Inventory Management
Inventory
-A stock or store of goods -Inventories are a vital part of business: (1) necessary for operations and (2) contribute to customer satisfaction -A "typical" firm has roughly 30% of its current assets and as much as 90% of its working capital invested in inventory
Two categories of problem
-Demand can be characterized by a continuous distribution -Demand can be characterized by a discrete distribution
Reorder point: under uncertainty
-Demand or lead time uncertainty creates the possibility that demand will be greater than available supply -To reduce the likelihood of a stockout, it becomes necessary to carry safety stock
Inventory management has two main concerns
-Level of customer service -Having the right goods available in the right quantity in the right place at the right time -Costs of ordering and carrying inventories
Single period model
-Model for ordering of perishables and other items with limited useful lives -The goal of the single-period model is to identify the order quantity that will minimize the long-run excess and shortage costs
Types of inventory
-Raw materials and purchased parts -Work-in-process (WIP) -Finished goods inventories or merchandise -Tools and supplies -Maintenance and repairs (MRO) inventory -Goods-in-transit to warehouses or customers (pipeline inventory)
Perpetual Inventory System
-System that keeps track of removals from inventory continuously, thus monitoring current levels of each item -An order is placed when inventory drops to a predetermined minimum level
Setup costs
-The costs involved in preparing equipment for a job -Analogous to ordering costs
Objectives of inventory control
-The overall objective of inventory management is to achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds 1. Measures of performance 2. Customer satisfaction -Number and quantity of backorders -Customer complaints 3. Inventory turnover
Cycle inventory
-The portion of total inventory that varies directly with lot size -Lot sizing- determining how frequently to order and what quantity
EOQ lot size intuition
-There is a trade-off between frequency of ordering (and the size of the order) and the inventory level. -Frequent orders (small lot sizes) lead to lower average inventory level, i.e., higher total ordering costs and lower total holding costs. -Fewer orders (large lot sizes) lead to higher average inventory level, i.e., lower total ordering costs and higher total holding costs.
Purpose of inventories
-To protect against uncertainties :Safety stock -To allow economic production and purchase: Cycle inventory -To cover anticipated changes in demand/supply: Anticipation inventory -To provide for transit: Pipeline inventory
EOQ
-Used often in manufacturing to calculate appropriate order size (from supplier) and lot sizes (for production) -Restaurants use EOQ to estimate order size of food and other supplies needed
Two principles:
-the lot size Q, varies directly with the elapsed time (or cycle) between orders. If a lot is ordered every 5 weeks, the average lot size must be 5 weeks demand -The longest time between orders for a given item, the greater the cycle inventory must be
Economic order quantity assumptions
1. Demand rate is constant, recurring, and known. 2. Lead time is constant and known. 3. No stockouts allowed. 4. Items are ordered or produced in a lot or batch, and the lot is received all at once. 5. Costs are constant -Unit cost (no quantity discounts). -Carrying cost is constant per unit. -Ordering (setup) cost per order. 6. Item is a single product or SKU; demand not influenced by other items.
Assumptions
1. Only one item is involved 2. Annual demand requirements are known 3. Usage rate is constant 4. Usage occurs continually, but production occurs periodically 5. The production rate is constant 6. Lead time does not vary 7. There are no quantity discounts
Assumptions of the basic EOQ Model
1. Only one product is involved 2. Annual demand requirements are known 3. Demand is even throughout the year 4. Lead time does not vary 5. Each order is received in a single delivery 6. There are no quantity discounts
Reasons for using the FOI model
1. Supplier's policy may encourage its use 2. Grouping orders from the same supplier can produce savings in shipping costs 3. Some circumstances do not lend themselves to continuously monitoring inventory position
determinants of the reorder point
1. The rate of demand 2. The lead time 3. The extent of demand and/or lead time variability 4. The degree of stockout risk acceptable to management
Inventory Functions
1. To meet anticipated customer demand 2. To smooth production requirements 3. To decouple operations 4. To protect against stockouts 5. To take advantage of order cycles 6. To hedge against price increases 7. To permit operations 8. To take advantage of quantity discounts
Cycle counting
A physical count of items in inventory
Radio frequency identification (RFID) tags
A technology that uses radio waves to identify objects, such as goods, in supply chains
Universal product code (UPC)
Bar code printed on a label that has information about the item to which it is attached
ABC approach
Classifying inventory according to some measure of importance, and allocating control efforts accordingly
Holding (carrying) costs
Cost to carry an item in inventory for a length of time, usually a year
Ordering costs
Costs of ordering and receiving inventory
Shortage costs
Costs resulting when demand exceeds the supply of inventory; often unrealized profit per unit
How much safety stock?
Depends on: 1. The average demand rate and average lead time 2. Demand and lead time variability 3. The desired service level
Excess cost
Different between purchase cost and salvage value of items left over at the end of the period
How much to order
Economic order quantity models identify the optimal order quantity by minimizing the sum of annual costs that vary with order size and frequency
Purchase cost
The amount paid to buy the inventory
Basic EOQ Model
The basic EOQ model is used to find a fixed order quantity that will minimize total annual inventory costs
EOQ Models
The basic economic order quantity model The economic production quantity model The quantity discount model
EPQ
The batch mode is widely used in production. In certain instances, the capacity to produce a part exceeds its usage (demand rate)
Service level
The probability that demand will not exceed supply during lead time
Two-bin system
Two containers of inventory; reorder when the first is empty
A items
Very important -10 to 20 percent of the number of items in inventory and about 60 to 70 percent of the annual dollar value
Reorder point
When the quantity on hand of an item drops to this amount, the item is reordered.
C items
least important -50 to 60 percent of the number of items in inventory but only about 10 to 15 percent of the annual dollar value
B items
moderately important
Reorder points
the inventory level at which action needs to be taken
Lead time
the time between placing an order and receiving it
Shortage cost
Generally, the unrealized profit per unit
Cycle counting management
How much accuracy is needed? A items: ± 0.2 percent B items: ± 1 percent C items: ± 5 percent
Pipeline inventory
Inventory created when an order for an item is issued but not yet received
Independent demand items
Items that are ready to be sold or used
Fixed order interval FOI model
Orders are placed at fixed time intervals
Periodic System
Physical count of items in inventory made at periodic intervals
Quantity discount
Price reduction for larger orders offered to customers to induce them to buy in large quantities
Effective Inventory Management
Requires: 1. A system keep track of inventory 2. A reliable forecast of demand 3. Knowledge of lead time and lead time variability 4. Reasonable estimates of -holding costs -ordering costs -shortage costs 5. A classification system for inventory items
Safety stock
Stock that is held in excess of expected demand due to variable demand and/or lead time -As the amount of safety stock carried increases, the risk of stockout decreases.