Inventory Management, Just-in-Time

1. Inventory Management,Just-in-Time Chapter 20 May 9, 2005

2. Inventory Management • Planning, coordinating and controlling activities related to the flow of inventory into, through and out of the organization • Inventory accounts for 40% of cost in manufacturing companies; 70% in merchandising • It costs anywhere from 20% to 30% of the value of the inventory just to hold it and manage it! • It is critical for firm’s to manage this asset well

3. Learning Objective 1 Identify categories of costs associated with goods for sale.

4. Costs Associated withHolding Goods for Sale • Purchasing costs are cost of goods acquired • from suppliers, including transportation costs. 2. Ordering costs include receiving and inspecting the items in the orders, preparing and issuing purchase orders, matching invoices with PO’s, approvals, etc. 3. Carrying costs include the opportunity cost of the investment tied up in inventory and the costs associated with storage, such as space rental, insurance, spoilage, obsolescence, etc.

5. Costs Associated withHolding Goods for Sale 4. Stockout costs occur when an organization runs out of a particular item for which there is a customer demand. Can include expediting costs, order costs, transportation, etc. Most significantly, opportunity costs of current and future lost sales if orders can’t be met.

6. Learning Objective 2 Balance ordering costs with carrying costs using the economic-order-quantity (EOQ) decision model.

7. Economic-Order-QuantityDecision Model Assumptions 1. The same quantity is ordered at each reorder point. 2. Demand, ordering costs, carrying costs, and purchase-order lead time are known with certainty. 3. Purchasing costs per unit are unaffected by the quantity ordered. (relevant range)

8. Economic-Order-QuantityDecision Model Assumptions 4. No stockouts occur. (by design) 5. Quality costs are considered only to the extent that these costs affect ordering costs or carrying costs.

9. Economic-Order-QuantityDecision Model Assumptions The EOQ minimizes the relevant ordering costs and carrying costs. Video store sells packages of blank video tapes. Video purchases packages of video tapes from Oaks, Inc., at $15/package.

10. Economic-Order-QuantityDecision Model Assumptions Annual demand is 12,844 packages, at the rate of 247 packages per week. Video requires a 15% annual return on investment. The purchase-order lead time is two weeks. What is the economic-order-quantity?

11. Economic-Order-QuantityDecision Model Assumptions Relevant ordering cost per purchase order: $209 Relevant carrying costs per package per year: Required annual ROI (15% × $15) $2.25 Relevant other costs 3.25 Total $5.50

12. Economic-Order-Quantity Decision Model Example EOQ = D = Demand in units for a year P = Relevant ordering costs per purchase order C = Relevant carrying costs of one unit in stock for a year

13. Economic-Order-Quantity Decision Model Example EOQ = = 988 packages

14. Economic-Order-Quantity Decision Model Example What are the relevant total costs (RTC)? RTC = Annual relevant ordering costs + Annual relevant carrying costs RTC = D Q × P + Q 2 × C DP Q + QC 2 or Q can be any order quantity, not just the EOQ.

15. Economic-Order-Quantity Decision Model Example When Q = 988 units, RTC = (12,844 × $209 ÷ 988) + (988 × $5.50 ÷ 2) = $5,434 total relevant costs How many deliveries should occur each time period? D EOQ = 12,844 988 = 13 deliveries

16. Economic-Order-Quantity Decision Model Example 10,000 8,000 Annual relevant total costs Relevant Total Costs (Dollars) 6,000 5,434 Annual relevant ordering costs 4,000 Annual relevant carrying costs 2,000 600 988 EOQ 1,200 1,800 2,400 Order Quantity (Units) 20 - 15

17. Reorder Point Reorder point = Number of units sold per unit of time × Purchase-order lead time EOQ = 988 packages Number of units sold/week = 247 Purchase-order lead time = 2 weeks Reorder point = 247 × 2 = 494 packages

18. Reorder Point 988 Reorder Point Reorder Point 494 Weeks 1 2 3 4 5 6 7 8 Lead Time 2 weeks Lead Time 2 weeks This exhibit assumes that demand and purchase-order lead time are certain: Demand = 247 tape packages/week Purchase-order lead time = 2 weeks 20 - 17

19. Safety Stock Example Safety stock is inventory held at all times regardless of the quantity of inventory ordered using the EOQ model. Video’s expected demand is 247 packages per week. Management feels that a maximum demand of 350 packages per week may occur.

20. Safety Stock Example How much safety stock should be carried? 350 Maximum demand – 247 Expected demand = 103 Excess demand per week 103 packages × 2 weeks lead time = 206 packages of safety stock.

21. Safety Stock Reorder Point 988 Reorder Point Reorder Point 700 206 Weeks 1 2 3 4 5 6 7 8 Lead Time 2 weeks Lead Time 2 weeks Factoring in safety stock, the new reorder point would be 494 plus 206 or 700. 20 - 17

22. Learning Objective 3 Identify and reduce conflicts that can arise between EOQ decision model and models used for performance evaluation.

23. Evaluating Managers andGoal-Congruence Issues The opportunity cost of investment tied up in inventory is a key input in the EOQ decision model. Some companies now include opportunity costs as well as actual costs when evaluating managers.

24. Just-In-Time Purchasing Just-in-time (JIT) purchasing is the purchase of goods or materials such that a delivery immediately precedes demand or use. Companies moving toward JIT purchasing argue that the cost of carrying inventories (parameter C in the EOQ model) has been dramatically underestimated in the past.

25. JIT Purchasing and EOQModel Parameters The cost of placing a purchase order (parameter P in the EOQ model) is also being re-evaluated. Three factors are causing sizable reduction in the cost of placing a purchase order (P). 1. Companies increasingly are establishing long-run purchasing arrangements.

26. JIT Purchasing and EOQModel Parameters 2. Companies are using electronic links, such as the Internet, to place purchase orders. 3. Companies are increasing the use of purchase order cards (similar to consumer credit cards like Visa and Master Card).

27. Learning Objective 4 Use a supply-chain approach to inventory management.

28. Supply-Chain Analysis Supply-chain analysis describes the flow of goods, services, and information from cradle to grave, regardless of whether those activities occur in the same organization or other organizations. By purchasers sharing demand information with suppliers, fewer stock outs, lower units produced, fewer rush orders, and lower inventories throughout

29. Learning Objective 5 Differentiate materials requirements planning (MRP) systems from just-in-time (JIT) systems for manufacturing.

30. Materials RequirementPlanning (MRP) Materials requirements planning (MRP) systems take a “push-through” approach that manufactures finished goods for inventory on the basis of demand forecasts. “Just in Case” MRP predetermines the necessary outputs at each stage of production.

31. Just in time • Uses a demand pull system in which customer orders begin the process of “pulling” production through the system based on lead times, production cycle and required shipping dates

32. Learning Objective 6 Identify the features of a just-in-time production system.

33. Just-In-Time Production Systems Just-in-time (JIT) production systems take a “demand pull” approach in which goods are only manufactured to satisfy customer orders.

34. Major Features of a JIT System 1. Organizing production into manufacturing cells 2. Hiring and retaining multi-skilled workers 3. Emphasizing total quality management, zero defects 4. Reducing manufacturing lead time and setup time 5. Building strong supplier relationships

35. Benefits of JIT System • Lower levels of inventory • Improved manufacturing throughput time • Lower rework, scrap and waste • Higher quality materials and suppliers • Reduced set-up times • Lower inventory carrying costs • Improved customer satisfaction

36. End of Chapter 20