Chapter 13 operations management

Some of the most important functions inventories serve are:

1. To meed anticipated customer demand 2. To smooth production requirements 3. To decouple operations

4 basic costs associated with inventories

1. purchase costs 2. holding costs 3. ordering costs 4. shortage costs

4 determinants of the reorder point quantity

1. the rate of demand (usually based on a forecast) 2. the lead time 3. the extent of demand and/or lead time variability. 4. the degree of stockout risk acceptable to management

shortage cost

unrealized profit per unit Cshortage = Cs = Revenue per unit − Cost per unit

reorder point (ROP)

when the quantity of an item on hand drops to a predetermined amount. In order to know when the reorder point has been reached, perpetual inventory monitoring is required. Safety stock is required is lead time and demand is variable.

cycle counting

a physical count of items in inventory.

excess cost

leftover items at the end of the period. Cexcess = Ce = Original cost per unit − Salvage value per unit

Economic production quantity

-Unlike the EOQ model, there are no ordering costs -inventory "trickles in" as it is produced.

the following about discrete stocking levels in the single period model are true

-after finding the optimal service level, pick the next highest stocking level (between 5-6 pick 6) -If the SL is equal to one of the probabilities, both that level and the next higher one have the same minimum cost.

The following is true regarding the A-B-C approach

-it provides a guideline for cycle counting -approximately 10-20% of items account for about 60-70% of annual dollar value -its purpose is to identify inventory items that are the most important to business

The following are true about inventory management

-one of the goals is to keep inventory costs within reasonable bounds -one of the goals is to achieve good customer service -inventory managers must decide how much to order.

The following about inventory control systems is true

-orders in two-bin systems may not be placed at the right time -some businesses are moving toward using RFIT tags to track inventory.

Key questions concerning cycle counting for management are

-who should count it? -when should cycle counting be performed? -how much accuracy is needed?

To be effective, management must have the following:

1. A system to keep track of the inventory on hand and on order. 2. A reliable forecast of demand that includes an indication of possible forecast error. 3. Knowledge of lead times and lead time variability. 4. Reasonable estimates of inventory holding costs, ordering costs, and shortage costs. 5. A classification system for inventory items.

Assumptions of the basic EOQ model

1. Only one product is involved 2. annual demand requirements are known 3. lead time is known and constant 4. demand is spread evenly throughout the year so that the demand rate is reasonably constant 5. each order is received in a single delivery 6. there are not quantity discounts

A-B-C approach

Classifying inventory according to some measure of importance, and allocating control efforts accordingly. Steps: 1. Multiply annual value by unit price for each item 2. arrange items in descending order by annual dollar amt. 3. classify items as A,B, or C

Holding, or carrying, costs

Cost to carry an item in inventory - physically, in storage - for a length of time, usually a year. Costs include interest, insurance, taxes (in some states), depreciation, obsolescence, deterioration, spoilage, pilferage, breakage, tracking, picking, and warehousing costs (heat, light, rent, security). They also include opportunity costs associated with having funds that could be used elsewhere tied up in inventory. Note that it is the variable portion of these costs that is pertinent.

If demand and lead time are both constant, the reorder point is simply

ROP = d × LT

Littles law

The average amount of inventory in a system is equal to the product of the average demand rate and the average time a unit is in the system.

Periodic systems

a physical count of items in inventory is made at periodic, fixed (weekly/monthly) intervals in order to decide how much to order of each item. Safety stock is required.

Inventory

a stock or store of goods.

The overall objective of inventory management is to

achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds.

Perpetual inventory system

aka continuous review system, keeps track of removal from inventory on a continuous basis so the system can provide information on the current level of inventory for each item.

single period model

aka newsboy problem; is used to handle ordering of perishables (fresh fruit, veggies, seafood, flowers) and items that have a limited useful life (newspapers, magazines, spare parts for specialized equipment)

universal product code (UPC)

bar code printed on a label that has information about the item to which it is attached

Dependent demand inventory

components of finished products, rather than finished products themselves.

Ordering costs

costs of ordering and receiving inventory

point of sale (POS) systems

electronically recorded items at time of sale.

Safety stock

extra inventory carried to reduce the probability of a stockout due to demand and/or lead-time variability.

Cycle stock

inventory that is intended to meet expected demand

Independent demand inventory

items that are ready to be used or sold.

in fixed order interval model, larger than expected demand causes

larger order sizes than expected.

Annual carrying cost is computed by

multiplying the average amount of inventory on hand by the cost to carry one unit for one year

fixed order interval (FOI) model

orders are placed at fixed time intervals (weekly, monthly etc). If demand is variable, the order size will tend to vary. Only periodic checks of inventory required.

quantity discounts

price reductions for larger orders.

Return on investment (ROI)

profit after taxes divided by total assets

Shortage costs

results when demand exceeds the supply of inventory on hand.

Purchase cost

the amount paid to a vendor or supplier to buy the inventory.

Setup costs

the cost involved with preparing equipment for a job.

Economic order quantity (EOQ)

the order size that minimizes total annual cost. Used to identify a fixed order size. As Q decreases, the annual ordering cost would increase. Orders are places when there is just enough inventory left to cover the lead time demand.

service level

the probability that demand will not exceed supply during lead time. 100%-stockout risk

Inventory turnover

the ratio of annual cost of goods sold to average inventory method. Indicates how many times a year the inventory is sold. Generally, the higher the better because it implies more efficient use of inventory.

what triggers orders in a fixed order interval model

the time since the last order

lead time

time interval between ordering and receiving the order.

two-bin system

two containers of inventory; reorder when the first is empty