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Operations Management > Chapter 9: Inventory Management > Flashcards

Chapter 9: Inventory Management Flashcards

1
Q

Inventory management

A

The planning and controlling of inventories to meet the competitive priorities of the organization

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2
Q

Lot sizing

A

A main part of inventory management

The determination of how frequently and in what quantity to order inventory

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3
Q

Lot size

A

The quantity of an inventory item that management either buys from a supplier or manufactures via internal processes

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4
Q

Level of inventory is determined by

A

Difference between input flow rate and output flow rate (latter both to customers and to scrap)

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5
Q

Pressures that incentivize small inventories

A
  • cost of capital
  • storage and holding costs
  • taxes, insurance, and shrinkage
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6
Q

Inventory holding cost

A

Aka inventory carrying cost

Cost of capital for inventory + variable cost of keeping items on hand (storage, handling, taxes etc…)

Generally stated as % of inventory value

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7
Q

Cost of capital (for inventory)

A

Opportunity cost of investing in inventory relative to the expected return on assets of similar risk

Generally weighted average cost of capital

Usually the largest component of inventory holding cost

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8
Q

Storage and handling Inventory holding costs

A

Incurred when a firm could use the storage space and labor productively in some other way

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9
Q

Forms of shrinkage

A

Pilferage
Obsolescence
Deterioration

If these rates are high a large inventory may be unwise

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10
Q

Pressures that incentivize holding large inventories

A
  • customer service
  • ordering cost
  • setup cost
  • labor and equipment utilization
  • transportation cost
  • payments to suppliers
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11
Q

Ordering cost

A

The cost of preparing a purchase order for a supplier or production order for manufacturing

Same regardless of order size so cost efficient to do large orders

Technologies may reduce these costs

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12
Q

Setup cost

A

Cost involved in changing over a machine or workspace to produce a different item

Again, incentivizes larger production runs for fewer changeovers

Technologies may increase flexibility and lower setup costs

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13
Q

How can holding large inventory increase labor productivity and facility utilization?

A
  • fewer number of set ups (which decrease overall utilization)
  • reduced cost of rescheduling production due to lack of inventory
  • stabilizes output rate for cyclical or seasonal items
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14
Q

Quantity discount

A

Drop in price per unit when order is sufficiently large

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15
Q

What relationship does inventory have with working capital?

A

Because inventory is financed by working capital, increasing inventory increases the need for working capital

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16
Q

Accounting inventory categories

A

Raw materials (RM)
Work-in-process (WIP)
Finished goods (FG)

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17
Q

Independent demand items

A

Items for which demand is influenced by market conditions and is not related to the inventory decisions for any other item held in stock or produced

Finished goods
(Wholesale and retail merchandise, service support inventory, product and replacement part distribution, maintenance repair and operating supplies

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18
Q

MRO supplies

A

Maintenance, repair, and operating supplies

Items that do not become part of the final service or product

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19
Q

Estimating demand for independent demand items

A

Forecasting

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20
Q

Dependent demand items

A

Items whose required quantity varies with the production of other items held in the firms inventory. (Are required as components)

Raw materials
Work in process

Demand is calculated, not forecasted

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21
Q

Operational inventory categories

A

Cycle
Safety stock
Anticipation
Pipeline

Identified conceptually, not physically

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22
Q

Cycle inventory

A

The portion of total inventory that varies directly with lot size

Given:
- lot size varies directly with elapsed time between orders
- the longer between orders the larger the cycle inventory must be

Inventory at it’s highest at the beginning of the interval (when new lot arrives) and lowest at the end (just before new lot arrives)

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23
Q

Calculating average cycle inventory

A

= cycle inventory maximum / 2

(Because minimum is approximately 0 just before new lot arrives)

Formula only exact when demand is constant and uniform

Scrap losses may cause estimating errors

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24
Q

Safety stock inventory

A

Surplus inventory that a company holds to protect against uncertainties in demand, lead time, and supply changes

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25
Q

Anticipation inventlry

A

Inventory used to absorb uneven rates of demand or supply

Often used when there are predictable, seasonal demand patterns (stockpiling during low demand to be ready for high demand)

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26
Q

Pipeline inventory

A

Inventory that is created when an order for an item is issued but not yet received

Because firm needs enough inventory on hand plus in transit to cover lead times for the order

Longer lead times or higher demand create more pipeline inventory

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27
Q

Average pipeline inventory between two stocking points

A

= average demand during lead time = average demand for the item per period * number of periods in the items lead item (time to move between two points)

Note: d (demand) and L (lead time) may not be constant, especially if lot size changes (changes lead time)

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28
Q

Primary inventory reduction lever

A

Tactic that must be used if inventory is to be reduced

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29
Q

Secondary inventory reduction lever

A

A tactic that reduces the penalty cost of applying the primary lever and the need for having inventory in the first place

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30
Q

Inventory reduction tactics: cycle inventory

A

Primary: reduce lot sizes of items moving in the supply chain (may increase set up costs or ordering costs)

Secondary (to manage setup and ordering costs)
- streamline ordering method
- increasing repeatability to eliminate need for changeovers

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31
Q

Repeatability and how to increase it

A

The degree to which the same work can be done again

Increases via: high product demand, use of specialization, devoting resources exclusive to a product, using same parts in many products, use of flexible automation, use of one-worker multiple-machines set up, via group technology

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32
Q

Results of increased repeatability

A

May justify new set up methods, reduced transportation costs, allow for quantity discounts

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33
Q

Inventory reduction tactics: safety stock inventory

A

Primary: place orders closer to time needed (problem if there are any uncertainties)

Secondary levers to address uncertainties:
- improve demand forecasts
- cut lead times of purchased or produced items (local suppliers)
- reduce supply uncertainties (fuller collaboration with suppliers, reduce scrap/rework, preventive maintenance)
- increase reliance on equipment and labor buffers (capacity cushions and cross-trained workers)

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34
Q

Inventory reduction tactics: anticipation inventory

A

Primary lever: matching demand and production.

Secondary levers to even out customer demand:
- add new products with different demand cycles
- provide off season promotional campaigns
- offer seasonal pricing plans

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35
Q

Inventory reduction tactics: pipeline inventory

A

Primary lever: reduce lead time

Secondary levers to help cut lead time:
- source from more responsive suppliers and reliable carriers, improve information sharing
- change Q (lot size) when lead time is dependent on lot size

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36
Q

Questions for each item of inventory

A

1) what degree of control should be imposed?
2) how much to order?
3) when to order?

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37
Q

ABC analysis

A

The process of dividing SKUs into three classes, according to their dollar usage, so that managers can focus on items that have the highest dollar value

Class A = highest dollar value, requires close control
Class B = mid range dollar usage, moderate control
Class C = lowest dollar usage, only loose control necessary

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38
Q

Determining SKU Dollar usage

A

Annual demand rate x cost of SKU = dollar usage

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39
Q

Finding classes for ABC analysis

A

Plot all SKUs on a chart and look for natural changes in the slope. Dividing lines between classes are inexact

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40
Q

Inventory treatment of class A skus

A

Review frequently - need to maintain high turnover so lot size should be reduced if possible

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41
Q

Inventory treatment of class B skus

A

Safety stocks can help provide cost effective coverage

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42
Q

Cycle counting

A

An inventory control methid whereby storeroom personnel physically count a small percentage of the total number of items each day, correcting errors as they are found

43
Q

Inventory holding cost

A

Sum of the cost of capital and the variable costs of keeping items on hand (storage and handling, taxes, insurance, shrinkage)

44
Q

Ordering cost

A

Cost of preparing a purchase order for a supplier or a productions order for the shop

45
Q

Setup cost

A

Cost of changing over a machine to produce a different item

46
Q

Cycle inventory

A

That portion of total inventory that varies directly with lot size

47
Q

Economic order quantity

A

EOQ

The lot size that minimizes total annual cycle-inventory holding and ordering costs

48
Q

Assumptions used in determining EOQ

A
  • demand rate for the item is constant and known with certainty
  • no restraints are placed on the size of each lot
  • only relevant costs are inventory holding costs and fixed costs per lot for ordering or setup
  • decisions for one item can be made independently of other items (not considering advantage from combining orders from same supplier)
  • lead time is constant and known with certainty, and amount received = amount ordered and receipt is all at once
49
Q

When to NOT use EOQ

A
  • using make to order strategy and customer wants entire order at once
  • order size is constrained by capacity limitations
50
Q

When to use modified EOQ

A
  • if significant quantity discounts exist
  • if replenishment is not instantaneous (items must be used or sold as completed without waiting for entire lot)
51
Q

When to use EOQ

A
  • company uses a make to stock strategy and item has stable demand
  • carrying costs per unit and setup and ordering costs are known and relatively stable
52
Q

Annual holding cost for calculating EOQ

A

= average cycle inventory* unit holding cost

(Average cycle inventory = lot size / 2)

53
Q

Annual ordering cost for calculating EOQ

A

= (number of orders/year)* (ordering or setup cost)

Average number of orders per year = annual demand / lot size

54
Q

Total annual cycle - inventory cost for calculating EOQ

A

= annual holding cost + annual ordering or setup cost

= (Lot size/2)unit holding cost for a year + (annual demand/lot size) cost of ordering or setting up one lot

Can be graphed with lot size as independent variable and annual cost as dependent variable

55
Q

Best lot size aka EOQ

A

If graph annual holding cost, annual ordering cost, and total annual cycle inventory cost with lot size as independent variable and annual cost as dependent variable best lot size will be:

Lowest point on total annual cycle inventory cost line, which should be where annual holding cost = annual ordering cost

56
Q

EOQ formula

A

= √((2*annual demand * set up or order cost)/holding cost for one unit for a year)

57
Q

If annual holding cost is greater than annual ordering cost

A

Lot size is too large

58
Q

Time between orders

A

TBO

Average time elapsed between receiving (or placing) replenishment orders of Q units for a particular lot size

Expressed as a fraction of a year

59
Q

Formula for time between orders

A

Lot size/ annual demand

Fraction is portion of a year (multiply by 12 to get % of a month, by 52 to get weeks, by 365 to get days)

60
Q

Sensitivity analysis

A

A technique for systematically changing crucial parameters to determine the effects of a change

In EOQ can change demand, various costs

61
Q

Advantages of reducing setup time and costs

A

Makes small lot production more economical and allows for use of lean systems where less inventory is held

62
Q

Continuous review system

A

Aka Q system, aka Reorder point system (ROP), aka fixed order quantity system

A system designed to track the remaining inventory of a sku each time a withdrawal is made to determine whether it is time to reorder

63
Q

Inventory position

A

IP

Measurement of a SKU’s ability to satisfy future demand

64
Q

Scheduled receipts

A

SR

Orders that have been placed and not yet received (aka open orders)

65
Q

Inventory position equation

A

= on-hand inventory + scheduled receipts - backorders

66
Q

Reorder point

A

R

The predetermined minimum level that an inventory position must reach before a predetermined quantity Q of the SKU is ordered

67
Q

Time between orders in an continuous review system

A

Varies

68
Q

Order quantity in a continuous review system

A

Fixed

69
Q

Reorder point when demand and lead time are constant

A

R= total demand during lead time

No safety stock needed if somehow the supplier always ships total quantities that arrive on time

70
Q

Reorder point when demand is variable

A

Means time between orders will also be variable (TBO)

Orders done when IP falls below R (must consider full inventory position, not just what is on hand)

Safety stock may reduce stockouts/backorders

71
Q

Reorder point with safety stock

A

= (average demand)*(constant lead time) + safety stock

72
Q

Determining level of safety stock

A

Usually a management decision based on customer service levels desires and tolerance for backorders vs inventory holding costs

73
Q

Service level

A

Aka cycle service level

The desired probability of not running out of stock in any one ordering cycle (beginning at time an order is place and ending with the arrival of the stock)

74
Q

Protection interval

A

The period over which safety stock must protect the user from running out of stock

For continuous system protection interval = lead time

75
Q

Probability of running short during the protection interval

A

100 - service level

76
Q

Steps to arrive at a reorder point

A

1) choose appropriate service level policy
2) determine the distribution of demand lead time
3) determine the safety stock and reorder point levels

77
Q

Distribution of demand during lead time

A

Need to know mean and standard deviation.
- how demand during lead times is distributed
- how lead times are distributed
If small variation then safety stock can be small, if large variation safety stock must be larger

78
Q

Average demand during lead time

A

Assuming lead time is constant and average demand for each period is identical and independent of other demands

= Average demand * lead time

79
Q

Standard deviation of distribution during lead time

A

= standard deviation for one period * square root of # of periods in lead time

80
Q

Assumptions when determining safety stock

A

Normally distributed demand during lead time (so can easily calculate probability of stock out for particular reorder point based on average demand)

81
Q

Probability of a stockout using normal distribution

A

Area to the right of the reorder point. (Area below reorder point= likelihood of having stock = service level policy)

82
Q

Safety stock equation

A

= z (number of standard deviations needed to achieve the cycle-service level) * σ (standard deviation during lead time))

85% service level z = 1.04

83
Q

Assumptions when demand and lead time are both variable

A
  • demand distribution and lead time are measured in same time units
  • demand and lead time are independent variables
84
Q

Standard deviation of demand during lead time when demand and lead time are variable

A

= square root of ((average lead time * variance of demand) + (average demand squared * variance of lead time))

Demand period and lead time must be same periods

85
Q

More conservative z value

A

Higher z value

86
Q

Systems based on the continuous review (Q) system

A
  • two bin system
  • base stock system
87
Q

Visual system

A

A system that allows employees to place orders when inventory visibly reaches a certain marker

Used with low value skus that have a steady demand. Overstocking common but inventory holding cost low

88
Q

Two- bin system

A

A visual system version of the continuous review (Q) system in which a SKU’s inventory is stored at two different locations

1st bin used first. When empty, an order needs to be placed but second bin provides stock until replenishment arrives

Normal level of second bin at reorder point r

89
Q

Base stock system

A

An inventory control system that issues a replenishment order (Q) each time a withdrawal is made for the same amount of the withdrawal

One for one replacement policy

Base stock level = reorder point

Used to minimize cycle inventory (more orders placed but each order smaller)

Appropriate for more expensive items

90
Q

Total costs of a continuous review system

A

= annual cycle-inventory holding costs + annual ordering costs + annual safety stock holding costs

= (Lot size/2)* annual holding cost for one unit + (annual demand/lot size)* cost of ordering one lot + (annual holding cost for one unit* safety stock)

91
Q

Advantages of the continuous review (Q) sustem

A
  • review frequency for each SKU may be individualized (can reduce total holding and ordering costs)
  • fixed lot sizes may result in quantity discounts
  • low levels of safety stock required
92
Q

Periodic review (P) system

A

A system in which an item’s inventory position is reviewed periodically rather than continuously

Establishes routine that may simplify delivery scheduling since a new order is always placed at the end of each review. Time between orders is fixed but lot size changes (each time ordered to bring up to target inventory (T))

93
Q

Order quantity in a periodic review system

A

= Target inventory - inventory position

94
Q

Inventory levels under P vs Q systems

A

Generally to gain benefit of periodic ordering (avoiding constant monitoring) a p system requires more inventory than a Q system for the same level of of protection against backorder and stockouts

95
Q

Ways to select time between reviews for a periodic review system

A
  • convenient interval
  • average time between orders for the economic order quantity
  • annual demand / lot size
96
Q

Target inventory when demand is variable and lead time is constant

A

T must be large enough to have inventory position last through the next review/lead time

T= average demand * (period + lead time) + safety stock

97
Q

Protection interval under periodic review system

A

= period + lead time

Because orders are placed at fixed intervals

98
Q

Safety stock required for periodic review inventory system

A

Again assuming normal probability distribution

Z = cycle service level (1- probability of stock out)

= Z* standard deviation of distribution of demand during the protection interval

standard deviation of distribution of demand during the protection interval = standard deviation of demand * square root of (P+ L)

99
Q

Total P system costs

A

Same as Q system

= (Lot size/2)* annual holding cost for one unit + (annual demand/lot size)* cost of ordering one lot + (annual holding cost for one unit* safety stock)

Where lot size = average demand * periods between orders

100
Q

Advantages of P system

A
  • administrative convenience (orders at fixed intervals). Standardized pick up and delivery
  • orders for multiple items from same supplier made on a single purchase order
  • IP only needs to be known when review is made
101
Q

Perpetual inventory system

A

System of inventory control in which the inventory records are always current

102
Q

Inventory systems based on the p system

A

Single-bin system
Optional replenishment system

103
Q

Single bin system

A

A system of inventory control in which a maximum level is marked on the storage shelf or bin and the inventory is brought up to that mark periodically

104
Q

Optional replenishment system

A

Aka: optional review. Min-max, or (s, S) system

System used to review the inventory position at fixed time intervals and, if position has dropped to (or below) a predetermined level, to place a variable sized order to cover expected needs

Orders not automatically placed unless inventory has dropped to predetermined minimum (reorder point R)

Operations Management (11 decks)

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