This document discusses inventory management. It defines different types of inventory like raw materials, work in progress, and finished goods. It describes the costs and disadvantages of holding inventory. It also explains different inventory models like economic order quantity and periodic review systems that are used to determine optimal order quantities and times. Key metrics like weeks of supply and inventory turns are also introduced.

1. Operations
Management
Inventory Management
Chapter 12
12-1

2. What is Inventory?
♦ Stock of materials
♦ Stored capacity
© 1995
Corel Corp.
© 1984-1994 T/Maker Co. © 1984-1994 T/Maker Co.
© 1995 Corel Corp.
12-2

3. Types of Inventory
♦ Raw material
♦ Work-in-progress
♦ Maintenance / repair / operating supplies
♦ Finished goods
12-3

4. The Material Flow Cycle
12-4

5. 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
12-5

6. Disadvantages of Inventory
♦ Higher costs
♦ Interest or opportunity costs
♦ Holding (or carrying) costs – storage, handling, taxes,
insurance, shrinkage
♦ Ordering (or setup) costs
♦ Risk of deterioration or obsolescence
♦ Hides production problems
♦ Yield / scrap variations
♦ Unscheduled downtime
Total cost = 20% - 40% of inventory value / year
12-6

7. Pressures on inventory
Pressure for lower inventory
•Inventory investment
•Inventory holding cost
Pressure for higher inventory
•Customer service
•Other costs related to inventory
12-7

8. Different Views of Inventory
Demand Type Types of Inventory
Independent Cycle
Dependent Pipeline
Safety Stock
Anticipation
Annual $ Volume
Process stage A
Raw Material B
Work in Process C
Finished Goods
Other
Maintenance / Repair
Operating Supplies
12-8

9. How Is Inventory Created?
♦ Cycle Inventory – result of lot size
Q+0
Average cycle inventory =
2
♦ Pipeline Inventory – in transit
Pipeline inventory = DL = dL
♦ Safety Stock
♦ Anticipation Inventory Types of Inventory
Cycle
Pipeline
Safety Stock
Anticipation
12-9

10. Inventory Calculations
We use 70 hypodermic needles a week.
We buy them in lots of 280. It takes three
weeks for order handling and shipment.
Cycle inventory = Q/2
= 280/2
= 140 needles
Pipeline inventory = DL = dL
= (70 needles/week)(3 weeks)
= 210 drills
Inventory Worksheets
12-10

11. Inventory Reduction Tactics
♦ Cycle inventory Reduce lot size
♦ Pipeline inventory Reduce lead time
♦ Safety Stock Reduce uncertainties
♦ Anticipation inventory Various
12-11

12. ABC Analysis
♦ Divides on-hand inventory into three classes on
the basis of annual dollar volume – A, B, and C
♦ $ volume = Annual demand x Unit cost
♦ Policies based on ABC analysis
♦ Develop class A suppliers more
♦ Maintain tighter physical control of A items
♦ Forecast A items more carefully
Annual $ Volume
A
B
C
12-12

13. ABC Analysis
% Annual $ Usage Class % $ Vol % Items
A 80 20
100
B 15 30
80 C 5 50
60
40
A
B
20 C
0
0 50 100
% of Inventory Items
12-13

14. Inventory Models for
Independent Demand
♦ Fixed order-quantity models
Help answer the
Help answer the
♦ Economic order quantity inventory planning
inventory planning
♦ Production order quantity questions!
questions!
♦ Quantity discount
♦ Probabilistic models
♦ Fixed order-period models
© 1984-1994
T/Maker Co.
12-14

15. EOQ – Economic Order Quantity
♦ Objective:
minimize (ordering cost + holding cost)
♦ Assumptions:
♦ Known and constant demand
♦ Known and constant lead time
♦ Instantaneous receipt of material
♦ No quantity discounts
♦ Only ordering / setup cost and holding cost
♦ No stockouts
12-15

16. Inventory Usage Over Time
Usage Rate
Q
Inventory Level
Average
Q
2
Cycle
Inventory
0
Time
12-16

17. EOQ Model
How Much to Order?
Annual Cost
ost
Total C
t
Minimum g Cos
H oldin
total cost
Ordering (Setup) Cost
Optimal Order quantity (Q)
Order Quantity (Q*)
12-17

18. Why Holding Costs Increase
More units must be stored if more are ordered
Purchase Order Purchase Order
Description Qty. Description Qty.
Microwave 1 Microwave 1000
Order quantity
12-18

19. Why Ordering 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 Purchase Order
Purchase Order
Description Purchase Order
Description Qty.
Purchase Order Qty.
Qty. Description Qty.
Microwave 1000 Description Qty. 1
Microwave
Description
Microwave
Microwave 11
Microwave 1
Order quantity
12-19

20. EOQ Model – When to Order
Inventory Level
Q*
Average
Cycle
Reorder Inventory
Point
(ROP)
Time
Lead Time
12-20

21. EOQ Model Equations
Optimal Order Quantity 2 ×D ×S
= Q* =
H
Expected Number of Orders =N = D
Q*
Working Days / Year
Expected Time Between Orders =T =
N
D
d = D = Demand per year
Working Days / Year S = Setup (order) cost per order
H = Holding (carrying) cost
ROP = d × L
d = Demand per day
L = Lead time in days
12-21

22. Inventory Models for
Independent Demand
♦ Fixed order-quantity models
Help answer the
Help answer the
♦ Economic order quantity inventory planning
inventory planning
♦ Production order quantity questions!
questions!
♦ Quantity discount
♦ Probabilistic models
♦ Fixed order-period models
© 1984-1994
T/Maker Co.
12-22

23. POQ – Production Order Quantity
♦ 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
12-23

24. EOQ POQ Model
Both production
and usage take Usage only takes
Maximum place
place
inventory
level
Inventory Level
Time
12-24

25. Inventory Models for
Independent Demand
♦ Fixed order-quantity models
Help answer the
Help answer the
♦ Economic order quantity inventory planning
inventory planning
♦ Production order quantity questions!
questions!
♦ Quantity discount
♦ Probabilistic models
♦ Fixed order-period models
© 1984-1994
T/Maker Co.
12-25

26. Quantity Discount Model
♦ Answers how much to order & when to order
♦ Allows quantity discounts
♦ Other EOQ assumptions apply
♦ Trade-off is between lower price & increased holding cost
Discount Discount Discount Discount
Number Quantity (%) Price (P)
1 0 to 999 No discount $ 5.00
2 1,000 to 1,999 4 $ 4.80
3 2,000 and over 5 $ 4.75
12-26

27. Quantity Discount – How Much to Order
12-27

28. Inventory Models for
Independent Demand
♦ Fixed order-quantity models
Help answer the
Help answer the
♦ Economic order quantity inventory planning
inventory planning
♦ Production order quantity questions!
questions!
♦ Quantity discount
♦ Probabilistic models
♦ Fixed order-period models
© 1984-1994
T/Maker Co.
12-28

29. Probabilistic Models
Service
Level P(Stockout)
Frequency
♦ Answer how much &
when to order X
♦ Allow demand to vary
♦ 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
12-29

30. Probabilistic Models - When to Order?
Service
Level P(Stockout)
Frequency
Inventory Level
X
SS
Reorder
ROP
Point
(ROP)
Safety Stock (SS)
Lead Time Time
Place Receive
order order
12-30

31. Inventory Models for
Independent Demand
♦ Fixed order-quantity models
Help answer the
Help answer the
♦ Economic order quantity inventory planning
inventory planning
♦ Production order quantity questions!
questions!
♦ Quantity discount
♦ Probabilistic models
♦ Fixed order-period models
© 1984-1994
T/Maker Co.
12-31

32. Fixed Period (P) Systems
♦ 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: Office Max representative calls every week
12-32

33. Inventory in a Fixed Period System
Target maximum
Various amounts (Qi) are ordered at regular time
intervals (p) based on the quantity necessary to
Time
bring inventory up to target maximum
Q4
p
Q3
p
Q2
12-33
p

34. Comparison of Q and P Systems
♦ Continuous Review System (Q)
A system designed to track the remaining inventory
of an item each time a withdrawal is made, to
determine whether it is time to replenish
♦ Periodic Review System (P)
A system in which an item’s inventory position is
reviewed periodically rather than continuously
12-34

35. Comparison of Q and P Systems
♦ Continuous Review System (Q)
♦ Individual review frequencies
♦ Possible quantity discounts
♦ Lower, less-expensive safety stocks
♦ Periodic Review System (P)
♦ Convenient to administer
♦ Orders may be combined
♦ Inventory position only required at review
12-35

36. Inventory Measures
Average inventory = $2 million
Cost of goods sold = $10 million
52 business weeks per year
Average inventory value
Weeks of supply =
Weekly sales (at cost)
$2 million
= = 10.4 weeks
($10 million)/(52 weeks)
Annual sales (at cost)
Inventory turns =
Average inventory value
$10 million
= = 5 turns/year
$2 million
12-36

37. Summary
♦ Functions of inventory –
Inventory enables value creation for many processes
♦ Costs of inventory
♦ Different views of inventory
♦ Inventory reduction tactics
♦ ABC and EOQ are traditional tools used to manage
inventory – still used in many circumstances
♦ Continuous review system (Q) for high-value parts;
Periodic review system (P) for some low value parts
♦ Weeks of Supply and inventory turns are widely-used
measures of inventory
12-37