Operation Management
BITS Pilani Abhishek Maiti
Pilani Campus
BITS Pilani
Pilani Campus
<MBAZG526/QMZG526, Operation
Management>
Lecture No. 9
Inventory Management
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• A stock or store of goods.
• It is to strike a balance between inventory investment and
customer service.
BITS Pilani, Pilani Campus
Functions of Inventory
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• To meet anticipated customer demand.
• To smooth production requirements.
• To decouple operations.
• To reduce the risk of stock-outs.
• To take advantage of order cycles.
• To hedge against price increases.
• To permit operations.
BITS Pilani, Pilani Campus
Types of Inventory
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
Raw material inventory : Materials that are usually purchased but
have yet to enter the manufacturing process.
Work-in-process (WIP) inventory : Products or components that are
no longer raw materials but have yet to become finished
products.
Maintenance/repair/operating (MRO) inventory: Maintenance,
repair, and operating materials.
Finished-goods inventory : An end item ready to be sold, but still an
asset on the company’s books.
BITS Pilani, Pilani Campus
Managing the Inventory
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• How inventory items can be classified (called ABC analysis).
• How accurate inventory records can be maintained (Inventory
Counting System).
BITS Pilani, Pilani Campus
ABC analysis
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• A method for dividing on-hand inventory into three
classifications based on annual dollar volume.
• Class A items (very important),
• Class B items (moderately important)
• Class C items (least important).
BITS Pilani, Pilani Campus
Class A items
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Class A items are the large investment items; vital few.
• 15-20 percent of the items accounting for 75-80 percent of the
total annual usage value.
• Computerized Materials Requirement Planning (MRP) would
be beneficial.
BITS Pilani, Pilani Campus
Class B items
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• 25-30 percent of the items accounting for 15-20 percent of the
total annual usage value.
• Historical data based order rather applying forecasting
techniques.
• Economic Order Quantity (EOQ) would be beneficial.
BITS Pilani, Pilani Campus
Class C items
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Class C items are the large investment items; trivial many.
• 50 percent of the items accounting for 5-10 percent of the total
annual usage value.
• Quantity discount model would be beneficial.
BITS Pilani, Pilani Campus
Inventory Counting System
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Periodic system : Physical count of items in inventory made
at periodic intervals (weekly, monthly).
• Two-bin system : Two containers of inventory; reorder when
the first is empty.
• Perpetual inventory system: System that keeps track of
removals from inventory continuously, thus monitoring current
levels of each item.
BITS Pilani, Pilani Campus
Inventory Counting System
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Universal product code (UPC) : Bar code printed on a label
that has information about the item to which it is attached.
• Point-of-sale (POS) systems : Record items at time of sale.
BITS Pilani, Pilani Campus
Terminology
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Cycle counting : A continuing reconciliation of inventory with
inventory records.
• Shrinkage : Retail inventory that is unaccounted for between
receipt and sale.
• Pilferage : A small amount of theft.
BITS Pilani, Pilani Campus
Guesstimation
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
How much Accuracy is Needed
BITS Pilani, Pilani Campus
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• APICS recommends the following guidelines for inventory
record accuracy:
• 0.2 percent for A items, 1 percent for B items and 5 percent
for C items.
• A items are counted frequently, B items are counted less
frequently, and C items are counted the least frequently.
BITS Pilani, Pilani Campus
Inventory Costs
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
Purchase cost: The amount paid to buy the inventory.
Holding (carrying) cost : 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.
Shortage costs : Costs resulting when demand exceeds the supply
of inventory; often unrealized profit per unit.
BITS Pilani, Pilani Campus
Inventory Ordering Policies
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Cycle stock : The amount of inventory needed to meet
expected demand.
• Safety stock : Extra inventory carried to reduce the probability
of a stock out due to demand and/ or lead time variability.
BITS Pilani, Pilani Campus
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
Any Question
BITS Pilani, Pilani Campus
Inventory Models
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Independent Demand Model.
• Dependent Demand Model. ( Will be deal later in Dependent
Demand Management)
BITS Pilani, Pilani Campus
Independent Demand Model
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
1. Basic economic order quantity (EOQ) model.
2. Production order quantity model.
3. Quantity discount model.
BITS Pilani, Pilani Campus
EOQ Model
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• EOQ model is the simplest of the three models.
• An inventory-control technique that minimizes the total of
ordering and holding costs.
Source: Operation Management by William J Stevenson
BITS Pilani, Pilani Campus
EOQ Model
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
Source: Heizer, Render, Muckson
BITS Pilani, Pilani Campus
Minimizing Costs
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
Source: Operation Management by William J Stevenson
BITS Pilani, Pilani Campus
Minimizing Costs
BITS Pilani, Pilani Campus
Minimizing Costs
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
BITS Pilani, Pilani Campus
Minimizing Costs
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
BITS Pilani, Pilani Campus
Class Exercise
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Sharp, Inc., a company that markets painless hypodermic
needles to hospitals, would like to reduce its inventory cost by
determining the optimal number of hypodermic needles to obtain
per order.
• The annual demand is 1,000 units; the setup or ordering cost is
$10 per order; and the holding cost per unit per year is $.50.
BITS Pilani, Pilani Campus
Class Exercise
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Sharp, Inc. (in Example 3 ) has a 250-day working year and
wants to find the number of orders ( N ) and the expected time
between orders ( T ).
BITS Pilani, Pilani Campus
Class Exercise
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Sharp, Inc. wants to determine the combined annual ordering
and holding costs.
BITS Pilani, Pilani Campus
Re-Order Point
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
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.
Reorder point (ROP) : The inventory level (point) at which
action is taken to replenish the stocked item.
BITS Pilani, Pilani Campus
Re-Order Point
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
BITS Pilani, Pilani Campus
Class Exercise
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• An Apple store has a demand (D) for 8,000 iPhones per year.
• The firm operates a 250-day working year.
• On average, delivery of an order takes 3 working days, but has
been known to take as long as 4 days.
• The store wants to calculate the reorder point without a safety
stock and then with a one-day safety stock.
BITS Pilani, Pilani Campus
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
Any Question
BITS Pilani, Pilani Campus
Production Order Quantity
Model
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Also known as Economic Production Quantity.
• The assumptions of the EPQ model are similar to those of the
EOQ model, except that instead of orders received in a single
delivery, units are received incrementally during production.
BITS Pilani, Pilani Campus
EPQ Model
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
BITS Pilani, Pilani Campus
EPQ Model
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
BITS Pilani, Pilani Campus
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
BITS Pilani, Pilani Campus
Class Exercise
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Nathan Manufacturing, Inc., makes and sells specialty hubcaps for the retail
automobile aftermarket.
• Nathan’s forecast for its wire-wheel hubcap is 1,000 units next year, with an
average daily demand of 4 units.
• However, the production process is most efficient at 8 units per day.
• So the company produces 8 per day but uses only 4 per day.
• The company wants to solve for the optimum number of units per order.
BITS Pilani, Pilani Campus
Quantity Discount Model
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• A reduced price for items purchased in large quantities.
BITS Pilani, Pilani Campus
Class Exercise
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
• Chris Beehner Electronics stocks toy remote control flying
drones.
• Recently, the store has been offered a quantity discount
schedule for these drones.
• Furthermore, setup cost is $200 per order, annual demand is
5,200 units, and annual inventory carrying charge as a percent
of cost, I , is 28%.
• What order quantity will minimize the total inventory cost?
BITS Pilani, Pilani Campus
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
BITS Pilani, Pilani Campus
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
BITS Pilani, Pilani Campus
Solution
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
Source: Heizer, Render, Muckson
BITS Pilani, Pilani Campus
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
Any Question
BITS Pilani, Pilani Campus
Further Reading / References
Prepared by Prof. Abhishek Maiti for the use of the students of Operation Management
1. Operation Management by Jay Heizer, Barry Render & Chuck Munson—
Chapter 12
2. Operation Management by William J Stevenson—Chapter 13
3. Application of ABC analysis in Inventory Management, Technical Note,
IIM Ahmedabad.
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THANK YOU
BITS Pilani, Pilani Campus
