Inventory Management
EOQ
What is inventory?
Inventory is the raw materials, component parts, work-in-process, or finished products that are held at a location in the supply chain.
What is Inventory?
Stock of materials Stored capacity Examples
1995 Corel Corp.
1984-1994 T/Maker Co. 1995 Corel Corp. EOQ
1984-1994 T/Maker Co.
The Functions of Inventory
To decouple or separate various parts of the production process To provide a stock of goods that will provide a selection for customers To take advantage of quantity discounts To hedge against inflation and upward price changes
EOQ
Benefits of Inventory
Hedge against uncertain demand
Hedge against uncertain supply Economize on ordering costs Smoothing
To summarize, we build and keep inventory in order to match supply and demand in the most cost effective way.
Types of Inventory
Raw material Work-in-progress Maintenance/repair/operating supply Finished goods
EOQ
The Material Flow Cycle
EOQ
Disadvantages of Inventory
Higher costs
Item cost (if purchased) Ordering (or setup) cost
Costs of forms, clerks wages etc.
Building lease, insurance, taxes etc.
Holding (or carrying) cost
Difficult to control Hides production problems
EOQ
Inventory Classifications
Inventory
1984-1994 T/Maker Co.
Process stage
Number & Value
Demand Type
Other
Raw Material WIP Finished Goods
EOQ
A Items B Items C Items
Independent Dependent
Maintenance Operating
The Material Flow Cycle
Input Other Wait Time Move Time Queue Time Setup Time Run Time Output
Cycle Time
1 Run time: Job is at machine and being worked on 2 Setup time: Job is at the work station, and the work station is being "setup." 3 Queue time: Job is where it should be, but is not being processed because other work precedes it. 4 Move time: The time a job spends in transit 5 Wait time: When one process is finished, but the job is waiting to be moved to the next work area. 6 Other: "Just-in-case" inventory.
EOQ
Inventory Costs
Holding costs - associated with holding or carrying inventory over time Ordering costs - associated with costs of placing order and receiving goods Setup costs - cost to prepare a machine or process for manufacturing an order
EOQ
Economic Order Quantity - EOQ
Q* = 2SD H
Example: Assume a car dealer that faces demand for 5,000 cars per year, and that it costs $15,000 to have the cars shipped to the dealership. Holding cost is estimated at $500 per car per year. How many times should the dealer order, and what should be the order size?
2(15,000 )(5,000 ) Q 548 500
*
Holding (Carrying) Costs
Obsolescence Insurance Extra staffing Interest Pilferage Damage Warehousing Etc.
EOQ
Inventory Holding Costs (Approximate Ranges)
Category
Housing costs (building rent, depreciation, operating cost, taxes, insurance) Material handling costs (equipment, lease or depreciation, power, operating cost) Labor cost from extra handling Investment costs (borrowing costs, taxes, and insurance on inventory) Pilferage, scrap, and obsolescence Overall carrying cost
EOQ
Cost as a % of Inventory Value
6% (3 - 10%) 3% (1 - 3.5%) 3% (3 - 5%) 11% (6 - 24%) 3% (2 - 5%) 26%
Ordering Costs
Supplies Forms Order processing Clerical support Etc.
EOQ
Setup Costs
Clean-up costs Re-tooling costs Adjustment costs Etc.
EOQ
Inventory Models
Fixed order-quantity models
Economic order quantity Production order quantity Quantity discount
Help answer the inventory planning questions!
Probabilistic models Fixed order-period models
1984-1994 T/Maker Co.
EOQ
The Basic EOQ Model
The optimal order size, Q,
is to minimize the sum of carrying costs and ordering costs.
Assumptions and Restrictions: - Demand is known with certainty and is relatively constant over time. - No shortages are allowed. - Lead time for the receipt of orders is constant. (will consider later) - The order quantity is received all at once and instantaniously.
How to determine the optimal value (to p10) Q*?
18
The Basic EOQ Model
We assumed that, we will only keep half the inventory over a year then
The total carry cost/yr = Cc x (Q/2).Total order cost = Co x (D/Q) Then , Total cost
TC C D C Q = Q 2
o c
Finding optimal Q*
(to p11)
19
EOQ Assumptions
Known and constant demand Known and constant lead time Instantaneous receipt of material No quantity discounts Only order (setup) cost and holding cost No stockouts
EOQ
Inventory Usage Over Time
Order quantity = Q (maximum inventory level)
Usage Rate
Minimum inventory 0
Inventory Level
Average Inventory (Q*/2)
Time
EOQ
EOQ Model How Much to Order?
Annual Cost
Minimum total cost
Order (Setup) Cost Curve
Optimal Order Quantity (Q*)
EOQ
Order quantity
The Basic EOQ Model
To order inven
Total annual inventory cost is sum of ordering and Tocarrying keep inven cost: TC C D C Q Q 2
o c
Try to get this value
Figure 16.5 The EOQ cost model
23
Examples
(to p13)
If delivery is not instantaneous, but there is a lead time L: When to order? How much to order?
Order Quantity Q
Inventory
Lead Time Place order Receive order
Time
Why Holding Costs Increase
More units must be stored if more are ordered
Purchase Order Description Qty. Microwave 1
Purchase Order Description Qty. Microwave 1000
Order quantity
EOQ
Order quantity
Why Order Costs Decrease
Cost is spread over more units
Example: You need 1000 microwave ovens
1 Order (Postage $ 0.33)
Purchase Order Description Qty. Microwave 1000
1000 Orders (Postage $330)
Purchase Order Purchase Order Purchase OrderQty. Description Purchase Order Description Qty. Qty. Description Microwave Qty. 11 Description Microwave Microwave Microwave 11
Order quantity
EOQ
Deriving an EOQ
1. Develop an expression for setup or ordering costs 2. Develop an expression for holding cost 3. Set setup cost equal to holding cost 4. Solve the resulting equation for the best order quantity
EOQ
EOQ Model When To Order
Inventory Level
Optimal Order Quantity (Q*) Reorder Point (ROP) Average Inventory (Q*/2)
Lead Time
EOQ
Time
EOQ Model Equations
Optimal Order Quantity Expected Number of Orders
= Q* =
2 D S H D =N = Q*
Expected Time Between Orders
=T =
Working Days
/ Year
d =
D
Working Days / Year
ROP = d L
EOQ
D = Demand per year S = Setup (order) cost per order H = Holding (carrying) cost d = Demand per day L = Lead time in days
The Reorder Point (ROP) Curve
Q*
Slope = units/day = d Inventory level (units)
ROP (Units)
Time (days)
Lead time = L
EOQ
Quantity Discount Model
Answers how much to order & when to order Allows quantity discounts
Reduced price when item is purchased in larger quantities Other EOQ assumptions apply
Trade-off is between lower price & increased holding cost
EOQ
Quantity Discount Schedule
Discount Number 1 2 3 Discount Quantity 0 to 999 1,000 to 1,999 2,000 and over Discount (%) No discount 4 5 Discount Price (P) $5.00 $4.80 $4.75
EOQ
Quantity Discount How Much to Order
EOQ
Probabilistic Models
Answer how much & when to order Allow demand to vary
Follows normal distribution Other EOQ assumptions apply
Consider service level & safety stock
Service level = 1 - Probability of stockout Higher service level means more safety stock
More safety stock means higher ROP
EOQ
Probabilistic Models When to Order?
Inventory Level
Frequency
Service Level
P(Stockout)
Optimal Order Quantity
Reorder Point (ROP) ROP
SS
Safety Stock (SS) Place order
EOQ
Lead Time
Receive order
Time
Fixed Period Model
Answers how much to order Orders placed at fixed intervals
Inventory brought up to target amount Amount ordered varies
No continuous inventory count
Possibility of stockout between intervals Example: P&G representative calls every 2 weeks
Useful when vendors visit routinely
EOQ
Inventory Level in a Fixed Period System
Various amounts (Qi) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum
Target maximum
On-Hand Inventory
Q1
Q2 Q3 p p p
Q4
Time
EOQ
Fixed Period Model When to Order?
Inventory Level
Target maximum
Period
EOQ
Period
Period
Time
