Inventory Management

Inventory Objective: Meet customer demand and be cost-effective

Why Inventory? Created by uncertainty Variations in delivery times Uncertain production schedules Large number of defects Large fluctuations in customer demand Poor forecasts of customer demand

What is Inventory? Raw materials Purchased parts & supplies Labor In-process products Component parts Working capital Tools, machinery, and equipment

Why hold inventory? Supply is not known with certainty Safety, or buffer, stock is kept to meet excess demand To meet demand that is seasonal or cyclical Toy manufacturers Meet variations in customer demand Suppliers with JIT need to continually replenish Take advantage of volume discounts Wal-Mart

Why hold inventory? (cont) - maintain buffer inventories to avoid work stoppages or delays

Demand Dependent demand Independent demand Component parts or materials used in the process of producing a final product Tires for a car Independent demand Final or finished products A car

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Inventory Costs Carrying costs Ordering costs Shortage costs

Carrying costs Costs of holding an item in inventory Cost of funds tied up in inventory Storage costs such as rent, heating, lighting, security and transportation Interest on loans to purchase inventory Depreciation Obsolescence Deterioration Breakage Taxes Pilferage

Ordering costs Costs associated with replenishing stock of inventory held Purchase orders Transportation & shipping Receiving Inspection Handling & storage Accounting Auditing

Shortage costs Occur when customer demand cannot be met due to insufficient inventory Can result in: Loss of profit Customer dissatisfaction Loss of goodwill Permanent loss of customers Loss of future sales Hard to quantify stock out costs

Continuous Inventory Systems A continual record of inventory level for every item is maintained Whenever inventory decreases to a certain point (the reorder point) a new order is placed The amount ordered, and when it is ordered, is called the Economic Order Quantity Example: Wal-Mart

Periodic Inventory System Inventory on hand is counted at fixed intervals After counting, an order is placed that will restore desired level of stock Different amounts are ordered, but at regular intervals

ABC Classification System 3-tiered system Used when a small percentage of items account for most of the inventory value ‘A’ items require close inventory control, ‘B’ and ‘C’ items less control

Economic Order Quantity Model (Basic) Demand is known with certainty and is constant over time No shortages are allowed Lead time for the receipt of orders is constant The order quantity is received all at once

EOQ model Annual ordering cost = C0D/Q Annual carrying cost = CCQ/2 Total annual inv. Cost TC = C0D/Q + CCQ/2 EOQ = QOPT = Ö2COD/CC TCMIN = COD/QOPT + CCQOPT/2

Reorder Point The inventory level in which an order is placed R = dL d = demand rate per period L = lead time

Safety Stocks Remaining inventory between the time an order is placed and when new stock is received If not enough inventory, a stockout can occur Safety stock is a hedge against running out of inventory