Inventory Management and Aggregate Planning ( discussion)

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SEU_MGT530_Module13_PPT_Ch13.pptx

Inventory Management

Chapter 13

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13-‹#›

You should be able to:

LO 13.1 Define the term inventory

LO 13.2 List the different types of inventory

LO 13.3 Describe the main functions of inventory

LO 13.4 Discuss the main requirements for effective management

LO 13.5 Explain periodic and perpetual review systems

LO 13.6 Describe the costs that are relevant for inventory management

LO 13.7 Describe the A-B-C approach and explain how it is useful

LO 13.8 Describe the basic EOQ model and its assumptions and solve typical problems

LO 13.9 Describe the economic production quantity model and solve typical problems

LO 13.10 Describe the quantity discount model and solve typical problems

LO 13.11 Describe reorder point models and solve typical problems

LO 13.12 Describe situations in which the fixed-order interval model is appropriate and solve typical problems

LO 13.12 Describe situations in which the single-period model is appropriate, and solve typical problems

Chapter 13: Learning Objectives

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Inventory

A stock or store of goods

Independent demand items

Items that are ready to be sold or used

Inventory

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

LO 13.1

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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

LO 13.2

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Inventories serve a number of functions such as:

To meet anticipated customer demand

To smooth production requirements

To decouple operations

To protect against stockouts

To take advantage of order cycles

To hedge against price increases

To permit operations

To take advantage of quantity discounts

Inventory Functions

LO 13.3

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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

Costs of ordering and carrying inventories

The overall objective of inventory management is to achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds

Measures of performance

Customer satisfaction

Number and quantity of backorders

Customer complaints

Inventory turnover

Objectives of Inventory Control

LO 13.3

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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

A classification system for inventory items

Effective Inventory Management

LO 13.4

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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 Counting Systems

LO 13.5

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Universal product code (UPC)

Bar code printed on a label that has information about the item to which it is attached

Radio frequency identification (RFID) tags

A technology that uses radio waves to identify objects, such as goods, in supply chains

Inventory Counting Technologies

LO 13.5

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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

Inventory Costs

LO 13.6

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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

LO 13.7

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Cycle Counting

Cycle counting

A physical count of items in inventory

Cycle counting management

How much accuracy is needed?

A items: ± 0.2 percent

B items: ± 1 percent

C items: ± 5 percent

When should cycle counting be performed?

Who should do it?

LO 13.7

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How Much to Order: EOQ Models

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

The basic economic order quantity model

The economic production quantity model

The quantity discount model

LO 13.8

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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

Basic EOQ Model

LO 13.8

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The Inventory Cycle

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

LO 13.8

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Total Annual Cost

LO 13.8

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Goal: Total Cost Minimization

Order Quantity (Q)

The Total-Cost Curve Is U-Shaped

Ordering Costs

QO

Annual Cost

(optimal order quantity)

Holding Costs

LO 13.8

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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.

Deriving EOQ

LO 13.8

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The batch mode is widely used in production. In certain instances, the capacity to produce a part exceeds its usage (demand rate).

Assumptions

Only one item 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

Economic Production Quantity (EPQ)

LO 13.9

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EPQ: Inventory Profile

Q

Qp

Imax

Production

and usage

Production

and usage

Production

and usage

Usage

only

Usage

only

Cumulative

production

Amount

on hand

Time

LO 13.9

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EPQ – Total Cost

LO 13.9

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EPQ

LO 13.9

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Quantity discount

Price reduction for larger orders offered to customers to induce them to buy in large quantities

Quantity Discount Model

LO 13.10

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Quantity Discounts

Adding PD does not change EOQ

LO 13.10

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Quantity Discounts (cont.)

The total-cost curve with quantity discounts is composed of a portion of the total-cost curve for each price

LO 13.10

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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

LO 13.11

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Reorder Point: Under Certainty

LO 13.11

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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

Reorder Point: Under Uncertainty

LO 13.11

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Safety Stock

LO 13.11

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As the amount of safety stock carried increases, the risk of stockout decreases.

This improves customer service level

Service level

The probability that demand will not exceed supply during lead time

Service level = 100% - stockout risk

Safety Stock?

LO 13.11

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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

How Much Safety Stock?

LO 13.11

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13-‹#›

Reorder Point

The ROP based on a normal

distribution of lead time demand

LO 13.11

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13-‹#›

Reorder Point: Demand Uncertainty

Note: If only demand is variable, then

LO 13.11

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13-‹#›

Reorder Point: Lead Time Uncertainty

Note: If only lead time is variable, then

LO 13.11

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13-‹#›

Fixed-order-interval (FOI) model

Orders are placed at fixed time intervals

Reasons for using the FOI model

Supplier’s policy may encourage its use

Grouping orders from the same supplier can produce savings in shipping costs

Some circumstances do not lend themselves to continuously monitoring inventory position

How Much to Order: FOI

LO 13.12

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13-‹#›

Fixed-Quantity vs. Fixed-Interval Ordering

Fixed Interval

Fixed Quantity

LO 13.12

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FOI Model

LO 13.12

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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

Single-Period Model

LO 13.13

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13-‹#›

Single-Period Model (cont.)

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

LO 13.13

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13-‹#›

Stocking Levels

LO 13.13

Service level

So

Balance Point

Quantity

Ce

Cs

So =Optimum

Stocking Quantity

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13-‹#›

order

per

cost

Ordering

year

per

units

in

usually

Demand,

year

per

usually

unit,

per

cost

(carrying)

Holding

units

in

quantity

Order

where

2

Cost

Ordering

Annual

Cost

Holding

Annual

Cost

Total

=

=

=

=

+

=

+

=

S

D

H

Q

S

Q

D

H

Q

S

Q

D

H

Q

TC

+

=

2

cost

holding

unit

per

annual

cost)

der

demand)(or

annual

(

2

2

O

=

=

H

DS

Q

(

)

rate

Usage

rate

delivery

or

Production

inventory

Maximum

where

2

Cost

Setup

Cost

Carrying

TC

max

max

min

=

=

-

=

=

+

÷

ø

ö

ç

è

æ

=

+

=

u

p

u

p

p

Q

I

S

Q

D

H

I

p

u

p

p

H

DS

Q

p

-

=

2

price

Unit

where

2

Cost

Purchasing

Cost

Ordering

Cost

Carrying

Cost

Total

=

+

+

=

+

+

=

P

PD

S

Q

D

H

Q

)

as

units

time

same

(in

time

Lead

LT

per week)

day,

per

period,

per

(units

rate

Demand

where

LT

ROP

d

d

d

=

=

´

=

Stock

Safety

time

lead

during

demand

Expected

ROP

+

=

demand

time

lead

of

deviation

standard

The

deviations

standard

of

Number

where

time

lead

during

demand

Expected

ROP

LT

LT

=

=

+

=

d

d

z

z

s

s

)

as

units

time

(same

time

Lead

LT

)

as

units

time

(same

period

per

demand

of

stdev.

The

per week)

day,

(per

period

per

demand

Average

deviations

standard

of

Number

where

LT

ROP

d

d

d

z

z

LT

d

d

d

=

=

=

=

+

´

=

s

s

LT

LT

d

d

s

s

=

)

as

units

time

(same

time

lead

Average

LT

)

as

units

time

(same

time

lead

of

stddev.

The

per week)

day,

(per

period

per

Demand

deviations

standard

of

Number

where

LT

ROP

LT

LT

d

d

d

z

zd

d

=

=

=

=

+

´

=

s

s

LT

LT

s

s

d

d

=

me

reorder ti

at

hand

on

Amount

orders)

between

time

of

(length

interval

Order

OI

where

LT

OI

LT)

OI

(

me

reorder ti

at

hand

on

Amount

stock

Safety

interval

protection

during

demand

Expected

Order

to

Amount

=

=

-

+

+

+

=

-

+

=

A

A

z

d

d

s

unit

per

cost

excess

unit

per

cost

shortage

where

level

Service

=

=

+

=

e

s

e

s

s

C

C

C

C

C