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Independent Demand
Dependent Demand
B(4)
C(2)
D(2)
E(1)
D(3)
F(2)
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Work center
Receiving
Finished Goods
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Some Terminology
Some terms that common to inventory management are: . Lead time - time interval between ordering and receiving the order . Carrying (holding) cost - the cost of holding an item for a specified period of time (usually a year), including cost of money, taxes, insurance, warehousing costs, etc . Ordering costs - costs of ordering and receiving inventory . Shortage costs - costs resulting when demand exceeds the supply of inventory on hand often resulting in down time, unsatisfied customers, and unrealized profits . Cycle counting - a periodic physical count of a classification of inventory or selected inventory items to eliminate discrepancies between the physical count and the inventory management system
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Classification Systems
The ABC method provides for classification of inventory according to some measure of importance (usually by annual dollar usage) A - very important (accuracy within .2 percent) B - moderately important (accuracy within 1 percent) C - least important (accuracy within 5 percent) The classification system does not necessarily mean that B and C items are unimportant from a production point of view. A stock-out of nuts and bolts which may be classified as C items can just as easily shut down a production line as a major component.
A B C
Few Many
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Number of Items
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How Much?
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Q
Quantity on hand Reorder point
Usage/demand rate
Receive order
Place order
Receive order
Time
Lead time
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Carrying Cost
Ordering Cost
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Total Cost
Basic EOQ = Q 0 =
2DS H
Q0 D
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D 9,600 = = 32 Q0 300
Example 2c: What is the length of the order cycle (Cycle Time)?
since there are 288 days in the year the Order Cycle = .03125* 288 = 9 days
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TC =
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TC =
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Units
3000 2000 1000 0 0 5 10 Time Cumulative Production Cumulative Usage Inventory On Hand
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15
20
25
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Maximum Inventory
Cumulative Production
Amount on hand
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Q0 (p - u) p
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C yc le T im e = R u n T im e =
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Non-instantaneous - Example
Example 4a: A toy manufacturer uses 48,000 rubber wheels per year for its popular dump truck series. The firm makes its own wheels, which it can produce at a rate of 800 per day. The toy trucks are assembled uniformly over the entire year. Carrying cost is $1 per wheel per year. Setup cost for a production run of wheels is $45. The firm operates 240 days per year. Determine the optimal run size.
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Non-instantaneous - Example
p = production or delivery rate = 800 w heels per day D = annual dem and = 48,000 w heels 48,000 u = usage rate = = 200 w heels per day 240 S = ordering cost = $45 H = carrying cost = $1 per w heel per year
Non-instantaneous - Example
Example 4b: Compute the minimum total cost for carrying and setup.
TC min = Carring Cost + Setup Cost I D = max ( H) + (S) Q0 2 1,800 48,000 = (1) + (45) 2,400 2 = 900 + 900 = $1,800
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Non-instantaneous - Example
Example 4c: Compute the cycle time for the optimal run size.
Cycle Time =
2,400 = 12 days 200 thus a run of wheels will be made every 12 days
Example 4d: Compute the run time for the optimal run size.
2,400 = 3 days 800 thus each production of wheels will take 3 days Run Time =
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Cost
EOQ
Quantity
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Order Price Per Quantity Box 1 to 49 20.00 50 to 79 18.00 80 to 99 17.00 100 or more 16.00
D = annual demand = 816 cases/ year S = ordering cost = $12 H = carrying cost = $4 per case per year
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Order Price Per Quantity Box 1 to 49 20.00 50 to 79 18.00 80 to 99 17.00 100 or more 16.00
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Therefore; the total cost is minimum for an order quantity of 100 and the EOQ with quantity discount = 100
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When To Reorder
The Reorder Point (ROP) is the quantity of inventory on hand that triggers a reorder. Four determinants for a reorder point . Rate of demand (based on a forecast) . Lead time . Extent of demand and lead time variability . Degree of stock out risk acceptable The ROP calculation will depend on the the variability situation . Variability in demand . Variability in lead time . Variability in demand & lead time When!
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ROP = d(LT)
where
d = demand rate (units per day or week) LT = lead time in days or weeks
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d = demand rate (units per day or week) = 2 / day LT = lead time in days or weeks = 7 days
ROP = 2(7) = 14 vitamins
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When To Reorder
If variability in demand or lead time is present the ROP is calculated using the following general formula. 3 specific formula will follow depending upon what is variable (demand, lead time, demand & lead time):
Receive order
Place order
Receive order
Place order
Receive order
Time
Lead time 1
Lead time 2
Lead time 3
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Safety Stock
The calculation of safety stock depends on the variability of demand, lead time and the service level the organization desires. Service Level is the proportion of customer orders that are serviced on-time. Customers usually understand that 100% of their orders will not be serviced ontime and will establish standards for service. By developing a probability distribution of demand during lead time, a company can use statistical calculations which determine how much safety stock is necessary to meet customer service requirements. In this case, the supply of inventory on hand a company must have to meet customer requirements is calculated by supply (inventory on hand) = expected demand + safety stock. This is depicted on the next slide.
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Safety Stock
Probability distribution of quantity of demand during lead time Service Level probability of no stock out
Expected demand Safety Stock
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Safety Stock
When variability in demand and/or lead time are present, and the standard deviation of the demand during lead time can be calculated; Safety Stock is calculated using the following formula:
Safety Stock = z dLT z = number of standard deviations necessary to achieve the deisred service level
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The risk of a stock out is .03; therefore, the service level (probability of no stock out) is .97. We can look this up in the standard normal distribution tables to calculate this number. Z(97%) = 1.881.
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ROP = Expected demand during lead time + Safety Stock = 50 + 9.40 = 59.40 tons
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Other Considerations
In the previous example, we were given the demand during lead time. When data on lead time demand are not readily available, we must determine the demand during lead time (which will depend on where variability exists). In this case there are 3 different formula for calculating the reorder point (ROP). The formula will depend on the variability situation. . Only variability in demand . Only variability in lead time . Both demand & lead time are variable
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ROP = Expected demand during lead time + Safety Stock = d(LT) + z LT(d ) where d = average daily or weekly demand
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ROP = Expected demand during lead time + Safety Stock = d * (averageLead Time) + zd LT where d = daily or weeklydemand LT = standard deviation of the lead time in days or weeks
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Inventory Management
As you can see, inventory management can be fairly complicated because of all of the scenarios that are possible. Using the correct quantitative tools to manage this very critical component of a business cash flow can reap great rewards. The process even becomes more complicated when we realize that an end product (dependent demand) is made up of components (independent demand) and that inventory must be managed at the component level as well as the end product level.
End Product
E(1)
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Homework
Read and understand all material in the chapter. Discussion and Review Questions Recreate and understand all classroom examples Exercises on chapter web page
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