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OPM537 BUSINESS OPERATIONS MANAGEMENT Chapter 10: INVENTORY MANAGEMENT Content ✔ The importance of Inventory ✔ Managing Inventory ✔ Inventory Model ✔ The Concept of Inventory Model for Independent De...

OPM537 BUSINESS OPERATIONS MANAGEMENT Chapter 10: INVENTORY MANAGEMENT Content ✔ The importance of Inventory ✔ Managing Inventory ✔ Inventory Model ✔ The Concept of Inventory Model for Independent Demand  1.0 Inventory ✔ Obj (inventory management): to strike a balance between inventory investment and customer service ✔ One of the most expensive assets of many companies representing as much as 50% of total invested capital ✔ Less inventory lowers costs but increases chances of shortages, which might stop processes or result in dissatisfied customers ✔ More inventory raises costs but improves the likelihood of meeting process and customer demands ◦ Functions: To provide a selection of goods for anticipated customer demand and to separate the firm from fluctuations in that demand To ‘decouple’ the firm of production process (safety/buffer stock) To take advantages of quantity discount To hedge against inflation and upward price changes 3 3 Types of Inventory i. Raw material inventory: refers to piece parts, components and materials that are used for the operations and business ii. Work-in-process (WIP) inventory refers to semi finished items, sub-assemblies or batches of incomplete or partial products waiting for the next processes or in transit awaiting for their schedule iii. Maintenance/repair/operating (MROs): refers to those items or spare parts that need to be kept for maintenance, repair of machines and replacement iv. Finished-goods inventory: refers to final products or ready made goods awaiting to be shipped out, distributed or exported to the various destinations and customers 4 4  2.0 Managing Inventory 1) Classification of inventory (ABC) ◦ ABC analysis: A method for dividing on-hand inventory into three classifications based on annual dollar volume ◦ Known as Pareto principle (critical few, trivial many) ◦ To establish inventory policies that focus resources on few critical parts Class Total dollar usage Total inventory items A 70 – 80% 15% B 15 – 25% 30% C 5% 55% 5 5  ABC Analysis Class A - high annual dollar volume Class B - medium annual dollar volume Class C - low annual dollar volume 6 6  2.0 Inventory Management System 1.0 Inventory Records and Control Record accuracy can be maintained by either periodic or perpetual system I. Periodic systems require regular (periodic) checks of inventory- check quantity on hand and resupplies as necessary- use two-bin system iI. Perpetual inventory tracks both receipts and subtractions from inventory on a continuing basis Record Accuracy : ◦ Incoming and outgoing record keeping must be accurate ◦ Stockrooms should be secure ◦ Necessary to make precise decisions about ordering, scheduling, and shipping 7 7 Inventory Management System 8 8 Inventory Management System 9 9 Inventory Management System 2) Inventory Records and Control -Records must be verified through a continuing audit. - Such audits are known as cycle counting ◦ Cycle counting ◦ Items are counted and records updated on a periodic basis ◦ A continuing reconciliation of inventory with inventory records – using ABC Analysis (A- counted frequently, B- counted less frequently, C- counted perhaps once every 6 months CYCLE COUNTING NUMBER OF ITEMS ITEM CLASS QUANTITY POLICY COUNTED PER DAY A 500 Each month 500/20 = 25/day B 1,750 Each quarter 1,750/60 = 29/day C 2,750 Every 6 months 2,750/120 = 23/day blank blank blank 77/day 10 10 Control of service inventory ◦ Can be a critical component of profitability ◦Techniques ◦ Good personal selection, training, and discipline ◦ Tight control of incoming shipments ◦ Effective control of all goods leaving the facility 11 11 3.0 Inventory Model Independent vs. dependent demand -Independent Demand – demand for finished good. -E.g: Computer, Bicycle and Pizza -Dependent Demand – demand for components parts. -E.g: Microchips for computer, Wheels for Bicycle and Cheese for Pizza. ◦Holding Cost - The Cost to keep or carry inventory in stock ex insurance, staffing, interest payment ◦Ordering Cost - The cost of ordering process ex clerical supports, forms, cost of suppliers, ◦Setup costs - The cost to prepare a machine or process for production ex time, labor, tools 12 12 4.0 Inventory Models for Independent Demand (When to Order & How much to Order?) 1) EOQ model (Economic Order Quantity) ✔ The most commonly used inventory-control technique ✔ Objective is to determine the optimal order quantity for an item of inventory so that the total annual inventory cost is minimized. ◦ Ordering cost curve = carrying cost curve ◦ Ordering cost = holding cost ◦ Assumption : a) Demand is known, constant & independent b) Lead time is known & constant c) Receipt of inventory is instantaneous & complete (The inventory from an order arrives in one batch at one time) d) Quantity discount are not possible e) The only variable cost are the cost of setting up or placing an order f) Stockouts (shortage) can be completely avoided 13 13 4.0 Inventory Models for Independent Demand ▪ Cost factors inventory control : ✔ Cost of item/purchase cost ✔ Ordering cost ✔ Carrying/holding cost Q= Number of Units per Order Q* =Optimum number of units per order (EOQ) D= Annual demand in units for the inventory item S= Setup or ordering cost for each order H= Holding or Carrying cost per unit per years 14 14  4.0 Inventory Models for Independent Demand ▪ Formulas ▪ Using the following variables, we can determine setup and holding costs and solve for Q Annual setup cost D S Q Annual holding cost Q H 2 EOQ (Q*) √ 2DS H Expected number of orders (N) D EOQ Expected time between orders (T) Number of working days N Total cost D S + Q H + PD Q H 15 15 4.0 Inventory Models for Independent Demand ▪ Formulas Lead time (l): time between placement and receipt of an order Demand per day (d) D Number of working day in a year Reorder point (ROP) dXl (refer to when to order) 16 16 Find optimal order quantity (Q*) Sharp a company that market needles to hospital would like to reduce inventory cost by determining the optimal number of needles. The annual demand is 1000 units, set up $10 per order and holding cost per unit per year $.50.What is the optimal demand qty for Sharp? D = 1,000 units S = $10 per order H = $.50 per unit per year Copyright © 2020 Pearson Education Ltd. All Rights Reserved. Answer D = 1,000 units S = $10 per order H = $.50 per unit per year Copyright © 2020 Pearson Education Ltd. All Rights Reserved. 2.Determine expected number of orders (N) D = 1,000 units Q* = 200 units S = $10 per order H = $.50 per unit per year Copyright © 2020 Pearson Education Ltd. All Rights Reserved. 3. Determine optimal time between orders (T) Sharp, Inc. has a 250-day working year and wants to find the number of orders (N) and the expected time between orders (T). D = 1,000 units Q* = 200 units S = $10 per order N = 5 orders/year H = $.50 per unit per year The company now knows not only how many needles to order per order but that the time between orders is 50 days and that there are five orders per year Copyright © 2020 Pearson Education Ltd. All Rights Reserved.  4. Determine the total annual cost Sharp, Inc. wants to determine the combined annual ordering and holding costs. D = 1,000 units Q* = 200 units S = $10 per order N = 5 orders/year H = $.50 per unit per year T = 50 days These are the annual setup and holding costs. The $100 total does not include the actual cost of goods. Notice that in the EOQ model, holding costs always equal setup (order) costs Copyright © 2020 Pearson Education Ltd. All Rights Reserved. Robust Model The EOQ model is robust Robust > giving satisfactory answers even with substantial variation in parameters It works even if all parameters and assumptions are not met The total cost curve is relatively flat in the area of the E OQ Copyright © 2020 Pearson Education Ltd. All Rights Reserved. Management in the Sharp, Inc., examples underestimates total annual demand by 50% (say demand is actually 1,500 needles rather than 1,000 needles) while using the same Q. How will the annual inventory cost be impacted? Ordering old Q* Ordering new Q* Copyright © 2020 Pearson Education Ltd. All Rights Reserved. 4.0 Inventory Models for Independent Demand 2) Production Order Quantity Model ◦ POQ : An economic order quantity technique applied to production orders ◦ when the firm may receive its inventory over a period of time. ◦ Assumptions: a) When inventory continuously flow or build up over a period of time after an order has been placed b) When units are produced and sold simultaneously ◦ In this model, inventory is received over a period of time, little by little. It takes into account daily production (or inventory flow) rate and daily demand rate. 24 24  4.0 Inventory Models for Independent Demand ❖ Annual inventory holding cost = (Average Inventory level) x (Holding cost/unit/year) ▪ Average inventory level = (Maximum inventory level) 2 ▪ Maximum inventory level Q (1-d) p ▪ Annual inventory holding cost Q (1 – d ) H 2 p ▪ Set ordering cost equal to holding cost to obtain Q* p: Q* = √ 2DS H(1-(d/p) 25 25 A PRODUCTION ORDER QUANTITY MODEL Nathan Manufacturing, Inc., makes and sells specialty wheels for the retail automobile aftermarket. Nathan’s forecast for its wire wheels is 1,000 units next year, with an average daily demand of 4 units. However, the production process is most efficient at 8 units per day. So the company produces 8 per day but uses only 4 per day. The company wants to solve for the optimum number of units per order. (Note: This plant schedules production of this wheel only as needed, during the 250 days per year the shop operates.) Annual demand = D = 1,000 units Setup costs = S = $10 Holding cost = H = $0.50 per unit per year Daily production rate = p = 8 units daily Daily demand rate = d = 4 units daily The difference between the production order quantity model and the basic EOQ model is that the effective annual holding cost per unit is reduced in the production order quantity model because the entire order does not arrive at once. topic9Company Logo 26 4.0 Inventory Models for Independent Demand 3) Quantity discount model ❖ Quantity discount is a reduced price for items purchased in large quantities. ❖ Greatest discount price may not minimize total inventory cost ❖ As discount quantity goes up, the product cost goes down, however holding cost increases because orders are larger ❖ Optimal order size (Q) = √ 2DS IP ❖ Total cost = setup cost + holding cost +product cost 27 27 4.0 Inventory Models for Independent Demand 3) Quantity discount model ❖ Quantity discount is a reduced price for items purchased in large quantities. ❖ Greatest discount price may not minimize total inventory cost ❖ As discount quantity goes up, the product cost goes down, however holding cost increases because orders are larger ❖ Optimal order size (Q) = √ 2DS IP ❖ Total cost = setup cost + holding cost +product cost 28 28 Quantity Discount Models Chris Beehner Electronics stocks toy remote-control drones. Recently, the store has been offered a quantity discount schedule for these drones. This quantity schedule was shown in Table 12.2. Furthermore, setup cost is $200 per order, annual demand is 5,200 units, and annual inventory carrying charge as a percentage of cost, I, is 28%. What order quantity will minimize the total inventory cost? Calculate Q* for every discount starting with the lowest price Infeasible – calculate Q* for next-higher price Feasible 5.0 Just-in-time Inventory System: ◦ Effective inventory tactics require “just in time” not “just in case” ◦ JIT is the minimum inventory necessary to keep a perfect system running ◦ With JIT inventory, the exact amount of goods arrives at the moment it is needed, not a minute or a minute after 30 Thank you 31