Inventory

Operations
Management
Inventory Management
Chapter 12
Transparency Masters
12-1
2004 by Prentice Hall,
Outline
GLOBAL COMPANY PROFILE: AMAZON.COM
FUNCTIONS OF INVENTORY
Types of Inventory
INVENTORY MANAGEMENT
ABC Analysis
Record Accuracy
Cycle Counting
Control of Service Inventories
12-2
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 Models
12-3
Outline - Continued
PROBABILISTIC MODELS WITH CONSTANT
LEAD TIME
FIXED PERIOD (P) SYSTEMS
12-4
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 Masters
Transparency
12-5
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.
12-6
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.
12-7
Order Fulfillment at AMAZONContinued

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 your doorstep within a week
12-8
What is Inventory?
Stock of materials
Stored capacity
Examples
1995
Corel Corp.
1984-1994 T/Maker Co.
1984-1994 T/Maker Co.
1995 Corel Corp.
12-9
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
12-10
Types of Inventory
Raw material
Work-in-progress
Maintenance/repair/operating supply
Finished goods
12-11
The Material Flow Cycle
12-12
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
12-13
Inventory Classifications
Inventory
Process
stage
Raw Material
WIP
Finished Goods
1984-1994
T/Maker Co.
Number
& Value
Demand
Type
A Items
B Items
C Items
Independent
Dependent
12-14
Other
Maintenance
Operating
The Material Flow Cycle

Input
Other
Wait
Time
Move
Time
Queue
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.
12-15
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
12-16
Classifying Items as ABC

Class
A
B
C
% Annual $ Usage
100
80
60
% $ Vol
80
15
5
% Items
15
30
55
40
20
0
0
50
100
% of Inventory Items
12-17
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)
12-18
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
12-19
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
12-20
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
12-21
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
12-22
Holding (Carrying) Costs

Obsolescence
Insurance
Extra staffing
Interest
Pilferage
Damage
Warehousing
Etc.
12-23
Inventory Holding Costs

(Approximate Ranges)
Category
Cost as a
% of Inventory Value
Housing costs (building rent, depreciation,

operating cost, taxes, insurance)
6%
(3 - 10%)
Material handling costs (equipment, lease

or depreciation, power, operating cost)
3%
(1 - 3.5%)
Labor cost from extra handling
3%
(3 - 5%)
Investment costs (borrowing costs, taxes,

and insurance on inventory)
11%
(6 - 24%)
Pilferage, scrap, and obsolescence

Overall carrying cost
12-24
3%
(2 - 5%)
26%
Ordering Costs
Supplies
Forms
Order processing
Clerical support
Etc.
12-25
Setup Costs
Clean-up costs
Re-tooling costs
Adjustment costs
Etc.
12-26
Inventory Models
Fixed order-quantity models
Help
Helpanswer
answerthe
the
inventory
inventoryplanning
planning
questions!
questions!
Economic order quantity

Production order quantity
Quantity discount
Probabilistic models
Fixed order-period models
1984-1994
T/Maker Co.
12-27
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
12-28
Inventory Usage Over Time
Minimum
inventory
Usage Rate
Inventory Level
Order quantity = Q
(maximum inventory
level)
Average
Inventory
(Q*/2)
Time
12-29
EOQ Model
How Much to Order?
Annual Cost
r ve
u
C
t
os
C
l
e
a
v
t
r
u
To
st C
o
C
g
n
i
d
l
Ho
Minimum
total cost
Order (Setup) Cost Curve

Optimal
Order Quantity (Q*)
12-30
Order quantity
Why Holding Costs Increase

More units must be stored if more are ordered
Purchase Order
Description
Qty.
Microwave
1
Purchase Order
Description
Qty.
Microwave
1000
Order quantity
12-31
Order quantity
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
PurchaseOrder
Order
Purchase
PurchaseOrder
OrderQty.
Description
Purchase
Description Qty.
Qty.
Description
Microwave Qty. 11
Description
Microwave
Microwave
Microwave
11
Order quantity
12-32
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
12-33
EOQ Model
When To Order
Inventory Level
Average
Inventory
(Q*/2)
Optimal
Order
Quantity
(Q*)
Reorder
Point
(ROP)
Time
Lead Time
12-34
EOQ Model Equations

Optimal Order Quantity
2 D S
H
D
=N =
Q*
= Q* =
Expected Number of Orders

Expected Time Between Orders
d =
D
Working Days
/ Year
ROP = d L
=T =
Working Days
/ Year
D = Demand per year

S = Setup (order) cost per order
H = Holding (carrying) cost
d = Demand per day
L = Lead time in days
12-35
The Reorder Point (ROP) Curve

Q*
Inventory level (units)
Slope = units/day = d
ROP
(Units)
Time (days)
Lead time = L
12-36
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
12-37
EOQ POQ Model

When To Order
Usage only takes
place
Inventory Level
Maximum
inventory
level
Both production
and usage take
place
Time
12-38
EOQ POQ Model

When To Order
Inventory Level
Average
Inventory
Optimal
Order
Quantity
(Q*)
Reorder
Point
(ROP)
Time
Lead Time
12-39
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
inaccurate engineering drawings or specifications
production personnel try to produce before
drawings or
specifications are complete
customer demands are unknown
12-40
POQ Model Inventory Levels

Inventory Level
Production portion of cycle
Demand portion of cycle with no

supply
Supply
Begins
Time
Supply
Ends
12-41
POQ Model Equations
Maximum inventory level

Setup Cost
Holding Cost
D
Q
2*D*S
d
H* 1 p
= Q* =
p
Optimal Order Quantity
= Q*
1 -
( )
d
p
* S
= 0.5 * H * Q
( )
1-
12-43
D = Demand per year

S = Setup cost
H = Holding cost
d = Demand per day
p = Production per day
Quantity Discount Model

Answers how much to order &
when to order
Allows quantity discounts
Reduced price when item is purchased in larger

quantities
Trade-off is between lower price & increased

holding cost
12-44
Quantity Discount Schedule

Discount
Number
1
2
3
Discount
Quantity
Discount
(%)
0 to 999
No discount
1,000 to 1,999
4
2,000 and over
5
12-45
Discount
Price (P)
$5.00
$4.80
$4.75
Quantity Discount How Much to

Order
12-46
Probabilistic Models
Answer how much & when to order
Allow demand to vary
Follows normal distribution

Consider service level & safety stock
Service level = 1 - Probability of stockout

Higher service level means more safety stock
More safety stock means higher ROP
12-47
Probabilistic Models
When to Order?
Inventory Level
Frequency
Service
Level
P(Stockout)
Optimal
Order
Quantity
SS
ROP
Reorder
Point
(ROP)
Safety Stock (SS)

Place
order
Lead Time
12-48
Receive
order
Time
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
12-49
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
On-Hand Inventory
Target maximum
Q1
Q4
Q2
Q3
p
p
Time
12-50
Fixed Period Model

When to Order?
Inventory Level
Period
Target maximum
Period
Period
12-51
Time

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Operations

2004 by Prentice Hall,

2004 by Prentice Hall,

Independent versus Dependent Demand

INVENTORY MODELS FOR INDEPENDENT

2004 by Prentice Hall,

2004 by Prentice Hall,

The functions of inventory and basic inventory

2004 by Prentice Hall,

Order Fulfillment at AMAZON

2004 by Prentice Hall,

Order Fulfillment at AMAZONContinued

2004 by Prentice Hall,

1984-1994 T/Maker Co.

1984-1994 T/Maker Co.

1995 Corel Corp.

2004 by Prentice Hall,

The Functions of Inventory

2004 by Prentice Hall,

2004 by Prentice Hall,

The Material Flow Cycle

2004 by Prentice Hall,

Item cost (if purchased)

Costs of forms, clerks wages etc.

Holding (or carrying) cost

Building lease, insurance, taxes etc.

2004 by Prentice Hall,

2004 by Prentice Hall,

The Material Flow Cycle

1 Run time: Job is at machine and being worked on

2004 by Prentice Hall,

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

2004 by Prentice Hall,

Classifying Items as ABC

2004 by Prentice Hall,

A items counted most often (e.g., daily)

2004 by Prentice Hall,

Advantages of Cycle Counting

2004 by Prentice Hall,

Techniques for Controlling

2004 by Prentice Hall,

2004 by Prentice Hall,

2004 by Prentice Hall,

Holding (Carrying) Costs

2004 by Prentice Hall,

Inventory Holding Costs

Housing costs (building rent, depreciation,

Material handling costs (equipment, lease

Labor cost from extra handling

Investment costs (borrowing costs, taxes,

Pilferage, scrap, and obsolescence

2004 by Prentice Hall,

2004 by Prentice Hall,

2004 by Prentice Hall,

Economic order quantity

2004 by Prentice Hall,

2004 by Prentice Hall,

Inventory Usage Over Time

2004 by Prentice Hall,

Order (Setup) Cost Curve