1. Supply Chain Management (SCM) Inventory management
Dr. Husam Arman
18/10/2009

2. Today’s Outline Inventory (system): What?
Motivation for holding inventories
Characteristics of inventory systems
Types of inventory
Inventory costs
Identifying critical inventory items
The EOQ model
Overview of inventory policies
P, Q and hybrid systems

3. Inventory System
Inventory is the stock of any item of resource used in an organization and can include: raw materials, component parts, supplies, work-in-process and finished goods
An inventory system is the set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be?

4. To summarize; Purposes of Inventory
1. To maintain independence of operations.
2. To meet variation in product demand.
3. To allow flexibility in production scheduling.
4. To provide a safeguard for variation in raw material delivery time.
5. To take advantage of economic purchase-order size. 4

5. 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.)
E(1) 6

6. Types of Inventory Cycle Inventory Safety Stock Inventory
The portion of total inventory that varies directly with lot size (Q)
Safety Stock Inventory
Surplus inventory that a company holds to protect against uncertainties in demand, lead time and supply
Anticipation Inventory
Inventory used to absorb uneven rates of demand or supply
Pipeline Inventory
Inventory moving from point to point in the material system

7. Characteristics of inventory systems
Demand
Constant Vs. Variable
Lead time
External order: time between placement of an order until arrival of goods
Internal production: amount of time required to produce a batch of items
Lead time can be deterministic or random
Replenishment
How does the order arrive? uniform over time, instantaneous batches

8. Characteristics of inventory systems
Review time
Continuous review: inventory level is known at all times
Periodic review: inventory level is known only discrete points in time
Excess demand
Back ordering: excess is satisfied in the future
Lost sales: excess demand is lost
Changing inventory
Inventory may change over time: limited shelf life (perishable good –food), obsolescence (e.g. automotive parts)

9. Inventory costs Optimization criterion: cost minimization
Holding (carrying) cost
Cost of storage, handling, tax / insurance, breakage deterioration, obsolescence, opportunity cost of alternative investment (cost of capital) etc.
Proportional to the amount of inventory on hand
Dimension: $ per unit per year
Setup (production change-over) or ordering cost
Cost of arranging specific equipment setups or someone placing an order
Penalty (shortage or stock-out) costs
Lost sales, loss of goodwill

10. Identifying critical inventory items (ABC analysis)

11. Q 3 page 628, demonstrate graphically
Homework - 2
Q 3 page 628, demonstrate graphically

12. The EOQ Model EOQ = Economic Order Quantity
Simplest, most fundamental model, basis for more complex models
Trade-off: fixed order costs and holding costs
One of the oldest and most well known inventory control techniques
Easy to use
Based on a number of assumptions!

13. The EOQ Model Assumptions; Constant demand rate
No constraints on lot size
Only relevant costs are holding and ordering/setup
Decisions for items are independent from other items
No uncertainty in lead time or supply

14. The EOQ Model
Average
cycle
inventory Q — 2

15. The EOQ Model

16. The EOQ Model Annual Holding Ordering Cost Total Annual Cost =+
C = Total annual cost
D = Demand
Q = Order quantity
S = Cost of placing an order or setup cost
H = Annual holding and storage cost per unit of inventory

17. Two Methods for holding cost
Holding cost (H) can be expressed either:
As a fixed cost, such as
H = $0.50 per unit per year
As a percentage of the item’s purchase cost (P)
H = I x P
I = a percentage of the purchase cost

18. How can we find EOQ? From above
The EOQ Model
How can we find EOQ? From above

19. The EOQ Model

20. Have a look at example 13.2, page 604
The EOQ Model
Have a look at example 13.2, page 604

21. Overview of inventory policies
Two basic questions:
Q1: When should we order (or produce)?
Q2: How much?
Typical answers to Q1:
When inventory level is equal (or below) a level R
Every P time units
Typical answers to Q2:
Order or produce Q units
Order or produce such that the inventory level T
Models:
Continuous review: (R, Q)
Periodic review: (P, T, Q)

22. Continuous Review (Q) System
Tracks inventory after every withdrawal
Determines if re-order (R) is necessary
Fixed Order Quantity (Q)
Inventory Position (IP) considers:
Scheduled Receipts (SR)
On-Hand Inventory (OH)
Backorders (BO)

23. Periodic Review (P) Time between orders is fixed, P
Quantity changes to meet needs
Stock positions are restored on pre-determined dates to (T) Target Inventory Level
When the order arrives (IP) and (OH) are identical

24. Comparison of Q and P Systems
Q Systems
P Systems
Idle state
Idle state
Demand occurs
Demand occurs
Review time?
Compute IP
Reorder point?
Compute IP
Compute Q needed for T
Issue order; Q
Issue order; Q

25. Comparison of Q and P Systems
Q Systems
Individual review frequencies
Possible quantity discounts as fixed Q
Lower, less-expensive safety stocks
P Systems
Convenient to administer as fixed interval
Orders may be combined
IP only required at review

26. Q System – recording point
Inv. Position = on hand inv. + scheduled receipts – backorders
IP = OH + SR - BO

27. Reorder Point (ROP) ROP = d x L Where; d = demand and L = lead time
d and L are certain

28. If demand and lead time is not certain we need to use Safety Stock

29. Q System- when demand and lead time are constant and certain

30. Q System- when demand and lead time are uncertain

31. Finding the safety stock using service level policy

32. Finding the safety stock using service level policy
If cycle service level is 85%, then
probability of stock out is 15%
Safety stock

34. Finding the safety stock using service level policy
Have a look at example 13.5 page 612

35. Q review system – total costs

36. Q review system – total costs
Have a look at example 13.6 page 614

37. Visual system R R Full Empty Order One Bin of Inventory
Two-Bin System
Full
Empty
Order One Bin of
Inventory R
One-Bin System
Order Enough to
Refill Bin R 25

38. Periodic review (P) system
We need to calculate;
Time between reviews, P
Target inventory level, T
P = EOQ / D (years)
T = d (P + L) + safety stock for protection interval
Where
d = demand during P + L
Safety stock =

39. P System

40. P review system – total costs

41. P review system – total costs
Have a look at example 13.8 page 617

42. Hybrid System

43. Hybrid System: Base-stock level System
Very simple system
Issue a replenishment order with a quantity equal to the withdrawal one
This will maintain the IP at a base-stock level
Expensive items (e.g. aero engine)
Just-in-time 24

44. Hybrid System: Optional Replenishment System
Maximum Inventory Level, M
Actual Inventory Level, I
q = M - I I M
Do you remember the P system?
Q = minimum acceptable order quantity
If q > Q, order q, otherwise do not order any. 24

45. Inventory Accuracy and Cycle Counting Defined
Inventory accuracy refers to how well the inventory records agree with physical count.
Cycle Counting is a physical inventory-taking technique in which inventory is counted on a frequent basis rather than once or twice a year. (e.g. class A in particular) 27