Chapter 13 Inventory Management- Inventoryo A stock of items kept to meet demando Virtually every type of organization maintains some form of inventoryo Types of inventory Raw materials Purchased parts and supplies Partially complete work in progress (WIP) Items being transported Tools and equipmento Inventory must be at sufficient levels to provide high quality customerservice in Quality Management- Quality Serviceo Availablility of goods consumers want when they want them- Reasons to hold extra inventoryo Prepare for seasonal and/or cyclical demando The bullwhip effect which occurs when information is distorted as it moves away from the end use customer- Inventory Managemento The purpose of inventory management is to determine the amount of inventory to keep in stock- how much to order and when to replenish, or order- Demando Inventory exists to meet customer demando Customers can be both inside and outside of the organizationo Demand for items is either dependent or independent Dependent demand- Items are used internally to produce a final product- Example: If a company makes 500 skateboards, it will need 2,000 wheels to finish the skateboard Independent demand - Items are final products demanded by external consumers- Inventory Costso Carrying costs Costs of holding items in inventory Include:- Facility storage- Material handling- Labor- Record keeping- Borrowing to purchase inventory- Product deteriorationo Ordering costs Costs associated with replenishing the stock of inventory beingheld React inversely to carrying costs, as order size increases fewer orders are requiredo Shortage costs Occur when customer demand cannot be met because of insufficient inventory Causes customer dissatisfaction and a loss of goodwill that can result in permanent loss of customers Shortage costs have an inverse relationship to carrying costs, when carrying costs increase shortage costs decrease- Inventory Control Systemso Continuous System (fixed order quantity)  A constant amount is ordered when inventory declines to a predetermined level, referred to as the reorder pointo Periodic Inventory System (Fixed time period) An order is placed for a variable amount after a fixed passage of time. Inventory is counted every month or week and after it is counted an order is placed to bring inventory back to the desired level- The ABC Classification Systemo An inventory classification system in which a small % of (A) items account for most of the inventory valueo 5 to 15% of inventory items account for 70-80% of the value (A)o 30% of inventory items account for 15% of the value (B)o 50-60% of inventory items account for 5-10% of the value (C)o Class A should experience tight control while B and C do not require as much attentionExample Part Unit Cost Annual Usage1 $ 30 452 $ 175 203 $ 15 654 $ 40 305 $15 506 $ 10 907 $ 5 858 $ 160 259 $ 205 3010 $ 10 60The manager wants to classify the above parts according to the ABC system to determine which parts should be most closely monitoredSolutionTo solve this problem:- Step 1 multiply the unit cost by the annual usage for each part to get the total value- Step 2 divide each part’s total value by the company’s total value to get the %total value- Step 3 divide each part’s annual usage by the company’s total annual usage toget the % total qty- Step 4 to determine which parts go in which class, simply find the items that fit as close to the ABC classification parameters listed aboveEconomic Order Quantity Models- Economic Order Quantityo The optimall order quantity that will minimize total inventory costs- The Basic EOQ Modelo A formula for determining the optimal order size that minimizes the sum of carrying costs and ordering costs. The formula is derived under a set of assumptions below” Demand is known with certainty and is constant over time No shortages are allowed Lead time for the receipt of orders is constant The order quantity is received all at once- Reorder Pointo = Demand rate per period X lead timeExample:- Demand= 2,000 cans/year- Store is open 335 days per year- Daily Demand = 2,000/335= 5.97 cans/day- Lead time= 14 days- Reorder point = 5.97 X 14 = 83.58 Cans- Order Cycleo The time between receipt of orders in an inventory cycle- Total annual ordering costo (Cost per order X Demand)/Quantity- Annual Carrying Costo (Annual per unit carrying cost X Avg Inventory Level)/2- Total annual inventory costo Total annual ordering cost + annual carrying costExample:The Soda Shop stocks soda in its warehouse and sells it online on its web page. Soda Shop stocks many kinds of soda, but their grape soda is their best selling. Soda shop wants to determine the optimal order size and total inventory cost for Grape Soda given an annual demand of 2,000 Cans of soda, an annual carrying cost of $0.15 per can and an ordering cost of $75 per order. They also want to know the number of orders that will be made annually and the time between orders (the order cycle). The store is open 335 days per yrSolution- Annual per unit carrying cost= $0.15 per can- Cost per order = $75- Demand = 2,000 cansOptimal order size= sqroot of (2(Cost per order X Demand))/Annual carrying cost= sqroot of (2 (75 X 2,000))/0.15= sqroot of (300,000)/.15= sqroot of 2 million= 1,414 cansTotal inventory cost is determined by substituting the optimal order size into the total cost formula= ((75 X 2000)/1414) + ((0.15 X 1414)/2)=106 + 106= $212# of orders per year is calculated by = D/Qopt= 2,000/1414=1.4 orders per yrOrder cycle equals= # days in business per yr / # orders per yr= 335/1.4= 239.28 daysQuantity Discounts- price discount on an item if predetermined numbers of units are ordered- To utilize the quantity discounts we simply add PD (per unit price of the itemX annual demand) to our equation for total inventory cost aboveSafety Stocks- a buffer added to on hand inventory during lead time- Stockouto An inventory shortage- Service levelo Probability that the inventory available during time will meet demandReorder Point With Variable Demand= (average daily demand X lead time) + the number of standard deviations corresponding to the service level profitability X ((the standard deviation of daily demand) X the sqroot of the lead time)Safety stock equals((the standard deviation of daily demand) X the sqroot of the lead time)ExampleFor Soda Shop lets assume daily demand for grape soda is normally distributed withan avg daily