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Lecture 2 - Inventory Management

The document covers inventory management, detailing its key concepts, types of inventories, and the reasons for maintaining them. It discusses various inventory policies such as (s,S) and (Q,R), and highlights the importance of forecasting demand and managing uncertainties. Additionally, it emphasizes the economic implications of holding costs and the need for strategic ordering to optimize inventory levels.

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6 views32 pages

Lecture 2 - Inventory Management

The document covers inventory management, detailing its key concepts, types of inventories, and the reasons for maintaining them. It discusses various inventory policies such as (s,S) and (Q,R), and highlights the importance of forecasting demand and managing uncertainties. Additionally, it emphasizes the economic implications of holding costs and the need for strategic ordering to optimize inventory levels.

Uploaded by

Everything Mobile
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Inventory Management

Lecture 2
Agenda
• What is inventory Management
• Key Concepts
• Inventory Policies
• Golden Rules
What is Inventory Management?
• Scenario 1 • Scenario 2
• Right Size • Another Branch
• Right Color

RIGHT ITEM RIGHT PLACE

• Scenario 3 • Scenario 4
• Out of stock • Only one pack
• Several weeks to receive shipment

RIGHT TIME RIGHT QUANTITY


What is Inventory Management?

Inventory
management

Item Place Time Quantity


Types of Inventories

Work In Finished Goods


Raw Material
Progress (WIP) (FG)

Maintenance, Repair and Overhaul (MRO)


Types of
Inventories
• Balance sheet of Intel
Types of
Inventories
• Balance sheet of GM Motors
Types of
Inventories
• Balance sheet if Amazon
Types of
Inventories
• Magnitude:
• 560 million products
Reasons for having inventories
• Unexpected change in customer demand
• The presence of many situations of significant uncertainty, e.g.,
delivery times, supplier costs etc.
• Uncertain lead times
• Economies of scale offered by transportation companies
Key Concepts
Key Concepts

Inventory
management

Item Place Time Quantity

Why not Big Inventories?


Key Concepts
• Holding cost: calculated by days
• Storage

• Insurance g cos
t
ldin

Cost ($)
Ho
• Tax

• Maintenance

• Obsolescence

Quantity
Key Concepts
• If the holding costs are so high, why not have no inventories
at all?
Key Concepts
• Production Cost
• Fixed Cost
• Variable Cost

Cost ($)
Productio
n cost

Quantity
Key Concepts
• Economic Order Quantity

o st
o tal c
T
t
cos
Cost ($) ldin
g
Ho
EOQ

Order co
st

Quantity
Economic
Lot Size
Model
• Considers a warehouse facing
constant demand for a single item,
the model assumes the following:
• Demand is constant at a rate of “D”
items per day
• Order quantities are fixed at “Q”
items per order
• A fixed cost “K” is incurred every
time the warehouse places an order
• Holding cost “h” is incurred per unit
held in the inventory per day
• The lead time is zero
• Initial inventory is zero
• The planning horizon in long
(infinite)
Economic Lot Size Model
• Total Inventory Cost

• Total Average cost per unit time

• Order Quantity that minimizes cost


Example
Consider a hardware supply warehouse that is contractually obligated to deliver
1,000 units of a specialized fastener to a local manufacturing company each week.
Each time the warehouse places an order for these items from its supplier, an
ordering and transportation fee of $20 is charged to the warehouse. The
warehouse pays $1.00 for each fastener and charges the local firm $5.00 for each
fastener. Annual holding cost is 25 percent of inventory value. The warehouse
manager would like to know how much to order when inventory gets to zero.

Assume that the plant works for 50 weeks per year.


Demand Uncertainty
• Demand is always uncertain therefore companies make forecasts to
help with planning. The following principles must be remembered for
forecasts:
• The forecast is always wrong
• The longer the planning horizon, the worst is the forecast
• Aggregate forecasts are more accurate (Risk Pooling)
Why a distributor holds inventory
• To satisfy demand occurring during lead times
• To protect against uncertain demand
• To balance annual inventory holding costs and annual fixed costs
Ordering Scenarios
• Single Period Models
• The optimal order quantity is not necessarily equal to the forecast or the
average demand. It depends on the relationship between marginal profit and
marginal loss.
• As the order quantity increases, the average profit increases until a certain
production quantity is reached , after which the profit starts decreasing.
• As we increase the production quantity, the risk – that is the probability of
large losses – always increases. At the same time the probability for large
gains also increases. This is called the risk/reward trade-off
Ordering Scenarios
• Initial inventory
• With every order there will be a fixed cost associated irrespective of the
quantity ordered.
• Whenever inventory level is reviewed, if it is below a certain value, s, an order
is placed to increase the inventory level to S
• This policy is called the (s,S) policy or the min, max policy
Multiple Order Opportunities
• In practical situations a decision maker may order repeatedly at any
time during the year.
• Continuous Review Policy
• Inventory is reviewed continuously, and an order is place when the inventory reaches a
particular level.
• Provides more responsive inventory management
• Inventory policy used is called (Q,R) policy. Where when inventory falls to the level R, an
order for Q units is placed
• Periodic Review Policy
• The inventory is reviewed at regular intervals and an appropriate quantity is ordered
after each review.
Inventory Characterization
• AVG = Average daily demand faced by the distributor
STD = Standard deviation of daily demand faced by the distributor
• L = Replenishment lead time from the supplier to the distributor in
days
• h = Cost of holding one unit of the product for one day at the
distributor
• α = service level. This implies that the probability of stocking out is 1-
α
(Q, R) Policy
• The reorder level (R) consists of
• L x AVG (demand during the lead time)
• z x STD x (safety stock)
(z is a constant referred to as the safety factor)
• The reorder level

• The order Quantity (Q)


Variable Lead times
• The lead time to the warehouse might not be fixed, in that case:

• The demand during the lead time is:

• Safety stock:

• The order quantity is as before.


Service Level Optimization
• The higher the service level, the higher is the inventory level
• For the same inventory level, the longer the lead time, the lower is
the service level
Three bin system
Golden Rules
• Forecast demand is always wrong.
• The longer the forecast horizon, the less accurate is the forecast.
• The higher the granularity is, the less accurate is the forecast.
Summary

Inventory Policies:
(s,S)
(Q,R)
Reorder Point
Safety Stock

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