Supply Chain

Management

STOCK MANAGEMENT
Lecturer:
Wilmer Jorge
INVENTORY PLANNING AND
CONTROL

2
 INTRODUCTION
In manufacturing there is a critical topic: Inventories.

The key point is to reduce the quantity of inventory at all

levels: raw materials and components, through direct
deliveries from the suppliers (directly to the production line);
work in process, through just-in-time techniques or using
small lots; or finished products, using levels of production
very near to the requirements of the market or by sending the
products to customers in a very short period.

3
 SHOULD WE HAVE INVENTORY?
All firms (including JIT operations) keep a supply of inventory for
the following reasons:

1. To maintain independence of operations. A supply of

materials at a work center allows that center flexibility in
operations. For example, because there are costs for making
each new production setup, this inventory allows
management to reduce the number of setups.

Independence of workstations is desirable on assembly lines as

well. The time that it takes to do identical operations will naturally
vary from one unit to the next.

4
 SHOULD WE HAVE INVENTORY?
2. To meet variation in product demand. If the demand for the
product is known precisely, it may be possible (though not
necessarily economical) to produce the product to exactly meet the
demand. Usually, however, demand is not completely
known, and a safety or buffer stock must be maintained to absorb
variation.

3. To allow flexibility in production scheduling. A stock of inventory

relieves the pressure on the production system to get the goods out. This causes
longer lead times, which permit production planning for smoother flow and
lower-cost operation
through larger lot-size production. High setup costs, for example, favor producing
a larger number of units once the setup has been made.

5
 SHOULD WE HAVE INVENTORY?
4. To provide a safeguard for variation in raw material delivery
time. When material is ordered from a vendor, delays can occur for
a variety of reasons: a normal variation in shipping time, a shortage
of material at the vendor’s plant causing backlogs, an unexpected
strike at the vendor’s plant or at one of the shipping companies, a
lost order, or a shipment of incorrect or defective material.

5. To take advantage of economic purchase order size. There

are costs to place an order: labor, phone calls, typing, postage, and
so on. Therefore, the larger each order is, the fewer the orders that
need be written. Also, shipping costs favor larger orders—the larger
the shipment, the lower the per-unit cost.

6
 Fundamentals of Inventory Management

INVENTORY
PLANNING AND
Supply of CONTROL Demand of
products and products and
services services

Matching of the
Resources of difference in time Customers
the operation between the supply of the
and demand of operation
material resources

7
STRUCTURE OF
STOCK MANAGEMENT SYSTEM
• The Stock Management has a great impact on all the functions
of the company, particularly in operations, in the marketing area
and in finance.
• The inventories provide service to customers, which is vital for
the marketing department.
• Finance study the general financial outlook of the organization,
including funds assigned to inventories.
• Any kind of operation needs inventory to assure the feasibility
and viability of a uniform and efficient production flow.

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STRUCTURE OF
STOCK MANAGEMENT SYSTEM
• Companies present objectives in conflict with respect to
inventories.
• Finance generally prefers to keep low inventory to save money
on holding
• Marketing prefers high inventory to support and increase sales.
• The Operations department prefers high inventory to support
long production runs and constant levels of production.
• The Stock Management has to balance these objectives in
conflict and administrate the right levels of inventory according
to the best interests of the company as a whole.

9
STRUCTURE OF
STOCK MANAGEMENT SYSTEM
• So, the objective of Stock Management consists of harmonize
two variables: customer service at a reasonable cost.

10
DEFINITION OF INVENTORY OR STOCK
1. Inventory or Stock is a certain amount of storable resources,
that are not used momentarily, in anticipation to future needs.
2. Inventory or Stock is a provision of items ready to be utilized
with the objective of being:
at the right quantity
at the right moment
at the right place
at the minimum cost

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DEFINITION OF INVENTORY OR STOCK
• These four characteristics define the objective of stock
management.
• The key aspect here is the service level:
– When the customer is serve in a very short time (timely
manner),
– Avoiding shortages or unnecessary quantities,
– Where the customer wants the inventory to be placed:
factory, shop, or somewhere else (right place),
– That maximizes profits (minimum cost).

12
 FUNCTIONS OF THE INVENTORY
• The inventory holding exists for the following reasons:
– Brings the product closer to consumers
• Manufacture is in a specific place and customers are in
all the country or even abroad.
• Solution: wholesalers, warehouses, distributors.
– Absorbs the differences with the real demand
• With sales forecast.
• With production capacity.
– Avoid stockouts
• Lead time of suppliers,
• Manufacturing lead times,
• Lead time on truckload transportation.

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TYPES OF INVENTORY
• It can be classified in:
a) By the Physical Form
b) By the Function
c) By the Nature of Demand

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a) By the Physical Form
• Raw Materials Inventory
• Maintenance, Repair, and Operating Supplies (MRO) Inventory.
• Work-in-Process Inventory
• Finished Products Inventory

15
 Raw Materials
• Raw materials inventory is the total cost of all component
parts currently in stock that have not yet been used
in work-in-process or finished products production.

• There are two subcategories of raw materials, which are:

Direct materials. These are materials incorporated into the
final product. For example, this is the wood used to
manufacture a cabinet.
Indirect materials. These are materials not incorporated into
the final product, but which are consumed during the
production process. For example, this is the lubricant, oils,
rags, light bulbs, and so forth consumed in a typical
manufacturing facility.

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Maintenance, Repair, and Operating Supplies (MRO)

• MRO items are used in production and plant

maintenance and can be items such as maintenance
supplies, spare parts, and consumables used in the
production process. These items can be either valuated
or non valuated and depending on the value of the items,
no physical inventory is performed.
• MRO items include oils, lubricants, gloves, safety
equipment and cleaning products.

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 Work-in-Process
• Material that has entered the production process but is
not yet a finished product. Work in progress (WIP)
therefore refers to all materials and partly finished
products that are at various stages of the production
process. WIP excludes inventory of raw materials at the
start of the production cycle and finished products
inventory at the end of the production cycle.

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 Finished Product
• Materials or products which have received the final
increments of value through manufacturing or
processing operations, and which are being held in
inventory for delivery, sale, or use.
• Completely manufactured products which ready for sale
and delivery to the marketplace.

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 b) By the Function
• Safety Inventory
• Decoupling Inventory
• In-transit Inventory
• Cycle Stock Inventory
• Seasonal Inventory

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 Safety Inventory
• Inventory held as buffer against mismatch between
forecasted and actual consumption or demand, between
expected and actual delivery time, and unforeseen
emergencies. Also called reserve inventory.
 Decoupling Inventory

• Inventory accumulated between two inter-dependent operations as a buffer

against breakdowns or unevenness in machine production rates, thus reducing
the need for output synchronization. Also called intermediate stock.

• A B C

20 units/hour 60 units/hour 40 units/hour

A B C

20 units/hour 60 units/hour 40 units/houir

Bottleneck

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 In-transit Inventory
• En-route goods or materials which are in the ownership of
the firm but in the possession of the carrier.
• Goods that have departed from the dispatch, loading, or
shipping point but have not yet arrived at the receipt,
offloading, or delivery point. Also called in transit inventory
or stock in transit.
 Cycle Stock Inventory
• Cycle stock inventory is the portion of an inventory that the
seller cycles through to satisfy regular sales orders. It is
part of on-hand inventory, which includes all of the items
that a seller has in its possession. For example, a retailer's
on-hand inventory would include the items on store shelves
as well as most of those in a store room or stock area.
Over time, cycle stock inventory refreshes itself, or turns
over, as new items replace older ones that are sold.
 Seasonal Inventory
• Very high inventory levels built up in anticipation of large
seasonal sales.
 c) By the nature of Demand
• Independent Inventory
• Dependant Inventory

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 Independent Demand
• An inventory of an item is said to be falling into the
category of independent demand when the demand for
such an item is not dependant upon the demand for
another item.
• Finished goods Items, which are ordered by External
Customers or manufactured for stock and sale, are
called independent demand items.
• Independent demands for inventories are based on
confirmed Customer orders, forecasts, estimates and
past historical data.
 Dependant Demand
• If the demand for inventory of an item is dependant upon
another item, such demands are categorized as dependant
demand.
• Raw materials and component inventories are dependant upon
the demand for Finished Goods and hence can be called as
Dependant demand inventories.
• Take the example of a Car. The car as finished goods is an
held produced and held in inventory as independent demand
item, while the raw materials and components used in the
manufacture of the Finished Goods - Car derives its demand
from the demand for the Car and hence is characterized as
dependant demand inventory.
 Dependant Demand
• This differentiation is necessary because the inventory
management systems and process are different for both
categories.
COST STRUCTURE

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 COST STRUCTURE
• Four types of costs:
1. Acquisition or Manufacturing Cost
2. Ordering Cost
3. Holding (Carrying) Costs
4. Set up (Production change) costs
5. Shortage Costs

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 1. ACQUISITION OR
MANUFACTURING COST
• This is the cost that comes from purchasing or manufacturing the products.
• The total cost can be expressed as cost per unit multiplied by the quantity
produced.
• Sometimes discount have been applied to the purchaisng cost if enoguh
units are purchased at once.

32
 2. ORDERING COST
• These costs refer to the managerial and clerical costs to
prepare the purchase or production order. Ordering costs
include all the details, such as counting items and calculating
order quantities.
• The costs associated with maintaining the system needed to
track orders are also included in ordering costs.

33
 2. ORDERING COST
• Inventory ordering costs encompass the cost associated with
procuring the inventory, not the purchase cost of materials.
• You need to place purchase orders, so salary of
purchasing staff or replenishment staff that are preparing
and sending orders to suppliers.
• You need to send orders, so all communication cost
(internet, phone, emails) are also included.
• You need to receive materials ordered, so receiving staff
that receive, data entry, handling, unpacking and
inspection is included as well
• You need to pay suppliers, so accounting staff related to
payables are included indeed.

34
 3. HOLDING (CARRYING) COSTS
• This broad category includes the costs for storage, facilities,
handling, insurance, pilferage, breakage, obsolescence,
depreciation, taxes, and the opportunity cost of capital.
Obviously, high holding costs tend to favor low inventory levels
and frequent replenishment.
• You need to purchase inventory, so you may need to borrow
money at a given rate that will not be used for other
investments having a higher return rate. This is the
investment costs.
• You need to store the inventory in a safe place so you need to
rent or own a facility or square meters, storage materials
(shelves, sign, painting…), energy (light, fridge…)) and facility
insurance. This is the warehousing costs.

35
 3. HOLDING (CARRYING) COSTS
• You need bear cost as inventory value may change: you need
inventory insurance (fire, robbery, damage…) and also bear
obsolescence cost or spoilage cost (especially for fresh
food).

36
 4. SET UP (Production change)
costs
• To make each different product involves obtaining the
necessary materials, arranging specific equipment setups,
filling out the required papers, appropriately charging time and
materials, and moving out the previous stock of material.
• If there were no costs or loss of time in changing from one
product to another, many small lots would be produced. This
would reduce inventory levels, with a resulting savings in cost.
One challenge today is to try to reduce these setup costs to
permit smaller lot sizes. (This is the goal of a JIT system).

37
 5. SHORTAGE COSTS
• When the stock of an item is depleted, an order for that item must
either wait until the stock is replenished or be canceled. When the
demand is not met and the order is canceled, this is referred to as a
stock out.
• A backorder is when the order is held and filled at a later date when
the inventory for the item is replenished.
• There is a trade-off between carrying stock to satisfy demand and
the costs resulting from stock outs and backorders. This balance is
sometimes difficult to obtain because it may not be possible to
estimate lost profits, the effects of lost customers, or lateness
penalties.

38
 INVENTORY PROFILE
• An inventory profile is a visual representation of the level of
inventory over time.
• If we have stock for a determined article and we want to follow
the evolution of this stock over time we can show this on a
diagram that contains the following:
 The ordinate axis will represent the quantities of stock.
 The abscissa axis will represent the time, generally expressed
in months.
• We will get the classic diagram of “sawtooth waveform” that
represents the evolution of stock over time.

39
 INVENTORY PROFILE
• On the diagram we can appreciate the development of a
determined stock and we can observe the relationship time-
volume that corresponds to the “fluctuating stock” and the “safety
stock”.
• The fluctuating stock is subject to fluctuations regarding inflows
and outflows of inventory.
• While the safety stock, keeps its a constant volume to anticipate
possible.

40
 Diagram: Inventory Profile

FLUCTUATING STOCK
Units

SAFETY STOCK

Time

41
INVENTORY PROFILE
• In the following figure we can verify that each purchase lot (Q)
must have a determined volume, according to the time in which
the stock will be comsumed (T).
• On the other hand, a lower volume in each purchase or a level
of consumption higher than expected, will lead to the need of
using the units that correspond to the “safety stock”.
• In the following figure, we supposed a quantity of inventory that
would last 6 months, but it only lasted 4 months.

42
 Diagram: Inventory Profile

PLANNED DURATION

REAL DURATION

J F M A M J
SAFETY STOCK

43
 Diagram: Inventory Profile

Q
QM

44
INVENTORY RE-STOCKING
• One of the most important factors to consider when making
decisions is known as: Lead-Time (Tiempo de espera de
suministros o Tiempo de demora de entrega o Tiempo de
abastecimiento o Tiempo de Aprovisionamiento o Adelanto
Temporal), which is the time that elapses from the moment
when you verify the need of the acquisition and the arrival of the
purchased lot at the company warehouse.
• If we need to receive the replenishment at the moment t2, it will
be necessary identity the need of thaty acquisition at the
moment t1.

45
INVENTORY RE-STOCKING
• The lead time (“L” or “d”) will be determined by the sum of time necessary in
the internal procedures and the corresponding normal interval for the
supplier to deliver the product.
• We can observe in the diagram that “M” represents the number of units in
the warehouse at the moment of placing an order.
• We can conclude from the observation of the diagram that an order can be
placed taking as a indicator the level “M” or the moment t1 which for this
particular case will not affect the results.

46
 Diagram. Inventory Re-stocking

SAFETY INVENTORY

L
t1 t2

47
INVENTORY RE-STOCKING
• The fact of taking “M” or t1 as an indicator of the need to place
an order, will depend on the inventory management policies the
company follows.
• In short, the representation in a diagram of the different factors
that predetermine the evolution of stocks follows the following
pattern:

48
 Diagram. Inventory Re-stocking

M QM

T
L

Q = Quantity ordered or purchasing lot

QM = Maximum stock when the replenishment arrives
T = Time where all the quantity ordered is consumed.
L = Lead time
s = Safety stock
M = On-hand inventory at the moment of placing an order
49
INVENTORY RE-STOCKING
• The following figure shows a simplified profile for a specific item
in a sales operation.
• Each time that an order is placed, they ask for Q units.
• The replenishment order arrives instantly.
• The demand for the item is stable and totally predictable with a
rate of D units per month.
• When the demand consumes all the inventory, a replenishment
order arrives instantly with Q units and so on.

50
 Diagram. Inventory Re-stocking

Inventory
Level
Units Stable and Predictable
Demand (D) Slope = rate of demand

Average Inventory= Q/2

Time
Q/D
Instant deliveries with a rate of D/Q per period

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 INVENTORY RE-STOCKING
• Under these conditions:

Q
Average Inventory 
2
Q
Time between orders (TBO) 
D

D
Frequency of deliveries (Nº of Orders) 
Q

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 INVENTORY DECISION-MAKING
To be successful, most businesses other than service businesses
are required to carry inventory. In these businesses, good
management of inventory is essential. The management of
inventory requires a number of decisions. Poor decision making
regarding inventory can cause:

1. Loss of sales because of stock outs.

2. Depending on circumstances, inadequate production for a
period of time.
3. Increases in operating expenses due to unnecessary carrying
costs or loss from discarding obsolete inventory.
4. An increase in the per unit cost of finished goods.

53
INVENTORY DECISION-MAKING
How much to order?: Quantity or volume decision
When should we place the orders?: Decisions on time

• These are the classic questions of inventory management.

• The first question is related to the quantity of the order placed.

• The second question has to do with the right moment to place the
order.

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INVENTORY DECISION-MAKING
What type of inventory control system should we use?: Decision of Control

• With the purpose to assure the right quantity to order at the right
time, we need an inventory control system.
• This system keeps accurate records, it must prepare the orders
when it is required, and must control the inflows and outflows of
inventory.

55
PLANEACIÓN Y
CONTROL DE
INVENTARIOS

56
 STOCK MANAGEMENT Part II
TIME DECISION: When to buy?
PLANEACIÓN Y
CONTROL DE
INVENTARIOS

57
 INVENTORY SYSTEMS
• When we supposed an instant replenishment and a stable and predictable
demand the decision of when to place the order was evident.
• You place the order when the inventory becomes zero.
• The replenishment occurs instantly and we avoid stockouts.
• If the replenishment does not occur immediately, but it happens in a time
between the placement and the reception of the order, the time when we
place the order is calculated as follows:

58
Diagram: The re-order level (ROL) and the re-order point (ROP) can be obtained from
the lead time (L) and the rate of demand.

Inventory
level Demand (D)= 100 units per week

400

300

Re-order level 200

100

Re-order point Lead time (L) Time (weeks)

59
 INVENTORY SYSTEMS
• In this case, the time to deliver the order is two weeks; so, the re-order point
(ROP) is the time in which the inventory becomes zero minus the lead time of
the order.
• This point also can be defined as the level of inventory in which an order has
to be placed to replenish the stock.
• Here, the re-order level (ROL) is 200 units.

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 FIXED-ORDER QUANTITY MODEL
WITH SAFETY STOCK (Q)
• A fixed–order quantity system perpetually monitors the inventory level and
places a new order when stock reaches some level, R. The danger of stock out
in this model occurs only during the lead time, between the time an order is
placed and the time it is received. As shown in the following figure.
• An order is placed when the inventory position drops to the reorder point, R.
During this lead time L , a range of demands is possible. This range is
determined either from an analysis of past demand data or from an estimate
(if past data are not available).
• This system is known as the Q-model.

61
FIXED-ORDER QUANTITY MODEL WITH
SAFETY STOCK (Q)
• In the figure we show how this system works.
• The level of inventory drops on a regular base until reach the re-
order point R, at this moment we place an order with Q units.
• The order arrives later, after the elapsed time L, and then the
replenishment cycle is repeated.
• The Q model is completely determined by two parameters:
Q and R.

62
 Figure. The Q-Model

2 The order is received 4 The order is received

7 The order is received

The order is placed The order is placed The order is placed

1 Q 3 Q 5
R
Q

L L L t

63
FIXED-ORDER QUANTITY MODEL WITH
SAFETY STOCK (Q)
• A term used widely in stock management is the service level,
which is the probability that every single order can be satisfied
with the inventory during the lead time.
• So, a service level of 100% will represent satisfying all the
demand with the inventory.
• The percentage of unfulfilled orcers is equal to 100 minus the
level of service.
• The re-order point is based on the notion of distribution of
probability during the lead time.
• When the order is placed, the inventory system is exposed to
stockouts to happen until the order is received.

64
FIXED-ORDER QUANTITY MODEL WITH
SAFETY STOCK (Q)
• As the re-order point is usually higher than zero, it is reasonable
to suppose that the system will not run out of material unless an
order is placed; the only one risk to inccur in stockout occurs
during the lead time where the materials/products are
replenished.
• The figure shows a typical distribution of probability of an
independent demand during the lead time.
• In this figure, the re-order point can be set at a level high
enough to reduce the probability of stockout to at any desire
level.

65
 Figure. Level of Service

m
Frequency Level of P (run out of
service
Inventory level stock)
Optimun
Optimal
quantity to
Order
order(Q*) X
Quantity S

Re-order ROP (R)

Reorder
point
Point
(ROP)
(ROP)

Safety Stock (S)

Order place Order received Time
Lead time

66
FIXED-ORDER QUANTITY MODEL WITH
SAFETY STOCK (Q)
• However, when we calculate this probability, it is necessary to
know the statistical distribution of the demand durign the lead
time.
• We will suppose that the demand is normally distributed.
• This assumption is very realistic for many problems of
inventory with independent demand.

67
FIXED-ORDER QUANTITY MODEL WITH
SAFETY STOCK (Q)
• The re-order point is defined as follows

R  m s
R = Re-order point
m = Demand or consumption during the lead time.
s = Safety stock

• We can determine the value of m as follows:

m  dL
d = Average daily demand
L = Lead time
FIXED-ORDER QUANTITY MODEL WITH
SAFETY STOCK (Q)
• We can express the safety stock as follows:

s  zK σ L
z = Number of standard deviations for a specified service probability
 = Standard deviation of usage during lead time
K = Service level

• And finally, we have that:

R  d  L  z σL
k
FIXED-ORDER QUANTITY MODEL WITH
SAFETY STOCK (Q)
• The re-order point is set equal to the average demand
during the lead time plus a specified number of standard
deviations to protect against stockouts.
• When controlling the z value, which is the number of standard
deviations used, we can control not just the re-order point but
also the service level.
• A high value for z will produce a high re-order point and a high
service level.
• The percentages that are shown in the following table come
from a normal distribution.

70
FIXED-ORDER QUANTITY MODEL WITH
SAFETY STOCK (Q)
• These percentages represent the probability that the demand is within the
specified number of standard deviations with respect to the mean.
• For a given level of service, it will be probable to determine the value of z
and then the re-order point taking the table as a base.
• We can observe that the standard deviation of the demand must be
calculated for the interval of the lead time.
• If we know the standard deviation of the demand, but it is in a different
interval of the time where the order is received, we can apply the following
equation to express that the data is in the same measure of time.

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 Table. Percentages of a normal distribute demand

% Level of % Level of % Level of % Level of

Z Z
Service Stock out Service Stock out
0.0 50.0 50 2.0 97.7 2.3
0.5 69.1 30.9 2.1 98.2 1.8
1.0 84.1 15.9 2.2 98.6 1.4
1.1 86.4 13.6 2.3 98.9 1.1
1.2 88.5 11.5 2.4 99.2 0.8
1.3 90.3 9.7 2.5 99.4 0.6
1.4 91.9 8.1 2.6 99.6 0.4
1.5 93.3 6.7 2.7 99.6 0.4
1.6 94.5 5.5 2.8 99.7 0.3
1.7 95.5 4.5 2.9 99.8 0.2
1.8 96.4 3.6 3.0 99.9 0.1
1.9 97.1 2.9
FIXED-ORDER QUANTITY MODEL WITH
SAFETY STOCK (Q)
• Conversion of the standard deviation of the demand with a different period
measurement.

L
σL  σ t
t

where
L = Standard deviation of the demand during period L
t = Standard deviation of the demand known for the interval t
L = period, expressed in the same interval t

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 FIXED-TIME PERIOD MODEL
(P-model)
• In a fixed–time period system, inventory is counted only at
particular times, such as every week or every month. Counting
inventory and placing orders periodically are desirable in
situations such as when vendors make routine visits to
customers and take orders for their complete line of products,
or when buyers want to combine orders to save transportation
costs. Other firms operate on a fixed time period to facilitate
planning their inventory count; for example, Distributor X calls
every two weeks and employees know that all Distributor X’s
product must be counted.

74
 FIXED-TIME PERIOD MODEL
(P-model)
• Fixed–time period models generate order quantities that vary from period to
period, depending on the usage rates. These generally require a higher level
of safety stock than a fixed–order quantity system. The fixed–order quantity
system assumes continual tracking of inventory on hand, with an order
immediately placed when the reorder point is reached.
• In contrast, the standard fixed–time period models assume that inventory is
counted only at the time specified for review.
• You can se how the P-model works in the following diagram.

75
 Figure. The P-model

2 The order is received 4 The order is received

Q1 6 The order is received

Q2 Q3

Q1 Q2
The order is 1 The order is 3
placed
placed 5
Q3

NI NI
Q = N − NI
NI

L L L
t
P P

76
 FIXED-TIME PERIOD MODEL
(P-model)
• The P-model works completely different than the Q-model
because:
1. It doesn’t have a re-order point but a target stock level
(N);
2. It doesn’t have an economic quantity considering that
the quantity varies according to the demand, and
3. In the P-model, the interval of the order is fixed (P), but not
the quantity of the order.
• The P-model is completely determined by two parameters:
• N and P.
• Using the formula of the EOQ, we can approximate the
optimum value for P.

77
 FIXED-TIME PERIOD MODEL
(P-model)
• As P is the time that elapses between orders, we can relate this to the EOQ
model as follows:

Q 1 2AD
P 
D D iC
• So, replacing the formula of the EOQ for Q, we have:

2A
P
iCD

78
FIXED-TIME PERIOD MODEL (P-model)
• In this case the target stock level is set high enough to cover the demand
during the lead time and the time for the periodic review.
• This time of coverage is necessary because the merchandise takes time to
get, equal to the lead time.
• With the purpose to reach a desirable level of service, the demand must be
covered during the time (P + L) with an average level, plus a safety stock.
• So, we get:

N  m's'
N = Target stock level
m’= Average demand during P + L
s’ = Safety stock

79
FIXED-TIME PERIOD MODEL (P-model)
• The consumption or demand during the lead time and the periodic review can
be determined by the following relation:
•
m'  d  (P  L)
donde
d = daily consumption
P + L = Time of periodic review + Lead time

• The safety stock must be established up to a level, high enough, to assure a

desirable customer service.
FIXED-TIME PERIOD MODEL (P-model)
• For the safety stock, we have the following relation:

s' zKσ'PL
donde ´P+L = standard deviation during P+L
z = Number of standard deviations for a specified service
probability
K= Level of service

• To control the “z” value, we can control the target stock level and
the desirable service level.

N  d  (P  L)  zKσ'PL
FIXED-TIME PERIOD MODEL (P-model)
Where:
N = Target stock level
d(P+L) = Demand during the review period and the lead time.
zk = z value related to the level of service k during the lead time
P+L = Standard deviation of the demand during the review period and the lead time.

• If we do not know the standard deviation of the demand for the combined
period (P+L), we can apply the following equation:

(P  L)
σ P L  σ t
t

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 Comparison of
Fixed–Order
Quantity and
Fixed–Time
Period Reordering
Inventory Systems

84
 BASE STOCK SYSTEMS
• In its simple form, a base stock system releases a replenishment order, Q, every time
there is a withdrawal, for the same quantity that was withdrawn.
• This replacement policy “one by one” preserves the same level of inventory at a
minimum level to satisfy the expected demand during the lead time, plus a safety stock.
• Consequently, the level of a base inventory is equivalent to the re-order point in a Q
system.
• However, the quantities of the order vary to hold the inventory at a minimum level R in
every moment.
• This system is appropriate to very expensive articles, like jet engines.

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 MIX SYSTEM OR MIN/MAX, MMS
• One of these systems is characterized by the inclusion of decision rules min-
max and for a set of periodic reviews.
• In this cases the systen has a re-order point (Min) and a target inventory
(Max).
• The review of the level of inventory is conducted every time that occurs a fixed
time, P*, similarly to the periodic review system.
• When the periodic review is conducted, no order is placed if the level of
inventory is higher than the Min.
• If the level of inventory is below the Min, an order is placed to level up to reach
the Max.

86
 Figure. MIX SYSTEM OR MIN/MAX, MMS

Level of
Inventory

Q Q
NImax Q = NI max − NI
NI

NImin
NI NI
Time
P* P* P*

Evolution of MMS stock

87
 COSTS IN INVENTORY

Inventory costs may vary from 28 to 32% of the total cost. Apart
from material costs, several other costs are also involved in
inventory. These are given as below:

• Ordering Costs
• Holding Costs/ Carrying Costs
• Stock Out Costs

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 Ordering Costs

• Stationary
• Clerical and processing, salaries/rentals
• Postage
• Processing of bills
• Staff work in expedition /receiving/ inspection and
documentation

89
 Holding/Carrying Costs

• Storage space (rent/depreciation)

• Property tax on warehousing
• Insurance
• Deterioration/Obsolescence
• Material handling and maintenance, equipment
• Stock taking, security and documentation
• Capital blocked (interest/opportunity cost)
• Quality control

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 Stock out Costs

• Loss of business/ profit/ market/ advise

• Additional expenditure due to urgency of purchases
a) telegraph / telephone charges
b) purchase at premium
c) air transport charges
• Loss of labor hours

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 TOTAL COST OF A SYSTEM
• COST ELEMENTS (Cost Structure)

o The unit costs of the product is constant and there is not any discount per large
quantities purchased.
o It exists a fixed cost to order per each lot and this cost is independent of the number
of products that each lot contains.
o The cost of holding inventory depends directly of the average level of inventory.
o The total cost of inventory is equal to the ordering costs plus the annual holding costs.

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 TOTAL COST OF A SYSTEM
• SYMBOLS TO USE IN THE FORMULA

D = Demand rate, units per year

A = cost per order placed, soles per order
C = unit cost, soles per unit
i = interest rate to hold inventory, % of the value of soles per year
Q = lot size, units
C(Q) = Total ordering costs plus holding costs, soles per year.

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 TOTAL COST IN A SYSTEM
• The annual cost to order is C1:

C1 = (cost per order)(orders per year)

D 
C1  A  
Q 
In the previous equation, D is the total demand per year, and the
product is ordered in Q units at once; in such a way that in a year
D/Q orders are placed.

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 ORDERING COSTS
Minimum Costs

Lot Size (Q)

95
 TOTAL COST IN A SYSTEM
• The annual cost to hold inventory is C2 :

C2 = (holding inventory annual rate)(unit cost)(average inventory)

Q 
C2  (i )(C) 
2

96
 CARRYING COSTS
Minimum Costs

Lot Size (Q)

97
 TOTAL COST IN A SYSTEM
• The cost of the product is C3 :

C3 = (cost of the article)(annual demand)

C3  CD

98
 TOTAL COST OF A SYSTEM
• El Total Relevant Cost per year is:

TRC(Q) = Ordering costs per year

+ Holding costs per year
+ Cost of the article
TRC(Q)  C1  C2  C 3
AD iCQ
TRC(Q)    CD
Q 2

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 TOTAL COST OF A SYSTEM
• The diagram shows the C(Q) against Q, where each component of
C(Q) is shown disaggregated, together with the total.
• When Q increases its amount, the cost component to order
decreases because less orders per year are placed; at the same
time, however, the componen of the holding costs increases
because it keeps a higher level of average inventory.
• In this way, the holding costs and the ordering costs balance each
other.
• This is precisely an exchange between the holding and ordering
costs, as we said before.
• Because of this exchange, the function C(Q) has a minimum.

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101
102
 ABC Classification System
• Classifying inventory according to annual value of consumption of
the items.

A - very important
High
B - mod. important A
C - least important Annual
$ value B
of items

Low C
Few Many
Number of Items

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 ABC Classification System (Cont’d)
• When a large number of items are
involved, relatively few items account for a
major part of activity, based on annual
value of consumption of items.

• It is based on the principles of ‘vital few

and trivial many’.

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 ABC Classification System
(Cont’d)
• A-items : 15% of the items are of the
highest value and their inventory accounts
for 70% of the total.
• B-items : 20% of the items are of the
intermediate value and their inventory
accounts for 20% of the total.
• C-items : 65%(remaining) of the items are
lowest value and their inventory accounts
for the relatively small balance, i.e., 10%.

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 Procedure for classification
• All items used in an industry are identified.
• All items are listed as per their value.
• The number of items are counted and
categorized as high-, medium- and low-
value.
• The percentage of high-, medium- and
low- valued items are determined.

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 Inventory Counting Systems
• Periodic System
Physical count of items made at periodic
intervals.
• Perpetual Inventory System
System that keeps track of removals from
inventory continuously, thus monitoring
current levels of each item.

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Pareto curve

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