Inventory Control

EOQ Assumptions

Known & constant demand

Known & constant lead time
Instantaneous receipt of material
No quantity discounts
Only order (setup) cost & holding cost
No stockouts
 Introduction

Types
1. Raw Materials
2. Bought Out Parts
3. WIP
4. Finished Goods
5. Maintenance repair and operating stores
6. Tools
7. Miscellaneous
 Important terms

Demand
Order Cycle
Lead Time
Safety Stock
Inventory Turnover
Re-Order Level
Reorder Quantity
 Inventory Holding Costs
Reasonably Typical Profile

% of
Category Inventory Value
Housing (building) cost 6%
Material handling costs 3%
Labor cost 3%
Inventory investment costs 11%
Pilferage, scrap, & obsolescence 3%
Total holding cost 26%
 EOQ Model
Annual Cost

Order Quantity
 EOQ Model
Annual Cost

Holding Cost

Order Quantity
 Why Order Cost Decreases

Cost is spread over more units

Example: You need 1000 microwave ovens
1 Order(Rs. 50) 1000 Orders (Postage Rs350)

Purchase Order PurchaseOrder

Purchase Order
PurchaseOrder
Order
Description
Purchase Qty.
Description Qty. Description Qty.
Microwave 1000 Description
Microwave
Description Qty.1
Qty.
Microwave 11
Microwave
Microwave 1
Order
quantity
 EOQ Model
Annual Cost

Holding Cost
Order (Setup) Cost

Order Quantity
 EOQ Model
Annual Cost

Total Cost Curve

Holding Cost
Order (Setup) Cost

Order Quantity
 EOQ Model
Annual Cost

Total Cost Curve

Holding Cost
Order (Setup) Cost

Optimal Order Quantity

Order Quantity (Q*)
 EOQ Formula Derivation
D= Annual demand (units)
Cp = Cost per unit (Rs) Total cost = (Q/2) x I x Cp + Co x (D/Q)
Q= Order quantity (units) inv carry cost order cost
Co = Cost per order (Rs)
I = Holding cost (%) Take the 1st derivative:
Ch = Holding cost (Rs) = I x Cp
d(TC)/d(Q) = (I x Cp) / 2 - (D x Co) / Q

Number of Orders = D / Q To optimize: set d(TC)/d(Q) = 0

Ordering costs = Co x (D / Q)
D Co/ Q = ICp / 2
Average inventory
units = Q / 2 Q/DCo = 2 / ICp
Rs = (Q / 2) x Ch
Q= (DCo x 2 )/ ICp
Cost to carry
average inventory = (Q / 2) x I x Cp Q = sqrt (2DCo / ICp)
= (Q /2) x Ch
Economic Order Quantity

2 D C0
EOQ
Ch
D= Annual demand (units)
Co = Cost per order
Cp = Cost per unit
I = Holding cost (%)
H= Holding cost (Rs.) = I x C
 EOQ Model Equations
2 DS
Optimal Order Quantity Q*
H
D
Expected Number Orders N
Q*
Working Days/Year
Expected Time Between Orders T
N
D D = Demand per year
d S = Setup (order) cost per order
Working Days/Year
H = Holding (carrying) cost
d = Demand per day
ROP d L L = Lead time in days
 EOQ
Example
Youre a buyer for Philips Coffee making
machine.
Philips needs 1000 coffee makers per
year. The cost of each coffee maker is Rs
3000. Ordering cost is Rs500 per order.
Carrying cost is 40% of per unit cost. Lead
time is 5 days. The company is open 365
days/yr.
What is the optimal order quantity & ROP?
 Example

2 D Co
EOQ
Ch
D = 1000
Cp = 3000
Co = Rs. 500
I = 40%
Ch= C x I
Ch = 3000 x 0.4 EOQ = ?
 The Basic EOQ Model To order inventory

Total annual inventory cost is sum of ordering To keep inventory

TC C D C Q
and carrying cost: o
Q
c
2

Try to get this value

Production Order Quantity
Model
Used when inventory builds up
over a period of time after an
order is placed
Used when units are produced
and sold simultaneously
 Production Order Quantity
Model
Part of inventory cycle during
which production (and usage) is
taking place
Inventory level

Demand part of cycle

with no production
Maximum
inventory

t Time

Figure 12.6
 Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days

Annual inventory Holding cost

= (Average inventory level) x
holding cost per unit per year

Annual inventory
= (Maximum inventory level)/2
level

Maximum Total produced during the Total used during the

=
inventory level production run production run
= pt dt
 Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days

Maximum Total produced during the Total used during the

=
inventory level production run production run
= pt dt
However, Q = total produced = pt ; thus t = Q/p

Maximum Q Q d
inventory level =p d =Q 1
p p p

Maximum inventory level Q d

Holding cost = (H) = 1 H
2 2 p
 Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
D = Annual demand

Setup cost = (D/Q)S

Holding cost = 1 HQ[1 - (d/p)]
2
1
(D/Q)S = 2 HQ[1 - (d/p)]

2
2DS
Q =
H[1 - (d/p)]

2DS
Q*p =
H[1 - (d/p)]
 Production Order Quantity
Example
D = 1,000 units p = 8 units per day
S = $10 d = 4 units per day
H = $0.50 per unit per year

2DS
Q* =
H[1 - (d/p)]

2(1,000)(10)
Q* = = 80,000
0.50[1 - (4/8)]

= 282.8 or 283 hubcaps

 Production Order Quantity
Model
Note:
D 1,000
d=4= Number of days the plant is in operation
= 250

When annual data are used the equation becomes

2DS
Q* =
annual demand rate
H 1
annual production rate
 Quantity Discount Models
Reduced prices are often available when
larger quantities are purchased
Trade-off is between reduced product cost and
increased holding cost

Total cost = Setup cost + Holding cost + Product cost

D Q
TC = S+ H + PD
Q 2
 Quantity Discount Models
A typical quantity discount schedule

Discount Discount
Number Discount Quantity Discount (%) Price (P)
1 0 to 999 no discount $5.00
2 1,000 to 1,999 4 $4.80

3 2,000 and over 5 $4.75

Table 12.2
 Quantity Discount Models
Steps in analyzing a quantity discount
1. For each discount, calculate Q*
2. If Q* for a discount doesnt qualify, choose
the smallest possible order size to get the
discount
3. Compute the total cost for each Q* or
adjusted value from Step 2
4. Select the Q* that gives the lowest total
cost
 Quantity Discount Models
Total cost curve for discount 2
Total cost
curve for
discount 1
Total cost $

Total cost curve for discount 3

b
a Q* for discount 2 is below the allowable range at point a and
must be adjusted upward to 1,000 units at point b

1st price 2nd price

break break

0 1,000 2,000
Figure 12.7
Order quantity
 Quantity Discount Example
Calculate Q* for every discount 2DS
Q* =
IP
2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)

2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80)

2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75)
 Quantity Discount Example
Calculate Q* for every discount 2DS
Q* =
IP
2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)

2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80) 1,000 adjusted
2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75) 2,000 adjusted
 The EOQ Model with Shortages

Here, we allow Q being shortage, so that we could borrow or replen

later
Max level of inventory

In the EOQ model wth shortages, the assumption that shortages

cannot exist is relaxed.
Assumed that unmet demand can be backordered with all demand
eventually satisfied.

Shortage
Shortage = S/Q

What we needed

On hand = (Q-S)/Q t1 + t2 = S/Q + (Q-S)/Q31= 1

 The EOQ Model with Shortages

Area = * (S/Q) * S
*base* height = * (Q-S) * (Q-S)/Q
2 = * S 2 /Q
= * (Q-S) /Q
(to p20)
In the EOQ model wth shortages, the assumption that shortages
cannot exist is relaxed.
Assumed that unmet demand can be backordered with all demand
eventually satisfied.

Shortage
Shortage = S/Q

What we needed

On hand = (Q-S)/Q 32
 The EOQ Model with Shortages

Total cost Total shortage costs total carrying costs total ordering cost

S2 (Q S ) 2 D
Total inventory cost : TC Cs Cc Co
2Q 2Q Q

2CoD Cs Cc
Optimal order quantity : Q*
Cc Cs

Cc
Shortage level : S * Q *
Cc Cs

33