MGMT 3613 Operations Management, Chapter 11 Notes

MGMT 3613 | Operations Management Chapter 11 Notes 1) Define the term inventory and list the major reasons for holding inventory. Ans: Inventory: is a stock or store of goods. - Inventories are a vital part of business. Not only are the necessary for operations, but they also contribute to customer satisfaction. - A typical firm usually has around 30% of it’s current assets and as much as 90% of it’s working capital invested in inventory. - the major source of revenues for retail and wholesale businesses is the sale of merchandise (inventory). Functions of Inventory 1. To meet anticipated customer demand. 2. To smooth production requirements. 3. To decouple operations. 4. To protect against stockouts. 5. To take advantages of order cycles. 6. To hedge against price increases. 7. To permit operations 8. To take advantage of quality discounts. 2) List the requirements for effective inventory management. Ans: to be effective, management must have the following: 1. A system to keep track of the inventory on hand and on order. 2. A reliable forecast of demand that includes an indication of possible forecast error. 3. Knowledge of lead times and lead time variability. 4. Reasonable estimates of inventory holding costs, ordering costs, and shortage costs. 5. A classification system for inventory items. 3) Discuss periodic and perpetual review systems. Ans: Periodic system: a physical count of items in inventory is made at periodic intervals (e.g. weekly, monthly) in order to decide how much to order of each item. - many small retailers use this approach. - an advantage of this type of system is that orders for many items occur at the same time, which can result in economies in processing and shipping orders. - there are also several disadvantages of periodic reviews. One is lack of control between reviews. Another is the need to protect against shortages between review periods by carrying extra stock. Perpetual inventory system: (a.k.a. a continual system) keeps track of removals from inventory on a continuous basis, so the system can provide information on the current level of inventory for each item. When the amount on hand reaches a predetermined minimum, a fixed quantity, q, is ordered. - an advantage of this system is the control provided by the continuous monitoring of inventory withdraws. Another advantage is the fixed-order quantity; management can determine an optimal order quantity. - a disadvantage is the added cost of record keeping. 4) Discuss the objectives of inventory management. Ans: Inventory management has two main concerns. One is the level of customer service, that is, to have the right goods, in sufficient quantities, in the right place, at the right time. The other is the costs of ordering and carrying inventories. - the overall objective of inventory management is to achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds. 5) Describe the A-B-C approach and explain how it is useful. Ans: A-B-C approach: classifies inventory items according to some measure of importance, usually annual dollar value, and then allocates control efforts accordingly. A(important), B (moderately important), and C (least important). - managers use the ABC concept in many different settings to improve operations. One key use occurs in customer service, where a manager can focus attention on the most important aspects of customer service by categorizing different aspects as very important, important, not very important. - ABC concept can also be used toward inventory using cycle counting which is a physical count of items in inventory. 6) Describe the basic EOQ model and its assumptions and solve typical problems. Ans: Economic order quantity (EOQ): EOQ models identify the optimal order quantity by minimizing the sum of certain annual costs that vary with order size. 1. 2. 3. 4. 5. 6. Assumptions of the basic EOQ model: Only one product is involved. Annual demand requirements are known. Demand is spread evenly throughout the year so that the demand rate is reasonable constant. Lead time does not vary. Each order is received in a single delivery. There are no quantity discounts. 7) Describe the economic production quantity model and solve typical problems. Ans: the assumptions of the economic production quantity model (EPQ) are similar to those of the EOQ model, except that instead of orders received in a single delivery, units are received incrementally during production. The assumptions are: 1. Only one item is involved. 2. Annual demand is known. 3. The usage rate is constant. 4. Usage occurs continually, but production occurs periodically. 5. The production rate is constant. 6. Lead time does not vary. 7. There are no quantity discounts. 8) Describe the quantity discount model and solve typical problems. Ans: Quantity discounts: are price reductions for large orders to customers to induce them to buy in large quantities. - if quantity discounts are offered, the buyer must weigh the potential benefits of reduced purchase price and fewer orders that will result from buying in large quantities against the increase in carrying costs caused by higher averages inventories. The buyers goal with quantity discounts is to select the order quantity that will minimize total cost, where total cost is the sum of carrying cost, ordering cost, and purchasing cost. 9) Describe reorder point models and solve typical problems. Ans: Reorder point (ROP): When the quantity on hand of an item drops to this amount, the item is reordered. (Note: in order to know when the reorder point has been reached, a perpetual inventory is required). - there are four determinants of the reorder point quantity: 1. The rate of demand (usually based on a forecast). 2. The lead time. 3. The extent of demand and/or lead time variability. 4. The degree of stockout risk acceptable to management. 10) Describe situations in which the single-period model would be appropriate. Ans: Single-period model: is used to handle ordering of perishables and items that have a limited useful life. - Analysis of single-period situations generally focuses on two costs: shortage and excess. Shortage cost: generally, the unrealized profit per unit excess cost: difference between purchase cost and savage value of items left over At the end of a period.