Inventory Management

&

Material requirement

Planning

Recommended text books :

1. Production Planning & Inventory Control By : Seetharama L.Narshimhan , Dennis W. Mc Leavy

2. Principles of Inventory and Material Mangement. By Richard J. Tersine ,

Strategic importance of inventory management

The cost structure of Indian manufacturing plants shows that materials constitute 66 percent of total costs, and material processing overhead as 24 percent.

This implies that management initiatives to control manufacturing costs need to focus on reduce material costs and overheads.

Indian Manufacturing sector is facing stiff competition from ASIAN market forcing it to be cost competitive in the final products and move towards mass customization .

The challenge is to move from mass production culture to mass customization.

Inventory concept & need for inventory management

Traditional Manufacturing Process. Causal Diagram.

Why inventory problem

Standardization Non standardization

Flow (Mass) Batch Job Project/ TurnProduction production production key production

MTS ETO

Standard parts & Non standard low volumeHigh Volume

Variation

TPS works on the premise of eliminating waste and being flexible and open to change. It’s approach is to identify and eliminate waste (non-value adding activities) through continuous improvement by flowing the product at the pull of the customer in pursuit of perfection.

The Toyota Production System is a philosophy of manufacturing that was created by the Toyota Corporation. TPS, has become synonymous with Lean Manufacturing.

TPS defined three types of waste: “Muda“( non value-added work), “Muri" (overburden) and “Mura“( unevenness). By eliminating waste, overall quality can be improved and production time as well as cost can be reduced.

Toyota Production System.

TPS defined three types of waste known as 3 M’s of TPS.

“Muda“( non value-added work)

“Muri" (overburden) Excess inventory

“Mura“( unevenness).

By eliminating waste, overall quality can be improved and production time as well as cost can be reduced.

Toyota Production System ( TPS) & 3 M’s According to TPS , there are seven types of wastes in production . 1. Over-production2. Motion (of operator or machine)3. Waiting (of operator or machine)4. Conveyance,5. Processing itself6 .Inventory 7. Correction (rework and scrap).

Lean manufacturing aims to improve the manufacturing process by eliminating seven wastes in all their forms.

Inventory types in manufacturing Industry

Raw Material ( RM Inventory )

Maintenance Repair & Operating supply. (MRO)

Work in Progress Inventory ( WIP )

Warehouse inventory ( CKD /SKD ) Semi Finished goods

Sales Return Inventory

Spares inventory

Scrap inventory

Refill inventory

In business accounting , the Inventory turnover is a measure of the number of times inventory is sold or used in a time period ( year) . The equation for inventory turnover equals the cost of goods sold divided by the average inventory . Inventory turnover is also known as inventory turns, stock turn, stock turns, turns, and stock turnover.

Inventory turn over = COGS Average inventory

Average Inventory = Opening stock + closing stock 2

A low turnover rate may point to overstocking

The purpose of increasing inventory turns is to reduce inventory for three reasons.Increasing inventory turns reduces holding cost . The organization spends less money on rent, utilities, insurance, theft and other costs of maintaining a stock of good to be sold. It increases net income and profitability as long as the revenue from selling the item remains constant. Items that turn over more quickly increase responsiveness to changes in customer requirements while allowing the replacement of obsolete items.

D = 4,800 Annual DemandP = 40.00 Cost to Place an OrderV = 62.50 Value of one unit at CostC = 40% Annual Carrying Cost as a Percentage

Assumptions of the Simple EOQ Model

1.Constant & Known rate of demand.2.Zero replenishment cycle or lead time.3.Fixed purchase price that is independent of the

order quantity or time.4.Fixed transportation cost that is independent of

the order quantity or time.5.No inventory in transit.6.Only one item in inventory, or at least no

interaction among items.7.An infinite planning horizon.8.No limit on capital availability.

Inventory models to overcome the assumptions .

Dimensions of inventory modelsDeterministic versus StochasticIndefinite versus finite planning horizonIndependent versus dependent demandSingle versus multiple:itemlocationechelon (interrelated locations)indenture (interrelated items)

MRP is an essential task for : Strategic inventory management

In MRP decision, lot size has to be considered as it affects the production schedule. However while doing so, set up cost need to be considered as it affects the production cost.

Effects of Lot sizingLot-for-lot+ ”Preserves” the MPS quantities+ Suitable for JIT manufacturing+ Generates smooth requirements for material and capacity– No economic considerations

Fixed order quantities– Lumps together requirements to large orders– Amplifies lumpiness through the BOM– Fluctuating material and capacity requirements

Variable quantity and cover-time+ Economic considerations considering discrete requirements - Estimation of cost parameters – Covering many periods net requirements tends to create amplified variability of demand for material and capacity

Inventory decision rules

Independent inventory Q,R policy

What can happen: Q,R Policy . Demand during lead time is greater than lead time

Demand during lead time is larger than order size.

If ordered only when replenishment comes, inventory is depleted.

Pink line when backorders, black when demand is lost.

Q,R Policy (amended with multiple R)

Inventory decision rules

Q is clear but S somewhat less clear. If we review inventory balance continuously, then when reorder point is reached and quantity Q ordered, it will lead to an expected opening inventory of S

However, if review is periodic, then the inventory can be more or less below R, so S would be S = Q + (R-inventory).

Policy Q,T is interesting. If demand during review T > Q, this policy does not really work. Unless we decide that it is still Q that is ordered but we can order or more times Q (n*Q).

In practice, Q could be some physical logistics limit, like full truckload or a full pallet.

In practice, S could be some periodic system, like shipping schedule or production cycle.

Buffering techniquesSafety stockPhysical safety quantity. Used when quantity, demand or consumption is unreliableSafety lead timeSafety in time, order receipt before requirementUsed when lead times are stochasticExtends the lead timeHedgingSafety in order quantities used when yield is stochastic (e.g. scrap)Mainly used in master production schedulingSlack in the system (e.g. spare capacity)5. Some Safety Stock StrategiesSpecified fill rate (demand filled from stock) or Specified service level (probability a stock out will not occur)Maximize $ demand filled from a given investment.Set SS based on specified number of Sigmas (Std.Dev., MAD, etc.)Set SS based on specified time supply.Minimize shortage occurrences for a given investment (# of orders with a problem.) Minimize transaction shortages for a given investment (# of problems in orders.)

Safety stock = Z*δdWhere– Z = value from the standard normal distribution– δd = standard deviation of demand during replenishment lead timeReorder Point = Z*δd + expected demand during lead timeExamples– Z(1,645) = 95%– Z(1,960) = 97,5 %– Z(3,090) = 99,9 %

 Minor ProblemsIt calculates the probability of a stock out during replenishment lead time, not customer service level measured as fill-rate. They are not the same thing.What if delivery time is not certain but a variable, too?The formula applies only for normally distributed demand, not other demand distributions. How to incorporate demand forecasts?

If the LT distribution is binomial, then the joint distribution can be created manually.Bowersox gives a following approximate formula for calculating Z for variable lead time situation

joint δ = √(t* δd 2+ d2* δt2

Wheret = replenishment lead timeδt = replenishment lead time varianced = demand during average replensihment lead timeδd = demand variance during average replensihment lead time

Q/2Q

Time

Inventory independent on market Demand ( Mass production )

Lead time

D Lt = Av demand x LT

ROP

Stock level = EOQ + DLt ( When supplier lead time not constant )

Stock level = EOQ + Dlt + variation in demand ( when demand fluctuates )

Cost trade off. When orders are placed more frequently, the ordering cost is high but carrying cost lost is low , on the other hand if less frequent orders are placed ordering cost will be low but carrying cost will be high.

Cost

Order Qty

Total cost

Total cost

Ordering cost

Carrying cost

Total no. of orders /year = D/ Q

Average Inventory = Q/2

Cost of ordering /year = D/Q x Co where Co is ordering cost per order

Carrying cost /year = Q/2 X Cc where Cc is carrying cost per unit per year

Total cost is minimum when

D/Q X Co = Q/2 X Cc

Q2 = 2 X DX Co/ Cc

EOQ= 2x D x Co Cc

Manufacturing model without shortage Items are produced & consumed simultaneously for a portion of the cycle time. The rate of consumption is uniform through out the year & cost of production remains same irrespective of production lot .

P

D

tp

P = production rate D= consumption rate P – D = inventory build up rate Q = Inventory at t1

Q

Q = Pxtp , tp = Q/P

2 DXCs Ci

=EBQ

I max = t p x ( P-D)

Cycle PP-D( )

I max = t p x ( P-D)

= Q/P x ( P-D) = Q x (1- D/P)

Av annual Inv = Q/2 x ( 1- D/P)

Av Annual Inv Cost = Q/2 x (1- D/P) Ci

Annual set up cost = D/Q x C s

Q/2 x(1-D/P) Ci = D/Q x Cs

Q2 = 2 x D x Cs (P-D )Ci

P

Q = 2x Dx Cs x P Ci P-D

Economic Batch Qty

A manufacturing unit has annual demand of 10000 valves. Each valve costs Rs 32. The product engineering department estimates the setup cost as Rs 55 & holding cost as 12.5 % of the valve. The production rate is uniform at 120 valve/day. Production happens for 250 days in a year.

Calculate optimal batch size & total inventory cost on the basis of optimal policy.

Find the number of set ups on the basis of optimal batch .

Ci= 12.5% of 32 = Rs 4 , D= 10000/250 = 40 units /day

EBQ = 2 x 10000 x 55 ( 120/120-40) = 642 valves. 4

(10000/642)x 55 + 642/2 ( 120-40/120) x 4 856.8 + 856.35 = Rs 1713.15 /yr

No of setups = 10000/ 642= 16 Approx

Inventory Control Techniques

Inventory control techniques are used to prevent : 1 financial leakage due o excessive stock & poor demand , 2 shortage of inventory3. Inventory Obsolescence Plan safety stock for critical & essential items Build selective control on fast & slow moving inventory .

Various Inventory control technique used are : ABC : Always Better Control VED : Vital Essential & Desirable SDE : Scarce Difficulty & Easy FNSD Fast moving , Normal , Slow moving , Dead

% items 0 10 30 100

ABC Classification

(InventoryValue )

Usage %

70

90

100

CLASS A

CLASS B

CLASS C

High annual consumption value items

Moderate annual Consumption value

Low annual consumption value

VED analysis : Vital : Without which production process will come to halt. Essential : Non availability of such item will affect the efficiency .Desirable : It is good if it is available , however alternate option can be done.

SDE : Scarce ( Short supply ) Difficult ( Imported components ) easily ( Short lead time )

Purchase Inventory review system :

Review process is administered on the basis of Fixed order quantity ( Q system ) and fixed period quantity system . ( P system )In Q system , whenever the stock level reaches the RoL , order is placed for a fixed quantity of material . RoL is calculated as a sum of demand during the lead time & variation in demand during lead time ( safety stock ) and average demand during delivery delays. ( reserve stock ) In p system , stock position is reviewed after every fixed period & order is placed according to stock position .

The goal of JIT in manufacturing organization is to continuously reduce the cost associated with requirement material resource. Its objective is to achieve zero ( minimal ) inventory through out the supply chain, hence implement good material control. The goal of JIT process is to reduce excess working capital held-up on account of material , minimal inventory at WIP . The constraints for implementing JIT are :

•Unpredictable quality of supply of material •Inability to hold tolerances. •Shortcoming in lead time. ( Erratic delivery ) •Short supply of quantity of material •Inaccurate forecasting •Non standard materials being used ( Increased variety ) •Last minute product changes.

Steps for implementing JIT in an organization.

•Do detailed analysis of inventory requirement of all types at every stage of production process.

•Estimate the market fluctuations on account of price, supply , quality demand etc. •Identify reliable source of suppliers who are capable of supplying material as when required.

•Take supplier in to confidence & sensitize them the importance of JIT inventory & build healthy business relationship with suppliers to have high commitment & ownership . Use Value engineering approach.

•Conduct periodic vendor appraisal & follow vendor rating system of evaluation .

•Give instant feed back on the supply & suggest improvement steps.

•Sign rate contract .

• Use IT enabled ordering system , ERP .

Value Engineering or Value Analysis

It is a technique of cost reduction and cost prevention. It focuses on building necessary functions at minimum cost with out compromising on quality, reliability ,performance & appearance. It helps in identifying unnecessary costs associated with any material , part components or service by analysis of function and efficiently eliminating them with out impairing the quality functional reliability or its capacity to provide service. It is a preventive process.

When to apply VE 1. Raw material cost increases suddenly .

2. Vendors are unreliable & organization is highly dependent on a few select vendor .

3. Cost of manufacturing is disproportionate to volume of production .

Value analysis is done w.r.t cost associated at: • Cost Value (Labour , Material & overhead).• Use Value • Esteem Value ( Look & finish ) • Performance Value ( Reliability , Safety , Service &

Maintenance )

Value = Performance ( Utility) Cost

Vendor analysis is done to minimize the cost incurred due to a supplier Inefficiency or inability .

Vendor cost to be considered are :

•Opportunity loss due to poor quality ( High rejection cost ) •leading to machine & labour idle time. •High re-work cost •Inconsistent lead time •Inability to meet the demand of the manufacturer•Poor Credit terms

Value engineering procedure: Constantly evaluate the inventory costs associated & benchmark against the best in practice.

As & when the cost of manufacturing increases disproportionately, identify an alternate source for contract manufacturing & monitor the quality & standards.

Use more standard parts which can be sourced easily

Develop more suppliers ( atleast 4 to5 for one part.) & minimize dependency on one supplier.

Audit the supplier’s work premise & rate them on the performance . Conduct quarterly vendor meet & share the highlights & concerns .

Material requirement planning (MRP )process.

Demand aggregation

Explode Demand into bill of material ( BOM)

Check InventoryStock(Stocking Policy )

Raise production . Raise subcontract work order contract

Analyze Make or Buy decision

Make Buy

Stockavailability

YNRaise Purchase Indent

Requirement Analysis

Batch production Turnkey production

Make or Buy decision .

Criteria of make : 1. Finished goods can be made cheaper by the firm. 2.Quality standardization can not be met by out side party. ( strict quality control. ) 3.Supply of the parts are unsteady ( Long lead time) 4.Capacity of production can be used for manufacturing some other part. ( Fixed cost)

Buy : 1.Heavy investment in the facility 2.Parts are standard and available easily.

3.Demand of the components are seasonal . 4.Patent of some legal implications exists. 5.Cost of buying is less than manufacturing.

A firm has extra capacity which can be used for production of gears, which they have been buying form the market at Rs 300 per unit. If the firm makes gears , it incurs the following cost. Mat cost Rs 90/unit. Lab cost 120/unit Overhead Rs 30/unit . The annual fixed cost of production estimated is Rs 240,000. Projected demand for next 24 months is 4000 units.

Will it be profitable for the firm to manufacturer?The same capacity can be utilized for producing agri-equipment. In such case there will be a saving of s 90,000. What should be the decision.

Making /Buying gears VC/unit = ( Rs 90 + 120+ 30) = Rs 240Total VC = 4000 X 240 = 9,60,000 Fixed cost = 2,40,000Total cost = 12,00,000

Purchase cost = ( 4000 x Rs 300/unit ) = 12,00,000 Fixed cost = 2,40,000 Total cost = 14,40,000

Make gears Make Gears and Agri Equipment Rs 12,00,000 12,00,000 – 90,000 = 11,10,000

There are two machines to manufacture a particular product in a firm . Alternatively , they can also buy it from local market. The cost associated areas follows. The annual demand for the product is 10000 units. When would it be feasible for the firm to use process A & B .

Cost ( Rs ) Machine A Machine B Buy FC/ Year 1,00,000 3,00,000 -----VC/ unit 75 70 -----Buy price / unit 80

Cost of Process A = 1,00,000 + 75 x 10000 = Rs 8,50,000Cost of process B = 3,00,000 + 70 x 10000 = Rs 10,00,000Cost of buying = 80 x 10000 = 8,00,000

Le t Q be the vol of production. For Process A 100000 + 75 Q =< 80 Q

100000 =< 5 Q 20000 units

TC A >= TC B

100000 +75Q >= 300000 + 70Q 5Q>= 200000 = 40000 units

When demand exceeds 20000 units , use process A & beyond 40000, use process B

Managing inventory can be a daunting task for an enterprise with tens of thousands of products that are located in hundreds of locations. The challenge is even greater when the locations are situated in different tiers or echelons of the enterprise’s distribution network. In such multi-echelon networks, new product shipments are first stored at a regional or central facility. These central facilities are the internal suppliers to the customer-facing locations. This is a common distribution model for many retail chains as well as for large distributors and manufacturers. For example, a large pharmaceutical wholesaler’s distribution network consists of one regional distribution center (RDC) and more than 30 forward distribution centers (DCs).

Multi-echelon Distribution Network

Managing inventory in a multi-echelon network presents major pitfalls.

• End customer service failures occur even when in adequateinventory exists in the network.

• Customer-facing locations experience undesirable stock outs, while service between echelons is more than acceptable.

• External suppliers deliver unreliable performance, becausethey have received unsatisfactory demand projections.

• Shortsighted internal allocation decisions are made for products with limited availability.•The network carries excess inventory in the form of redundant safety stock.