Copyright 2006 John Wiley & Sons, Inc. Beni Asllani University of Tennessee at Chattanooga Inventory Management Operations Management Chapter 13 Roberta Russell & Bernard W. Taylor, III

Copyright 2006 John Wiley & Sons, Inc.13-2 Two Forms of Demand  Dependent  Demand for items used to produce final products   Tires stored at a Goodyear plant are an example of a dependent demand item  Independent  Demand for items used by external customers   Cars, appliances, computers, and houses are examples of independent demand inventory

Copyright 2006 John Wiley & Sons, Inc. E(1 ) Independent vs. Dependent Demand Independent Demand (Demand not related to other items or the final end-product) Dependent Demand (Derived demand items for component parts, subassemblies, raw materials, etc.)

Copyright 2006 John Wiley & Sons, Inc.13-4 Types of Inventory   Raw materials   Purchased parts and supplies   Work-in-process (partially completed) products (WIP)   Items being transported   Tools and equipment

Copyright 2006 John Wiley & Sons, Inc.13-5 Inventory and Quality Management   Customers usually perceive quality service as availability of goods they want when they want them   Inventory must be sufficient to provide high-quality customer service in TQM

Copyright 2006 John Wiley & Sons, Inc.13-6 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

Copyright 2006 John Wiley & Sons, Inc.13-7 NEGATIVE ASPECTS OF INVENTORY Overuse can prohibit quality feedback Overuse can prohibit quality feedback Large inventories hide operational problems Large inventories hide operational problems Financial costs to carrying excess inventory Financial costs to carrying excess inventory Risk of damage Risk of damage Tracking and accounting costs Tracking and accounting costs Risk of obsolescence and depreciation Risk of obsolescence and depreciation Impact on value adding system flexibility Impact on value adding system flexibility

Copyright 2006 John Wiley & Sons, Inc.13-8 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

Copyright 2006 John Wiley & Sons, Inc.13-9 Economic Order Quantity (EOQ) Models   EOQ optimal order quantity that will minimize total inventory costs   Basic EOQ model   Production quantity model

Copyright 2006 John Wiley & Sons, Inc 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  Order quantity is received all at once

Copyright 2006 John Wiley & Sons, Inc Inventory Order Cycle Demand rate Time Lead time Order placed Order receipt Inventory Level Reorder point, R Order quantity, Q 0

Copyright 2006 John Wiley & Sons, Inc EOQ Cost Model (cont.) Order Quantity, Q Annual cost ($) Total Cost Carrying Cost = CcQCcQ22CcQCcQ222 Slope = 0 Minimum total cost Optimal order Q opt Q opt Ordering Cost = CoDCoDQQCoDCoDQQQ

Copyright 2006 John Wiley & Sons, Inc Production Quantity Model   An inventory system in which an order is received gradually, as inventory is simultaneously being depleted   AKA non-instantaneous receipt model assumption that Q is received all at once is relaxed   p - daily rate at which an order is received over time, a.k.a. production rate   d - daily rate at which inventory is demanded

Copyright 2006 John Wiley & Sons, Inc Production Quantity Model (cont.) Q(1-d/p) Inventorylevel (1-d/p) Q2 Time 0 Order receipt period BeginorderreceiptEndorderreceipt Maximum inventory level Average

Copyright 2006 John Wiley & Sons, Inc Quantity Discounts Price per unit decreases as order quantity increases TC = + + PD CoDCoDQQCoDCoDQQQ CcQCcQ22CcQCcQ222 where P = per unit price of the item D = annual demand

Copyright 2006 John Wiley & Sons, Inc Fixed-Period (P) Systems  Orders placed at the end of a fixed period  Inventory counted only at end of period  Order brings inventory up to target level  Only relevant costs are ordering and holding  Lead times are known and constant  Items are independent from one another

Fixed-Period (P) Systems On-hand inventory Time Q1Q1Q1Q1 Q2Q2Q2Q2 Target maximum (T) P Q3Q3Q3Q3 Q4Q4Q4Q4 P P Figure 13.9