Inventory Management

Inflow > Outflow Inflow < Outflow Inflow = Outflow INVENTORY The Law of the Bath Tub

Arguments for Carrying Inventory Balancing supply and demand Protection from uncertainties Buffer interface Realizes economies of scale through reduction of fixed costs Allows quick response to customer demands Keeps production line running Supports long production runs

Disadvantages for Carrying Inventory May become obsolete Can be damaged or deteriorate May be hazardous to store May take up excessive W/H space Could be totally lost or hidden Opportunity Cost Could be duplicated at different W/H

Cycle stock In-process or work-in-process In-transit inventory Safety stock or Buffer inventory Seasonal stock Promotional stock Speculative stock Dead stock Consignment stock [held in customers W/H, but charged when is used] Consignment stock [held in customers W/H, but charged when is used] Types of Inventory Inventory Management

Symptoms of Poor Inventory Management[4] 1.An increase in backorders 2.More cancelled customer orders 3.Insufficient storage space 4.Unnecessary obsolete products Inventory Management

Financial Impact of Inventory [3] 1.Inventory is often a company’s largest asset 2.Inventories can account for 20% of total assets 3.Inventory costs may run up to % of the value of a product and ~ 40% of total integrated logistics costs Inventory Management

Definitions Inventory accuracy refers to how well the inventory records agree with physical count Cycle Counting is a physical inventory- taking technique in which inventory is counted on a frequent basis rather than once or twice a year Inventory Management

How to Measure Inventory The Dilemma: closely monitor and control inventories to keep them as low as possible while providing acceptable customer service. Average Aggregate Inventory Value: how much of the company’s total assets are invested in inventory? Ford: billion Sears: billion

Formulas for Measuring Supply-Chain Performance One of the most commonly used measures in all of operations management is “Inventory Turnover” In situations where distribution inventory is dominant, “Weeks of Supply” is preferred and measures how many weeks’ worth of inventory is in the system at a particular time

Inventory Measures - Examples Weeks of Supply –Ford: 3.51 weeks –Sears: 9.2 weeks

Inventory Measures - Examples Weeks of Supply –Ford: 3.51 weeks –Sears: 9.2 weeks Inventory Turnover (Turns) –Ford: 14.8 turns –Sears: 5.7 turns –GM: 8 turns –Toyota: 35 turns

Example of Measuring SC Performance Suppose a company’s new annual report claims their costs of goods sold for the year is $160 million and their total average inventory (production materials + work-in-process) is worth $35 million. This company normally has an inventory turn ratio of 10. What is this year’s Inventory Turnover ratio? What does it mean? valueinventory aggregate Average sold goods ofCost turnoverInventory 

Example of Measuring Supply-Chain Performance (Continued) = $160/$35 = 4.57 Since the company’s normal inventory turnover ration is 10, a drop to 4.57 means that the inventory is not turning over as quickly as it had in the past. Without knowing the industry average of turns for this company it is not possible to comment on how they are competitively doing in the industry, but they now have more inventory relative to their cost of goods sold than before. = $160/$35 = 4.57 Since the company’s normal inventory turnover ration is 10, a drop to 4.57 means that the inventory is not turning over as quickly as it had in the past. Without knowing the industry average of turns for this company it is not possible to comment on how they are competitively doing in the industry, but they now have more inventory relative to their cost of goods sold than before.

Inventory Costs [7] 1.Cost of placing an order 2.Price discount costs for large orders or Extra costs for small orders 3.Stock-out costs 4.Working capital costs (funding for the lag between paying our suppliers and receiving payment from our customers) 5.Storage costs 6.Obsolescence costs 7.Production inefficient costs [hidden costs not realized  JIT] Inventory Management

Inventory Costs Two types: ordering and carrying Inventory Management

Cost of placing the order Price discount costs Inventory Management Ordering Costs [2]

1.Capital or opportunity cost 2.Storage space cost 3.Inventory service cost 4.Inventory risk cost 5.Insurance 6.Storage and handling 7.Depreciation 8.Deterioration 9.Taxes 10.Interest Inventory carrying cost varies between 10 – 20 % of the product cost. Carrying or Holding Costs [10]

Time Q On-hand Inventory Time Q On-hand Inventory Many orders, low inventory level Few orders, high inventory level While carrying costs increase, ordering costs fall and vice versa

OBJECTIVES: To determine the best ordering policy, i.e. 1.To decide how much, and 2.when to order Economic Order Quantity [EOQ] model One of the oldest and most commonly used in inventory control Based on a number of assumptions HOW MUCH? Inventory Management

EOQ Assumptions 1.Continuous and known demand rate 2.Lead time/replenishment cycle is known and constant 3.Price to purchase is independent of the amount needed 4.Transportation costs remain constant 5.No stock outs (or shortages) are permitted 6.No inventory is in transit 7.The order quantity is received all at once Inventory Management

The Inventory Order Cycle Steady & predictable demand, D 0 Time Inventory Level Order quantity, Q Inventory Management Q D Slope = Demand rate Average inventory = Q D Instantaneous deliveries at a rate of per period Q D

The Inventory Order Cycle Steady & predictable demand, D 0 Time Inventory Level Q Q D Slope = Demand rate Average inventory = Q D Average inventory = Q/D [2 shaded areas are equal] Time interval between deliveries = Q/D Frequency of deliveries, N = reciprocal of the time interval = 1 / [Q/D] = D/Q

Order Quantity, Q Annual cost ($) Total Cost Carrying Cost = CcQCcQ22CcQCcQ222 Slope = 0 Minimum total cost Optimal order Q opt Q opt Ordering Cost = CoDCoDQQCoDCoDQQQ EOQ Cost Model

C O - cost of placing order D - annual demand C C - annual carrying cost/unitQ - order quantity Annual ordering cost = Annual carrying cost = ordering cost x No of orders = holding cost/unit x average inventory = C O D/Q = C C Q/2 Total cost = C O D/Q + C C Q/2 C o.D Q C c.Q Q C o D C c Q * C o D C c TC C o D Q * C c Q *     min TC C o D Q C c Q Q C o D Q C c C o D Q C c Q * C o D C c      

EOQ Model Cost Curves Slope = 0 Total Cost curve Ordering Cost = C o D/Q Order Quantity, Q Annual cost ($) Minimum total cost Optimal order Q * (EOQ) Carrying Cost = C c Q/2 Total Costs= Carrying Cost + Ordering Cost C t = C c Q/2 + C o D/Q EOQ, Q = 2 D C o C c

QUESTION The annual demand for a product is 8,000 units. The ordering cost is € 30 per order. The cost of the item is € 10 and the carrying cost has been calculated at € 3 to carry out one item in stock for one year. Calculate: a.What is the EOQ? b.The numbers of orders to be placed annually, and c.The overall costs. Example: Basic EOQ

ANSWER D = 8,000 units C O = € 30 C C = € 3 Q * C o D C c    2 2 (8,000) (30) units Number oforders per year= D Q *  8, orders Total Costs= Carrying Cost + Ordering Cost Holding Costs = Average quantity in stock x Cost of holding item for 1 year = 400/2 x 3 = € 600 Ordering Costs = Cost of ordering x Number of orders = 30 x 20 = € 600 therefore Total Costs = € € 600 = € 1,200. Example: Basic EOQ

Zartex Co. produces fertilizer to sell to wholesalers. One raw material – calcium nitrate – is purchased from a nearby supplier at $22.50 per ton. Zartex estimates it will need 5,750,000 tons of calcium nitrate next year. The annual carrying cost for this material is 40% of the acquisition cost, and the ordering cost is $595. a) What is the most economical order quantity? b) How many orders will be placed per year? c) How much time will elapse between orders? Example: Basic EOQ

Economical Order Quantity (EOQ) D = 5,750,000 tons/year Cc =.40(22.50) = $9.00/ton/year Co = $595/order = 27, tons per order Example: Basic EOQ EOQ = 2(5,750,000)(595)/9.00

Total Annual Stocking Cost (TSC) TSC = (27, /2)(9.00) + (5,750,000/27, )(595) = 124, , = $248, Note: Total Carrying Cost equals Total Ordering Cost Example: Basic EOQ

Number of Orders Per Year = D/Q = 5,750,000/27, = orders/year Time Between Orders = Q/D = 1/208.5 = years/order = (365 days/year) = 1.75 days/order Note: This is the inverse of the formula above. of the formula above. Example: Basic EOQ

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