Operations Management: Inventory Management

We have to take care that:

The CONSUME of materials is CONTINUOUS. The PURCHASING of the needed materials is PERIODICAL.

To calculate the ROP when demand is constant we

1. Calculate the "d" (demand per day) 2. Calculate the order lead time (assume it is constant) 3. We decide a safety stock to keep in the inventory (ss) So we now have ROP= d X L + ss

Ordering Costs

1. Cost of Supplies (pencils, paper, computer etc) 2. Cost of order processing (included the wage of the purchasing manager) 3. Cost of transport

Assumptions of News Vendor Model

1. Demand is not constant, it varies but it has a known distribution, and this means that the minimum and the maximum value of demand are known values. 2. The model is valid only for 1 item (calculations are only for 1 item). 3. The order lead time is assume to be equal to zero. 4. The holding costs are equal to zero.

Which are the costs associated with the inventories?

1. Holding Costs 2. Ordering Costs 3. Set Up Costs

Managing the inventory well means deciding:

1. How much to order (order quantity) 2. When to order= setting a correct reorder point= safety stock level

In a manufacturing organization you find 4 types of inventory

1. Raw Materials Inventory 2. Work-In-Progress Inventory* 3. Finished Products Inventory* 4. Maintenance-Repair-Operating supply Inventory

When an Operations Manager analyzes and decides about the inventory he cares of:

1. The minimum stock level to keep in the warehouse (safety stock) 2. The quantity of item/material to order 3. The average consume of the item 4. The observed order lead time

At a general level there are several issues that the Operations Manager should consider:

1. The ordering costs 2. The holding costs 3. The available space in the warehouses for storing goods 4. The discounts offered by the suppliers 5. Any long-term agreement or contract established with the supplier 6. Savings or penalties related with the transportation costs and arrangements 7. The costs (and penalties) the company might incur in case of shortages

Holding Costs

1. obsolescence, pilferage, scraps, damages 2. Housing costs (Ex: rent for the warehouse or its depreciation, operating costs like lighting, cleaning, fixing, maintenance, insurance) 3. Material handling costs (example: forklifts, conveyor belts, power needed for them) 4. Labor costs (example: wage for the warehouse managers) 5. Investment costs (example: interest payments on the money borrowed from banks for buying the raw materials used for producing the finished goods)

When considering quantity discounts there is

A major trade-off between reduced product cost and increased holding cost (if we buy a larger quantity the product is costing less money but since we have a larger quantity stored in the warehouse we are incurring higher holding costs).

Production Order Quantity Model

Applicable in 2 situations: 1. When inventory continuously flows or builds up over a period of time (after an order has been placed) 2. When units are produced and sold simultaneously. Under these circumstances we then take into account the daily production and the daily demand rate.

The fundamental goal for properly managing the inventories is:

Assuring a correct amount of materials when they are needed for the process. Minimizing the costs involved with the expenses for purchasing the materials and holding them in the warehouses.

Set up Costs

Costs for preparing a machine or a process for the production of products. Example: a. time and labor to set up the machine, changing the tools/holders or cleaning. b. time and labor for bringing the materials from the raw materials warehouse to the shop floor

Economic Order Quantity (EOQ)

Defines the OPTIMAL QUANTITY to order for minimizing both the holding costs and the ordering costs. Assumptions: a. Demand is known, constant, independent b. Order lead time is known and constant c. The receival of the materials is instantaneous and complete (after sending the purchasing order) d. Quantity discounts are not possible e. The only variable costs are the ordering costs and holding costs f. Stockouts can be completely avoided if orders are placed at the right time.

There is variation in

Demand from clients: can vary and not be easily predictable. Order delivery time from suppliers: sometimes materials can arrive with a delay. Fluctuations of prices for the raw materials; also price can be lower if a discount is allowed because a larger quantity is purchased.

Fixed-quantity models

Economic Order Model Production Order Quantity Model Quantity Discount Model When using these models we need to continuously monitor inventory quantity for knowing when we are at the ROP. Maintain accurate records of inventory whenever an item is added or withdrawn.

Safety Stocks

Extra stocks that companies put in to keep in the inventory. They do this because Demand and Order Lead Time can both vary.

Fixed-Period (P) Systems

Inventory is ordered at the end of a given period. On-hand inventory is counted at this specific moment. Do not have to take care in monitoring the quantity of stored items. Do not have the use of reorder point (ROP). Example: Vending Machines Advantage: No physical count of inventory items after an item is withdrawn. Disadvantage: Possibility of a stock-out during the time between 2 refills. Companies might keep higher safety stocks in order to avoid stock-outs even if this implies incurring higher holding costs.

Goal of the EOQ Model

Minimizing Inventory Costs, that means minimizing total costs of inventory (the sum of holding and ordering costs).

Models

Over time several different models have been created. When it comes to study and understand inventory, as first step it is important to understand the concept of Independent Demand versus Dependent Demand for an item.

NewsVendor Model

Simulates the sale of newspaper in the morning by the news vendor who has to decide how many newspapers to buy that he will then sell during the day. Does not want to end the day with unsold newspapers that are useless and valueless and so represent lost money. Does not want to face an early shortage of newspaper in order to avoid lost sales (and revenues). Has a goal: Minimizing costs (losses) and maximizing revenues (and profit)

For calculating the reorder point (ROP) we need to know:

The demand rate The order lead time

Reorder Point

The inventory level (quantity) of the item at which an order must be placed.

A simple model for the reorder point presents the following assumptions:

The receival of the ordered materials/items is instantaneous, that means: The firm places an order just when the inventory level for the item is equal to zero. The firm receives the ordered item immediately.

Order Lead Time

Time between the placement (sending) of the purchasing order and the receival of the ordered item. The "when-to-order" decision is usually expressed in terms of REORDER POINT.

If we consider the order lead time we have to take care of:

a. Bureaucratic time for sending the order and for the receival of it by the supplier. b. The speed of the supplier in processing all received orders. c. The transportation d. Risks of delays along the route for unforecastable reasons (incidents, weather, etc..) e. Time spent at the receival of the item for the quality check and the control procedures and for making the item fully available for the process.