Inventory Management Chapter 17

Topics Basic concepts. Management issues. Inventory-related costs. Economic order quantity model. Quantity discount model. Order timing decisions. Order quantity and reorder point interactions. Multi-item management. Multiple items from a single source.

Independent versus Dependent Demand Independent demand is for an item for which demand is influenced by factors outside of company decisions. Dependent demand is for an item for which demand is directly dependent on demand or requirement of another item. An item may have both independent and demand.

Functions of Inventory Transit stock (pipeline inventories): depends on the time to transport inventories between locations. Cycle stock: order quantities larger than immediate requirements—thus satisfying multiple periods of demand. Safety stock: provides protection against irregularities and uncertainties in supply or demand. Anticipation stock: stock to meet demand in peak periods or special situations, e.g., planned shutdown.

Management Issues Routine inventory decisions: How much to order (Q, S). When to order (R, T). Inventory system performance: Inventory turnover. Customer service; e.g, fill rate. Implementation - basic systems are in place before implementing advanced methods.

Inventory-related Costs Ordering costs - incurred each time a replenishment order is placed. Carrying costs - function of the item’s value and length of time it’s held in inventory. Cost of capital, opportunity cost. Taxes, insurance, inventory shrinkage, storage costs. Shortage and customer service costs - incurred when demand exceeds available supply. Loss of contribution margin and loss of good will. Tracking backorders. Customer service measures (surrogate for cost).

Economic Order Quantity Model (EOQ) TAC=(A/Q)C P + (Q/2)C H = annual ordering cost + annual carrying cost.

Quantity Discount Model TAC=(v)A + (A/Q)C P + (Q/2)C H =annual purchase cost + annual ordering cost + annual carrying cost Calculating the minimum-cost order quantity: 1. Calculate EOQ using minimum unit cost. If valid, this is the optimum Q. 2. If invalid, calculate TAC using all break points. 3. Calculate an EOQ for each item cost. 4. Calculate TAC for each valid EOQ from step Optimum Q is the lowest cost found in step 2 or step 4.

Order Timing Decisions Reorder point influenced by: Demand rate. Lead time required for replenishment. Uncertainty in demand rate and replenishment time. Management policy on desired customer service level. Safety stock is added to the average demand during expected lead time to yield the reorder point (figure 17.7).

Safety Stock Stock-out probability - acceptable risk of stocking out during any given order replenishment order cycle (figure 17.8). R = d + Z  d Customer service level or fill rate- percentage of demand, measured in units, that can be supplied directly from inventory (figure 17.8). R = d +  d E(Z)

Multi-item Management Single-criterion ABC analysis. Separate inventory items into three groupings based on annual cost-volume usage (unit cost x annual usage). A items: high dollar usage (significant few). B items: intermediate dollar usage. C items: low dollar usage (trivial many). Commonly, a small percentage of items account for a large percentage of the annual cost volume usage.

Multi-item Management Multiple-criteria ABC analysis. Non-cost criteria—lead time, obsolescence, availability, substitutability, criticality. Inventory policies set for the established categories: Inventory record verification. Order quantity. Safety stock. Classification of the item.

Multiple Items/Single Source Placing orders for several items provided by the same source can result in significant inventory cost savings. Individual item reorder points. Place order when an item reaches reorder point. Add other items using ratio of current on-hand plus on-order to the reorder point. Add until a total dollar value or weight is reached. Determine a joint EOQ, TBO. Methods: economic dollar value order, simultaneous reorder point, full truckload.

Multiple Items/Single Source Group reorder points—providing a service level for the group. Sum individual reorder points. Convert item reorder points into dollars and sum. Base on periods (e.g., months) of supply. Place orders on a periodic basis—bring inventory levels for each item to service level needed until the next order.

Concluding Principles The difference between dependent and independent demand must serve as the first basis for determining appropriate inventory management procedures. Organizational criteria must be clearly established before we set safety stock levels and measure performance. A sound basic independent demand system must be in place before we attempt to implement some of the advanced techniques presented here.

Concluding Principles Savings in inventory-related costs can be achieved by a joint determination of the order point and order quantity parameters. Combined ordering of several inventory items obtained from a single source can cut inventory-related costs. All criteria should be taken into account in classifying inventory items for management priorities.

Concluding Principles The policies developed for each ABC classification should be used to guide the classification of each item as well as to manage its inventories. Management must be sure the organization is prepared to take on advanced systems before attempting implementation.

Homework Assignment Problems 17.3, 17.6, and Due Tuesday, November 26