INVENTORY MANAGEMENT

RUDI CANDRA S.Ak

Study Objectives

1. Describe the just-in-case inventory management model.

2. Discuss just-in-time (JIT) inventory management.
3. Explain the basic concepts of constrained optimization.
4. Define the theory of constraints and tell how it can be used to
manage inventory.

2
Just-in-Case Inventory Management

Three types of inventory costs can be readily identified with inventory:

• The cost of acquiring inventory.
• The cost of holding inventory.
• The cost of not having inventory on hand when needed.

3
Just-in-Case Inventory Management
Ordering Costs: The costs of placing and receiving an order.
Examples: Clerical costs, documents, insurance for shipment, and unloading.
Setup Costs: The costs of preparing equipment and facilities so they can be used to
produce a particular product or component.
Examples: Setup labor, lost income (from idled facilities), and test runs.
Stock-Out Costs: The costs of not having sufficient inventory.
Examples: Lost sales, costs of expediting (extra setup, transportation, etc.) and the costs of
interrupted production.
Carrying Costs: The costs of carrying inventory.
Examples: Insurance, inventory taxes, obsolescence, opportunity cost of capital tied up in inventory,
and storage.

4
Just-in-Case Inventory Management

5
Just-in-Case Inventory Management
Economic Order Quantity

TC = PD/Q + CQ/2
Where
TC = The total ordering (or setup) and carrying cost
P = The cost of placing and receiving an order (or the cost of setting up a production run)
Q = The number of units ordered each time an order is placed (or the lot size for
production)
D = The known annual demand
C = The cost of carrying one unit of stock for one year

6
Just-in-Case Inventory Management
Economic Order Quantity
Assume
P = $40 per
order
D = 25,000
units
C = $2 per
EOQ =  2DP  C 
unit = (2  25,000  50)  $2
= 1,000,000
= 1,000

7
Just-in-Case Inventory Management
When to Order (Reorder Point)

Reorder Point = Rate of Usage x Lead Time

Example: Assume that the average rate of usage is

100 parts per day. Assume also that the
lead time is 4 days. What is the reorder
point?

Reorder point = rate of usage × lead time

= 4 × 100 = 400 units

An order should be placed when inventory drops to 400 units. 8

Just-in-Case Inventory Management
When to Order (Reorder Point)

When You Order in this

quantity item will be ready on
time when it needed

9
Just-in-Case Inventory Management
Demand Uncertainty
To avoid running out of parts, organizations often choose to carry safety
stock (extra inventory carried to serve as insurance against fluctuations in
demand).

Example:
If the maximum usage of the VCR part is Maximum usage 120
120 units per day, the average usage is Average usage (100)
100 units per day, and the lead time is four Difference 20
days Lead time × 4
Safety stock 80

10
Just-in-Case Inventory Management

11
JIT Inventory Management
Setup and Carrying Costs: The JIT Approach

• JIT reduces the costs of acquiring inventory to insignificant levels by

• Drastically reducing setup time
• Using long-term contracts for outside purchases
• Carrying costs are reduced to insignificant levels by reducing
inventories to insignificant levels.

12
JIT Inventory Management
Avoidance of Shutdown: the JIT approach

• Total preventive maintenance

• to reduce machine failures
• Total quality control
• To reduce defective parts
• The Kanban system
• To control production

13
JIT Inventory Management
Kanban System

• The Kanban system is responsible for ensuring that the necessary

products are produced in the necessary quantities at the necessary
time.
• A card system is used to monitor work in process
• A withdrawal Kanban
• A production Kanban
• A vendor Kanban

14
JIT Inventory Management
Kanban Card

15
JIT Inventory Management
Kanban Process

16
JIT Inventory Management
• Managing discounts and price increases
• Traditional: holding inventories
• JIT: negotiate long-term contracts
• Vendors
• Careful selection; consider more than price
• Close to production facility
• Establish more extensive supplier involvement

17
JIT Inventory Management
JIT Limitations

• Patience in implementation is needed.

• Time is required.
• JIT may cause lost sales and stressed workers.
• Production may be interrupted due to an absence of inventory.

18
Sullivan, Inc., uses 40,000 plastic housing units each year in its production of paper shredders. The cost of
placing an order is $40. The cost of holding one unit of inventory for one year is $5. Currently, Sullivan
places eight orders of 5,000 plastic housing units per year.
1. Compute the annual ordering cost.
2. Compute the annual carrying cost.
3. Compute the cost of Sullivan’s current inventory policy. Is this the minimum cost? Why or why not?
4. Compute the economic order quantity.
5. Compute the ordering and carrying costs for the EOQ.
6. How much money does using the EOQ policy save the company over the policy of purchasing 5,000 plastic
housing units per order?

Bristol Manufacturing produces a component used in its production of clothes dryers. The time to set up and
produce a batch of the components is two days. The average daily usage is 320 components, and the maximum
daily usage is 375 components.
Required:
Compute the reorder point assuming that safety stock is carried by Bristol Manufacturing. How much safety
stock is carried by Bristol?
19
Basic Concepts of Constrained Optimization

Every firm faces limited resources and limited demand for each
product.
• External constraints (e.g., market demand)
• Internal constraints (e.g., machine or labor time availability)
Constrained optimization is choosing the optimal mix given the
constraints faced by the firm.

20
Basic Concepts of Constrained Optimization
Linear Programming

A method that searches among possible solutions until

the optimal solution is identified

Example: The objective function:

Two products, X and Y, provide Z = $300X + $600Y
contribution margins of $300 and
$600, respectively.
The objective is to maximize total
contribution margin.

21
Basic Concepts of Constrained Optimization
Linear Programming

22
Basic Concepts of Constrained Optimization
Linear Programming

Internal constraints: X+Y  80

X+Y  80 X + 3Y  120
X + 3Y  120 2C + Y  90
2C + Y  90 X  60
External constraints:
Y  100
X  60 X  0
Y  100 Y  0

23
Basic Concepts of Constrained Optimization

24
Basic Concepts of Constrained Optimization
Linear Programming

Corner Point X-Value Y-Value Z = $300X + $600Y

A 0 0 $ 0
B 0 40 24,000
C 30 30 27,000
D 45 0 13,500

C is the optimal solution!

25
Theory of Constraints
Measures of Systems Performance
• Throughput*
• The rate at which an organization generates money through sales
• Inventory
• The money the organization spends in turning materials into throughput
• Operating expenses
• The money the organization spends in turning inventories into throughput

*Throughput =
 Var Exp 
Sales - Unit-level
Rev
Time

26
Theory of Constraints
Five-Step Method for Improving Performance
• Identify an organization’s constraints.
• Exploit the binding constraints.
• Subordinate everything else to the decisions made in Step 2.
• Elevate the organization’s binding constraints.
• Repeat the process as a new constraint emerges to limit output.

27
Theory of Constraints

28
Theory of Constraints

29
Theory of Constraints

30
THANK
YOU AND
KEEP
STUDY!