Lecture Principle of inventory and material management - Lecture 31

Lecture 31 - Independent Demand and Ordering System (Revision). The contents of this chapter include all of the following: What is inventory, cost of inventory, benefits of inventory, multi period model, optimal quantity to order, safety stock, periodic review system, single period inventory model.

Independent Demand and Ordering System (Revision)

Books

• Introduction to Materials Management, Sixth Edition, J. R. Tony Arnold, P.E., CFPIM, CIRM, Fleming  College, Emeritus, Stephen N. Chapman, Ph.D., CFPIM, North Carolina State University, Lloyd M.  Clive, P.E., CFPIM, Fleming College

• Operations Management for Competitive Advantage, 11th Edition, by Chase, Jacobs, and Aquilano, 2005,  N.Y.: McGraw­Hill/Irwin.

• Operations Management, 11/E, Jay Heizer, Texas Lutheran University, Barry Render, Graduate School of  Business, Rollins College, Prentice Hall

Inventory is the raw materials, component  parts, work­in­process, or finished products  that are held at a location in the supply chain.

At the macro level:

Investment in inventory is currently over $1.25  Trillion (U.S. Department of Commerce).  

This figure accounts for almost 25% of GNP.

Enormous potential for efficiency increase by  controlling inventories

Inventory is one of the biggest corporate assets ($).

– Sales growth: right inventory at the right place at  the right time 

– Cost reduction: less money tied up in inventory,  inventory management, obsolescence

Higher profit

Why do we care?

At the firm level:

Each of Solectron’s big customers, which include Cisco, Ericsson, and Lucent was expecting explosive growth for wireless phones and networking gear….when the bottom finally fell out, it was too late for Solectron to halt orders from all of its 4,000 suppliers Now, Solectron has $4.7 billion in inventory (BW, March 19, 2001)

“When Palm formally reported its quarterly numbers in June, the damage was gruesome Its loss totaled $392 million, a big chunk of which was attributable to writing

down excess inventory - piles of unsold devices.” (The

Industry Standard, June 16, 2001)

“Liz Claiborne said its unexpected earnings decline is the consequence of higher than anticipated excess

inventories” (WSJ, August 1993)

• Cost of not having it. 

• Cost of going to the grocery or gas station (time,  money), cost of drawing money.

• Cost of holding and storing, lost interest.

• Price discounts.

• How much you consume.

• Some safety against uncertainty.

• Physical holding costs:

– out of pocket expenses for storing inventory (insurance,  security, warehouse rental, cooling)

– All costs that may be entailed before you sell it 

(obsolescence, spoilage, rework )

• Opportunity cost of inventory: foregone return on  the funds invested.

• Operational costs:

– Delay in detection of quality problems.

– Delay the introduction of new products.

– Increase throughput times.

Warehouse RetailSupplier

• Ordering costs

• Holding costs

Multiperiod model – The Economic Order  Quantity

Total Time Period over which demand for Q has occurred

Q

Inventory position

The average  inventory for each  period is…

Q 2

Q S

Q

2  H

548 500

) 000 ,

5 )(

000 ,

15 (

2

*

Q

Receive order

Receive order

What if the lead time to receive cars is 10 days?  (when should you  place your order?)

Since D is given in years, first convert: 10 days = 10/365yrs

Receive order

Place order Lead Time

Inventory at time of receipt

Receive order

Stockout Point

Unfilled demand

Receive order

Lead Time

If Actual Demand > Expected, we Stock Out

ROP = Expected Demand

outs 50% of the time.

Uncertain Demand

Receive order

Time

Place order

Lead Time

Exp ecte d

Lea d-tim e

Dem

and

Inventory Level

Service level

Safety Stock

Probability

of stock-out

Decide what Service Level you want to provide  (Service level = probability of NOT stocking out)

Service level

Safety Stock

Probability

of stock-out

Safety stock = (safety factor z)(std deviation in LT demand)

Read z from Normal table for a given service level

Average Inventory =  (Order Qty)/2 + Safety Stock

Receive order

Time

Place order

Lead Time

Inventory

Level

Order Quantity

Safety Stock (SS)

EOQ/2

Average Inventory

Back to the car lot…  recall that the lead time is 10 days and the expected  yearly demand is 5000. You estimate the standard deviation of daily demand  demand to be   d = 6.  When should you re­order if you want to be 95% sure  you don’t run out of cars?

Since the expected yearly demand is 5000, the expected demand over the lead  time is 5000(10/365) = 137. The z­value corresponding to a service level of  0.95 is 1.65. So

Order 548 cars when the inventory level drops to 168.

168 )

36 ( 10 65

1 137

ROP

Order Quantity

It is not unusual for companies to order less or more than  the EOQ for several reasons:

• They may not have a known uniform demand;

• Some suppliers have minimum order quantity that are  beyond the demand.

JIT or “Lean Systems” would recommend reducing order quantities to the lowest practical levels

• Orders are placed at specified, fixed­time intervals (e.g.  every Friday), for a order size  (Q) to bring on­hand 

236 52weeks

x  D

Q RP

belts  

424 8

416 3

5 1.77 1.645

3 5 units  

52 TI

zσ L)

d(RP SS

L) d(RP

$16

$229

$245 Difference

Cost   

Annual

$245 130

115

$0.97 2

268

$10 5

52 TCp

The SPI model is designed for products that share the following  characteristics:

– Sold at their regular price only during a single­time period

– Demand is highly variable but follows a known probability distribution

– Salvage value is less than its original cost so money is lost when these products are sold for their salvage value

• Objective is to balance the gross profit of the sale of a unit with  the cost incurred when a unit is sold after its primary selling  period

SPI Model Example: T­shirts are purchase in multiples of 10 for a charity event for $8 each. When sold during the event the selling price is $20. After the event their salvage 

End of Lecture 31