Provides production lot size ¨ ¨ Lower holding cost than EOQ model Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -37 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

EOQ POQ Model When To Order Inventory Level Maximu m inventor y level Both production and usage take place Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e Usage only takes place Time 12 -38 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

EOQ POQ Model When To Order Inventory Level Average Inventory Optimal Order Quantity (Q*) Reorder Point (ROP) Time Lead Time Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -39 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Reasons for Variability in Production Most variability is caused by waste or by poor management. Specific causes include: employees, machines, and suppliers produce units that do not conform to standards, are late or are not the proper quantity q inaccurate engineering drawings or specifications q production personnel try to produce before drawings or specifications are complete q customer demands are unknown q Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -40 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

POQ Model Inventory Levels Inventory Level Production portion of cycle Demand portion of cycle with no supply Supply Begins Time Supply Ends Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -41 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

POQ Model Equations Optimal Order Quantity = Q* = p Maximum inventory level = Q* Setup Cost = Holding Cost D Q ( ) 1 - d p * S ( ) = 0. 5 * H * Q 1 - Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 2*D*S d H* 1 p 12 -43 d p D = Demand per year S = Setup cost H = Holding cost d = Demand per day p = Production per day © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Quantity Discount Model ¨ Answers how much to order & when to order ¨ Allows quantity discounts Reduced price when item is purchased in larger quantities ¨ Other EOQ assumptions apply ¨ ¨ Trade-off is between lower price & increased holding cost Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -44 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Quantity Discount Schedule Discou nt Numbe r 1 Discount Quantity Discount (%) Discount Price (P) 0 to 999 No discount $5. 00 2 1, 000 to 1, 999 4 $4. 80 3 2, 000 and over 5 $4. 75 Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -45 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Quantity Discount – How Much to Order Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -46 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Probabilistic Models ¨ Answer how much & when to order ¨ Allow demand to vary Follows normal distribution ¨ Other EOQ assumptions apply ¨ ¨ Consider service level & safety stock Service level = 1 - Probability of stockout ¨ Higher service level means more safety stock ¨ ¨ More safety stock means higher ROP Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -47 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Probabilistic Models When to Order? Inventory Level Frequenc y Service Level Optimal Order Quantity P(Stockout) SS X ROP Reorder Point (ROP) Safety Stock (SS) Place order Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e Lead Time 12 -48 Receive order Time © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Fixed Period Model ¨ Answers how much to order ¨ Orders placed at fixed intervals Inventory brought up to target amount ¨ Amount ordered varies ¨ ¨ No continuous inventory count ¨ Possibility of stockout between intervals ¨ Useful when vendors visit routinely ¨ Example: P&G representative calls every 2 weeks Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -49 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Inventory Level in a Fixed Period System Various amounts (Qi) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum Q 1 Target maximum Q 4 Q 2 On-Hand Inventory Q 3 p p p Time Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e 12 -50 © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458

Fixed Period Model When to Order? Inventory Level Period Target maximum Period Transparency Masters to accompany Heizer/Render – Principles of Operations Management, 5 e, and Operations Management, 7 e Period 12 -51 Time © 2004 by Prentice Hall, Inc. , Upper Saddle River, N. J. 07458