Taylor Introms10 PPT 16

Inventory Management
Chapter 16
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall
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Chapter Topics
Elements of Inventory Management Inventory Control Systems Economic Order Quantity Models The Basic EOQ Model The EOQ Model with Non-Instantaneous Receipt The EOQ Model with Shortages EOQ Analysis with QM for Windows EOQ Analysis with Excel and Excel QM Quantity Discounts Reorder Point Determining Safety Stocks Using Service Levels Order Quantity for a Periodic Inventory System Copyright 2010 Pearson Education, Inc. Publishing as
Prentice Hall
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Elements of Inventory Management Role of Inventory (1 of 2)
Inventory is a stock of items kept on hand used to meet customer demand.. A level of inventory is maintained that will meet anticipated demand. If demand not known with certainty, safety (buffer) stocks are kept on hand. Additional stocks are sometimes built up to meet seasonal or cyclical demand. Large amounts of inventory sometimes purchased to take advantage of discounts.
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Elements of Inventory Management Role of Inventory (2 of 2)
In-process inventories maintained to provide independence between operations. Raw materials inventory kept to avoid delays in case of supplier problems. Stock of finished parts kept to meet customer demand in event of work stoppage. In general inventory serves to decouple consecutive steps.
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Elements of Inventory Management Demand

Inventory exists to meet the demand of customers. Customers can be external (purchasers of products) or internal (workers using material). Management needs an accurate forecast of demand. Items that are used internally to produce a final product are referred to as dependent demand items. Items that are final products demanded by an external customer are independent demand items.
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Elements of Inventory Management Inventory Costs (1 of 3)

Carrying costs - Costs of holding items in storage.
Vary with level of inventory and sometimes with length of time held. Include facility operating costs, record keeping, interest, etc. Assigned on a per unit basis per time period, or as percentage of average inventory value (usually estimated as 10% to 40%).
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Ordering costs - costs of replenishing stock of inventory.
Expressed as dollar amount per order, independent of order size. Vary with the number of orders made. Include purchase orders, shipping, handling, inspection, etc.
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Shortage (stockout ) costs - Associated with insufficient inventory.
Result in permanent loss of sales and profits for items not on hand. Sometimes penalties involved; if customer is internal, work delays could result.
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Inventory Control Systems

An inventory control system controls the level of inventory by determining how much (replenishment level) and when to order. Two basic types of systems -continuous (fixedorder quantity) and periodic (fixed-time). In a continuous system, an order is placed for the same constant amount when inventory decreases to a specified level. In a periodic system, an order is placed for a variable amount after a specified period of time.
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Inventory Control Systems Continuous Inventory Systems

A continual record of inventory level is maintained. Whenever inventory decreases to a predetermined level, the reorder point, an order is placed for a fixed amount to replenish the stock. The fixed amount is termed the economic order quantity, whose magnitude is set at a level that minimizes the total inventory carrying, ordering, and shortage costs. Because of continual monitoring, management is always aware of status of inventory level and critical parts, but system is relatively expensive to maintain.
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Inventory Control Systems Periodic Inventory Systems

Inventory on hand is counted at specific time intervals and an order placed that brings inventory up to a specified level. Inventory not monitored between counts and system is therefore less costly to track and keep account of. Results in less direct control by management and thus generally higher levels of inventory to guard against stockouts. System requires a new order quantity each time an order is placed. Used in smaller retail stores, drugstores, grocery stores and offices.
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Economic Order Quantity Models

Economic order quantity, or economic lot size, is the quantity ordered when inventory decreases to the reorder point. Amount is determined using the economic order quantity (EOQ) model. Purpose of the EOQ model is to determine the optimal order size that will minimize total inventory costs. Three model versions to be discussed: 1. Basic EOQ model 2. EOQ model without instantaneous receipt 3. EOQ model with shortages
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Economic Order Quantity Models Basic EOQ Model (1 of 2)

A formula for determining the optimal order size that minimizes the sum of carrying costs and ordering costs. Simplifying assumptions and restrictions: Demand is known with certainty and is relatively constant over time. No shortages are allowed. Lead time for the receipt of orders is constant. The order quantity is received all at once and instantaneously.
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Economic Order Quantity Models Basic EOQ Model (2 of 2)
Figure 16.1 The Inventory Order Cycle
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Basic EOQ Model Carrying Cost (1 of 2)

Carrying cost usually expressed on a per unit basis of time, traditionally one year. Annual carrying cost equals carrying cost per unit per year times average inventory level: Carrying cost per unit per year = Cc Average inventory = Q/2 Annual carrying cost = CcQ/2.
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Basic EOQ Model Carrying Cost (2 of 2)
Figure 16.4 Inventory
Average
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Basic EOQ Model Ordering Cost

Total annual ordering cost equals cost per order (Co) times number of orders per year. Number of orders per year, with known and constant demand, D, is D/Q, where Q is the order size: Annual ordering cost = CoD/Q Only variable is Q, Co and D are constant parameters.
Relative magnitude of the ordering cost is dependent on order size.
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Basic EOQ Model Total Inventory Cost (1 of 2)

Total annual inventory cost is sum of ordering and carrying cost:
D +C Q TC = C oQ c 2
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Basic EOQ Model Total Inventory Cost (2 of 2)
Figure 16.5 The EOQ Cost Model
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Basic EOQ Model EOQ and Minimum Total Cost

EOQ occurs where total cost curve is at minimum value and carrying cost equals ordering cost: Qopt Co D TC = + Cc min Q 2 opt 2Co D Qopt = Cc The EOQ model is robust because Q is a square root and errors in the estimation of D, Cc and Co are dampened.
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Basic EOQ Model Example (1 of 2)

I-75 Carpet Discount Store, Super Shag carpet sales. Given following data, determine number of orders to be made annually and time between orders given store is open every day except Sunday, Thanksgiving Day, and Christmas Day. Model parameters: Cc = $0.75, Co = $150, D = 10,000yd Optimal order size: 2Co D 2(150)(10,000) Q = = = 2,000 yd opt Cc (0.75)
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Basic EOQ Model Example (2 of 2)

Total annual inventory cost: Qopt TC = Co D + Cc = (150)10,000 + (0.75) (2,000) = $1,500 min Qopt 2 2,000 2 Number of orders per year: D = 10,000 = 5 Q 2,000 opt Order cycle time = 311 days = 311 = 62.2 store days 5 D / Qopt
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Basic EOQ Model EOQ Analysis Over Time (1 of 2)

For any time period unit of analysis, EOQ is the same. Shag Carpet example on monthly basis: Model parameters: Cc = $0.0625 per yd per month Co = $150 per order D = 833.3 yd per month Optimal order size: 2Co D 2(150)(833.3) Qopt = = = 2,000 yd Cc (0.0625)
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Basic EOQ Model EOQ Analysis Over Time (2 of 2)

Total monthly inventory cost: Q D + C opt TC = Co c 2 min Q opt = (150) (833.3) + (0.0625) (2,000) 2,000 2 = $125 per month Total annual inventory cost = ($125)(12) = $1,500
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EOQ Model Non-Instantaneous Receipt Description (1 of 2)
In the non-instantaneous receipt model the assumption that orders are received all at once is relaxed. (Also known as gradual usage or production lot size model.) The order quantity is received gradually over time and inventory is drawn on at the same time it is being replenished.
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EOQ Model Non-Instantaneous Receipt Description (2 of 2)
Figure 16.6
The EOQ Model with Non-Instantaneous Order Receipt 16-
Non-Instantaneous Receipt Model Model Formulation (1 of 2)

p = daily rate at which the order is received over time d = daily rate at which inventory is demanded d Maximum inventory level = Q 1 p
Average inventory level = Q 1 d 2 p Total carrying cost = Cc Q 1 d 2 p
D + C Q 1 d Total annual inventory cost = Co Q c 2 p

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Non-Instantaneous Receipt Model Model Formulation (2 of 2)

Q 1 d = C D at lowest point of total cost curve Cc p o 2 Q 2Co D Optimal order size: Qopt = Cc (1 d / p)
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Non-Instantaneous Receipt Model Example (1 of 2)

Super Shag carpet manufacturing facility: Co = $150 Cc = $0.75 per unit D = 10,000 yd per year = 10,000/311 = 32.2 yd per day p = 150 yd per day 2Co D Optimal order size: Qopt = = 2(150)(10,000) Cc 1 d 0.75 1 32.2 p 150 = 2,256.8 yd
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Non-Instantaneous Receipt Model Example (2 of 2)

Total minimum annual inventory cost = Co D+ Cc Q dp 1 Q 2 = (150) (10,000) (.075) (2,256.8) 32.2 $1,329 + 1 = (2,256.8) 2 150
Production run length = Q= 2,256.8 15.05 days = p 150 Number of orders per year (prod uction runs) = D Q = 10,000 = 4.43 runs 2,256.8
d= 32.21,772 2,256.8 1 = Maximum inventory level = Q p 1 150
yd
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EOQ Model with Shortages Description (1 of 2)

In the EOQ model with shortages, the assumption that shortages cannot exist is relaxed. Assumed that unmet demand can be backordered with all demand eventually satisfied.
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EOQ Model with Shortages Description (2 of 2)
Figure 16.7 The EOQ Model with Shortages
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EOQ Model with Shortages Model Formulation (1 of 2)

2 Total shortage costs = Cs S 2Q Total ordering cost = Co D Q S 2 + C (Q S )2 + C D Total inventory cost = Cs oQ 2Q c 2Q 2C D C + C o s c Optimal order quantity = Q = opt C C c s Cc Shortage level = Sopt = Qopt C +C c s
(Q S )2 Total carrying costs = Cc 2Q
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Figure 16.8
Cost Model with Shortages
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I-75 Carpet Discount Store allows shortages; shortage cost Cs, is $2/yard per year. Co = $150 Cc = $0.75 per yd Cs = $2 per yd D = 10,000 yd Optimal order quantity: 2Co D Cs + Cc 2(150)(10,000) 2 + 0.75 = 2,345.2 yd = Q = opt Cc Cs 0.75 2

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Shortage level: Cc 0.75 = 639.6 yd = 2,345.2 S =Q opt opt C + C 2 + 0.75 c s

Total inventory cost: S 2 + C (Q S )2 + C D TC = Cs oQ 2Q c 2Q 2 2 = (2)(639.6) + (0.75)(1,705.6) + (150)(10,000) 2(2,345.2) 2(2,345.2) 2,345.2 = $174.44 + 465.16 + 639.60 = $1,279.20
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Number of orders = D = 10,000 = 4.26 orders per year Q 2,345.2 Maximum inventory level = Q S = 2,345.2 639.6 = 1,705.6 yd Time between orders = t = days per year = 311 = 73.0 days number of orders 4.26
Time during which inventory is on hand = t = Q S = 2,345.2-639.6 = 0.171 or 53.2 days 1 D 10,000 Time during which there is a shortage = t = S = 639.6 = 0.064 year or 19.9 days 2 D 10,000
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EOQ Analysis with QM for Windows
Exhibit 16.1
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EOQ Analysis with Excel and Excel QM (1 of 2)
Exhibit 16.2
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EOQ Analysis with Excel and Excel QM (2 of 2)
Exhibit 16.3
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Quantity Discounts
Price discounts are often offered if a predetermined number of units is ordered or when ordering materials in high volume. Basic EOQ model used with purchase price added: TC = Co D + Cc Q + PD Q 2 where: P = per unit price of the item D = annual demand Quantity discounts are evaluated under two different scenarios: With constant carrying costs With carrying costs as a percentage of purchase Copyright 2010 Pearson Education, Inc. Publishing as price
Prentice Hall
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Quantity Discounts with Constant Carrying Costs Analysis Approach

Optimal order size is the same regardless of the discount price. The total cost with the optimal order size must be compared with any lower total cost with a discount price to determine which is the lesser.
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Quantity Discounts with Constant Carrying Costs Example (1 of 2) For following discount schedule University bookstore:
offered by Comptek, should bookstore buy at the discount terms or order the basic EOQ order size? Quantity Price 1- 49 $1,400 50 89 1,100 90 + 900 Determine optimal order size and total cost: Co = $2,500 Cc = $190 per unit D = 200
2CoD 2(2,500)(200) Q = = = 72.5 opt Cc 190

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Quantity Discounts with Constant Carrying Costs Example totalof 2) eligible discount price Compute (2 cost at
($1,100): Q CoD TC = +C c opt PD + min Q 2 opt
= (2,500)(200) (190) (72.5) (1,100)(200) $233,784 + + = (72.5) 2
Co total Q Compare with D TC = + Cc cost of with order size of 90 and + PD Q 2 price of $900: = (2,500)(200) + (190)(90) + (900)(200) = $194,105 (90) 2
Because $194,105 < $233,784, maximum discount
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Quantity Discounts with Carrying Costs Percentage of Price Example (1 of 3)

Optimal order size and total cost determined using basic EOQ model with no quantity discount. This cost then compared with various discount quantity order sizes to determine minimum cost order. This must be compared with EOQ-determined order size for specific discount price. Data: Co = $2,500 D = 200 computers per year
University Bookstore example, but a different optimal order size for each price discount.
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Quantity Discounts with Carrying Costs Percentage of Price Example (2 of 3)

Quantity Price Carrying Cost 0 - 49 $210 50 - 89 1,100 1,100(.15) = Compute optimum order size for purchase price 165 without discount and Cc = $210: 90 + 900(.15) 2Co D 900 2(2,500)(200) = 69 = Q = = 135 opt Cc 210 Compute new order size: Q = 2(2,500)(200) = 77.8 opt 165
$1,400
1,400(.15) =
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Quantity Discounts with Carrying Costs Percentage oftotal cost:Example (3 of 3) Compute minimum Price
Co D TC = + Cc Q + PD = (2,500)(200)+ 165(77.8)+ (1,100)(200) Q 2 77.8 2 = $232,845
Compare with cost, discount price of $900, order quantity of 90: TC = (2,500)(200) + (135)(90) + (900)(200)= $191,630 90 2
Optimal order size = 2(2,500)(200)follows: Q computed as = 86.1 opt 135

Since this order size is less than 90 units , it is not
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Quantity Discount Model Solution with QM for Windows
Exhibit 16.4
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Quantity Discount Model Solution with QM for Windows
Exhibit 16.5
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Reorder Point (1 of 4)
The reorder point is the inventory level at which a new order is placed. Order must be made while there is enough stock in place to cover demand during lead time. Formulation: R = dL where d = demand rate per time period L = lead time For Carpet Discount store problem: R = dL = (10,000/311)(10) = 321.54
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Figure 16.9 Reorder Point and Lead Time
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Inventory level might be depleted at slower or faster rate during lead time. When demand is uncertain, safety stock is added as a hedge against stockout.
Figure 16.10
Inventory Model with Uncertain Demand
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Figure 16.11
Inventory model with safety stock
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Determining Safety Stocks Using Service Levels

Service level is probability that amount of inventory on hand is sufficient to meet demand during lead time (probability stockout will not occur). The higher the probability inventory will be on hand, the more likely customer demand will be met. Service level of 90% means there is a .90 probability that demand will be met during lead time and .10 probability of a stockout.
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Reorder Point with Variable Demand (1 of 2)

R = dL + Z where: R = reorder point d = average daily demand L = lead time d L
= the standard deviation of daily demand
Z = number of standard deviations corresponding to service level probability Z d L = safety stock

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Reorder Point with Variable Demand (2 of 2)
Reorder Point for a Service Copyright 2010 Pearson Education, Inc. Publishing as Level Prentice Hall
Figure 16.12
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Reorder Point with Variable Demand Example

I-75 Carpet Discount Store Super Shag carpet. For following data, determine reorder point and safety stock for service level of 95%. d = 30 yd per day L = 10 days = 5 yd per day d For 95% service level, Z = 1.65 (Table A-1, appendix A) R = dL + Z = 326.1 yd d L = 30(10) + (1.65)(5)( 10) = 300 + 26.1
Safety stock is second term in reorder point formula : 26.1.

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Determining Reorder Point with Excel
Exhibit 16.6
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Reorder Point with Variable Lead Time

For constant demand and variable lead time: R = d L + Zd where: d = constant daily demand L = average lead time = standard deviation of lead time L d = standard deviation of demand during lead time L Zd = safety stock L L
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Reorder Point with Variable Lead Time Example

Carpet Discount Store: d = 30 yd per day L = 10 days
= 3 days
Z = 1.65 for a 95% service level R = d L + Zd L = (30)(10) + (1.65)(30)(3) = 300 + 148.5 = 448.5 yd
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Reorder Point Variable Demand and Lead Time

When both demand and lead time are variable: 2 2 R = d L + Z ( ) L + ( ) d L d 2 where: d = average daily demand L = average lead time 2 2 ( ) L + ( ) d = standard deviation L d of demand during lead time 2 2 Z ( ) L + ( ) d = safety stock L d
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Reorder Point Variable Demand and Lead Time Example

Carpet Discount Store: d = 30 yd per day = 5 yd per day d L = 10 days = 3 days L Z = 1.65 for 95% service level 2 2 R = d L + Z ( ) L + ( ) d L d 2 = (30)(10) + (1.65) (5)(5)(10) + (3)(3)(30)(30) = 300 + 150.8 = 450.8 yds
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Order Quantity for a Periodic Inventory System

A periodic, or fixed-time period inventory system is one in which time between orders is constant and the order size varies. Vendors make periodic visits, and stock of inventory is counted. An order is placed, if necessary, to bring inventory level back up to some desired level. Inventory not monitored between visits. At times, inventory can be exhausted prior to the visit, resulting in a stockout. Larger safety stocks are generally required for the periodic inventory system.
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Order Quantity for Variable Demand

For normally distributed variable daily demand: Q = d (t + L) + Z t + L I b d b where: d = average demand rate t = the fixed time between orders b L = lead time = standard deviation of demand d Z t + L = safety stock d b I = inventory in stock
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Order Quantity for Variable Demand Example

Corner Drug Store with periodic inventory system. Order size to maintain 95% service level: d = 6 bottles per day = 1.2 bottles d t = 60 days b L = 5 days I = 8 bottles Z = 1.65 for 95% service level Q = d (t + L) + Z t + L I b d b = (6)(60 + 5) + (1.65)(1.2) 60 + 5 8 = 398 bottles
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Order Quantity for the Fixed-Period Model Solution with Excel
Exhibit 16.7
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Example Problem Solution Electronic Village Store (1 of 3)

For data below determine: Optimal order quantity and total minimum inventory cost. Assume shortage cost of $600 per unit per year, compute optimal order quantity and minimum inventory cost. D = 1,200 personal computers Step 1 (part a): Determine the Optimal Order Cc = $170 Quantity. Co = $450 2Co D 2(450)(1,200) Q= = = 79.7 personal computers Cc 170
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Q + C D = 170 79.7 = 450 1,200 Total cost = Cc 79.7 2 oQ 2 = $13,549.91 Step 2 (part b): Compute the EOQ with Shortages. Cs = $600 2Co D Cs + Cc 2(450)(1200) 600 + 170 = Q= Cc C s 170 600

= 90.3 personal computers

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Cc 170 = 19.9 personal computers = 90.3 S =Q Cc + Cs 170 + 600

Cs S 2 (Q S )2 + Co D Total cost = + Cc 2Q 2Q Q (600)(19.9)2 + 170 (90.3 19.9)2 + 450 1,200 = 90.3 2(90.3) 2(90.3) = $11,960.98
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Example Problem Solution Computer Products Store (1 of 2)

Sells monitors with daily demand normally distributed with a mean of 1.6 monitors and standard deviation of 0.4 monitors. Lead time for delivery from supplier is 15 days. Determine the reorder point to achieve a 98% service level. d parameters. Step 1: Identify = 1.6 monitors per day L = 15 days
= 0.4 monitors per day d

Z = 2.05 (for a 98% service level)
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Example Problem Solution Computer Products Store (2 of 2)

Step 2: Solve for R.
R = dL + Z d L = (1.6)(15)+ (2.05)(.04) 15
= 24+ 3.18 = 27.18 monitors
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Taylor Introms10 PPT 16

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Inventory Management

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Elements of Inventory Management Role of Inventory (1 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Elements of Inventory Management Role of Inventory (2 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Elements of Inventory Management Demand

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Elements of Inventory Management Inventory Costs (1 of 3)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Elements of Inventory Management Inventory Costs (2 of 3)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Elements of Inventory Management Inventory Costs (3 of 3)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Inventory Control Systems

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Inventory Control Systems Continuous Inventory Systems

Inventory Control Systems Periodic Inventory Systems

Economic Order Quantity Models

Economic Order Quantity Models Basic EOQ Model (1 of 2)

Economic Order Quantity Models Basic EOQ Model (2 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Figure 16.1 The Inventory Order Cycle

Basic EOQ Model Carrying Cost (1 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Basic EOQ Model Carrying Cost (2 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Figure 16.4 Inventory

Basic EOQ Model Ordering Cost

Relative magnitude of the ordering cost is dependent on order size.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Basic EOQ Model Total Inventory Cost (1 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Basic EOQ Model Total Inventory Cost (2 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Figure 16.5 The EOQ Cost Model

Basic EOQ Model EOQ and Minimum Total Cost

Basic EOQ Model Example (1 of 2)

Basic EOQ Model Example (2 of 2)

Basic EOQ Model EOQ Analysis Over Time (1 of 2)

Basic EOQ Model EOQ Analysis Over Time (2 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

EOQ Model Non-Instantaneous Receipt Description (1 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

EOQ Model Non-Instantaneous Receipt Description (2 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

The EOQ Model with Non-Instantaneous Order Receipt 16-

Non-Instantaneous Receipt Model Model Formulation (1 of 2)

D + C Q 1 d Total annual inventory cost = Co Q c 2 p

Non-Instantaneous Receipt Model Model Formulation (2 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Non-Instantaneous Receipt Model Example (1 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Non-Instantaneous Receipt Model Example (2 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

EOQ Model with Shortages Description (1 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

EOQ Model with Shortages Description (2 of 2)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Figure 16.7 The EOQ Model with Shortages

EOQ Model with Shortages Model Formulation (1 of 2)

(Q S )2 Total carrying costs = Cc 2Q