Chapter 13 Inventory Management Inventory o A stock of items kept to meet demand o Virtually every type of organization maintains some form of inventory o Types of inventory Raw materials Purchased parts and supplies Partially complete work in progress WIP Tools and equipment Items being transported o Inventory must be at sufficient levels to provide high quality customer service in Quality Management Quality Service o Availablility of goods consumers want when they want them Reasons to hold extra inventory o Prepare for seasonal and or cyclical demand o The bullwhip effect which occurs when information is distorted as it moves away from the end use customer Inventory Management o 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 Demand o Inventory exists to meet customer demand o Customers can be both inside and outside of the organization o 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 Costs o Carrying costs Costs of holding items in inventory Include Labor Facility storage Material handling Record keeping Borrowing to purchase inventory Product deterioration o Ordering costs Costs associated with replenishing the stock of inventory being React inversely to carrying costs as order size increases fewer held orders are required o 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 Systems o Continuous System fixed order quantity The ABC Classification System A constant amount is ordered when inventory declines to a predetermined level referred to as the reorder point o 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 o An inventory classification system in which a small of A items account for most of the inventory value o 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 attention Unit Cost 30 175 15 40 15 10 5 160 205 10 Annual Usage 45 20 65 30 50 90 85 25 30 60 The manager wants to classify the above parts according to the ABC system to determine which parts should be most closely monitored Example Part 1 2 3 4 5 6 7 8 9 10 Solution To 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 to get 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 above Economic Order Quantity Models Economic Order Quantity The Basic EOQ Model o The optimall order quantity that will minimize total inventory costs o 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 Point o Demand rate per period X lead time Example Store is open 335 days per year Demand 2 000 cans year Daily Demand 2 000 335 5 97 cans day Lead time 14 days Reorder point 5 97 X 14 83 58 Cans Order Cycle o The time between receipt of orders in an inventory cycle Total annual ordering cost o Cost per order X Demand Quantity Annual Carrying Cost o Annual per unit carrying cost X Avg Inventory Level 2 Total annual inventory cost o Total annual ordering cost annual carrying cost Example 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 yr Solution Annual per unit carrying cost 0 15 per can Cost per order 75 Demand 2 000 cans Optimal 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 cans Total 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 yr Order cycle equals days in business per yr orders per yr 335 1 4 239 28 days Quantity 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 item X annual demand to our equation for total inventory cost above Safety Stocks a buffer added to on hand inventory during lead time Stockout o An inventory shortage Service level o Probability that the inventory available during time will meet demand Reorder 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 Example For Soda Shop lets assume daily demand for grape soda is normally distributed with an avg daily demand of 50 cans and a standard deviation of 4 cans per day The lead time to receive a new order of grape soda is 14 days Determine the reorder point and safety stock if the store wants a service level