12 Inventory Management PowerPresentation® prepared by David J. McConomy, Queen’s University

Learning Objectives Describe the traditional inventory management model. Describe JIT inventory management.

Learning Objectives Describe the theory of constraints and explain how it can be used to manage inventory.

Basics of Traditional Inventory Management Inventory Costs Ordering Costs Setup Costs Carrying Costs Stockout Costs 3

Inventory Costs 1. Ordering Costs: The costs of placing and receiving an order Examples: clerical costs, documents, insurance for shipment, and unloading. 2. Setup Costs: The costs of preparing equipment and facilities so they can be used to produce a particular product or component Examples: setup labour, lost income (from idled facilities), and test runs. When a firm produces the goods internally, ordering costs are replaced by setup costs.

Inventory Costs (continued) 3. Carrying Costs: The costs of keeping inventory Examples: insurance, obsolescence, opportunity cost of funds tied up in inventory, handling costs and storage space. 4. Stockout Costs: The costs of not having sufficient inventory Examples: lost sales (both current and future), costs of expediting (increased transportation charges, overtime, etc.) and the costs of interrupted production.

Why Inventory Is Needed: Traditional View Dealing with uncertainty of demand Dealing with uncertainty of supply Dealing with unreliable production processes

Why Inventory Is Needed: Traditional View (continued) To buffer against production interruptions To take advantage of discounts To hedge against future price increases

The Appropriate Inventory Policy Two Basic Questions Must be Addressed How much should be ordered or produced? When should the order be placed or the setup be performed?

An Inventory Model Total Costs = Ordering costs + Carrying costs TC = PD/Q + CQ/2 where TC = The total ordering (or setup) and carrying costs P = The cost of placing and receiving an order (or the cost of setting up a production run) D = The known annual demand Q = The number of units ordered in each order (or the lot size for production) C = The cost of carrying one unit of stock for one year Economic order quantity (EOQ) =  2PD/C 7

An EOQ Illustration EOQ =  2PD/C D = 10,000 units Q = 1,000 units P = $25 per order C = $2 per unit EOQ =  (2 x 25 x 10,000) / 2 EOQ =  250,000 EOQ = 500 units 8

Reorder Point When Demand is Certain Reorder point = Rate of usage x Lead time Example: Assume that the average rate of usage is 50 units per day for a component. Assume also that the time required to place and receive an order is 4 days. What is the reorder point? Reorder point = 4 x 50 = 200 units Thus, an order should be placed when inventory drops to 200 units.

Reorder Point When Demand is Uncertain (Ave. rate of usage x Lead time) + Safety stock where: Safety stock = (Maximum usage - Average usage) x Lead time

Reorder Point (continued) Example: Suppose that the maximum usage is 60 units per day and the average usage is 50 units per day. The lead time is 4 days. What is the reorder point? Safety stock = (60 - 50) x 4 = 40 units Reorder point = (50 x 4) + 40 = 240 units

Reorder Point (no safety stock) Reorder point = Rate of usage x Lead time 100 80 60 40 20 ROP Time

Traditional versus JIT Inventory Procedures Inventory Control Systems Traditional Systems JIT Systems 1. Balance setup and carrying costs 2. Satisfy customer demand 3. Avoid manufacturing shutdowns 4. Take advantage of discounts 5. Hedge against future price increases 1. Drive setup and carrying costs to zero 2. Use due-date performance *3. Total preventive maintenance *4. Total quality control *5. The Kanban system *Rather than holding inventories as a hedge against plant-shutdowns, JIT attacks the plant-shutdown problem by addressing these issues. 11

JIT And Inventory Management Setup and Carrying Costs: The JIT Approach JIT reduces the costs of acquiring inventory to insignificant levels by: Drastically reducing setup time Using long-term contracts for outside purchases Carrying costs are reduced to insignificant levels by reducing inventories to insignificant levels

JIT And Inventory Management Due-Date Performance: The JIT Solution Lead times are reduced so that the company can meet requested delivery dates and to respond quickly to customer demand. Lead times are reduced by: reducing setup times improving quality using cellular manufacturing

JIT And Inventory Management Avoidance of Shutdown: The JIT Approach Total preventive maintenance to reduce machine failures Total quality control to reduce defective parts Cultivation of supplier relationships to ensure availability of quality raw materials and subassemblies The use of the Kanban system is also essential

JIT And Inventory Management JIT Purchasing Versus Holding Inventories Careful vendor selection Long-term contracts with vendors Prices are stipulated (usually producing a significant savings) Quality is stipulated The number of orders placed are reduced

What is the Kanban System? A Card System is used to monitor work-in-process A withdrawal Kanban A production Kanban A vendor Kanban 12

The Withdrawal Kanban Item No. TVD-114 Preceding Process Item Name LCD Screen Computer Assembly Computer Type Compaq 4/25 Box Capacity 12 Subsequent Process Box Type AD-1942 Final Assembly 13

The Production Kanban Item No. TVD-114 Process Item Name LCD Screen Computer Assembly Computer Type Contra 4/25 Box Capacity 12 Box Type ___C 14

The Vendor Kanban Item No. TVD-114 Item Name Computer Chassis Type Black Plastic Box Capacity 12 Location North Receiving Gate Box Type Cardboard--Type A Time to Deliver 8:30 AM., 12:30 P.M., 2:30 P.M. Name of Vendor Hovey Supply Company 15

The Kanban Process (7) Withdrawal Store (1) Lot with P-Kanban CB Assembly (5) Attach W-Kanban (1) Remove W-Kanban Attach to Post (6) Signal Remove (4) P-Kanban Attach to Post CB Store (2), (3) Withdrawal Post Production Ordering Post Final Assembly 16

Theory of Constraints Three Measures of Organizational Performance Throughput Inventory Operating expenses 17

The Theory of Constraints: Five Steps to Improve Performance 1. Identify the organization’s constraint(s). 2. Exploit the binding constraint(s). 3. Subordinate everything else to the decisions made in Step 2. 4. Elevate the binding constraint(s). 5. Repeat the process. 18

The Drum-Buffer-Rope System Raw Materials Initial Process Process C Rope Process A Final Process Process B Finished Goods Time Buffer Drummer Process 19