Fundamentals of Operations

Management

Lecture-24
Inventory Management

Instructor: Sayda Uzma Tahira

Contact Info: [email protected]

University of Central Punjab, Lahore

 Outline
► The Importance of Inventory
► Managing Inventory
► Inventory Models
 Inventory Management at
Amazon.com

► Amazon.com started as a “virtual”

retailer – no inventory, no warehouses,
no overhead; just computers taking
orders to be filled by others
► Growth has forced Amazon.com to
become a world leader in warehousing
and inventory management
 Inventory Management at
Amazon.com
1. Each order is assigned by computer to the
closest distribution center that has the
product(s)
2. A “flow meister” at each distribution center
assigns work crews
3. Lights indicate products that are to be picked
and the light is reset
4. Items are placed in crates on a conveyor, bar
code scanners scan each item 15 times to
virtually eliminate errors
 Inventory Management at
Amazon.com
5. Crates arrive at central point where items
are boxed and labeled with new bar code
6. Gift wrapping is done by hand at 30
packages per hour
7. Completed boxes are packed, taped,
weighed and labeled before leaving
warehouse in a truck
8. Order arrives at customer within 1 - 2 days
 Inventory Management

The objective of inventory

management is to strike a balance
between inventory investment and
customer service
 Importance of Inventory
▶ One of the most expensive assets of
many companies representing as
much as 50% of total invested capital
▶ Operations managers must balance
inventory investment and customer
service
 Functions of Inventory
1. To provide a selection of goods for
anticipated demand and to separate
the firm from fluctuations in demand
2. To decouple or separate various
parts of the production process
3. To take advantage of quantity
discounts
4. To hedge against inflation
 Types of Inventory
▶ Raw material
▶ Purchased but not processed
▶ Work-in-process (WIP)
▶ Undergone some change but not completed
▶ A function of cycle time for a product
▶ Maintenance/repair/operating (MRO)
▶ Necessary to keep machinery and processes
productive
▶ Finished goods
▶ Completed product awaiting shipment
 Managing Inventory

1. How inventory items can be classified

(ABC analysis)
2. How accurate inventory records can
be maintained
 ABC Analysis
▶ Divides inventory into three classes based
on annual dollar volume
▶ Class A - high annual dollar volume
▶ Class B - medium annual dollar volume
▶ Class C - low annual dollar volume
▶ Used to establish policies that focus on the
few critical parts and not the many trivial
ones
 ABC Analysis
ABC Calculation
(1) (2) (3) (4) (5) (6) (7)
PERCENT
OF PERCENT
ITEM NUMBER ANNUAL ANNUAL OF ANNUAL
STOCK OF ITEMS VOLUME UNIT DOLLAR DOLLAR
NUMBER STOCKED (UNITS) x COST = VOLUME VOLUME CLASS
#10286 20% 1,000 $ 90.00 $ 90,000 38.8% A
72%
#11526 500 154.00 77,000 33.2% A
#12760 1,550 17.00 26,350 11.3% B
#10867 30% 350 42.86 15,001 6.4% 23% B
#10500 1,000 12.50 12,500 5.4% B
#12572 600 $ 14.17 $ 8,502 3.7% C
#14075 2,000 .60 1,200 .5% C
#01036 50% 100 8.50 850 .4% 5% C
#01307 1,200 .42 504 .2% C
#10572 250 .60 150 .1% C
8,550 $232,057 100.0%
Percentage of annual dollar usage ABC Analysis
Figure 12.2
A Items
80 –
70 –
60 –
50 –
40 –
30 –
20 – B Items
10 – C Items
0 – | | | | | | | | | |

10 20 30 40 50 60 70 80 90 100
Percentage of inventory items
 ABC Analysis
▶ Other criteria than annual dollar volume
may be used
▶ High shortage or holding cost
▶ Anticipated engineering changes
▶ Delivery problems
▶ Quality problems
 ABC Analysis
▶ Policies employed may include
1. More emphasis on supplier development for
A items
2. Tighter physical inventory control for A items
3. More care in forecasting A items
 Record Accuracy
► Accurate records are a critical
ingredient in production and
inventory systems
► Periodic systems require regular
checks of inventory
► Two-bin system
► Perpetual inventory tracks receipts
and subtractions on a continuing basis
► May be semi-automated
 Record Accuracy

► Incoming and outgoing

record keeping must be
accurate
► Stockrooms should be secure
► Necessary to make precise decisions
about ordering, scheduling, and
shipping
 Cycle Counting
▶ Items are counted and records updated on
a periodic basis
▶ Often used with ABC analysis
▶ Has several advantages
1. Eliminates shutdowns and interruptions
2. Eliminates annual inventory adjustment
3. Trained personnel audit inventory accuracy
4. Allows causes of errors to be identified and
corrected
5. Maintains accurate inventory records
Control of Service Inventories
▶ Can be a critical component
of profitability
▶ Losses may come from
shrinkage or pilferage
▶ Applicable techniques include
1. Good personnel selection, training, and
discipline
2. Tight control of incoming shipments
3. Effective control of all goods leaving facility
 Inventory Models
▶ Independent demand - the demand for
item is independent of the demand for any
other item in inventory
▶ Dependent demand - the demand for
item is dependent upon the demand for
some other item in the inventory
 Inventory Models
▶ Holding costs - the costs of holding or
“carrying” inventory over time
▶ Ordering costs - the costs of placing an
order and receiving goods
▶ Setup costs - cost to prepare a machine
or process for manufacturing an order
▶ May be highly correlated with setup time
 Holding Costs
TABLE 12.1 Determining Inventory Holding Costs
COST (AND RANGE)
AS A PERCENT OF
CATEGORY INVENTORY VALUE
Housing costs (building rent or depreciation, 6% (3 - 10%)
operating costs, taxes, insurance)
Material handling costs (equipment lease or 3% (1 - 3.5%)
depreciation, power, operating cost)
Labor cost (receiving, warehousing, security) 3% (3 - 5%)
Investment costs (borrowing costs, taxes, and 11% (6 - 24%)
insurance on inventory)
Pilferage, space, and obsolescence (much 3% (2 - 5%)
higher in industries undergoing rapid change like
PCs and cell phones)
Overall carrying cost 26%
 Holding Costs
TABLE 12.1 Determining Inventory Holding Costs
COST (AND RANGE)
AS A PERCENT o n OF
ly p e n
deINVENTORYd in g
CATEGORY
y c o n s id er a b VALUE
osts va
ing c(building r r e st r a tes6% . (3 - 10%)
Holdcosts
Housing , and
rent or depreciation,
a t io n in t e
operating
e b u s
costs,in e ss
taxes, , lo c
insurance) s o m e h ig h tech
th e r t ha n 15% , er- 3.5%)
t(1
e r a
Materialehandlingll y g r e
costs a t(equipment lease or g c o st s g r
3%e a
G n m s h a v e h oldin
nd fashion it
depreciation, power, e
operating cost)
a
Labor cost (receiving,
than 4 0%. warehousing, security) 3% (3 - 5%)
Investment costs (borrowing costs, taxes, and 11% (6 - 24%)
insurance on inventory)
Pilferage, space, and obsolescence (much 3% (2 - 5%)
higher in industries undergoing rapid change like
PCs and cell phones)
Overall carrying cost 26%
 Inventory Models for
Independent Demand
Need to determine when and
how much to order

1. Basic economic order quantity

(EOQ) model
2. Production order quantity model
3. Quantity discount model