1. Inventory Management

2. What is
Inventory Management?

3. Inventory: A stock or store of goods.
Firms typically stock many items in inventory.
Many of the items a firm carries in inventory relate to the kind of business it engages in.

4. Independent demand is uncertain. Dependent demand is certain.
Inventory
Independent Demand A
B(4)
C(2)
D(2)
E(1)
D(3)
F(2)
Dependent Demand
Independent demand is uncertain. Dependent demand is certain.
Inventory: a stock or store of goods

5. Independent demand – finished goods, items that are ready to be sold
Inventory Models
Independent demand – finished goods, items that are ready to be sold
E.g. a computer
Dependent demand – components of finished products
E.g. parts that make up the computer

6. Examples
Manufacturing firms carry supplies of raw materials, purchased parts, finished items, spare parts, tools,....
Department stores carry clothing, furniture, stationery, appliances,...
Hospitals stock drugs, surgical supplies, life-monitoring equipment, sheets, pillow cases,...
Supermarkets stock fresh and canned foods, packaged and frozen foods, household supplies,...
Not all items in inventory are items to be sold.

7. The Nature and Importance of Inventories
Inventories are a vital part of business
Necessary for operations
Contribute to customer satisfaction
Inventories represent a significant portion of total assets
Sale of merchandise (inventory) is a major source of revenues for retail and wholesale businesses

8. Types of Inventories Raw materials & purchased parts
Partially completed goods called work in progress
Finished-goods inventories
(manufacturing firms) or merchandise (retail stores)

9. Types of Inventories (Cont’d)
Replacement parts, tools, & supplies
Goods-in-transit to warehouses or customers

10. Functions of Inventory
To meet anticipated demand: Anticipation stock – average demand
To smooth production requirements: Seasonal inventories
To protect against stock-outs: Safety stock – uncertainty
To take advantage of quantity discounts
To help hedge against price increases
2. stock-up against seasonal demand
3. To decouple components of the production-distribution system, delay in one will not hinder the other.
4. safety stocks

11. Inadequate Control of Inventories
Inadequate control of inventories can result in both under- and overstocking of items.
Understocking (too few) results in missed deliveries, lost sales, dissatisfied customers, and production bottlenecks (idle workers or machines).
Resulting underage cost.
Overstocking (too many) ties up funds that might be more productive elsewhere.
Resulting overage cost.
In other words, the manager tries to achieve a balance in stocking.
Goal: matching supply with demand!

12. Objective of Inventory Control
To achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds
Right goods, right place, right time, right quantity
Inventory management has two main concerns
Two fundamental decisions:
When to order (timing)
How much to order (size)

13. Performance Measures
Performance measures used to judge the effectiveness of inventory management
Customer satisfaction: the number and quantity of backorders, customer complaints.
2. Inventory turnover
The higher, the better – more efficient use of inventory
Desirable number of turns depend on industry and profit margin
Indicate how many times a year the inventory is sold
turnover
3. Days of inventory on-hand: the expected number of days of sales that can be supplied from existing inventory.
Performance measures used to judge the effectiveness of inventory management:

14. Inventory Counting Systems
Periodic System
Physical count of items made at periodic intervals
Perpetual Inventory System System that keeps track of removals from inventory continuously, thus monitoring current levels of each item

15. Inventory Counting Systems (Cont’d)
Two-Bin System - Two containers of inventory; reorder when the first is empty
Universal Bar Code - Bar code printed on a label that has information about the item to which it is attached

16. Lead Time: Time interval between ordering and receiving the order
3. Lead Time Information
Lead Time: Time interval between ordering and receiving the order
- Lead time variability: the greater
the potential variability, the greater
the need for additional stock to
reduce the risk of a shortage
between deliveries

17. Ordering cost : Costs of ordering/producing and receiving inventory.
4. Inventory Costs
Ordering cost : Costs of ordering/producing and receiving inventory.
Eg. RM12 per order
Unit ordering/production cost: cost of obtaining one unit of the inventory.
Eg. RM 77 per item
Buy stationary,
Some raw materials – steel, nails, etc.

18. b. Holding (carrying) cost: Physically holding item in storage.
4. Inventory Costs cont.
b. Holding (carrying) cost: Physically holding item in storage.
interest
insurance
taxes
depreciation
obsolescence
warehouse costs (heat, light, rent, security)
opportunity costs
Holding costs are stated in either way:
a percentage of unit price
a dollar amount per unit
deterioration
spoilage
theft
breakage
Holding cost also include opportunity costs having funds tied up in inventory.

19. c. Shortage costs: Costs resulting when demand exceeds supply.
4. Inventory Costs cont.
c. Shortage costs: Costs resulting when demand exceeds supply.
Opportunity cost for not making a sale
Loss of customer goodwill
Lateness charges
Cost of lost production
It is often difficult to quantify shortage costs.
One objective of Inventory Control is to minimize
the sum of these costs by balancing them.

20. Replenishment Strategy
-- EOQ (Basic)

21. Basic Economic Order Quantity Model (EOQ)
Assumptions:
1. Ordering in batch from supplier.
2. Only one product is involved.
3. Constant demand rate. Demand is spread evenly throughout the year.
4. Constant lead time. Lead time does not vary much for a long enough time.
5. Single delivery for each order.
6. A single flat unit price from the supplier.

22. Profile of Inventory Level Over Time
The Inventory Cycle
Figure 11.2
Profile of Inventory Level Over Time
Order/batch size Q
Demand rate D
Reorder
point
Time
Receive
order
Place
order
Receive
order
Place
order
Receive
order
Order lead time
Order cycle time

23. High average inventory
Inventory Level vs. Order Frequency
Small order
Low average inventory
Short order cycle time
Large order
High average inventory
Long order cycle time

24. Now the Question is…..
Economic order quantity (EOQ): The order size Q that minimizes total costs per unit time.
Fixed ordering cost S IGD / order
Unit ordering cost P IGD / unit
( P = unit price, assuming no other unit ordering cost component)
Unit carrying cost H= h P IGD / time
( h = carrying cost rate for one IGD value of inventory/time)
NO shortage cost here! Demand is a constant and it is always met.

25. H = rP = IGD80 * 0.2 = IGD16 /unit · yr Match!
Example 2
Demand for a certain radial tires at a tire company is 800 units per month. Each tire costs the company IGD 80. Ordering costs are IGD 75, and the annual carrying costs are 20 percent of the purchase price.
D = 800 * 12 = 9600 /yr
S = IGD75 /order
P = IGD80, r = 0.20
H = rP = IGD80 * 0.2 = IGD16 /unit · yr
Match!

26. Solution to Example 2
1. How many tires should the manager order in each lot?
2. What is the company's average inventory of this tire?
3. How often will an order be placed (length of order cycle)?

27. Solution to Example 2 (Cont.)
4. How many times per year will an order be placed?
5. How much does the company spend annually on ordering costs?
6. How much does the company spend annually on holding (carrying) costs?

28. Solution to Example 2 (Cont.)
7. What is the total annual cost if the EOQ quantity is ordered? OR
The ordering and carrying costs are equal at the EOQ