INVENTORY MANAGEMENT Chapter Twenty McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

Inventory Inventory can be visualized as stacks of money sitting on forklifts, on shelves, and in trucks and planes while in transit. For many businesses, inventory is the largest asset on the balance sheet at any given time. Inventory can be difficult to convert back into cash. It is a good idea to try to get your inventory down as far as possible. The average cost of inventory in the United States is 30 to 35 percent of its value.

Introduction: A Balancing Act for Management Both the presence and absence of inventory contribute to value and to costs. Too much inventory is an investment that will provide no return. Too little inventory results in missed or late sales and deliveries. Carrying the correct amount of inventory is a difficult balancing act.

Inventory Models Single-period model Used when we are making a one-time purchase of an item Single-period model Used when we want to maintain an item “in-stock,” and when we restock, a certain number of units must be ordered Fixed-order quantity model Item is ordered at certain intervals of time Fixed–time period model

Definitions Inventory: the stock of any item or resource used in an organization Includes raw materials, finished products, component parts, supplies, and work-in-process Manufacturing inventory: refers to items that contribute to or become part of a firm’s product Inventory system: the set of policies and controls that monitor levels of inventory Determines what levels should be maintained, when stock should be replenished, and how large orders should be

Why Should Businesses Carry Inventory? Decoupling: Reducing the direct dependency of a process step on its predecessor. This could be in a process or in the supply chain. Decouple customer from supplier and machine from machine Disruptions, if decoupled, don’t have as serious of an impact Decoupling enhances reliability and response time

Why Should Businesses Carry Inventory? Decoupling Meeting Demand Emergency Situations

Why Should Businesses Avoid Carrying Too Much Inventory? No Financial returns - Inventory is an investment that should provide a financial return; excess inventory is an investment that provides no return. Associated costs - In addition to the cost of purchasing it, inventory also has other “carrying” costs: Cost of storage, Cost of insurance, Reduction in flexibility

Why Should Businesses Avoid Carrying Too Much Inventory? Reduces management’s ability to make quick decisions (reduces flexibility) Less adaptability to changing market conditions

Purposes of Inventory To maintain independence of operations To meet variation in product demand To allow flexibility in production scheduling To provide a safeguard for variation in raw material delivery time To take advantage of economic purchase order size

Inventory Costs Costs Holding (or carrying) costs Costs for storage, handling, insurance, and so on Setup (or production change) costs Costs for arranging specific equipment setups, and so on Ordering costs Costs of placing an order Shortage costs Costs of running out

Demand Types Independent demand – the demands for various items are unrelated to each other For example, a workstation may produce many parts that are unrelated but meet some external demand requirement Dependent demand – the need for any one item is a direct result of the need for some other item Usually a higher-level item of which it is part

Independent vs. Dependent Demand Inventory Example: Independent demand: Kitchen table – Need 500 tables five weeks from now Dependent demand: Kitchen table legs – Need 4 per table or 2,000 legs Calculation of dependent demand (Chapter 12)

Inventory Control Systems Continuous Review System – An inventory system used to manage independent demand inventory where the inventory level for an item is constantly monitored and when the reorder point is reached, an order is released. Periodic Review System – An inventory system that is used to manage independent demand inventory where the inventory level for an item is checked at regular intervals and restocked to some predetermined level.

ROP Problem For men’s size XL Trevecca T-shirts at the bookstore, the average weekly demand is 7, with a standard deviation of 3. the replenishment lead time is 1 week. What should the re-order point be to maintain a 99% confidence (z=2.35) of satisfying the demand during the lead time? ROP = Average Demand (LT)+(z*sd)

Continuous Review System Key features: Inventory levels are monitored constantly, and a replenishment order is issued only when the reorder point is reached. The size of a replenishment order is typically based on the trade-off between holding costs and ordering costs. The reorder point is based on both demand and supply considerations, as well as on how much safety stock managers want to hold.

Fixed-Order Quantity Model Always order Q units when inventory reaches reorder point (R). Inventory is consumed at a constant rate, with a new order placed when the reorder point (R) is reached once again.   Inventory arrives after lead time (L). Inventory is raised to maximum level (Q).  

Economic Order Quantity (EOQ) The optimal order quantity (Qopt) occurs where total costs are at their minimum    

Quantity Discounts Quantity Discounts – Price reductions for ordering larger quantities.

Quantity Discounts Two-step process: Calculate the EOQ. If the EOQ represents a quantity that can be purchased for the lowest price, stop – we have found the lowest cost order quantity. Otherwise, go to Step 2. Compare total holding, ordering, and item costs at the EOQ quantity with total costs at each price break above the EOQ. There is no reason to look at quantities below the EOQ, as these would result in higher holding and ordering costs, as well as higher item costs.