Operations Management (opm530) C9 Inventory Management

Operations Management Inventory Management Chapter 9 Prepared by: Shatina Saad @ FPP

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Outline ♦ Functions Of Inventory ♦

Types Of Inventory

♦ Inventory Management ABC Analysis ♦ Record Accuracy ♦ Cycle Counting ♦ Control of Service Inventories ♦

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Outline - Continued ♦ Inventory Models Independent Versus Dependent Demand ♦ Holding, Ordering, And Setup Costs ♦

♦ Inventory Models For Independent Demand Basic Economic Order Quantity (EOQ) Model ♦ Minimizing Costs ♦ Reorder Points ♦ by: Shatina Saad @ Order Quantity Model PreparedProduction 9-3 FPP ♦ Quantity Discount Models ♦

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Learning Objectives When you complete this chapter, you should be able to : Identify or Define: ABC analysis ♦ Record accuracy ♦ Cycle counting ♦ Independent and dependent demand ♦ Holding, Ordering, and Setup Costs ♦

Describe or Explain: The functions of inventory and Preparedbasic by: Shatina Saad @ inventory models 9-4 FPP ♦

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What is Inventory? ♦ Stock of materials ♦ Stored capacity ♦ Examples

© 1995 Corel Corp.

© 1984-1994 T/Maker Co.

© 1984-1994 T/Maker Co.

© 1995 Corel Corp.

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The Functions of Inventory ♦ To ”decouple” or separate various parts of the production process ♦ To provide a stock of goods that will provide a “selection” for customers ♦ To take advantage of quantity discounts ♦ To hedge against inflation and upward price changes

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Types of Inventory ♦ Raw material (RM) ♦ Work-in-progress (WIP) ♦ Maintenance/repair/operating supply (MRO) ♦ Finished goods (FG)

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Disadvantages of Inventory ♦ Higher costs ♦

Item cost (if purchased) ♦ Ordering (or setup) cost ♦

♦

Costs of forms, clerks’ wages etc.

Holding (or carrying) cost ♦

Building lease, insurance, taxes etc.

♦ Difficult to control ♦ Hides production problems

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Inventory Classifications Inventory

Proces s stage

Numb er & Value

Raw A Material Items WIP B Finished Items Goods C Prepared by: Shatina Saad @ FPP Items

© 19841994 T/Maker Co.

Dema nd Type Independ ent Depende nt 9-9

Other

Maintena nce Operating OPM 533

The Material Flow Cycle Other

Wait Time

Input

Move Time

Q ueu e T ime Cycle Time

Setup Time

Run Time Output

1 Run time: Job is at machine and being worked on 2 Setup time: Job is at the work station, and the work station is being "setup." 3 Queue time: Job is where it should be, but is not being processed because other work precedes it. 4 Move time: The time a job spends in transit 5 Wait time: When one process is finished, but the job is waiting to be moved to the next work area. 6 Other: "Just-in-case" inventory. Prepared by: Shatina Saad @ FPP

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ABC Analysis ♦ Divides on-hand inventory into 3 classes ♦

A class, B class, C class

♦ Basis is usually annual $ volume ♦

$ volume = Annual demand x Unit cost

♦ Policies based on ABC analysis ♦ ♦ ♦

Develop class A suppliers more Give tighter physical control of A items Forecast A items more carefully

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Classifying Items as ABC

Class % $ Vol % Items A 80 15 B 15 30 C 5 55

% Annual $ Usage 100 80 60

A

40

B

20

C

0 0

50

100

% of Inventory Items

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Cycle Counting ♦ Physically counting a sample of total inventory on a regular basis ♦ Used often with ABC classification ♦

A items counted most often (e.g., daily)

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Advantages of Cycle Counting

♦ Eliminates shutdown and interruption of production necessary for annual physical inventories ♦ Eliminates annual inventory adjustments ♦ Provides trained personnel to audit the accuracy of inventory ♦ Allows the cause of errors to be identified and remedial action to be taken ♦ Maintains accurate inventory records Prepared by: Shatina Saad @ FPP

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Techniques for Controlling Service Inventory Include: ♦ Good personnel selection, training, and discipline ♦ Tight control of incoming shipments ♦ Effective control of all goods leaving the facility

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Independent versus Dependent Demand ♦ Independent demand - demand for item is independent of demand for any other item ♦ Dependent demand - demand for item is dependent upon the demand for some other item

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Inventory Costs ♦ Holding costs - associated with holding or “carrying” inventory over time; e.g. obsolescence, insurance, extra staffing, interest, pilferage, damage, warehousing, etc. ♦ Ordering costs - associated with costs of placing order and receiving goods; eg. Supplies, forms, order processing, clerical support, etc. ♦ Setup costs - cost to prepare a machine or process for manufacturing an order; e.g. cleanup costs, re-tooling costs, adjustment costs, etc.

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Inventory Holding Costs (Approximate Ranges) Category Housing costs (building rent, depreciation, operating cost, taxes, insurance)

Cost as a % of Inventory Value 6% (3 - 10%)

Material handling costs (equipment, lease or depreciation, power, operating cost)

3% (1 - 3.5%)

Labor cost from extra handling

11% (6 - 24%)

3% (3 - 5%)

Investment costs (borrowing costs, taxes, and insurance on inventory) Pilferage, scrap, and Prepared by: Shatina Saad @ obsolescence FPP

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3% (2 - 5%) 26% OPM 533

Inventory Models ♦ Fixed order-quantity models ♦

Economic order quantity ♦ Production order quantity ♦ Quantity discount

Help answer the inventory planning questions!

♦ Probabilistic models ♦ Fixed order-period models

© 1984-1994 T/Maker Co.

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1. EOQ Assumptions ♦ Known and constant demand ♦ Known and constant lead time ♦ Instantaneous receipt of material ♦ No quantity discounts ♦ Only order (setup) cost and holding cost ♦ No stockouts

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Inventory Usage Over Time Usage Rate

Inventory Level

Order quantity =Q (maximum inventory level)

Minimum inventor 0 y

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Average Inventory (Q*/2)

Time 9-21

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EOQ Model How Much to Order? Annual Cost r ve u C st o e C v r l a u Tot tC s o C g n ldi o H

Minimu m total cost

Order (Setup) Cost Curve Optimal Order Quantity (Q*) Prepared by: Shatina Saad @ FPP

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Order quantity OPM 533

Why Holding Costs Increase

♦ More units must be stored if more are ordered

Purchase Order Descriptio Qty. n Microwave 1

Purchase Order Descriptio Qty. n Microwave 1000

Order quantity

Order quantity Prepared by: Shatina Saad @ FPP

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Why Order Costs Decrease Cost is spread over more units Example: You need 1000 microwave ovens 1 Order (Postage $ 0.33)

1000 Orders (Postage $330) PurchaseOrder Order Purchase Purchase Order Descriptio Qty. Purchase Order Descriptio Qty. Descriptio Qty.1 n Microwave Description Qty. n Microwave 1 n Microwave 1 Microwave 1

Purchase Order Description Qty. Microwave 1000

Order quantity Prepared by: Shatina Saad @ FPP

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Deriving an EOQ 1. Develop an expression for setup or ordering costs 2. Develop an expression for holding cost 3. Set setup cost equal to holding cost 4. Solve the resulting equation for the best order quantity

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EOQ Model Equations

× × Optimal Order Quantity=Q* = 2 D S H

xpected Number of Orders =N =

D Q*

Working Days /Year xpected Time Between Orders =T =

N

d=

D

Working Days /Year

ROP = d × L

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D = Demand per year S = Setup (order) cost per order H = Holding (carrying) cost d = Demand per day L = Lead time in days OPM 533 9-26

The Reorder Point (ROP) Curve Q*

Inventory level (units)

Slope = units/day =d

ROP (Unit s)

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Lead time =L

Time (days) OPM 533

2. Production Order Quantity Model ♦ Answers how much to order and when to order ♦ Allows partial receipt of material ♦

Other EOQ assumptions apply

♦ Suited for production environment ♦

Material produced, used immediately ♦ Provides production lot size

♦ Lower holding cost than EOQ model Prepared by: Shatina Saad @ FPP

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Reasons for Variability in Production Most variability is caused by waste or by poor management. Specific causes include: employees, machines, and suppliers produce units that do not conform to standards, are late or are not the proper quantity ❑ inaccurate engineering drawings or specifications ❑ production personnel try to produce before drawings or specifications are complete ❑ customer demands are unknown ❑

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POQ Model Inventory Levels

Inventory Level

Production portion of cycle Demand portion of cycle with no supply

Time

Supply Supply Begins Ends Prepared by: Shatina Saad @ FPP

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POQ Model Inventory Levels Inventory Level Inventory level with no demand

Production Portion of Cycle

Q*

Supply Supply Begins Ends Prepared by: Shatina Saad @ FPP

Max. Inventory Q·(1- d/p)

Demand portion of cycle with no supply 9-31

Time

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POQ Model Equations

Optimal Order Quantity

= Q* p

Maximum inventory level = Q* Setup Cost =

D Q

=

( ) 1-

p

( )

0.5 * H * Q 1 Holding Cost =

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d

p

( )

d

*S

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2*D*S d H* 1p

D = Demand per year S = Setup cost H = Holding cost d = Demand per day OPM 533 p = Production

3. Quantity Discount Model

♦ Answers how much to order & when to order ♦ Allows quantity discounts ♦ ♦

Reduced price when item is purchased in larger quantities Other EOQ assumptions apply

♦ Trade-off is between lower price & increased holding cost

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Quantity Discount Schedule Disco unt Numb 1 er 2 3

Discount Quantity

Discoun t (%)

Discount Price (P)

0 to 999

No discount 4

$5.00

5

$4.75

1,000 to 1,999 2,000 and over

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$4.80

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Quantity Discount – How Much to Order

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