Chapter 12 Inventory Control and Management

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Chapter 12 – Inventory Control and Management

Islamic University of Gaza - Palestine

Learning Outcomes

• Describe the functions and costs of an inventory system. • Determine the order quantity and Economic Order Quantity. • Determine the reorder point and safety stock for inventory

systems with uncertain demand.

• Design a continuous or periodic review inventory-control

system.

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Lecture Outline

• Elements of Inventory Management • Inventory Control Systems

• Economic Order Quantity Models

• Order Quantity for a Periodic Inventory System

What Is Inventory?

• Stock of items kept to meet future demand • Purpose of inventory management

– how many units to order – when to order

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– Purchasing

– Production scheduling

– Efficient servicing of customer demands

Inventories provide flexibility for the firm in:

Types of Inventory

• Raw materials

• Purchased parts and supplies

• Work-in-process (partially completed) products (WIP) • Items being transported

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Role of Inventory in Services

• Decoupling inventories • Seasonal inventories • Speculative inventories • Cyclical inventories • In-transit inventories • Safety stocks

Objectives of inventory control

• Protection against fluctuations in demand; • Better use of men, machines and material; • Protection against fluctuations in output; • Control of stock volume;

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Considerations in Inventory Systems

• Type of customer demand • Planning time horizon • Replenishment lead time • Constraints and relevant costs

Relevant Inventory Costs

• Ordering costs

• Receiving and inspections costs • Holding or carrying costs

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How Much to Order?

• Forecast usage • Ordering cost • Carrying cost

Ordering can mean either the purchase or production of the Ordering can mean either the purchase or production of the

item item

..

The optimal quantity to order depends on:

When to Order?

Issues to consider:

Lead Time -- The length of time between the placement of an order for an inventory item and when the item is received in inventory.

Order Point -- The quantity to which inventory must fall in order to signal that an order must be placed to replenish an item.

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Inventory Management Questions

• What should be the order quantity (Q)?

• When should an order be placed, called a reorder point (ROP)?

• How much safety stock (SS) should be maintained?

Reorder Point

Level of inventory at which a new order is placed Level of inventory at which a new order is placed

R = dL

where

d = demand rate per period L = lead time

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Reorder Point: Example

Demand = 10,000 yards/year Store open 311 days/year

Daily demand = 10,000 / 311 = 32.154 yards/day Lead time = L = 10 days

R = dL = (32.154)(10) = 321.54 yards

Inventory Models

• Economic Order Quantity (EOQ) • Special Inventory Models

With Quantity Discounts Planned Shortages

• Demand Uncertainty - Safety Stocks • Inventory Control Systems

Continuous-Review (Q,r) Periodic-Review (order-up-to)

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Safety Stocks

Safety stock is inventory held at all times regardless of the quantity of inventory ordered using the EOQ model. Safety stock

buffer added to on hand inventory during lead time Stock out

an inventory shortage Service level

probability that the inventory available during lead time will meet demand

(other definition of safety stocks is the amount helds in reserve as a cushion against uncertain demand (or usage) and replenishment lead time.

Economic-Order-Quantity: Decision Model Assumptions

1. The same quantity is ordered at each reorder point. .

2. Demand, ordering costs, carrying costs, and purchase-order lead time are known with certainty.

3. Purchasing costs per unit are unaffected by the quantity ordered.

4. No stock outs occur.

5. Quality costs are considered only to the extent that these costs affect ordering costs or carrying costs.

6. The EOQ minimizes the relevant ordering costs and carrying costs.

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How Much Safety Stock?

• Amount of uncertainty in inventory demand

• Amount of uncertainty in the lead time

• Cost of running out of inventory

• Cost of carrying inventory Depends on the:

Economic Order Quantity (EOQ) Models

• EOQ

– optimal order quantity that will minimize total

inventory costs • Basic EOQ model

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Assumptions of Basic EOQ Model

• Demand is known with certainty and is constant over

time

• No shortages are allowed

• Lead time for the receipt of orders is constant • Order quantity is received all at once

Determining Order Quantities

Lot-for-lot

Order exactly what is needed

Fixed-order

quantity

Specifies the number of units to order

whenever an order is placed

Min-max

system

Places a replenishment order when the on-

hand inventory falls below the

predetermined minimum level.

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Periodic Review Systems

• Orders are placed at specified, fixed-time intervals (e.g.

every Friday), for a order size (Q) to bring on-hand inventory (OH) up to the target inventory (TI), similar to the min-max system.

• Advantages are:

– No need for a system to continuously monitor item – Items ordered from the same supplier can be reviewed

on the same day saving purchase order costs

• Disadvantages:

– Replenishment quantities (Q) vary

– Order quantities may not quality for quantity discounts – On the average, inventory levels will be higher than Q

systems-more stockroom space needed

Inventory Control Systems

• Continuous system

(fixed-order-quantity)

• constant amount ordered

when inventory declines to predetermined level

• Periodic system

(fixed-time-period)

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Inventory and Supply Chain Management

• Bullwhip effect

• (The bullwhip) effect (or whiplash effect) is an observed phenomenon in forecast-driven distribution channels. It refers to a trend of larger and larger swings in inventory in response to changes in demand, as one looks at firms further back in the supply chain for a product.)

– demand information is distorted (malformed) as it

moves away from the end-use customer

– higher safety stock inventories to are stored to

compensate

• Seasonal or cyclical demand

• Inventory provides independence from vendors • Take advantage of price discounts

• Inventory provides independence between stages and

avoids work stop-pages

Bullwhip effect

Illustration of the bullwhip effect: The final customer places an order (whip) and order fluctuations build up upstream the supply chain.

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Two Forms of Demand

Dependent

Demand for items used to produce final Demand for items used to produce final

products products

Tires stored at a Goodyear plant are an example of a dependent demand item

Independent

Demand for items used by external Demand for items used by external

customers customers

Cars, computers, and houses are examples of independent demand inventory

Inventory and Quality Management

• Customers usually perceive quality service as availability

of goods they want when they want them

• Inventory must be sufficient to provide high-quality

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Inventory Costs

Carrying cost: cost of holding an item in inventory Ordering cost: cost of refilling inventory

Shortage cost: temporary or permanent loss of sales when demand cannot be met

Appropriate Level of Inventories

Employ a cost-benefit analysis

Compare the benefits of economies of production, purchasing, and product marketing against the cost of the additional investment in inventories.

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Classifying Inventory Items

• ABC Classification (Pareto Principle)

• A Items: very tight control, complete and accurate

records, frequent review

• B Items: less tightly controlled, good records, regular

review

• C Items: simplest controls possible, minimal records,

large inventories, periodic review and reorder

ABC Method of Inventory Control

Method which controls expensive inventory items more closely than

less expensive items.

– Review “A” items

most frequently ABC method of ABC method of inventory control inventory control 70 70 90 90 100 100 C u m u la ti ve P e rc en tage C u m u la ti ve P e rc en tage o f I n ven to ry V a lue o f I n ven to ry V a lue

A

B

C

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ABC Classification

• Class A

– 5 – 15 % of units

– 70 – 80 % of value

• Class B

– 30 % of units

– 15 % of value

• Class C

– 50 – 60 % of units

– 5 – 10 % of value

ABC Classification: Example

1

1 $

$ 60

60

90

2

350

40

3

30

130

4

80

60

5

30

100

6

20

180

7

10

170

8

320

50

50 PART

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ABC Classification: Example (cont.)

Example Example 1010..11

1

1 $

$ 60

60

90

2

350

40

3

30

130

4

80

60

5

30

100

6

20

180

7

10

170

8

320

50

9

510

60

10

20

120

120 PART

PART

UNIT COST

ANNUAL USAGE

TOTAL % OF TOTAL % OF TOTAL

PART VALUE VALUE QUANTITY % CUMMULATIVE

9 $30,600 35.9 6.0 6.0 8 16,000 18.7 5.0 11.0 2 14,000 16.4 4.0 15.0 1 5,400 6.3 9.0 24.0 4 4,800 5.6 6.0 30.0 3 3,900 4.6 10.0 40.0 6 3,600 4.2 18.0 58.0 5 3,000 3.5 13.0 71.0 10 2,400 2.8 12.0 83.0 7 1,700 2.0 17.0 100.0 $85,400