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Supply Chain Management (SCM) Inventory management

Dr. Husam Arman

18/10/2009

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Today’s Outline

Inventory (system): What?Motivation for holding inventoriesCharacteristics of inventory systemsTypes of inventory Inventory costsIdentifying critical inventory items The EOQ model Overview of inventory policies P, Q and hybrid systems

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Inventory System

Inventory is the stock of any item of resource used in an organization and can include: raw materials, component parts, supplies, work-in-process and finished goodsAn inventory system is the set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be?

To summarize; Purposes of Inventory

1. To maintain independence of operations.

2. To meet variation in product demand.

3. To allow flexibility in production scheduling.

4. To provide a safeguard for variation in raw material delivery time.

5. To take advantage of economic purchase-order size.

E(1)

Independent vs. Dependent Demand

Independent Demand (Demand not related to other items or the final end-product)

Dependent Demand

(Derived demand items for

component parts, subassemblies, raw materials,

etc.)

Types of InventoryCycle Inventory

The portion of total inventory that varies directly with lot size (Q)

Safety Stock Inventory

Surplus inventory that a company holds to protect against uncertainties in demand, lead time and supply

Anticipation Inventory

Inventory used to absorb uneven rates of demand or supply

Pipeline Inventory

Inventory moving from point to point in the material system

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Characteristics of inventory systemsDemand

Constant Vs. VariableLead time

External order: time between placement of an order until arrival of goods

Internal production: amount of time required to produce a batch of items

Lead time can be deterministic or randomReplenishment

How does the order arrive? uniform over time, instantaneous batches

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Characteristics of inventory systems

Review time Continuous review: inventory level is known at all times Periodic review: inventory level is known only discrete

points in timeExcess demand

Back ordering: excess is satisfied in the future Lost sales: excess demand is lost

Changing inventory Inventory may change over time: limited shelf life

(perishable good –food), obsolescence (e.g. automotive parts)

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Inventory costs

Optimization criterion: cost minimizationHolding (carrying) cost

Cost of storage, handling, tax / insurance, breakage deterioration, obsolescence, opportunity cost of alternative investment (cost of capital) etc.

Proportional to the amount of inventory on hand Dimension: $ per unit per year

Setup (production change-over) or ordering cost Cost of arranging specific equipment setups or

someone placing an orderPenalty (shortage or stock-out) costs

Lost sales, loss of goodwill

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Identifying critical inventory items (ABC analysis)

Homework - 2

Q 3 page 628, demonstrate graphically

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The EOQ ModelEOQ = Economic Order QuantitySimplest, most fundamental model, basis for more complex models Trade-off: fixed order costs and holding costs One of the oldest and most well known inventory control techniquesEasy to useBased on a number of assumptions!

Assumptions; 1. Constant demand rate 2. No constraints on lot size3. Only relevant costs are holding and

ordering/setup4. Decisions for items are independent from

other items5. No uncertainty in lead time or supply

The EOQ Model

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The EOQ Model

Averagecycleinventory

Q

Q—2

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The EOQ Model

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The EOQ Model

S Q

D H

2

Q = C

Total Annual Cost =Annual

OrderingCost

AnnualHolding

Cost+

C = Total annual costD = DemandQ = Order quantityS = Cost of placing an order or setup cost

H = Annual holding and storage cost per unit of inventory

Two Methods for holding cost

Holding cost (H) can be expressed either:1. As a fixed cost, such as

H = $0.50 per unit per year2. As a percentage of the item’s purchase cost

(P) H = I x PI = a percentage of the purchase cost

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The EOQ Model

S Q

D H

2

Q = C

How can we find EOQ? From above

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The EOQ Model

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The EOQ Model

Have a look at example 13.2, page 604

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Overview of inventory policiesTwo basic questions:

Q1: When should we order (or produce)? Q2: How much?

Typical answers to Q1:When inventory level is equal (or below) a level

REvery P time units

Typical answers to Q2: Order or produce Q units Order or produce such that the inventory level T

Models: Continuous review: (R, Q) Periodic review: (P, T, Q)

Continuous Review (Q) System

• Tracks inventory after every withdrawal– Determines if re-order (R) is necessary

• Fixed Order Quantity (Q)

• Inventory Position (IP) considers:• Scheduled Receipts (SR)

• On-Hand Inventory (OH)

• Backorders (BO)

Periodic Review (P)

• Time between orders is fixed, P• Quantity changes to meet needs• Stock positions are restored on pre-

determined dates to (T) Target Inventory Level • When the order arrives (IP) and (OH) are

identical

Comparison of Q and P SystemsP SystemsQ Systems

Idle state

Demand occurs

Compute IP

Idle state

Demand occurs

Compute IP Reorder point?

Review time?

Compute Q needed for T

Issue order; Q

Issue order; Q

Comparison of Q and P Systems

P Systems· Convenient to

administer as fixed interval

· Orders may be combined

· IP only required at review

Q Systems· Individual review

frequencies· Possible quantity

discounts as fixed Q· Lower, less-

expensive safety stocks

Q System – recording point Inv. Position = on hand inv. + scheduled receipts – backorders

IP = OH + SR - BO

Reorder Point (ROP)

ROP = d x LWhere; d = demand and L = lead timed and L are certain

If demand and lead time is not certain we need to use Safety Stock

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Q System- when demand and lead time are constant and certain

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Q System- when demand and lead time are uncertain

Finding the safety stock using service level policy

Finding the safety stock using service level policy

LZ

If cycle service level is 85%, then probability of stock out is 15%

Safety stock

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Have a look at example 13.5 page 612

Finding the safety stock using service level policy

Q review system – total costs

L z HS Q

D H

2

Q = C

Q review system – total costs

Have a look at example 13.6 page 614

Visual system

Two-Bin System

Full Empty

Order One Bin ofInventory

One-Bin System

Order Enough toRefill Bin

R

R

Periodic review (P) system We need to calculate;1. Time between reviews, P2. Target inventory level, T P = EOQ / D (years) T = d (P + L) + safety stock for protection interval Where d = demand during P + LSafety stock =

LPZ

LPt LP

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P System

P review system – total costs

LP z HS Q

D H

2

Q = C

LP z HS Q

D H

2

dP = C

P review system – total costs

Have a look at example 13.8 page 617

Hybrid System

Hybrid System: Base-stock levelSystem

Very simple system Issue a replenishment order with a quantity equal to the withdrawal one This will maintain the IP at a base-stock level Expensive items (e.g. aero engine) Just-in-time

Hybrid System: Optional Replenishment System

Maximum Inventory Level, M

MActual Inventory Level, I

q = M - I

I

Q = minimum acceptable order quantity

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

Do you remember the P system?

Inventory Accuracy and Cycle CountingDefined

• Inventory accuracy refers to how well the inventory records agree with physical count.

• Cycle Counting is a physical inventory-taking technique in which inventory is counted on a frequent basis rather than once or twice a year. (e.g. class A in particular)