Inventory

Inventory - I
● Items from last class
● What is inventory
● Inventory Video
● Inventory Cost Structure
● Basic Ideas for Managing Independent
Demand Inventory
Economic Order Quantity Exercise

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 Inventory Definition

● A stock of items held to meet

future demand

● Question: Goods vs Services?

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 Types of Inventory

Inputs Process Outputs

• Raw Materials • Finished Goods
• Purchased parts • Scrap and Waste
• Maintenance and
Repair Materials (in warehouses, or
“in transit”)
In Process
• Partially Completed
Products and (often on the
Subassemblies factory floor)
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 Types of Inventory

Work in
process

Vendors Raw Work in Finished Customer

Materials process goods
Work in
process

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 Water Tank Analogy for Inventory

Inventory Level
Supply Rate

Buffers Demand
Inventory Level Rate from Supply
Rate

Demand Rate
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 Independent and Dependent Demand
Inventory
● Independent demand
– items demanded by external customers
(Kitchen Tables)
● Dependent demand
– items used to produce final products (table
top, legs, hardware, paint, etc.)
– Demand determined once we know the type
and number of final products

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 Independent and Dependent Demand
Inventory Management
● Independent demand
– Uncertain / forecasted
– Continuous Review / Periodic Review
● Dependent demand
– “Requirements” / planned
– Materials Requirements Planning / Just in
Time

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 Reasons To Hold Inventory
● Meet variations in customer demand:
Meet unexpected demand
Smooth seasonal or cyclical demand
● Pricing related:
Temporary price discounts
Hedge against price increases
Take advantage of quantity discounts
● Process & supply surprises
Internal – upsets in parts of or our own processes
External – delays in incoming goods
● Transit

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 Reasons To NOT Hold Inventory
● Carrying cost
Financially calculable
● Takes up valuable factory space
Especially for in-process inventory
● Inventory covers up “problems” …
That are best exposed and solved

Driver for increasing inventory turns (finished

goods) and lean production/Just in time for work in
process

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 Inventory Hides Problems

Bad
Design
Lengthy Poor
Setups Quality
Machine
Inefficient Unreliable
Breakdown
Layout Supplier

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 To Expose Problems:
Reduce Inventory Levels

Bad
Design
Lengthy Poor
Setups Quality
Machine
Inefficient Unreliable
Breakdown
Layout Supplier

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 Remove Sources of Problems
and Repeat the Process

Poor
Quality

Lengthy
Setups

Bad
Machine
Design Inefficient Unreliable
Breakdown
Layout Supplier

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 Video
● Inventory concepts that occur in the
textbook supply chain
● Watch for:

Difference between independent and

dependent demand inventory
“How much and when” to order

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 Inventory Cost Structures
● Ordering (or setup) cost
● Carrying (or holding) cost:
Cost of capital
Cost of storage
Cost of obsolescence, deterioration, and loss
● Stock out cost
● Item costs, shipping costs and other cost subject
to volume discounts

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 Typical Inventory Carrying Costs
Costs as % of
Inventory Value
Housing cost: 6%
Building rent or depreciation (3% - 10%)
Building operating cost
Taxes on building
Insurance 3%
(1% - 4%)
Material handling costs:
Equipment, lease, or depreciation
Power 3%
Equipment operating cost (3% - 5%)
10%
Manpower cost from extra handling and supervision (6% - 24%)

Investment costs: 5%
Borrowing costs (2% - 10%)
Taxes on inventory (15% - 50%)
Insurance on inventory
Pilferage, scrap, and obsolescence

Overall carrying cost

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 Inventory Management Systems

● Functions of Inventory Management

– Track inventory
– How much to order
– When to order
● Prioritization
● Inventory Management Approach
– EOQ
– Continuous / Periodic

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 ABC Prioritization
● Based on “Pareto” concept (80/20 rule)
and total usage in dollars of each item.
● Classification of items as A, B, or C often
based on $ volume.
● Purpose: set priorities for management
attention.

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 ABC Prioritization
● ‘A’ items: 20% of SKUs, 80% of dollars
● ‘B’ items: 30 % of SKUs, 15% of dollars
● ‘C’ items: 50 % of SKUs, 5% of dollars
● Three classes is arbitrary; could be any
number.
● Percents are approximate.
● Danger: dollar use may not reflect
importance of any given SKU!

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 ABC Analysis Example
+Class C
100 — +Class B
90 —
Percentage of dollar value Class A
80 —

70 —

60 —

50 —

40 —

30 —

20 —

10 —

0—
10 20 30 40 50 60 70 80 90 100
Percentage of items
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 Annual Usage of Items by Dollar Value
Percentageof
Annual Usagein Total Dollar
Item Units Unit Cost Dollar Usage Usage
1 5,000 $ 1.50 $ 7,500 2.9%
2 1,500 8.00 12,000 4.7%
3 10,000 10.50 105,000 41.2%
4 6,000 2.00 12,000 4.7%
5 7,500 0.50 3,750 1.5%
6 6,000 13.60 81,600 32.0%
7 5,000 0.75 3,750 1.5%
8 4,500 1.25 5,625 2.2%
9 7,000 2.50 17,500 6.9%
10 3,000 2.00 6,000 2.4%
Total $ 254,725 100.0%

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 ABC Chart For Previous Slide
45.0% 120.0%
40.0%
100.0%

Cumulative % Usage
35.0%
A B C
Percent Usage

30.0% 80.0%
25.0%
60.0%
20.0%
15.0% 40.0%
10.0%
20.0%
5.0%
0.0% 0.0%
3 6 9 2 4 1 10 8 5 7

Item No.

Percentage of Total Dollar Usage Cumulative Percentage

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 Inventory Management Approaches
● A-items
– Track carefully (e.g. continuous review)
– Sophisticated forecasting to assure
correct levels
● C-items
– Track less frequently (e.g. periodic review)
– Accept risks of too much or too little
(depending on the item)

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 Economic Order Quantity (EOQ)
Model
● Demand rate D is constant, recurring, and known
● Amount in inventory is known at all times
● Ordering (setup) cost S per order is fixed
● Lead time L is constant and known.
● Unit cost C is constant (no quantity discounts)
● Annual carrying cost is i time the average $ value of the
inventory
● No stockouts allowed.
● Material is ordered or produced in a lot or batch and the
lot is received all at once

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 EOQ Lot Size Choice
● There is a trade-off between lot size and
inventory level.
Frequent orders (small lot size): higher
ordering cost and lower holding cost.
Fewer orders (large lot size): lower ordering
cost and higher holding cost.

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 EOQ Inventory Order Cycle
Demand
Order qty, Q
rate
Inventory
Level

ave = Q/2

Reorder point, R

0 Lead Lead Time

time time
As Q increases, average Order Order Order Order
inventory level increases, but
number of orders placed Placed Received Placed Received
decreases
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 Total Cost of Inventory – EOQ Model

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 Answer to Inventory Management
Questions for EOQ Model

Keeping track of inventory

Implied that we track continuously
How much to order?
Solve for when the derivative of total cost with respect
to Q = 0: -SD/Q^2 + iC/2 = 0
Q = sqrt ( 2SD/iC)
When to order?
Order when inventory falls to the “Reorder Point-level” R
so we will just sell the last item as the new order
comes in:
R = DL

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 Re-order Point Example
Demand = 10,000 yds/year

Lead time = L = 10 days

When inventory falls to R, we order so as not

to run out before the new order comes in.
R=?

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 Re-order Point Example
Demand = 10,000 yds/year
Daily demand = 10,000 / 365 = 27.4 yds/day
Lead time = L = 10 days

R = D*L = (27.4)(10) = 274 yds

(usually can neglect issues of working days vs
weekends, etc.)

Don’t forget to convert to consistent time units!

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 EOQ Summary
How much to order?
Q = sqrt(2DS/iC)

When to order?
R = DL

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 EOQ Exercise
● Now you do it
● See Excel Spreadsheet:
Excel_Inv_Examples.xls, EOQ tab
● Compute the values of R and Q and
compare to the simulation
● Next see what happens when you have
volume discounts (EOQ w Discount Tab)

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 EOQ Example
Unit Cost C $0.45 /unit
Holding cost factor i 25% /year
Ordering cost S $15.00 /order
Demand rate D 10000 units/year
Lead time L 0.0192 year

Solutions:
Re-order point R units (rounded)
Q = sqrt(2SD/(iC)) units (rounded)

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