F O U R T H E D I T I O N Inventory Systems for Independent Demand © The McGraw-Hill Companies, Inc., 2003 chapter 16 DAVIS AQUILANO CHASE PowerPoint Presentation by Charlie Cook

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –2 Chapter Objectives Introduce the different types of inventories that exist in a company and provide a rationale for why companies maintain inventories. Identify the various costs associated with carrying and maintaining inventories. Define the classical inventory models and the conditions necessary for them to be applicable. Show how economic order quantity is calculated for each of the different inventory models.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –3 Chapter Objectives (cont’d) Introduce the single-period inventory model and the concept of yield management with respect to service operations. Present some of the current inventory management trends and issues that exist in companies today.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –4 Managerial Issues Inventory is no longer viewed as an asset Product life cycles are becoming shorter increasing the likelihood of product obsolescence. Inventory concealing other problems. The high costs of inventory storage.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –5 Definition of Inventory Inventory –The stock of any item or resource used in an organization, includes raw materials, finished goods, and work-in-process. Inventory Management System –The set of policies and controls that monitors levels of inventory and determines: What levels should be maintained. When stock should be replenished. How large orders should be.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –6 Types of Inventory Raw Materials –Vendor-supplied items that have not had any labor added by the firm receiving the items. Finished Goods –Completed products that are still in the possession of the firm that manufactured them. Work-in-Process (WIP) –Items that have been partially processed but are still incomplete.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –7 Reason for Maintaining Inventory To protect against uncertainty: –Shortages of raw materials. –Work-in-process variations. –Changes in demand for finished products. To support a strategic plan –As a cyclic demand buffer for a level-output strategy. To take advantage of economies of scale –Large quantity purchases reduce the average total unit costs related to fixed ordering, setup costs, and transportation costs.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –8 Inventory Costs Holding and Carrying Costs –Storage costs (facility, insurance, taxes, utilities) –Capital costs (opportunity costs) –Obsolescence/shrinkage costs (depreciated value) Setup or Ordering Costs Shortage (or Stockout) Costs Purchase Costs Transportation Costs

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –9 Independent versus Dependent Demand Independent Demand –The demand that pertains to the requirements for end products (external market demand). Dependent Demand –The requirements for components that are directly dependent on the demand for the end products in which they are used.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –10 Types of Inventory Systems Fixed-Order Quantity –A system where the order quantity remains constant but the time between orders varies. Preferred for important or expensive items because average inventory is lower. Provides a quicker response to stockouts Is more expensive to maintain due to inventory record-keeping costs.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –11 Types of Inventory Systems Fixed-Time Period –A system where the time period between orders remains constant but the order quantity varies. Has larger average inventory to prevent stockouts. Useful when purchasing multiple items from one vendor to save on costs.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –12 Comparison of Fixed-Order Quantity and Fixed-Time Period Reordering Inventory Systems Exhibit 16.1

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –13 Basic Inventory Models Fixed-Order-Quantity Model Assumptions: –Demand for the product is known, constant, and uniform throughout the period. –Lead time (L), which is the time from ordering to receipt, is constant. –Price per unit of product is constant (no quantity discounts). –Ordering or setup costs are constant –All demands for the product are known with certainty, no back orders or stockouts. –There is no interaction with other products.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –14 Basic Fixed-Order Quantity Model Exhibit 16.2

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –15 Fixed-Order-Quantity Model TC=Total Annual Cost D=Annual demand in units C=Cost per unit Q=Quantity to be order (the optimum is termed the economic order quantity—EOQ) S=Setup or ordering cost H=Annual holding cost per unit Total annual cost = Annual purchase cost + Annual ordering cost + Annual holding cost

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –16 Annual Product Cost, Based on Size of Order Exhibit 16.3

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –17 Fixed-Order-Quantity Model (cont’d) Economic Order Quantity –The optimal quantity to order taking into consideration both the cost to carry inventory and the cost to order the item. –Minimizes total inventory cost D=Annual demand in units S=Setup or ordering cost H=Annual holding cost per unit

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –18 Fixed-Order-Quantity Model (cont’d) Reorder Point –The point in time by which stock must be ordered to replenish inventory before a stockout occurs.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –19 Basic Inventory Models Fixed Order Quantity Model with Usage –Considers a supplier that will provide an order quantity over a period of time rather than all at once. d=the constant demand rate for the item in production p=production rate of the process (p - d)=inventory that accumulates each time period (Q/p)=number of time periods required to fill the order

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –20 Basic Inventory Models (cont’d) Fixed Order Quantity Model with Usage (cont’d)

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –21 Fixed Order Quantity Model with Usage during Production Time Exhibit 16.4

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –22 Basic Inventory Models (cont’d) Fixed-Time-Period Model –Inventory is counted at fixed intervals. –Ceiling (par) inventory is established. –Safety stock level is established. –Order quantity to return inventory to ceiling level varies based on on-hand inventory less safety stock at time inventory is counted.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –23 Fixed-Time Period Inventory Model Exhibit 16.5

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –24 Basic Inventory Models (cont’d) Quantity-Discount Model –Addresses price discounts associated with minimum order quantities. –Two types of quantity discounts Incremental discounts which apply increasing discounted unit prices as orders reach or exceed certain quantity levels of units. In the all-units approach, discounts are applied to all units with the unit cost determined by the size of the purchase order.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –25 Total Cost Curves for a Quantity-Discount Model Exhibit 16.6

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –26 Total Cost Calculations in a Quantity-Discount Model Exhibit 16.7

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –27 Inventories and Service Levels Determining Safety Stock Levels –Variation in product demand. –Variability in the lead time required to replenish the item. –The desired level of service that the company wants to provide its customers.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –28 The Impact of Variation, Lead Time, and Service Level on the Amount of Safety Stock (SS) Required Exhibit 16.8

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –29 Economic Order Quantity Models in Relation to the Real World Costs are difficult to measure. Demand is not constant. Lack of focus on lot sizing and inventory control. Need to focus on reducing setup costs to reduce EOQs and total costs.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –30 Effect of Reduced Setup Costs on Order Size and Total Costs Exhibit 16.9

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –31 Perishable Inventory Single-Period Inventory Model –Product is only viable for sale during a single time period. –Demand for the product is highly variable, but follows a known probability distribution. –The scrap value of the product or the value of the product after the time period has elapsed is less than the initial cost of the product.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –32 Inventory Management in Services Yield Management or Revenue Management –Goal is maximizing capacity utilization by selling all of a service capacity for some price that exceeds the service’s variable costs per unit of service. –A large proportion of capacity is sold in advance for reduced prices; some capacity is held for last-minute customers willing to pay full prices.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –33 Additional Issues in Inventory Management Determining Realistic Costs –Accounting data is usually expressed in averages; marginal costs are needed to determine proper lot sizes. –Carrying and ordering costs are not constant. –Some costs (e.g., obsolescence) are subjective. Inventory Accuracy –Shrinkage, misidentification, and misplaced items create inventory inaccuracies.

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –34 Cost to Place Orders versus the Number of Orders Placed: Linear Assumption and Normal Reality Exhibit 16.10

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –35 ABC Inventory Planning ABC Analysis –A method for grouping items by dollar volume to identify those items to be monitored closely. –Follows the Pareto principle. –“A” items: high dollar volume (15%) –“B” items: moderate dollar volume (35%) –“C” items: low dollar volume (50%)

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –36 Annual Usage of Inventory by Value Exhibit 16.11

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –37 ABC Grouping of Inventory Items Exhibit 16.12

Fundamentals of Operations Management 4e© The McGraw-Hill Companies, Inc., –38 Current Trends in Inventory Management Inventory is a liability, not an asset. Average amount of inventory relative to annual sales is decreasing. Firms are focusing on reducing setup and order costs, resulting in smaller economic order quantities. Firms are working more closely with vendors to reduce product throughput times and, consequently, lead times.