PRODUCTION AND OPERATIONS MANAGEMENT Ch 13 Inventory Management

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PRODUCTION AND OPERATIONS MANAGEMENT Ch. 13: Inventory Management POM - J. Galván 1

PRODUCTION AND OPERATIONS MANAGEMENT Ch. 13: Inventory Management POM - J. Galván 1

Learning Objectives n n n Explain what inventory is Explain how inventory is classified

Learning Objectives n n n Explain what inventory is Explain how inventory is classified Explain ABC Analysis and Cycle Counting Compare inventory models Use inventory models to find how much and when to order POM - J. Galván 2

What is Inventory? n n n Stock of materials Stored capacity Examples © 1995

What is Inventory? n n n Stock of materials Stored capacity Examples © 1995 Corel Corp. POM - J. Galván © 1995 Corel Corp. © 1998 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle River, N. J. 07458 3

The Functions of Inventory n n n Provide a stock of goods to meet

The Functions of Inventory n n n Provide a stock of goods to meet anticipated customer demand provide a “selection” of goods Decouple suppliers from production and production from distribution Allow one to take advantage of quantity discounts To provide a hedge against inflation To protect against shortages due to delivery variation To permit operations to continue smoothly with the use of “work-in-process” POM - J. Galván 4

Disadvantages of Inventory n Higher costs Item cost (if purchased) • Ordering (or setup)

Disadvantages of Inventory n Higher costs Item cost (if purchased) • Ordering (or setup) cost • n Costs • of forms, clerks’ wages etc. Holding (or carrying) cost n Building n n lease, insurance, taxes etc. Difficult to control Hides production problems POM - J. Galván 5

Types of Inventory Raw material n Work-in-process n Maintenance/repair/operating supplies n Finished goods n

Types of Inventory Raw material n Work-in-process n Maintenance/repair/operating supplies n Finished goods n POM - J. Galván 6

Inventory Classifications Inventory Process stage Raw Material WIP Finished Goods Number & Value A

Inventory Classifications Inventory Process stage Raw Material WIP Finished Goods Number & Value A Items B Items C Items Demand Type Other Independent Dependent Maintenance Dependent Operating POM - J. Galván 7

The Material Flow Cycle Input Other Wait Time Move Time Queue Setup Time Run

The Material Flow Cycle Input Other Wait Time Move Time Queue Setup Time Run Time Output Cycle Time 1 2 3 4 5 6 Run time: Job is at machine and being worked on Setup time: Job is at the work station, and the work station is being "setup. " Queue time: Job is where it should be, but is not being processed because other work precedes it. Move time: The time a job spends in transit Wait time: When one process is finished, but the job is waiting to be moved to the next work area. Other: "Just-in-case" inventory. POM - J. Galván 8

ABC Analysis n Divides on-hand inventory into 3 classes • n Basis is usually

ABC Analysis n Divides on-hand inventory into 3 classes • n Basis is usually annual $ volume • n A class, B class, C class $ 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 POM - J. Galván 9

Classifying Items as ABC Class A B C % Annual $ Usage 100 80

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 50 100 150 % of Inventory Items POM - J. Galván 10

ABC Analysis 100 — Percentage of dollar value 90 — 80 — Class B

ABC Analysis 100 — Percentage of dollar value 90 — 80 — Class B Class C Class A 70 — 60 — 50 — 40 — 30 — 20 — 10 — 0— 10 20 30 40 50 60 70 80 90 100 Percentage of items

Cycle Counting n n Physically counting a sample of total inventory on a regular

Cycle Counting n n Physically counting a sample of total inventory on a regular basis Used often with ABC classification • A items counted most often (e. g. , daily) POM - J. Galván 12

Advantages of Cycle Counting n n n Eliminates shutdown and interruption of production necessary

Advantages of Cycle Counting n n n 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 POM - J. Galván 13

Techniques for Controlling Service Inventory Include: Good personnel selection, training, and discipline n Tight

Techniques for Controlling Service Inventory Include: Good personnel selection, training, and discipline n Tight control of incoming shipments n Effective control of all goods leaving the facility n POM - J. Galván 14

Independent versus Dependent Demand Independent demand - demand for item is independent of demand

Independent versus Dependent Demand Independent demand - demand for item is independent of demand for any other item n Dependent demand - demand for item is dependent upon the demand for some other item n POM - J. Galván 15

Holding, Ordering, and Setup Costs Holding costs - associated with holding or “carrying” inventory

Holding, Ordering, and Setup Costs Holding costs - associated with holding or “carrying” inventory over time n Ordering costs - associated with costs of placing order and receiving goods n Setup costs - cost to prepare a machine or process for manufacturing an order n POM - J. Galván 16

Holding Costs Obsolescence n Insurance n Extra staffing n Interest n Pilferage n Damage

Holding Costs Obsolescence n Insurance n Extra staffing n Interest n Pilferage n Damage n Warehousing n Etc. n POM - J. Galván 17

Determining Inventory Holding Costs Category Housing costs Material handling costs Labor cost from extra

Determining Inventory Holding Costs Category Housing costs Material handling costs Labor cost from extra handling Investment costs Pilferage, scrap, and obsolescence POM - J. Galván Cost as a % of Inventory Value 6% (3 - 10%) 3% (1 - 3. 5%) 3% (3 - 5%) 11% (6 - 24%) 3% (2 - 5%) 18

Ordering Costs Supplies n Forms n Order processing n Clerical support n Etc. n

Ordering Costs Supplies n Forms n Order processing n Clerical support n Etc. n POM - J. Galván 19

Setup Costs Clean-up costs n Re-tooling costs n Adjustment costs n Etc. n POM

Setup Costs Clean-up costs n Re-tooling costs n Adjustment costs n Etc. n POM - J. Galván 20

Inventory Models n Fixed order quantity models Economic order quantity • Production order quantity

Inventory Models n Fixed order quantity models Economic order quantity • Production order quantity • Quantity discount • n n Help answer the inventory planning questions! Probabilistic models Fixed order period models POM - J. Galván © 1984 -1994 T/Maker Co. 21

EOQ Assumptions n n n Known and constant demand Known and constant lead time

EOQ Assumptions n n n 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 POM - J. Galván 22

EOQ Model How Much to Order? Annual Cost rve u C st o C

EOQ Model How Much to Order? Annual Cost rve u C st o C l ve a r t u o T t. C s o C g n i d Hol Order (Setup) Cost Curve Optimal Order Quantity (Q*) POM - J. Galván Order Quantity 23

Why Holding Costs Increase n More units must be stored if more ordered Purchase

Why Holding Costs Increase n More units must be stored if more ordered Purchase Order Description Qty. Microwave 1000 Order quantity POM - J. Galván Order quantity 24

Why Order Costs Decrease n Cost is spread over more units Example: You need

Why Order Costs Decrease n Cost is spread over more units Example: You need 1000 microwave ovens 1 Order (Postage $ 0. 32) 1000 Orders (Postage $320) Purchase Order Description Qty. Microwave 1000 Purchase. Order. Qty. Description Purchase Description Qty. Description Microwave. Qty. 11 Description Microwave 11 Microwave Order quantity POM - J. Galván 25

EOQ Model When To Order Inventory Level Average Inventory (Q*/2) Optimal Order Quantity (Q*)

EOQ Model When To Order Inventory Level Average Inventory (Q*/2) Optimal Order Quantity (Q*) Reorder Point (ROP) Time Lead Time POM - J. Galván 26

Deriving an EOQ Develop an expression for setup or ordering costs n Develop an

Deriving an EOQ Develop an expression for setup or ordering costs n Develop an expression for holding cost n Set setup cost equal to holding cost n Solve the resulting equation for the best order quantity n POM - J. Galván 27

EOQ Model Equations 2 ×D ×S = Q* = H D Expected Number of

EOQ Model Equations 2 ×D ×S = Q* = H D Expected Number of Orders = N = Q* Optimal Order Quantity Expected Time Between Orders d = D Working Days ROP = d × L / Year =T = Working Days / Year N D = Demand per year S = Setup (order) cost per order H = Holding (carrying) cost d = Demand per day L = Lead time in days POM - J. Galván 28

Production Order Quantity Model n n Answers how much to order and when to

Production Order Quantity Model n n Answers how much to order and when to order Allows partial receipt of material • n Other EOQ assumptions apply Suited for production environment Material produced, used immediately • Provides production lot size • n Lower holding cost than EOQ model POM - J. Galván 29

Reasons for Variability in Production Most variability is caused by tolerating waste or by

Reasons for Variability in Production Most variability is caused by tolerating waste or by poor management. Specific causes include: q employees, machines, and suppliers produce units that do not conform to standards, are late or are not the proper quantity q engineering drawings or specifications are inaccurate q production personnel try to produce before drawings or specifications are complete q customer demands are unknown POM - J. Galván 30

POQ Model Inventory Levels Inventory Level Production portion of cycle Demand portion of cycle

POQ Model Inventory Levels Inventory Level Production portion of cycle Demand portion of cycle with no supply Supply Begins Time Supply Ends POM - J. Galván 31

POQ Model Equations 2*D*S = Qp * = Optimal Order Quantity d H* 1

POQ Model Equations 2*D*S = Qp * = Optimal Order Quantity d H* 1 p d Max. Inventory Level = Q * 1 p ( ) Setup Cost Holding Cost D S = * Q = 0. 5 * H * Q ( ) 1 - POM - J. Galván d p ( ) D = Demand per year S = Setup cost H = Holding cost d = Demand per day p = Production per day 33

Quantity Discount Model n n Answers how much to order & when to order

Quantity Discount Model n n Answers how much to order & when to order Allows quantity discounts Reduced price when item is purchased in larger quantities • Other EOQ assumptions apply • n Trade-off is between lower price & increased holding cost POM - J. Galván 34

Quantity Discount Model How Much to Order? Total Cost Price 1 Price 2 Price

Quantity Discount Model How Much to Order? Total Cost Price 1 Price 2 Price 3 TC for Discount 1 TC for Discount 2 TC for Discount 3 Quantity Ordered Lowest cost not in discount range Discount Quantity 1 Discount Quantity 2 POM - J. Galván Order Quantity 35

Probabilistic Models n n Answer how much & when to order Allow demand to

Probabilistic Models n n Answer how much & when to order Allow demand to vary Follows normal distribution • Other EOQ assumptions apply • n Consider service level & safety stock Service level = 1 - Probability of stockout • Higher service level means more safety stock • n More safety stock means higher ROP POM - J. Galván 36

Probabilistic Models When to Order? Inventory Level Freq Service Level Optimal Order Quantity P(Stockout)

Probabilistic Models When to Order? Inventory Level Freq Service Level Optimal Order Quantity P(Stockout) SS Reorder Point (ROP) X ROP Safety Stock (SS) Place order Lead Time POM - J. Galván Receive order Time 37

Probabilistic Models When to Order Inventory Level Freq Service Level P(Stockout) Optimal Order Quantity

Probabilistic Models When to Order Inventory Level Freq Service Level P(Stockout) Optimal Order Quantity SS ROP Reorder Point (ROP) Safety Stock (SS) Place order Lead Time POM - J. Galván Receive order Time 38

Fixed Period Model n n Answers how much to order Orders placed at fixed

Fixed Period Model n n Answers how much to order Orders placed at fixed intervals Inventory brought up to target amount • Amount ordered varies • n No continuous inventory count • n Possibility of stockout between intervals Useful when vendors visit routinely • Example: P&G representative calls every 2 weeks POM - J. Galván 39

Fixed Period Model When to Order? Inventory Level Period Target maximum Period POM -

Fixed Period Model When to Order? Inventory Level Period Target maximum Period POM - J. Galván Time 40