Chapter 13 Inventory Management McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved Chapter 13: Learning Objectives  You should be able to: Define the term inventory, list the major reasons for holding inventories, and list the main requirements for effective inventory management Discuss the nature and importance of service inventories Explain periodic and perpetual review systems Explain the objectives of inventory management Describe the A-B-C approach and explain how it is useful Describe the basic EOQ model and its assumptions and solve typical problems Describe the economic production quantity model and solve typical problems Describe the quantity discount model and solve typical problems Describe reorder point models and solve typical problems 10 Describe situations in which the single-period model would be appropriate, and solve typical problems Instructor Slides 13-2 Inventory Inventory  A stock or store of goods Independent demand items  Items that are ready to be sold or used 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 Instructor Slides 13-3 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) Instructor Slides 13-4 Inventory Independent Demand Inventory: a stock or store of goods Dependent Demand A C(2) B(4) D(2) E(1) D(3) F(2) Independent demand is uncertain Dependent demand is certain 12-5 Objectives of Inventory Control 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  The overall objective of inventory management is to achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds Costs of ordering and carrying inventories Measures of performance Customer satisfaction  Number and quantity of backorders  Customer complaints Inventory turnover Instructor Slides 13-6 Inventory Management Management has two basic functions concerning inventory: Establish a system for tracking items in inventory Make decisions about When to order How much to order Instructor Slides 13-7 Effective Inventory Management  Requires: A system keep track of inventory A reliable forecast of demand Knowledge of lead time and lead time variability Reasonable estimates of  holding costs  ordering costs  shortage costs Instructor Slides A classification system for inventory items 13-8 Inventory Counting Systems Periodic System Physical count of items in inventory made at periodic intervals 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  Two-bin system  Two containers of inventory; reorder when the first is empty Instructor Slides 13-9 Demand Forecasts and Lead Time  Forecasts  Inventories are necessary to satisfy customer demands, so it is important to have a reliable estimates of the amount and timing of demand  Point-of-sale (POS) systems  A system that electronically records actual sales  Such demand information is very useful for enhancing forecasting and inventory management Lead time  Time interval between ordering and receiving the order Instructor Slides 13-10 How Much Safety Stock? The amount of safety stock that is appropriate for a given situation depends upon: The average demand rate and average lead time Demand and lead time variability The desired service level Expected demand ROP = + zσ dLT during lead time where z = Number of standard deviations σ dLT = The standard deviation of lead time demand Instructor Slides 13-77 ROP Models Z is determined by stockout risk or service level (SL) SL = – Stockout Risk  For example 95% service level implies that the probability that demand will not exceed supply during lead time is 95% There is a 5% chance that demand will exceed supply during the lead time 12-78 Reorder Point: Demand Uncertainty ROP = d × LT + zσ d LT where z = Number of standard deviations and is determined by stockout risk or service level d = Average demand per period (per day, per week) σ d = The stdev of demand per period (same time units as d ) LT = Lead time (same time units as d ) Note: If only demand is variable, then Instructor Slides σ dLT = σ d LT 13-79 Variable Demand Rate Constant Lead Time Example Assume that the demand rate for a product is normally distributed with a mean of 10 tons and the standard deviation of tons Lead time is days Q: What is the expected demand during lead time? (d )( LT ) = (10)(4) = 40 tons 12-80 Variable Demand Rate Constant Lead Time Example Q: For a service level of 97%, what is the safety stock:  Z = 1.88 (from the standard normal table) ss =   Z LT (σd) Click to edit Master text styles Second level = (1.88)(2)(2) = 7.52 Third level Fourth level Fifth level 12-81 Reorder Point: Lead Time Uncertainty ROP = d × LT + zdσ LT where z = Number of standard deviations d = Demand per period (per day, per week) σ LT = The stddev of lead time (same time units as d ) LT = Average lead time (same time units as d ) σ dLT = dσ LT Note: If only lead time is variable, then Example: Page 598, Solved Problem Instructor Slides 13-82 Variable Demand and Lead Time Demand Rate: Random Variable Mean: d Standad Deviation:σ d Lead Time: Random Variable Mean: LT Standard Deviation: σ LT 12-83 Variable Demand and Lead Time Click to edit Master text styles ROPSecond = ( level d )( LT ) + Z LTσ 2 d + d σ LT Third level Fourth level Example: Solved problem 6, page 598 (text) Fifth level 12-84 Single-Period Model  Single-period model  Model for ordering of perishables and other items with limited useful lives  Shortage cost  Generally, the unrealized profit per unit  Cshortage = Cs = Revenue per unit – Cost per unit  Excess cost  Different between purchase cost and salvage value of items left over at the end of the period  Cexcess = Ce = Cost per unit – Salvage value per unit Instructor Slides 13-85 Single-Period Model  The goal of the single-period model is to identify the order quantity that will minimize the long-run excess and shortage costs  Two categories of problem:  Demand can be characterized by a continuous distribution  Demand can be characterized by a discrete distribution Instructor Slides 13-86 Stocking Levels Cs Service level = C s + Ce where C s = shortage cost per unit Ce = excesscost per unit Cs Ce Service level Quantity Instructor Slides So So =Optimum Balance Point Stocking Quantity 13-87 Single Period Model Single period model: model for ordering of perishables and other items with limited useful lives Shortage cost: generally the unrealized profits per unit Cs = Revenue per unit – Cost per unit Excess cost: difference between purchase cost and salvage value of items left over at the end of a period  Ce = Original cost per unit – Salvage value per unit 12-88 Single Period Model Continuous stocking levels  Identifies optimal stocking levels  Optimal stocking level balances unit shortage and excess cost  Examples 15 & 16; pages 589, 590 Discrete stocking levels  Service levels are discrete rather than continuous  Desired service level is equaled or exceeded  Examples 17 & 18; pages 591 & 592 12-89 Example 15 Ce = $0.20 per unit Cs = $0.60 per unit Service level = Cs/(Cs+Ce) = 6/(.6+.2) Service level = 75 Ce Cs Service Level = 75% Quantity Stockout risk = 1.00 – 0.75 = 0.25 12-90 Operations Strategy  Improving inventory processes can offer significant cost reduction and customer satisfaction benefits  Areas that may lead to improvement:  Record keeping  Records and data must be accurate and up-to-date  Variation reduction  Lead variation  Forecast errors  Lean operations  Supply chain management Instructor Slides 13-91 ... Customer complaints Inventory turnover Instructor Slides 13-6 Inventory Management Management has two basic functions concerning inventory: Establish a system for tracking items in inventory Make...  Maintenance and repairs (MRO) inventory  Goods-in-transit to warehouses or customers (pipeline inventory) Instructor Slides 13-4 Inventory Independent Demand Inventory: a stock or store of... classification system for inventory items 13-8 Inventory Counting Systems Periodic System Physical count of items in inventory made at periodic intervals Perpetual Inventory System  System