Operations Management: Sustainability and Supply Chain Management - Chapter 12 Inventory Management
Operations Management: Sustainability and Supply Chain Management
Chapter 12: Inventory Management
Copyright
© 2023, 2020, 2017 Pearson Education, Inc. All Rights Reserved
Outline
Global Company Profile: Amazon.com
The Importance of Inventory
Managing Inventory
Inventory Models
Inventory Models for Independent Demand
Probabilistic Models and Safety Stock
Single-Period Model
Fixed-Period (P) Systems
Inventory Management at Amazon.com
1. Introduction to Amazon.com
Amazon.com started as a “virtual” retailer with no inventory, warehouses, or overhead.
Current status: Amazon has evolved into a world leader in warehousing and inventory management due to growth.
2. Inventory Management Processes
Each customer order is assigned by computer to one of Amazon's distribution centers.
Use of robots and technology enhances employee productivity:
Average picker's productivity increased from 100 items/hour to 300-400 items/hour.
Items are placed into crates on conveyors, and barcode scanners track each item, scanning them 15 times to virtually eliminate errors.
Once items arrive at a central point, they are boxed and labeled with new barcodes.
Customer orders are typically delivered within 1-2 days, with the expectation of low prices, fast delivery, and error-free fulfillment.
Learning Objectives
By the end of this chapter, students should be able to:
Conduct an A B C analysis
Explain and use cycle counting
Explain and use the Economic Order Quantity (EOQ) model for independent inventory demand
Compute a reorder point and explain safety stock
Apply the production order quantity model
Explain and use the quantity discount model
Understand service levels and probabilistic inventory models
Importance of Inventory
Inventory is one of the most expensive assets for many companies, potentially representing up to 50% of total invested capital.
Less inventory can lower costs but increases chances of stockouts, leading to process stoppages or dissatisfied customers.
More inventory may increase costs but enhances the chances of meeting operational and customer demands.
Functions of Inventory
Enable a selection of goods based on anticipated demand while managing fluctuations.
Decouple various parts of the production process, ensuring smooth operations.
Take advantage of quantity discounts offered by suppliers.
Serve as a hedge against inflation, maintaining purchasing power.
Types of Inventory
Raw Material Inventory
Inventory of purchased items that have not yet undergone processing.
Work-in-Process (WIP)
Inventory that has undergone some transformation but is not yet finished.
Flow time is a key determinant for WIP.
Maintenance, Repair, and Operating (MRO) Inventory
Inventory necessary for ensuring machinery and production processes are functioning efficiently.
Finished Goods Inventory
Completed products that are ready for shipment to customers.
Managing Inventory
Effective managing of inventory includes:
Classification of inventory items via A B C analysis.
Maintenance of accurate inventory records.
A B C Analysis
Definition and Purpose
Inventory classification method dividing inventory into three categories based on annual dollar volume:
Class A: High annual dollar volume items.
Class B: Medium annual dollar volume items.
Class C: Low annual dollar volume items.
The purpose is to focus inventory management efforts on the critical few items instead of the trivial many.
**Calculation
Potential criteria beyond annual dollar volume include:
High shortage or holding costs.
Anticipated engineering changes.
Delivery problems from suppliers.
Quality issues with inventory items.
Policies related to A items may include:
Increased emphasis on supplier development.
Tighter physical inventory control.
More careful demand forecasting.
Record Accuracy
Accurate inventory records are vital for effective inventory management.
Types of systems include:
Periodic Systems: Require regular inventory checks; often use two-bin systems.
Perpetual Inventory Systems: Track receipts and issues continuously; may be semi-automated.
Maintaining precise records about incoming and outgoing inventory is essential for decision making (ordering, scheduling, shipping).
Cycle Counting
Definition: Periodic counting of items to update inventory records.
Utilized frequently with A B C analysis.
Advantages include:
Elimination of shutdowns and interruptions.
Removal of annual inventory adjustments.
Allowing trained personnel to audit inventory accuracy.
Facilitating identification and correction of error causes.
Maintaining accurate inventory records.
Cycle Counting Example
Inventory Breakdown: 5,000 items total; 500 A items, 1,750 B items, 2,750 C items.
Policy: Count all A items monthly, B items quarterly, and C items bi-annually.
Count Rate:
A: 500 items/month = 25 items/day (over 20 working days).
B: 1,750 items/quarter = 29 items/day (over 60 days).
C: 2,750 items/6 months = 23 items/day (over 120 days).
Control of Service Inventories
This area can significantly influence profitability as losses might arise from shrinkage or pilferage.
Key techniques for control:
Selection, training, and discipline of personnel.
Tight control measures for incoming shipments.
Effective management of all outgoing inventory.
Inventory Models
1. Independent vs. Dependent Demand
Independent Demand: The demand for an inventory item does not depend on the demand for other items in stock.
Dependent Demand: The demand for an inventory item relies on the demand for another type of item within inventory.
2. Holding, Ordering, and Setup Costs
Holding Costs: Expenses associated with the storage and maintenance of inventory over time.
Ordering Costs: Costs incurred when placing orders and receiving goods.
Setup Costs: Costs associated with preparing machines or processes for manufacturing an order, often correlated with setup times.
3. Holding Costs Structure
The following table outlines various holding costs associated with inventory management:
Category
Cost % Range
Housing Costs
6% (3 - 10%)
Material Handling Costs
3% (1 - 3.5%)
Labor Cost
3% (3 - 5%)
Investment Costs
11% (6 - 24%)
Pilferage and Obsolescence Costs
3% (2 - 5%)
Overall Carrying Cost
26%
Holding costs are notable in that they can vary significantly based on business sector, geographical location, and current interest rates.
4. Economic Order Quantity (EOQ)
The EOQ model is designed to find the optimal order quantity that minimizes total costs.
Key Assumptions of EOQ Model
Demand is constant, known, and independent.
Lead time is known and fixed.
Receipt of inventory happens instantly and completely.
Quantity discounts are not available.
Only variable costs include setup or ordering and holding.
Stockouts are entirely avoidable.
5. EOQ Calculation Framework
Addressing the minimization of total costs involves the following:
Set the equation for setup or ordering costs.
Determine the equation for holding costs.
Equate setup cost with holding cost.
Solve for the optimal order quantity, Q*.
6. EOQ Parameters
Variables Used
Let:
= Quantity of units per order.
= Optimal number of units per order (EOQ).
= Annual demand in units for each inventory item.
= Setup/ordering cost per order.
= Holding/carrying cost per unit per year.
7. EOQ Example Calculation
Given:
Demand (D) = 1,000 units.
Setup cost (S) = $10 per order.
Holding cost (H) = $0.50 per unit per year.
Determine:
Optimal quantity and total annual costs.
Reorder Points
The reorder point (ROP) determines when new orders should be placed.
The importance of Lead time (L) is to measure the time between placing an order and receiving it.
ROP Calculation Example
Given annual demand (8,000 iPhones), with a 250-working-day year, and a lead time of 3 working days (up to 4).
Production Order Quantity Model
1. Model Characteristics
This model applies when inventory accumulates over time post-order placement.
It is used when production and sale of units occur simultaneously.
Production Model Formula
2. Production Order Example
Given:
D = 1,000 units,
p = 8 units/day,
d = 4 units/day,
S = $10,
H = $0.50 per unit/year.
Quantity Discount Model
1. Understanding the Model
Pricing discounts typically become available when larger quantities are purchased, balancing the lowered product costs against increased holding costs.
2. Discounts Schedule Example
Price Range
Quantity Ordered
Price per Unit
Initial Price
0 to 119
$100
Discount Price 1
120 to 1,499
$98
Discount Price 2
1,500 and over
$96
Probabilistic Models and Safety Stock
These models are utilized when demand is not constant or certain.
Safety stock is employed to maintain service levels and mitigate stockouts, computed as follows:
Annual stockout costs are determined using the formula:
Safety stock of 20 frames results in an ROP of 70 frames when the baseline is 50 units.
Use of Safety Stock Under Variability
When demand fluctuates, use safety stock calculated from average demand and service levels to set reorder points.
Example: If average demand is 350 kits with a service level of 95% and a Z of 1.645, the ROP computed would reflect the added safety stock.
Single-Period Model
This model describes scenarios where only a single order is made for a product, typically with minimal or no value after the sales period ends.
Example:
Average demand for a product, costs, and service levels are calculated to determine optimal stocking levels.
Fixed-Period (P) Systems
1. Model Characteristics
Requires continuous inventory monitoring, engages periodic reviews (P systems), where orders are placed at predetermined times.
2. Practical Implications
These systems may increase the risk of stockouts between review periods, necessitating higher safety stock levels.
Conclusion
Effective inventory management encompasses a diverse range of models and practices tailored to optimize efficiency, minimize costs, and meet customer service commitments while navigating the challenges posed by demand variability and supply issues.