Inventory Management and Mrp-Erp

Department of Business Economics & Administration
Departament dEconomia de lEmpresa /
Operations Management
Session 6 Inventory Management & MRP / ERP
12 1
Outline
Global Company Profile: Amazon.com
Functions of Inventory
Types of Inventory
Inventory Management
ABC Analysis Record Accuracy Cycle Counting
Control of Service Inventories

Department of Business Economics & Administration 12 2
Outline Continued
Inventory Models
Independent vs. Dependent Demand Holding, Ordering, and Setup Costs
Outline Continued
Inventory Models for Independent Demand
The Basic Economic Order Quantity (EOQ) Model Minimizing Costs Reorder Points Production Order Quantity Model Quantity Discount Models
Outline Continued
Probabilistic Models and Safety Stock
Other Probabilistic Models
Fixed-Period (P) Systems
Learning Objectives
When you complete this chapter you should be able to:
1. Understand an ABC analysis 2. Explain cycle counting 3. Explain the EOQ model for independent inventory demand 4. Understand service levels and probabilistic inventory models
Amazon.com
Amazon.com started as a virtual retailer no inventory, no warehouses, no overhead; just computers taking orders to be filled by others
Growth has forced Amazon.com to become a world leader in warehousing and inventory management
Amazon.com
1. Each order is assigned by computer to the closest distribution center that has the product(s) 2. A flow meister at each distribution center assigns work crews 3. Lights indicate products that are to be picked and the light is reset 4. Items are placed in crates on a conveyor. Bar code scanners scan each item 15 times to virtually eliminate errors.
Amazon.com
5. Crates arrive at central point where items are boxed and labeled with new bar code 6. Gift wrapping is done by hand at 30 packages per hour
7. Completed boxes are packed, taped, weighed and labeled before leaving warehouse in a truck 8. Order arrives at customer within a week
Inventory
One of the most expensive assets of many companies representing as much as 50% of total invested capital
Operations managers must balance inventory investment and customer service
Functions of Inventory
1. To decouple or separate various parts of the production process 2. To decouple the firm from fluctuations in demand and provide a stock of goods that will provide a selection for customers 3. To take advantage of quantity discounts 4. To hedge against inflation
4 Main Types of Inventory

Raw material
Purchased but not processed
Work-in-process
Undergone some change but not completed A function of cycle time for a product
Maintenance/repair/operating (MRO)
Necessary to keep machinery and processes productive
Finished goods
Completed product awaiting shipment
The Material Flow Cycle

Cycle time 95%
Input Wait for inspection Wait to be moved
5%
Output
Move Wait in queue Setup Run time for operator time time
Figure 12.1
Inventory Management
How inventory items can be classified
How accurate inventory records can be maintained
ABC (Or Pareto) Analysis

Divides inventory into three classes based on annual dollar volume
Class A - high annual dollar volume Class B - medium annual dollar volume Class C - low annual dollar volume
Used to establish policies that focus on the few critical parts and not the many trivial ones
Control of Service Inventories

Can be a critical component of profitability Losses may come from shrinkage or pilferage Applicable techniques include
1. Good personnel selection, training, and discipline 2. Tight control on incoming shipments 3. Effective control on all goods leaving facility
Independent Versus Dependent Demand

Independent demand - the demand for item is independent of the demand for any other item in inventory Dependent demand - the demand for item is dependent upon the demand for some other item in the inventory
Holding, Ordering, and Setup Costs

Holding costs - the costs of holding or carrying inventory over time
Ordering costs - the costs of placing an order and receiving goods

Setup costs - cost to prepare a machine or process for manufacturing an order
Inventory Models for Independent Demand

Need to determine when and how much to order Basic economic order quantity
Production order quantity

Quantity discount model
Basic EOQ Model

Important assumptions
1. Demand is known, constant, and independent 2. Lead time is known and constant 3. Receipt of inventory is instantaneous and complete 4. Quantity discounts are not possible 5. Only variable costs are setup and holding 6. Stockouts can be completely avoided
Inventory Usage Over Time

Order quantity = Q (maximum inventory level) Usage rate Average inventory on hand Q 2
Inventory level
Minimum inventory
0 Time
Figure 12.3
Minimizing Costs
Objective is to minimize total costs
Curve for total cost of holding and setup Minimum total cost Annual cost Holding cost curve
Setup (or order) cost curve Optimal order quantity (Q*) Order quantity
Table 11.5
Reorder Points
EOQ answers the how much question The reorder point (ROP) tells when to order
ROP =
Lead time for a Demand per day new order in days
=dxL
D d = Number of working days in a year
Reorder Point Curve

Inventory level (units) Q*
Slope = units/day = d
ROP (units)
Figure 12.5
Time (days) Lead time = L

Production Order Quantity Model

Used when inventory builds up over a period of time after an order is placed Used when units are produced and sold simultaneously
Production Order Quantity Model

Inventory level Part of inventory cycle during which production (and usage) is taking place
Maximum inventory
Demand part of cycle with no production
Time
Figure 12.6
Probabilistic Models and Safety Stock

Used when demand is not constant or certain
Use safety stock to achieve a desired service level and avoid stockouts ROP = d x L + ss
Annual stockout costs = the sum of the units short x the probability x the stockout cost/unit x the number of orders per year
Probabilistic Demand
Inventory level
Minimum demand during lead time
Maximum demand during lead time

Mean demand during lead time ROP = 350 + safety stock of 16.5 = 366.5 ROP Normal distribution probability of demand during lead time Expected demand during lead time (350 kits) Safety stock 16.5 units
0
Figure 12.8
Lead time
Time
Place order
Receive order
Probabilistic Demand
Probability of no stockout 95% of the time
Risk of a stockout (5% of area of normal curve)
Mean demand 350
ROP = ? kits Safety stock
Quantity
Number of standard deviations


Orders placed at the end of a fixed period
Inventory counted only at end of period Order brings inventory up to target level
Only relevant costs are ordering and holding
Lead times are known and constant Items are independent from one another

Target quantity (T) Q4
On-hand inventory
Q2
Q1 P
P
Q3
P Time
Figure 12.9
Fixed-Period Systems
Inventory is only counted at each review period May be scheduled at convenient times
Appropriate in routine situations

May result in stockouts between periods
May require increased safety stock
Department of Business Economics & Administration
Operations Management
Material Requirements Planning (MRP) and ERP
12 33
Outline
Global Company Profile: Wheeled Coach Dependent Demand Dependent Inventory Model Requirements
Master Production Schedule Bills of Material Accurate Inventory Records Purchase Orders Outstanding Lead Times for Components
Outline Continued
MRP Structure
MRP Management
MRP Dynamics
MRP and JIT
MRP In Services
Distribution Resource Planning (DRP)
Outline Continued
Enterprise Resource Planning (ERP)
Advantages and Disadvantages of ERP Systems ERP in the Service Sector
Learning Objectives
1. Develop a product structure 2. Build a gross requirements plan
3. Build a net requirements plan

4. Determine lot sizes for lot-for-lot, EOQ, and PPB
Learning Objectives
5. Describe MRP II 6. Describe closed-loop MRP 7. Describe ERP
Wheeled Coach
Largest manufacturer of ambulances in the world
International competitor
12 major ambulance designs

18,000 different inventory items 6,000 manufactured parts 12,000 purchased parts
Wheeled Coach
Four Key Tasks
Material plan must meet both the requirements of the master schedule and the capabilities of the production facility Plan must be executed as designed Minimize inventory investment Maintain excellent record integrity
Benefits of MRP
1. Better response to customer orders 2. Faster response to market changes
3. Improved utilization of facilities and labor

4. Reduced inventory levels
Dependent Demand
The demand for one item is related to the demand for another item Given a quantity for the end item, the demand for all parts and components can be calculated
In general, used whenever a schedule can be established for an item MRP is the common technique
Dependent Demand
Effective use of dependent demand inventory models requires the following
1. 2. 3. 4. 5. Master production schedule Specifications or bill of material Inventory availability Purchase orders outstanding Lead times
Master Production Schedule (MPS)

Specifies what is to be made and when Must be in accordance with the aggregate production plan Inputs from financial plans, customer demand, engineering, supplier performance As the process moves from planning to execution, each step must be tested for feasibility The MPS is the result of the production planning process

MPS is established in terms of specific products Schedule must be followed for a reasonable length of time The MPS is quite often fixed or frozen in the near term part of the plan The MPS is a rolling schedule The MPS is a statement of what is to be produced, not a forecast of demand
The Planning Process

Production Capacity Inventory Marketing Customer demand Finance Cash flow
Procurement Supplier performance
Human resources Manpower planning
Management Return on investment Capital
Aggregate production plan
Engineering Design completion
Master production schedule
Change production plan?
Figure 14.1 Departament dEconomia de lEmpresa /
The Planning Process

Master production schedule Change requirements? Change capacity? Material requirements plan Capacity requirements plan No Realistic? Is capacity plan being met? Is execution meeting the plan? Change master production schedule?
Yes
Execute capacity plans Execute material plans
Figure 14.1 Departament dEconomia de lEmpresa /
Aggregate Production Plan

Months Aggregate Production Plan (Shows the total quantity of amplifiers) Weeks Master Production Schedule (Shows the specific type and quantity of amplifier to be produced 240-watt amplifier 150-watt amplifier 75-watt amplifier 1 January 1,500 February 1,200
100 500
100 500 300
100 450
100 450 100

Figure 14.2

Can be expressed in any of the following terms:
A customer order in a job shop (maketo-order) company Modules in a repetitive (assemble-toorder or forecast) company
An end item in a continuous (stock-toforecast) company

Bills of Material
List of components, ingredients, and materials needed to make product Provides product structure
Items above given level are called parents Items below given level are called children
BOM Example
Level 0 Product structure for Awesome (A) A B(2) Std. 12 Speaker kit
12 Speaker kit w/ C(3) Std. amp-booster
E(2)
Packing box and installation kit of wire, bolts, and screws
E(2)
F(2) Std. 12 Speaker
booster assembly
D(2)
G(1)
D(2)
Amp-booster
12 Speaker
12 Speaker
Lead Times
The time required to purchase, produce, or assemble an item
For production the sum of the order, wait, move, setup, store, and run times For purchased items the time between the recognition of a need and the availability of the item for production
Time-Phased Product Structure

Start production of D Must have D and E completed here so production can begin on B
1 week
D
2 weeks
2 weeks to produce
E
A
2 weeks 1 week
E
2 weeks
1 week
G
3 weeks
C F
1 week
D
| | | | | | | |
4 5 Time in weeks
Figure 14.4
MRP Structure
Data Files BOM Master production schedule Output Reports
MRP by period report
MRP by date report
Lead times
(Item master file) Planned order report
Inventory data Material requirement planning programs (computer and software)
Purchase advice
Exception reports Order early or late or not needed Order quantity too small or too large
Purchasing data
Figure 14.5
MRP Management
MRP is a dynamic system
Facilitates replanning when changes occur

System nervousness can result from too many changes Time fences put limits on replanning
Pegging links each item to its parent allowing effective analysis of changes
MRP in Services
Some services or service items are directly linked to demand for other services These can be treated as dependent demand services or items
Restaurants Hospitals Hotels
MRP in Services
(a) PRODUCT STRUCTURE TREE Veal picante #10001
Chef; Work Center #1
Helper one; Work Center #2
Cooked linguini #20002
Spinach #20004
Prepared veal and sauce #20003
Asst. Chef; Work Center #3
Uncooked linguini #30004 Figure 14.10
Sauce #30006
Veal #30005
MRP in Services
(b) BILL OF MATERIALS
Part Number 10001
Description Veal picante
Quantity 1
Unit of Measure Serving
Unit cost
20002
20003 20004 30004 30005 30006
Cooked linguini
Prepared veal and sauce Spinach Uncooked linguini Veal Sauce
1
1 0.1 0.5 1 1
Serving
Serving Bag Pound Serving Serving
0.94 2.15 0.80
MRP in Services
(c) BILL OF LABOR FOR VEAL PICANTE
Labor Hours Work Center 1 2 Operation Cook linguini Labor Type Helper one Setup Time .0069 .0005 .0125 Run Time .0041 .0022 .0500 Assemble dish Chef
Cook veal and sauce
Assistant Chef
Distribution Resource Planning (DRP)

Using dependent demand techniques through the supply chain
Expected demand or sales forecasts become gross requirements Minimum levels of inventory to meet customer service levels Accurate lead times Definition of the distribution structure

An extension of the MRP system to tie in customers and suppliers
1. Allows automation and integration of many business processes 2. Shares common data bases and business practices 3. Produces information in real time
Coordinates business from supplier evaluation to customer invoicing


ERP modules include
Basic MRP Finance Human resources Supply chain management (SCM) Customer relationship management (CRM)
ERP and MRP
Figure 14.11
Advantages of ERP Systems

1. Provides integration of the supply chain, production, and administration 2. Creates commonality of databases 3. Can incorporate improved best processes
4. Increases communication and collaboration between business units and sites

5. Has an off-the-shelf software database 6. May provide a strategic advantage
Disadvantages of ERP Systems

1. Is very expensive to purchase and even more so to customize 2. Implementation may require major changes in the company and its processes 3. Is so complex that many companies cannot adjust to it 4. Involves an ongoing, possibly never completed, process for implementation 5. Expertise is limited with ongoing staffing problems
SAPs ERP Modules

Figure 14.12 Cash to Cash
Covers all financial related activity: Accounts receivable General ledger Accounts payable Treasury Cash management Asset management
Promote to Deliver
Covers front-end customer-oriented activities: Marketing Quote and order processing Transportation Documentation and labeling After sales service Warranty and guarantees
Design to Manufacture
Covers internal production activities: Design Shop floor engineering reporting Production Contract/project engineering management Plant Subcontractor maintenance management
Procure to Pay
Covers sourcing activities: Vendor sourcing Purchase requisitioning Purchase ordering Purchase contracts Inbound logistics Supplier invoicing/ matching Supplier payment/ settlement Supplier performance
Recruit to Hire
Covers all HR- and payroll-oriented activity: Time and attendance Payroll Travel and expenses
Dock to Dispatch
Covers internal inventory management: Warehousing Forecasting Distribution planning Replenishment planning Physical inventory Material handling
ERP in the Service Sector

ERP systems have been developed for health care, government, retail stores, hotels, and financial services Also called efficient consumer response (ECR) systems
Objective is to tie sales to buying, inventory, logistics, and production


Inventory Management and Mrp-Erp

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Inventory Management and Mrp-Erp

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Department of Business Economics & Administration

Departament dEconomia de lEmpresa /

Control of Service Inventories

Departament dEconomia de lEmpresa /

Department of Business Economics & Administration 12 3

Departament dEconomia de lEmpresa /

Departament dEconomia de lEmpresa /

Fixed-Period (P) Systems

Department of Business Economics & Administration 12 5

Departament dEconomia de lEmpresa /

Department of Business Economics & Administration 12 6

Departament dEconomia de lEmpresa /

Departament dEconomia de lEmpresa /

Department of Business Economics & Administration 12 9

Departament dEconomia de lEmpresa /

Operations managers must balance inventory investment and customer service

Department of Business Economics & Administration 12 10

Departament dEconomia de lEmpresa /

Departament dEconomia de lEmpresa /

4 Main Types of Inventory

Departament dEconomia de lEmpresa /

The Material Flow Cycle

Departament dEconomia de lEmpresa /

Department of Business Economics & Administration 12 14

Departament dEconomia de lEmpresa /

ABC (Or Pareto) Analysis

Departament dEconomia de lEmpresa /

Control of Service Inventories

Departament dEconomia de lEmpresa /

Independent Versus Dependent Demand

Departament dEconomia de lEmpresa /

Holding, Ordering, and Setup Costs

Ordering costs - the costs of placing an order and receiving goods

Departament dEconomia de lEmpresa /

Inventory Models for Independent Demand

Production order quantity

Department of Business Economics & Administration 12 19

Basic EOQ Model

Departament dEconomia de lEmpresa /

Inventory Usage Over Time

Departament dEconomia de lEmpresa /

Departament dEconomia de lEmpresa /

Lead time for a Demand per day new order in days

Departament dEconomia de lEmpresa /

Reorder Point Curve

Time (days) Lead time = L

Departament dEconomia de lEmpresa /

Production Order Quantity Model

Department of Business Economics & Administration 12 25

Departament dEconomia de lEmpresa /

Production Order Quantity Model

Demand part of cycle with no production

Departament dEconomia de lEmpresa /

Probabilistic Models and Safety Stock

Departament dEconomia de lEmpresa /

Minimum demand during lead time

Maximum demand during lead time

Probability of no stockout 95% of the time

Risk of a stockout (5% of area of normal curve)

Mean demand 350

ROP = ? kits Safety stock

Number of standard deviations

Departament dEconomia de lEmpresa /