11-1 Inventory Management

Chapter 11

Inventory
Management
11-2 Inventory Management

MANUFACTURING RESOURCE PLANNING

CORE MRP II
Aggregate Production
Aggregate Forecast
Plan

Master Production Rough-Cut Capacity

Detailed Forecast
Schedule Planning

Material Capacity
Requirements Requirements
Planning Planning

Purchasing Dispatching
11-3 Inventory Management

Independent Demand

A Dependent Demand

B(4) C(2)

D(2) E(1) D(3) F(2)

Independent demand is uncertain.

Dependent demand is certain.
11-4 Inventory Management

Why Have Inventory?

• Anticipation of demand surge

• Cycle stock to minimize setups/orders

• Buffering against uncertainty

• Pipeline inventory of goods in transit

11-5 Inventory Management

Lot-Sizing
• Cycle stock inventories are determined by two
interrelated decisions
– When to order/produce
– How much to order/produce

• Lot-sizing models attempt to provide answers which

minimize the total cost over some period of time
11-6 Inventory Management

Reactive vs. Proactive

Systems
• Two basic types of inventory systems

• Reactive systems
– Require little detailed knowledge of future demand
– Never look beyond the next purchase/production order

• Proactive systems
– Require detailed knowledge of demand
– Plan purchase/production orders far into the future
11-7 Inventory Management
Reactive Inventory
Systems
• Order Q more units when inventory drops
below ROP
– Q -- Order quantity (lot size)
– ROP – Reorder point
– LT -- Lead time (1 Period)
– T -- Reorder interval
Q

INVENTORY

ROP

LT

T
TIME
11-8 Inventory Management
Reactive Inventory
Systems
• How should Q and ROP be determined?

• ROP = expected demand during lead time + safety stock

INVENTORY

ROP

LT

T
TIME
11-9 Inventory Management

Finding ROP
• D -- Average demand per period (40)

• If safety stock is zero, then:

– ROP = (D)(LT) = ____________________

INVENTORY

ROP

LT

T
TIME
11-10 Inventory Management

Finding Q
• EOQ -- The best or most "economic" order
quantity that minimizes the total cost per period
– Need to determine how Q affects holding and setup
costs per period
Q

INVENTORY

ROP

LT

T
TIME
11-11 Inventory Management

Economic Order Quantity

The total cost per period function TC[Q] can be written as
a function of Q:

• TC[Q] = total holding cost + total setup cost

• TC[Q] = (avg. inventory)Ch + (setups/period)Cs

Q D
• TC[Q] = ( ) Ch + ( Q ) Cs
2
11-12 Inventory Management

Economic Order Quantity

Q   D
TC[Q] =   Ch +   CS
2 Q 
Q   40 
TC[Q] =   0.50 +   40
2 Q

100   40 
TC[100] =   0.50 +   40 = 25 + 16 = 41
 2  100 

 50   40 
TC[50] =   0.50 +   40 = 12.5 + 32 = 44.5
2  50 
11-13 Inventory Management

Cost Minimization Goal

The Total-Cost Curve is U-Shaped
Q D
TC = H + S
Annual Cost

2 Q

Ordering Costs

Order Quantity
QO (optimal order quantity)
(Q)
11-14 Inventory Management

Deriving the 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.

2DS 2(Annual Demand )(Order or Setup Cost )

Q OPT = =
H Annual Holding Cost
11-15 Inventory Management

Economic Order Quantity

2DCS
• Solution: EOQ =
Ch
2(40)(40)
Example : Q = = 80
0.50

TOTAL

COST
SETUP
HOLDING

EOQ

Q
11-16 Inventory Management

Economic Order Quantity

 80   40 
TC[80] =   0.50 +   40 = 20 + 20 = 40
2  80 

TOTAL

COST
SETUP
HOLDING

EOQ

Q
11-17 Inventory Management

Proactive Inventory Systems

• If we have a detailed forecast for the part or product . .

– A lot-sizing decisions can be planned in advance
– A proactive, rather than reactive approach
11-18 Inventory Management

Lot For Lot

• Simplest lot-sizing rule

• Make as much as you need each period

– Maximizes total setup cost
– Minimizes total holding cost

Period 1 2 3 4 5 6 Total
Demand 50 10 30 80 50 20
Lot Size
Projected Available Balance 0
Net Requirements
Setup Cost
Holding Cost
Total Cost
11-19 Inventory Management

Economic Order Quantity

• EOQ can also be modified for use in a
proactive system
– Some EOQ assumptions are violated
– Use average demand for EOQ formula
2(40)(40)
EOQ = = 80
0.50
Period 1 2 3 4 5 6 Total
Demand 50 10 30 80 50 20
Lot Size
Projected Available Balance 0
Net Requirements 50
Setup Cost
Holding Cost
Total Cost
11-20 Inventory Management

Periodic Order Quantity

• POQ modifies the EOQ for discrete demand
– Assumes a single best reorder interval (number of periods
covered by a single lot)

EOQ 80
POQ = = =2
D 40
Period 1 2 3 4 5 6 Total
Demand 50 10 30 80 50 20
Lot Size
Projected Available Balance 0
Net Requirements 50
Setup Cost
Holding Cost
Total Cost
11-21 Inventory Management

Operations Strategy
• Too much inventory
– Tends to hide problems
– Easier to live with problems than to eliminate
them
– Costly to maintain
• Wise strategy
– Reduce lot sizes
– Reduce safety stock