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CHAPTER 21 INVENTORY MANAGEMENT: ECONOMIC ORDER QUANTITY, JIT, AND THE THEORY OF CONSTRAINTS QUESTIONS FOR WRITING AND DISCUSSION 1. Ordering costs are the costs of placing and receiving an order. Examples include clerical costs, documents, and unloading. Setup costs are the costs of preparing equipment and facilities so that they can be used for producing a product or component. Ex- amples include wages of idled production workers, lost income, and the costs of test runs. Carrying costs are the costs of carry- ing inventory. Examples include insurance, taxes, handling costs, and the opportunity cost of capital tied up in inventory 2. As ordering costs decrease, fewer and lar- ger orders must be placed. This, in turn, increases the units in inventory and, thus, increases carrying costs. 3. Reasons for carrying inventory: (a) to bal- ance setup and carrying costs; (b) to satisfy customer demand; (c) to avoid shutting down manufacturing facilities; (d) to take ad- vantage of discounts; and (e) to hedge against future price increases. 4. Stock-out costs are the costs of insufficient inventory, e.g., lost sales and interrupted production. 5. Safety stock is simply the difference between maximum demand and average demand, multiplied by the lead time. By re- ordering whenever the inventory level hits the safety-stock point, a company is en- sured of having sufficient inventory on hand to meet demand. 6. The economic order quantity is the amount of inventory that should be ordered at any point in order to minimize the sum of order- ing and carrying costs. 7. JIT minimizes carrying costs by driving in- ventories to insignificant levels. Ordering costs are minimized by entering into long- term contracts with suppliers (or driving setup times to zero). 8. Shutdowns in a JIT environment are avoided by practicing total preventive main- tenance and total quality control and by de- veloping close relationships with suppliers to ensure on-time delivery of materials. Intern- ally, a Kanban system is used to ensure the timely flow of materials and components. 9. The Kanban system is used to ensure that parts or materials are available when needed (just in time). The flow of materials is controlled through the use of markers or cards that signal production of the neces- sary quantities at the necessary time. 10. JIT hedges against future price increases and obtains lower input prices (better usu- ally than quantity discounts) by the use of long-term contractual relationships with sup- pliers. Suppliers are willing to give these breaks so that they can reduce the uncer- tainty in the demand for their products. 11. Constraints represent limited resources or demand. Internal constraints are limiting factors found within the firm. External con- straints are limiting factors imposed on the firm from external sources.
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