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.