Inventory Management

Inventory is one of the most expensive assets of many companies.

It represents as much as 60% of total invested capital.

Inventory Management

Inventory is any stored resource that is used to satisfy a current or future need.

Raw materials, work-in-process, and finished goods are examples of inventory.

Why do we hold Inventory? Improve customer service Reduce certain costs such as

◦ ordering costs◦ stockout costs◦ acquisition costs

Contribute to the efficient and effective operation of the production system

Why we do not hold Inventory? Certain costs increase such as

◦ Carrying costs, Handling cost◦ Labor Cost◦ Warehouse Cost◦ Logistics Cost◦ cost of return on investment◦ reduced-capacity costs (Storage, warehouse)◦ cost of production problems (Excess Inventory)

Two Fundamental Inventory Decisions

How much to order of each material when orders are placed with either outside suppliers or production departments within organizations

When to place the orders

Independent Demand Inventory Systems

Demand for an item carried in inventory is independent of the demand for any other item in inventory

Finished goods inventory is an example Demands are estimated from forecasts and/or

customer orders

Dependent Demand Inventory Systems

Items whose demand depends on the demands for other items

For example, the demand for raw materials and components can be calculated from the demand for finished goods

The systems used to manage these inventories are different from those used to manage independent demand items

Independent vs. Dependent Demand

Inventory Costs Costs associated with ordering too much

(represented by carrying costs) Costs associated with ordering too little

(represented by ordering costs) These costs are opposing costs, i.e., as one

increases the other decreases

Inventory Costs (continued) The sum of the two costs is the total stocking cost

(TSC) This cost behavior is the basis for answering the

first fundamental question: how much to order It is known as the economic order quantity (EOQ)

Economic Order Quantities (EOQ)

Behavior of EOQ Systems As demand for the inventoried item occurs, the

inventory level drops When the inventory level drops to a critical point,

the order point, the ordering process is triggered The amount ordered each time an order is placed

is fixed or constant When the ordered quantity is received, the

inventory level increases

inventory

cost

Serv

ice level

100%

Reorder point should balancethe risks of stockouts against costs of overstocking

Company needs to balance ordering costs vs inventory carrying costs

Inventory v/s Service levels

Economic Order Quantities Typical assumptions made

◦ annual demand (D), carrying cost (C) and ordering cost (S) can be estimated

◦ average inventory level is the fixed order quantity (Q) divided by 2 which implies no safety stock orders are received all at once demand occurs at a uniform rate no inventory when an order arrives

CDS /2 = EOQ CDS /2 = EOQ

Example of EOQZartex Co. produces fertilizer to sell to wholesalers.

One raw material – calcium nitrate – is purchased from a nearby supplier at $22.50 per ton. Zartex estimates it will need 5,750,000 tons of calcium nitrate next year.

The annual carrying cost for this material is 40% of the acquisition cost, and the ordering cost is $595. a) What is the most economical order quantity?b) How many orders will be placed per year?

Economical Order Quantity (EOQ)

D = 5,750,000 tons/yearC = .40(22.50) = $9.00/ton/yearS = $595/order

EOQ= √2DS/C

EOQ=√2(5750000)(595)/9.00 (27,573.135) tons per order

ABC Classification of Inventory Typical observations

◦ A small percentage of the items (Class A) make up a large percentage of the inventory value

◦ A large percentage of the items (Class C) make up a small percentage of the inventory value

These classifications determine how much attention should be given to controlling the inventory of different items

Copyright 2006 John Wiley & Sons, Inc.18

Class A◦ 5 – 15 % of units◦ 70 – 80 % of value

Class B◦ 30 % of units◦ 15 % of value

Class C◦ 50 – 60 % of units◦ 5 – 10 % of value

ABC Classification

Copyright 2006 John Wiley & Sons, Inc.21

11 $ 60$ 60 909022 350350 404033 3030 13013044 8080 606055 3030 10010066 2020 18018077 1010 17017088 320320 505099 510510 6060

1010 2020 120120

PARTPART UNIT COSTUNIT COST ANNUAL USAGEANNUAL USAGE

Supply Chain Management

Copyright 2006 John Wiley & Sons, Inc.22

Example 10.1Example 10.1

11 $ 60$ 60 909022 350350 404033 3030 13013044 8080 606055 3030 10010066 2020 18018077 1010 17017088 320320 505099 510510 6060

1010 2020 120120

PARTPART UNIT COSTUNIT COST ANNUAL USAGEANNUAL USAGETOTAL % OF TOTAL % OF TOTALPART VALUE VALUE QUANTITY % CUMMULATIVE

9 $30,600 35.9 6.0 6.08 16,000 18.7 5.0 11.02 14,000 16.4 4.0 15.01 5,400 6.3 9.0 24.04 4,800 5.6 6.0 30.03 3,900 4.6 10.0 40.06 3,600 4.2 18.0 58.05 3,000 3.5 13.0 71.0

10 2,400 2.8 12.0 83.07 1,700 2.0 17.0 100.0

$85,400

AA

BB

CC

% OF TOTAL % OF TOTALCLASS ITEMS VALUE QUANTITY

A 9, 8, 2 71.0 15.0B 1, 4, 3 16.5 25.0C 6, 5, 10, 7 12.5 60.0

Supply Chain Management

In ABC classification, items kept in inventory are not of equal importance in terms of:

◦ dollars invested

◦ profit potential

◦ sales or usage volume

◦ stock-out penalties

Dynamics of Inventory Planning Continually review ordering practices and

decisions Modify to fit the firm’s demand and supply

patterns Constraints, such as storage capacity and

available funds, can impact inventory planning Computers and information technology are used

extensively in inventory planning