Lecture Fundamentals of operations management (4/e): Chapter 21 - Davis, Aquilano, Chase

Chapter 16 Inventory systems for independent demand, after studying this chapter you will be able to: Introduce the different types of inventories that exist in a company and provide a rationale for why companies maintain inventories, identify the various costs associated with carrying and maintaining inventories, define the classical inventory models and the conditions necessary for them to be applicable,...

Inventory Systems for Independent Demand

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chapter 16

DAVIS AQUILANO CHASE

PowerPoint Presentation by Charlie Cook

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Chapter Objectives

Chapter Objectives

• Introduce the different types of inventories that exist in

a company and provide a rationale for why companies maintain inventories

• Identify the various costs associated with carrying and maintaining inventories

• Define the classical inventory models and the

conditions necessary for them to be applicable

• Show how economic order quantity is calculated for each of the different inventory models

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• Present some of the current inventory management trends and issues that exist in companies today

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Managerial Issues

Managerial Issues

• Inventory is no longer viewed as an asset

• Product life cycles are becoming shorter

increasing the likelihood of product

obsolescence.

• Inventory concealing other problems.

• The high costs of inventory storage.

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Definition of Inventory

Definition of Inventory

• Inventory

–The stock of any item or resource used in an

organization, includes raw materials, finished goods, and work-in-process.

• Inventory Management System

–The set of policies and controls that monitors

levels of inventory and determines:

• What levels should be maintained.

• When stock should be replenished.

• How large orders should be.

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Types of Inventory

Types of Inventory

• Raw Materials

–Vendor-supplied items that have not had any

labor added by the firm receiving the items.

• Finished Goods

–Completed products that are still in the

possession of the firm that manufactured them.

• Work-in-Process (WIP)

–Items that have been partially processed but are

still incomplete.

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Reason for Maintaining Inventory

Reason for Maintaining Inventory

• To protect against uncertainty:

–Shortages of raw materials.

–Work-in-process variations.

–Changes in demand for finished products.

• To support a strategic plan

–As a cyclic demand buffer for a level-output

strategy.

• To take advantage of economies of scale

–Large quantity purchases reduce the average

total unit costs related to fixed ordering, setup costs, and transportation costs.

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Inventory Costs

Inventory Costs

• Holding and Carrying Costs

–Storage costs (facility, insurance, taxes, utilities) –Capital costs (opportunity costs)

–Obsolescence/shrinkage costs (depreciated

value)

• Setup or Ordering Costs

• Shortage (or Stockout) Costs

• Purchase Costs

• Transportation Costs

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Independent versus Dependent Demand

Independent versus Dependent Demand

• Independent Demand

–The demand that pertains to the requirements

for end products (external market demand).

• Dependent Demand

–The requirements for components that are

directly dependent on the demand for the end products in which they are used.

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Types of Inventory Systems

Types of Inventory Systems

• Fixed-Order Quantity

–A system where the order quantity remains

constant but the time between orders varies.

• Preferred for important or expensive items

because average inventory is lower.

• Provides a quicker response to stockouts

• Is more expensive to maintain due to inventory

record-keeping costs.

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Types of Inventory Systems

Types of Inventory Systems

• Fixed-Time Period

–A system where the time period between orders

remains constant but the order quantity varies.

• Has larger average inventory to prevent stockouts.

• Useful when purchasing multiple items from one

vendor to save on costs.

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Comparison of Fixed­ Order Quantity and  Fixed­Time Period  Reordering Inventory 

Systems

Comparison of Fixed­ Order Quantity and  Fixed­Time Period  Reordering Inventory 

Systems

Exhibit 16.1

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Basic Inventory Models

Basic Inventory Models

• Fixed-Order-Quantity Model Assumptions:

–Demand for the product is known, constant, and

uniform throughout the period.

–Lead time (L), which is the time from ordering to

receipt, is constant.

–Price per unit of product is constant (no quantity

discounts).

–Ordering or setup costs are constant

–All demands for the product are known with

certainty, no back orders or stockouts.

–There is no interaction with other products.

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Basic Fixed­Order Quantity Model Basic Fixed­Order Quantity Model

Exhibit 16.2

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Q

D DC

TC

2

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Annual Product Cost, Based on Size of Order

Annual Product Cost, Based on Size of Order

Exhibit 16.3

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Fixed­Order­Quantity Model (cont’d)

Fixed­Order­Quantity Model (cont’d)

• Economic Order Quantity

–The optimal quantity to order taking into

consideration both the cost to carry inventory and the cost to order the item.

–Minimizes total inventory cost

H

DS EOQ 2 D = Annual demand in units S = Setup or ordering cost

H = Annual holding cost per unit

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Fixed­Order­Quantity Model (cont’d)

Fixed­Order­Quantity Model (cont’d)

• Reorder Point

–The point in time by which stock must be

ordered to replenish inventory before a stockout occurs.

L d

R

delivery  

and   order  

placing  

between  

periods  

time  

of   Number L

(constant)  

period  

time  

per   demand  

Average  

d

point  

Reorder  

R

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Basic Inventory Models

Basic Inventory Models

• Fixed Order Quantity Model with Usage

–Considers a supplier that will provide an order

quantity over a period of time rather than all at once.

H I

S Q D

DC

p Q

d p

I max

d = the constant demand rate for the item in production

p = production rate of the process (p ­ d) = inventory that accumulates each time period

(Q/p) = number of time periods required to fill the order

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p S

Q

D DC

TC

2

d p

p H

DS

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Fixed Order Quantity Model with Usage during Production Time

Fixed Order Quantity Model with Usage during Production Time

Exhibit 16.4

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Basic Inventory Models (cont’d)

Basic Inventory Models (cont’d)

• Fixed-Time-Period Model

–Inventory is counted at fixed intervals.

–Ceiling (par) inventory is established.

–Safety stock level is established.

–Order quantity to return inventory to ceiling

level varies based on on-hand inventory less safety stock at time inventory is counted.

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Fixed­Time Period Inventory Model Fixed­Time Period Inventory Model

Exhibit 16.5

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Basic Inventory Models (cont’d)

Basic Inventory Models (cont’d)

• Quantity-Discount Model

–Addresses price discounts associated with

minimum order quantities.

–Two types of quantity discounts

• Incremental discounts which apply increasing

discounted unit prices as orders reach or exceed certain quantity levels of units.

• In the all-units approach, discounts are applied to

all units with the unit cost determined by the size

of the purchase order.

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Total Cost Curves for a  Quantity­Discount Model

Total Cost Curves for a  Quantity­Discount Model

Exhibit 16.6

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Total Cost Calculations in a  Quantity­Discount Model

Total Cost Calculations in a  Quantity­Discount Model

Exhibit 16.7

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Inventories and Service Levels

Inventories and Service Levels

• Determining Safety Stock Levels

–Variation in product demand.

–Variability in the lead time required to replenish

the item.

–The desired level of service that the company

wants to provide its customers.

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• Costs are difficult to measure.

• Demand is not constant.

• Lack of focus on lot sizing and inventory

control.

• Need to focus on reducing setup costs to

reduce EOQs and total costs.

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Perishable Inventory

Perishable Inventory

• Single-Period Inventory Model

–Product is only viable for sale during a single

time period.

–Demand for the product is highly variable, but

follows a known probability distribution.

–The scrap value of the product or the value of

the product after the time period has elapsed is less than the initial cost of the product.

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Inventory Management in Services

Inventory Management in Services

• Yield Management or Revenue Management

–Goal is maximizing capacity utilization by selling

all of a service capacity for some price that

exceeds the service’s variable costs per unit of service.

–A large proportion of capacity is sold in advance

for reduced prices; some capacity is held for

last-minute customers willing to pay full prices.

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Additional Issues in  Inventory Management

Additional Issues in  Inventory Management

• Determining Realistic Costs

–Accounting data is usually expressed in

averages; marginal costs are needed to

determine proper lot sizes.

–Carrying and ordering costs are not constant –Some costs (e.g., obsolescence) are subjective.

• Inventory Accuracy

–Shrinkage, misidentification, and misplaced

items create inventory inaccuracies.

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ABC Inventory Planning

ABC Inventory Planning

• ABC Analysis

–A method for grouping items by dollar volume to

identify those items to be monitored closely.

–Follows the Pareto principle.

–“A” items: high dollar volume (15%)

–“B” items: moderate dollar volume (35%)

–“C” items: low dollar volume (50%)

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Annual Usage of Inventory by Value

Annual Usage of Inventory by Value

Exhibit 16.11

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ABC Grouping of Inventory Items

ABC Grouping of Inventory Items

Exhibit 16.12

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Current Trends in  Inventory Management

Current Trends in  Inventory Management

• Inventory is a liability, not an asset.

• Average amount of inventory relative to annual sales is decreasing.

• Firms are focusing on reducing setup and

order costs, resulting in smaller economic

order quantities.

• Firms are working more closely with vendors

to reduce product throughput times and,

consequently, lead times.