In this chapter we will discuss: Purpose of inventories, costs of inventories, independent versus dependent demand, economic order quantity, continuous review system, periodic review system, using P and Q system in practice, ABC inventory management.
Operations Management Contemporary Concepts and Cases Chapter Fifteen Independent Demand Inventory McGrawHill/Irwin Copyright © 2011 by The McGrawHill Companies, Inc. All rights reserved Chapter 15 Outline Purpose of Inventories Costs of Inventories Independent versus Dependent Demand Economic Order Quantity Continuous Review System Periodic Review System Using P and Q System in Practice ABC Inventory Management 152 Definitions Inventory: a stock of materials used to facilitate production or satisfy customer demand Types of inventory – – – – Raw materials, purchased parts (RM) Work in process (WIP) Finished goods (FG) Maintenance, repair & operating supplies (MRO) 153 Inventory Management Technologies Bar coding Point of sale (data) (POS) Radiofrequency Identification (RFID) 154 Materials-Flow Process (Fig 15.1) Productive Process Work in process Vendors Raw Materials Work in process Finished Customer goods Work in process 155 Water Tank Analogy for Inventory Inventory Level Supply Rate Inventory Level Demand Rate 156 Purpose of Inventories (1) To protect against uncertainties (safety stock) – – – – demand (FG, MRO) supply (RM, MRO) lead times (RM, WIP) schedule changes (WIP) To allow economic production and purchase (discounts for buying RM in bulk) 157 Purpose of Inventories (2) To cover anticipated changes in demand (as in a level strategy) or supply – FG – RM To provide for transit (pipeline inventories) – – – RM FG WIP (independence of operations) 158 Inventory Cost Structures (1) Item cost – Expressed as cost per unit or SKU. Gets into LIFO and FIFO issues. – Problem can be compounded by quantity discounts Ordering (or setup) cost – – – Paperwork, worker time (ordering) Worker time, downtime (setup) Typically expressed as a fixed cost per order or setup. 159 Inventory Cost Structures (2) Carrying (or holding) cost: – Cost of capital (market rate or internal rate of return) – Cost of storage (building, utilities, insurance, handling) – Cost of obsolescence, deterioration, and loss (shrinkage) – Management cost (record keeping, counting) Typically expressed as a percentage of SKU cost. Estimated U.S. average is 35% per year Businesses often use only cost of capital (understatement) 1510 Reorder Point The Reorder point is defined as: R = m + s where: R = reorder point m = mean demand during lead time s = safety or buffer stock Using the normal distribution: s = zσ where: z = safety factor (from normal table) σ = standard deviation of lead time demand Thus: R = m + zσ 1533 Periodic Review System (1) Instead of reviewing continuously, we review the inventory position at fixed intervals. For example, the bread truck visits the grocery store on the same days every week Inventory brought up to a ‘target’ level Also known as “P system,” “Fixedorder interval system” or “Fixedorderperiod system” 1534 Periodic Review System (2) Has a target inventory level rather than a reorder point Does not use EOQ (directly) since order quantity varies according to demand The order interval is fixed, the order quantity varies 1535 Periodic Review (P) System (Fig 15.9) 1536 Time Between Orders (P) and Target Level (T) Calculation P 2S iC D T m' s ' Where: T = target inventory level m’ = average demand over P+L s’ = safety stock 1537 Using P and Q System in Practice Use P system when orders must be placed at specified intervals Use P systems when multiple items are ordered from the same supplier (joint replenishment) Use P system for inexpensive items 1538 Using P and Q Systems in Practice P may be easier to use since levels are reviewed less often P requires more safety stock since may only order at fixed points P is more likely to run out since cannot respond quickly to increases in demand Either may be more costly: P in safety stock, Q in monitoring cost 1539 P and Q Systems at Home P system: You go to the grocery store on the same day every week. You ask: “What will we need for the next week?” – P is more likely to run out since cannot respond quickly to increases in demand – P will carry more inventory (enough to last until the next trip) Q system: You go to the grocery store each time you need something. You ask: “What do we need?” – Q may require more ordering and unplanned order (trips to the store) 1540 Service Level versus Inventory Level (Fig 15.10) 105% Service Level (%) 100% 95% 90% 85% 1.1 1.0 1.2 1.3 1.4 1.5 1.6 2.1 2.2 2.3 2.4 2.0 1.9 1.7 1.8 2.5 z values 80% 75% 150 160 170 180 190 200 210 220 230 240 250 260 270 280 290 300 Q 100 100 Average Inventory Level 1541 ABC Inventory Management (1) Based on “Pareto” concept (80/20 rule) and total usage in dollars of each item Classification of items as A, B, or C based on usage Purpose is to set priorities on effort used to manage different SKUs, i.e., to allocate scarce management resources 1542 ABC Inventory Management (2) ‘A’ items: 20% of SKUs, 80% of dollars ‘B’ items: 30% of SKUs, 15% of dollars ‘C’ items: 50% of SKUs, 5% of dollars Three classes is arbitrary; could be any number Percents are approximate Danger: Dollar use may not reflect importance of any given SKU! Some low value, but critical items may be classified as ‘A.’ 1543 Annual Usage of Items by Dollar Value (Table 15.4) Item 10 Total Annual Usage in Units Unit Cost Dollar Usage 5,000 $ 1.50 $ 7,500 1,500 8.00 12,000 10,000 10.50 105,000 6,000 2.00 12,000 7,500 0.50 3,750 6,000 13.60 81,600 5,000 0.75 3,750 4,500 1.25 5,625 7,000 2.50 17,500 3,000 2.00 6,000 $ 254,725 Percentage of Total Dollar Usage 2.9% 4.7% 41.2% 4.7% 1.5% 32.0% 1.5% 2.2% 6.9% 2.4% 100.0% 1544 ABC Chart for Table 15.4 120.0% 40.0% A Percent Usage 35.0% 30.0% B 100.0% C 80.0% 25.0% 60.0% 20.0% 15.0% 40.0% 10.0% 20.0% 5.0% 0.0% Cumulative % Usage 45.0% 0.0% 10 Item No Percentage of Total Dollar Usage Cumulative Percentage 1545 Summary Purpose of Inventories Costs of Inventories Independent versus Dependent Demand Economic Order Quantity Continuous Review System Periodic Review System Using P and Q System in Practice ABC Inventory Management 1546 End of Chapter Fifteen 1547 ... Using P and Q System in Practice ABC? ?Inventory? ?Management 152 Definitions Inventory: a stock of materials used? ?to? ?facilitate production or satisfy customer? ?demand Types of? ?inventory – – – – Raw materials, purchased parts (RM)... process Finished Customer goods Work in process 155 Water Tank Analogy for Inventory Inventory Level Supply Rate Inventory? ?Level Demand Rate 156 Purpose of Inventories (1) To? ?protect against uncertainties (safety stock)... Frequent orders (small lot sizes) lead? ?to? ?lower average? ?inventory? ?level, i.e., higher total ordering costs and lower total holding costs – Fewer orders (large lot sizes) lead? ?to? ?higher average? ?inventory? ?level, i.e., lower total ordering