Independent-Demand Inventory

Outline

Introduction Purpose of Inventories Inventory Cost Structures Independent versus Dependent Demand Economic Order Quantity Continuous Review System Periodic Review System Using P and Q System in Practice ABC Inventory Management

Introduction

Definition of Inventory The Flow and Stock of Inventory

A Material-Flow Process
Productive Process Work in process
Customer

Work in process Work in process

Work in process

Finished goods

Inventory

Definition--The stock of any item or resource used in an organization

Raw materials Finished products Component parts Supplies

Work in process
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Inventory System Defined

Inventory is the stock of any item or resource used in an organization. These items or resources can include: raw materials, finished products, component parts, supplies, and workin-process. An inventory system is the set of policies and controls that monitor levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be.

A Water Tank Analogy for Inventory

Inventory Level Supply Rate

Inventory Level

Demand Rate

Purpose of Inventories

To protect against uncertainties To allow economic production and purchase To cover anticipated changes in demand or supply To provide for transit

Inventory Cost Structures

Item cost Ordering (or setup) cost Carrying (or holding) cost:

Cost of capital Cost of storage Cost of obsolescence, deterioration, and loss

Stock out cost

Independent vs. Dependent Demand

Independent Demand (Demand not related to other items) Dependent Demand (Derived)

E(1)

Classifying Inventory Models

Fixed-Order Quantity Models

Event triggered

Fixed-Time Period Models

Time triggered
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Independent versus Dependent Demand

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Economic Order Quantity (EOQ) Assumptions

Demand rate is constant, recurring, and known. Lead time is constant and known. No stockouts allowed. Material is ordered or produced in a lot or batch and the lot is received all at once Unit cost is constant (no quantity discounts) Carrying cost depends linearly on the average level of inventory Ordering (setup) cost per order is fixed The item is a single product

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EOQ Inventory Levels

Order Interval Lot size = Q Average Inventory Level = Q/2

Time

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Notations and measurement units in EOQ

D = Demand rate, units per year S = Cost per order placed, or setup cost, dollars per order C = Unit cost, dollars per unit i = Carrying interest rate, percent of dollar value per year Q = Lot size, units
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Total Cost of Inventory

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EOQ Example (1) Problem Data

Given the information below, what are the EOQ and reorder point? Annual Demand = 1,000 units Days per year considered in average daily demand = 365 Cost to place an order = $10 Holding cost per unit per year = $2.50 Lead time = 7 days Cost per unit = $15

EOQ Example (1) Solution

Q O PT = 2D S = H 2(1,000 )(10) = 89.443 units or 90 u n its 2.50

1,000 units / year d = = 2.74 units / day 365 days / year

_

R eo rd er p o in t, R = d L = 2 .7 4 u n its / d ay (7 d ays) = 1 9 .1 8 o r 2 0 u n its

In summary, you place an optimal order of 90 units. In the course of using the units to meet demand, when you only have 20 units left, place the next order of 90 units.

EOQ Example (2) Problem Data

Annual Demand = 10,000 units Days per year considered in average daily demand = 365 Cost to place an order = $10 Holding cost per unit per year = 10% of cost per unit Lead time = 10 days Cost per unit = $15
Determine the economic order quantity and the reorder point.

EOQ Example (2) Solution

Q OPT = 2D S = H 2 (1 0 ,0 0 0 )(1 0 ) = 3 6 5 .1 4 8 u n its, o r 3 6 6 u n its 1 .5 0

10,000 units / year d= = 27.397 units / day 365 days / year

_

R = d L = 2 7 .3 9 7 u n its / d ay (1 0 d ays) = 2 7 3 .9 7 o r 2 7 4 u n its

Place an order for 366 units. When in the course of using the inventory you are left with only 274 units, place the next order of 366 units.

Continuous Review System

Assumption of constant demand is relaxed. Monitoring of on hand stock position in a continuous system Q system (another name for continuous review system)

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A Continuous Review (Q) System

R = Reorder Point Q = Order Quantity L = Lead time 22

Probability Distribution of Demand over Lead Time

m = mean demand

R = Reorder point

s = Safety stock

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Periodic Review System

All assumption of EOQ (except that demand is constant and no stockout) remains in effect. Also known as P System or Fixed-orderInterval System

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A Periodic Review (P) System

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Time Between Orders (P) and Target Level (T) Calculation

2S P iC D

T m' s'
Where: m = average demand over P+L s = safety stock 26

Using P and Q System in Practice

Use P system when orders must be placed at specified intervals. Use P systems when multiple items are ordered from the same supplier (jointreplenishment). Use P system for inexpensive items.

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Service Level versus Inventory Level

105% 100% 2.5 1.7 2.4 2.1 2.2 2.3 2.0 1.8 1.9

ervice Level (%) S

95% 90% 1.2 85% 1.0 80% 75% 1.1 1.3 1.4 1.5

1.6

z values

Q 100

150 160 170 180 190 200 210 220 230 240 250 260 270 280 290 300

100

Average Inventory Level

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Special Purpose Model: Price-Break Model Formula

Based on the same assumptions as the EOQ model, the price-break model has a similar Qopt formula:
QOPT = 2DS 2(Annual Demand)(Or der or Setup Cost) = iC Annual Holding Cost

i = percentage of unit cost attributed to carrying inventory C = cost per unit Since C changes for each price-break, the formula above will have to be used with each price-break cost value.

Price-Break Example Problem Data (Part 1)

A company has a chance to reduce their inventory ordering costs by placing larger quantity orders using the price-break order quantity schedule below. What should their optimal order quantity be if this company purchases this single inventory item with an e-mail ordering cost of $4, a carrying cost rate of 2% of the inventory cost of the item, and an annual demand of 10,000 units? Order Quantity(units) Price/unit($) 0 to 2,499 $1.20 2,500 to 3,999 1.00 4,000 or more .98

Price-Break Example Solution (Part 2)

First, plug data into formula for each price-break value of C.
Annual Demand (D)= 10,000 units Cost to place an order (S)= $4

Carrying cost % of total cost (i)= 2% Cost per unit (C) = $1.20, $1.00, $0.98

Next, determine if the computed Qopt values are feasible or not.

Interval from 0 to 2499, the Qopt value is feasible. Interval from 2500-3999, the Qopt value is not feasible.

QOPT = QOPT =

2DS = iC 2DS = iC 2DS = iC

2(10,000)( 4) = 1,826 units 0.02(1.20) 2(10,000)( 4) = 2,000 units 0.02(1.00) 2(10,000)( 4) = 2,020 units 0.02(0.98)

Interval from 4000 & more, the QOPT = Qopt value is not feasible.

Price-Break Example Solution (Part 3)

Since the feasible solution occurred in the first price-break, it means that all the other true Qopt values occur at the beginnings of each price-break interval. Why?
Total annual costs

Because the total annual cost function is a u shaped function. So the candidates for the price-breaks are 1826, 2500, and 4000 units.

1826

2500

4000

Order Quantity

Price-Break Example Solution (Part 4)

Next, we plug the true Qopt values into the total cost annual cost function to determine the total cost under each price-break.

D Q TC = DC + S+ iC Q 2
TC(0-2499)=(10000*1.20)+(10000/1826)*4+(1826/2)(0.02*1.20) = $12,043.82 TC(2500-3999)= $10,041 TC(4000&more)= $9,949.20 Finally, we select the least costly Qopt, which is this problem occurs in the 4000 & more interval. In summary, our optimal order quantity is 4000 units.

Miscellaneous Systems Optional Replenishment System

Maximum Inventory Level, M

q=M-I Actual Inventory Level, I I Q = minimum acceptable order quantity

If q > Q, order q, otherwise do not order any.

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Miscellaneous Systems Bin Systems

Two-Bin System Order One Bin of Inventory

Full

Empty

One-Bin System

Order Enough to Refill Bin

Periodic Check
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ABC Inventory Management

Based on Pareto concept (80/20 rule) Classification of items as A, B, or C Example (See Table)

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Annual Usage of Items by Dollar Value

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%

Item 1 2 3 4 5 6 7 8 9 10 Total

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ABC Chart
45.0% 40.0% 35.0% 120.0%

30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 3 6 9 2 4 1 10 8 5 7 Item No. Percentage of Total Dollar Usage Cumulative Percentage

80.0% 60.0% 40.0% 20.0% 0.0%

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Cumulative % Usage

100.0%

Percent Usage

Inventory Accuracy and Cycle Counting

Inventory accuracy

Do inventory records agree with physical count?

Cycle Counting

Frequent counts

Which items? When? By whom?

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