Ch15 inventory+control
- 2. Inv.Control - Objectives Introduction Purpose of Inventories Inventory Cost Structures Independent versus Dependent Demand Economic Order Quantity Continuous Review System Periodic Review System Using P and Q System in Practice Selective Inventory Control Systems
- 3. Introduction Inventory: a stock of materials used to facilitate production or to satisfy customer demand. Types of inventory – – – – Raw materials (RM) Work in process (WIP) Finished goods (FG) Maintenance, repair & operating supplies (MRO)
- 4. A Material-Flow Process Productive Process Work in process Vendors Raw Materials Work in process Work in process Finished Customer goods
- 5. A Water Tank Analogy for Inventory Inventory Level Supply Rate Inventory Level Demand Rate
- 6. Purpose of Inventories To protect against uncertainties – – – – in demand (finished goods, MRO) supply (RM, MRO) lead times (RM/PP or WIP) schedule changes (WIP) To allow economic production and purchase (as in discounts for buying RM/PP in bulk)
- 7. Purpose of Inventories (Contd.) To cover anticipated changes in demand (as in a level strategy) or supply – finished goods – RM/PP To provide for transit (pipeline inventories) – – – RM/PP finished goods WIP (independence of operations)
- 8. Inventory Cost Structures Ordering (or setup) cost – Paperwork, worker time (ordering) – worker time, downtime (setup) – Typically expressed as a fixed cost per order or setup.
- 9. Inventory Cost Structures(contd.) Carrying (or holding) cost: – Cost of capital (market rate or internal rate of return) – Cost of storage (building, utilities, insurance, handling) – Cost of obsolescence, deterioration, and loss (shrinkage) – Management cost (record keeping, counting) Typically expressed as a percentage of SKU cost. Average in INDIA is estimated to be 25 percent per year. Businesses often use only cost of capital (understatement).
- 10. Inventory Cost Structures(contd.) How the 25 percent carrying cost is distributed Cost of Capital—15 percent Obsolescence—2 percent Storage—5 percent Materials Handling—2 percent Shrinkage/pilferage—1 percent Insurance—1 percent
- 11. Inventory Cost Structures(contd.) Stock out Cost (Back order or Lost sales or Understocking Cost) – – – – record maintenance lost income customer dissatisfaction Typically expressed as a fixed cost per backorder or as a function of aging of backorders.
- 12. Inventory Cost Structures(contd.) Overstocking Cost ( Opportunity Loss Cost) - Cost incurred due to carrying Inventories excess to set norms
- 13. Forms of Demand Independent demand – – – – finished goods, spare parts, MRO based on market demand requires forecasting managed using ‘replenishment philosophy’, i.e. reorder when you reach a pre-specified level.
- 14. Forms of Demand(contd.) Dependent demand – parts that go into the finished products, RM/PP or WIP – dependent demand is a known function of independent demand – calculate instead of forecast – Managed using a ‘requirements philosophy’, i.e. only ordered as needed for higher level components or products.
- 15. Economic Order Quantity (EOQ) Developed in 1915 by F.W. Harris Answers the question ‘How much do I order?’ Used for independent demand items. Objective is to find order quantity (Q) that minimizes the total cost (TC) of managing inventory. Must be calculated separately for each SKU. Widely used and very robust (i.e. works well in a lot of situations, even when its assumptions don’t hold exactly).
- 16. Economic Order Quantity (EOQ) Basic Model Assumptions Demand rate is constant, recurring, and known. Lead time is constant and known. No stockouts allowed. Material is ordered or produced in a lot or batch and the lot is received all at once Costs are constant – – – Unit cost is constant (no quantity discounts) Carrying cost is a constant per unit (SKU) Ordering (setup) cost per order is fixed The item is a single product or SKU.
- 17. EOQ Lot Size Choice There is a trade-off between frequency of ordering (or the size of the order) and the inventory level. – Frequent orders (small lot size) lead to a lower average inventory size, i.e. higher ordering cost and lower holding cost. – Fewer orders (large lot size) lead to a larger average inventory size, i.e. lower ordering cost and higher holding cost.
- 18. Notations and measurement units in EOQ D = Demand rate, units per year S = Cost per order placed, or setup cost, Rupees per order C = Unit cost, Rupees per unit i = Carrying rate, percent of value per year Q = Lot size, units TC= total of ordering cost plus carrying cost
- 19. Cost Equations in EOQ Ordering cost = (cost per order) x orders per year) = SD/Q Carrying cost per year = (annual carrying rate) x (unit cost) x average inventory = iCQ/2 Total annual cost (TC) = ordering cost per year + carrying cost per year = SD/Q + iCQ/2
- 20. Total Cost of Inventory
- 21. TC and EOQ TC = ordering cost + holding cost = S*(D/Q) + iC*(Q/2) EOQ = Q = 2 SD iC note: Although we have used annual costs, any time period is all right. Just be consistent! The same is true for currency designations.
- 22. Continuous Review System Relax assumption of constant demand. Demand is assumed to be random. Check inventory position each time there is a demand (i.e continuously). If inventory position drops below the reorder point, place an order for the EOQ. Also called fixed-order-quantity or Q system (the fixed order size is EOQ).
- 23. A Continuous Review (Q) System R = Reorder Point Q = Order Quantity L = Lead time
- 24. A Continuous Review (Q) System Amount to order = EOQ Order when inventory position = reorder point. Reorder point = lead time * demand/period = R = lead time demand (when demand is constant) Reorder point is independent of EOQ! EOQ tells how much to order. Reorder point tells when to order.
- 25. Periodic Review System Instead of reviewing continuously, we review the inventory position at fixed intervals. For example, the bread truck visits the grocery store on the same days every week. Also known as “P system”, “Fixed-orderinterval system” or “Fixed-order-period system”
- 26. Periodic Review System (contd.) Each time we review the inventory, we either order or don’t. The decision depends upon our reorder point. The amount we order is the amount needed to bring us up to a target (T).
- 27. A Periodic Review (P) System
- 28. Using P and Q System in Practice Use P system when orders must be placed at specified intervals. Use P systems when multiple items are ordered from the same supplier (jointreplenishment). Use P system for inexpensive items.
- 29. Using P and Q Systems in Practice P may be easier to use since levels are reviewed less often. P requires more safety stock since may only order at fixed points. P is more likely to run out since cannot respond to increases in demand immediately Either may be more costly: P in safety stock, Q in monitoring cost.
- 30. FORMULAE – INVENTORY MANAGEMENT E.O.Q. = 2 X Annual Demand X Ordering cost Unit Price X Inv. Carr. Cost (%) Fixed order Qty model ( “Q” System) o Order Qty = E.O.Q. o Reorder Point = Average Daily Demand X Lead-time in days Total Annual Cost = Annual + Annual + Annual Purchase Ordering Inventory Cost Cost Carr. Cost (i.e. Annual Demand X Unit Cost)
- 31. o Safety Stock = Constant based X Std. deviation on Service level in demand Fixed order Qty model with safety stock o Reorder Point = (Average daily demand + Safety X lead-time in days) Stock Fixed – Time Period Model with Safety Stock (“P” System) o Safety stock = Constant based X on Service level * Where = * Std. deviation (during Review period + leadtime ) (R.P. + L.T.) X (Std. Dev.) 2
- 32. o Optimal Order Qty (Q) = Average Daily Demand X (Review Period +Leadtime) + (Plus) Safety Stocks – (minus) Current Inventory Status (Physical Stocks + Quantity on order)
- 33. Selective Inventory Control System Methods of classification:- Title Basis Main Use A-B-C Value of Consumption To control- raw material/ w.i.p/ components H-M-L (High-MedLow) Unit price of the material Mainly to control purchase X-Y-Z Value of items in storage To review the inventories & their uses at scheduled intervals V-E-D (vital/essen/ desirable Criticality of the component To determine stock levels of spare parts F-S-N (fast/slow/nonmoving) Consumption pattern of the component To control obsolescence S-D-E (scarce/diff/easy) Problems faced in procurement Lead-time analysis & purchasing strategy G-O-L-F (govt/open/local/fore ign) Source of materials Procurement strategies S-0-S (seasonal/ off seasonal) Nature of supplies Procurement stocking strategies for seasonal items like agricultural V-E-I-N (vital/ essen/ imp/normal) Plant &machinery Production Machinery & Services
- 34. Cumulative % of Annual consumption value A-B-C Analysis 100 Class ‘C’ 90 Class ‘B’ 65 Class ‘A’ 0 15 40 Cumulative % of Total number of items 100
- 35. ABC Inventory Management Based on “Pareto” concept (80/20 rule) and total usage in dollars of each item. Classification of items as A, B, or C based on usage. Purpose is to set priorities on effort used to manage different SKUs, i.e. to allocate scarce management resources.
- 36. ABC Inventory Management (contd.) ‘A’ items: 20% of SKUs, 80% of Ann.Con.Value ‘B’ items: 30 % of SKUs, 15% of Ann.Con.Value ‘C’ items: 50 % of SKUs, 5% of A.C.Value Three classes is arbitrary; could be any number. Percents are approximate. Danger: Consumption Value may not reflect importance of any given SKU!
- 37. Miscellaneous Systems: Bin Systems Two-Bin System Order One Bin of Inventory Full Empty One-Bin System Order Enough to Refill Bin Periodic Check
- 38. The Two-Bin System Q Re-order point shifts with usage First Bin Re-order Level Normal Lead-time Usage Time Second Bin O Lead-time Safety stock
- 39. Inventory Accuracy and Cycle Counting Inventory accuracy refers to how well the inventory records agree with physical count Cycle Counting is a physical inventory-taking technique in which inventory is counted on a frequent basis rather than once or twice a year
- 40. 40 Question Bowl The average cost of inventory in India is which of the following? a. 10 to 15 percent of its cost b. 15 to 20 percent of its cost c. 20 to 25 percent of its cost d. 25 to 30 percent of its cost e. 30 to 35 percent of its cost Answer: d. 25 to 30 percent of its cost
- 41. 41 Question Bowl a. b. c. d. e. Which of the following is a reason why firms keep a supply of inventory? To maintain independence of operations To meet variation in product demand To allow flexibility in production scheduling To take advantage of economic purchase order size All of the above Answer: e. All of the above (Also can include to provide a safeguard for variation in raw material delivery time.)
- 42. 42 Question Bowl An Inventory System should include policies that are related to which of the following? a. How large inventory purchase orders should be b. Monitoring levels of inventory c. Stating when stock should be replenished d. All of the above e. None of the above Answer: d. All of the above
- 43. 43 Question Bowl Which of the following is an Inventory Cost item that is related to the managerial and clerical costs to prepare a purchase or production order? a. Holding costs b. Setup costs c. Carrying costs d. Shortage costs e. None of the above Answer: e. None of the above (Correct answer is Ordering Costs.)
- 44. 44 Question Bowl Which of the following is considered a Independent Demand inventory item? a. Bolts to a automobile manufacturer b. Timber to a home builder c. Windows to a home builder d. Containers of milk to a grocery store e. None of the above Answer: d. Containers of milk to a grocery store
- 45. 45 Question Bowl If you are marketing a more expensive independent demand inventory item, which inventory model should you use? a. Fixed-time period model b. Fixed-order quantity model c. Periodic system d. Periodic review system e. P-model Answer: b. Fixed-order quantity model
- 46. 46 Question Bowl If the annual demand for an inventory item is 5,000 units, the ordering costs are Rs100 per order, and the cost of holding a unit is stock for a year is Rs10, which of the following is approximately the Qopt? a. b. c. d. e. 5,000 units Rs5,000 500 units 316 units None of the above Answer: d. 316 units (Sqrt[(2x5000x1 00)/10=316.227 7)
- 47. 47 Question Bowl The basic logic behind the ABC Classification system for inventory management is which of the following? a. Two-bin logic b. One-bin logic c. Pareto principle d. All of the above e. None of the above Answer: c. Pareto principle
- 48. 48 Question Bowl a. b. c. d. e. A physical inventory-taking technique in which inventory is counted frequently rather than once or twice a year is which of the following? Cycle counting Mathematical programming Pareto principle ABC classification Stockkeeping unit (SKU) Answer: a. Cycle counting
- 49. 49 Solved Problems – OPERATIONS MANAGEMENT (Class of 2010) Q1. A supplier is offering stainless steel bars at Rs 95 per kg for order of upto 100kg each, and at Rs 80 per kg for orders of 101kg and above. Your annual requirement is 1200kg. If your ordering cost is Rs 300 per order, and holding cost is 20%, what would be the most economical quantity to order? (10 Marks) Answer. E.O.Q(1) = √2 × Annual Demand × Ordering Cost √Unit Cost × Holding Cost E.O.Q = √2 × 1200 × 300 √95 × 0.20 E.O.Q = 195 units E.O.Q(2) = √2 × 1200 × 300 √80 × 0.20 = 212 units
- 50. 50 Now, E.O.Q (1), i.e. 195 units does not fall in the category of upto 100kg Therefore here consider it’s optimum E.O.Q as 100 units so that it falls under the category of Rs 95 per kg Now, find the Total Cost For 100 units • Ordering Cost = 1200 × 300 = Rs 3600/100 • Purchase Cost = 1200 × 95 = Rs 1,14,000/• Holding Cost = 100 × 0.2 × 95 = Rs 950/Therefore Total Cost = Rs 1,18,550/- For 212 units • Ordering Cost = 1200 × 300 = Rs 1698/212 • Purchase Cost = 1200 × 80 = Rs 96,000/-
- 51. 51 • Holding Cost = 212 × 0.2 × 80 = Rs 1696/2 Therefore Total Cost = Rs 99,394/Therefore most Economic Order Quantity to order is 212 kgs