INVENTORY

MANAGEMENT

2-508-97 Production and Operations Management Copyright 2006 John Wiley & Sons, Inc. 1
 Inventory Management : Introduction

Operations :
Marketing : stocks in sufficient
Level of service quantities

Inventory
Management Finance :
Cash flow and
Cost of money
Information Systems :
Inventory control Judicial Aspects :
systems Ownership and
responsibility
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 Types of Inventories

 Raw materials

 Components (purchased parts)

 Partially completed goods: work in progress (WIP)

 Finished Goods

 M.R.O. (Maintenance, Repairs and Operating supplies)

Independent versus dependent demand

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 Functions of Inventory
 To meet anticipated demand (make-to-stock)

 In-Transit inventory: goods being transported

 To take advantage of order cycles or to take advantage of

quantity discounts (cycle stock)

 To protect against stock-outs (safety stocks)

 To smooth production requirements (seasonal inventories)

 To decouple production and distribution (WIP buffers)

 To help hedge against price increases (speculative
inventories)
 Strategic flooding (?)
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 Independent versus Dependent Demand
Independent
demand

A
Chair

B (1) C (1) D (2) E (4)

Back Seat Front Leg
subassembly subassembly legs supports
Dependent
demand

F (2) G (4) H (1) I (1)

Back Back Seat Seat
legs slats frame cushion

J (4)
Seat-frame
boards

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 Inventory Related Costs

 Acquisition Cost

 Holding (carrying) Cost

 Ordering (set-up) Cost

 Shortage Cost

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 Acquisition Cost

 Price paid to acquire the product.

 Can be subject quantity discounts

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 Holding (Carrying) Cost

 Total holding cost is composed of a multitude of costs

which vary depending on the type of product stocked.

 It includes:
 Cost of money / opportunity cost (3-24%)
 Obsolescence (2-20%)
 Spoilage / Damage (1-5%)
 Warehousing (1-3%)
 Insurance / Administration / Maintenance (1-5%)

 Total ~ 8-50% (12↔24%)

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 Ordering Cost

 Order processing

 Supplies / Forms

 Clerical support

 Receiving / Inspection

 Follow up / Expediting

 For manufacturing
 Clean-up cost
 Re-tooling cost
 Adjustment cost

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 Shortage Cost

 Reputation of the company;

 Loss of orders / profits
 Increase in the costs:
Overtime/ sub-contracting
Additional delivery
Purchasing price premium
Idle machinery and human resources
Etc…

IMPACT ON THE CUSTOMER...

DIFFICULT TO DETERMINE
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 Inventory Models

Two questions:
How Much to order?
When to order ?

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 Basic Economic Order Quantity (EOQ):
Principles
 Assumptions of the basic EOQ model

Only one product is involved

Annual demand requirements are known
Demand is spread evenly throughout the year (constant
demand rate)
Lead time does not vary
Each order is received in a single delivery
There are no quantity discounts

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 Criticisms of EOQ

 Successfully applied to many environments (where the

underlying assumptions reasonably hold)
E.g. used in setting lot sizes in batch manuf.
environments, MRP type systems, managing input
buffers, etc.
 Simple system illustrating the economic trade-off between
setups, inventory, demand.
 Too simplified?
Stable and known demand
Independent products (ignores resource constraints)
Setup costs are hard to estimate (True cost of a setup
depends on the capacity utilization)
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 Introducing Lead Times

Profile of Inventory Level Over Time

Q Demand

rate
Quantity
on hand

Reorder
point

Time
Receive Place Receive Place Receive
order order order order order

Lead time

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 Insights

 Fixed order cost reduction & JIT

Lowering fixed costs results in smaller order quantities
and reduced inventory and flow time.
 Square root effect:
Quadrupling outflow rate will only double the EOQ (and
inventory and flow time)
Inventory growth should not track sales growth
proportionally!
100% increase in demand requires a 41% increase in
cycle inventory (but order more frequently)
 Centralization

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 Economic Production Quantity (EPQ)

 Production done in batches or lots

 Capacity to produce a part exceeds the part’s usage
or demand rate
 Assumptions of EPQ are similar to EOQ except orders
are received incrementally during production

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 The challenge of inventory management
Managers must avoid these
two traps

Too much stock Not enough stock

(overstock) (shortages)

• Very costly (warehousing, insurance, • Increased risks of stock-outs

staff, etc...) ; causing production delays;

• Immobilization of funds ; • Disruptions in the operations

(bottlenecks, overtime, rushes) ;
• May cause cash-flow problems ;
• Causes delays and shortages and
• Increased risks of deterioration or increased lead times to customers.
obsolescence of products;

• May cause sales below cost.

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