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Chapter 13

Chapter 13. Inventory Management. Independent vs. Dependent Demand. Independent Demand (Chapter 13). Dependent Demand (Chapter 15). A. C(2). B(4). D(2). E(1). D(3). F(2). Independent demand is uncertain Dependent demand is certain. Types of Inventories (1 of 2).

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Chapter 13

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  1. Chapter 13 Inventory Management

  2. Independent vs. Dependent Demand Independent Demand (Chapter 13) Dependent Demand (Chapter 15) A C(2) B(4) D(2) E(1) D(3) F(2) Independent demand is uncertain Dependent demand is certain Chapter 13 Inventory Management

  3. Types of Inventories (1 of 2) • Raw materials & purchased parts • Partially completed goods called work in progress • Finished-goods inventories • (manufacturing firms) or merchandise (retail stores) Chapter 13 Inventory Management

  4. Types of Inventories (2 of 2) • Replacement parts, tools, & supplies • Goods-in-transit (pipeline) to warehouses or customers Chapter 13 Inventory Management

  5. Functions of Inventory • Meet anticipated demand • Smooth production requirements • Decouple components (areas) of the production-distribution • Protect against stock-outs • Take advantage of order cycles • Help hedge against price increases or to take advantage of quantity discounts • Permit operations (operation lead time) Chapter 13 Inventory Management

  6. Concerns ofInventory Management • Level of customer service • have the right goods, in sufficient quantities, in the right place, at the right time • in other words, the customer gets what ever he/she wants when he/she wants it • Inventory-related costs • ordering costs • carrying costs Chapter 13 Inventory Management

  7. Objectives ofInventory Management (1 of 2) • Achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds • Two fundamental decisions • how much to order • when to place the order Chapter 13 Inventory Management

  8. Objectives ofInventory Management (2 of 2) • Possible performance measures • customer satisfaction • number of backorders/lost sales • number of customer complaints • inventory turnover • ratio of annual cost of goods sold to average inventory investment • days of inventory • expected number of days of sales that can be supplied from existing inventory Chapter 13 Inventory Management

  9. Requirements for Effective Inventory Management • A system to keep track of the inventory on hand and on order • A classification system for inventory items • A reliable forecast of demand that includes an measure of forecast error • Reasonable estimates of inventory holding costs, ordering costs, and shortage costs • Knowledge of lead times and lead time variability Chapter 13 Inventory Management

  10. Inventory Counting Systems (1 of 2) • Perpetual Inventory (Continual) System • Keeps track of removals from and receipts into inventory continuously • Periodic System • Physical count of items made at periodic intervals Chapter 13 Inventory Management

  11. 0 214800 232087768 Inventory Counting Systems (2 of 2) • Universal Product Code - Bar code printed on a label that hasinformation about the item to which it is attached • Cycle counting - taking physical counts of items and reconciling with records on a continual rotating basis Chapter 13 Inventory Management

  12. High A Annual $ volume of items B C Low Few Many Number of Items ABC Classification System • Classifying inventory according to some measure of importance and allocating control efforts accordingly • A - very important • B - mod. important • C - least important Figure 13-1 Chapter 13 Inventory Management

  13. Demand Forecast andLead Time Information • Reliable estimates of the amount and timing of demand • Lead time - time interval between ordering and receiving the order • Extent of variability in demand and lead time Chapter 13 Inventory Management

  14. The Typical Procurement Cycle Internal Order Cycle Order Request/Requisition Authorization signatures obtained Verification by inventory control Purchasing researches vendors, obtains quotes, etc. Order transferred to vendor Vendor Cycle Receives and enters order Manufactures or “picks” order Ships order Internal Receiving Cycle Receiving Incoming inspection Inventory control receives order, updates records, and notifies department Chapter 13 Inventory Management

  15. Cost Information • Holding or carrying costs • Ordering costs • Shortage costs Chapter 13 Inventory Management

  16. Holding or Carrying Costs • Cost to carry a unit in inventory for a length of time • Includes interest (opportunity cost), insurance, taxes, depreciation, obsolescence, deterioration • May be expressed as a percentage of unit price or as a dollar amount per unit Chapter 13 Inventory Management

  17. Ordering Costs • Cost of ordering and receiving inventory • Include determining how much is needed, preparing invoices, shipping costs, inspecting goods upon receipt for quantity and quality • Generally expressed as a fixed dollar amount, regardless of order size Chapter 13 Inventory Management

  18. Shortage Costs • Result when demand exceeds the inventory on hand • Include the opportunity cost of not making a sales, loss of customer goodwill, late charges, and in the case of internal customers, the cost of lost production or downtime • Difficult to measure, thus may have be subjectively estimated Chapter 13 Inventory Management

  19. Basic Systems for Independent Demand • Fixed-order-quantity systems • basic economic order quantity (EOQ) model [purchasing model] • basic economic order quantity model with incremental or noninstantaneous replenishment [production order quantity] • quantity discount model • Fixed-order-interval systems Chapter 13 Inventory Management

  20. Basic Model Assumptions • Only one product is involved • Annual demand requirements are known • Demand is spread evenly throughout the year so that the demand rate is reasonable constant • Lead time does not vary • Each order is received in a single delivery • There are no quantity discounts, i.e., the price is constant Chapter 13 Inventory Management

  21. How the Basic Fixed-Order-Quantity Model Works Profile of Inventory Level Over Time Q Usage rate Quantity on hand Reorder point Place order Place order Receive order Receive order Receive order Lead time Figure 13-2 Chapter 13 Inventory Management

  22. Q D S H TC = + 2 Q How Much to Order Goal is to minimize total annual costs Total Annual = cost Annual carrying cost Annual ordering cost + Chapter 13 Inventory Management

  23. Cost Minimization Goal The Total Cost Curve is U-Shaped Annual Cost Annual Carrying Costs Annual Ordering Costs QO (optimal order quantity) Order Quantity (Q) Chapter 13 Inventory Management

  24. Minimum Total Cost The total cost curve reaches its minimum where the carrying and ordering costs are equal. Alternatively we can use calculus by taking the first derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q. Chapter 13 Inventory Management

  25. D=9,600 tires/year H=$16/tire/year S=$75/order Example 2, page 555 a. What is the EOQ? Chapter 13 Inventory Management

  26. D=9,600 tires/year H=$16/tire/year S=$75/order Example 2, page 555 b. How many times per year does the store reorder? Chapter 13 Inventory Management

  27. D=9,600 tires/year H=$16/tire/year S=$75/order Example 2, page 555 c. What is the length of an order cycle? Chapter 13 Inventory Management

  28. D=9,600 tires/year H=$16/tire/year S=$75/order Example 2, page 555 d. What is the total cost if the EOQ quantity is ordered? Chapter 13 Inventory Management

  29. Fixed Order Quantity Model with Incremental Replenishment • Used to determine the order size, production lot, if an item is produced at one stage of production and then sent to the next stage or the customer • Differs from the basic model because orders are assumed to be supplied or produced at a uniform rate (p) rather than the order being received all at once Chapter 13 Inventory Management

  30. Fixed Order Quantity Model with Incremental Replenishment Profile of Inventory Level Over Time Production rate - usage rate Q Quantity on hand Usage rate Reorder point Time Place order Place order Receive order Start to receive order Start to receive order Finish receiving order Chapter 13 Inventory Management Lead time

  31. Fixed Order Quantity Modelwith Incremental Replenishment • It is also assumed that the supply rate, p, is greater than the usage rate, u • The change in maximum inventory level requires modification of the TC equation Chapter 13 Inventory Management

  32. Fixed Order Quantity Modelwith Incremental Replenishment • The optimization results in Chapter 13 Inventory Management

  33. Example 4, page 558 D=48,000 wheels/year p=800 wheels/day H=$1/wheel/year S=$45/setup a. Optimal run size Chapter 13 Inventory Management

  34. Example 4, page 558 D=48,000 wheels/year p=800 wheels/day H=$1/wheel/year u=200 wheels/day S=$45/setup b. Minimum total annual cost for carrying and setup Chapter 13 Inventory Management

  35. Example 4, page 558 D=48,000 wheels/year p=800 wheels/day H=$1/wheel/year u=200 wheels/day S=$45/setup c. Cycle time for the optimal run size Chapter 13 Inventory Management

  36. Example 4, page 558 D=48,000 wheels/year p=800 wheels/day H=$1/wheel/year u=200 wheels/day S=$45/setup d. Run time Chapter 13 Inventory Management

  37. Quantity Discount Model • This model differs from the basic model because the price per unit (P) may vary with the quantity ordered • The supplier offers a lower unit price if larger quantities are ordered at one time • This is presented as a price or discount schedule, i.e., a certain unit price covers a certain order quantity range Chapter 13 Inventory Management

  38. Discount ScheduleProblem 14, page 588 Price Quantity 1 - 399 $10 $9 400 - 599 600+ $8 Chapter 13 Inventory Management

  39. Quantity Discount • Under this condition, annual product cost becomes an incremental cost and must be considered in the determination of the EOQ • The total annual costs (TC) = Annual holding cost + annual setup cost + annual product cost TC = (Q/2)H + (D/Q)S + DP Chapter 13 Inventory Management

  40. Total Cost Curve for Price 1 Total Cost Curve for Price 2 Total Cost Curve for Price 3 Order Quantity Costs FunctionsUnder Quantity Discount Figure 13-8 $ cost Chapter 13 Inventory Management

  41. Total Cost Curve for Price 1 Total Cost Curve for Price 2 Total Cost Curve for Price 3 Order Quantity Costs FunctionsUnder Quantity Discount $ cost Quantity at which price 1 ends and price 2 begins Chapter 13 Inventory Management

  42. Total Cost Curve for Price 2 Total Cost Curve for Price 3 Costs FunctionsUnder Quantity Discount Total Cost Curve for Price 1 $ cost Quantity at which price 2 ends and price 3 begins Order Quantity Chapter 13 Inventory Management

  43. Costs FunctionsUnder Quantity Discount TOTAL COST CURVE $ cost Order Quantity Chapter 13 Inventory Management

  44. Quantity Discount To find the EOQ, the following procedure is used • Compute the basic EOQ. Chapter 13 Inventory Management

  45. Quantity Discount • Using the appropriate price for the for the EOQ found in Step 1, compute the TC Chapter 13 Inventory Management

  46. Quantity Discount • Compute the TC for all quantities greater than Step 1’s EOQ where a discount begins. Select the quantity with the lowest TC as the EOQ Chapter 13 Inventory Management

  47. 600 Problem 14a, page 588 P=$10 $ cost P=$9 P=$8 $41,000 400 Order Quantity Chapter 13 Inventory Management

  48. 600 Problem 14b, page 588 D=25 stones/day x 200 days/year = 5,000stones/year H=.30 x P P=$10 S=$48/order $ cost P=$9 P=$8 400 Order Quantity Chapter 13 Inventory Management

  49. Quantity Discount To find the EOQ, the following procedure is used • Compute the basic EOQ using the lowest unit price and H=IP where I is an interest rate. If the resulting EOQ is feasible, i.e., that quantity can be purchased at the price used, it is optimal. Otherwise, go on to Step 2 Chapter 13 Inventory Management

  50. D=5,000 stones/year H=.30 x $8 = $2.40/year/stone S=$48/order Problem 14b, page 588 • Compute the basic EOQ Chapter 13 Inventory Management

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