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SCM 304 Inventory Management

Inventory
those stocks or items used to support production (raw materials
and work-in-process items), supporting activities (maintenance, repair, and operating supplies)
and customer service (finished goods and spare parts)
Purpose of Inventory
1. To meet anticipated customer demand
2. To smooth production requirements
3. To decouple operations
4. To protect against stockouts
5. To take advantage of order cycles
6. To hedge against price increases
7. To permit operations
8. To take advantage of quantity discounts
Why Inventories are a vital part of business:
(1) necessary for operations and
(2) contribute to customer satisfaction
Objectives of Inventory Control
1. Level of customer service
• Having the right goods available in the right quantity in the right place at the right time
2. Costs of ordering and carrying inventories
• The overall objective of inventory management is to achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds
1. Customer satisfaction
2. Measures of performance
» Number and quantity of backorders
» Customer complaints
3. Inventory turnover
Effective Inventory Management
Requires:
1. A system keep track of inventory
2. A reliable forecast of demand
3. Knowledge of lead time and lead time variability
4. Reasonable estimates of
• holding costs
• ordering costs
• shortage costs
5. A classification system for inventory items
Inventory Costs
• Purchase cost
– The amount paid to buy the inventory
• Holding (carrying) costs
– Cost to carry an item in inventory for a length of time,
usually a year
• Ordering costs
– Costs of ordering and receiving inventory
• Setup costs
– The costs involved in preparing equipment for a job
– Analogous to ordering costs
• Shortage costs
– Costs resulting when demand exceeds the supply of
inventory; often unrealized profit per unit
A-B-C approach
A items (very important)
• 10 to 20 percent of the number of items in inventory and about
60 to 70 percent of the annual dollar value
– B items (moderately important)
– C items (least important)
• 50 to 60 percent of the number
of items in inventory but only
about 10 to 15 percent of the
annual dollar value
Inventory Systems
• The set of policies and controls that monitor
levels of inventory
• Determines what levels should be
maintained, when stock should be
replenished, and how large orders should be
Independent demand
the demands for various items are unrelated to each other
Dependent demand
the need for any one item is a direct result of the need for some other item
Inventory Management
Questions of Interest:
1. How Much to Order (Quantity of the Order)
2. When to Order (Timing of the Order)
EOQ
Economic order quantity models identify
the optimal order quantity by minimizing
the sum of annual costs that vary with
order size and frequency
1. The basic economic order quantity model
2. The economic production quantity model
3. The quantity discount model
Basic EOQ Model
The basic EOQ model is used to find a fixed order
quantity that will minimize total annual inventory costs
Basic EOQ Model Assumptions:
1. Only one product is involved
2. Annual demand requirements are known
3. Demand is even throughout the year
4. Lead time does not vary
5. Each order is received in a single delivery
6. There are no quantity discounts
Fixed-Order Quantity Model
Inventory is consumed at a constant rate,
with a new order placed when the
reorder point (R) is reached once again
Inventory Models with Price Break
(Quantity Discount Models)
• Under quantity discounts, a supplier offers
a lower unit price if larger quantities are
ordered at one time
• This model differs from the basic EOQ
Model because the purchasing cost (C)
varies with the quantity ordered
Reorder point
– When the quantity on hand of an item drops to this amount, the
item is reordered.
– Determinants of the reorder point
1. The rate of demand
2. The lead time
3. The extent of demand and/or lead time variability
4. The degree of stockout risk acceptable to
management
Reorder Point: Under Uncertainty
• Demand or lead time uncertainty creates the possibility
that demand will be greater than available supply
• To reduce the likelihood of a stockout, it becomes
necessary to carry safety stock
– Safety stock
• Stock that is held in excess of expected demand
due to variable demand and/or lead time
Safety stock
refers to the amount of inventory carried in addition to expected demand.
Safety stock approaches
A common approach is to simply keep a certain
number of weeks of supply
A better approach is to use probability.
• Assume demand is normally distributed.
• Assume we know mean and standard deviation.
• To determine probability, we plot a normal distribution for expected demand and note where the amount we have lies on the curve.
Fixed-Order Quantity Model with Safety Stock
• In the fixed order quantity model, the ordering process is
triggered when the inventory level drops to a critical
point, the Reorder Point (ROP).
• This starts the lead time for the item.
• Lead time is the time to complete all activities associated
with placing, filling and receiving the order.
• During the lead time, customers continue to draw down
the inventory
• It is during this period that the inventory is vulnerable to
stockout (run out of inventory)

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