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CHAPTER

Inventory Management

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Objectives
1. Describe theAfter studying this traditional inventory management model. you should chapter, 2. Discuss JIT inventory management. be able to: 3. Explain the theory of constraints, and tell how it can be used to manage inventory.

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Inventory Costs
1. Ordering costs are the costs of placing and receiving an order. 2. Setup costs are the costs of preparing equipment and facilities so they can be used to produce a particular product or component. 3. Carrying costs are the costs of carrying inventory.

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Traditional Reasons for Carrying Inventory

1. To balance ordering or setup costs and carrying costs.

2. To satisfy customer demand.

3. To avoid shutting down manufacturing facilities because of machine failure, defective parts, unavailable parts, or late delivery of parts. 4. To buffer against unreliable production processes. 5. To take advantage of discounts. 6. To hedge against future price increases.

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The Appropriate Inventory Policy

Two Basic Questions Must be Addressed
How much should be ordered or

produced?
When should the order be placed or

the setup be performed?

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The Traditional Inventory Model

Total Costs = Ordering costs + Carrying costs TC = PD/Q + CQ/2
Where TC = The total ordering (or setup) and carrying costs 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 D = The known annual demand C = The cost of carrying one unit of stock for one year

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The Traditional Inventory Model

Economic order = 2PD/C quantity (EOQ) D = 10,000 units Q = 1,000 units P = $25 per order C = $2 per unit

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The Traditional Inventory Model

EOQ = ($2 x $25 x 10,000)/2
EOQ = 250,000

EOQ = 500 units

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Reorder Point
Demand is Certain

Reorder point = Rate of usage x Lead time

Example: The producer uses 50 parts per day and that the lead time is 4 days. Reorder point = 4 x 50 = 200 units Thus, an order should be placed when inventory drops to 200 units.

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Reorder Point
Demand is Certain

Inventory (units) (EOQ) 500

400

300
(ROP) 200 100 2 4 6 8 10 12 Days 14 16 18 20

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Reorder Point
Safety Stock

If the refrigerator part was used at a rate of 60 parts a day instead of 50, the firm would use 200 parts after three and one-third days. The safety stock is determined as follows:
Maximum usage Average usage Difference Lead time Safety stock 60 50 10 x4 40

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Reorder Point
Safety Stock

ROP = (Average rate of usage x Lead time) + Safety stock ROP = (50 x 4) + 40

ROP = 240 units

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A Manufacturing Example
The manager of Benson Company is trying to determine the size of the production runs for the blade fabrication. The controller supplies the following information: Average demand for blades 320 per day Maximum demand for blades 340 per day Annual demand for blades 80,000 Unit carrying cost $5 Setup cost $12,500 Lead time 20 days

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A Manufacturing Example
EOQ =

2PD C 2 x 80,000 x 2,500 5

400,000,000

= 20,000 blades

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A Manufacturing Example
Maximum usage Average usage Difference Lead time Total safety stock 340 320 20 x20 400

Reorder point = (Average usage x Lead time) + Safety stock = (320 x 20) + 400 = 6,800 units

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Traditional Inventory Systems

Push-through system Significant inventories Large supplier base Short-term supplier contracts Departmental structure Specialized labor Centralized services Low employee involvement Supervisory management style Acceptable quality level Driver tracing dominates

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Traditional Manufacturing Layout

Product A Product B Lathes
Department. 1

A B Abrasive Grinders
Department 2

Department 3

Welding B Equipment

Each process passes through departments that specialize in one process.

Finished Product A
Finished Product B

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JIT Inventory Systems

Pull-through system Insignificant inventories Small supplier base Long-term supplier contracts Cellular structure Multiskilled labor Decentralized services High employee involvement Facilitating management style Total quality control Direct tracing dominates

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JIT Inventory Systems

JIT has two strategic objectives:
To increase profits To improve a firms competitive positions

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JIT Manufacturing Layout

Cell A Cell B

Grinder Lathe

Welding Lathe Finished Product Product B

Grinder

Welding Finished Product

Product A

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JIT And Inventory Management

Setup and Carrying Costs: The JIT Approach
JIT reduces the costs of acquiring inventory to insignificant levels by: 1. Drastically reducing setup time 2. Using long-term contracts for outside purchases Carrying costs are reduced to insignificant levels by reducing inventories to insignificant levels

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JIT And Inventory Management

Due Date Performance: The JIT Solution
Lead times are reduced so that the company can meet requested delivery dates and to respond quickly to customer demand.

Lead times are reduced by:

reducing setup times improving quality using cellular manufacturing

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JIT And Inventory Management

Avoidance of Shutdown: The JIT Approach
Total preventive maintenance to reduce machine failures Total quality control to reduce defective parts Cultivation of supplier relationships to ensure availability of quality raw materials and subassemblies The use of the Kanban system is also essential

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What is the Kanban System?

A Card System is used to monitor work-inprocess A withdrawal Kanban
A production Kanban A vendor Kanban

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Withdrawal Kanban
Item No.___________________ 15670T07
Circuit Board Item Name_________________ TR6547 PC Computer Type_____________

_____________ Processing Process _____________ CB Assembly _____________

Subsequent Process 8 Box Capacity_______________ _____________ C Final Assembly Box Type__________________ _____________

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Production Kanban
Item No.___________________ 15670T07
Circuit Board Item Name_________________ TR6547 PC Computer Type_____________ 8 Box Capacity_______________ C Box Type__________________

_____________ Process _____________ CB Assembly

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Vendor Kanban
Item No.___________________ Name of Receiving Co. 15670T08
Computer Casing Item Name_________________ 8 Box Capacity_______________ C Box Type__________________

_____________ Electro PC Receiving Gate

75

Time to Deliver Name of Supplier

8:30 A.M., 12:30 P.M., 2:30 P.M.

Garry Supply

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Kanban Process
(7) Lot with P-Kanban CD Assembly (6) Signal Remove (4) P-Kanban (5) Attach W-Kanban

Withdrawal Store
(1)

(1)

CB Stores
Attach to Post (2), (3) Production Ordering Post

Remove W-Kanban Attach to Post

Withdrawal Post
Final Assembly

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JITs Limitations
Time is required to build sound relationships with suppliers.
Sharp reductions in inventory buffers may cause a regimented workflow and high levels of stress among production workers. The absence of inventory to buffer production interruptions. Current sales are placed at risk to achieve assurance of future sales.

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JIT And Inventory Management

Discounts and Price Increases: JIT Purchasing Versus Holding Inventories
Careful vendor selection
Long-term contracts with vendors Prices are stipulated (usually producing a significant savings) Quality is stipulated

The number of orders placed are reduced

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Theory of Constraints
Three Measures of Organizational Performance
Throughput
Inventory Operating expenses

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Theory of Constraints
Five Steps to Improve Performance 1. Identify the organizations constraint(s). 2. Exploit the binding constraint(s). 3. Subordinate everything else to the decisions made in Step 2. 4. Elevate the binding constraint(s). 5. Repeat the process.

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Drum-Buffer-Rope System
Materials

Initial Process
Rope

Process C

Process A

Final Process

Process B
Time Buffer

Finished Goods

Drummer Process

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Drum-Buffer-Rope System
Confer Company
Rope Time 12 Units Part X Material for 12 Parts per Day (Part X: 6 and Part Y: 6) Grinding Process DRUMMER Drilling Process Polishing Process

Buffer 12 Units Part Y

Finished Goods 6 Units Part X per Day 6 Units Part Y per Day

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Chapter Nineteen

The End

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