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Production Planning and Control Inventory Management

Production Planning and Control Inventory Management. Dr. Lotfi K. Gaafar. Production Planning and Control. The Production Control System. Sales and order entry. Demand forecasting. Customer. Shop-floor scheduling and control. Materials requirement planning. Aggregate planning.

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Production Planning and Control Inventory Management

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  1. Production Planning and Control Inventory Management Dr. Lotfi K. Gaafar Production Planning and Control- Inventory Management(1)

  2. Production Planning and Control The Production Control System Sales and order entry Demand forecasting Customer Shop-floor scheduling and control Materials requirement planning Aggregate planning Shipping and receiving Production Inventory management Inventory Vendors Production Planning and Control- Inventory Management(2)

  3. Demand Management • Basic Problem: establish an interface between the customer and the plant floor, that supports both competitive customer service and workable production schedules. • Issues: • Customer Lead Times: shorter is more competitive. • Customer Service: on-time delivery. • Batching: grouping like product families can reduce lost capacity due to setups. • Interface with Scheduling: customer due dates are are an enormously important control in the overall scheduling process. Production Planning and Control- Inventory Management(3)

  4. Why Manage Inventory? • Total $ investment on in inventories is $1.37 trillion (last quarter of 1999) • 34% in Manufacturing • 26% in Retail • 22% in Wholesale • 8% in Farm • 10% in Other 82% of the total Production Planning and Control- Inventory Management(4)

  5. Why Manage Inventory? • In 1998, American companies spent $898 billion in logistics-related activities (or 10.6% of Gross Domestic Product). • Transportation 58% • Inventory 38% • Management 4% • By effectively managing inventory: • Xerox eliminated $700 million inventory from its supply chain • Wal-Mart became the largest retail company utilizing efficient inventory management • GM has reduced parts inventory and transportation costs by 26% annually Production Planning and Control- Inventory Management(5)

  6. Customers, demand centers sinks Field Warehouses: stocking points Sources: plants vendors ports Regional Warehouses: stocking points Supply Inventory & warehousing costs Production/ purchase costs Transportation costs Transportation costs Inventory & warehousing costs Production Planning and Control- Inventory Management(6)

  7. Why Manage Inventory? • By not managing inventory successfully • In 1994, “IBM continues to struggle with shortages in their ThinkPad line” (WSJ, Oct 7, 1994) • In 1993, “Liz Claiborne said its unexpected earning decline is the consequence of higher than anticipated excess inventory” (WSJ, July 15, 1993) • In 1993, “Dell Computers predicts a loss; Stock plunges. Dell acknowledged that the company was sharply off in its forecast of demand, resulting in inventory write downs” (WSJ, August 1993) Production Planning and Control- Inventory Management(7)

  8. Inventory • Where do we hold inventory? • suppliers and manufacturers • warehouses and distribution centers • retailers • Types of Inventory • WIP and subassemblies • raw materials • finished goods • Why do we hold inventory? (Short answer) • Economies of scale • Uncertainty in supply and demand Production Planning and Control- Inventory Management(8)

  9. Why do we hold inventory? • Economies of scale • Uncertainty in supply and demand • Speculation • Transportation • Smoothing production/purchasing • Logistics • Cost of controlling inventory Production Planning and Control- Inventory Management(9)

  10. Decisions to Make • We have to decide • How often we review the inventory • When we should issue a (replenishment/production) order • How large the order should be Production Planning and Control- Inventory Management(10)

  11. Characteristics of Inv. Systems • Demand • Constant (level) or variable • Deterministic (known) or Stochastic (random or uncertain) • Lead Time • Review Time • Continuous or periodic review • Excess Demand • Backordered or lost • Changing inventory Production Planning and Control- Inventory Management(11)

  12. Relevant Costs • Unit value or unit variable cost (c) • Cost of making a part available for usage • Purchase + Freight + Mfg. Costs • Usually different from “accounting” cost • Should include more than just book value Production Planning and Control- Inventory Management(12)

  13. Relevant Costs • Holding cost (cost of carrying in inv.) • Opportunity costs of the money tied to inventory (I = ic), where i is the available rate of return on investment (may use IRR). • Warehousing and Handling (cost of providing space to store items, counting and moving items in the warehouse) • Deterioration, damage, obsolescence • Insurance and taxes • W: Warehousing cost, $ per item per year Production Planning and Control- Inventory Management(13)

  14. Relevant Costs Inv. Avg. inv. level Time, t 1 2 Production Planning and Control- Inventory Management(14)

  15. Relevant Costs • Ordering or Setup Cost (P) • Fixed cost • Independent of the size of the replenishment or production order • Ordering forms, phone calls, other communication costs, receiving, inspection, cost of interrupted production, opportunity cost of lost time, etc. Production Planning and Control- Inventory Management(15)

  16. EOQ History • Introduced in 1913 by Ford W. Harris, “How Many Parts to Make at Once” • Interest on capital tied up in wages, material and overhead sets a maximum limit to the quantity of parts which can be profitably manufactured at one time; “set-up” costs on the job fix the minimum. Experience has shown one manager a way to determine the economical size of lots. • Early application of mathematical modeling to Scientific Management Production Planning and Control- Inventory Management(16)

  17. EOQ Modeling Assumptions • 1.Production is instantaneous – there is no capacity constraint and the entire lot is produced simultaneously. • 2.Delivery is immediate – there is no time lag between production and availability to satisfy demand. • 3.Demand is deterministic – there is no uncertainty about the quantity or timing of demand. • 4.Demand is constant over time – in fact, it can be represented as a straight line, so that if annual demand is 365 units this translates into a daily demand of one unit. • 5.A production run incurs a fixed setup cost – regardless of the size of the lot or the status of the factory, the setup cost is constant. • 6.Products can be analyzed singly – either there is only a single product or conditions exist that ensure separability of products. Production Planning and Control- Inventory Management(17)

  18. EOQ Model • Time unit: one year • Total Cost = setup cost + opportunity cost + Warehousing cost, total cost is calculated per unit. • Purchase Cost Constant • Opportunity cost is always based on average quantity • Warehousing cost may be based on average quantity for mixed storage areas, or on maximum quantity for dedicated storage. • Goal: Find the order quantity that minimizes total costs • General Equation for dedicated storage for mixed storage Production Planning and Control- Inventory Management(18)

  19. EOQ Model Assumptions: • No Stockouts • Order when no inventory • Order size determines policy Inventory Qavg = Q/2 Order Quantity Q Avg. Inventory (Qavg) Production Planning and Control- Inventory Management(19)

  20. EOQ Model Total Cost Holding Cost Order Cost Optimal Order Quantity, Q* Production Planning and Control- Inventory Management(20)

  21. EOQ Model for dedicated storage for mixed storage By differentiation: for dedicated storage for mixed storage Production Planning and Control- Inventory Management(21)

  22. EOQ Model Example: 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? Production Planning and Control- Inventory Management(22)

  23. EOQ Model • Tradeoff between set-up costs and holding costs when determining order quantity. In fact, we order so that these costs are equal per unit time • Total Cost is not particularly sensitive to the optimal order quantity Production Planning and Control- Inventory Management(23)

  24. EOQ Observations • Batching causes inventory (i.e., larger lot sizes translate into more stock). • Under specific modeling assumptions the lot size that optimally balances holding and setup costs is given by the square root formula: • Total cost is relatively insensitive to lot size (so rounding for other reasons, like coordinating shipping, may be attractive). • carrying cost (cc) = I + W or cc = I + 2W Production Planning and Control- Inventory Management(24)

  25. EOQ Trade-off • Two interpretations: • If you order more (larger Q), you incur higher inventory cost, but less setup cost • If you order less frequently, you incur larger inventory cost, but less setup cost • The trade-off is not linear! Production Planning and Control- Inventory Management(25)

  26. Economic Manufacturing Quantity (EMQ) • What happens when there is finite production rate? • A: production rate (in units per year) • A>D (demand rate per year). Why? • What happens if you keep producing? • The inventory will keep growing forever with a rate of A-D. • There are many possible scenarios. The common two are: • A: Start producing Q when inventory reaches zero. • B: Start producing a batch of Q so that the quantity is finished when the previous batch is consumed. Production Planning and Control- Inventory Management(26)

  27. EMQ- Scenario A Start producing Q when inventory reaches zero at the rate of A parts per time unit. Consumption is continuous at the rate of D parts per time unit until inventory reaches zero, at which time production starts again. Inv Q QM TA Time TC Start Prod. Start Prod. Stop Prod. Production Planning and Control- Inventory Management(27)

  28. EMQ- Scenario A for dedicated storage for mixed storage By differentiation: for dedicated storage for mixed storage Production Planning and Control- Inventory Management(28)

  29. EMQ- Scenario B Start producing a batch of Q, at the rate of A parts per time unit, so that the quantity is finished when the previous batch is consumed. Consumption is continuous at the rate of D parts per time unit. Inventory never reaches zero. QMis the minimum inventory level. Inv Q QM QM TA Start Prod. Start Prod. T Stop Prod. Time Production Planning and Control- Inventory Management(29)

  30. EMQ- Scenario B for dedicated storage for mixed storage By differentiation: for dedicated storage for mixed storage Production Planning and Control- Inventory Management(30)

  31. Resource Constrained Multiple Product Systems • Another EOQ assumption: • Even if you have multiple items to worry, you can analyze them separately • What happens if the items share capacitated resources? • Budget • Machines • Personnel • Space, etc. Production Planning and Control- Inventory Management(31)

  32. MedEquip Example Costs • D = 1000 racks per year • c = $250 • P = $500 (estimated from supplier’s pricing) • cc = (0.1)($250) + 10 = $35 per unit per year Production Planning and Control- Inventory Management(32)

  33. Costs in EOQ Model Production Planning and Control- Inventory Management(33)

  34. Dynamic Lot Sizing • Another EOQ assumption: • Demand is constant over time • Dynamic Lot Sizing relaxes this assumption • Demand is changing over time • But demand in each period is known (so still deterministic). Production Planning and Control- Inventory Management(34)

  35. Dynamic Lot Sizing • Examples: • MRP • Firm orders and contracts for future periods • Seasonal demand patterns • Demand with trend (increasing or decreasing over time) Production Planning and Control- Inventory Management(35)

  36. Dynamic Lot Sizing • Example: • Other data • Beginning inventory: 0 • Setup cost: $150 • Inventory carrying cost: $2 per unit per period Production Planning and Control- Inventory Management(36)

  37. Dynamic Lot Sizing • Issues: • Determine a planning horizon • Calculate total cost over the planning horizon • Implementing decisions over time • Rolling horizon concept • Discrete demand vs. Continuous demand • Discrete Replenishments vs. Any-time replenishments Production Planning and Control- Inventory Management(37)

  38. Dynamic Lot Sizing • Quick Solutions • Order every period exactly as much as you need • Lot-for-Lot • Determine a fixed order quantity and order when you need to order (i.e., when on-hand inventory is less than the next period’s demand) • Example: EOQ • Order constant time-supply (i.e., order the amount sufficient to cover total demand in next three months) Production Planning and Control- Inventory Management(38)

  39. Dynamic Lot Sizing • Lot-for-lot solution: Total Cost = 150 + 10 * 150 = $1650 Production Planning and Control- Inventory Management(39)

  40. Dynamic Lot Sizing • Other heuristics: • EOQ as a Time Supply • Periodic Order Quantity (POQ) • Part-Period Balancing (PPB) • Silver-Meal (or Least Period Cost) Production Planning and Control- Inventory Management(40)

  41. Dynamic Lot Sizing • Example • Calculate EOQ: • Average demand per week = ____ • Holding cost per unit per week = ____ • EOQ = ____ • Total Holding and Setup Cost = ____ Production Planning and Control- Inventory Management(41)

  42. Dynamic Lot Sizing- EOQ Total Cost = 642 + 4 * 150 = $1242 Production Planning and Control- Inventory Management(42)

  43. Dynamic Lot Sizing - POQ • Periodic Order Quantity • Calculate EOQ using Average Demand • Calculate Time Supply and round it to the nearest integer • In each replenishment, order to cover that many periods’ demand • Fixed order interval, but different quantity in each replenishment Production Planning and Control- Inventory Management(43)

  44. Dynamic Lot Sizing - POQ Total Cost = 422 + 4 * 150 = $1022 Production Planning and Control- Inventory Management(44)

  45. Dynamic Lot Sizing - PPB • Part-Period Balancing • Select the number of periods covered by the replenishment such that the total inventory carrying costs are as close as possible to the setup cost. Production Planning and Control- Inventory Management(45)

  46. Dynamic Lot Sizing - PPB Total Cost = 422 + 4 * 150 = $1022 Production Planning and Control- Inventory Management(46)

  47. Dynamic Lot Sizing - SM • Silver-Meal (SM) Heuristic • Minimize total relevant costs per unit time for the duration of the replenishment quantity. • Replenishment quantity Q should last for an integer number of periods: cover the total demand in periods 1 through T (decision variable T) • Min (Setup Cost + Inv Cost through T) / T • Q = D1 + … + DT • Total Relevant Cost through T: TRC(T) • Select T such that TRC(T)/T is minimized. Production Planning and Control- Inventory Management(47)

  48. Dynamic Lot Sizing - SM Total Cost = 366 + 4 * 150 = $966 Production Planning and Control- Inventory Management(48)

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