Chapter 6 Inventory Control Models

1. Chapter 6 Inventory Control Models 6-1

2. Chapter Learning Objectives Students will be able to: • Understand the importance of inventory control. • Use the economic order quantity (EOQ) to determine how much to order. • Compute the reorder point (ROP) in determining when to order more inventory. • Perform sensitivity analysis on basic inventory quantities. 6-2

3. Chapter Learning Objectives continued Students will be able to: • Determine the economic order quantity without the instantaneous receipt assumption. • Handle inventory problems that allow quantity discounts or have planned shortages. • Understand the use of safety stock with known and unknown stockout costs. • Perform ABC analysis. 6-3

4. Chapter Outline 6.1 Introduction 6.2 Importance of Inventory Control 6.3 Inventory Decision 6.4 Economic Order Quantity(EOQ): Determining How Much to Order 6.5 Reorder Point: Determining When to Order 6-4

5. Chapter Outline - continued 6.6 EOQ without the Instantaneous Receipt Assumption 6.7 Quantity Discount Models 6.8 Use of Safety Stock 6.9 ABC Analysis 6.10 Sensitivity Analysis 6-5

6. Inventory as an Important Asset Other Assets 60% • Inventory can be the most expensive and the most important asset for an organization Inventory 40% Inventory as a percentage of total assets 6-6

7. Inventory Planning and Control - Fig. 6.1 Planning on what Inventory to Stock and How to Acquire It Forecasting Parts/Product Demand Controlling Inventory Levels Feedback Measurements to Revise Plans and Forecasts 6-7

8. The Inventory Process Suppliers Customers Inventory Storage Raw Materials Finished Goods Fabrication and Assembly Work in Process Inventory Processing 6-8

9. Importance of Inventory Control Five Functions of Inventory • Decoupling • Storing resources • Adapting to irregular supply and demand • Enabling the company to take advantage of quantity discounts • Avoiding stockouts and shortages 6-9

10. Inventory Decisions • How much to order • When to order wish to minimize total inventory cost 6-10

11. Inventory Costs • Cost of the items • Cost of ordering • Cost of carrying, or holding inventory • Cost of safety stock • Cost of stockouts 6-11

12. Ordering Costs • Developing and sending purchase orders • Processing and inspecting incoming inventory • Bill paying • Inventory inquiries • Utilities, phone bills, etc., - purchasing department. • Salaries/wages - purchasing department employees • Supplies (e.g., forms and paper) - purchasing department 6-12

13. Carrying Costs • Cost of capital • Taxes • Insurance • Spoilage • Theft • Obsolescence • Salaries/wages - warehouse employees • Utilities/building costs - warehouse • Supplies (e.g., forms, paper) - warehouse 6-13

14. Inventory Usage Over Time - Fig. 6.2 6-14

15. Costs as Functions of Order Quantity - Fig. 6.3 Annual Cost Total Cost Curve Minimum Cost Carrying (holding) Cost Curve Ordering (set-up) Cost Curve Q* Order Quantity 6-15

16. Costs as Functions of Order Quantity - Fig. 6.3 Total Cost Minimum Cost Carry Cost Order Cost Optimal Quantity 6-16

17. Steps in Finding the Optimum Inventory • Develop an expression for the ordering cost. • Develop and expression for the carrying cost. • Set the ordering cost equal to the carrying cost. • Solve this equation for the optimum desired. 6-17

18. EOQ : Basic Assumptions • Demand is known and constant • Lead time is known and constant • Receipt of inventory is instantaneous • Quantity discounts are not possible • The only variable costs are the cost of setting up or placing an order, and the cost of holding or storing inventory over time • Stockouts can be completely avoided if orders are placed at the appropriate time 6-18

19. Developing the EOQ • Annual ordering cost: • Annual holding or carrying cost: • Total inventory cost: 6-19

20. EOQ Per Unit Carrying Cost: 2DC * = Q C h Percentage Carrying Cost: 2 DC 0 * = Q IP 0 6-20

21. Inputs and Outputs of the EOQ Model Input Values Output Values Annual Demand (D) Economic Order Quantity (EOQ) Ordering Cost (Co) EOQ Models Carrying Cost (Ch) Reorder Point (ROP) Lead Time (L) Demand Per Day (d) 6-21

22. The Reorder Point (ROP) Curve - Fig. 6.4 Q* Slope = Units/Day = d ROP (Units) Inventory Level (Units) L Lead Time (Days) ROP = (Demand per day) x (Lead time for a new order, in days) = d x L 6-22

23. Inventory Control and the Production Process Production Portion of Cycle Maximum Inventory Level Inventory Level Demand Portion of Cycle Demand Portion of Cycle Time 6-23

24. Production Quantity EOQ • Annual Carrying Cost: • Annual Ordering Cost: • Setup Cost: • Ordering Costs: 6-24

25. Production Quantity EOQ 6-25

26. Quantity Discount Models - Fig. 6.6 6-26

27. Quantity Discount Steps • 1. Calculate Q for each discount • 2. Adjust Q upward if quantity is too low for discount • 3. Compute total cost for each discount • 4. Select Q with the the lowest total cost 6-27

28. The Use of Safety Stock Fig. 6.7 Inventory on Hand Time Stockout Inventory on Hand Stockout is avoided Safety Stock Time 6-28

29. The Use of Safety Stock • Known stockout costs: • Given probability of demand, find total cost for each safety stock alternative • Unknown stockout costs: • Set service level; use normal distribution 6-29

30. Service Level versus Carrying Costs 6-30

31. Summary of ABC Analysis Table 6.6 Are Complex Quantitative Control Techniques Used? Inventory Group Dollar Usage (%) Inventory Items (%) Yes In some cases No A B C 70 20 10 10 20 70 • Group A Items - Critical • Group B Items - Important • Group C Items - Not That Important 6-31

32. ABC Inventory Analysis 100 90 80 70 60 50 40 30 20 10 0 A Items Percent of Annual Dollar Usage B Items C Items 1 2 3 4 5 6 7 8 9 10 Percent of Inventory Items 6-32

33. ABC Inventory Policies • Greater expenditure on supplier development for A items than for B items or C items • Tighter physical control on A items than on B items or on C items • Greater expenditure on forecasting A items than on B items or on C items 6-33