OM Chapter 12 Managing Inventories

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1OM, Ch. 12 Managing Inventories2009 South-Western, a part of Cengage Learning

MANAGING INVENTORIESCHAPTER 12

DAVID A. COLLIER AND

JAMES R. EVANS

OM


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Can you cite any experiences in which the lack ofappropriate inventory at a retail store has caused youas the customer to be dissatisfied?

Inventory is any asset held for future use or sale.

The expenses associated with financing andmaintaining inventories are a substantial part of thecost of doing business (i.e., cost of goods sold).

Inventory Management involves planning,

coordinating, and controlling the acquisition, storage,handling, movement, distribution, and possible sale ofraw materials, component parts and subassemblies,supplies and tools, replacement parts, and other assets

that are needed to meet customer wants and needs.

Chapter 12 Managing Inventories


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Basic Inventory Concepts

Raw materials, component parts,subassemblies, and supplies are inputs tomanufacturing and service-delivery processes.

Work-in-process (WIP) inventory consists ofpartially finished products in various stages ofcompletion that are awaiting further processing.

Finished goods inventory is completedproducts ready for distribution or sale tocustomers.



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Basic Inventory Concepts

Cycle inventory (order or lot sizeinventory) is inventory that results frompurchasing or producing in larger lots than areneeded for immediate consumption or sale.

Safety stock inventory is an additionalamount of inventory that is kept over and

above the average amount required to meetdemand.

Chapter 12 Basic Inventory Concepts


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Inventory managers deal with twofundamental decisions:

1. When to order items from a supplier

or when to initiate production runs ifthe firm makes its own items

2. How much to order or produce eachtime a supplier or production order isplaced



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Inventory Management Decisions & Costs

Four categories of inventory costs:

Ordering costs or setup costs are

incurred as a result of the work involved inplacing purchase orders with suppliers orconfiguring tools, equipment, and machineswithin a factory to produce an item.

Inventory-holding costs or inventory- carrying costs are the expenses associatedwith carrying inventory.



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OM, Ch. 12 Managing Inventories2009 South-Western, a part of Cengage Learning

Characteristics of Inventory Systems

Number of items: each item is identified byits stock-keeping unit (SKU).

A stock-keeping unit (SKU) is a single itemor asset stored at a particular location.

Maintaining data integrity on thousands of

SKUs is difficult but must be done. The qualityof inventory model decisions is related to thequality of information used in the model(s).



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Nature of Demand Independent demand is demand for an SKU that is

unrelated to the demand for other SKUs and needs to beforecast.

Dependent demand is demand directly related to the

demand for other SKUs and can be calculated withoutneeding to be forecast.

Deterministic demand is when uncertainty is notincluded in its characteristics.

Stochastic demand incorporates uncertainty by usingprobability distributions.

Static demand is stable demand. Dynamic demand varies over time.



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Number of time periods in planninghorizon: short or long planning horizon such asdays, weeks, months, quarters, and years.

Size of time periods: hours, days, weeks,months, quarters.

The lead time is the time between placementof an order and its receipt.



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A stockout is the inability to satisfy demand foran item. When a stockout happens, the item iseither back-ordered or a sale is lost.

A backorder occurs when a customer is willingto wait for an item.

A lost sale occurs when the customer isunwilling to wait and purchases the itemelsewhere.



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Inventory Management Infrastructure

ABC inventory (Pareto) analysis givesmanagers useful information to identify thebest methods to control each category ofinventory (see Exhibits 12.2 to 12.4).

A vital few SKUs represent a high

percentage of the total dollar inventoryvalue.

Chapter 12 ABC Inventory Analysis


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ABC Inventory (Pareto) Analysis

A items account for a large dollar value butrelatively small percentage of total items (e.g.,10% to 30 % of items, yet 60% to 80% of total

dollar usage). C items account for a small dollar value but a

large percentage of total items (e.g., 5% to 15% ofitems, yet about 50% of total dollar usage). Thesecan be managed using automated computersystems.

B items are between A and C.

Chapter 12 ABC Inventory Analysis


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In a fixed quantity system (FQS) , the order

quantity or lot size is fixed; the same amount, Q,is ordered every time.

The process of triggering an order is based on theinventory position.

Inventory position (IP) is the on-hand quantity(OH) plus any orders placed but which have notarrived (scheduled receipts, or SR), minus any

backorders (BO).IP = OH + SR BO [12.1]



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Fixed Quantity System

When inventory falls at or below a certain value, r ,called the reorder point , a new order is placed.

Reorder point depends on the lead time andnature of demand oftentimes, the reorder point isselected using the average demand during thelead time ( L ).

r = L = (d) ( L) [12.2] Where d is average demand per unit of time and L

is the lead time expressed in the same units oftime.



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Exhibit 12.6 Fixed Quantity System (FQS) under Stable Demand


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The Economic Order Quantity (EOQ) model is a classic

economic model developed in the early 1900s that minimizestotal cost, which is the sum of the inventory-holding cost andthe ordering cost.

Cost of storing one unit in inventory for the year (denotedby C h ), is given by C h = ( I) ( C ), where I is annualinventory-holding charge, C is unit cost of the inventoryitem, and Q is the number of units in inventory.


[12.4]annual inventory

holding cost

average

inventory

annual holding

cost per unit=

( )=

1

2QC h

( )


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Optimal Order Quantity: order quantity that minimizesthe total cost.

Q* is the quantity that minimizes the total cost and isknown as the economic order quantity, or EOQ .


Q* = 2DC o C h [12.7]


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Only a single item (SKU) is considered.

The entire order quantity (Q) arrives inthe inventory at one time. No physical

limits are placed on the size of the orderquantity, such as shipment capacity orstorage availability.

Only two types of costs are relevant order/setup and inventory holding costs.

Chapter 12 Key Assumptions of the EOQ Model


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No stockouts are allowed.

The demand for the item is deterministicand continuous over time. This meansthat units are withdrawn from inventoryat a constant rate proportional to time.For example, an annual demand of 365units implies a monthly demand of365/12 and a daily demand of one unit.

Lead time is constant.

Chapter 12 Key Assumptions of the EOQ Model (continued)


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Exhibit 12.9 Chart of Holding, Ordering, and Total Costs


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Fixed Period Systems

An alternative to a fixed order quantity system is afixed period system (FPS) sometimes called aperiodic review system in which the inventory position

is checked only at fixed intervals of time, T , rather thanon a continuous basis.

Two principal decisions in a FPS:

1. The time interval between reviews (T) , and2. The replenishment level (M)



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Single-Period Inventory Model

Applies to inventory situations in which oneorder is placed for a good in anticipation of afuture selling season where demand is

uncertain. At the end of the period, the product has either

sold out or there is a surplus of unsold items to

sell for a salvage value. Sometimes called a newsvendor problem ,

because newspaper sales are a typical exampleof the single-period inventory problem.

Chapter 12 Special Models for Inventory Management

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OM Chapter 12 Managing Inventories