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PRESENTATION ON APPLIED OPERATION RESEARCH

By : Srinath N For: NSB-NIILM School of Business - 4th Semester

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Session Plan
What is Inventory/Inventory Mgnt ? What are the types of Inventory Inventory Cost Models in Inventory Mgnt EOQ with shortage and with shortage Optimum Stock, Buffer Stock.
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Objective of this class ,after reading the present module, learner will be able to:
Overall Objectives: Understand the concept of Inventory Mgnt Know Phases and Process of Inventory Mgnt Specific Objectives: Define basic terms related with Inventory. Define types of Inventory Why is inventory cost so important in organization point of view. How to drive optimum inventory . What are the problem in Inventory . Techniques used in Inventory Mgnt .

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Hello Every one, this is third Unit/module in Applied Operations Research for Management . In government the use of Applied operations research has spread from military to widely varied departments at all levels. Availability of faster and flexible computing Systems & the number of qualified OR professionals has enhanced the acceptance and popularity of the discipline. The growth of OR has not been limited to the USA and the UK, now it has reached to many countries including India. India was one of the first few countries who started using OR. In 1949, the first OR unit was established in the Regional Research Laboratory at Hyderabad. Today, OR is a popular subject in management, mechanical engineering and the mathematics. The knowledge of OR is very essential not just for placement but also for career growth. This is first module defines Operations Research and gives a brief historical background of it. It also gives insight into the approaches and tools of OR and identify the application areas in which OR has used successfully.

All The Best for this wonderful Journey

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MOTIVATION FOR STUDYING INVENTORY MANAGEMENT

Economics involved in producing or purchasing in batches Uncertainty in both demand and supply Seasonality in demand pattern Availability of different Transportation and Distribution modes

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Introduction & importance of Inventory

Inventory is defined as Store/stock of goods .It is an idle resource of an organization . Vital part of business Dollar value of inventory carried by different type of firm vary widely. Typical a firm might have 30% of its current assets and perhaps as much as 90% of working capital invested in inventory. Since Inventory represent significant portion of total assets a reduction in inventory will result in increase in ROI . Eg Retail, Wholesale business Effective and efficient management is imperative to avoid unnecessary investment Improper inventory management affects long term profitability and may fail ultimately 10 to 20% of inventory can be reduced without any adverse effect on production and sales by using simple inventory planning and control techniques

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Reasons To Hold Inventory

Help in smooth and efficient running of business. Provide adequate service to the customer. Helps in minimizing going out of stock.
Meet variations in customer demand:
Meet unexpected demand Smooth seasonal or cyclical demand

Acts as buffer stock when materials are arrived late.

upsets in parts of or our own processes delays in incoming goods

Pricing related:
Temporary price discounts Hedge against price increases Take advantage of quantity discounts

1/19/2012

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Types of Inventory

Work in process
Vendors

Raw Materials Work in process

Work in process

Finished Customer goods

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Nature of Inventories
Raw Materials
Basic inputs that are converted into finished product through the manufacturing process Semi-manufactured products need some more works before they become finished goods for sale

Work-in-progress

Finished Goods Completely manufactured products ready for sale Supplies Office and plant cleaning materials not directly enter
production but are necessary for production process and do not involve significant investment.

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Types of Inventory

Manufacturing or purchasing an item at a rate higher than its consumption rate, to reduce set-up/ordering costs. Involves Trade-off between Inventory and setup/ordering costs. Maintaining extra stock over the average requirement to guard against uncertainty. Involves Trade-off between Inventory Investment and Customer Service level

BATCH OR CYCLE STOCK

BUFFER OR SAFTY STOCK ANTICIPATION STOCK

Maintaining extra stock to meet peak season demand. Involves trade-off between Inventory Carrying costs and costs related to changing production levels.

TRANSPORTATION STOCK
Goods-in transit arises because of the necessity of moving material from one place to another. Movement rate Depends on Inventory carrying and Transportation costs

DECOUPLING STOCK
Inventory used to reduce the interdependence of the various stages of production system is know as decoupling inventory .

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Objective of Inventory Management

To maintain a optimum size of inventory for efficient and smooth production and sales operations To maintain a minimum investment in inventories to maximize the profitability Effort should be made to place an order at the right time with right source to acquire the right quantity at the right price and right quality

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Inventory and Quality Management

Customers usually perceive quality service as availability of goods they want when they want them Inventory must be sufficient to provide highquality customer service in TQM

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TECHNIQUES OF OR
Linear programming- It has been used to solve problems involving assignment of jobs to machines, blending, product mix, advertising media selection, least cost diet, distribution, transportation and many others. Dynamic programming- It has been applied to capital budgeting, selection of advertising media, cargo loading and optimal routing problems. Waiting line or queuing theory- It has been useful to solve problems of traffic congestion, repair and maintenance of broken-down machines, number of service facilities, scheduling and control of airtraffic, hospital operations, counter in banks and railway booking agencies. Inventory control / planning- These models have been used to determine economic order quantities, safety stocks, reorder levels, minimum and maximum stock level.

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TECHNIQUES OF OR
Decision theory- It has been helpful in controlling hurricuanes, water pollution, medicine, space exploration, research and development projects. Network analysis (PERT& CPM)- These techniques have been used in planning, scheduling and controlling construction of dams, brides, roads and highways and development & production of aircrafts, ships, computers etc. Simulation- It has been helpful in a wide variety of probabilistic marketing situations. Theory of replacement- It has been extensively employed to determine the optimum replacement interval for three types of replacement problems: i) Items that deteriorate with time. ii) Items that do not deteriorate with time but fail suddenly. iii) Staff replacement and recruitment.

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Holding the right amount at the right time is difficult! Dell Computer s was sharply off in its forecast of demand, resulting in inventory write-downs 1993 stock plunge Liz Claiborne s higher-than-anticipated excess inventories 1993 unexpected earnings decline, IBM s ineffective inventory management 1994 shortages in the ThinkPad line Cisco s declining sales 2001 $ 2.25B excess inventory charge

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Inventory Cost
Purchase cost = price * Demand Ordering cost = Cost per order* No of order in the planned period Carrying cost = Cost of one unit of item in the inentory for given length of time *avr no of units of items carried in inventory Shortage cost = Cost of being short of one unit * Avr no of units short Total Inventory Cost= Purchase cost + ordering cost + carrying cost+ Shortage Cost.

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Inventory problem Analysis

Relevant Inventory cost Demand for Inventory items Replenishment Lead time Length of planning Constraint on inventory system
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Inventory turn over = Annual Sale/ Avr Inventory. For Wal-Mart Inventory turn over is high. Inventory control policy or system Periodic System & continuous System ( T ,S policy & T ,s ,S policy) ( s, S policy & s R policy)

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ABC Classification
Class A
5 15 % of units 70 80 % of value
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Class B
25 % of units 15 % of value

Class C
50 60 % of units 5 10 % of value

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ABC CLASSIFICATION

SELECTIVE CONTROL OF MATERIALS ABC ANALYSIS Classification of all consumption items, based on the Consumption Value . If Annual Demand = D units Cost per unit =Rs.C Then, Consumption value = Rs.(DxC). Based on this, Inventory of a number of items can be separated into A, B and C classes.

A Items: Those relatively few items that account for high consumption value (CV), say,15% of the items accounting for 70% of the consumption value. B items: say,25% of the items, accounting for 20% of the consumption value. C items: Bulk of the items, say,60%, that account for 10% of the consumption value
ABC CLASSIFICATION EXAMPLE: Annual Usage/CV(Rs) 1. 39400 2. 30500 3. 10900 4. 9800 5. 3800 6. 2000 7. 1800 8. 800 9. 600 10. 400 Cum.Usage 39400 (39.4%) A 69900 (69.9%) A 80800 (80.8%) B 90600 (90.6%) B 94400 (94.4%) B 96400 (96.4%) C 98200 (98.2%) C 99000 (99.0%) C 99600 (99.6%) C 100000 (100%) C

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ABC CLASSIFICATION Example problem

Item no 8 5 3 2 1 4 16 5 11 9 7 8 Annual Demand 1000 3900 1900 1000 2500 1500 400 500 8000 100 200 9000 Unit cost 4000 700 500 915 330 100 300 200 10 70 210 2

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Bin systems
Two-Bin - quantity stock in bin 2 = re-order level
Full Empty Order one bin

One-Bin (periodic check)

Order enough to refill bin? ROQ Options Keep order costs to a minimum? Order one year's supply in one go? OR

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Optimisation = Efficiency + Savings

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Kellogg s
The largest cereal producer in the world. LP-based operational planning (production, inventory, distribution) system saved $4.5 million in 1995.

Procter and Gamble

A large worldwide consumer goods company. Utilised integer programming and network optimization worked in concert with Geographical Information System (GIS) to re-engineering product sourcing and distribution system for North America. Saved over $200 million in cost per year.

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Hewlett-Packard
Robust supply chain design based on advanced inventory optimization techniques. Realized savings of over $130 million in 2004
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INVENTORY CONTROL MODELS Model without price Discount Model with price Discount

DETERMINISTIC Demand

PROBABILISTIC Demand

STATIC/ UNIFORM

DYNAMIC/ VARIABLE

Variable Demand with constant lead time Model with no shortage Model with shortage Fixed order Qty with variable lead time Fixed interval ordering model with variable lead time

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Economic Order Quantity (EOQ) Assumptions Demand Uniform Lead time is Instantaneous Production Rate is infinite Shortage not allowed Holding cost Cc/qty unit per time Set up cost Co per time setup.

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EOQ Cost Model without shortage

Co - cost of placing order Cc - annual per-unit carrying cost perAnnual ordering cost = Annual carrying cost = CoD Total cost = Q Cc Q + 2 D - annual demand Q - order quantity CoD Q Cc Q 2

Copyright 2006 John Wiley & Sons, Inc.

12-26

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EOQ Cost Model

Deriving Qopt CoD C cQ TC = + Q 2 CoD xTC = + Q2 xQ Cc 2 Proving equality of costs at optimal point CoD C cQ = Q 2 Q2 2CoD = Cc 2CoD Cc

C 0D Cc 0= + Q2 2 Qopt = 2CoD Cc

Qopt =

Copyright 2006 John Wiley & Sons, Inc.

12-27

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EOQ Aim = Cost Minimisation

Annual cost ($) Slope = 0 Minimum total cost Carrying Cost = CcQ 2 Total Cost

Ordering Cost =

CoD Q

Optimal order Qopt

Copyright 2006 John Wiley & Sons, Inc. 12-28

Order Quantity, Q

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Formula to Remember
2D.Co Optimum Order Qty or Lot Size No of order to be placed in a year Cc

Q*opt =

Orders per year = D/Qopt

Optimal length of time b/w orders = 2 *Co / D*Cc ( Sqrt of 2* Setup cost / Demand * carrying cost Total annual inventory cost= 2* annual Demand* ordering cost*carrying cost

Manufacturing Model with No shortage

D.Co P- D P 2Cc P Q*opt = 2D.Co Cc P- D

N* =

Optimum production Run /Yr Optimum Lot Size 2Co 2Cc.D P P- D P- D P

Optimum Length of Each lot = Size Production run ( t*)

Total Min Production Inventory Cost= 2* D*Co*Cc

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EOQ Model with out Shortage or EOQ Example

The production Dept requires 3600Kg of raw materials fro manufacturing items it has been estimated cost of placing order is Rs 36 and carrying cost is 25% of investment in inventory . The price is Rs 10 per Kg .the purchase manager want to determine the ordering policy for raw materials.

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Solution. D= 3600 Co = Rs 36 per order Cc= 25% of investment in inventories ( 25% of 10 Rs =2.50)
Q*opt = 2CoD = Cc
2*36*3600/2.50

=321.99 Kg Per order

Order Cycle = Q */D = 321.99 /3600= .894 Total Variable cost = 2* annual Demand* ordering cost*carrying cost = 2*3600*36*2.50 = Rs804.98 Total Cost = TVC +DC = 805+ (3600*10 ) = Rs36805

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EOQ Solution
Q eoq = 2DCo = Cc 2(1,000 )(10) 2.50 = 89.443 units or 90 units

1,000 units p.a. d = = 2.74 units/day 365 days p.a.

Reorder point D L = 2.74 units/day = 19.18 or 20 for 7 day lead time

EOQ order = 90 units. When only 20 units left, place next order for 90 units.

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EOQ and ROQ example 2

Annual Demand = 10,000 units Days per year considered in average daily demand = 365 Cost to place an order = Rs10 Holding cost per unit per year = 10% of cost per unit Cost per unit = Rs15 Lead time = 10 days

2DCo Q eoq = Cc =

2(10,000)(10) 1.50 = 365.148 (366 units)

10,000 units/year D= 365 days

= 27.397 units/day

If lead time = 10 days, ROL= 273.97 = 274 units Place order for 366 units. When 274 left, place next order for 366.

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EOQ example
The Annual Demand is 3200units.the unit cost is Rs 6 and inventory carrying cost is 25% .if one procurement is Rs 150 the det. Assume the demand is for one yr. i)EOQ ii) No of order in yr iii) the optimal cost iv) time required b/w 2 consecutive order The Annual Demand is 12000units/yr .The set up cost per run is Rs 350and holding cost is Rs .20Per unit per month . Assume the no shortage and replacement is instantaneous . Det . i)optimum Lot size ii) the optimal run size iv) Min Total Expected annual cost. The Annual requirement is 3000 units/yr .The ordering cost is Rs 100/order the cost per unit is Rs 10. the carrying cost is 30% of unit cost .. Det . i) EOQ , suppose the order cost is brought down to Rs 80/ order. But the same qty determined above has to be order ii) find new EOQ using the ordering cost of Rs 80 what would be the saving cost for the firm

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2DCo Q eoq = Cc =

2(3200)(150) 1.50 = 800 units

Orders per year = D/Qopt =3200/800 = 4 order/yr . time required b/w 2 consecutive order = 1/ 4 Yr ie ( 25/100 per annual) Total Variable cost = 2* annual Demand* ordering cost*carrying cost = 2*3200*150*1.50 = Rs 1272.79 1200

the optimal cost = Demand* unit cost materials + TVC the optimal cost = (3200*6)+1200 = Rs 20400

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2DCo Q eoq = Cc =

2(12000)(350) 2.4 = 1870 units

Optimum Scheduling = 1870/12000 = 1870*12/12000 =1.87 month ( time b/w 2 consecutive orders ) . the optimal cost = 2*Demand* setup cost * holding cost the optimal cost = 2*12000*350*2.4 =Rs 4490/yr

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2DCo Q eoq = Cc =

2(3000)(100) 3 = 447 units

No of order 3000/447 = 6.77 approx to 7 orders . the optimal cost = 2*Demand* setup cost * holding cost the optimal cost = 2*3000*100*3 =Rs 1341/yr 2DCo Q** = eoq Cc = 2(3000)(80) 3 = 400 units

No of order 3000/400 = 7.5 approx to 8 orders the optimal cost = 2*Demand* setup cost 8 holding cost . the optimal cost = 2*3000*80*3 =Rs 1200/yr Total inventory cost = D/Q** * Co+ Q** /2* Ch=(8*80+(400/2)*3) =1240 Total Saving in cost is 1240-1200 =Rs 40 or 0.4 %

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EOQ Example Manufacturing

The items are produced at a rate of 50Units/Day. The Demand occurs at the Rate of 25 items per day. Setup cost is Rs 100/run (.01/unit of item) per day. i)Economic lot Size ii) Lot size for one run iii) Find run of cycle and mim cost per run. The Demand is 12000 units per yr for items it can produce 200 units per month. One time Setup cost is Rs 400/run and holding cost per unit per month is .015/unit. i)Economic lot Size ii) Max Inventory Manufacturing time * total time

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Safety Stock
Quantity

Maximum probable demand during lead time Expected demand during lead time

ROP Safety stock reduces risk of stockout during lead time

12-42

Safety stock
LT Time

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EOQ Cost Model with shortage Formula to Remember

2DCo Cc+Cs = Optimum Order Qty or Lot Size or Economic qty order. Cs Cc+Cs

Q*

opt

Cc

Cs

2DCo Optimum Stock level M* = Ch

Cc Optimum Shortage level = R*= Q* Cc+Cs Cc +Cs Cs Cs Cc+Cs

Total Cycle time= Q*/ D =

2*Co D*Cc

Optimum Cost (TVC ) = 2 .D.Co.Ch

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EOQ Example with shortage Purchasing & Manufactuirng

The Demand is deterministic & constant and is equal to 600 units per yr The unit cost is Rs 50 while the cost of placing the order is Rs 5 the inventory carrying cost is 20 % of Cost of inventory, the cost of shortage is Rs 1 per month . FIND Optimal Order qty , when stock out is permitted . If stock out is not permitted what is the loss for the company ? The Demand in the company is 18000/Yr .Items at rate of 3000 Per month. One time Setup cost is Rs 500/run and holding cost per unit per month is .015/unit. The shortage cost is Rs 20 for one unit per yr. Det i) Economic lot Size & No of shortages ii) Manufacturing time &time b/w Set up.

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Solution : D= 600 units Co = Rs 5 , Cc = 20% of Rs 50 , Cs = Rs 1 per unit the for 12 month Rs 12. = (2*600*5/10) ( 10+12/12 ) =33 units

2DCo Cc+Cs

Q*opt =

Cc

Cs

Max no of back order = q*( Cc/ Cc + Cs) =33 * (10 /10+12) =15 units Yearly Cost = (2.D.Co.Cc ) ( Cs/ (Cc+Cs) = (2*600*10*5 ) (12/10+12) =181 If the Stock out not permitted then Q* = (2. D.C0/Cc) =24.5 units Cost will be = (2. D.Co.Cc) =245 The a cost when back ordering or stock not permitted = 245-181 = Rs64 .

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