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McGraw-Hill/IrwinCopyright 2010 by The McGraw-Hill Companies,Inc.All rights reserved.12Inventory ManagementLearning ObjectivesDefine the term inventory,list the major reasons for holding inventories,and list the main requirements for effective inventory management.Discuss the nature and importance of service inventoriesDiscuss periodic and perpetual review systems.Discuss the objectives of inventory management.Describe the A-B-C approach and explain how it is useful.2Learning ObjectivesDescribe the basic EOQ model and its assumptions and solve typical problems.Describe the economic production quantity model and solve typical problems.Describe the quantity discount model and solve typical problems.Describe reorder point models and solve typical problems.Describe situations in which the single-period model would be appropriate,and solve typical problems.3Independent DemandAB(4)C(2)D(2)E(1)D(3)F(2)Dependent DemandIndependent demand is uncertain.Dependent demand is certain.Inventory:a stock or store of goodsInventory4Inventory ModelsIndependent demand:finished goods,items that are ready to be soldE.g.a computerDependent demand:components of finished productsE.g.parts that make up the computer5Types of InventoriesRaw materials and purchased partsPartially completed goods called work-in-processFinished-goods inventories(manufacturing firms)or merchandise(retail stores)6Types of InventoriesReplacement parts,tools,and suppliesGoods-in-transit to warehouses or customers7Functions of InventoryTo meet anticipated demandTo smooth production requirementsTo decouple operationsTo protect against stockouts8Functions of InventoryTo take advantage of order cyclesTo help hedge against price increases To permit operationsTo take advantage of quantity discounts9Objective of Inventory ControlTo achieve satisfactory levels of customer service while keeping inventory costs within reasonable boundsLevel of customer serviceCosts of ordering and carrying inventoryInventory turnover is the ratio ofthe average cost of goods sold tothe average inventory investment.10A system to keep track of inventoryA reliable forecast of demandKnowledge of lead timesReasonable estimates ofHolding costsOrdering costsShortage costsA classification systemEffective Inventory Management11Inventory Counting SystemsPeriodic System Physical count of items made at periodic intervalsPerpetual Inventory System System that keeps track of removals from inventory continuously,thus monitoringcurrent levels of each item12Inventory Counting SystemsTwo-bin system:Two containers of inventory;reorder when the first is emptyUniversal Product Code(UPC):Bar code printed on a label that hasinformation about the item to which it is attached0214800 23208776813Lead time:time interval between ordering and receiving the orderHolding(carrying)costs:cost to carry an item in inventory for a length of time,usually a yearOrdering costs:costs of ordering and receiving inventoryShortage costs:costs when demand exceeds supplyKey Inventory Terms14ABC Classification System Classifying inventory according to some measure of importance and allocating control efforts accordingly.A-very importantB-moderately importantC-least importantFigure 12.1 Annual$value of itemsA AB BC CHighLowLowHighPercentage of Items15Cycle CountingA physical count of items in inventoryCycle counting managementHow much accuracy is needed?When should cycle counting be performed?Who should do it?16Economic order quantity(EOQ)modelThe order size that minimizes total annual costEconomic production modelQuantity discount modelEconomic Order Quantity Models17Only one product is involvedAnnual demand requirements knownDemand is even throughout the yearLead time does not varyEach order is received in a single deliveryThere are no quantity discountsAssumptions of EOQ Model18The Inventory CycleFigure 12.2Pro Inventory Level Over TimeQuantityon handQReceive orderPlaceorderReceive orderPlaceorderReceive orderLead timeReorderpointUsage rateTime19Total CostAnnualcarryingcostAnnualorderingcostTotal cost =+TC =Q2H DQS+20Cost Minimization GoalOrder Quantity(Q)The Total-Cost Curve is U-ShapedOrdering CostsQO Annual Cost(optimal order quantity)Figure 12.4C21Deriving the EOQUsing calculus,we take the derivative of the total cost function and set the derivative(slope)equal to zero and solve for Q.22Minimum Total CostThe total cost curve reaches its minimum where the carrying and ordering costs are equal.Q2H DQS=23Production done in batches or lotsCapacity to produce a part exceeds the parts usage or demand rateAssumptions of EPQ are similar to EOQ except orders are received incrementally during productionEconomic Production Quantity(EPQ)24Only one item is involvedAnnual demand is knownUsage rate is constantUsage occurs continuallyProduction rate is constantLead time does not varyNo quantity discountsEconomic Production Quantity Assumptions25Economic Run Size26Total Costs with Purchasing CostAnnualcarryingcostPurchasingcostTC =+Q2H DQSTC =+AnnualorderingcostPD+27Total Costs with PDCostEOQTC with PDTC without PDPD0QuantityAdding purchasing costdoesnt change EOQFigure 12.728Total Cost with Constant Carrying Costs OCEOQ Quantity Total CostTCaTCcTCb Decreasing PriceCC a,b,cFigure 12.929When to Reorder with EOQ OrderingReorder Point:When the quantity on hand of an item drops to this amount,the item is reorderedSafety Stock:Stock that is held in excess of expected demand due to variable demand rate and/or lead timeService Level:Probability that demand will not exceed supply during lead time30Determinants of the Reorder PointThe rate of demandThe lead timeDemand and/or lead time variabilityStockout risk(safety stock)31Safety StockFigure 12.12LTTimeExpected demandduring lead timeMaximum probable demandduring lead timeROPQuantitySafety stockSafety stock reduces risk ofstockout during lead time32Reorder PointFigure 12.13ROPRisk ofa stockoutService levelProbability ofno stockoutExpecteddemandSafetystock0zQuantityz-scaleThe ROP based on a normaldistribution of lead time demand33Orders are placed at fixed time intervalsOrder quantity for next interval?Suppliers might encourage fixed intervalsMay require only periodic checks of inventory levelsRisk of stockoutFill rate:the percentage of demand filled by the stock on handFixed-Order-Interval Model34Tight control of inventory itemsItems from same supplier may yield savings in:OrderingPackingShipping costsMay be practical when inventories cannot be closely monitoredFixed-Interval Benefits35Requires a larger safety stockIncreases carrying costCosts of periodic reviewsFixed-Interval Disadvantages36Single period model:model for ordering of perishables and other items with limited useful livesShortage cost:generally the unrealized profits per unitExcess cost:difference between purchase cost and salvage value of items left over at the end of a periodSingle Period Model37Continuous stocking levelsIdentifies optimal stocking levelsOptimal stocking level balances unit shortage and excess costDiscrete stocking levelsService levels are discrete rather than continuousDesired service level is matched or exceededSingle Period Model38Optimal Stocking LevelService LevelSoQuantityCeCsBalance pointService level=CsCs+CeCs=Shortage cost per unitCe=Excess cost per unit39Example 15Ce=$0.20 per unitCs=$0.60 per unitService level=Cs/(Cs+Ce)=.6/(.6+.2)Service level=.75Service Level=75%QuantityCeCsStockout risk=1.00 0.75=0.2540
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