Inventory Management

1. Inventory Management

2. INVENTORY Inflow > Outflow Inflow < Outflow INVENTORY Inflow = Outflow INVENTORY The Law of the Bath Tub

3. Allows quick response to customer demands Balancing supply and demand Protection from uncertainties Buffer interface • Realizes economies of scale through reduction of fixed costs • Keeps productionline running • Supports longproductionruns Arguments forCarrying Inventory

4. May become obsolete Can be damaged or deteriorate May be hazardous to store May take up excessive W/H space Could be totally lost or hidden Opportunity Cost Could be duplicated at different W/H Disadvantages forCarrying Inventory

5. Inventory Management Types of Inventory Cycle stock In-process or work-in-process In-transit inventory Safety stock or Buffer inventory Seasonal stock Promotional stock Speculative stock Dead stock Consignment stock [held in customers W/H, but charged when is used]

6. Inventory Management Symptoms of Poor Inventory Management[4] • An increase in backorders • More cancelled customer orders • Insufficient storage space • Unnecessary obsolete products

7. Inventory Management Financial Impact of Inventory [3] • Inventory is often a company’s largest asset • Inventories can account for 20% of total assets • Inventory costs may run up to 40- 50% of the value of a product and ~ 40% of total integrated logistics costs

8. Inventory Management Definitions • 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

9. How to Measure Inventory • The Dilemma: closely monitor and control inventories to keep them as low as possible while providing acceptable customer service. • Average Aggregate Inventory Value: how much of the company’s total assets are invested in inventory? • Ford: 6.825 billion • Sears: 4.039 billion

10. Formulas for Measuring Supply-Chain Performance • One of the most commonly used measures in all of operations management is “Inventory Turnover” • In situations where distribution inventory is dominant, “Weeks of Supply” is preferred and measures how many weeks’ worth of inventory is in the system at a particular time

11. Inventory Measures - Examples • Weeks of Supply • Ford: 3.51 weeks • Sears: 9.2 weeks

12. Inventory Measures - Examples • Weeks of Supply • Ford: 3.51 weeks • Sears: 9.2 weeks • Inventory Turnover (Turns) • Ford: 14.8 turns • Sears: 5.7 turns • GM: 8 turns • Toyota: 35 turns

13. Example of Measuring SC Performance Suppose a company’s new annual report claims their costs of goods sold for the year is $160 million and their total average inventory (production materials + work-in-process) is worth $35 million. This company normally has an inventory turn ratio of 10. What is this year’s Inventory Turnover ratio? What does it mean? Cost of goods sold = Inventory turnover Average aggregate inventory value

14. Example of Measuring Supply-Chain Performance (Continued) = $160/$35 = 4.57 Since the company’s normal inventory turnover ration is 10, a drop to 4.57 means that the inventory is not turning over as quickly as it had in the past. Without knowing the industry average of turns for this company it is not possible to comment on how they are competitively doing in the industry, but they now have more inventory relative to their cost of goods sold than before.

15. Inventory Management Inventory Costs [7] • Cost of placing an order • Price discount costs for large orders or Extra costs for small orders • Stock-out costs • Working capital costs (funding for the lag between paying our suppliers and receiving payment from our customers) • Storage costs • Obsolescence costs • Production inefficient costs [hidden costs not realized JIT]

16. Inventory Management Inventory Costs • Two types: ordering and carrying

17. Inventory Management Ordering Costs [2] • Cost of placing the order • Price discount costs

18. Carrying or Holding Costs [10] • Capital or opportunity cost • Storage space cost • Inventory service cost • Inventory risk cost • Insurance • Storage and handling • Depreciation • Deterioration • Taxes • Interest Inventory carrying cost varies between 10 – 20 % of the product cost.

19. While carrying costs increase, ordering costs fall and vice versa Many orders, low inventory level Q On-hand Inventory Time Q Few orders, high inventory level On-hand Inventory Time

20. Inventory Management OBJECTIVES: To determine the best ordering policy, i.e. • To decide how much, and • when to order HOW MUCH? • Economic Order Quantity [EOQ] model • One of the oldest and most commonly used in inventory control • Based on a number of assumptions

21. Inventory Management EOQ Assumptions • Continuous and known demand rate • Lead time/replenishment cycle is known and constant • Price to purchase is independent of the amount needed • Transportation costs remain constant • No stock outs (or shortages) are permitted • No inventory is in transit • The order quantity is received all at once

22. Q Q Q D D D Instantaneous deliveries at a rate of per period Inventory Management The Inventory Order Cycle Order quantity, Q Average inventory = Slope = Demand rate Steady & predictable demand, D Inventory Level 0 Time

23. Q Average inventory = Slope = Demand rate Steady & predictable demand, D Inventory Level 0 Time Q Q D D The Inventory Order Cycle • Average inventory = Q/D [2 shaded areas are equal] • Time interval between deliveries = Q/D • Frequency of deliveries, N = • reciprocal of the time interval = 1 / [Q/D] = D/Q

24. Annual cost ($) Total Cost Slope = 0 Carrying Cost = Minimum total cost CcQ 2 CoD Q Ordering Cost = Optimal order Qopt Order Quantity, Q EOQ Cost Model

25. C .D C C D C Q .Q o c o c = + TC = Q 2 Q 2 ¶ 2 C D TC C D C 2 o o c = = + Q 2 ¶ C Q 2 c Q 2 C D C D C o o c = = - + Q 0 * 2 C 2 c Q C Q C D 2 C D c * o o = + = TC Q min * Q 2 C * c EOQ Cost Model CO - cost of placing order D - annual demand CC - annual carrying cost/unit Q - order quantity Annual ordering cost = Annual carrying cost = ordering cost x No of orders = holding cost/unit x average inventory = COD/Q = CCQ/2 Total cost = COD/Q + CCQ/2

26. Total Cost curve Annual cost ($) Slope = 0 Minimum total cost Carrying Cost = CcQ/2 Ordering Cost = CoD/Q Optimal order Q* (EOQ) Order Quantity, Q 2 D Co EOQ, Q = Cc EOQ Model Cost Curves Total Costs = Carrying Cost + Ordering Cost Ct = CcQ/2 + CoD/Q

27. Example: Basic EOQ QUESTION The annual demand for a product is 8,000 units. The ordering cost is € 30 per order. The cost of the item is € 10 and the carrying cost has been calculated at € 3 to carry out one item in stock for one year. Calculate: • What is the EOQ? • The numbers of orders to be placed annually, and • The overall costs.

28. 2 C D o = Q * C c 2 (8,000) (30) = 3 = 400 units D 8,000 = = Number of orders per year = 20 orders Total Costs = Carrying Cost + Ordering Cost 400 Q * Holding Costs = Average quantity in stock x Cost of holding item for 1 year = 400/2 x 3 = € 600 Ordering Costs = Cost of ordering x Number of orders = 30 x 20 = € 600 therefore Total Costs = € 600 + € 600 = € 1,200. Example: Basic EOQ D = 8,000 units CO = € 30 CC = €3 ANSWER

29. Example: Basic EOQ Zartex Co. produces fertilizer to sell to wholesalers. One raw material – calcium nitrate – is purchased from a nearby supplier at $22.50 per ton. Zartex estimates it will need 5,750,000 tons of calcium nitrate next year. The annual carrying cost for this material is 40% of the acquisition cost, and the ordering cost is $595. a) What is the most economical order quantity? b) How many orders will be placed per year? c) How much time will elapse between orders?

30. EOQ = 2(5,750,000)(595)/9.00 Example: Basic EOQ • Economical Order Quantity (EOQ) D = 5,750,000 tons/year Cc = .40(22.50) = $9.00/ton/year Co = $595/order = 27,573.135 tons per order

31. Example: Basic EOQ • Total Annual Stocking Cost (TSC) TSC = (27,573.135/2)(9.00) + (5,750,000/27,573.135)(595) = 124,079.11 + 124,079.11 = $248,158.22 Note: Total Carrying Cost equals Total Ordering Cost

32. Example: Basic EOQ • Number of Orders Per Year = D/Q = 5,750,000/27,573.135 = 208.5 orders/year • Time Between Orders = Q/D = 1/208.5 = .004796 years/order = .004796(365 days/year) = 1.75 days/order Note: This is the inverse of the formula above.

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