What is Inventory?

Parts and materials Available capacity Human resources

1995 Corel Corp.

1984-1994 T/Maker Co. 1995 Corel Corp.

1984-1994 T/Maker Co.

The Functions of Inventory

To decouple or separate various parts of the production process To provide a stock of goods that will provide a selection for customers To take advantage of quantity discounts To hedge against inflation and upward price changes

Inventory Classifications
Inventory

Process stage

Number & Value

Demand Type

Other

Raw Material WIP & Finished Goods

A Items B Items C Items

Independent Dependent

Maintenance Dependent Operating

Sources of Waste
JIT fights seven types of waste Waste of motion --excessive or unnecessary human activity Waste of waiting --jobs waiting to be processed Waste of inventory --building up unnecessary inventory stocks Waste of conveyance --jobs being unnecessary moved Waste of processing --excessive or unnecessary operations Waste of overproduction --producing more than demanded Waste of correction (defective products) --waste due to scrap, rework, repair, etc.

Disadvantages of Inventory
Higher costs

Ordering (or setup) cost

Costs of processing, clerks wages etc.

Holding (or carrying) cost

Building lease, insurance, opportunity, taxes

etc.

Difficult to control Hides production problems

Holding Costs Breakdown (Approximate Ranges)

Category
Housing costs

Cost as a % of Inventory Value

6% (3 - 10% 3% (1 - 3.5%0 3% (3 - 5%)

Material handling costs

Labor and administration cost Investment costs Pilferage, scrap, and obsolescence

11% (6 - 24%) 3% (2 - 5%)

EOQ Model: Minimize the overall Costs

Cost

Ordering & Setup Costs Curve

Optimal Order Quantity (Q*)

Order Quantity

Inventory Holding Costs

Obsolescence Insurance Extra staffing Interest Pilferage Damage Warehousing Etc.

Ordering Costs & Setup Costs

Order processing Clerical support Clean-up costs Re-tooling costs Relocation or adjustment costs

Underline Decisions Supported by EOQ Models

Objective: Minimizing the total inventory costs How much to order (Economic Order Quantity) When to order? (Reorder Point) How often should we place orders (Ordering Period) Others

How to Take advantage of quantity discount What if the lead time and demand are not constant? Heuristics: Fixed Period Systems

Basic EOQ Model (Constant Demand and Lead Time)

Inventory Level
Optimal Order Quantity (Q*) Reorder Point (ROP) Lead Time Average Inventory (Q*/2)

Time

Derive the EOQ: Finding Q* that Minimizes the Total Costs

Total inventory cost = Order (Setup) cost + Holding cost

D Q TC S H Q 2 To minimize TC, we set the derivative of TC with respect to Q* equal to 0

d (TC ) DS H ( 2 ) 0 dQ Q 2
Thus,

2 DS Q* H

EOQ Model Equations: How much to Order

2 D S = Q* = H D Expected Number of Orders = N = Q*
Optimal Order Quantity

Expected Time Between Orders

=T =

Working Days / Year

D = Demand per year S = Setup (order) cost per order H = Holding (carrying) cost

Reorder Point: When to Order?

When there is lead time between order and delivery, we need to identify the reorder point to avoid out of stock. This provides answer for the second inventory When to order? ROP = (Demand per day)(Lead time for a new order in days) = d L
d= D
Working Days / Year

EOQ Example
Electronic Assembler, Inc. has to order 2920 TX5 circuit boards per year. The ordering cost is $80 per order; and the holding cost per unit per year is $50. The purchase price is $28. The items can be delivered in 5 days. The company would like to reduce its inventory costs by determining the optimal number of circuit boards to obtain per order. The conditions of ordering and inventory handling satisfy the assumptions of the EOQ model. Annual demand D = 2,920 units Daily demand d = 2,920/365=8 units Holding cost H = $50 per unit per year Ordering cost S = $80 per order Purchase price P = $28 per unit Lead time LT = 5 days Answer the following questions with detailed calculations and explanation: 1. Optimal quantity per order (EOQ): 2. Annual total relevant costs (optimal): 3. Annual total costs (optimal): 4. Number of orders per year: 5. Inventory cycle time (Nd=365 working days per year): 6. Reorder Point (ROP):

Production Order Quantity Model

Allows partial receipt of material

Other EOQ assumptions apply

Suited for production environment

Material produced, used immediately Provides production lot size

Lower holding cost than EOQ model

POQ Model
Inventory Level
Optimal Order Quantity (Q*) Reorder Point (ROP) Lead Time

Average Inventory

Time

POQ Model Inventory Levels Inventory Level

Inventory level with no demand Production Portion of Cycle Max. Inventory Q(1- d/p)

Q*

Supply Begins

Supply Ends

Demand portion of cycle with no supply

Time

POQ Model Equations

Optimal Order Quantity = Q* p =

2*D*S d H* 1 p
d p

Maximum inventory level Setup Cost Holding Cost = D Q * S

= Q*

( )

1 -

)
D = Demand per year S = Setup cost H = Holding cost d = Demand per day p = Production per day

= 0.5 * H * Q

( )
1d

Quantity Discount Model

Answers how much to order & when to order Allows quantity discounts

Reduced price when item is purchased in larger quantities Other EOQ assumptions apply

Trade-off is between lower price & increased holding cost

Quantity Discount Model How Much to Order?

Total Cost

Initial Price

Discount 1 Price

Discount 2 Price

Quantity which would be ordered

Lowest cost not in discount range

Quantity to earn Discount 1

Quantity to earn Discount 2

Order Quantity

Probabilistic Models
Allow demand and lead time to vary

Follows normal distribution Other EOQ assumptions apply Service level = 1 - Probability of stockout Higher service level means more safety stock
More safety stock means higher ROP

Consider service level & safety stock

Probabilistic Models When to Order?

Inventory Level
Optimal Order Quantity Reorder Point (ROP) ROP
Frequency

Service Level

P(Stockout)

SS

Safety Stock (SS) Place order

Lead Time

Receive order

Time

ABC Classification: Pareto Principle (Critical few and trivial many)

% Annual $ Usage
100 80 60 40 20 0 0

Class A B C

% $ Vol 80 15 5

% Items 15 30 55

A B
50

C
% of Inventory Items
100

Heuristics: Fixed Period Model

Orders placed at fixed intervals

Inventory brought up to target amount Amount ordered varies Possibility of stockout between intervals Example: P&G representative visits every 2 weeks

No continuous inventory count

Useful when vendors visit routinely

Heuristics: Fixed Period Model

Inventory Level Target maximum

Period

Period

Period

Time

Implementing JIT via Agile Inventory Management

Traditional: inventory exists in case problems arise JIT objective: Eliminate redundant inventory JIT requires

Small lot sizes Low setup time Containers for fixed number of parts

JIT inventory: Minimum inventory to keep system running (lean but agile)

Lowering Inventory Reduces Waste

Work in process inventory level (hides problems) Unreliable Vendors Capacity Imbalances

Scrap

Lowering Inventory Reduces Waste

Reducing inventory reveals problems so they can be solved.

Unreliable Vendors

WIP
Scrap

Capacity Imbalances

To Lower Inventory, Reduce Lot Sizes

Inventory Level
Lot Size 200

Average inventory = 40

Average inventory = 100

Lot Size 80

Average inventory = (Lot size)/2

Time

Which Increases Inventory Costs

Cost

Setup Cost
Smaller Optimal Lot Size Lot Size

Lot Size

Unless Setup Costs are Reduced

Cost

Setup Cost
New optimal lot size Original optimal lot size

Lot Size

Steps to Reduce Setup Time (Honda Assembly Line)

Initial Setup Time Separate setup into preparation, and actual setup, doing as much as possible while the Step 1 machine/process is running (save 30 minutes) Move material closer and improve Step 2 material handling (save 20 minutes) Step 3 Standardize and improve tooling (save 15 minutes)

90 min

60 min

45 min
25 min

Step 4 Step 5

Use one-touch system to eliminate adjustments (save 10 minutes) Training operators and standardizing work procedures (save 2 minutes)

15 min 13 min

Reducing Lot Sizes Increases the Number of Lots

Small lots increase flexibility to meet customer demands Strategies for eliminating waste and for eliminating waiting

Freeze Part of the Schedule

JIT Small Lots
A A B B B C A

Time
Flexibility between Nissan plant and Dealers Five day before delivery: 100% flexibility Four day before: Freeze number of each model Three day before: Freeze change color Two day: Freeze major options One day before: Freeze minor options