5 INVENTORY MANAGEMENT

Inventory definition Inventory are the items used to support: production (raw materials and work-in-process items), supporting activities (maintenance, repair and operating supplies) and customer service (finished goods and spare parts) (APICS dictionary) Inventory is the stock of any item or resource used in an organization

Why inventory occure ? Variance between the rate of input (rate of supply) and the rate of output (rate of demand) Flow Model of Inventory Rate of output (demand rate) Rate of input (supply rate) Cyclic inventory Noncyclic inventory

Types of Inventory Raw materials inventory Work-in-process (WIP) inventory Finished products inventory

Types of Inventory Raw materials inventory: The purchased items that are transformed into components or products. Components inventory: Parts or subassemblies used in building the final product. Work-in-process (WIP) inventory: Any item that is in some stage of completion in the manufacturing process Finished goods inventory: Completed products that will be delivered to customers. Maintenance, repair, and operational (MRO) inventory: Inventories of some items (such as maintenance supplies, spare parts, lubricants, cleaning compounds, and office supplies) are used to support general operations and maintenance Distribution inventory: Finished goods and spare parts that are at various points in the distribution system.

Types of Inventory Division of inventory based on the type of demand Independent demand inventory – demand for item is independent on demand of others items (the source of demand is usually from an external customer). Items of independent demand are the finished products Dependent demand inventory – demand for item is dependent directly on demand of another item. Items of dependent demand are the components and raw materials Stool Leg x (4) Seat (1) Independent demand Demand forcast - 100 stools, independent demand Calculation – 400 legs, dependent demand Dependent demand

Inventory functions To decouple or separate various parts of the production process To provide a stock of goods to meet anticipated customer demand and provide a “selection” of goods To balance the seasonal fluctuations in demand To take advantage of quantity discounts To hedge against inflation and price changes To protect against delivery variation due to weather, supplier shortages, quality problems. Safety stocks – reduce the risk of shortages

Inventory Usage over Time Stock consumption Stock replenishement Time Quantity Average stock CYCLIC STOCK Safety stock NON-CYCLIC STOCK Excess stock

Inventory in the manufacturing company S U P L I E R C T O M Supply stage Production stage Distribution stage Supplies PURCHASED STOCKS raw materials components Parts production PROCESSED STOCKS (unfinished production) work in progress Products assembly Distribution STOCKS FOR SALE finished products spare parts

Inventory costs INDEPENDENT on the order quantity FIXED COSTS Purchasing cost/unit, production cost/unit Costs of stock facilities Staff costs VARIABLE COSTS DEPENDENT on the order quantity Holding costs Ordering costs/Setup or production change costs Shortage costs Excess costs

ORDERING COST/ PURCHASING COST Inventory costs ORDERING COST/ PURCHASING COST SETUP COST Supplies Forms Order processing Clerical support Etc. Clean-up costs Re-tooling costs Adjustment costs Etc. HOLDING COST SHORTAGE COST Stockout Cost Backorders (customer order for the product must wait until the stock is replenished) backorders service cost, lower service cost Lost sale (customer order is cancelled) profit lost cost, lower service cost Warehousing Obsolescence Insurance Interest Damage Etc. EXCESS COST Inventory Risk Cost excess is holding in the next periods cost of prolonged holding stock, cost of price reduction excess is not holding in the next periods (lost sale) liquidation (clearing) stock cost

Holding (Carrying) Costs (calculation) % of Category Inventory Value Warehousing 3% Obsolescence 6% Insurance 3% Extra staffing 2% Interest 5% Damage 4% Total holding cost (variable) 23% of Inventory Value H = % * price/unit

Goal of inventory management To find a balance between customer service level and cost of shortage 100 % Level of customer service Risk of shortage Availability level Safety stock level There is a trade off between carrying stock to satisfy demand (customer service) and the costs resulting from stock out (cost of shortage). Example: Availability level (customer service level) - 90% Probability of shortage -10% Availability level (customer service level) - 95% Probability of shortage - 5% Safety stock must be increased

Inventory management decisions Manufactured stock Purchased stock Determine the order quantity (purchasing batch/lot) HOW MUCH TO ORDER ? HOW MUCH TO ORDER? Determine the production order quantity (production batch/lot) WHEN TO ORDER ? Determine the production order loanched time Determine the purchased order loanched time WHEN TO ORDER ?

INVENTORY MANAGEMENT SYSTEM Inventory management system is the set of policies and controls that monitor levels of inventory and determine what stock level should be maintained, when stock should be replenished, and how large orders should be.

INVENTORY MANAGEMENT SYSTEMS INVENTORY MANAGEMENT (CONTROL) SYSTEMS INDEPENDENT DEMAND INVENTORY CONTROLSYSTEMS DEPENDENT DEMAND INVENTORY CONTROL SYSTEMS MATERIAL REQUIREMENTS PLANNING SYSTEM (MRP) PERIODIC REVIEW SYSTEMS CONTINUOUS REVIEW SYSTEMS FIXED ORDER PERIOD SYSTEMS FIXED ORDER QUANTITY SYSTEMS Economic Order Quantity Model Economic Production Quantity Model Back Order Inventory Model Quantity Discounts Model

Fixed Order Quantity Systems ASSUMPTIONS Order quantity is fixed (constant) Order cycle – variable Continuous inventory level control How much to order? (Order Quantity Models) FIXED ORDER QUANTITY - FOQ 1. Order quantity is arbitrary define (for example Q = 1000 units) 2. Order quantity is define using Economic Order Quantity Model - EOQ Possible options

Economic Order Quantity Model – EOQ ASSUMPTIONS Demand is known and constant Lead time (delivery time) is known and constant Stock replenishment is immediate Q - order quantity S - maximal stock Sav - average stock R - reorder point T - order cycle Cz - Stock cycle LT - lead time (delivery time) WD - number of working days per year

Economic Order Quantity calculation D - annual demand HC - annual holding cost H - holding cost per unit per year SC - total order cost per year S - cost per order TC – total cost Cmin – minimal total cost Q - order quantity EOQ/Q*- economic order quantity Q Annul cost Total Cost Holding Cost Setup Cost Q* Cmin Economic Order Quantity Objective : Total cost minimalization

EOQ Model - example Number of orders per year Annual holding cost DATA D = 1200 units/year S = 100 $/order H = 6 $/unit./year WD = 240 working days /year Number of orders per year Annual holding cost Economic Order Quantity Total order cost per year Maximal stock Total inventory cost Average stock Order cycle

When to order? - Reorder Point model Reorder Point (R) - Stock level which inform about the necessity of placing an order to replenish inventory Where: Q - order quantity S - maximal stock SS - safety stock Sav - average stock R - reorder point d - demand rate LT - lead time (delivery time)

Fixed Order Period System Assumptions Quantity ordered - varies Fixed order cycle Periodic inventory monitoring T - order cycle (order period) Q - order quantity S - desired level of inventory s - point at what order is placed SS - safety stock d - demand rate LT - lead time (delivery time) Reorder point ORDER QUANTITY?

FOQ and FOP - comparison FIXED ORDER-QUANTITY SYSTEM FOQ Filling your tank with 40 liters when the level reach 1/10 full FIXED ORDER-PERIOD SYSTEM FOQ Filling your tank every Saturday