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Inventory Management: Economic Order Quantity, JIT, and the Theory of Constraints

Inventory Management: Economic Order Quantity, JIT, and the Theory of Constraints. 20. CHAPTER. Just-in-Case Inventory Management. OBJECTIVE. 1. To develop an inventory policy that deals with the tradeoff between acquisition costs and carrying costs, two basic questions must be addressed:

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Inventory Management: Economic Order Quantity, JIT, and the Theory of Constraints

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  1. Inventory Management: Economic Order Quantity, JIT, and the Theory of Constraints 20 CHAPTER

  2. Just-in-Case Inventory Management OBJECTIVE 1 • To develop an inventory policy that deals with the tradeoff between acquisition costs and carrying costs, two basic questions must be addressed: • How much should be ordered (or produced) to minimize inventory costs? • When should the order be placed (or the setup done)? 20-2

  3. Just-in-Case Inventory Management OBJECTIVE 1 Total ordering and carrying cost can be described as: Where: TC = the total ordering and carrying cost P = the cost of placing and receiving an order Q=the number of units ordered each time an order is placed D = the known annual demand C = the cost of carrying one unit of stock for one year 20-3

  4. Just-in-Case Inventory Management OBJECTIVE 1 The objective of inventory management is to identify the order quantity that minimizes the total cost – called the Economic Order Quantity 20-4

  5. Just-in-Case Inventory Management OBJECTIVE 1 When to Order or Produce Reorder point: the point in time when a new order should be placed Lead time: the time required to receive the economic order quantity once an order is place or a setup is initiated Reorder point: Rate of usage * Lead time Because the demand for a product is not known with certainty, the possibility of a stock-out exits. Safety stock can help avoid this. Safety stock: extra inventory carried to serve as insurance against fluctuations in demand Reorder point: (Average rate of usage * Lead time) + Safety stock 20-5

  6. JIT Inventory Management OBJECTIVE 2 Setup and Carrying Costs: The JIT Approach • JIT reduces the costs of acquiring inventory to insignificant levels by: • Drastically reducing setup time • Using long-term contracts for outside purchases Carrying costs are reduced to insignificant levels by reducing inventories to insignificant levels.

  7. JIT Inventory Management OBJECTIVE 2 Due-Date Performance: The JIT Solution • Lead times are reduced so that the company can meet requested delivery dates and to respond quickly to customer demand. • Lead times are reduced by: • Reducing setup times • Improving quality • Using cellular manufacturing 20-7

  8. JIT Inventory Management OBJECTIVE 2 Avoidance of Shutdown: The JIT Approach • Total preventive maintenance to reduce machine failures • Total quality control to reduce defective parts • The use of the Kanban system is also essential 20-8

  9. JIT Inventory Management OBJECTIVE 2 What is the Kanban System? A card system is used to monitor work in process The Kanban system is responsible for ensuring that the necessary products are produced in the necessary quantities at the necessary time. • A withdrawal Kanban • A production Kanban • A vendor Kanban 20-9

  10. JIT Inventory Management OBJECTIVE 2 • Discounts and Price Increases: JIT Purchasing versus Holding Inventories • Careful vendor selection • Long-term contracts with vendors • Prices are stipulated (usually producing a significant savings) • Quality is stipulated • The number of orders placed are reduced 20-10

  11. JIT Inventory Management OBJECTIVE 2 JIT Limitations: • Patience in implications is needed • Time is required • JIT may cause lost sales and stressed workers • Production may be interrupted due to an absence of inventory 20-11

  12. Basic Concepts of Constrained Optimization OBJECTIVE 3 • Every firm faces limited resources and limited demand for each product • External constraints – market demand • Internal constraints – machine or labor time availability Constrained optimization is choosing the optimal mix given the constraints faced by the firm. 20-12

  13. Basic Concepts of Constrained Optimization OBJECTIVE 3 Linear Programming Linear programming model: expresses a constrained optimization problem as a linear objective function subject to a set of linear constraints A feasible solution is a solution that satisfies the constraints in the linear programming model. Linear programming is a method that searches among possible solutions until it finds the optimal solution. See Cornerstone 20-4 20-13

  14. Theory of Constraints (TOC) OBJECTIVE 4 • Goal – to make money now and in the future by managing constraints • Recognizes that the performance of any organization is limited by its constraints • TOC focuses on three operational measures of systems performance • Throughput = (sales revenue – unit level variable expenses)/time • Inventory is all the money the organization spends in turning materials into throughput • Operating expenses defined as all the money the organization spends in turning inventories into throughput and represent all other money that an organization spends 20-14

  15. Theory of Constraints (TOC) OBJECTIVE 4 Five Step Method for Improving Performance • Identify an organization’s constraints • Exploit the binding constraints • Subordinate everything else to the decisions made in Step 2 • Elevate the organization’s binding constraints • Repeat the process as a new constraint emerges to limit output 20-15

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