INVENTORY IS BAD. DIRECT FINANCIAL EFFECTS Pay money to get Place to Store Equipment to move DAMAGE...

INVENTORY

IS

BAD

• DIRECT FINANCIAL EFFECTSPay money to get

Place to StoreEquipment to move

• DAMAGE - OBSOLESCENCE• INCREASED CYCLE TIME

Less flexibility in manufacturingBullwhip Effect elsewhere

• LOWER QUALITY• ETC.

WHY?

WHY CARRY INVENTORY?• FLUCTUATION INVENTORY - Protect against random changes in demand.

•ANTICIPATION INVENTORIES - Build in off season to meet peak demand

•LOT-SIZE INVENTORIES - To take advantage of economies of scale in production and purchasing

•PIPELINE INVENTORY - Goods in transit between destinations

•WORK-IN-PROCESS - Buffers to cushion effects of breakdowns and to synchronize work rates•Showcase Item

•You don’t buy unless you don’t see it

CONFLICTING DESIRESDEPARTMENT BIAS REASON

MARKETING HIGH (FG) Customer Service

PURCHASING HIGH (RM) Quantity Discounts Low Freight

PRODUCTION HIGH (WIP, RM) Prevent Delays and Idle Capacity

LOW (WIP) Cut Cost & Lead-time Improve Response Time & Quality

FINANCE LOW Improve ROI Reduce Working Capital Needs

TYPES OF INVENTORY

• RAW MATERIALS

• COMPONENTS

• GOODS IN PROCESS

• FINISHED GOODS

• SUPPLIES

TYPES OF DEMAND

• INDEPENDENT (of other items) Uniform (flow from faucet)

Other Continuous<<< EOQ AND RELATED MODELS>>>

• DEPENDENT (on other items) or LUMPY<<< MRP AND LOT SIZING MODELS>>

Andres A. Calderon:

Coffee is independent

Andres A. Calderon:

Coffee is independent

Andres A. Calderon:

if you make cars, you know how many tires you need

Andres A. Calderon:

if you make cars, you know how many tires you need

KEYS TO INVENTORY MANAGEMENT

• DEMAND FORECAST

• INVENTORY STATUS

• ECONOMIC ANALYSIS

TWO BASIC DECISIONS

• WHEN TO REPLENISH?

• HOW MUCH TO ORDER?

BALANCE COSTS

• CARRYING OR HOLDING COST– You see can of paint, but I see stacks of bills

(opportunity cost) – Now suppose you have bread: damage,

obsolescence, insurance– Proportional to the amount carried and time

carried

BALANCE COSTS

• ORDERING COST– Not proportional to amount ordered, does not

include qty discount

• SHORTAGE OR STOCKOUT COST– profit loss of paint sell and paint brush– customer goes to another store, loss of future

business– Difficult to determine

BALANCE COSTS

• COST OF CONTROLLING THE SYSTEM– People counting inventory, check thresholds,

order– Automated ordering system

ECONOMIC ORDER QUANTITY

ASSUMPTIONS

• Single product with demand independent of other items

• Known and uniform demand

• No shortages permitted

• No lead-time

ECONOMIC ORDER QUANTITY MODEL ASSUMPTIONS

• Funds invested in inventory from order arrival to sale.

• Costs considered Carrying cost - Depends on amount and

time carried.– H=$0.50 / unit per year

– Some folks only know the fraction per item cost

ECONOMIC ORDER QUANTITY MODEL ASSUMPTIONS

• Costs considered Ordering cost - Independent of quantity

ordered– S=10/order

– C=items cost

• Infinite horizon

Model

• Average cost per year=H(Q/2)+S(D/Q)+CD– (Q/2) carrying– (D/Q) Average number of orders per year– CD Goods

COST PER “YEAR”

COST = H *(Q/2) + S * (D/Q) + D*C

H = i*C

H = Carrying cost per unit per yearS = Ordering costD = Demand per yearC = Item’s cost per unitQ = Proposed quantity per order I = Carrying cost fraction

ECONOMIC ORDER QUANTITY

Q = SQRT( 2 * S * D / H)

SENSITIVITY

Q = Order Quantity

Q*

Cos

t

Ordering CostCarrying Cost

Total Cost

REORDER POINT

Order When The Amount On Hand And On Order Falls To

ROP = Average Demand During Lead Time + Safety Stock

For a normal distribution:

ROP = L * d-bar + z * s * Sqrt(L)

L = lead time in daysD-bar = average daily demands = standard deviation of daily demandz = number of standard deviations above the mean required to achieve the desired service level.

CYCLE SERVICE LEVEL

• Probability we do not have a stockout during an inventory cycle.

• Probability that we do not run out between order placement and order arrival.

• Stockout based on inventory cycles not customers -- the percentage of customer demand satisfied is much higher.