CHAPTER 6 Inventory Management

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-2 Purposes of Inventory Enables the firm to achieve economics of scale Balances supply and demand Enables specialization in manufacturing Provides protection from uncertainties in demand and order cycle Acts as a buffer between critical interfaces within the supply chain

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-3 Kinds of Inventory Cycle Stock In-transit Inventories Safety or Buffer Stock Speculative Stock Seasonal Stock Dead Stock

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-4 The Effect of Reorder Quantity on Average Inventory Investment with Constant Demand and Lead Time a 6-3 a

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-5 The Effect of Reorder Quantity on Average Inventory Investment with Constant Demand and Lead Time b 6-3 b

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-6 The Effect of Reorder Quantity on Average Inventory Investment with Constant Demand and Lead Time c 6-3 c

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-7 Average Inventory Investment Under Conditions of Uncertainty A. With variable demand Inventory Average cycle inventory S s ( afety tock 50) y Average inventor (150) Days { { a 6-4 a

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-8 Average Inventory Investment Under Conditions of Uncertainty B. With variable lead time Inventory Average cycle inventory y Average inventor (140) { Day S s ( afety tock 40) s { b 6-4 b

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-9 C. With variable demand and lead time Inventory Average cycle inventory y Average inventor (200) { Day yS s ( afet 0 tock 10) s { 8 Average Inventory Investment Under Conditions of Uncertainty c 6-4 c

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-10 EOQ = 2PD CV where: P = The ordering cost (dollars per order) D = Annual demand or usage of the product (number of units) C = Annual inventory carrying cost (as a percentage of product cost or value) V = Average cost or value of one unit of inventory The EOQ Model 6-5

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-11 The Assumptions of EOQ Continuous, constant, known demand Constant and know lead time Constant purchase price that is independent of the order quantity or time Constant transportation cost that is independent of the order quantity or time No stockouts No inventory in transit No limit on capital

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-12 Size of order Annual cost (dollars) Lowest total cost (EOQ) Total cost Inventory carrying cost Ordering cost Cost Trade-offs to Determine the Most Economic Order Quantity 6-6

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-13 Order Quantity Number of Orders (D/Q) Ordering Cost PX (D/Q) Inventory Carrying Cost 1/2 Q X C X V Total Cost $ 4,800 3,200 2,400 1,920 1,600 1,400 1, $ ,000 1,250 1,500 1,750 2,000 2,500 3,750 5,000 $ 5,300 3,950 3,400 3,170 3,100 3,150 3,200 4,460 4,470 5,480 Cost Trade-offs Required to Determine the Most Economic Order Quantity 6-7

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-14 Adusting EOQ for Volume Discounts Transportation Discounts Quantity Discounts Incremental Replenishment Because of The EOQ must be adjusted

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-15 Inventory Management Under Uncertainty Uncertainties with demand and lead time cause most managers to concentrate on when to order rather than the quantity to order. The order quantity is important to the extent that it influences the number of orders, and consequently the number of times that the company is exposed to a potential stockout at the end of each order cycle. There are two methods used for inventory control under conditions of uncertainty: a. The fixed order point or fixed order quantity model b. The fixed order interval model

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-16 Inventory Management Under Uncertainty Fixed order point or order quantity model: an order is placed when inventory on hand and on order reached a predetermined minimum level required to satisfy demand during the order cycle. The EOQ will be ordered whenever demand drops the inventory level to the reorder point. Fixed order interval model: current inventory is compared with forecast demand, and an order is placed for the necessary quantity at a regular, specified time. In either case, we must calculate safety stock requirements.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-17 Symptoms of Poor Inventory Increasing numbers of back orders Increasing dollar investment in inventory with back orders remaining constant. High customer turnover rate. Increasing number of orders being canceled. Periodic lack of sufficient storage space. Wide variance in inventory turnover among distribution centers and major inventory items. 6-8

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 6-18 Improving Inventory Management - Methods ABC Analysis Forecasting Enterprise Resource Planning Software Improved Order Processing Systems