inventory management for independent demand chapter 12
TRANSCRIPT
Inventory Managementfor Independent Demand
Chapter 12
MGMT 326
Foundations
of Operatio
nsIntroductio
n
Strategy
ManagingProjects
QualityAssuran
ce
Facilities
& WorkDesign
Products &
Processes
ProductDesign
ProcessDesign
ManagingQuality
Statistical
ProcessControl
Just-in-Time & Lean Systems
FacilityLayout
Capacity
and Locatio
n
LinearProgram-ming
ManagingInventory
Planning& Control
Chapter Outline
Basic concepts Objectives of inventory management Dependent and independent demand
ABC inventory analysis Inventory costs
Item costs Holding costs Order or setup costs Shortage costs
Chapter Outline (2)
Inventory policy Fixed order quantity method Economic order quantity – the
optimal fixed order quantity Reorder point
Reorder point when demand is constant Reorder point when demand is variable
Economic production quantity – the optimal production quantity
Objectives of Inventory Management
Maintain good customer service Minimize inventory investment,
consistent with the required level of customer service
Types of DemandDependent Demand
Demand for raw materials, component parts, and subassemblies used to make a finished product
Both the amount of demand and the date required depend on the production schedule
Types of Demand (2) Independent Demand
Any demand that is not used to meet a production schedule is called independent demand
Examples of independent demand: finished goods; retail and distributor inventories; service inventories; maintenance, repair, and operating (MRO) inventories MRO includes fuels, repair parts, office
supplies, cleaning supplies
Dependent and Independent Demand:
Types of Inventory
Dependent demand:used to meet a
production schedulein manufacturing
Independent demand:
not used to meet a production schedule
Work-in-process(WIP)
Raw materials
Component parts
Manufacturer Service Company
Finished goods
MRO
Retail ordistributorinventories
Service inventories
MRO
ABC Inventory Analysis For an inventory item, the annual usage in dollars is
(annual demand)x(cost per unit). Annual demand is also called annual usage in units. ABC inventory analysis divides inventory items into 3
categories: A items usually account for at least 60% of annual
usage and should be controlled most closely B items require a moderate level of control. A and B
items should account for at least 80% of annual usage. C items require less control than other items. These
items are those with the least usage that were not classified asA and B items
© Wiley 2007
The AAU Corp. is considering doing an ABC analysis on its entire inventory but has decided to test the technique on a small sample of 15 of
its SKU’s. The annual usage and unit cost of each item is shown below
Steps in ABC Analysis
1. Compute Annual Usage in Dollars for each item.
2. Compute Total Annual Usage.3. Compute the percentage of Annual
Usage for each item.4. Sort the list of items by the percentage
of Annual Usage in Dollars, from largest to smallest.
Steps in ABC Analysis (2)
5. Calculate the Cumulative Percentage of Annual Usage in Dollars for the first item, first 2 items, first 3 items, etc. For the last item, the cumulative % should be 100%.
6. Using Cumulative % as a guide, assign the items to A, B, and C categories.
© Wiley 2007
© Wiley 2007
Relevant Inventory Costs
Measurable Cost of Inventory =
ItemCosts
HoldingCosts
Order Costs for purchased
itemsOR
Setup Costs foritems made byyour company
Shortage costs:Administrative& transportationcosts related toback orders
+ + +
Shortages and back orders result in lost sales and lost goodwill. These costs are relevant but hard to measure.
Item Costs
Item costs For purchased items, the item cost is
the purchase price, plus shipping For work in process, the item cost is
the cost of materials and labor used in the item
For finished goods, the item cost is the cost of goods sold.
Inventory Holding Costs Inventory holding costs include capital
costs, storage costs, and risk costs Capital costs:
If inventory is financed with borrowed money, the capital cost is the interest rate paid
If inventory is financed from retained earnings, the capital cost is the opportunity cost of not putting the money into other investments
Storage costs: the costs of space, people, and equipment used in inventory storage
Inventory Holding Costs (2)
Risk costs: cost of taxes and insurance on inventory, damage, obsolescence, and theft
Inventory holding costs are usually computed as a percentage of item costs
Ordering and Setup Costs
For purchased items, ordering costs are the fixed costs associated with placing an order with a supplier
For items made internally, setup costs are used instead of order costs. The setup cost is the cost of work that must be done before production actually begins.
Shortage Costs
Administrative and transportation costs related to back orders
Lost good will and lost sales due to product shortages – hard to measure
Inventory Management Policies
An inventory management policy should determine How much to order When to order
Fixed Order Quantity Method
An inventory policy for independent demand. Based on the following rules:
1. Order the same amount, Q, each time Q is called the order quantity
2. Place an order when the amount in inventory gets down to the reorder point, R
Compute Q and R for each item.
Fixed Order Quantity Method (2)Relevant Costs
Assume Quantity discounts are not available Orders are placed early enough that
shortages do not occur Relevant costs
Order costs Inventory holding costs
Fixed Order Quantity Method (3)
Annual Inventory Cost
Figure 12.2, page 430Given:D = annual demand =
10,400Weekly demand = 200L = lead time = 1 weekQ = order quantity = 600Average inventory= (Q/2) = 600/2 = 300
Fixed Order Quantity Method (4)Notation
Q = order quantity D = annual demand for the item S = cost of placing one order H = inventory holding cost per unit per year
(commonly called holding cost) L = lead time (time between order placement
and order receipt) R = reorder point TC = annual cost of placing orders
+ annual cost of holding inventory
Fixed Order Quantity Method (5)Costs
Annual cost of placing orders =
Annual cost of holding inventory =
Total annual cost =
Economic Order Quantity
The economic order quantity (EOQ) is the fixed order quantity (Q) that minimizes the total annual costs of placing orders and holding inventory (TC).
Economic Order QuantityAssumptions
Demand (D) is known and constant H is known and constant Order costs (S) are constant The order quantity arrives in a
single shipment No quantity discounts are available All demand will be met (no
shortages)
We want to minimize TC D, S, and H are constant. TC is a function of Q.
1
2 2
D Q HTC S H DS Q
Q Q
Economic Order Quantity (3)
* 2DSQ
H
*
* 2
D QTC S H
Q
Let Q* be the economic order quantity. Then
For Q*, annual order cost = annual inventory cost
*
* 2
D QS H
Q
Simple Reorder Point
Use this method when daily demand is constant.
R = reorder point d = daily demand (may have to
compute this) L = lead time (Caution: if lead time is
given in weeks, convert this to days. A week may be 5, 6, or 7 days).
R = dL
Reorder Point with Safety Stock Safety stock (SS) is extra inventory that is
kept to meet unexpected demand.
Reorder point withoutsafety stock
Reorder pointwith safety stock
Reorder Point with Safety Stock (2)
How much safety stock (SS) ?
Reorder point with safety stock: Service level is the probability of having
enough inventory to meet demand during lead time
The probability of a stockout is (1 - service level)
Demand during lead time is normally distributed with mean and standard deviation dL
SSLdR demanddaily average d
Ld
Reorder Point with Safety Stock (2)
How much safety stock (SS) ?
z is the number of standard deviations required to meet the desired service level
SS = zdL
Reorder point with safety stock: R = +
zdL
Ld
Reorder Point with Safety StockExample
Given D = annual demand = 10,000 N = number of business days per year = 250 The company operates 5 days per week = average daily demand dL = standard deviation of demand during lead
time = 20 L = lead time = 1 week Service level = 96%Find: reorder point with safety stock: R = + zdL
Ld
d
Computing Reorder Point with Safety Stock
1. If average daily demand ( ) is not given, compute it.Note: = D/N and D = = 10,000/250 = 40
2. If the lead time is given in weeks or months, compute lead time in days.L = 1 week = 1(5) = 5 daysNote: 1 week is the number of days per
week that the company operates. This may be 5, 6, or 7.
d
d
d dN
Computing Reorder Point with Safety Stock (2)
3. Find the z value for the service level (96%)
Probability of a stockout =1 – servicelevel = 4%
z
50% 46%
Ld
Appendix B givesthis area.
Computing Reorder Point with Safety Stock (3)
3. Find the z value for the service level (96%) (cont.)(a) Write the service level as a decimal
96% = 0.9600(b) Subtract 0.5000 from the service level
0.9600 – 0.5000 = 0.4600(c) Use the table in Appendix B, page 652, to
find the area that is closest to 0.4600The closest area in the table is 0.4599, which occurs when z = 1.75Use z = 1.75
Computing Reorder Point with Safety Stock (4)
4. Compute R
R = L+ zdL
= 40(5) + 1.75(20) = 200 + 35 = 235
Note: If the computation gives a fractional value, round up to nearest integer.
Example: Computed R = 210.2 R = 211
d
Economic Production Quantity
Key question: How many units of a part or product should be made at one time?
The economic production quantity (EPQ) is the production quantity (lot size) that minimizes the total annual cost of setups and holding inventory.
Economic Production Quantity (2)
Notation
Q = Amount to make (lot size) D = annual demand for the item d = daily demand for the item p = daily production rate S = cost of one setup H = inventory holding cost per unit per year
(commonly called holding cost) TC = annual cost of setups
+ annual cost of holding inventory The EPQ is the quantity that minimizes TC
Economic Production Quantity (3)Assumption: Daily demand < daily production. When the item is being made, some is sold or used to make a product. The remainder goes into inventory. When production stops, the inventory is used until there is no inventory left. Then production resumes.
Ending inventory= beginning inventory+ production- sales or usage
Economic Production Quantity (4)
Length of production run = Q/p During production, d units are sold or used each day. (p
– d) units go into inventory.
p
dQdp 1)(
p
QIMAX
Maximum inventory:
Total cost:
H
2
IS
Q
DTC MAX
EPQ
Economic productionquantity (EPQ):
p
d1H
2DSEPQ
EOQ vs. EPQ When to use economic order quantity
(EOQ): Demand is independent Compute how much to order (order quantity)
When to use economic production quantity (EPQ): Parts or products will be produced: demand
is dependent Compute how much to make at one time
(production lot size)