Logistics management

INVENTORY MANAGEMENT
- CONTROL

Joanna Oleśków-Szłapka
 What Is Inventory?
□Stock of items kept
to meet future
demand
□Purpose of
inventory
management
□how many units
to order?
□when to order?
 Types of Inventory

Inputs Outputs
• Raw Materials Process
• Finished Goods
• Purchased parts • Scrap and Waste
• Maintenance and
Repair Materials
(in warehouses, or
“in transit”)

In Process
• Partially Completed
Products and
Subassemblies (often on the factory
floor)
 Water Tank Analogy for
Inventory

Inventory Level
Supply Rate

Buffers Demand
Rate from Supply
Inventory Level Rate

Demand Rate
 Two Forms of Demand

 Dependent
 Demand for items used to produce
final products
 Tires stored at a Goodyear plant are
an example of a dependent demand
item
 Independent
 Demand for items used by external
customers
 Cars, appliances, computers, and
houses are examples of independent
demand inventory
Inventory Hides Problems

Bad
Design
Lengthy Poor
Setups Quality
Machine
Inefficient Unreliable
Breakdown
Layout Supplier
 Inventory and Supply Chain
Management - problems
□Bullwhip effect
□demand information is distorted as it moves
away from the end-use customer
□higher safety stock inventories to are stored to
compensate
□Seasonal or cyclical demand
□Inventory provides independence from
vendors
□Take advantage of price discounts
□Inventory provides independence between
stages and avoids work stop-pages
 Inventory Costs

 Carrying cost
 cost of holding an item in inventory
 Ordering cost
 cost of replenishing inventory
 Shortage cost
 temporary or permanent loss of sales
when demand cannot be met
Typical Inventory Carrying Costs
Costs as % of
Inventory Value
Housing cost: 6%
□ Building rent or depreciation (3% - 10%)

□ Building operating cost

□ Taxes on building
□ Insurance 3%
(1% - 4%)
Material handling costs:
□ Equipment, lease, or depreciation
□ Power 3%
□ Equipment operating cost (3% - 5%)
10%
Manpower cost from extra handling and supervision
(6% - 24%)

Investment costs: 5%
□ Borrowing costs (2% - 10%)
□ Taxes on inventory (15% - 50%)
□ Insurance on inventory
Pilferage, scrap, and obsolescence

Overall carrying cost

 INVENTORY CONTROL
□ Inventory control is concerned with minimizing
the total cost of inventory.
□ The three main factors in inventory control
decision making process are:
The cost of holding the stock (e.g., based on the
interest rate).
The cost of placing an order (e.g., for row
material stocks) or the set-up cost of production.
The cost of shortage, i.e., what is lost if the stock
is insufficient to meet all demand.
□ The third element is the most difficult to measure
and is often handled by establishing a "service
level" policy, e. g, certain percentage of demand
will be met from stock without delay.
 Inventory Control Systems

 Continuous system (fixed-

order-quantity)
 constant amount ordered
when inventory declines to
predetermined level
 Periodic system (fixed-time-
period)
 order placed for variable
amount after fixed passage of
time
 Zero Inventory?

□Reducing amounts of raw materials and

purchased parts and subassemblies by
having suppliers deliver them directly.

□Reducing the amount of works-in process

by using just-in-time production.

□Reducing the amount of finished goods

by shipping to markets as soon as possible.
 How to Measure Inventory
□The Dilemma: closely monitor and control
inventories to keep them as low as
possible while providing acceptable
customer service.
□Average Aggregate Inventory Value:
how much of the company’s total
assets are invested in inventory?
□Ford:6.825 billion
□Sears: 4.039 billion
 Inventory Measures
□Weeks of Supply
□Ford: 3.51 weeks
□Sears: 9.2 weeks
□Inventory Turnover (Turns)
□Ford: 14.8 turns
□Sears: 5.7 turns
□GM: 8 turns
□Toyota: 35 turns
ABC CLASSIFICATION
 ABC Classification

□The ABC Classification The ABC

classification system is to grouping
items according to annual sales
volume, in an attempt to identify the
small number of items that will
account for most of the sales volume
and that are the most important ones
to control for effective inventory
management.
 ABC Classification
□Class A
□5 – 15 % of units
□70 – 80 % of value
□Class B
□30 % of units
□15 % of value
□Class C
□50 – 60 % of units
□ 5 – 10 % of value
ABC Classification: Example

PART UNIT COST ANNUAL USAGE

1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120
 ABC Classification:
Example (cont.)
TOTAL % OF TOTAL % OF TOTAL
PART PART
VALUE UNIT
VALUECOSTQUANTITY
ANNUAL USAGE
% CUMMULATIVE
9 1
$30,600 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 11.0
2 14,000 16.4 4.0
A40 15.0
3 30 130
1 5,400 6.3 9.0 24.0
4 4
4,800 5.680 6.0 B60 30.0
3 5
3,900 4.630 10.0 100 40.0
% OF TOTAL % OF TOTAL
6 6
3,600
CLASS ITEMS20
4.2 18.0
VALUE 180QUANTITY
58.0
5 3,000
7 3.510 13.0 170 71.0
10 2,400
A 9, 8,2.8
2 12.0
71.0 C 83.0
8 320 50 15.0
7 1,700
B 1, 4,2.0
3 17.0
16.5 100.0
25.0
9
C 5107
6, 5, 10, 12.5 60 60.0
$85,400
10 20 120
Example 10.1
 ABC Analysis
□ Recognizes fact some inventory items are more
important than others.
□ Purpose of analysis is to divide all of company's
inventory items into three groups: A, B, and C.
□ Depending on group, decide how inventory levels
should be controlled.
 Silicon Chips, Inc.
Example
□Maker of super-fast DRAM chips, has
organized its 10 inventory items on an
annual dollar-volume basis.
□Parts are identified by item number,
part number, annual demands, and
unit costs.
□How should company classify items into
groups A, B, and C?
 Silicon Chips, Inc. Example
□How should company classify items into groups A, B,
and C?
 Inventory Management
Approaches
□A-items
– Track carefully (e.g. continuous review)
– Sophisticated forecasting to assure
correct levels
□C-items
– Track less frequently (e.g. periodic
review)
– Accept risks of too much or too little
(depending on the item)
Economic Order
Quantity Model
 Economic Order Quantity
(EOQ) Models
□EOQ
□optimal order quantity that will
minimize total inventory costs
□Basic EOQ model
□Production quantity model
 Assumptions of Basic EOQ
Model

 Demand is known with certainty and

is constant over time
 No shortages are allowed
 Lead time for the receipt of orders is
constant
 Order quantity is received all at once
 EOQ Lot Size Choice

□There is a trade-off between lot

size and inventory level.
□Frequent orders (small lot size): higher
ordering cost and lower holding cost.
□Fewer orders (large lot size): lower
ordering cost and higher holding cost.
 EOQ Inventory Order Cycle
Demand
Order qty, Q
rate
Inventory
Level

ave = Q/2

Reorder point, R

0 Lead Lead Time

time time
As Q increases, average Order Order Order Order
inventory level
increases, but number of Placed Received Placed Received
orders placed decreases
Total Cost of Inventory – EOQ
Model
 Answer to Inventory
Management Questions for EOQ
Model
Keeping track of inventory
□Implied that we track continuously
How much to order?
□Solve for when the derivative of total cost with
respect to Q = 0: -SD/Q^2 + iC/2 = 0
□Q = sqrt ( 2SD/iC)
When to order?
□Order when inventory falls to the “Reorder Point-
level” R so we will just sell the last item as the
new order comes in:
□R = DL
 The EOQ Model

Q = Number of pieces per order

Q* = Optimal number of pieces 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 year
 An EOQ Example

Determine optimal number of needles to order

D = 1,000 units
S = $10 per order
H = $.50 per unit per year

2DS
Q* =
H
2(1,000)(10)
Q* = = 40,000 = 200 units
0.50
 An EOQ Example

Determine optimal number of needles to order

D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year

Expected Demand
number of = N = =
orders Order quantity
 An EOQ Example

Determine optimal number of needles to order

D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year

Number of working
Expected days per year
time between = T =
orders N
 An EOQ Example

Determine optimal number of needles to order

D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days

Total annual cost = Setup cost + Holding cost

D Q*
TC = S + H
Q* 2
 Reorder Point

 EOQ answers the “how much” question

 The reorder point (ROP) tells when to
order
Demand Lead time for a
ROP = per day new order in days

=dxL
D
d = Number of working days in a year
 Reorder Point: Example

Demand = 10,000 kg/year

Store open 311 days/year
Daily demand = 10,000 / 311 = 32.154 kg/day
Lead time = L = 10 days

R = dL = (32.154)(10) = 321.54 kg = 322 kg

 Safety Stocks

 Safety stock
 buffer added to on hand inventory during lead
time
 Stockout
 an inventory shortage
 Service level
 probability that the inventory available during
lead time will meet demand
 Variable Demand with
a Reorder Point
Q
Inventory level

Reorder
point, R

0
LT LT
Time
 Reorder Point with
a Safety Stock
Inventory level

Q
Reorder
point, R

Safety Stock
0
LT LT
Time
 Reorder Point With
Variable Demand

R = dL + zσ d L
where
d = average daily demand
L = lead time
σ d = the standard deviation of daily demand
z = number of standard deviations
corresponding to the service level
probability (service factor)
zσ d L = safety stock
Reorder Point for
a Service Level

Probability of
meeting demand during
lead time = service level

Probability of
a stockout

Safety stock
zσ d L

dL R
Demand
Safety factor values for CSL
 Reorder Point for
Variable Demand

The carpet store wants a reorder point with a 95%

service level and a 5% stockout probability
d = 30 m per day
L = 10 days
σ d = 5 m per day

For a 95% service level, z = 1.64

R = dL + z σ d L Safety stock = z σ d L
= 30(10) + (1.64)(5)( 10) = (1.64)(5)( 10)
= 325.9 m = 25.9 m