1 OPERATIONS MANAGEMENT for MBAs Second Edition Prepared by Scott M. Shafer Wake Forest University Meredith and Shafer John Wiley and Sons, Inc.

2 Chapter 9 Inventory Management

3 Introduction

Chapter 9: Inventory Management4 Mothers Work, Inc. 4 Custom designed inventory management system helped transform company from small mail-order operation to dominant retailer of maternity clothes 4 Inventory system –detail down to individual garment –provides picture of entire inventory pipeline –daily reports on what is and isn’t selling

Chapter 9: Inventory Management5 Mothers Work, Inc. continued 4 System used to test market fashions before committing to large production runs 4 Can produce more of hot selling styles in two weeks 4 Can wait to last possible moment before ordering or producing more garments 4 Facilitates providing sufficient inventory levels and reduces need to mark down items

Chapter 9: Inventory Management6 Electronic Commerce 4 Changing way products bought and sold 4 Initially large companies such as Wal-Mart, GM and Kodak developed private networks 4 Private networks now moving to Internet

Chapter 9: Inventory Management7 Campbell Soup 4 60% of orders received contain mistakes 4 Salespeople spend 40% of time fixing problems instead of selling 4 Campbell estimates that electronic commerce will reduce cost of processing purchase order from $150 to $25

Chapter 9: Inventory Management8 Fruit of the Loom 4 Developed system to link its 50 wholesalers to its central warehouse 4 If customer needs product and wholesaler is low, product shipped directly from central warehouse to customer

Chapter 9: Inventory Management9 Issues Illustrated by Examples 4 Many organizations are increasing their emphasis on reducing lead times and meeting delivery schedules 4 The importance of integrating the inventory management system with the rest of the organization

10 General Considerations

Chapter 9: Inventory Management11 Functions of Inventories 4 Transit Inventories 4 Buffer Inventories (safety stocks) 4 Anticipation Inventories 4 Decoupling Inventories 4 Cycle Inventories

Chapter 9: Inventory Management12 Forms of Inventories 4 Raw Materials 4 Maintenance, repair, and operating supplies 4 Work-In-Process (WIP) 4 Finished Goods

Chapter 9: Inventory Management13 Inventory-Related Costs 4 Ordering or Setup Costs 4 Inventory Carrying or Holding Costs 4 Stockout Costs 4 Capacity Associated Costs 4 Cost of Goods

Chapter 9: Inventory Management14 Decisions in Inventory Management 4 When to order? 4 How much to order?

Chapter 9: Inventory Management15 Types of Inventory Management Systems 4 Reorder point systems –time between orders varies –constant order quantity 4 Periodic review systems –time between orders fixed –order quantity varies 4 Material requirements planning (MRP) –dependent demand items

Chapter 9: Inventory Management16 Fluctuations in Inventory

Chapter 9: Inventory Management17 Reorder Point Systems 4 Reorder point 4 Lead time 4 Two-bin system 4 Perpetual inventory system

Chapter 9: Inventory Management18 A Reorder Point System

Chapter 9: Inventory Management19 Periodic Review System maximum inventory level - on-hand inventory - on-order quantity + demand over lead time reorder quantity

Chapter 9: Inventory Management20 Periodic Review System Without Considering On-Order Quantity

Chapter 9: Inventory Management21 Periodic Review System (Assumes None On Order at Time of Reorder)

Chapter 9: Inventory Management22 Priorities for Inventory Management: The ABC Concept 4 A items –15-20% of items that account for 75-80% of annual inventory value 4 B items –30-40% of items that account for15% of annual inventory value 4 C items –40-50% of items that account for 10-15% of annual inventory value

Chapter 9: Inventory Management23 ABC Inventory Categories

24 The Economic Order Quantity (EOQ)

Chapter 9: Inventory Management25 Assumptions 4 Constant rate of demand 4 Shortages not allowed 4 Stock replenishment can be scheduled to arrive exactly when inventory drops to zero 4 Purchase price, ordering cost, and per unit holding cost are independent of quantity ordered 4 Items are ordered independently of each other

Chapter 9: Inventory Management26 Notation Q = order quantity U = annual usage C O = order cost per order C H = annual holding cost per unit

Chapter 9: Inventory Management27 Water Distributor’s Inventory Pattern

Chapter 9: Inventory Management28 Water Distributor’s Inventory Graph

Chapter 9: Inventory Management29 Annual Order Cost $ Q

Chapter 9: Inventory Management30 Annual Holding Cost $ Q

Chapter 9: Inventory Management31 Graph of Annual Inventory Costs

Chapter 9: Inventory Management32 Finding an Optimal Policy

Chapter 9: Inventory Management33 Alternative Way of Deriving EOQ

Chapter 9: Inventory Management34 Alternative Way of Deriving EOQ continued

Chapter 9: Inventory Management35 EOQ Example 4 Given: –25,000 annual demand –$3 per unit per year holding cost –$100 ordering costs

Chapter 9: Inventory Management36 Cautions Regarding EOQ 4 GIGO 4 Exclude “sunk” costs 4 Very small EOQ values my not be valid

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