Chapter 12.pptx of operations management

13-1
Inventory
Management
Chapter 13
Copyright ©2021 McGraw-Hill Higher Education. All rights reserved. No
reproduction or distribution without the prior written consent of McGraw-Hill
Education

13-2
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
Copyright ©2021 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the
prior written consent of McGraw-Hill Education

13-3
 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
Copyright ©2021 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution
without the prior written consent of McGraw-Hill Education

13-4
 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

13-5
 Inventories serve a number of functions such as:
1. To meet anticipated customer demand
2. To smooth production requirements
3. To decouple operations
4. To protect against stockouts
5. To take advantage of order cycles
6. To hedge against price increases
7. To permit operations
8. To take advantage of quantity discounts
Inventory Functions
LO 13.3

13-6
 Inventory management has two main concerns:
1. Level of customer service
 Having the right goods available in the right quantity in
the right place at the right time
2. 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
1. Measures of performance
2. Customer satisfaction
 Number and quantity of backorders
 Customer complaints
3. Inventory turnover
Objectives of Inventory Control
LO 13.3

13-7
 Requires:
1. A system 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
Effective Inventory Management
LO 13.4
Copyright ©2021 McGraw-Hill Higher Education. All rights reserved. No reproduction or
distribution without the prior written consent of McGraw-Hill Education

13-8
 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

13-9
 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

13-10
 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 Copyright ©2021 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution

13-11
 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

13-12
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

13-13
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
1. The basic economic order quantity model
2. The economic production quantity model
3. The quantity discount model
LO 13.8

13-14
 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
Basic EOQ Model
LO 13.8 Copyright ©2021 McGraw-Hill Higher Education. All rights reserved. No reproduction or

13-15
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

13-16
Total Annual Cost
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
LO 13.8

13-17
Goal: Total Cost Minimization
Order Quantity
(Q)
The Total-Cost Curve Is U-Shaped
Ordering Costs
QO
Annual
Cost
(optimal order quantity)
Holding Costs
S
Q
D
H
Q
TC 

2
LO 13.8

13-18
 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
cost
holding
unit
per
annual
cost)
der
demand)(or
annual
(
2
2
O 

H
DS
Q
LO 13.8

13-19
 The batch mode is widely used in production. In
certain instances, the capacity to produce a part
exceeds its usage (demand rate).
 Assumptions
1. Only one item is involved
2. Annual demand requirements are known
3. Usage rate is constant
4. Usage occurs continually, but production occurs periodically
5. The production rate is constant
6. Lead time does not vary
7. There are no quantity discounts
Economic Production Quantity (EPQ)
LO 13.9

13-20
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

13-21
 
rate
Usage
rate
delivery
or
Production
inventory
Maximum
where
2
Cost
Setup
Cost
Carrying
TC
max
max
min















u
p
u
p
p
Q
I
S
Q
D
H
I
p
EPQ – Total Cost
LO 13.9 Copyright ©2021 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution

13-22
EPQ
u
p
p
H
DS
Qp


2

13-23
 Quantity discount
 Price reduction for larger orders offered to
customers to induce them to buy in large
quantities
Quantity Discount Model
price
Unit
where
2
Cost
Purchasing
Cost
Ordering
Cost
Carrying
Cost
Total







P
PD
S
Q
D
H
Q
LO
13.10

13-24
Quantity Discounts
Adding PD does not change EOQ
LO
13.10

13-25
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

13-26
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
1. The rate of demand
2. The lead time
3. The extent of demand and/or lead time variability
4. The degree of stockout risk acceptable to management
LO
13.11

13-27
)
as
units
time
same
(in
time
Lead
LT
per week)
day,
per
period,
per
(units
rate
Demand
where
LT
ROP
d
d
d




Reorder Point: Under Certainty
LO
13.11

13-28
 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
Stock
Safety
time
lead
during
demand
Expected
ROP 

LO
13.11

13-29
Safety Stock
LO
13.11

13-30
 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

13-31
 The amount of safety stock that is appropriate
for a given situation depends upon:
1. The average demand rate and average lead time
2. Demand and lead time variability
3. The desired service level
How Much Safety Stock?
demand
time
lead
of
deviation
standard
The
deviations
standard
of
Number
where
time
lead
during
demand
Expected
ROP
LT
LT




d
d
z
z


LO
13.11

13-32
Reorder Point
The ROP based
on a normal
distribution of lead
time demand
LO
13.11

13-33
Reorder Point: Demand Uncertainty
)
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









LT
LT d
d 
 
Note: If only demand is variable, then
LO
13.11

13-34
Reorder Point: Lead Time Uncertainty
)
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









LT
LT 
 d
d 
Note: If only lead time is variable, then
LO
13.11

13-35
 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

13-36
Fixed-Quantity vs.
Fixed-Interval Ordering
Fixed Interval
Fixed Quantity
LO
13.12

13-37
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

FOI Model
LO
13.12

13-38
 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

13-39
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

13-40
Stocking Levels
unit
per
cost
excess
unit
per
cost
shortage
where
level
Service




e
s
e
s
s
C
C
C
C
C
LO
13.13
Service level
So
Balance Point
Quantity
Ce Cs
So =Optimum
Stocking Quantity

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