EIE 4102

OPERATIONS MANAGEMENT AND LOGISTICS

LECTURE TOPIC 6: INVENTORY MANAGEMENT

By: Prof. J. N. Keraita

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 Introduction
 Inventory management refers to the process of ordering, storing,
and using a company’s inventory in an economic way..
 In case of inventory shortage, loss of customer, risk of stopping
in production and loss of image may occur.
 Inventory control systems are the ordering and monitoring
methods used to control the quantity and timing of inventory
transactions.
 The methods used in inventory control systems change from
simple counting, visual inspection and two-bin methods to
electronic data processing systems. 2

 Inventory is one of the most important cost items of

enterprises. Therefore excess inventory is a waste. Refer to lean
manufacturing, JIT etc.
 Relationship to Lean Manufacturing
 Priority planning determines what materials are needed and
when they are needed in order to meet customers’ demands.
 A feasible solution that satisfies a customer’s requirement may
not be good enough.
 We demand a good plan that satisfies customers while
maintaining the lowest possible total cost.
 There are many practical reasons for holding inventory. So
inventory shows that there are problems to be solved for the
enterprises. But inventory can also be considered as the main
problem that hides the problems and hinders recovery.
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 Problems related to production should not be hidden by using

excessive inventory and should be solved as soon as problems
arise.
 Manufacturing Organization (1)
 Manufacturing organization is not the same as plant layout. The
same system can be viewed differently depending on what is being
studied.
The designs of manufacturing organizations for high-mix/low-
volume products and low-mix/high-volume products are different.
 Two Forms: flow shop and job shop
 Flow Shop: machines and operators perform stable, standard,
usually uninterrupted materials management - low-mix/high-
volume product - mass production - products with very similar
design - low or no setups - continuous production
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- material flow is
continuous - produces continuous products such as steel and
chemical.
 Flow shop can also be used for repetitive production which
produces different products with same process.
 Manufacturing Organization (2)
 Job Shop: Equipments are organized by function. Each job, a
certain amount of a product in production, follows a distinct
routing through the shop.
A routing comprises a number of operations. There are setups
between operations.
The process is not continuous, and material flows are sometimes
interrupted. Each job contains a certain quantity of a product.
 Machine utilization in a job shop is lower than that in a flow
shop. Unless the quantity of a product is large enough to support a
specialized facility, continuous production through
5 a flow shop is
impossible.
 Inventory Classes
 Raw Materials
Semi-finished Goods
Finished Goods
 Work-In-Process (WIP)
 Maintenance, Repair, and Operational Supplies (MRO)
Maintenance supplies, spare parts, and consumables used in
the manufacturing process and supporting operations but are
not part of the product.
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 Inventory Functions (1)
 Safety stock - protect against unpredictable events and prevent
disruptions in manufacturing.
 Lot-size Inventory - In order to take advantage of quantity price
discounts, reduce shipping and setup costs, etc, items are purchased
in quantities greater than needed immediately.
De-coupling stock - Inventory between facilities that process
materials at different rates - de-couples facilities to prevent the
disparity in production rates at different facilities from interfering
with any one facility’s production thus increasing the utilization of
facilities.
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 Pipeline Inventory - Inventory to fill the transportation network
and the distribution system including the flow through intermediate
stocking points. Time is needed to move goods from one location to
another, between orders, receiving, stocking etc.
 Inventory Functions (2)
 Transportation Inventory - inventory in transit between
locations - part of pipeline inventory. The only way to reduce
the inventory in transit is to reduce the transit time.
 Anticipation Inventory - Additional inventory above basic
pipeline inventory to cover projected trends of increasing sales,
planned sales promotion programs, seasonal fluctuations, plant shut
downs, and vacations. Anticipation inventory differs from safety
stock in that it is a predictable amount.
Hedge Inventory - Inventory held to protect against future
fluctuations due to a dramatic change in prices, strikes, war,
unsettled government, etc. How does it differ from
8 safety stock.
 ABC Classification Method
 As there are enormous materials in the warehouse, we cannot
manage/pay attention to all the materials in the same way. In
planning, order releasing, receiving, storing, counting, and costing,
we use sophisticated and precise approach for class A materials,
and simpler approach for class C materials.
 Pareto’s Law - a small number of items often dominate the
results achieved
 Offline Lecture
1. All enterprises are pursuing high customer service level, high
operating efficiency, and low inventory cost. However, these
objectives are in conflict. Discuss how each one of them
conflicts the other two.
2. Give the steps in ABC classification. Discuss the control
approaches in the cases A, B and C.

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 Inventory Control Systems
 Inventory control systems are the ordering and monitoring
methods used to control the quantity and timing of inventory
transactions.
 Traditional inventory control systems can be examined under
two groups as “continuous” and “periodic” review systems.
However, there are several hybrid systems that use the features of
both of these systems.
 Today, various production systems such as “material
requirements planning (MRP)” and “just in time” which are
integrated with inventory control systems have become
widespread. 11
 Continuous Review System (1)
 A fixed amount of order is placed when the inventory level falls
to a predetermined level. This amount is calculated by considering
the annual average demand amount, order expenses, and unit price.
The order point is determined by the level of safety stock, usage
speed and the duration of the lead time.
 Therefore, the design of this system requires the determination
of the order quantity (Q) and the re-order point (r).
 These decision variables, should be selected so as to minimize
the total inventory costs.
 The safety stock should also be considered. 12

 The time between the two orders is different depending on the

change in demand. Similarly, the lead time (L) in each cycle is also
different.
Continuous Review System (2)

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 Continuous Review System (3)
 The control is carried out by the eyes, by two-bin methods, by
hand-held records or by the help of a computer.
It is recommended to use this method for inventory items in
group A. Thus, the risk of being under stock is minimized in the
business.
 In a two-bin system, the materials under check are kept in two
boxes, a large quantity and a small quantity one.
At the bottom of the large box, there is a material request form
for ordering material again. It is at this that materials in the small
box start being used. 14

 The small box contains an adequate amount of safety stock

(SS), which will be sufficient until new material orders are
received and in case delivery of the order is delayed or if more
material is used than the estimated.
 Periodic Review System (1)
In periodic review system, the inventory level is controlled at the
beginning or end of predetermined time intervals.
 During this check, the available inventory level is compared
with the predetermined order completion target (R). If the level of
inventory at the time of review I(t) is below the point of re-order
(r), a new order is placed to complete inventory levels to the order
completion level (Q=R-I(t)).

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Periodic Review System (2)

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 Inventory Related Cost Components (1)
In addition to the unit cost (C) associated with the inventory
models, there are three cost components that need be taken into
account.
Inventory Holding Cost (H)
 Inventory holding cost is the sum of the cost of capital plus the
variable costs of keeping items on hand, such as storage and
handling costs and taxes, insurance, and shrinkage costs.
A large part of this cost arises from cost of investment tied to the
inventory. This cost can be considered as the cost of opportunity
loss which is the result of the deprivation of loan interest or other
investments that could have been done with this money.
 Inventory Related Cost Components (2)
Shortage Cost
 Costs that occur when there is no inventory or when the stock is
out of stock.
 In this case the demand will not be met, and there are two
options: Customer demands are subsequently met or loss of sales
occurs when the customer’s demand is not met. These costs are
difficult to estimate, but they do exist.
Order Cost (A)
 The cost of ordering depends on the production or purchase of
the material ordered.
Minimize Inventory Cost
 Material Requirement Planning (MRP) (1)
 MRP is a method that tries to find the most economical answer
to the questions of “when to order” and “how much to order” for
dependent inventory items.
 The MRP determines when and how much a material is needed,
taking into account the bill of materials, inventory, open orders in
the purchasing system and production targets in the main
production program.
 The processes have a time dimension, with this feature, a
production program is prepared for all subparts and purchasing.
 Therefore, MRP can be viewed as a production and purchasing
programming system applied to parts and components purchased or
manufactured with a dependent demand.
 Material Requirement Planning (MRP) (2)
 The three important factors for successful implementation of the
MRP system are:
 Supply sources should be reliable and punctual. Since the
delay allowances are too small, the smallest failure in the supply
can cause the entire production to stop.
 MRP requires a great deal of information and processing
capacity. For this reason, MRP application is not possible
without computer and other information technologies.
 All employees such as operator, analyst, purchasing agent,
planner, quality controller, must be fully trained in the updating
of the system.
 Material Requirement Planning (MRP) (3)
 The MRP system contributes to the provision of effective
inventory management at the following points:
 Inventory investments are kept in a minimum level.
 The MRP system is sensitive to changes.
 MRP creates a forward-looking perspective based on
inventory items.
 Order quantities are determined according to the
requirements.
 It focuses on the timing and complete fulfillment of
requirements.
 Economic Order Quantity (EOQ) Theory
The EOQ formula was created by Ford W. Harris in 1915. Although
it was developed long before MRP logic was invented, it can easily
be incorporated into the overall Material Resource Planning (MRP
II) system. In stable demand cases, EOQ is still frequently used.

 Assumptions
 Economic Order Quantity (EOQ) Variables

Total Cost: Example

(Total Cost) = (Annual Purchasing Cost) + (Annual Ordering
Cost) + (Annual Holding Cost)
 EOQ Example
(Total Cost) = (Annual Purchasing Cost) + (Annual Ordering Cost)
+ (Annual Holding Cost).
 Offline Lecture
The annual demand for a material stocked in an enterprise is 180
units. The cost of ordering the material is T 200 per batch and the
purchasing cost is T 100 per unit. The inventory holding cost is
determined as 20%. Lead time of the product is 1 month. Calculate
the economic order quantity for this material, the order in which it
should be ordered, how many times to order in a year, and the stock
related cost components.

NOTE!!
Check example attached.
 Presented By:
Prof. J. N. Keraita

END!!

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