Inventory Control class presentation .pptx

Inventory control class

1. Module 2 Inventory Management P. Acharya 1

2. Inventory Inventory has often been rightly recognised as one of the major impediments to firm’s business growth. In 70’s and 80’s the Ford motor company had 15 times more WIP than that of the Toyota severely impacting its competitive advantage against the later. Ever since, the firms have successfully managed to reduce the inventory carrying costs. Even though total business inventory has gone up with increase in industry business, the increase in inventory carrying cost has reduced Firms’ inventory to sales ratio has fallen over the years. Inventory to sales ratio has gone down from 23% to 14% P. Acharya 2

3. Why we need Inventory Because of demand-supply gap Time factor- Transport/Production/Transit/Distribution . Risk factor – Manufacturer/Distributor/Retailer Uncertainty factor- S trike/Breakdown/Natural calamity Economic factor: Quantity discount/Coordinated replenishment P. Acharya 3

4. Inventory Exists in many form Secondary Vendor Primary Vendor RM Inv. Manufacturer WIP Inv. Distribution Centre Customers FG Inv. 4 P. Acharya

5. Types of Inventory Inventory Types Description Production Inventory Raw materials Component items subassemblies Work-in-process (WIP) Inventory Semifinished goods in the shop floor lying between work centres Finished Goods (FG) Inventory Finished goods coming out of shop floor and going to factory warehouse MRO inventory (Maintenance, Repair and operating supplies) Jigs, fixtures, cutting tools, lubricants etc. 5 P. Acharya

6. Too much-Too Little inventory Too much Inventory Too Little inventory Carrying charges high Too frequent ordering, so order/set up cost high Working capital tied up in inventory Loss of quantity discount High transport costs High stock out rate hence low service level P. Acharya 6

7. Too high Inventory Factor Too Low Inventory High Total Distribution Costs Low High Volume of sales Low High Carrying costs Low Low Procurement costs High Low Stockout costs High Low Profitability Low High Availability Low High Working capital need Low High Volume of production Low P. Acharya 7

8. Inventory Costs Inventory Ordering Costs Inventory Carrying/Holding Costs Inventory Stock out Costs 8 P. Acharya

9. Ordering or Procurement or Set up Cost Costs of Reviewing Cost of Order forms Costs of mailing, postal costs/fax Cost of change of set up Cost of expediting/chasing Order cost decreases with the increase in order quantity 9 P. Acharya

10. Carrying or Holding costs Interest on capital tied up in inventory (opportunity cost) Cost of record keeping Cost of deterioration, obsolescence and pilferage Cost of storage facility, rental costs Cost of insurance, taxes etc. Carrying cost increases with the increase in order quantity. 10 P. Acharya

11. Stock out Costs Customer may wait and be back as and when product is ready Customer may buy an expensive or a cheaper substitute Back ordering Customer may go to a competitor firm Temporary shifting: cost of lost sales Permanent shifting: cost of lost customer Amidst all this, the Cost of loss of Goodwill is difficult to assess. 11 P. Acharya

12. Stock out Costs In case of a producer, stock out costs amounts to the expenses that result from the tearing down of existing production set up to run emergent orders and attendant cost of expediting. Unsatisfied demand leads to immediate cost of backordering or lost sales. Again poor customer service leads to a loss of goodwill. Halt in production due to shortage of stock has costs related to underutilisation of manpower and equipment. 12 P. Acharya

13. Inventory Nomenclature Order Quantity : It is the quantity of items procured in one order Demand rate/ Consumption rate : It is the rate at which inventory is consumed and shown as the – ve slope. Lead Time : The time between the day the order processing begins to the day the item is available on shelf for effective use. 13 P. Acharya

14. Lead Time 14 P. Acharya

15. Safety Stock : The minimum stock which is maintained to take care of the uncertainties in demand and/or lead time Re-Order Point : It is the stock position at which ordering action for a fresh order is initiated Stock Position= Stock on hand + Stock on order – Back order – committed stock 15 P. Acharya

16. Economic Ordering Two questions in inventory management are always critical. They are- 16 P. Acharya When to order ? How much to order ?

17. Assumptions of Simple EOQ Model Demand rate is constant denoted by the – ve slope Lead time is constant or zero. Replenishment is one time and instantaneous No stock out is allowed. Hence no safety stock is required. 17 P. Acharya

18. EOQ Formula where, A= Order cost per order/units D= Annual demand in units v= unit value of the item r= Annual inventory carrying rate Q= Quantity ordered in one order Where, order cost = A.D/Q carrying cost = Q.C/2 = Q.v.r /2 18 P. Acharya

19. P. Acharya 19 LT ROP Q Time Quantity

20. EOQ = At EOQ, order cost OC = carrying cost CC = Thus at EOQ , OC = CC and Total Cost TC = D*v+ (considering the purchase cost) P. Acharya 20

21. Cost Curve 21 P. Acharya

22. Economic Ordering under Quantity Discount Let unit price = v if Q < Q b = v (1-d) if Q ≥ Q b where d is the % of discounts expressed as fraction And Q b is the threshold value at which discount is offered V = Unit price of the item P. Acharya 22

23. STEP-1 Assuming we can avail quantity discount Unit Price = v (1-d) EOQ = If EOQ > Q b , order EOQ units else go to step-2   P. Acharya 23

24. STEP-2 TRC ( Q b ) = AD/ Q b + ( Q b /2) * v (1-d) r + Dv (1-d) --- (1) TRC (Q*) = + Dv ----------- (2) If (1) is greater than (2) then order Q* = units If (2) is greater than (1) then order Q b units   P. Acharya 24

25. Inventory Management Systems Fixed order quantity system Perpetual or continuous review inventory system Two-bin inventory system Fixed order interval system Periodic review inventory system P. Acharya 25

26. Continuous Review Inventory System The stock position is continuously reviewed and replenishment is made when the stock position reaches a pre-determined ROP level. Features are- Variable demand rate Fixed reorder point Fixed order quantity Fixed or variable lead time Variable time between orders P. Acharya 26

27. P. Acharya 27 ROP SS Q LT Time Quantity

28. Important parameters are EOQ, ROP, SS etc. Average Inventory is given by I avg = SS + Q/2 Carried out for A-class items P. Acharya 28

29. P. Acharya 29 Advantages Limitations Less chances of stock out and hence high service level Costly process of controlling inventory Efficient and economic order size Can’t avail quantity discount because of small orders Safety stock needed for lead time period Can’t make Coordinated replenishment Less attention to slow moving items Numerous independent orders can result in high transportation cost Very good for costly A-Class items Suffers from clerical errors ROP, SS, OQ may not be reviewed for years

30. Periodic Review Inventory System The stock position is reviewed at a fixed interval and replenishment is made at the review period by the amount given by- OQ = I max - I RP Features are- Variable demand rate Variable reorder point Variable order quantity Fixed or variable lead time Fixed time between orders (known as RP or Review Period) P. Acharya 30

31. P. Acharya 31 RP RP I max SS

32. P. Acharya 32 Limitations Advantages High chances of stock out and hence low service level Inventory control is cheaper Economic order quantity may not be possible Quantity discount can be availed because of bulk orders High amount of Safety stock needed to avoid stock out Coordinated replenishment is possible for number of items reviewed on the same day Not good for A-Class items Lower transportation cost Works well for B-Class items SS, OQ can be reviewed frequently

33. Inventory Classification Why to classify ? Can we control or manage all? Do we need to manage all? What if we leave out some? How are some different from others? How do we segregate ? Is there any basis? If so what are they?

34. Can we Control/Manage all? There are hundreds of thousands of items in inventory. Managing or controlling all is next to impossible. So there is a need to segregate some that needs to be controlled from all that are there .

35. Do we need to Manage all? Fortunately, not. From many thousands of items only a few need to be seriously controlled Rest do not need that much of attention While some may need no control at all

36. What if we leave out some? How are some different from others? Some are precious, highly valued , or highly critical to production, or getting exhausted quickly, high demand items as compared to others So in other words there are many items which are cheap, easily available or have very little impact in production assembly which can be excluded from close scrutiny.

37. How do we segregate ? Is there any basis? Cost based Criticality based Movement based Demand Variability based

38. Inventory Classification ABC classification: Cost based VED Classification: Criticality based FSN Classification: Movement based XYZ Classification: Demand variability based Combining two or more approaches is key. P. Acharya 38

39. ABC Classification It is a cost based classification. The aim is to separate the ‘vital few’ from ‘many’. The governing criteria is Annual Usage Class of Items Nature of items % of items % of annual usage A Highly Costly 10% 70% B Moderately costly 20% 20% C Cheap 70% 10%

40. Steps in Carrying out an ABC Classification List out items with their annual demand and unit value ( Rs .) Find Annual Usage for each of these items Annual Usage = annual demand × unit value Arrange the items as per descending order of Annual Usage. Find the Cumulative Annual Usage. Select the cut off margins (in %) for the A, B and C category of items from the Cumulative Annual Usage column.

41. Illustrative Case: Example-1 Item Number Annual Demand Unit Cost ( Rs .) Annual Usage( Rs .) 1 200 4 800 2 100 2 200 3 50 120 6000 4 500 3 1500 5 400 0.5 200 6 100 22 2200 7 1000 1 1000 8 150 60 9000 9 40 2.5 100 10 10 30 300

42. Item Number Annual Usage Cumulative Usage % Contribution 8 9000 9000 42.2% A (70.4%) 3 6000 15000 70.4% 6 2200 17200 80.75% B (22.1%) 4 1500 18700 87.8% 7 1000 19700 92.5% 1 800 20500 96.2% C (7.5%) 10 300 20800 97.65% 2 200 21000 98.6% 5 200 21200 99.5% 9 100 21300 100%

43. Pareto Curve

44. Inventory Control System A Class Items Perpetual/ Continuous Inventory Control System (review stock position continually and order when it reaches ROP) B Class Items Periodic Inventory Control System (review stock position once in 2/3 months and order) C Class Items Do we need to control? That’s costlier than the items itself!!

45. VED Classification It is a classification based on criticality in production system Class of Items Nature of items Description Impact V Highly Critical The item for which no replacement is available Production gets halted E Moderately Critical The item for which replacement is available with difficulty Production gets delayed or becomes costlier D Non Critical The item whose replacement is easily available Minimal Impact

46. Combined ABC- VED Classification VA VB VC (Stock anyway) EA EB EC DA (Procure only when required) DB DC Order Quantity Review Period

47. F-S-N Classification F: Fast Moving Items S: Slow Moving Items N: Non-Moving Items

48. XYZ Classification X item – Low Demand variability Y item – Moderate Demand variability Z item – High Demand variability P. Acharya 48

49. XYZ Classification X Y Z Very little variation Some variation The most variation X items are characterised by steady turnover over time. Future demand can be reliably forecast. Although demand for Y items is not steady, variability in demand can be predicted to an extent. This is usually because demand fluctuations are caused by known factors, such as seasonality, product lifecycles, competitor action or economic factors. It's more difficult to forecast demand accurately. Demand for Z items can fluctuate strongly or occur sporadically. There is no trend or predictable causal factors, making reliable demand forecasting almost impossible. P. Acharya 49

50. Items having variable demand and Lead Time When both demand and lead time follow probability distribution function. Let D m = Mean demand = Standard deviation of demand L m = Mean Lead time = Standard deviation of Lead Time X DLT = Mean demand during lead time σ DLT = Standard deviation of demand during lead time  

51. Items having variable demand and variable Lead Time (A-class Items) X DLT = D m * L m σ DLT = Safety Stock = k σ DLT ROP = SS + X DLT = k σ DLT + D m * L m  

52. Cost of stock out S = Estimated cost of stock out Where pi = probability of occurrence of an outcome arising because of a stock out Ci = unit cost to the company for each outcome Then, Q = SQRT(2D(A+S)/ vr ) is Order Quantity with Stock out And, Q* = SQRT(2AD/ vr ) is Order Quantity without Stock out Additional quantity to be procured and kept in stock in the event of stock out is = Q – Q* P. Acharya 52

53. Illustration-1 Modern industries Ltd. has a daily demand of 30 units in the forthcoming year for premium category item. The ordering cost is Rs. 100 per order and the annual inventory carrying rate is 20%. The purchase price per unit is Rs. 50. Assuming uniform rate of demand and constant lead time in all order cycles and an annual working days of 350 in the firm, find out- (a) Number of orders per year (b) Time between successive orders (c) Maximum inventory level (d) If the lead time is 10 days, find the Reorder Point.

54. Illustration-2 The Maxwell manufacturing company purchases 8000 units of a switches each year at a unit price of Rs. 10.00. The order cost per order is Rs. 30.00 and unit holding cost is Rs. 3.00. What are the economic order quantity, the total annual cost and the number of orders to place in one year. What is the consumption during lead time in a no-stockout situation if the lead time is 2 weeks. Suppose the firm decides to change the existing ordering policy by ordering after a review of stock every four weeks, what is the minimum peak inventory level required assuming the present consumption pattern to remain same.

55. Illustration-3 Daily demand of bread packets in Super mart is 100 and the lead time is 3 days. Manager found currently 60 bread packets in the Mart. No back orders presently exist, but the system shows an order in pipeline of 250 packets and the Mart has a policy of shipping 80 bread packets to Narayana Hospital on a priority basis upon any fresh arrival. Should a new order be placed?

56. Illustration-4 The VSM auto manufacturer have an annual demand of Oilring set of 2000 units to be used in engine assembly. The purchase price is quoted as given below- $2/unit for Q < 1000 $1.9/unit for 1000≤ Q < 2000 $1.86/unit for Q ≥ 2000 If order cost is $20/order and annual inventory carrying rate is 16%, Then find out the optimum lot size

57. Illustration-5 i ) Average monthly demand for an item is 160 and its standard deviation 28. The delivery lead time is constant at 6 weeks. The ordering cost per order is Rs.450 and annual carrying rate is 20% on the unit price of Rs. 140. Assuming a 95 % service level for which k = 1.65, compute- a) EOQ, b) Time between orders, c) Safety stock, d) Reorder point, e) Average annual inventory. ii) If the lead time of delivery of the item too becomes variable having a mean lead of 5.3 weeks and SD of 1.94 months, compute the above parameters. Comment on the findings.