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Chapter 13

Chapter 13. Inventory Management. What is inventory?. Examples: Parts in a factory Paper towels in your cupboard Customers on hold Paperwork in secretary’s in-box Not limited to physical products Inventory is DELAY in business process. 12- 2. What is inventory?. Within organization:.

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Chapter 13

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  1. Chapter 13 Inventory Management

  2. What is inventory? • Examples: • Parts in a factory • Paper towels in your cupboard • Customers on hold • Paperwork in secretary’s in-box • Not limited to physical products Inventory is DELAY in business process. 12-2

  3. What is inventory? Within organization: Transformation Input Output • Raw materials • Materials received • Customers waiting in a bank • Paperwork in in-box • Work-in-Process • Semi-finished products • Customers at the counter • Paperwork on desk • Finished goods • Products waiting to be shipped • Customers leaving the bank • Paperwork in out-box Between organizations: Goods-in-transit 12-3

  4. Functions of Inventory • To smooth capacity requirements • To deal with uncertainty: • In business process: decoupling consecutive stages in business process • In demand • To reduce ordering costs • To take advantage of quantity discount • To hedge against possible price increase in the near future

  5. ABC Classification System • Classifying inventory according to importance and Allocating control efforts accordingly • Importance: measured by annual $ volume Annual $volume A 60% B 30% C 10% 15% 50% 35% Number of Items 12-5

  6. ABC Classification System A-B-C approach Classifying inventory according to some measure of importance, and allocating control efforts accordingly A items (very important) 10 to 20 percent of the number of items in inventory and about 60 to 70 percent of the annual dollar value B items (moderately important) C items (least important) 50 to 60 percent of the number of items in inventory but only about 10 to 15 percent of the annual dollar value A High B C Annual $ value of items Low Few Many Number of Items 12-6

  7. How Much to Order: EOQ Models The basic economic order quantity model The economic production quantity model The quantity discount model 12-7

  8. Economic Order Quantity Model • Example: a small store selling 2-liter bottles of soft drink • Demand Rate: d = 10 units/day • Annual Demand: D = 3,650 units/year • Purchase cost (Price): P = $1/unit • Ordering cost: S = $20/order • Holding cost: • Rate: h = 15%/year • Annual Cost/Unit/Year: H = $0.15/unit/year

  9. The Inventory Cycle Units Usage rate Order Quantity (Q) Time Receive order Receive order 12-9

  10. The Inventory Cycle Large Q Small Q Time 12-10

  11. The Inventory Cycle Profile of Inventory Level Over Time Q Usage rate Quantity on hand Reorder point Time Place order Receive order Receive order Receive order Place order Lead time 12-11

  12. Total Annual Cost 12-12

  13. Goal: Total Cost Minimization The Total-Cost Curve is U-Shaped Annual Cost Holding Costs Ordering Costs Order Quantity (Q) Q* (optimal order quantity) 12-13

  14. Deriving EOQ Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q. The total cost curve reaches its minimum where the carrying and ordering costs are equal. 12-14

  15. Economic Order Quantity Model • Example: a small store selling 2-liter bottles of soft drink • Demand Rate: d = 10 units/day • Annual Demand: D = 3,650 units/year • Purchase cost (Price): P = $1/unit • Ordering cost: S = $20/order • Holding cost: • Rate: h = 15%/year • Annual Cost/Unit/Year: H = $0.15/unit/year

  16. D = 3,650 • P = $1 • h = 15%/year • S = $20 12-16

  17. Economic Production Quantity (EPQ) Assumptions Only one product is involved Annual demand requirements are known Usage rate is constant Usage occurs continually, but production occurs periodically The production rate is constant Lead time does not vary There are no quantity discounts 12-18

  18. EPQ: Inventory Profile Q Production and usage Usage only Production and usage Usage only Production and usage Q* Cumulative production Imax Amount on hand Time 12-19

  19. EPQ – Total Cost 12-20

  20. EPQ 12-21

  21. Quantity Discount Model Quantity discount Price reduction offered to customers for placing large orders 12-22

  22. TC w/ Purchase Cost TC w/ Purchase Cost Purchase Cost TC w/o Purchase Cost EOQ

  23. Quantity Discount • D = 1,000 units/year • S = $75 • h = 35%/year

  24. Minimize Total Relevant Cost Price Break for P=4.8 Price Break for P=4.5

  25. Total Relevant Cost Curve Objective: Find Q* for the lowest point on the Total Relevant Cost Curve

  26. EOQ=299 (P=$4.8) >max, infeasible within range, feasible EOQ=293 (P=$5.0) <min, infeasible EOQ=309 (P=$4.5)

  27. Points on feasible segment of lower curve(s): higher than price break Upper curve(s): higher than feasible EOQ Points on feasible EOQ curve: higher than EOQ itself Feasible EOQ Lower Price Break(s)

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