T6.
Stock management
Inventory
The objective of inventory management is to strike a balance between inventory
investment and customer service.
• One of the most expensive assets of many companies representing as
much as 50% of total invested capital.
• Operations managers must balance inventory investment and customer
service.
Functions of inventory
1. To decouple or separate various parts of the production process.
2. To decouple the firm from fluctuations in demand and provide a stock of
goods that will provide a selection for customers.
3. To take advantage of quantity discounts.
4. To hedge against inflation.
Types of inventories
• Raw material
o Purchased but not processed.
• Work-in-process.
o Undergone some changes but not completed.
o A function of cycle time for a product
• Maintenance/repair/operating (MRO)
o Necessary to keep machinery and processes.
• Finished goods.
o Purchased but not processed.
The material flow cycle
It is a systematic approach to understanding materials from the extraction of raw
materials, processing, and manufacturing to their final disposition.
Good material flow systems reduce the costs involved, speed up the process,
decrease movement time, eliminate waste, and clear congestion.
The Material Flow Cycle: most of the time that work is in process (95% of
the flow time) is not productive time.
ABC analysis
Divide inventory into three classes based on annual dollar volume:
o Class A - high annual dollar volume
o Class B - medium annual dollar volume
o Class C – the low annual dollar volume
Used to establish policies that focus on the few critical parts and not the many
trivial ones
Policies employed may include:
- More emphasis on supplier development for A items
- Tighter physical inventory control for A items
- More care in forecasting A items
Control of systems inventories
Can be a critical component of profitability
Losses may come from shrinkage (inventory that is unaccounted for between
receipt and time of sale) or pilferage (inventory theft).
Applicable techniques include
1. Good personnel selection, training, and discipline
2. Tight control of incoming shipments
3. Effective control of all goods leaving the facility
Holding, Ordering, and Setup costs
• Holding costs - the costs of holding or “carrying” inventory over time
• Ordering costs - the costs of placing an order and receiving goods
• Setup costs - cost to prepare a machine or process for manufacturing an
order
Basic EOQ Model
Basic economic order quantity: the EOQ model: an inventory-control technique
that minimizes the total costs of ordering and holding inventory.
IMPORTANT ASSUMPTIONS
1. Demand for an item is known, reasonably constant, and independent of
decisions for other items.
2. Lead time, the time between placement and receipt of the order, is known
and consistent.
3. Receipt of inventory is instantaneous and complete; the inventory from an
order arrives in one batch at one time
4. Quantity discounts are not possible.
5. The only variable costs are the cost of setting up or placing an order (setup
or ordering cost), and the cost of holding or storing inventory over time
(holding or carrying cost).
6. Stockouts (shortages) can be completely avoided if orders are placed at the
right time.
We want to find the smallest total cost (top curve), which is the sum of the
two curves. A reduction in either holding or setup costs will reduce the total
cost curve.
With the EOQ model, the
optimal order quantity
will occur at a point
where
the total setup cost is
equal to the total holding
cost.
Robust Model
One benefit of the EOQ
model is that is robust.
By robust, we mean that
it gives satisfactory
answers even with
substantial variation in its
parameters.
The total cost curve is relatively flat in the area of the EOQ, which means that
variations in setup costs, holding costs, demand or even EOQ make relatively
modest differences in total costs.
Reorder Points
EOQ answers the “how much” question. The reorder point (ROP) tells when to
Order.
The reorder point (ROP) is the inventory level (point) at which action is taken to
restock the item in stock.
• Lead time: in purchasing systems, the time between placing an order and
receiving it; in production systems, the wait, move, queue, setup, and run
times for each component produced.
• Safety stock: extra stock to allow for uneven demand, a buffer.
Production Order Quantity Model
Applicable under two situations:
- Used when inventory builds up over some time after an order is placed (in
the EOQ model was assumed that the entire inventory order was received
at one time).
- Used when units are produced and sold simultaneously.
Quantity Discount Models
Reduced prices are often available when larger quantities are purchased.
The trade-off is between reduced product cost and increased holding cost.
Inventory costs may also be expressed to include the actual cost of the material
purchased (PxD).
Probabilistic Demand
Probabilistic models: a statistical model applicable when product demand or any
other variable is not known but can be specified using a probability distribution.
- The service level is the complement of the probability of a stockout.
- Safety stock involves adding some units as a buffer to the reorder point.
Other models:
When data on demand during lead time is not available, there are other models
available:
1. When demand is variable and lead time is constant.
2. When lead time is variable and demand is constant.
3. When both demand and lead time are variable.
