CHAPTER Inventory Management

After studying this chapter, you should be able to: Objectives 1. Describe the traditional inventory management model. 2. Discuss JIT inventory management. 3. Explain the theory of constraints, and tell how it can be used to manage inventory. After studying this chapter, you should be able to:

Inventory Costs 1. Ordering costs are the costs of placing and receiving an order. 2. Setup costs are the costs of preparing equipment and facilities so they can be used to produce a particular product or component. 3. Carrying costs are the costs of carrying inventory.

Traditional Reasons for Carrying Inventory 1. To balance ordering or setup costs and carrying costs. 2. To satisfy customer demand. 3. To avoid shutting down manufacturing facilities because of machine failure, defective parts, unavailable parts, or late delivery of parts. 4. To buffer against unreliable production processes. 5. To take advantage of discounts. 6. To hedge against future price increases.

The Appropriate Inventory Policy Two Basic Questions Must be Addressed How much should be ordered or produced? When should the order be placed or the setup be performed?

The Traditional Inventory Model Total Costs = Ordering costs + Carrying costs TC = PD/Q + CQ/2 Where TC = The total ordering (or setup) and carrying costs P = The cost of placing and receiving an order (or the cost of setting up a production run) Q = The number of units ordered each time an order is placed D = The known annual demand C = The cost of carrying one unit of stock for one year 7

The Traditional Inventory Model Economic order quantity (EOQ) =  2PD/C D = 10,000 units Q = 1,000 units P = $25 per order C = $2 per unit

The Traditional Inventory Model EOQ =  ($2 x $25 x 10,000)/2 EOQ =  250,000 EOQ = 500 units 8

Reorder Point Reorder point = Rate of usage x Lead time Demand is Certain Reorder point = Rate of usage x Lead time Example: The producer uses 50 parts per day and that the lead time is 4 days. Reorder point = 4 x 50 = 200 units Thus, an order should be placed when inventory drops to 200 units.

Reorder Point Demand is Certain Inventory (units) (EOQ) 500 400 300 200 100 (ROP) 2 4 6 8 10 12 14 16 18 20 Days

Reorder Point Safety Stock If the refrigerator part was used at a rate of 60 parts a day instead of 50, the firm would use 200 parts after three and one-third days. The safety stock is determined as follows: Maximum usage 60 Average usage 50 Difference 10 Lead time x4 Safety stock 40

Reorder Point ROP = (Average rate of usage x Lead time) + Safety stock ROP = (50 x 4) + 40 ROP = 240 units

A Manufacturing Example The manager of Benson Company is trying to determine the size of the production runs for the blade fabrication. The controller supplies the following information: Average demand for blades 320 per day Maximum demand for blades 340 per day Annual demand for blades 80,000 Unit carrying cost $5 Setup cost $12,500 Lead time 20 days

A Manufacturing Example  EOQ = 2PD C  2 x 80,000 x 2,500 = 5  400,000,000 = = 20,000 blades

A Manufacturing Example Maximum usage 340 Average usage 320 Difference 20 Lead time x20 Total safety stock 400 Reorder point = (Average usage x Lead time) + Safety stock = (320 x 20) + 400 = 6,800 units

Traditional Inventory Systems Push-through system Significant inventories Large supplier base Short-term supplier contracts Departmental structure Specialized labor Centralized services Low employee involvement Supervisory management style Acceptable quality level Driver tracing dominates 11

Traditional Manufacturing Layout B  Welding Equipment Department 3 Department. 1 Lathes Abrasive Grinders A B Department 2 Product A Product B Each process passes through departments that specialize in one process. Finished Product A Finished Product B

JIT Inventory Systems Pull-through system Insignificant inventories Small supplier base Long-term supplier contracts Cellular structure Multiskilled labor Decentralized services High employee involvement Facilitating management style Total quality control Direct tracing dominates

JIT Inventory Systems JIT has two strategic objectives: To increase profits To improve a firm’s competitive positions

JIT Manufacturing Layout Cell A Cell B Grinder Grinder  Welding  Welding Lathe Product A Lathe Product B Finished Product Finished Product

JIT And Inventory Management Setup and Carrying Costs: The JIT Approach JIT And Inventory Management JIT reduces the costs of acquiring inventory to insignificant levels by: 1. Drastically reducing setup time 2. Using long-term contracts for outside purchases Carrying costs are reduced to insignificant levels by reducing inventories to insignificant levels

JIT And Inventory Management Due Date Performance: The JIT Solution JIT And Inventory Management Lead times are reduced so that the company can meet requested delivery dates and to respond quickly to customer demand. Lead times are reduced by: reducing setup times improving quality using cellular manufacturing

Avoidance of Shutdown: The JIT Approach JIT And Inventory Management Total preventive maintenance to reduce machine failures Total quality control to reduce defective parts Cultivation of supplier relationships to ensure availability of quality raw materials and subassemblies The use of the Kanban system is also essential

What is the Kanban System? A Card System is used to monitor work-in-process A withdrawal Kanban A production Kanban A vendor Kanban 12

Withdrawal Kanban Item No.___________________ _____________ Item Name_________________ _____________ Computer Type_____________ _____________ Box Capacity_______________ _____________ Box Type__________________ _____________ 15670T07 Processing Process Circuit Board CB Assembly TR6547 PC 8 Subsequent Process C Final Assembly 13

Production Kanban Item No.___________________ _____________ Item Name_________________ _____________ Computer Type_____________ Box Capacity_______________ Box Type__________________ 15670T07 Process Circuit Board CB Assembly TR6547 PC 8 C

Vendor Kanban Item No.___________________ Item Name_________________ _____________ Box Capacity_______________ Box Type__________________ Time to Deliver Name of Supplier 15670T08 Name of Receiving Co. Computer Casing Electro PC Receiving Gate 8 C 75 8:30 A.M., 12:30 P.M., 2:30 P.M. Garry Supply

Kanban Process CB Stores Withdrawal Store (7) (1) Lot with P-Kanban CD Assembly (5) Attach W-Kanban (1) Remove W-Kanban Attach to Post (6) Signal Remove (4) P-Kanban Attach to Post CB Stores (2), (3) Production Ordering Post Withdrawal Post Final Assembly 16

JIT’s Limitations Time is required to build sound relationships with suppliers. Sharp reductions in inventory buffers may cause a regimented workflow and high levels of stress among production workers. The absence of inventory to buffer production interruptions. Current sales are placed at risk to achieve assurance of future sales.

JIT And Inventory Management Discounts and Price Increases: JIT Purchasing Versus Holding Inventories Careful vendor selection Long-term contracts with vendors Prices are stipulated (usually producing a significant savings) Quality is stipulated The number of orders placed are reduced

Theory of Constraints Three Measures of Organizational Performance Throughput Inventory Operating expenses 17

Five Steps to Improve Performance Theory of Constraints Five Steps to Improve Performance 1. Identify the organization’s constraint(s). 2. Exploit the binding constraint(s). 3. Subordinate everything else to the decisions made in Step 2. 4. Elevate the binding constraint(s). 5. Repeat the process. 18

Drum-Buffer-Rope System Materials Rope Initial Process Process C Process A Final Process Process B Finished Goods Drummer Process Time Buffer 19

Drum-Buffer-Rope System Material for 12 Parts per Day (Part X: 6 and Part Y: 6) Confer Company Grinding Process Rope Time 12 Units Part X Buffer 12 Units Part Y DRUMMER Drilling Process Finished Goods 6 Units Part X per Day 6 Units Part Y per Day Polishing Process

Chapter Nineteen The End