Inventory Management

Concept
Inventory is the stock of any material on hand at given time.

From sc perspective Inventory is any idle material resource of an enterprise awaiting future sales, use or transformation.
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Types of Inventories
On the basis of nature of materials Raw materials & purchased parts
Incoming students

Work in progress
Current students

Finished-goods inventories
(manufacturing firms) or merchandise (retail stores) Graduating students

Maintenance/repair/operating (MRO) inventories

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On the basis of utility

Working stock Safety stock Anticipation stock Pipeline stock Decoupling stock Psychic stock

Functions of Inventory
To meet anticipated demand

To smooth production requirements

To protect against stock-outs To take advantage of order cycles To help hedge against price increases or to take advantage of quantity discounts

To permit operations
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Inventory performance measures and levels

Inventory level
Low or high

Customer service levels

Can you deliver what customer wants? Right goods, right place, right time, right quantity

Inventory turnover
Cost of goods sold per year / average inventory investment

Inventory costs, more will come

Costs of ordering & carrying inventories

Decisions: Order size and time

Key Inventory Terms

Lead time: time interval between ordering and receiving the order, denoted by LT Holding (carrying) costs: cost to carry an item in inventory for a length of time, usually a year, denoted by H Ordering costs: costs of ordering and receiving inventory, denoted by S Shortage costs: costs when demand exceeds supply

Effective Inventory Management

A system to keep track of inventory A reliable forecast of demand Knowledge of lead times

Reasonable estimates of
Holding costs Ordering costs

Shortage costs

A classification system
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ABC Classification System

Classifying inventory according to some measure of importance and allocating control efforts accordingly. Importance measure= price*annual sales

A - very important B - mod. important C - least important

High Annual $ volume of items Low

A B C
Few Many

Number of Items
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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

Annual Usage of Items by Dollar Value

Item 1 2 3 4 5 6 7 8 9 10 Total Percentage of Annual Usage in Total Dollar Units Unit Cost Dollar Usage Usage 5,000 $ 1.50 $ 7,500 2.9% 1,500 8.00 12,000 4.7% 10,000 10.50 105,000 41.2% 6,000 2.00 12,000 4.7% 7,500 0.50 3,750 1.5% 6,000 13.60 81,600 32.0% 5,000 0.75 3,750 1.5% 4,500 1.25 5,625 2.2% 7,000 2.50 17,500 6.9% 3,000 2.00 6,000 2.4% $ 254,725 100.0%

ABC Chart For Previous Slide

45.0% 40.0% 35.0% 120.0% 100.0%

Percent Usage

30.0% 25.0%

80.0% 60.0%

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

Item No. Percentage of Total Dollar Usage Cumulative Percentage

Cumulative % Usage

V-E-D Classification
Based on the critical nature of items. Applicable to spare parts of equipment, as they do not follow a predictable demand pattern. V-Vital : Items without which the activities will come to a halt. E-Essential : Items which are likely to cause disruption of the normal activity. D-Desirable : In the absence of which the work does not get hampered.
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H-M-L Classification
Based on the unit value (in rupees) of items. Similar to A-B-C analysis

H-High M-Medium L -Low

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F-S-N Classification
Takes into account the distribution and handling patterns of items from stores. Important when obsolescence is to be controlled. F Fast moving S Slow moving N Non moving

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S-D-E Classification
Based on the lead-time analysis and availability. S Scarce : longer lead time D Difficult : long lead time E Easy : reasonable lead time

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Classification of Materials for

Inventory Control
Classification A-B-C Criteria Annual value of consumption of the items

V-E-D
H-M-L F-S-N S-D-E

Critical nature of the components with respect to products.

Unit price of material Issue from stores Purchasing problems in regard to availability

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EOQ Model
Assumptions:
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 Infinite production capacity There are no quantity discounts

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Deriving the EOQ

Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q.
Q OPT = 2DS = H 2( Annual Demand )(Order or Setup Cost ) Annual Holding Cost

The total cost curve reaches its minimum where the carrying and ordering costs are equal.

Total cost(Q EOQ )

2 DSH
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EOQ example
Demand, D = 12,000 computers per year. Holding cost, H = 100 per item per year. Fixed cost, S = $4,000/order. Find EOQ, Cycle Inventory, Optimal Reorder Interval and Optimal Ordering Frequency.

EOQ = 979.79, say 980 computers Cycle inventory = EOQ/2 = 490 units Optimal Reorder interval, T = 0.0816 year = 0.98 month Optimal ordering frequency, n=12.24 orders per year.
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Total Costs with Purchasing Cost Annual Annual Purchasing + TC = carrying + ordering cost cost cost Q H TC = 2 + DS Q

PD

Note that P is the price.

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Types of inventories (stocks) by function

Deterministic demand case Anticipation stock
For known future demand

Cycle stock
For convenience, some operations are performed occasionally and stock is used at other times Why to buy eggs in boxes of 12?

Pipeline stock or Work in Process

Stock in transfer, transformation. Necessary for operations. Students in the class

Stochastic demand case Safety stock

Stock against demand variations
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4. When to Reorder with EOQ Ordering

Reorder Point - When the quantity on hand of
an item drops to this amount, the item is reordered. We call it ROP.

Safety Stock - Stock that is held in excess of

expected demand due to variable demand rate and/or lead time. We call it ss.

(lead time) Service Level - Probability that

demand will not exceed supply during lead time. We call this cycle service level, CSL.

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Operations Strategy
Too much inventory
Tends to hide problems Easier to live with problems than to eliminate them Costly to maintain

Wise strategy
Reduce lot sizes Reduce set ups Reduce safety stock Aggregate negatively correlated demands Remember component commonality Delayed postponement
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