POM II

INDEPENDENT DEMAND INVENTORY

INVENTORY
Inventory is the stock of any item or resource used in an organization and can include: raw materials, finished products, component parts, supplies-intransit and work-in-process. An inventory management system is the set of policies and controls that monitor levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be

WHY INVENTORY
1. To maintain independence of operations 2. To meet variation in product demand, production rate and lead time 3. To allow flexibility in production scheduling 4. To provide a safeguard for variation in raw material delivery time 5. To take advantage of volume discounts 6. Hedge against inflation

7. Disruptions
8. Reduces no of ordering / set up

NEGATIVE ASPECTS
Quality of product service bundle Hide operational problems High cost Obsolescence Damage during storage Cost of tracking New product / technology introduction

STOCK POINTS

SUPPLIERS VALUE ADDING SYSTEM DISTRIBUTOR RETAILER RM, RM, INPROCESS INV FINISHED GOODS PRODUCT PRODUCT COMPONENTS COMPONENTS PIPELINE INV

Independent vs. Dependent Demand

Independent Demand (Demand for the final endproduct or demand not related to other items)

Finished product
Dependent Demand (Derived demand items for component parts, subassemblies, raw materials, etc)

E(1 )

Component parts

Inventory Systems
Single-Period Inventory Model One time purchasing decision (Example: vendor selling t-shirts at a cricket game) Seeks to balance the costs of inventory overstock and under stock Multi-Period Inventory Models Fixed-Order Quantity Models Event triggered (Example: running out of stock) Fixed-Time Period Models Time triggered (Example: Monthly sales call by sales representative)

INVENTORY CONTROL SYSTEM

When to order
How much to order Buffer Stock Maximum Inventory How often to review stock

COSTS
Holding (or carrying) costs

Costs for storage, handling, insurance, etc

Setup (or production change) costs Costs for arranging specific equipment setups, etc Ordering costs Costs of someone placing an order, transportation etc Shortage costs

SINGLE PERIOD

d + z *

Single-Period Inventory Model

Cu P Co Cu
Where : Co Cost per unit of demand over estimated Cu Cost per unit of demand under estimated P Probability that theunit will be sold

Single Period Model Example

Our college basketball team is playing in a tournament game this weekend. Based on our past experience we sell on average 2,400 shirts with a standard deviation of 350. We make Rs100 on every shirt we sell at the game, but lose Rs50 on every shirt not sold. How many shirts should we make for the game?
Cu = Rs100 and Co = Rs50; P 100 / (100 + 50) = .667

Z.667 = .432 (use NORMSINV(.667)) therefore we need 2,400 + .432(350) = 2,551 shirts

UNCERTAIN DEMAND
UNIT COST = SALE PRICE = PURCHASE
DEMAND 10 20 30 40 50 60 70 PROB 0.05 0.15 0.3 0.2 0.1 0.1 0.1

1 2 30
SOLD 10 20 30 30 30 30 30 EARN 20 40 60 60 60 60 60 COST 30 30 30 30 30 30 30 PROFIT -10 10 30 30 30 30 30 Probable profit -0.5 1.5 9 6 3 3 3 25

Probable profit

UNCERTAIN DEMAND
UNIT COST = SALE PRICE = PURCHASE 1 2 30
OPORTUNITY LOST 0 0 0 -10 -20 -30 -40 Probable profit -0.5 1.5 9 4 1 0 -1 14

DEMAND 10 20 30 40 50 60 70

PROB 0.05 0.15 0.3 0.2 0.1 0.1 0.1

SOLD 10 20 30 30 30 30 30

EARN 20 40 60 60 60 60 60

COST 30 30 30 30 30 30 30

PROFIT -10 10 30 30 30 30 30

Probable profit

Fixed-Order Quantity Model Assumptions

Demand for the product is constant and uniform throughout the period Lead time (time from ordering to receipt) is constant Price per unit of product is constant Instantaneous replacement

FIXED ORDER QUANTITY

ORDER QUANTITY

QTY

AVERAGE INVENTORY

REORDER POINT

TIME

Fixed-Order Quantity Model Assumptions

Inventory holding cost is based on average inventory

Ordering or setup costs are constant All demands for the product will be satisfied (No back orders are allowed)

TOTAL COST
Total Annual = Cost Annual Annual Annual Purchase + Ordering + Holding Cost Cost Cost

D Q TC = DC + S + H Q 2

EOQ

Q OPT =

2DS = H

2(Annual Demand)(Order or Setup Cost) Annual Holding Cost

Cost Minimization

Total Cost
C O S T

Holding Costs Annual Cost of Items (DC) Ordering Costs

QOPT Order Quantity (Q)

REORDER POINT

R e o rd e r p o in t, R = d L
_

d = average daily demand (constant) L = Lead time (constant)

EOQ Example
Given the information below, what are the EOQ and reorder point?

Annual Demand = 1,000 units Cost to place an order = Rs10 Holding cost per unit per year = Rs2.50 Lead time = 7 days Cost per unit = Rs15

Q = ((2*1000*10)/2.5)^1/2 = ROP= (1000/250)*7 = 28

4000

PRICE DISCOUNT

Price-Break Example Problem

A company has a chance to reduce their costs by placing larger quantity orders using the price-break order quantity schedule below. What should their optimal order quantity be if this company purchases this single inventory item with an ordering cost of Rs4, a carrying cost rate of 2% of the inventory cost of the item, and an annual demand of 10,000 units?
Order Quantity(units) Price/unit(Rs) 0 to 2,499 Rs1.20 2,500 to 3,999 1.00 4,000 or more .98

Price-Break
First, plug data into formula for each price-break value of C
Annual Demand (D)= 10,000 units Cost to place an order (S)= Rs4

Carrying cost % of total cost (i)= 2% Cost per unit (C) = $1.20, $1.00, $0.98

Next, determine if the computed Qopt values are feasible or not

Interval from 0 to 2499, the Qopt value is feasible Interval from 2500-3999, the Qopt value is not feasible

QOPT = QOPT =

2DS = iC 2DS = iC 2DS = iC

2(10,000)( 4) = 1,826 units 0.02(1.20) 2(10,000)( 4) = 2,000 units 0.02(1.00) 2(10,000)( 4) = 2,020 units 0.02(0.98)

Interval from 4000 & more, the QOPT = Qopt value is not feasible

Price-Break
Since the feasible solution occurred in the first pricebreak, it means that all the other true Qopt values occur at the beginnings of each price-break interval. Why? Because the total annual cost function is a u shaped function So the candidates for the pricebreaks are 1826, 2500, and 4000 units
0 1826 2500 4000 Order Quantity

Total annual costs

Price-Break

D Q TC = DC + S+ iC Q 2
TC(0-2499)=(10000*1.20)+(10000/1826)*4+(1826/2)(0.02*1.20) = Rs12,043.82 TC(2500-3999)= Rs10,041 TC(4000&more)= Rs9,949.20

SENSITIVITY ANALYSIS
Deviation from EOQ may become inevitable - Truck load requirement - Space in warehouse It will result in increase in cost Sensitivity analysis to be done to estimate increase in cost

VARIABLE LEAD TIME ,DEMAND

ORDER QUANTITY

REORDER POINT QTY

SAFETY STOCK

TIME

SAFETY STOCK
Safety Stock - Stock that is held in excess of expected demand due to variable demand rate and/or lead time. Service Level - Probability that demand will not exceed supply during lead time.

OP for Discrete DDLT Distribution

One of Sharp Retailers inventory items is now being analyzed to determine an appropriate level of safety stock. The manager wants an 80% service level during lead time. The items historical DDLT is: DDLT (units) Occurrences 3 8 4 6 5 4 6 2

OP for Discrete DDLT Distribution

Probability Probability of DDLT (cases) of DDLT DDLT or Less 3 .4 .4 4 .3 .7 5 .2 .9 6 .1 1.0 To provide 80% service level, OP = 5 cases

REORDER POINT
The ROP based on a normal Distribution of lead time demand
Service level Risk of a stockout Probability of no stockout Expected demand 0

ROP
Safety stock z

Quantity

z-scale

SAFETY STOCK VARIABLE DEMAND

Average demand during lead time Standard deviation of Demand During lead time

SAFETY STOCK VARIABLE DEMAND

ROP

Average demand during lead time + z * standard deviation of demand during lead time d

ROP

z * sd( demand during lead time)

sd (demand during lead time ) =

Rules of Thumb in Setting ROP

Set safety stock level at a percentage of EDDLT
ROP = EDDLT + j(EDDLT)

where j is a factor between 0 and 3.

Set safety stock level at square root of

RO OP = EDDLT + EDDLT EDDLT

FIXED PERIOD MODEL

L T

T T

FIXED REORDER CYCLE

D = demand for the year T = Time between orders ( fraction of year) Average inventory = D*T/2 Orders per year = 1/T

Total Inv Cost = CO * (1/T) +(D*T/2) * IC

FIXED PERIOD MODEL

q = Average demand + Safety stock Inventory currently on hand

Q = d(T + L) + Z T + L - I Where : Q = quantitiy to be ordered T = the number of days between reviews L = lead time in days d = forecast average daily demand z = the number of standard deviations for a specified service probabilit y T + L = standard deviation of demand over thereview and lead time I = currentinventory level (includes items on order)

Optional Replenishment System

Maximum Inventory Level, M

q=M-I Actual Inventory Level, I

M
I

Q = minimum acceptable order quantity

If q > Q, order q, otherwise do not order any.

ABC Classification System

Items kept in inventory are not of equal importance in terms of:

Rupees invested profit potential

% of Rs Value 30
0
30

60

A B C

sales or usage volume % of

stock-out penalties
Use

60

So, identify inventory items based on percentage of total consumption, where A items are roughly top 80 %, B items as next 15 %, and the lower 5% are the C items

Inventory Accuracy and Cycle Counting

Inventory accuracy refers to how well the inventory records agree with physical count Cycle Counting is a physical inventory-taking technique in which inventory is counted on a frequent basis rather than once or twice a year

Inventory Counting Systems

Periodic System
Physical count of items made at periodic intervals

Perpetual Inventory System

System that keeps track of removals from inventory continuously, thus monitoring current levels of each item

Inventory Counting Systems

Two-Bin System - Two containers of inventory; reorder when the first is empty Universal Bar Code - Bar code printed on a label that has information about the item to which it is attached
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