Inventory Control

Workshop Series

© APICS, 2003

Basics of

Inventory Management

By Anthony D. Wilbon, Ph.D.

© APICS, 2003

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Workshop Objectives

• Provide a basic description of the functions of inventory management

• Define various methods of inventory management

• Discuss real world applications of inventory management

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Workshop Topics

• Inventory Management Systems

• Costs Associated with Inventory Systems

• Quantitative Methods of Inventory Management

• Material Requirements Planning

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What Is Inventory Management?

• The set of policies and controls that monitor levels of inventory and determines

– What levels should be maintained

– When stock should be replenished

– How large orders should be.

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Objectives of Inventory

Management Systems

• Inventory management is needed to – Provide optimum customer service

– Minimize the inventory investment

– Maximize the productivity of the operations.

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Elements of Inventory

Management Systems

• Inputs

– Must forecast demand for products accurately

– Must establish policies for inventory management

– Must have an accurate assessment of lead times

• Continuous monitoring of customer service levels and investments in inventory

• Outputs

– Managing vendors

– Management of excess stock

– Implement plans for ordering and replenishing

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Types of Inventory

• The stock of any item or resource used in an organization – Raw materials

– Work-in-process

– Maintenance, repair, operating supply

– Finished goods

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Reasons for Holding Inventory

• To provide a hedge against upward price changes in materials (e.g., inflation)

• To provide a stock of goods that will provide a selection for customers

• To take advantage of discounts available through buying in large quantities

• To protect against uncertainty

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Inventory Costs

• Holding costs—carrying or storing inventory over time

• Ordering costs—placing orders and receiving goods into the firm

• Setup costs—preparing the system for creating an order

• Additional costs include – Shortage or stockout costs

– Purchase or item costs

– Transportation costs

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Disadvantages of Inventory

• Maintaining large inventory is difficult to control

• Large inventory levels conceal other problems

• Product life cycles are becoming shorter increasing the likelihood of product obsolescence

• The high costs of inventory storage

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ABC Analysis

• A method for grouping items by

dollar volume to identify those

items to be monitored closely

• Follows the Pareto principle

• Divides on-hand inventory into

three classes

– A class, B class, C class

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ABC Analysis (continued)

• Basis is usually annual $ volume

• $ volume = annual demand × unit cost

– “A” items: high dollar volume (15%)

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

– “C” items: low dollar volume (50%)

• Set strategies from ABC analysis to better forecast, tighten control, and develop closer relationships with class A suppliers

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ABC Exercise ABC_CLASS_APICS[1].pdf

Carl Bork is opening a small automotive supply firm.

There are many items of varying costs associated with

carrying the inventory. Since Carl is just starting the

business, his time is limited and he can not spend it

monitoring all items in his inventory. He has classified

the items according to how much he has spent on them

and the demand. Use ABC analysis to classify the

items into three categories.

Item Number Annual

Demand Unit Cost

H101 50 450 D203 25 250 F234 15 20 J232 65 400 S322 75 150

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ABC Solution

Item Number

Annual Demand

Unit Cost Demand × Cost Classification

H101 50 450 22500 A D203 25 250 6250 B F234 15 20 300 C J232 65 400 26000 A S322 75 150 11250 B

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Cycle CountingABC_CLASS_APICS[1].pdf

• A process of physically counting some of total inventory on a regular basis

• When used with ABC analysis, count the “A” items most often.

– For example, “A” items get counted daily, “B” items get counted weekly, “C” items are counted monthly.

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Inventory Management Models

• Two primary models

– Fixed order models

• A system where the order quantity remains constant but the time between orders varies

– Fixed time period models

• A system where the time period between orders remains constant but the order quantity varies

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How Much to Order at One Time

• Objectives:

– Maximize customer service

– Minimize sum of all costs involved

• Decision rules for determining what lot size to order

at one time:

– Lot-for-lot

– Fixed order quantity (FOQ)

– Economic order quantity (EOQ)

– Order n periods of supply

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Fixed Order Quantity Models

• Economic order quantity

• Quantity discount

• Safety stock and reorder point

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Fixed Order Quantity Model Assumptions

• Demand for the product is known, constant, and uniform throughout the period

• The time from ordering to receipt (aka lead time) is known and constant

• Price per unit of product is constant (no quantity discounts)

• Ordering or setup costs are constant

• No back orders or stockouts

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Primary Questions for Inventory Systems

• How much to order?

• When to order?

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How Much to Order

Total Cost Curve

Holding Cost Curve

Order/Setup Cost Curve

Order Quantity

Annual Costs

Optimal Order

Quantity

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When to Order

Time

Inventory Levels

Optimal

Order

Quantity

0

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Optimal order quantity = Q = 2 × D × S H Expected number of orders = N = D/Q Expected time between orders = T = working days/year N Reorder point (ROP) = d x L, where d = D

Reorder Point Calculation in 7 minutes: ROP - YouTube working days/year Where:

D = Demand per year S = Setup (order) cost per order H = Holding costs per unit per year d = Demand per day L = Lead time in days

Economic Order Quantity Model EOQ Calculation in 13 min. - How to Calculate Economic Order Quantity Model or EOQ Model - YouTube

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Basic Economic Order

Quantity Model

Total annual cost = Annual item cost + Annual ordering cost + Annual holding cost

TC = Total annual cost

D = Annual demand in units

P = Price or cost per unit

Q = Quantity to be order

S = Setup or ordering cost

H = Annual holding cost per unit

TC = PD + D × S + Q × H Q 2

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EOQ Exercise

Charles Ross is developing an inventory system for his new firm that sells robotic pet dogs. He estimates that the annual demand for his product is 3000 units. The cost of each dog is $100 and the holding cost is $5. Charles performed further analysis and determined that the order (setup) costs will be approximately $20 per order. It will take about 5 days for an order to arrive from the supplier.

With EOQ analysis, he is now ready to develop an inventory system that will give him the lowest total cost. Using the EOQ formulas, calculate all of the necessary functions for his system.

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EOQ Solution

Q = 2DS = 2×3000×20 = 154.9 or 155 dogs H 5 Number of orders per year = D/Q = 3000/155 = 19.35 or 19 orders Assuming 250 business days per year: Optimal number of days between orders = 250/19 = 13.15 or 13 days Total annual inventory costs

TC = PD + D×S + Q×H = 100×3000 + 3000×20 + 155×5 Q 2 155 2 TC = 300,000 + 387.1 + 387.5 = $300,774.6

Reorder point (ROP) = D × L = 3000/250 × 5 = 60 dogs

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Quantity Discount Model

• Allows quantity discounts

– Vendor provides a reduced price when item is purchased in larger quantities

– Other EOQ assumptions apply

• Must balance the trade-off between

– Lower item price resulting from the discount

– Increased cost of holding more inventory

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Quantity Discount Exercise

Spartan Sweaters, Inc., is a retailer in Flint, Michigan. The store specializes in sweaters but also sells other college-related paraphernalia. The specialty of the store, the letter sweater, costs $45. There is an annual demand of 5000. The owner of the store has determined that the order (setup) cost is $10 per order and the holding cost is $7.

The owner is considering a new supplier for the sweaters whereby each sweater would only cost $40. However, to receive the discount the store would have to buy 7000 at a time. Should the owner use the new supplier and take the discount.

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Quantity Discount Solution

Q = 2DS = 2×5000×10 = 119.52 or 120 sweaters H 7 Total annual inventory costs TC = PD + D×S + Q×H = 45×5000 + 5000×10 + 120×7 Q 2 120 2 TC = 225,000 + 416.67 + 420 = $225,836.67 Recalculate total cost considering the discounted price and that you have to order a larger amount to get the discount. TC = PD + D×S + Q×H = 40×5000 + 5000×10 + 7000×7 Q 2 7000 2 TC = 200,000 + 7.143 + 24500 = $224,507.14

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Stockouts

• Issues with stock levels

– Uncertainty in product demand

– Variability in the lead time required to replenish the item

• These issues raise possibility of a stockout.

• Management concern is maintaining a desirable level of service to provide its customers.

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Safety Stock and Reorder Point

• From previous discussions we know

– Reorder point = ROP = D×L • Where D = daily demand and L = order lead time

• If we include safety stock, we get

– ROP = D×L + safety stock

• The amount of safety stock depends on the cost of running out of stock and the holding costs for that additional inventory

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Stockout Costs

Annual stockout costs = (the sum of the units short) ×

(the probability of demand) ×

(the stockout costs/unit) ×

(the number of orders per year)

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Safety Stock Exercise

Cuddle Bears has determined that the reorder point for its

teddy bears is 40 units without safety stock. The holding

cost per bear per year is $3. The costs associated with

running out of stock due to lost sales is $50 per bear. The

optimal number of orders per year is 10. Demand during

the reorder period follows the following probability.

How much safety stock should Cuddle Bears maintain?

Demand during Reorder Period

Probability

20 0.2

30 0.2

40 0.2

50 60

0.2 0.2

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Safety Stock Solution

The safety stock with the lowest total cost is 20

bears. Therefore, Cuddle Bears should change its

reorder point to 40 + 20 = 60 bears.

Safety Stock

Additional Holding Cost

Stockout Cost Total Cost

20 20(3) = $60 $0 $60

10 10(3) = $30 10(.2)(50)(10) = $1000 $1030 0 $0 10(.2)(50)(10) +

20(.2)(60)(10) = $3400 $3400

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Independent and Dependent Demand

• The EOQ model assumes that demand for one item is independent of the demand for another item.

• Often the real world suggests demand for one item depends on another. – For example, demand for microchips is

dependent on demand for computers, cell phones, etc.

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First come, first served

(FCFS)

Jobs are performed in order

received

Earliest job due date

(EDD)

Jobs are performed according to

end-item due dates

Earliest operation due

date (ODD)

Jobs are performed according to

operation due dates

Shortest process time

(SPT)

Jobs are sequenced according to

process time

Critical ratio (CR)

Jobs are sequenced using an

index of relative priority of orders

at a work center

Dispatching Rules

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Material Requirements Planning

http://www.youtube.com/watch?v=dujJR6ep1vo&feature=related

“A set of techniques that uses bill of

material data, inventory data, and the

master production schedule to

calculate requirements for materials.”

– APICS Dictionary, 10th edition

–What´s it´s IIS?-

–http://www.youtube.com/watch?v=-rzdwHgZIaE&feature=related

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Material Requirements Planning

• Use of dependent models such as MRP requires knowledge of – What is to be made and when

– What is in stock and what is on order

– Lead times.

• A major input to MRP and plans at the end-item level is the master production schedule.

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Master Production Schedule (MPS)

• Specifies what is to be made and when

• Corresponds with production plan which includes – Overall level of output

– Financial plans

– Customer demand

– Inventory fluctuations

– Supplier performance

• Tells us what is required to satisfy demand and meet the production plan

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MRP Structure

• Often computerized

• Requires MPS, bill of material, inventory purchase records, and lead times for each item as input

• Output is a series of reports that provide plans and advice for when and how much to order

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MRP Benefits

• Enhances inventory planning and scheduling

• Assists in meeting delivery schedules

• Reduces inventory levels

• Increases customer satisfaction

• Allows faster response times for management

• Reduces idle time

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MRP Program Output

• Output Reports

– Primary reports • Planned orders

• Order release notices

• Changes in due dates

• Cancellations or suspensions of open orders

• Inventory status data

– Secondary reports • Planning reports

• Performance reports

• Exception reports

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Balancing Real Decisions and

Mathematical Models

• 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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Balancing Real Decisions and

Mathematical Models (continued)

• 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.

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Balancing Real Decisions and

Mathematical Models (cont.)

• Inventory Accuracy

– Shrinkage, misidentification, and misplaced items create inventory inaccuracies.

• 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.

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References

• APICS—The Performance Advantage

• CPIM and CIRM course material

• Production and Inventory Management

Journal

• Internet Sources (e.g., Center for

Inventory Management,

www.centerforinventorymanagement.org)

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Additional Reference Sources

• APICS (800) 444-APICS (2742) or (703) 354-8851

• APICS Online Bookstore www.apics.org/Bookstore/default.htm

• APICS International Conference and Exposition

• APICS SM SIG Workshop—Inventory Essentials

for Small Manufacturers

• Web Sites