Materials Management

Materials Management Operations ManagementSession 3

Objectives • By the end of this session, student will be able to: • Appreciate the need to make key inventory decisions • Understand and calculate the costs associated with inventory • Use the Economic Order Quantity System to determine order volumes and frequencies • Understand the relationship between inventory control and customer service.

Topics • How inventory comes about • Decisions and Costs • Economic Order Quantity (EOQ) • Pareto principle of stock control

Definitions • Inventory • the stock of any item or resource used in an organization: raw materials, finished products, component parts, supplies and work-in-process. • An inventory system • policies and controls for monitoring levels of inventory Information system that records transactions and enables analysis of stock requirements and levels/quantities, costs etc

Stock Inventory Level Supply Rate Stock Level Rate of Demand

Independent vs. Dependent Demand Independent Demand (not related to other items or final end-product) e.g. Office Stationary Dependent Demand (derived from component parts, sub-assemblies, raw materials, etc.)

Why Does Inventory Arise? • Raw-materials bought at advantageous price • Components and Sub-assemblies • Work-in-progress or in-transit • Finished-goods • In the warehouse • Awaiting shipment • In delivery vehicles • In tanks • On shelves • In the stores • Strategic inventory • Scrap & re-work

Inventory Types • Buffer Inventorycompensates for unexpected fluctuations in supply or demand • Cycle Inventorybecause a stage in the process cannot supply all items simultaneously • De-coupling Inventoryin a process layout WIP joins a queue • Anticipation Inventorywhen demand fluctuations are large but predictable • Pipeline Inventorywhen stock is allocated until it is available eg. In delivery

Single & Multi-Stage Inventory Systems Single-Stage Inventory System SalesOperation Stock Suppliers Small Retail Shop Multi-Stage Inventory System InputStocks Finished GoodsStock WIP Suppliers Stage 1 Stage 2 Stage 3 Television Manufacturer

Inventory Decisions • How much to order • When to order • How much it will cost • What the re-order level is • How much safety stock needed • How to control a large inventory system

The Volume Decision • Simple Illustration – Food Shopping • Do we hold little stock in the cupboards and the refrigerator and shop frequently or • Do we have a large refrigerator and larder and buy in bulk • What issues do we think about when making the decision? • Translate these into a business context.

Inventory Costs • Ordering Costs • Administrative costs of ordering • Production Inefficiency Cost • Inventory obscures operational problems • Holding Costs • Working capital cost • Storage costs • Insurance • Deterioration and obsolescence • Stock Out Costs • Cost to the business of running out of stock • Discounts for Bulk Purchase

Order Quantities & Re-order Points Average Stock q/2 No. of units on hand q q Safety or buffer level R L Time R = Re-order point L = Lead time By having a lower buffer level and re-ordering more often inventory may be reduced

EOQ Aim = Cost Minimisation Holding + ordering costs = total cost curve Find QEOQ inventory order point to minimise total costs Total Cost Cost Holding Costs Ordering Costs Qeoq Order Quantity (Q)

Economic Order Quantity (EOQ) Assumptions • Single product line • Demand rate: recurring, known, constant • Lead time: constant , known • No quantity discounts - stable unit cost • No stock-outs allowed • Items ordered/produced in a lot or batch • Batch received all at once • Holding cost is linear based on average stock level • Fixed order + set up cost

Safety Stock and Re-order Levels • Reserve • Buffer • Cushion against uncertain demand (usage) & lead time • "2-bin" system • Use of JIT • Depends on: • Uncertainty: demand & lead time • Cost of • being out of stock • carrying inventory • increasingly better service • Service level policy • % confidence of not hitting a stock-out situation

Bin Systems Two-Bin Bin 1Items beingused Bin 2Re-orderLevel Order when Bin 1 empty One-Bin Periodic CheckOrder enough to refill bin?

Annual Demand X Order Cost per Order Annual Order Cost = Number of units in each order Q 2 D Q = = H S Order Cost & Holding Cost Q = number of pieces per order QEOQ = Optimum number of pieces per order D = annual demand in units for the inventory item S = Setup or ordering cost for each order H = Holding or carrying cost per unit per year Order Quantity Annual Holding Cost = X Holding cost per unit per year 2

D Q S 2DS 2DS H H Q2 = Q 2 = H QEOQ = Calculate EOQ Economic (optimal) order quantity is found when annual setup cost equals annual holding cost

When to place an order – finding Re-order Point (ROP) ROP = DL D = Avg daily demand (constant) L = Lead time (constant) EOQ & ROP 2DS 2(Annual Demand)(Order or set-up cost) QEOQ = = H Annual Holding Cost • Exercise – find EOQ and ROP: • Annual demand = 1,000 units • Days/year in average daily demand = 365 • Cost to place an order = £10 • Holding cost /unit p.a. = £2.50 • Lead time = 7 days • Cost per unit = £15

Solution 2DS 2(1,000 )(10) = 89.443 units or 90 units QEOQ = = H 2.50 1,000 units p.a. D = = 2.74 units/day 365 days p.a. Reorder point D L = 2.74 units/day = 19.18 or 20 for 7 day lead time EOQ order = 90 units. When only 20 units left, place next order for 90 units.

2DS 2(10,000)(10) Q = = = 365.148 (366 units) H 1.50 10,000 units/year eoq D = = 27.397 units/day 365 days If lead time = 10 days, ROL= 273.97 = 274 units Place order for 366 units. When 274 left, place next order for 366. EOQ and ROQ - Example 2 Annual Demand = 10,000 units Days per year considered in average daily demand = 365 Cost to place an order = £10 Holding cost per unit per year = 10% of cost per unit Lead time = 10 days Cost per unit = £15

Exercise 1 • Each month a particular retailer sells 100 TV sets. The inventory holding cost is £50 per TV per month. The ordering cost is £100 and each TV set costs the retailer £80. • What is the EOQ? • How many orders will be placed each month? • If the inventory cost is increased by £5 per TV per month, what will be the change in the EOQ?

Exercise 2 • A fishmonger with a market stall sells 5000kg of fish each month. It costs £10 to have fresh fish delivered, and each kg of fish ordered costs the fishmonger £2. The cost of keeping the fish is £1 per kg per month, which is largely due to the cost of refrigeration. All fish must be sold within a week of delivery or else be discarded. • What is the EOQ? • How many orders will be placed each month?

ABC System of Inventory Control 100 90 Pareto – 20/80 Principle:- • Class A Items20% of high usage value items account for 80% of total usage value • Class B Itemsnext 30% accounts for around 10% of total usage value • Class C Itemsabout 50% of total items stocked only account for 10% of usage value 80 C Cumulative % of Inventory Value B A 100 50 20 % of total number of items

Interpretation of ABC System • Often interpreted as indicating that managers should concentrate on A Class Items since these produce most revenue • However, could also be interpreted as indicating that managers should look closely at C Class items since these tie up most working capital

Stock Check • Book stock vs physical stock • Stock valuation – wastage & shrinkage • Audit stock security systems • Organising the stock check • Internal & external audit • Segmentation of duties

Materials Management