Inventory Management

Dr. Sri Bramantoro Abdinagoro

Department of Metallurgy and Materials
Faculty of Engineering
Universitas Indonesia

2018
What is Inventory?

•Stock or suppy of goods to match the

future demand
•Purpose of Inventory Management
•How many unit ordered
•When ordered

Copyright 2006 John Wiley & Sons, Inc. 12-2

Kind of Inventory

•Raw Materials
•Parts and supplies
•Work-in-process ; WIP
•The goods to be transfered
•Tools and equipment

Copyright 2006 John Wiley & Sons, Inc. 12-3

Inventory and Supply Chain Management

•Bullwhip effect
•demand information is distorted as it moves
away from the end-use customer
•higher safety stock inventories to are stored to
compensate
•Seasonal or cyclical demand
•Inventory provides independence from
vendors
•Take advantage of price discounts
•Inventory provides independence between
stages and avoids work stop-pages

Copyright 2006 John Wiley & Sons, Inc. 12-4

 Two kind of Demand

Dependent
Demand for items used to produce final
products
Tires stored at a Goodyear plant are an
example of a dependent demand
item
Independent
Demand for items used by external
customers
Cars, appliances, computers, and houses
are examples of independent
demand inventory

Copyright 2006 John Wiley & Sons, Inc. 12-5

Inventory and Quality Management

•Customers usually perceive quality

service as availability of goods they
want when they want them
•Inventory must be sufficient to
provide high-quality customer service
in TQM

Copyright 2006 John Wiley & Sons, Inc. 12-6

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

Copyright 2006 John Wiley & Sons, Inc. 12-7

 Inventory Control Systems

Continuous system (fixed-order-quantity)

constant amount ordered when inventory
declines to predetermined level
Periodic system (fixed-time-period)
order placed for variable amount after fixed
passage of time

Copyright 2006 John Wiley & Sons, Inc. 12-8

 ABC Classification
•Class A
•5 – 15 % of units
•70 – 80 % of value
•Class B
•30 % of units
•15 % of value
•Class C
•50 – 60 % of units
• 5 – 10 % of value
Copyright 2006 John Wiley & Sons, Inc. 12-9
ABC Classification: Example

PART UNIT COST ANNUAL USAGE

1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120

Copyright 2006 John Wiley & Sons, Inc. 12-10

 ABC Classification: Example (cont.)

TOTAL % OF TOTAL % OF TOTAL

PART PART
VALUE UNIT
VALUE COST ANNUAL% CUMMULATIVE
QUANTITY USAGE
9 $30,600 1 35.9 $ 60 6.0 906.0
8 16,000 2 18.7 350 5.0 4011.0
2 14,000 16.4 % OF TOTAL A % OF TOTAL
CLASS 3ITEMS 30 4.0
VALUE 13015.0
QUANTITY
1 5,400 6.3 9.0 24.0
4 4,800 4 5.6 80 6.0 B 6030.0
3 3,900 5 4.6 30 10.0 10040.0
A 9, 8, 2 71.0 15.0
6 3,600
B 6 1, 4, 34.2 20 16.5
18.0 18058.0
25.0
5 3,000 7 6, 5, 3.5 13.0
10 12.5 170 71.0
12.0 C
C 10, 7 60.0
10 2,400 2.8 83.0
8 320 50
7 1,700 2.0 17.0 100.0
9 510 60
$85,400
10 20 120
Example 10.1
Copyright 2006 John Wiley & Sons, Inc. 12-11
 Economic Order Quantity (EOQ) Models

•EOQ
•optimal order quantity that will minimize
total inventory costs
•Basic EOQ model
•Production quantity model

Copyright 2006 John Wiley & Sons, Inc. 12-12

 Assumptions of Basic EOQ Model

• Demand is known with certainty

and is constant over time
• No shortages are allowed
• Lead time for the receipt of orders
is constant
• Order quantity is received all at
once
Copyright 2006 John Wiley & Sons, Inc. 12-13
 Inventory Order Cycle

Order quantity, Q
Demand
rate
Inventory Level

Reorder point, R

0 Lead Lead Time

time time
Order Order Order Order
placed receipt placed receipt

Copyright 2006 John Wiley & Sons, Inc. 12-14

EOQ Cost Model
Co - cost of placing order D - annual demand
Cc - annual per-unit carrying cost Q - order quantity

CoD
Annual ordering cost =
Q
C cQ
Annual carrying cost =
2
CoD C cQ
Total cost = +
Q 2

Copyright 2006 John Wiley & Sons, Inc. 12-15

 EOQ Cost Model

Deriving Qopt Proving equality of

costs at optimal point
CoD C cQ
TC = +
Q 2 CoD C cQ
=
TC CoD Cc Q 2
= 2 +
Q Q 2
2CoD
C0 D Cc Q2 =
Cc
0= 2 +
Q 2
2CoD
2CoD Qopt =
Qopt = Cc
Cc

Copyright 2006 John Wiley & Sons, Inc. 12-16

 EOQ Cost Model (cont.)

Annual
cost ($) Total Cost
Slope = 0
CcQ
Minimum Carrying Cost =
2
total cost

CoD
Ordering Cost = Q

Optimal order Order Quantity, Q

Qopt

Copyright 2006 John Wiley & Sons, Inc. 12-17

 EOQ Example

Cc = $0.75 per yard Co = $150 D = 10,000 yards

2CoD C oD CcQ
Qopt = TCmin = +
Cc Q 2
2(150)(10,000) (150)(10,000) (0.75)(2,000)
Qopt = (0.75) TCmin = 2,000 + 2

Qopt = 2,000 yards TCmin = $750 + $750 = $1,500

Orders per year = D/Qopt Order cycle time = 311 days/(D/Qopt)

= 10,000/2,000 = 311/5
= 5 orders/year = 62.2 store days
Copyright 2006 John Wiley & Sons, Inc. 12-18
Production Quantity Model

•An inventory system in which an order is

received gradually, as inventory is
simultaneously being depleted
•AKA non-instantaneous receipt model
•assumption that Q is received all at once is
relaxed
•p - daily rate at which an order is received
over time, a.k.a. production rate
•d - daily rate at which inventory is demanded
Copyright 2006 John Wiley & Sons, Inc. 12-19
 Production Quantity Model (cont.)

Inventory
level

Maximum
Q(1-d/p) inventory
level

Average
Q inventory
(1-d/p)
2 level

0
Begin End Time
order order
Order
receipt receipt
receipt period

Copyright 2006 John Wiley & Sons, Inc. 12-20

 Production Quantity Model (cont.)

p = production rate d = demand rate

Q
Maximum inventory level = Q - d
p

= Q 1- d 2CoD
p
Qopt = d
Q d Cc 1-
Average inventory level = 1- p
2 p

CoD C cQ d
TC = Q + 2 1- p
 Production Quantity Model: Example

Cc = $0.75 per yard Co = $150 D = 10,000 yards

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

2CoD 2(150)(10,000)
Qopt = = = 2,256.8 yards
Cc 1- d 0.75 1 -
32.2
p 150

CoD CcQ d
TC = Q + 2 1- p = $1,329

Q 2,256.8
Production run = = = 15.05 days per order
p 150
 Production Quantity Model: Example (cont.)

D 10,000
Number of production runs = = = 4.43 runs/year
Q 2,256.8

d 32.2
Maximum inventory level = Q 1 - = 2,256.8 1 -
p 150
= 1,772 yards
 Quantity Discounts

Price per unit decreases as order

quantity increases
C oD CcQ
TC = + + PD
Q 2

where

P = per unit price of the item

D = annual demand
 Quantity Discount Model (cont.)

ORDER SIZE PRICE

0 - 99 $10 TC = ($10 )
100 – 199 8 (d1)
200+ 6 (d2) TC (d1 = $8 )

TC (d2 = $6 )
Inventory cost ($)

Carrying cost

Ordering cost

Q(d1 )Copyright
= 100 2006
Qopt Q(d2 ) = 200
John Wiley & Sons, Inc. 12-25
 Quantity Discount: Example
QUANTITY PRICE
Co = $2,500
1 - 49 $1,400 Cc = $190 per computer
50 - 89 1,100 D = 200
90+ 900

2CoD 2(2500)(200)
Qopt = = = 72.5 PCs
Cc 190

For Q = 72.5 CcQopt

CoD
TC = + + PD = $233,784
Qopt 2

For Q = 90 C cQ
CoD
TC = + + PD = $194,105
Q 2
Copyright 2006 John Wiley & Sons, Inc. 12-26
 Reorder Point

Level of inventory at which a new order is

placed

R = dL
where
d = demand rate per period
L = lead time

Copyright 2006 John Wiley & Sons, Inc. 12-27

 Reorder Point: Example

Demand = 10,000 yards/year

Store open 311 days/year
Daily demand = 10,000 / 311 = 32.154 yards/day
Lead time = L = 10 days

R = dL = (32.154)(10) = 321.54 yards

Copyright 2006 John Wiley & Sons, Inc. 12-28

 Safety Stocks
Safety stock
buffer added to on hand inventory during lead time
Stock-out
an inventory shortage
Service level
probability that the inventory available
during lead time will meet demand

Copyright 2006 John Wiley & Sons, Inc. 12-29

 Variable Demand with
a Reorder Point
Q
Inventory level

Reorder
point, R

0
LT LT
Time

Copyright 2006 John Wiley & Sons, Inc. 12-30

Inventory level Reorder Point with a Safety Stock

Q
Reorder
point, R

Safety Stock
0
LT LT
Time
Copyright 2006 John Wiley & Sons, Inc. 12-31
 Reorder Point With Variable Demand

R = dL + zd L
where
d = average daily demand
L = lead time
d = the standard deviation of daily demand
z = number of standard deviations
corresponding to the service level
probability
zd L = safety stock
Reorder Point for a Service Level

Probability of
meeting demand during
lead time = service level

Probability of
a stockout

Safety stock
zd L

dL R
Demand
Copyright 2006 John Wiley & Sons, Inc. 12-33
 Reorder Point for Variable Demand

The carpet store wants a reorder point with a 95%

service level and a 5% stockout probability
d = 30 yards per day
L = 10 days
d = 5 yards per day

For a 95% service level, z = 1.65

R = dL + z d L Safety stock = z d L
= 30(10) + (1.65)(5)( 10) = (1.65)(5)( 10)
= 326.1 yards = 26.1 yards
 Order Quantity for a Periodic Inventory System

Q = d(tb + L) + zd tb + L - I

where
d = average demand rate
tb = the fixed time between orders
L = lead time
sd = standard deviation of demand
zd tb + L = safety stock
I = inventory level
Fixed-Period Model with Variable Demand

d = 6 bottles per day

sd = 1.2 bottles
tb = 60 days
L = 5 days
I = 8 bottles
z = 1.65 (for a 95% service level)

Q = d(tb + L) + zd tb + L - I
= (6)(60 + 5) + (1.65)(1.2) 60 + 5 - 8
= 397.96 bottles
Questions?