OML - Inventory MS

Operations Management
Inventory Management
OM Inventory Management
AMAZON.com
Jeff Bezos, in 1995, started AMAZON.com
as a virtual retailer no inventory, no

warehouses, no overhead; just a bunch of
computers.
Growth forced AMAZON.com to excel in inventory management! AMAZON is now a worldwide leader in warehouse management and automation.
2
Order Fulfillment at AMAZON

1.
You order items;, computer assigns your order to distribution center [closest facility that has the product(s)] Lights indicate products ordered to workers who retrieve product and reset light. Items placed in crate with items from other orders, and crate is placed on conveyor. Bar code on item is scanned 15 times virtually eliminating error.
3
2.
3.
Order Fulfillment at AMAZON

4.
Crates arrive at central point where items
are boxed and labeled with new bar code.

5.
Gift wrapping done by hand (30 packages
per hour)
6.
Box is packed, taped, weighed and labeled before leaving warehouse in a truck. Order appears on your doorstep within a week
7.
The Functions of Inventory
To decouple or separate various parts of
the production process
To have a stock of goods that will provide a
selection for customers

To take advantage of quantity discounts
To hedge against inflation and upward price

changes
Disadvantages of Inventory
Higher costs

Item cost (if purchased) Ordering (or setup) cost
Costs of forms, clerks wages etc.
Holding (or carrying) cost
Building lease, insurance, taxes etc.
Difficult to control
Hides production problems
6
Types of Inventory

Raw material Work-in-process (WIP)
Maintenance/repair/operating
supplies (MRO)
Finished goods
7
Inventory Management
Two ingredients of inventory mgmt systems
Classification of inventory items
Basis for establishing inventory policies
Maintenance of accurate inventory records
ABC Analysis

Divides on-hand inventory into 3 classes
A class, B class, C class

$ volume = Annual demand x Unit cost A (70%-80% of total annual $ volume); B (1525%), C (5%)
Basis is usually annual $ volume
Other criteria could include
Delivery problems Quality problems High unit cost

9
Classifying Items as ABC

% Annual $ Usage
100 80 60 40 20 0 0 50 100
Class A B C
% $ Vol 80 15 5
% Items 15 30 55
A B
C
% of Inventory Items
10
ABC Analysis
Policies then established for each class after analysis
Policies based on ABC analysis could include
Focus more on development of class A
suppliers

Have tighter physical control of A items
Forecast A items more carefully
11
Record Accuracy
Good Inventory policies are meaningless
if mgmt does not know what inventory is

on hand
Incoming and outgoing record-keeping

must be good
Stock-room security must be good

Cycle counting can result in accurate
record keeping
12
Cycle Counting
Continuous audit for verifying accuracy of inventory records Physically counting inventory on a regular basis Used often with ABC classification
A items counted most often (e.g., daily)
Cause of inaccuracies traced and appropriate remedial action taken Does not require the facilities to be shut down for this periodic audit
OM Inventory Management 13
Advantages of Cycle Counting
Eliminates shutdown and interruption of production necessary for annual physical inventories Eliminates annual inventory adjustments
Provides trained personnel to audit the accuracy of inventory

Allows the cause of errors to be identified and remedial action to be taken Maintains accurate inventory records
14
Independent versus Dependent Demand
Independent demand - demand for item is independent of demand for any other item
Demand for cars is independent of demand for white boards
Dependent demand - demand for item is dependent upon the demand for some other item
Demand for car wipers is dependent on demand for cars
15
Inventory Costs
Holding costs - associated with holding or

carrying inventory over time Ordering costs - associated with costs of placing order and receiving goods Setup costs - cost to prepare a machine or process for manufacturing an order
16
Inventory Models

When to order and how much to order Fixed order-quantity models

Economic order quantity
Production order quantity

Quantity discount
Probabilistic models Fixed order-period models

17
EOQ Assumptions
Known, constant and independent demand Known and constant lead time
Instantaneous and complete receipt of material

No quantity discounts Only order (setup) cost and holding cost considered
OM Inventory Management No stock
outs
18
Inventory Usage Over Time

Order quantity = Q (maximum inventory level)
Usage Rate
Minimum inventory 0
Inventory Level
Average Inventory (Q*/2)
Time
19
EOQ Model How Much to Order?

Annual Cost
Minimum total cost
Order (Setup) Cost Curve

Optimal Order Quantity (Q*)
Order quantity
20
Deriving an EOQ
1.
Develop an expression for setup or ordering costs
2. 3. 4.
Develop an expression for holding cost Set setup cost equal to holding cost Solve the resulting equation for the best order quantity
21
Minimizing cost
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
22
The EOQ Model

Annual setup cost = S
D Q
Q Q* D S H
= Number of pieces per order = Optimal number of pieces per order (EOQ) = Annual demand in units for the inventory item = Setup or ordering cost for each order = Holding or carrying cost per unit per year
Annual setup cost =
(Number of orders placed per year) x (Setup or order cost per order)
Setup or order cost per order
Annual demand Number of units in each order
D (S) Q
23
The EOQ model

Annual setup cost = Annual holding cost =
Q Q* D S H
= Number of pieces per order = Optimal number of pieces per order (EOQ) = Annual demand in units for the inventory item = Setup or ordering cost for each order = Holding or carrying cost per unit per year
D Q Q H 2
Annual holding cost = (Average inventory level) x (Holding cost per unit per year)
= Order quantity 2 (Holding cost per unit per year)
Q (H) 2
24
The EOQ model

Annual setup cost = Annual holding cost =
Q Q* D S H
= Number of pieces per order = Optimal number of pieces per order (EOQ) = Annual demand in units for the inventory item = Setup or ordering cost for each order = Holding or carrying cost per unit per year Optimal order quantity is found when annual setup cost equals annual holding cost
2DS = Q2H Q2 = 2DS/H Q* = 2DS/H
D Q Q H 2
Solving for Q*
25
Production Order Quantity Model
Answers how much to order and when to order Allows partial receipt of material no instantaneous receipt of materials
Other EOQ assumptions apply
Suited for production environment

Material produced, used immediately Provides production lot size

26
Lower holding cost than EOQ model
Production order quantity model
Inventory level
Part of inventory cycle during which production (and usage) is taking place Demand part of cycle with no production
Maximum inventory
Time
27
POQ model
Q = Number of pieces per order H = Holding cost per unit per year t = Length of the production run in days p = Daily production rate d = Daily demand/usage rate
Maximum inventory level
Total produced during the production run
Total used during the production run
= pt dt
28
POQ model
Q = Number of pieces per order H = Holding cost per unit per year t = Length of the production run in days
Maximum inventory level =
p = Daily production rate d = Daily demand/usage rate
Total produced during the production run
Total used during the production run
= pt dt
However, Q = total produced = pt ; thus t = Q/p

Maximum inventory level =p Q p d Q p =Q 1 d p Q 1 2 d p
Holding cost =
Maximum inventory level (H) = 2
H
29
POQ model
Q = Number of pieces per order H = Holding cost per unit per year D = Annual demand p = Daily production rate d = Daily demand/usage rate
Setup cost = (D/Q)S Holding cost = 1 HQ[1 - (d/p)]
2
(D/Q)S = Q2
1HQ[1 - (d/p)] 2
= 2DS H[1 - (d/p)] 2DS H[1 - (d/p)]
30
Q* =
p
Quantity Discount Model
Answers how much to order & when to order
Allows quantity discounts
Reduced price when item is purchased in larger quantities
Other EOQ assumptions apply
Trade-off is between lower price &
increased holding cost

Quantity Discount Model

Reduced prices are often available when larger quantities are purchased Trade-off is between reduced product cost and increased holding cost
Total cost = Setup cost + Holding cost + Product cost
TC =
D S+ Q
Q H + PD 2
32
Quantity discount model

A typical quantity discount schedule
Discount Number
Discount Quantity 0 to 999

1,000 to 1,999 2,000 and over
Discount (%) no discount

4 5
Discount Price (P)
1
2 3
$5.00
$4.80 $4.75
33
Quantity discount model

Steps in analyzing a quantity discount
1. For each discount, calculate Q* 2. If Q* for a discount doesnt qualify, choose the smallest possible order size to get the discount 3. Compute the total cost for each Q* or adjusted value from Step 2 4. Select the Q* that gives the lowest total cost
Fixed Period Model
Answers how much to order

Orders placed at fixed intervals
Inventory brought up to target amount
Amount ordered varies

Possibility of stockout between intervals Example: P&G representative calls every 2 weeks
35
No continuous inventory count
Useful when vendors visit routinely
Inventory Level in a Fixed Period System

Various amounts (Qi) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum
Target maximum
On-Hand Inventory
Q1
Q2 Q3 p p p
Q4
Time

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Operations Management

Jeff Bezos, in 1995, started AMAZON.com

as a virtual retailer no inventory, no

Order Fulfillment at AMAZON

Order Fulfillment at AMAZON

Crates arrive at central point where items

are boxed and labeled with new bar code.

Gift wrapping done by hand (30 packages

The Functions of Inventory

To decouple or separate various parts of

the production process

To have a stock of goods that will provide a

selection for customers

To take advantage of quantity discounts

To hedge against inflation and upward price

Item cost (if purchased) Ordering (or setup) cost

Costs of forms, clerks wages etc.

Holding (or carrying) cost

Building lease, insurance, taxes etc.

Raw material Work-in-process (WIP)

Classification of inventory items

Basis for establishing inventory policies

Maintenance of accurate inventory records

Divides on-hand inventory into 3 classes

A class, B class, C class

Basis is usually annual $ volume

Other criteria could include

Delivery problems Quality problems High unit cost

Classifying Items as ABC

Policies then established for each class after analysis

Policies based on ABC analysis could include

Focus more on development of class A

Have tighter physical control of A items

Forecast A items more carefully

Good Inventory policies are meaningless

if mgmt does not know what inventory is

Incoming and outgoing record-keeping

Stock-room security must be good

A items counted most often (e.g., daily)

Advantages of Cycle Counting

Provides trained personnel to audit the accuracy of inventory

Independent versus Dependent Demand

Demand for cars is independent of demand for white boards

Demand for car wipers is dependent on demand for cars

Holding costs - associated with holding or

When to order and how much to order Fixed order-quantity models

Economic order quantity

Production order quantity

Probabilistic models Fixed order-period models

Instantaneous and complete receipt of material

OM Inventory Management No stock

Inventory Usage Over Time

Average Inventory (Q*/2)

EOQ Model How Much to Order?

Minimum total cost

Order (Setup) Cost Curve

Develop an expression for setup or ordering costs

Setup (or order) cost curve Optimal order quantity (Q*)

The EOQ Model

Annual setup cost =

Annual demand Number of units in each order

The EOQ model

The EOQ model

Production Order Quantity Model