3.NOTS WM Inventory MGT

What is inventory ?
• “ Inventory means idle resource of any kind

having economic value”-Fred Hansman
• “ Inventory is a sum of value of Raw Materials,

spare parts, consumables, Semi-processed
and Finished Stock at any given point of time”
Why Do need inventory?
• Uncertainty of demand
Ensure smooth production

• High cost of stoppage of production.
• Market dynamics
• Uncertainty of supplies.
• To satisfy customers.
• Loss of sales from delay in supply
• Loss of goodwill and delayed payment from
customers if orders are not delivered in full
• Higher transportation costs to fill “rush” orders
• Disruption of the production process
• Inefficient production scheduling
• Purchasing of small volume supplies at high prices
to meet shortages
• Quality or specification differences due to the need
to call upon other sources
CATEGORIES OF INVENTORY
• PRODUCTION INVENTORY
• Raw Materials, chemicals, components, packing materials
purchased from market.
• Spare, components, chemicals manufactured in the organization
for captive consumption.
• MRO. MAINTENANCE, REPAIRS & OPERATING SUPPLIES:

• Tools, spares, lubricants, bearings, consumables etc
• WORK IN PROCESS/ SEMI FINISHED GOODS.
• FINISHED GOODS.: Products ready for sale .

• Following Inventories are part of Working Capital
• in Balance Sheet.
• a).Goods In Transit: Goods already paid for but not received in stores
• b) Stock in Trade: All Finished Goods at warehouses, ready for sale
ready for sale.
SALES & MARKETING FINANCIAL DEPARTMENT
DEPARTMENT
Quick delivery Low inventory levels
No stock outs Low cost of operations
Varieties and volumes Higher inventory turnover
Frequent and small deliveries Low cost of delivery
TOP MANAGEMENT MANUFACTURING DEPARTMENT
Higher inventory turnover Less varieties

Low Operation cost Economic batch quantity
Excellent Customer Service Quick off takes
No rejection and cancellation
DIFFERENT VIEWS
• Marketing Manager: Likes to hold more inventory to

prevent sales loss.
•
• Production Manager: Want to hold more for smooth
production.
•
• Finance Manager: Needs low inventory to minimize
blocking of funds
•
• Materials Manager: Has to ensure optimum
inventory.
INVENTORY AS % OF SALES
COMPANY SALES RAW WORK IN FINISHED TOTAL
TURNOVER MATERIAL & PROGRESS GOODS INVENTORIES
RS CRORES COMPONENT
L&T 7917 10.13 (0.12) 685.66 (8.66) 24.63 (0.32) 720.48 (9.10)
HINDUSTAN 10972 510.14 (4.65) 47.72 (0.43) 577.11 (5.26) 1134.98

UNILIVER LTD (10.34)
RANBAXY 2164 181.78 (8.39) 62.30 (2.88) 180.72 (8.35) 424.85

LABORATORIES (19.62)
LTD
(SUNPHARMA)
FACTORS INFLUENCING INVENTORY
• How much to stock & When to stock buy ?
• Based on Sales forecast & production

schedule.
• Quantity in stock & pending orders.-`
• Lead Time- manufacturing, transportation

• Market trends- Shortage, scarcity/down trend
• Seasonality Nature of item- perishable,
imported.
Obsolescence
Tools: Selective Inv Control, EOQ, ROL, P System Q System etc
Introduction
• One of the major objectives of SCM is efficient “flow of
materials” or “flow of goods” among Supply Chain members
• The flow of materials and goods involves the use of
inventories at various levels in a supply chain
• Inventory can be defined as an idle resource of any kind that
is held to meet some future demand
• The resource can be input materials, semi-finished goods, or
finished goods
• Inventories exist because of mismatch between supply and
demand. If supply matches with demand, there is no need to
carry inventory
• But in reality, mismatch between supply and demand always
exists. Hence inventories have to be created to balance the
mismatches
Introduction
• If supply exceeds demand, the level of inventory held increases
• If demand exceeds supply, there will be a decrease in the
inventory level
• Inventory is spread throughout the supply chain from raw
materials and semi-finished goods to finished goods that
suppliers, manufacturers, wholesalers and retailers hold
• Inventory constitutes a significant portion of the assets of a
firm
• Since inventory costs constitute a major portion of the costs of
a firm, even a small reduction in the inventory levels can lead
to a remarkable improvement in the profitability of the firm
• Thus inventory management offers substantial opportunities
for improving the profitability of the firms
Introduction
• Therefore, inventory management is one of the most

important processes of SCM
• It aims at maintaining optimum inventory level at minimum
cost, without affecting the customer service levels
• In this module, we explain the importance and functionality of
inventory in SC
• We will then discuss the basic inventory management
decisions. There are two key inventory decisions taken in a SC
• Cycle inventory decisions, and
• Safety inventory decisions
ROLE OF INVENTORY IN A SUPPLY CHAIN
• In make-to-order production, there is no need for holding

inventory, as the product is made only after the customer has
placed an order
• But this is not always practical
• Manufacturers generally have to produce goods without
knowing precisely the level of demand for the product. Hence
holding inventory is necessary
• Inventory serves the following purposes in a supply chain:
• Decoupling,
• Balancing supply and demand, and
• Buffer uncertainties
• Decoupling
• Inventories are used to “decouple” various operations in the
production-distribution system
• The objective is to reduce the dependence between various
operational units by building up inventory at each level of the
system
• Inventory enables the firm to continue other production
processes even when there is a breakdown in one level of the
production process
• Inventory also protects the firm from raw material shortages
due to disruptions in supply
• Similarly, finished goods inventory helps the marketing
department to continue sales operations during
manufacturing disruptions
• Balancing Supply and Demand
• Inventory is used to balance the mismatch between the
demand and supply from the manufacturing unit
• This is more important in seasonal supply/demand situations
• For example, demand for air-conditioners peaks in summer
and starts to decline thereafter
• Balancing this mismatch is a challenging task
• If a firm maintains a relatively stable workforce and produces
at a constant level throughout the year, irrespective of
seasonality, firm will have to carry excess units of inventory
• This inventory helps the firm to meet the demand during peak
period
• Balancing Supply and Demand

• Certain types of products are in demand throughout the year,
but supply of raw material is seasonal
• While there is a year round demand for food products like
jams, fruit juices etc., the supply of fruits is seasonal
• In such cases, company can manufacture finished products in
excess of market demand, and store them for future
consumption
• Buffer Uncertainties
• Another important function of inventory is to protect the
operating units from uncertainties
• For this purpose, buffer stock or safety stock is maintained
• Safety stock protects firms from two types of uncertainties:
• The first type of uncertainty occurs when actual demand exceeds
forecasted demand
• Second of uncertainty occurs when there is delay in delivery of goods, a
delay in processing an order, etc.
• Safety stock gives the firms access to the required goods
regardless of uncertainties in supply and demand
• Many mathematical models and statistical tools have been
developed to ascertain the right level of safety stock
INVENTORY RELATED DEFINITIONS
• Inventory Policy
• Guidelines that a company must follow to control inventory
• Includes guidelines regarding when to order, at what point to
order, what quantity to order etc.
• Also includes strategic decisions regarding location of
distribution centers, inventory positioning etc.
• Thus, inventory policy guides the inventory management in a
firm
• Cycle Inventory
• Refers to stock that is held to satisfy demand between two
replenishment cycles
• At the beginning the inventory will be maximum but gradually,
as the customer demand is met, the inventory level reaches zero
• Before reaching zero level, the stock must be replenished
• The replenishment order should be placed when the available
inventory is greater than or equal to customer demand
• The quantity ordered is known as the order quantity
• The inventory held in process is known as cycle inventory
• Transit Stock
• Refers to stock that is either moving or awaiting movement in
transportation vehicles
• It is also known as pipeline stock
• It can be regarded as a portion of cycle stock, even though it is
not usable or accessible until it arrives at its destination
• With increase in focus on small lots, JIT strategies, and
frequent order cycles, transit inventory is occupying a major
portion of total inventory
FACTORS INFLUENCING INVENTORY
• How much to stock & When to stock buy ?
• Based on Sales forecast & production

schedule.
• Quantity in stock & pending orders.-`
• Lead Time- manufacturing, transportation

• Market trends- Shortage, scarcity/down trend
• Seasonality Nature of item- perishable,
imported.
Obsolescence
Tools: Selective Inv Control, EOQ, ROL, P System Q System etc
LEAD TIME
• “Period between recognition of a need and its fulfillment”
• Internal Lead Time: From Indenting to placing order

• Supplier’s Lead Time : Placing order to Dispatch by supplier.
• Transportation Lead Time: Dispatch by supplier till Receipt
in Stores.
• Inspection Lead Time : Receipt in stores till receiving OK
from QC.
• HOW TO REDUCE LEAD TIME ?
• Internal Lead Time:

SELECLTIVE INVENTORY CONTROL
TYPE OF CONTROL CRITERIA
A B C Analysis Annual Consumption value
High Medium Low Unit Price of Material
Vital Essential Desirable Criticality of item
Fast Slow Non Moving Sale Pattern
Scarce Difficult Easy Availability of Material
Govt Open,Local Foreign Source of supply
Seasonal Off Seasonal Seasonal availability
XYZ Stock value of in stores
P(Low shelf) Q R(High Shelf ) Shelf life of item
A B C
Very tight control Moderate Loose, Delegate
Procure exact
Requirement More / Less Estimated Usage
Very Low Safety
Stock Low Fairly large
Accurate
Planning Past sale Rough Estimate
Posting individual Individual issue Collective issues
Higher Authority Middle Lower
Daily Monitoring Monthly Quarterly
Law of Pareto
V E D & A B C ANALYSIS
V ITEMS E ITEMS D ITEMS

Constant Control
& Regular Follow Moderate
A Items up Stock Nil stocks
B Items Moderate Stocks Moderate Very Low
C Items High Stocks Moderate Low stock

FNS & ABC ANALYSIS
F ITEMS S ITEMS N ITEMS
Dispose off
Tight Inventory Very Low at optimum
A Items Control level of stocks price
Normal Inventory Low Level Dispose off

B Items control stock AEAP
May dispose
Low Level at lower
C Items Increase stocks stocks price
ABC ANALYSIS COMPUTATION
• Prepare tabulation as under
Item no Annual Consumption Quantity Unit Price Total Value
Compute Total Annual Consumption Value

Arrange total value in descending order.
(Higher Value First)
Compute Cumulative Value
Find out 70% of Total Cumulative Value for A
Category Items
Find out 90% of Total Cumulative Value for B
Category Items
Balance are C Value Category Items
Compute ABC
Item No Annual Quantity Unit cost Rs
101 360 100
102 300 1050
103 1800 6
104 1800 5
105 480 50
106 2400 1
107 3600 2
108 180 500
109 500 48
110 3000 2
111 1000 1
112 1000 1
A=80% B=15% C=5%
ABC ANALYSIS
Item No Total value Cumulative Class
102 315000 315000 A
108 90000 405000 A 4.2
101 36000 441000 B
105 24000 465000 B
109 24000 489000 B 5
103 10800 499800 C
104 9000 508800 C
107 7200 516000 C
110 6000 522000 C
106 2400 524400 C
111 1000 525400 C
112 1000 526400 C
A=80% B=15% C=5%
ABC & VED MATRIX
INVENTORY DECISIONS IN A SUPPLY CHAIN
• Cycle Inventory Decisions
• Impact of fixed costs on cycle inventory decisions
• Lot sizing for a single product
• Example 1
• Suppose the daily production requirement for a product (input) is 10 units
and the lead time for procuring it is 10 days
• Since the company knows these details exactly, it can schedule the orders
to arrive just when the last unit of inventory is being used
• Thus, inventory beyond cycle stock is not required
• Let us assume the work year to be 240 working days
• Since the daily requirement is 10 units, the firm requires 2400 units per
year. Assume that ordering cost is Rs. 500 per order and each unit costs Rs.
100

• Example 1
• What order size, the company should choose?
• To ensure uninterrupted production, company should procure in lot sizes
that at least cover the lead time requirement, i.e., it should order 100
units every 10 days
• But this quantity may not result in lowest annual inventory cost (TC)
• Therefore, company must choose the lot size that minimizes the total cost
• For this, the company must arbitrarily evaluate various lot sizes and select
the one with minimum cost
• Let us assume the following options are shortlisted:
• Option I: 100 units, Option II: 200 units, Option III: 300 units
• Example 1
• What should be the order size that the company should choose?
• To ensure uninterrupted production and to cover at least the lead time
requirement, it should order 100 units every 10 days, but this may not
result lowest annual inventory cost (TC)
• To minimize the total cost, the company should arbitrarily evaluate various
lot sizes and select the one with minimum cost
• Option I: 100 units
• Option II: 200 units
• Option III: 300 units

• Example 1
• The figure 1 A depicts the scenario when the reorder quantity is 100 units
• The reorder point is 100 units, i.e., as and when the inventory level falls
below 100 units, the order needs to be placed
• In this case, the order needs to be placed every 10 days
• we also know that the average cycle stock equals half the order quantity
(100/2) = 50 units
• Over a period of one year, 100 units are purchased 24 times (total 2400
units)
• Figure 2 – Option B

• Example 1
• Figure 2 B shows the scenario when the reorder quantity is
200 units
• In this case, an order is placed every 20 days
• The cycle inventory is 100 units
• 200 units are purchased 12 times a year (total 2400 units)
• Figure 3 – Option C

• Example 1
• Figure 3 C depicts the scenario when the reorder quantity is
300 units
• Orders for 300 units are placed 8 times a year (total 2400
units)
Re-order level systems - formula:
ROL = (R d x L) + S
Where...
Re-order level (ROL) =

Demand in the lead-time + Safety stock (S)
Demand in the lead-time =

Rate of demand/usage (Rd) (e.g., per week)
x Lead-time (L) (e.g., in weeks)
ITC M11:U4:4.5-2
Basic re-order level stock replenishment system
Quantity (fixed quantity, variable interval)
Fixed order
quantity
Slope = Rd
Re-order Re-order Re-order Re-order

level
Safety
stock { Lead-time
Time
Re-order level
Given the following data, what is the re-order level:
Safety stock = 100 units
Supply lead-time = 6 weeks
Average weekly demand = 200 units
Re Order Level
(200 X 600) + 100 = 1300 Units

Periodic review stock replenishment system
(fixed interval, variable quantity)
Periodic reviews Variable order

quantities
B
A C D
Quantity
Lead-time Lead-time Lead-time
Safety
stock {
Z Time
Fixed
Lead-time
review
interval
Periodic review systems
- formula to calculate the order size:
Order size =
(Demand over the review interval + the lead-time)
- (Actual stock) - (Pipeline stock)
+(Safety stock)
In a periodic review system, the basis for

determining the order size (which varies each
time) is therefore the (fixed) review interval.
Action Point 4.5-2
Re-order quantity
Given the following data, what quantity should be re-ordered?
Expected demand per week = 100
Lead time = 3 weeks
Review interval = 4 weeks
Safety stock = 300
Physical stock = 450
On order (pipeline) = 200
ORDER QUANTITY =
Periodic reviews
Lead-time Lead-time Lead-time
What should the next order quantity be?
Safety
Stock {
Review Lead-time
interval
PERIODIC REVIEW
TECHNIQUE
Order Quantity
= (100 x 7) – 450 – 200 + 300 = 350
RELEVANT COSTS
• Ordering/Procurement/Acquisition Cost(U)
•
It include Salary wages of Purchase dept,
source devt cost, cost of sending tender,
enquiry, follow up, visits, stationery,
negotiation, Rent, depreciation of Purchase
dept, receiving and inspection cost, cost
effecting payment, cost of entertaining
suppliers.
•
• Ordering Cost= Total Ord.Cost/No of Orders
•
Inventory Carrying Cost
• Inventory Carrying Cost (I)
•
• Opportunity cost, Insurance cost, Interest cost,
• Property taxes, storage costs, Obsolescence cost,
Rent of warehouse, salary wages of stores dept,
Material handling cost,
•
• ICC = Total Inv.Mangt Cost/Av Inventory X 100
INVENTORY COSTS
• Under stocking Cost (KU)
• Losses incurred due to not stocking the material.

• Loss of production, loss of sale, goodwill.
• Over stocking Cost (KO)
• Opportunity lost due to blockages of funds in

unnecessary inventory.
ECONOMIC ORDER QUANTITY
• “That quantity at which cost of ordering the
annual requirement of an item & ICC are
minimum ie Total cost of both is optimum”
• A = Annual consumption in units

• U = Ordering cost per order 2AU
• C = Cost per unit EOQ = -------
• I = Inventory Carrying cost IC
• EOQ model
No of Qty/ Av Inv Ordering ICC Total
Ords Order Cost Cost
A B C D E F
B/A B/2 A x 200 Cx100x0.30 D + E
1 10000 5000 200 150000 150200

5 2000 1000 1000 30000 31000
10 1000 500 2000 15000 17000
27 370 185 5400 5550 10950
28 358 179 5600 5370 10970
EOQ
• Find out EOQ :
• ANNUAL DEMAND = 10,000,
• ORDERING COST = Rs 200,
• UNIT COST = RS 100,
• INVENTORY CARRYUING COST 30%
EOQ
• EOQ = 2AU
• IC
• = 2 X 10,000 X 200
• 100 X 0.30
• = 365
EOQ & DISCOUNT
• 1% Discount is offered if order is placed for
1000 nos. Should the discount be accepted ?
• Savings in Discount & Saving in Ordering Cost

> Increase in Inventory Carrying Cost
• Then Accept other wise reject.
• Saving OC = A/Q - A/New Q X U
• Saving in Discount = A x C x discount
• Increase in ICC = New Q/2 – Q/2 x C x ICC %
EOQ & DISCOUNT
10000 - 10000
• Saving in Order Cost = 365 1000 X 200 = Rs 3480
• Saving in discount = 10000 x 100 x 0.01 = Rs 10000.00
• Total Saving Rs 13480.00
• Increase in ICC = 1000 – 365 x 100 x 0.30 = Rs 9525.00
2 2
• Saving of Rs 13480 – Rs 9525 = Rs 3955. Accept discount

EOQ
• ASSUMPTIONS:
• 1.Consumption patter is known
• 2. Supplies are available as and when required.
• LIMITATIONS:
• 1.Ordering to nearest packing size.

• 2. Computation of cost is difficult
• 3. Freight consideration
• 4. Perishable items
• 5. Market conditions
• 6. Seasonality
• 7. Import 8. Discount
LEAD TIME
• “Period between recognition of a need and its fulfillment”
• Internal Lead Time: From Indenting to placing order

• Supplier’s Lead Time : Placing order to Dispatch by supplier.
• Transportation Lead Time: Dispatch by supplier till Receipt
in Stores.
• Inspection Lead Time : Receipt in stores till receiving OK
from QC.
• HOW TO REDUCE LEAD TIME ?
• Internal Lead Time:

INVENTORY POLICIES
ITC a major cigarette manufacturer maintains a

stock of
6 days pre GST inventory at its factories,
4 days post GST inventories in transit and
6 days stock at wholesalers premises.
STANDARDISATION
Illy Whiteny 1801, USA
What is Standard ?
Any specification intended for repeated use
become a standard. It is a model to which an object
or an action may be compared”.
According to International Standards Organization
(ISO) standardization is a process of formulating and
applying rules for an orderly approach to a specific
activity for the benefit and with the co-operation of
all concerned and in particular the promotion of
optimum overall economy , taking due account of
functional conditions and safety requirements.
Objectives:1. Increase trade within and outside country.
2. Protect consumer
3. Integrate safety, health and environment.
4. Assure interchangeability, compatibility.
Advantages:
1. Mass production- reduced mfg cost
2. Improved Quality of Product
3. Improved technology
4. Buyers benefit by quantity discount
5. No errors in specifications
6. Creates competition amongst suppliers
7. Faster inspection. 8. Less space
9. Reduction in wastage/scrap
Types of Standards
1. International Standards- ASME, British

Standards, BP, USP, DIN, Japanese Industry
Standard) JIS
2. National Standards- Bureau of Indian

Standard ISI, Ag Mark, IP
3. Industry Standards- Paper, Textile, electronics
4. Company Standards.
CODIFICATION
Pin 111
“Code No gives an unique and unambiguous identification to an item/material.”
Code may consist of digits or alphabets or both,

It should enable easy identification of item.
Advantages:
1. Lengthy description avoided
2. Duplication of items avoided
3. Accurate identification
4. Accuracy in records, reports, issues, receipts
5. Compulsory for computerization. 6. Variety reduction possible

• Brisch System 7 digits
• Basic Class, Class, Sub Sub Class, Type

Tool Cutting Reamer Bridge taper
• Basic Material, Sub Type, Size
• Bright MS Hand tap 1/8”
• Kodak System uses 10 digits

Mumbai’s DABBAWALLAS
Each Dabbawalla handles over 35 tiffins.

Everyday they deliver 2 lacs tiffins in Mumbai
Area of 60 – 70 kms
They use Alphabet code with VIBGYOR colours signifying

origin, destination, group handling the tiffins. Eg 10 –
9/M/16 means:
10- destination Nariman Point

9 – specific area in Nariman Point
M- Mittal Towers
16- floor
BARCODING:
Barcodes translates digital/alphanumerical
codes into group of thick and thin bars or
vertical lines which are printed on label and
reconverted into digital/alphanumeric code by
Bar Code Reader.
• Safety Inventory
• Refers to the stock held in excess of cycle inventory to cover
the uncertainty of demand and replenishment cycles
• The objective of holding safety inventory is to have a certain
amount of inventory on hand to cover the short term
variability in demand and lead time
COST OF CARRYING INVENTORY
• Capital Cost
• It is one of the major components of inventory carrying costs
• It is also called opportunity cost because it refers to the return
on investment that we can get from the ”next best investment
opportunity” which we now cannot obtain as the funds are
tied up in inventory
• Insurance Costs
• Include amount paid to insurers for insuring against the risks
of holding inventory for a period of time
• The amount charged depends on the nature of the product
and the types of storage facilities used. For example,
insurance costs may be high for perishable goods and high
value goods
• Obsolescence Costs
• This cost estimates the rate at which the value of the product
stored decreases either due to market conditions or due to
deterioration in quality of the products
• It can range from 0% to 100% depending on nature of
products. Fashion garments may have as much as 100%
obsolescence cost
• Storage Costs
• Refers to the expenses on storage facility
• The costs depend upon the type of warehouse facility being
used
• Privately owned warehouses charge according to space
allocated for storage
• Public warehouses charge according to amount of inventory
being stored
• Miscellaneous Costs
• Firms also have to deal with all costs associated with pilferage,
damage, security, taxes, and relocation
• Cycle Inventory Decisions
• Example 1
• Suppose the daily production requirement for a product (input) is 10 units
and the lead time for procuring it is 10 days
• Since the company knows these details exactly, it can schedule the orders
to arrive just when the last unit of inventory is being used
• Thus, inventory beyond cycle stock is not required
• Let us assume the work year to be 240 working days
• Since the daily requirement is 10 units, the firm requires 2400 units per
year. Assume that ordering cost is Rs. 500 per order and each unit costs Rs.
100

• Example 1
• What order size, the company should choose?
• To ensure uninterrupted production, company should procure in lot sizes
that at least cover the lead time requirement, i.e., it should order 100
units every 10 days
• But this quantity may not result in lowest annual inventory cost (TC)
• Therefore, company must choose the lot size that minimizes the total cost
• For this, the company must arbitrarily evaluate various lot sizes and select
the one with minimum cost
• Option I: 100 units, Option II: 200 units, Option III: 300 units
• Example 1
• What should be the order size that the company should choose?
• To ensure uninterrupted production and to cover at least the lead time
requirement, it should order 100 units every 10 days, but this may not
result lowest annual inventory cost (TC)
• To minimize the total cost, the company should arbitrarily evaluate various
lot sizes and select the one with minimum cost
• Option I: 100 units
• Option II: 200 units
• Option III: 300 units

• Example 1
• The figure 1 A depicts the scenario when the reorder quantity is 100 units
• The reorder point is 100 units, i.e., as and when the inventory level falls
below 100 units, the order needs to be placed
• In this case, the order needs to be placed every 10 days
• we also know that the average cycle stock equals half the order quantity
(100/2) = 50 units
• Over a period of one year, 100 units are purchased 24 times (total 2400
units)
• Figure 2 – Option B

• Example 1
• Figure 2 B shows the scenario when the reorder quantity is
200 units
• 200 units are purchased 12 times a year (total 2400 units)
• Figure 3 – Option C

• Example 1
• Figure 3 C depicts the scenario when the reorder quantity is
300 units
• Orders for 300 units are placed 8 times a year (total 2400
units)
• Though option I (100 units) reduces the inventory carrying

costs, it increases the ordering costs
• The total costs TC is given by the following formula:
• TC = Annual material costs + Annual order cost + Annual
inventory cost, where
• Annual material cost = C x R (1)
• Where C is the cost per unit and R is the annual sales volume
or demand
• Annual order cost = number of orders per year x ordering cost
per lot = (R/Q) x S (2)
• Where Q is the order quantity and S is the cost incurred for
placing each order
• Figure 4: EOQ model
• Annual inventory carrying cost = (Q/2) x hC (3)
• Where h is the annual carrying cost as a fraction of the average
inventory value
• Therefore, total annual cost, TC = CR + (R/Q) x S + (Q/2) x hC (4)
• The cost trade-offs required to determine the most economic
order quantity are shown in Figure 4 above
• The annual holding cost increases with increase in order
quantity
• In contrast, the annual ordering cost decreases with increase in
the order quantity
• Material cost is independent of the lot size as the price of the
material is fixed. The optimal lot size is the one which minimizes
the total cost of inventory
• The standard formula for EOQ is as follows:
  2 RS  
Q*   
 hC 
• Where Q* = economic order quantity EOQ
• R = annual sales volume or demand, in units
• S = cost per order
• h = annual carrying cost as a fraction of inventory value
• C = cost per unit
• Using the example given, we determine the EOQ for the

product
• The various costs are given in the example
• We assume inventory holding cost to be 20% of the unit cost
• R = 2400 units, S = Rs. 500, h = 0.20, C = Rs. 100
  2 *500* 2400  
Q*     346
  0.20*100  
• Total ordering cost = (2400/346) x 500 = Rs. 3468
• Total inventory carrying cost = (346/2) x (0.20 x 100)
• = Rs. 3460
• From the above calculations, we observe that at an EOQ of
346, total ordering cost and total inventory cost are almost
equal
• Thus, we can achieve a balance between ordering costs and
inventory carrying costs by ordering in EOQ quantities
• This in turn minimizes total inventory costs
• To reduce total costs, the company should order in a lot size of
346 units
• Thus, in a year, 7 orders would be placed and the cycle
inventory would be 173 units
• Lot sizing Decisions for Multiple Products
• To reduce fixed costs, firms need to review fixed costs and
identify components where savings can be obtained
• Transportation costs and ordering costs are major sources of
fixed costs
• These can be reduced by aggregating multiple products in a
single order
• If the company is sourcing different goods from same location,
these can be transported in a single vehicle reducing
transportation costs
• As ordering and transportation costs are spread over multiple
products, firm can order products in smaller lots more
frequently.
• Lot sizing Decisions for Multiple Products

• Multiple products carried in a single vehicle, will keep
transportation costs constant
• But ordering costs i.e. loading and receiving costs may
increase with increase in orders for each new products
• As ordering costs increase with each order, the firm should
identify high volume items and low volume items
• Low volume items should be ordered less frequently than
high volume items, so that ordering costs are kept low
• Such type of aggregation is known as tailored aggregation
• Impact of Quantity Discounts on Cycle Inventory

Decisions
• In previous discussions, we had assumed that material cost
(i.e. price per unit) was constant irrespective of quantity
purchased
• However, price discount is generally offered depending on the
quantity purchased
• Discount is generally of two types:
• Lot size based discount , depending on the quantity ordered in each lot,
and
• Volume based discount based on the volume ordered for a given period of
time, irrespective of the lot size
Decisions
• Lot size based discounts
• In this case, unit price of product decreases as quantity ordered increases
• The pricing schedule consists of certain break points q0, q1, q2. … qr
• If order quantity is greater than or equal to price break point, the discount
price applies to all the units
• Thus, ordering (qi + 1) units is less expensive than ordering (qi – 1) units
• To arrive at op
• timal lot size when using quantity discount, we need to evaluate the EOQ for
each price break point Ci
• Then we need to decide upon the lot size which minimizes overall costs
The cost curve is shown below:

Decisions
• EOQ for each value of I, where 0 ≤ I ≤ r can be evaluated as
under:  2 RS 
Qi   
 hCi 
• There are three possible cases for Qi
• I. qi ≤ Qi < qi+1
• II. Qi < qi
• III. Qi > qi+1
• When qi ≤ Qi < qi+1
• in this case, quantity falls within the discounted price range,
we can order in Qi units and the cost per unit will be Ci
• Then the total annual cost would be,
• TCi = CiR + (R/Qi)*S + [(Qi)/2]*hCi
• When Qi < qi
• a lot size of Qi is not eligible for discounted price as this
quantity is less than minimum quantity required for discount
• The lot size should be increased to qi. The total annual cost
will be
• TCi = CiR + (R/qi)*S + [(qi)/2]*hCi
•
• When Qi > qi+1

• In this case, ordering qi+1 units will allow us to avail discount
discounted price, whereas ordering more than qi+1 will not
give any additional discounts. The total annual cost is
• TCi = Ci+1R + (R/qi+1)*S + [(qi+1)/2]*hCi+1
• Hence we need to evaluate the appropriate case at each price
point and choose the lot size which has least annual cost
• Quantity discounts as a lever for improving supply

chain coordination
• Quantity discounts can be utilized to improve coordination
between channel members and increase overall profits
• Effective coordination can make supply chain efficient and
responsive
• Quantity discounts can be an effective coordination
mechanism if the suppliers and buyers decide upon a joint
inventory policy which will benefit both parties
• Volume based discounts
• In this case, discounts are based on quantity bought in a year
irrespective of the lot size
• In such case, the manufacturer can offer the product for Rs. 5
when quantity is below 50000 units and Rs. 4 when the quantity
is above 50000 units
• It is advantageous for the retailer to order in lot sizes of 50000
units or more and sell the product to the customer at Rs.5
• Volume based discounts are more helpful than lot size based
discounts in maximizing profits
• The key difference is that lot size based discounts are based on
quantity purchased with each order, while volume based
discounts are based on price or volume purchased for given year
• Impact of trade promotions on cycle inventory
decisions
• In trade promotion, retailers are offered discounts on the
quantity purchased
• There are no restrictions on the quantity purchased
• These schemes are offered for a temporary period
• Trade promotions are common in consumer goods industry
where different discount schemes are offered throughout the
year. The main objectives are:
• Promoting the brand through displays, price discounts (by retailers), and
advertisements
• Improving the position in the market by increasing market share
• Impact of trade promotions on cycle inventory
decisions
• Such deals will lead to forward buying, i.e. stocking up extra
goods by the retailer to take advantage of discounts and
holding the inventory for future sale
• Forward buying reduces end-consumer demand after
promotional period
• As retailer buys large quantities during promotional period, he
places fewer orders during subsequent periods resulting in
decrease in revenue for manufacturer
• If forward constitutes major portion of sales during
promotional period, manufacturer’s profit margins will
decrease
• Safety Inventory Decisions
• Safety inventory is kept for the purpose of covering
uncertainties in demand
• There are two types of uncertainties that directly affect the
inventory:
• Demand uncertainty, and
• Lead time uncertainty
• Demand uncertainty arises due to changes in consumer
behavior, market conditions and product life cycles
• Lead time uncertainty arises due to transportation delays,
production problems etc.
• Sometimes both demand and lead time uncertainty are
present
• Calculating safety inventory under demand

uncertainty
• Although sales forecasts predict approximate demand, the
actual demand often varies from the predicted demand
• Firms carry safety stock in addition to cycle inventory to
protect themselves from stock out situations arising from
demand uncertainty
• Thus, the average inventory is half the order quantity plus
safety stock
uncertainty
• Suppose the daily demand for a product is 30 units and the
lead time is 10 days
• The order quantity of 300 units can be replenished every 10
days
• The cycle inventory of 150 units is sufficient under conditions
of constant demand and stable lead time
• Suppose, there is a sudden increase in demand, say, daily
demand increases to 37 units, the stock will be sold out in 8
days. Thus the firm will face stock out for 2 days, losing
revenue and customers

uncertainty
• Under such conditions, a buffer stock must be held to satisfy
demand during periods of shortages
• In this case, a buffer stock covering 2 days can cover demand
uncertainty
• The safety stock in this case is 60 units
• The order quantity will be increased to 360 units and, and the
average inventory rises to 210 units (150 + 60)
• Calculating safety inventory under lead time
uncertainty
• Lead time uncertainty is due inconsistent order replenishment
by the supplier
• Suppose in the previous example, there is delay in delivering
the order by 2 days and order is delivered on the 12th day
• In such case, the firm will not have stock for 2 days
• The safety stock in this case is 60 units and the cycle inventory
is 210 units
• Lead time uncertainty can be quantified using standard
deviation
• Joint impact of demand and lead time uncertainty

• In business, both types of uncertainties ar5e generally present
at the same time
• Thus we need to understand the joint impact of the two
variables
• Suppose in the previous example, the actual demand is 37
units against the forecasted demand of 30 units
• Suppose the delivery of the order is delayed by 2 days
• This will result in stock out for 4 days
• So the company must hold safety stock of 120 units (60 + 60)
to protect against both uncertainties
• The order quantity will rise to 420 units (300 + 120) and the
average inventory will increase to 270 units (150 + 60 + 60)

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What is inventory ?

• “ Inventory means idle resource of any kind

• “ Inventory is a sum of value of Raw Materials,

Ensure smooth production

• MRO. MAINTENANCE, REPAIRS & OPERATING SUPPLIES:

• WORK IN PROCESS/ SEMI FINISHED GOODS.

• FINISHED GOODS.: Products ready for sale .

TOP MANAGEMENT MANUFACTURING DEPARTMENT

Higher inventory turnover Less varieties

• Marketing Manager: Likes to hold more inventory to

HINDUSTAN 10972 510.14 (4.65) 47.72 (0.43) 577.11 (5.26) 1134.98

RANBAXY 2164 181.78 (8.39) 62.30 (2.88) 180.72 (8.35) 424.85

• Based on Sales forecast & production

• Quantity in stock & pending orders.-`

• Lead Time- manufacturing, transportation

• Therefore, inventory management is one of the most

• In make-to-order production, there is no need for holding

• Balancing Supply and Demand

• Based on Sales forecast & production

• Quantity in stock & pending orders.-`

• Lead Time- manufacturing, transportation

• Internal Lead Time: From Indenting to placing order

• HOW TO REDUCE LEAD TIME ?

• Internal Lead Time:

V ITEMS E ITEMS D ITEMS

B Items Moderate Stocks Moderate Very Low

C Items High Stocks Moderate Low stock

Normal Inventory Low Level Dispose off

Compute Total Annual Consumption Value

• Lot sizing for a single product

• Lot sizing for a single product

• Lot sizing for a single product

• Lot sizing for a single product

Re-order level (ROL) =

Demand in the lead-time =

x Lead-time (L) (e.g., in weeks)

Re-order Re-order Re-order Re-order

(200 X 600) + 100 = 1300 Units

Periodic reviews Variable order

Lead-time Lead-time Lead-time

- (Actual stock) - (Pipeline stock)

In a periodic review system, the basis for

Lead-time Lead-time Lead-time

What should the next order quantity be?

• Losses incurred due to not stocking the material.

• Over stocking Cost (KO)

• Opportunity lost due to blockages of funds in

• A = Annual consumption in units

1 10000 5000 200 150000 150200

• Savings in Discount & Saving in Ordering Cost

• Saving in discount = 10000 x 100 x 0.01 = Rs 10000.00

• Total Saving Rs 13480.00

• Increase in ICC = 1000 – 365 x 100 x 0.30 = Rs 9525.00

• Saving of Rs 13480 – Rs 9525 = Rs 3955. Accept discount

• 1.Consumption patter is known

• 2. Supplies are available as and when required.

• 1.Ordering to nearest packing size.

• Internal Lead Time: From Indenting to placing order

• HOW TO REDUCE LEAD TIME ?

• Internal Lead Time:

ITC a major cigarette manufacturer maintains a

1. Mass production- reduced mfg cost

2. Improved Quality of Product