2000 by Prentice-Hall, Inc1 Inventory Management – Chapter 10  Stock of items held to meet future demand  Inventory management answers two questions  How much to order  When to order

2000 by Prentice-Hall, Inc2 Types of Inventory  Raw materials  Purchased parts and supplies  Labor  In-process (partially completed) products  Component parts  Working capital  Tools, machinery, and equipment

2000 by Prentice-Hall, Inc3 Reasons to Hold Inventory  Meet unexpected demand  Smooth seasonal or cyclical demand  Meet variations in customer demand  Take advantage of price discounts  Hedge against price increases  Quantity discounts

2000 by Prentice-Hall, Inc4 Two Forms of Demand  Dependent  Items used to produce final products  Independent  Items demanded by external customers

2000 by Prentice-Hall, Inc5 Inventory Costs  Carrying Cost  Cost of holding an item in inventory  Ordering Cost  Cost of replenishing inventory  Shortage Cost  Temporary or permanent loss of sales when demand cannot be met

2000 by Prentice-Hall, Inc6 Inventory Control Systems  Continuous system (fixed-order- quantity)  Constant amount ordered when inventory declines to predetermined level  Periodic system (fixed-time-period)  Order placed for variable amount after fixed passage of time

2000 by Prentice-Hall, Inc7 ABC Classification System  Demand volume and value of items vary  Classify inventory into 3 categories, typically on the basis of the dollar value to the firm PERCENTAGEPERCENTAGE CLASSOF UNITSOF DOLLARS A B3015 C

2000 by Prentice-Hall, Inc8 ABC Classification 1$ PARTUNIT COSTANNUAL USAGE Example 10.1

2000 by Prentice-Hall, Inc9 ABC Classification Example $ PARTUNIT COSTANNUAL USAGE TOTAL% OF TOTAL% OF TOTAL PARTVALUEVALUEQUANTITY% CUMMULATIVE 9$30, , , , , , , , , , $85,400

2000 by Prentice-Hall, Inc10 ABC Classification Example $ PARTUNIT COSTANNUAL USAGE TOTAL% OF TOTAL% OF TOTAL PARTVALUEVALUEQUANTITY% CUMMULATIVE 9$30, , , , , , , , , , $85,400 A B C

2000 by Prentice-Hall, Inc11 ABC Classification Example $ PARTUNIT COSTANNUAL USAGE TOTAL% OF TOTAL% OF TOTAL PARTVALUEVALUEQUANTITY% CUMMULATIVE 9$30, , , , , , , , , , $85,400 A B C % OF TOTAL CLASSITEMSVALUEQUANTITY A9, 8, B1, 4, C6, 5, 10,

2000 by Prentice-Hall, Inc12 ABC Classification – – – – – 0 0 – |||||| % of Quantity % of Value A B C

2000 by Prentice-Hall, Inc13 Assumptions of Basic EOQ Model  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

2000 by Prentice-Hall, Inc14 The Inventory Order Cycle Demand rate Time Lead time Order placed Order receipt Inventory Level Reorder point, R Order quantity, Q 0 Figure 10.1

2000 by Prentice-Hall, Inc15 EOQ Cost Model C o - cost of placing orderD - annual demand C c - annual per-unit carrying costQ - order quantity Annual ordering cost = CoDCoDQQCoDCoDQQQ Annual carrying cost = CcQCcQ22CcQCcQ222 Total cost = + CoDCoDQQCoDCoDQQQ CcQCcQ22CcQCcQ222

2000 by Prentice-Hall, Inc16 EOQ Cost Model Slope = 0 Total Cost Order Quantity, Q Annual cost ($) Minimum total cost Optimal order Q opt Q opt Carrying Cost = CcQCcQ22CcQCcQ222 Ordering Cost = CoDCoDQQCoDCoDQQQ Figure 10.2

2000 by Prentice-Hall, Inc17 Quantity Discounts Price per unit decreases as order quantity increases Price per unit decreases as order quantity increases TC = + + PD CoDCoDQQCoDCoDQQQ CcQCcQ22CcQCcQ222 where P = per unit price of the item D = annual demand

2000 by Prentice-Hall, Inc18 Quantity Discounts Price per unit decreases as order quantity increases Price per unit decreases as order quantity increases TC = + + PD CoDCoDQQCoDCoDQQQ CcQCcQ22CcQCcQ222 where P = per unit price of the item D = annual demand ORDER SIZEPRICE $ ( d 1 ) ( d 2 )

2000 by Prentice-Hall, Inc19 Quantity Discount Model Figure 10.4 Q opt Carrying cost Ordering cost Inventory cost ($) Q( d 1 ) = 100 Q( d 2 ) = 200 TC ( d 2 = $6 ) TC ( d 1 = $8 ) TC = ($10 )

2000 by Prentice-Hall, Inc20 When to Order Reorder Point is the level of inventory at which a new order is placed R = dL where d = demand rate per period L = lead time

2000 by Prentice-Hall, Inc21 Safety Stocks  Safety stock  buffer added to on hand inventory during lead time  Stockout  an inventory shortage  Service level  probability that the inventory available during lead time will meet demand

2000 by Prentice-Hall, Inc22 Variable Demand with a Reorder Point Figure 10.5 Reorder point, R Q LT Time LT Inventory level 0

2000 by Prentice-Hall, Inc23 Reorder Point with a Safety Stock Figure 10.6 Reorder point, R Q LT Time LT Inventory level 0 Safety Stock

2000 by Prentice-Hall, Inc24 Reorder Point With Variable Demand R = dL + z  d L where d=average daily demand L=lead time  d =the standard deviation of daily demand z=number of standard deviations corresponding to the service level probability z  d L=safety stock