11-1 Inventory Management

Inventory
Management

Operations Management, Eighth Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
11-2 Inventory Management

Inventory: a stock or store of goods Independent Demand

A Dependent Demand

B(4) C(2)

D(2) E(1) D(3) F(2)

Independent demand is uncertain.

Dependent demand is certain.
11-3 Inventory Management

Types of Inventories

 Raw materials & purchased parts

 Partially completed goods called
work in progress
 Finished-goods inventories
 (manufacturing firms)
or merchandise
(retail stores)
11-4 Inventory Management

Types of Inventories (Cont’d)

 Replacement parts, tools, & supplies

 Goods-in-transit to warehouses or customers
11-5 Inventory Management

Functions of Inventory

 To meet anticipated demand

 To smooth production requirements
 To decouple operations
 To protect against stock-outs
11-6 Inventory Management

Functions of Inventory (Cont’d)

 To take advantage of order cycles

 To help hedge against price increases
 To permit operations
 To take advantage of quantity discounts
11-7 Inventory Management

Objective of Inventory Control

 To achieve satisfactory levels of customer

service while keeping inventory costs within
reasonable bounds
 Level of customer service
 Costs of ordering and carrying inventory
11-8 Inventory Management

Key Inventory Terms

 Lead time: time interval between ordering

and receiving the order
 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
 Shortage costs: costs when demand exceeds
supply
11-9 Inventory Management

ABC Classification System

Figure 11.1
Classifying inventory according to some
measure of importance and allocating control
efforts accordingly.
A - very important
B - mod. important
High
A
C - least important Annual
$ value B
of items

Low C
Few Many
Number of Items
11-10 Inventory Management

ABC ANALYSIS
(ABC = Always Better Control)
This is based on cost criteria.
It helps to exercise selective control when confronted with large number
of items it rationalizes the number of orders, number of items & reduce
the inventory.
About 10 % of materials consume 70 % of resources
About 20 % of materials consume 20 % of resources
About 70 % of materials consume 10 % of resources
‘A’ ITEMS
Small in number, but consume large amount
of resources
Must have:
•Tight control
•Rigid estimate of requirements
•Strict & closer watch
•Low safety stocks
•Managed by top management
11-11 Inventory Management

‘B’ ITEM
Intermediate
Must have:
•Moderate control
•Purchase based on rigid requirements
•Reasonably strict watch & control
•Moderate safety stocks
•Managed by middle level management

‘C’ ITEMS
Larger in number, but consume lesser amount of resources
Must have:
•Ordinary control measures
•Purchase based on usage estimates
•High safety stocks
ABC analysis does not stress on items those are less
costly but may be vital
11-12 Inventory Management
ANNUAL COST CUMMULATIVE
ITEM % ITEM
[Rs.] COST [Rs.]
COST %
ABC
1 90000 90000
10 % 70 %
A 2 50000 140000
3 20000 160000
N 4 7500 167500
20 % 20 %
A 5 7500 175000
6 5000 180000
L
7 4500 184500
Y 8 4000 188500
9 2750 191250
S
10 1750 193000
I 11 1500 194500

S 12 1500 196000
13 500 196500 10 %
70 %
14 500 197000
15 500 197500
WORK 16 500 198000
SHEET 17 500 198500
18 500 199000
19 500 199500
20 500 200000
11-13 Inventory Management
VED ANALYSIS
• Based on critical value & shortage cost of an item
–It is a subjective analysis.
•Items are classified into:
Vital:
•Shortage cannot be tolerated.
Essential:
•Shortage can be tolerated for a short period.
Desirable:
Shortage will not adversely affect, but may be using more
resources. These must be strictly Scrutinized

V E D ITEM COST

A AV AE AD CATEGORY 1 10 70%

B BV BE BD CATEGORY 2 20 20%

C CV CE CD CATEGORY 3 70 10%

CATEGORY 1 - NEEDS CLOSE MONITORING & CONTROL

CATEGORY 2 - MODERATE CONTROL.
CATEGORY 3 - NO NEED FOR CONTROL
11-14 Inventory Management
SDE ANALYIS
Based on availability
Scarce
Managed by top level management
Maintain big safety stocks
Difficult
Maintain sufficient safety stocks
Easily available
Minimum safety stocks
FSN ANALYSIS
Based on utilization.
Fast moving.
Slow moving.
Non-moving.
Non-moving items must be periodically reviewed to prevent
expiry
& obsolescence
HML ANALYSIS
Based on cost per unit
Highest
Medium
Low
This is used to keep control over consumption
at departmental level for deciding the frequency of physical verification.
11-15 Inventory Management

Economic Order Quantity Models

 Economic order quantity model

 Economic production model
 Quantity discount model
11-16 Inventory Management

Assumptions of EOQ Model

 Only one product is involved

 Annual demand requirements known
 Demand is even throughout the year
 Lead time does not vary
 Each order is received in a single delivery
 There are no quantity discounts
11-17 Inventory Management

The Inventory Cycle

Figure 11.2

Profile of Inventory Level Over Time

Q Usage
Quantity rate
on hand

Reorder
point

Time
Receive Place Receive Place Receive
order order order order order
Lead time
11-18 Inventory Management

Total Cost

Annual Annual
Total cost = carrying + ordering
cost cost
Q + DS
TC = H
2 Q
11-19 Inventory Management

Cost Minimization Goal

Figure 11.4C

The Total-Cost Curve is U-Shaped

Q D
TC  H  S
Annual Cost

2 Q

Ordering Costs

Order Quantity
QO (optimal order quantity)
(Q)
11-20 Inventory Management

Minimum Total Cost

The total cost curve reaches its minimum

where the carrying and ordering costs are
equal.

2DS 2( Annual Demand )(Order or Setup Cost )

Q OPT = =
H Annual Holding Cost
11-21 Inventory Management

Total Costs with Purchasing Cost

Annual Annual Purchasing

+
TC = carrying + ordering cost
cost cost

Q + DS + PD
TC = H
2 Q
11-22 Inventory Management

When to Reorder with EOQ Ordering

 Reorder Point - When the quantity on hand

of an item drops to this amount, the item is
reordered
 Safety Stock - Stock that is held in excess of
expected demand due to variable demand
rate and/or lead time.
 Service Level - Probability that demand will
not exceed supply during lead time.
11-23 Inventory Management

Determinants of the Reorder Point

 The rate of demand

 The lead time

 Demand and/or lead time variability

 Stockout risk (safety stock)

11-24 Inventory Management

Safety Stock
Figure 11.12
Quantity

Maximum probable demand

during lead time

Expected demand
during lead time

ROP

Safety stock reduces risk of Safety stock

stockout during lead time LT Time