operations managnment

Operations Management MGT 320

CHAPTER 13

Inventory Management

Sections 13.1 to 13.5 (basic EOQ)

• 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)

Types of Inventory (Refer pg. 552)

13-3

Functions of Inventory Control (Refer pg. 553)

• To meet customer demand

• To smooth production

• To decouple operations

• To protect against stock outs

• To produce economically

• To hedge against price increase

Objectives of Inventory Control (Refer pg. 554)

• To achieve satisfactory levels of customer service by keeping the costs low

• Inventory Management: 1. Establish a system for tracking items in inventory

2. Make decisions about • When to order

• How much to order

Requirements for Effective Inventory Management (Refer pg. 555) 1. A system to keep track of inventory

2. A reliable forecast of demand

3. Knowledge of lead time and lead time variability

4. Reasonable estimates of

• holding costs

• ordering costs

• shortage costs

5. A classification system for inventory items

Inventory Counting Systems (Refer pg. 555)

 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

Inventory Costs (Refer pg. 557)

 Purchase cost  The amount paid to buy the inventory

 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

 Setup costs  The costs involved in preparing equipment for a job  Analogous to ordering costs

 Shortage costs  Costs resulting when demand exceeds the supply of inventory; often unrealized profit

per unit

ABC Classification System (Refer pg. 558)

• A-B-C approach • Classifying inventory according to some measure of importance, and allocating control efforts

accordingly

• A items (very important)

• 10 to 20 percent of the number of items in inventory and about 60 to 70 percent of the annual dollar value

• B items (moderately important)

• C items (least important)

• 50 to 60 percent of the number

of items in inventory but only

about 10 to 15 percent of the

annual dollar value

ABC Classification System (Refer pg. 559)

How Much to Order: EOQ Models (Refer pg. 561)

Economic order quantity models identify the optimal order quantity by minimizing the sum of annual costs that vary with order size and frequency

1. The basic economic order quantity model

2. The economic production quantity model

3. The quantity discount model

Basic EOQ Model (Refer pg. 561)

The basic EOQ model is used to find a fixed order quantity that will minimize total annual inventory costs

Assumptions: 1. Only one product is involved

2. Annual demand requirements are known

3. Demand is even throughout the year

4. Lead time does not vary

5. Each order is received in a single delivery

6. There are no quantity discounts

The Inventory Cycle (Refer pg. 562)

Profile of Inventory Level Over Time

Quantity

on hand

Q

Receive

order

Place

order Receive

order Place

order

Receive

order

Lead time

Reorder

point

Usage

rate

Time

Total Annual Cost (Refer pg. 563)

orderper cost Ordering

yearper unitsin usually Demand,

yearper usually unit,per cost (carrying) Holding

unitsin quantity Order

where

2

Cost Ordering AnnualCost Holding AnnualCost Total













S

D

H

Q

S Q

D H

Q

Total Cost Minimization (Refer pg. 563)

Order Quantity

(Q)

The Total-Cost Curve is U-Shaped

Ordering Costs

QO

A n

n u

a l

C o

s t

(optimal order quantity)

Holding Costs

S Q

D H

Q TC 

2

Finding EOQ (Refer pg. 564)

The total cost curve reaches its minimum where the carrying and ordering costs are equal.

H

DS Q

2 O 

yearper usually unit,per cost carrying)(or Holding

orderper cost Ordering

yearper unitsin usually Demand,

units)(in Quantity Ordering Economic O









H

S

D

Q

Example (pg.564)

A tire company expects to sell approximately 9600 tires in a year. Annual carrying cost for one tire is estimated to be $16. the cost for the company to process each order is estimated to be $75. (288 working days)

• In what quantities should they order?

• How many times should they order in a year?

• What is the length of the order cycle?

• What is the total inventory cost not including the cost of the tires?

Example 2

A tire company expects to sell approximately 900 tires in a month. Annual carrying cost for one tire is estimated to be $15. the cost for the company to process each order is estimated to be $80. The lead time for delivery is (4) days.

• a) What is the Economic Ordering Quantity (EOQ)?

• b) How many times in a year should she reorder based on EOQ?

• c) What is the length of an order cycle?

• d) What is the reorder point (ROP)? (assume 365 days in a year)

• e) What will be the total inventory cost if the items are ordered based on EOQ?