Inventory Management

Inventory

A stock of items or materials held to satisfy eventual demand

Components of Inventory

• Raw materials, purchased parts and supplies

• WIP products

• Finished goods

• Rework items

• Tools, machinery and equipment

Anticipation inventory

• used to meet demand forecast

  • seasonality

Safety stock

• used as a buffer to protect against uncertainties

Lot size inventory

• result of batch ordering

Pipeline inventory

• in transit

Hedge inventory

• used to protect against future events 

  • price increase of RM 

Maintenance, Repair, and Operating (MRO) inventory

• used to minimize disruptions to general operations and maintenance

Decoupling

• Work-in-process items waiting for the next step 

Why keep inventory?

• Buffer against expected and unexpected changes 

• Faster customer service 

• Economies of scale (production, purchasing)

• Not to be dependent on suppliers

Cons of having too much inventory

• Cost (ties up working capital, may deteriorate or get stolen)

• Need for storage space 

• Need for labour (material handling, transfer

• Complacency

General objective of inventory management

• to keep enough inventory to meet customer demand and be cost efficient 

Main operational concerns of inventory management

• When to order and how many to order

Inventory Control Systems

• Different ways of determining when and how many to order 

Types of Inventory Control Systems

• Q system - fixed quantity 

• P system - fixed time period

• ABC system

Q System

• Reorder a fixed quantity Q whenever the inventory falls to or below a reorder point R 

• continuous review system

• Time between orders varies

Q system continuous review system

• reviews the inventory each time a withdrawal occurs

P system

• Reorder after a fixed time period P

• Periodic review system 

• Order quantity Q varies

  • Q = (Target inventory level) - (Current inventory level)

P system periodic review system

reviews the inventory periodically 

Comparison of Q and P systems

• Administrative cost: Q > P

• Frequency of record keeping system: Q > P

• Responsiveness to demand: Q>P

• Average inventory level: Q<P

• Ease to combine orders: Q<P

ABC system

• an inventory classification system in which a small percentage of items account for most of the inventory value

• aka A - Level items

A Items Inventory Management Policy

• High priority 

• Tight control with regular review 

• Carefully determined Q, frequent deliveries, continuous review 

• detailed inventory records, updated monthly

B Items Inventory Management Policy

• moderate priority 

• moderate control with regular attention 

• Order quantities or order points reviewed quarterly

• batch updating of inventory records

C Items Inventory Management Policy

• Low priority 

• Simple control

• Large Inventories, visual review

• Simplified counting, annual review

Inventory Management costs

• Ordering (set-up) cost

• Holding (carrying) cost

• Shortage (stockout) cost

Ordering (Setup) cost

• fixed cost incurred whenever a replenishment order is placed, regardless of the quantity 

Types of ordering (set up) costs

• Requisition and purchase ordering

• transportation and shipping

• receiving and storage

• inspection

• accounting and accounting costs

Holding (carrying) cost

• cost to keep one item in inventory for a period of time (usually a year)

• $ per unit per period or % of a unit cost/price

Types of Holding costs

• Utilities

• Interest on loans, depreciation, obsolescence, spoilage

Shortage (stockout) cost

Cost of not being able to meet customer demand

Types of shortage (stockout costs)

• loss of sales

• loss of future sales

• loss of production

• penalties

Backorder

• the order is filled from the next shipment

• result of a stockout

Economic Order Quantity Models

• used to manage anticipation inventory 

• Mathematical model for determining order quantity and when to reorder

Assumptions of the EOQ model

• Demand is independent, known, and constant 

• Supply is certain and received all at once in a batch

• Replenishment lead time is known and constant

• Cost information is fixed and constant

• No shortages and no back orders

Lead time (EOQ)

Time between order placed and order received

Order cycle time formula (EOQ)

# of days in a year / # of orders

Reorder point formula (EOQ)

• R = dL

• average daily demand x lead time

EOQ objective

• to minimize TC

EOQ formula

• EOQ = (2DC0/CH)^(1/2)

Total annual inventory management cost TC (EOQ)

• Annual ordering cost + Annual holding cost 

• Ordering cost x # of orders + Holding cost x average inventory

TC formula (EOQ)

TC = C0(D/Q)+CH(Q/2)

Economic Production Quantity Model

• An order is received gradually, not all at once

• Common when inventory user is also the producer 

• Inventory is depleted while it is being replenished

Order receipt and Production and Usage cycles (EPQ)

• Order receipt and production and usage stage begins when order is placed

• Order receipt ends and production and usage stage shifts to usage stage when max inventory is reached

Total annual inventory cost TC (EPQ)

• Annual Set up cost + Annual holding cost

• Set up cost x # of production runs + holding cost x average inventory

• d = daily demand rate

• p = daily production rate, where p > d

TC formula (EPQ)

TC = (C0(D/Q) + CH(Q/2)(1-d/p)

Optimal production quantity EPQ

EPQ = (2DC0/CH(1-d/p))^1/2

Length of production run formula

Q/p

Max inventory level

Q(1-d/p)

Safety Stock

• Buffer added to on-hand inventory to protect from demand/supply variability during the lead time

EOQ Model and safety stock

• EOQ model considers only anticipation inventory and says nothing about safety stock

General objective of Safety stock

to minimize shortage costs

Methods of Safety stock

1. % of annual demand as safety stock 

2. Satisfy a specified service level

   1. includes demand behaviour and probability of stockout in consideration

Service level

• The probability that the inventory during lead time will meet demand