Chapter 12 Inventory Management McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc All Rights Reserved Chapter 12: 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 – Discuss periodic and perpetual review systems – Discuss the objectives of inventory management – Describe the A-B-C approach – Describe the basic EOQ model and its assumptions and solve typical problems 12-2 Chapter 12: Learning Objectives (contd.) • You should be able to: – 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 – Describe situations in which the single-period model would be appropriate 12-3 Inventory • Inventory – A stock or store of goods • Independent demand items – Items that are ready to be sold or used 12-4 Inventory Costs • Holding (carrying) costs – Cost to carry an item in inventory for a length of time, usually a year • Ordering costs – Costs of ordering and receiving inventory • Shortage costs – Costs resulting when demand exceeds the supply of inventory; often unrealized profit per unit 12-5 Basic EOQ Model • The basic EOQ model is used to find a fixed order quantity that will minimize total annual inventory costs • Assumptions – Only one product is involved – Annual demand requirements are known – Demand is even throughout the year – Lead time does not vary – Each order is received in a single delivery – There are no quantity discounts 12-6 Deriving EOQ • Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q • The total cost curve reaches its minimum where the carrying and ordering costs are equal DS 2(annual demand)(order cost) Q   H annual per unit holding cost * 12-7 Economic Production Quantity (EPQ) • Assumptions – Only one product is involved – Annual demand requirements are known – Usage rate is constant – Usage occurs continually, but production occurs periodically – The production rate is constant – Lead time does not vary – There are no quantity discounts 12-8 EPQ DS Q  H * p p p u 12-9 When to Reorder • Reorder point – When the quantity on hand of an item drops to this amount, the item is reordered – Determinants of the reorder point The rate of demand The lead time The extent of demand and/or lead time variability The degree of stockout risk acceptable to management 12-10 Reorder Point: Under Certainty ROP d LT where d Demand rate (units per period, per day, per week) LT Lead time (in same time units as d ) 12-11 Reorder Point: Under Uncertainty • Demand or lead time uncertainty creates the possibility that demand will be greater than available supply • To reduce the likelihood of a stockout, it becomes necessary to carry safety stock – Safety stock • Stock that is held in excess of expected demand due to variable demand and/or lead time Expected demand ROP   Safety Stock during lead time 12-12 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   z dLT during lead time where z Number of standard deviations  dLT The standard deviation of lead time demand 12-13 Reorder Point: Demand Uncertainty ROP d  z d LT where z Number of standard deviations d Average demand per period (per day, per week)  d The stddev of demand per period (same time units as d ) LT Lead time (same time units as d ) Note :  dLT  d LT 12-14 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 12-15 ... Discuss the objectives of inventory management – Describe the A-B-C approach – Describe the basic EOQ model and its assumptions and solve typical problems 12- 2 Chapter 12: Learning Objectives (contd.).. .Chapter 12: 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. .. risk acceptable to management 12- 10 Reorder Point: Under Certainty ROP d LT where d Demand rate (units per period, per day, per week) LT Lead time (in same time units as d ) 12- 11 Reorder Point: