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Introduction to P/OMIntroduction to Supply Chain ManagementSCM – AcquisitionSCM – MaintainSCM – TransformSCM – DistributeWebster Chapters•Information Technology•Foundations•Demand Management•Supply Management•Inventory Management•Capacity Management•Production Management•Transportation Management•Quality Management

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Production/Operations Management

Dr. Eliot Elfner

St. Norbert College

Spring 2008

SCM – Maintain

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Key issues addressed byphysical supply:

•ACQUIRE –From whom and when should materials be ordered or produced?–What criteria should be used to evaluate suppliers?

•MAINTAIN–How much, when and where should material be stored?

•TRANSFORM–When and how should inputs be converted into outputs

•LOGISTICS–By what transportation mode and particular transport service should materials be transported?

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Inventory

• Stock of items held to meet future demand

• Inventory management answers two questions

– How much to order– When to order

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Types of Inventory

• Raw materials• Purchased parts and supplies• Labor• In-process (partially completed)

products• Component parts• Working capital• Tools, machinery, and equipment• Finished goods

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Reasons To Hold Inventory

• Meet unexpected demand• Smooth seasonal or cyclical

demand• Meet variations in customer

demand• Take advantage of price discounts• Hedge against price

increases• Quantity discounts

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Inventory Costs

• Carrying Cost– cost of holding an item in inventory

• Ordering Cost– cost of replenishing inventory

• Shortage Cost– temporary or permanent loss of

sales when demand cannot be met

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Inventory Costs

• Ordering cost: cost incurred each time an order is placed with a supplier or production is ordered with its own shop.

• Setup costs: cost involved in changing over a machine to produce a different part or item.

• Holding cost: cost associated with maintaining an item in inventory until it is used or sold.

• Stockout or shortage cost: occurs when the demand for an item exceeds its supply.

• Item cost: becomes relevant if a quantity discount is available.

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• Warehouse Space

• Material Handling Costs

• Opportunity Costs

• Insurance - Property and Goods

• Property Taxes

• Administrative Expenses

• Shrinkage and Obsolescence

Inventory Management

Costs of Having an Inventory

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Good inventory management is important to all because..

• Inventories represent a major commitment of monetary resources

• Inventories affect virtually all aspects of a company’s daily operations

• Inventories are a major competitive weapon for many companies

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Types of Inventory Items

• Independent demand items are finished goods or parts that are shipped as end items to customers - EOQ Models

• Dependent demand items are raw materials, component parts, or subassemblies that are used in the production of a finished product - MRP/ERP Models

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Inventories are typically measured in three ways:

Average aggregate inventory value: used to accumulate total value of all items held in inventory on the average, over some time period.

Weeks of supply: computed by dividing average aggregate inventory held, by sales per week at cost.

Inventory turns: computed by dividing annual sales at cost, by average aggregate inventory value maintained during the year.

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Inventory ManagementTypes of Materials to be Managed

• Raw Materials

• Supplies

• Partially Manufactured Goods

• Finished Components for Final Assembly

• Finished Products Ready for Shipment

• Materials in Transit

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Objectives of Inventory Management

• Buffer Internal Routine Activities from Outside Variability

• Never Run Out of Anything• Never Have Much of Anything on Hand• Never Pay More for Material than

Necessary (i.e. - take quantity discounts)

CONFLICTING GOALS

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Prioritizing Inventory Management - ABC Analysis• Based on the Pareto Malfeasance

Curve

• Uses the “80-20” Rule– 80% of the cost of Inventory

Management Will be the Result of 20% of the Items in the Inventory

– Based on Different Valuations of Items in the Inventory

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Prioritizing Inventory Management - ABC Analysis• “A” Items - The Vital Few - 80% of

Inventory Value

– Require extensive Systems of Inventory Management (MRP, JIT, etc.)

• “B” Items - 15 - 20% of Inventory Value

– Often included in the “A” Item Control Systems

• “C” Items - The Trivial Many - The Rest – Control based on never running out

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“C” Item Inventory Control Methods (Simple)

• Inventory Turnover Goals

• Dollar Limits

• Time Limits

• Fixed Ordering Times

• Fixed Ordering Quantities

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Types of InventoryControl Systems

• Continuous review systems(each time a withdrawal is made from inventory, the remaining quantity of the item is reviewed to determine whether an order should be placed)• Periodic review systems(the inventory of an item is reviewed at fixed time intervals, and an order Is placed for the appropriate amount)

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Continuous Review and Periodic Review Systems

Continuous ReviewSystem Advantages

• Lower Safety Stock• Fixed lot sizes may

make it easier to obtain quantity discounts

• Individual review of items is used and this may be very desirable for expensive items

Periodic Review System Advantages

• Less time consuming and expensive to maintain

• Allows combining orders to the same supplier

• Inventory record keeping costs can be reduced

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“B” Level Inventory Management

• Independent vs. Dependent Demand

• Concerned with Questions of “How Much” and “When”

• EOQ, ELS, and Quantity Discount Models

• Concern w/Suboptimization/Releasing Capital

• Safety Stock

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“B” Level Inventory Management

Disadvantages• Cost of Accurate Data• Dynamic Nature of Inventory

Systems• Best suited to “B” Level,

Independent Demand Items• Assumes Constant, Steady Demand• Sub-Optimizes• Other Management Methods

Overlap-MRP

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Inventory Costs

• Ordering cost: cost incurred each time an order is placed with a supplier or production is ordered with its own shop.

• Setup costs: cost involved in changing over a machine to produce a different part or item.

• Holding cost: cost associated with maintaining an item in inventory until it is used or sold.

• Stockout or shortage cost: occurs when the demand for an item exceeds its supply.

• Item cost: becomes relevant if a quantity discount is available.

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Inventory models give answers to two questions:

When should an order be placed or a new lot be manufactured?

ROP

How much should be ordered or purchased?

EOQ/ELS

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Components ofInventory Costs

• Purchase Price

• Inventory Ordering Costs

• Inventory Carrying Costs

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• Insurance

• Interest

• Spoilage

• Obsolescence

• Material Handling

• Etc.

Components of InventoryCarrying Costs

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Inventory Cost Model

• Total Cost = Annual Purchase Costs+ Annual Ordering Costs+ Annual Carrying Costs

• A Function of Ordering Quantity

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Quantitative Model

TC = Total CostsPC = Annual Purchasing CostsOC = Annual Ordering CostsCC = Annual Carrying CostsTC = PC + OC + CC

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Assumptions Of BasicEOQ Model

• Demand is known with certainty

• Demand is relatively constant over time

• No shortages are allowed

• Lead time for the receipt of orders is constant

• The order quantity is received all at once

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The Inventory Order Cycle

Demand rate

0 TimeLead time

Order Placed

Order Received

Inve

nto

ry L

eve

l

Reorder point, ROrder qty, Q

Lead time

Order Placed

Order Received

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EOQ Cost Model

CO - cost of placing order D - annual demand

CC - annual per-unit carrying cost Q - order quantity

Annual ordering cost = COD/Q

Annual carrying cost = CCQ/2

Total cost = COD/Q + CCQ/2

TCCoD

QCcQ

TCQ

CoD

Q

Cc

CoD

Q

Cc

QoptCoDCc

2

2 2

02 2

2

2

2

2

2

min

2

optc

opt

o

c

oopt

c

o

co

QC

Q

DCTC

C

DCQ

C

DCQ

QC

Q

DC

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EOQ Model Cost Curves

Total Cost

Ordering CostCoD/Q

Order QuantityQ

Annualcost ($)

Minimumtotal cost

Optimal order Qopt

Carrying CostCcQ/2

Slope = 0

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EOQ Example

CC = $0.75 per yard CO = $15 D = 10,000 yards

Number of

Order cycl

orders per year =D

Qopt

e time =311

D / Qopt60.2 store days

10 0002 000

5

3115

,,

QoptCoDCc

yards

2

2 150 10 0000 75

2 000

( )( , )( . )

,

TCCoDQopt

CcQoptmin

( )( , ),

( . )( , )

$750 $1,

2

150 10 0002 000

0 75 2 0002

750 500

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EOQ With Noninstantaneous Receipt

Q(1-d/p)

Inventorylevel

(1-d/p)Q2

Time0

Orderreceipt period

BeginOrderreceipt

EndOrderreceipt

Maximuminventory level

Averageinventory level

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EOQ With Noninstantaneous Receipt

Max inv level = Q -Qp

1-dp

Avg inv level =12

1-dp

1-dp

Total carrying cost = 1-dp

1-dp

1-dp

d Q

QQ

CoQ

TCCoD

QCoQ

QoptCoD

Cc

2

2

2

2

p = production rate d = demand rate

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Production Quantity Example

CC = $0.75 per yard CO = $15 D = 10,000 yards

d = 10,000/311 = 32.2 yards per day p = 150 yards per day

QoptCoD

Cc

2

2 150 10 000

0 75

1-dp

1-32.2150

= 2,256.8 yards

( )( , )

.

TCCoD

QCoQ

min

( )( , ), .

( . ) , .

$1,

2

150 10 0002 256 8

0 75 2 256 82

329

1-dp

1-32.2150

Production run = Q/p=2,256.8/150=15.05 yardsNumber of production runs = D/Q=10,000/2,256.8 = 4.43

Max inv level = 1-dp

1-32.2150

Q yards

2 256 8 1722, . ,

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Quantity Discounts

Price per unit decreases as order quantity increases

Order

Size Price

0-99 $10

100-199 $8 (d1)

200+ $6 (d2)

TCCoD

QCoQ

PD

P per unit p

2

rice

D = annual demand

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Economic Order QuantityQuantity Discounts (Solution Procedure)

Step 1: Compute Q for the unit cost associated with each discount category.Step 2: For those Q that are too small to receive the discount price, adjust the order quantity upward to the nearest quantity that will receive the discount price.Step 3: For each order quantity determined in Steps 1 and 2, compute the total annual inventory price using the unit price associated with that quantity. The quantity that yields the lowest total annual inventory cost is the optimal order quantity.

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Quantity Discount Model

Qopt

Carrying cost

Ordering cost

Inve

ntor

y co

st (

$)

Q(d1 ) = 100 Q(d2 ) = 200

TC (d2 = $6 )

TC (d1 = $8 )

TC = ($10 )

Quantity (Q)

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Quantity Discount Example

Order CC = $190 per computer

Size Price CO = $2,500

1-49 $1,400 D = 200

50-89 1,100

90+ 900

QoptCoDCc

2

2 2 500 200190

( , )( )

= 72.5 PCs

TCCoDQopt

CoQopt PDmin

( , )( ).

( )( . )( , )( )

$233,

2

2 500 20072 5

190 72 52

1100 200

784

TCCoD

QCoQ

PD90 22 500 200

90190 90

2900 200

105

( , )( ) ( )( )( )( )

$194, Lowest total cost order quantity

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HOMEWORK

• Read Webster, Chapters 6 & 7

• Problems DUE Tue, 4/15 in class– P. 138, Problems 2, a-e and 3, a-e– P. 140, Problem 14

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Material Requirements Planning (MRP) is a production system that was specifically designed to handle dependent demand inventory items.

Dependent Demand Inventory Control

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MRP

• Computerized inventory control & production planning system

• Schedules component items when they are needed - no earlier and no later

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When to Use MRP

• Dependent and discrete items

• Complex products

• Job shop production

• Assemble-to-order environments

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MRP Inputs & Outputs

Master Production Schedule

MaterialRequirements

Planning

Work Orders Purchase Orders Rescheduling Notices

ProductStructure

File

InventoryMaster

File

Planned Order Releases

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MRP Inputs

• Master production schedule

• Product structure file

• Inventory master file

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Master Production Schedule

• Drives MRP process with a schedule of finished products

• Quantities represent production not demand

• Quantities may consist of a combination of customer orders & demand forecasts

• Quantities represent what needs to be produced, not what can be produced

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Level 0

Level 1

Level 2

Level 3

Product Structure Tree

Clipboard

Rivet (2)

Iron Rod (3 in.)

Spring (1)

Spring Steel (10 in.)

Bottom Clip (1)

Top Clip (1)

Pivot (1)

Sheet Metal (8 in2)

Clip Assembly (10)

Sheet Metal (8 in2)

Board (1)

Pressboard (1)

Finish (2oz.)

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The MRP Matrix

Lot size: LT: PD 1 2 3 4 5 6 7 8 9 10Gross requirementsScheduled receiptsProjected on handNet requirementsPlanned order receiptsPlanned order releases

• Item – name or number identifying scheduled item

• LLC– low-level-code; lowest level at which item

appears in a product structure

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Production Planning and Scheduling Framework

ResourcePlanning

AggregateProductionPlanning

DemandForecasting

Rough-cutCapacityPlanning

Master ProductionSchedule

DetailedCapacityPlanning

MaterialRequirements

Planning

Purchasing Shop-FloorControl

Feedback

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Bill of Material for the Office Chair Example

Level 0

Level 1

Level 2

Back Cushion Seat Cushion Chair Frame Fasteners (8)

Fasteners (3)Wheels (6)Base Unit Adjuster Mechanism

Office Chair

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For all components and subassemblies

MRP systems determine:

• Order Quantities

• Planned order release dates

• Order due dates

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Operation Setback Chart for Economy Office Chair

1 - Way Adjuster Mechanism

Wheels

Base Unit

Fastener - 1 1/4”

Nylon Back Cushion

Nylon Seat Cushion

Economy Chair Frame

Fastener - 1 1/4”

Period 1 Period 2 Period 3 Period 4 Period 5 Period 6 Period 7 Period 8

Economy Office Chair

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POM Tools•Forecasting•Lean Manufacturing•Project Management•Simulation•Statistical Process Control

Issues to be concerned with when using MRP systems:

• Loss of visibility for low level components

• MRP nervousness• Minimum length of the planning

horizon• Freezing the MPS• Lumpiness of demand

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Lot Sizing Procedures

• Lot for Lot• Fixed Order Quantity• Period Order Quantity• Part Period Balancing

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Introduction to P/OMIntroduction to Supply Chain ManagementSCM – AcquisitionSCM – MaintainSCM – TransformSCM – DistributeWebster Chapters•Information Technology•Foundations•Demand Management•Supply Management•Inventory Management•Capacity Management•Production Management•Transportation Management•Quality Management

POM Tools•Forecasting•Lean Manufacturing•Project Management•Simulation•Statistical Process Control

Distribution Requirements Planning

• extends the logic of MRP into the physical distribution system.

• is a mechanism for integrating the physical distribution system with the production planning and scheduling system.

• assists in maintaining distribution inventories in field warehouses, distribution centers, etc., by improving the linkages between marketplace requirements and manufacturing activities.

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Introduction to P/OMIntroduction to Supply Chain ManagementSCM – AcquisitionSCM – MaintainSCM – TransformSCM – DistributeWebster Chapters•Information Technology•Foundations•Demand Management•Supply Management•Inventory Management•Capacity Management•Production Management•Transportation Management•Quality Management

POM Tools•Forecasting•Lean Manufacturing•Project Management•Simulation•Statistical Process Control

Distribution RequirementsPlanning (Con’t)

• helps managers anticipate future requirements and closely match the supply of products to demand, and adjust to changes in the marketplace.

• can yield significant logistics savings through improved planning of transportation, dispatching, etc.

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Introduction to P/OMIntroduction to Supply Chain ManagementSCM – AcquisitionSCM – MaintainSCM – TransformSCM – DistributeWebster Chapters•Information Technology•Foundations•Demand Management•Supply Management•Inventory Management•Capacity Management•Production Management•Transportation Management•Quality Management

POM Tools•Forecasting•Lean Manufacturing•Project Management•Simulation•Statistical Process Control

Distribution Requirements Planning

• Central coordinating role

• Detailed local information

• Critical link between marketplace, demand forecasting, and master production scheduling

• Generates valuable information for the master scheduling process

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Introduction to P/OMIntroduction to Supply Chain ManagementSCM – AcquisitionSCM – MaintainSCM – TransformSCM – DistributeWebster Chapters•Information Technology•Foundations•Demand Management•Supply Management•Inventory Management•Capacity Management•Production Management•Transportation Management•Quality Management

POM Tools•Forecasting•Lean Manufacturing•Project Management•Simulation•Statistical Process Control

DRP in Production Planning and Scheduling

Resource Planning

AggregateProduction Planning

DemandForecasting

Distribution Requirements Planning

MasterProductionScheduling Planned

Shipments

Marketplace(Customersand other demandsources)

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Introduction to P/OMIntroduction to Supply Chain ManagementSCM – AcquisitionSCM – MaintainSCM – TransformSCM – DistributeWebster Chapters•Information Technology•Foundations•Demand Management•Supply Management•Inventory Management•Capacity Management•Production Management•Transportation Management•Quality Management

POM Tools•Forecasting•Lean Manufacturing•Project Management•Simulation•Statistical Process Control

Production/Operations Management

Dr. Eliot Elfner

St. Norbert College

Spring 2008

The End – Maintain