INVENTORY

MANAGEMENT
Facts on Inventory Management
 INVENTORY MANAGEMENT:
A SHORT STORY
The senior executives of “Alpha
Numerics” were having their annual
retreat to review accomplishments of
the past year and to discuss major
policy issues for the coming year. As
was the norm, the retreat was held at a
small hotel in the mountains of
Pennsylvania, well removed from the
company’s actual manufacturing facility.
INVENTORY MANAGEMENT :
A SHORT STORY

The first day’s meeting had gone well, but in

the early evening, after dinner, the
subject of inventory control and the
number of shortages that had occurred
over the past year came up for discussion.

The Vice-President of engineering

suggested that, as a solution to the
shortage problem, purchasing should order
all of the projected material requirements
a the beginning of the year.
 INVENTORY MANAGEMENT: A
SHORT STORY

The Vice-President was so taken aback by this

suggestion that, to the amazement of the others in
the room, he leaped onto the conference table and
shouted out, “Inventory is evil!” He turned to the
President and said,

“If we were to follow this suggestion, Mr. President,

do you have an extra 25,000 square feet of
warehouses space where we can store the material?”
INVENTORY MANAGEMENT: A SHORT
STORY

The President shook his head.

“and do you, Mr. Vice-President of Finance, have
an extra $5 million dollars to buy all this
material?” The Vic-President of Finance similarly
shook his head.
“And are you, Mr. Vice-President of Marketing,
going to provide me with a perfect forecast of he
products we expect to sell for he next year?”

The Vice-President of Marketing said, ”No, of

course . That would be impossible.”
 INVENTORY MANAGEMENT: A SHORT STORY

And turning to the VP of Engineering who made the

initial proposal, he said, “and you’ll keep the same
designs in he coming year without many any changes,
won’t you?” The VP of Engineering said, ”that would
be very unrealistic. ”All of the individuals in the room
then looked up to the VP of Manufacturing still
standing on the conference table and said, “we see
what you mean. Inventory is indeed evil!”
 Inventory Management: (Continued)
Learning Objectives: After this chapter, you should be
able to;
• Define the term inventory and list the major reasons for holding
inventories;
• Contrast independent and dependent demand;
• List the main requirements for effective inventory management;
• Discuss the objectives of inventory management;
• Describe the basic EOQ model and its assumptions and solve
typical problems;
• Describe the economic run size model and solve typical
problems;
• Describe the quantity discount model and solve typical problems.
Inventory Management: (Continued)

Good Inventory Management is essential to the

successful operation of most organization for a
number reasons;
The amount of money inventory represents;
The impact that inventories have on the daily
operations of an organization

Q- trigger!
What is lacking is an understanding of
* What needs to be done and
* How to do it!
Inventory Management: (Continued)
INTRODUCTION
An Inventory is a stock or sore of goods;
* Firms typically stock hundreds or thousands
of items in inventory; ranging from small things such
as pencil, paper clips, screw, nuts, and bolts to large
items such as machines, trucks, construction
equipment and airplanes.
Dependent Demand
* Items in inventory that are subassemblies
or components parts to be used in the production of
finished goods
Independent Demand
* Items are the finished goods of other end
items.
Inventory Management: (Continued)

Inventories are vital part of business. Not

only are they necessary for operations, but also they
contribute to customer satisfaction.
Q-Trigger
* A typical firm probably has about 30% of is
current assets and perhaps as much as 90% of is
working capital invested in inventory.
* A typical manufacturing firm carries
different types of inventories, including the
following;
Raw materials and purchased parts;
Partially completed goods, called work-
in-process (WIP);
Inventory Management: (Continued)
Finished goods inventories (manufacturing
firms) or merchandise (retail stores);
Replacement parts, tools and
supplies;
Goods-in-transition warehouse or
customers.
Service firms do not carry these
types of inventories, although hay do carry
inventories of supplies and equipment.
Inventory Management: (Continued)

FUNCTIONS OF INVENTORY:

To meet anticipated demand;

To smooth production requirements;
To decouple components of he production-
distribution system;
To protect against stock-outs;
To take advantage of order cycles;
To hedge against price increases or to take
advantage of quantity discounts;
To permit operations.
Inventory Management: (Continued)

Requirements for effective inventory management;

* A system to keep track of the inventory on
hand and on hand and on order;
* A reliable forecast of demand that includes
an indication of possible forecast error;
* Knowledge of lead times and lead time
variability;
* Reasonable estimates of inventory holding
costs, ordering costs, and shortage costs;
* A classification system for inventory items.
Inventory Management: (Continued)

INVENTORY COUNTING SYSTEMS

* Perpetual Inventory System – a system that
keeps track of removals from inventory
continuously, thus monitoring current levels of
each item;
* Two- bin System – two containers of inventory;
reorder when the first is empty;
* Universal Product Code – bar code printed on a
label that has information about the item to
which it is attached.
Inventory Management: (Continued)

DEMAND FORECAST AND LEAD TIME INFORMATION

Inventories are used to satisfy demand requirements,
so it is essential to have reliable estimates of the amount
and timing of demand.
COST INFORMATION
Holding or Carrying Costs – relate to physically having
items in storage. Costs include interest, insurance, taxes,
depreciation, obsolescence, deterioration, spoilage,
pilferage, breakage, and warehousing costs.
Ordering Costs – are the costs of ordering and
receiving inventory. These include determining how much is
needed, preparing invoices, inspecting goods upon arrival for
quality and quantity, and moving the goods to temporary
storage
Inventory Management: (Continued)

Q-TRIGGER
What levels should be
maintained?
When stock should be
replenished, and;
How large orders should be?
 Inventory Management: (Continued)
Assumptions of the basic EOQ model
2. Only one product is involved;
3. Annual demand requirements are known;
4. Demand is spread evenly throughout the year so
that the demand rate is reasonable constant;
5. Lead time does not vary;
6. Each order is received in a single delivery;
7. There are no quantity discounts.
 IE 1
1. A local distributor for a national tire company
expects to sell approximately 9,600 steel-belted
radial tires of a certain size and tread design next
year. Annual carrying costs are $16 per tire, and
ordering costs are $75. The distributor operates
288 days a year.
b. What is the EOQ?
c. How many times per year does the store reorder?
d. What is the length of an order cycle?
 IE 2
2. Piddling Manufacturing assembles television
sets. It purchases 3,600 black-and-white
picture tubes a year at $65 each. Ordering
costs are $31, and annual carrying costs are
20 percent of the purchase price. Compute
the optimal quantity and the total annual cost
ordering and carrying the inventory.
EOQ with Non-instantaneous
Replenishment
The basic EOQ model assumes that
each order is delivered at a single
point in time. In some instances,
however, such as when a firm is both a
producer and user or when deliveries
are spread over time, inventories tend
to build gradually instead of
instantaneously.
IE 3
3. A toy manufacturer uses a 48,000 rubber wheels per year
for its popular dump truck series. The firm makes its own
wheels, which it can produce at a rate of 800 per day.
The toy trucks are assembled uniformly over the entire
year. Carrying cost is &1 per wheel. Setup cost for a
production run of wheels is $45. The firm operates 240
days per year. Determine each of the following:
b. Optimal run size
c. Minimum total annual cost for carrying and setup
d. Cycle time for the optimal run size
e. Run time
Quantity Discounts are price reductions for large orders offered
to customers to induce them to buy in large quantities.
• If quantity discounts are offered, the customer must weigh the
potential benefits of reduced purchase price and fewer orders that will
result from buying in large quantities against the increase in carrying
costs caused by higher average inventories.
• The buyer’s goal with quantity discounts is to select the order quantity
that will minimize total cost, where total cost is the sum of carrying
cost, ordering cost, and purchasing cost.
IE 4
4. The maintenance department of a large hospital
uses about 816 cases of liquid cleanser annually.
Ordering costs are $12, carrying costs are $4 per case
a year, and the new price schedule indicates that
orders of less than 50 cases will cost $20 per case, 50
to 79 cases will cost $18 per case, 80 to 99 cases will
cost $17 per case, and larger orders will costs $16 per
case. Determine the optimal order quantity and the total
cost.
 Inventory Management: Illustrative
Examples
When carrying costs are expressed as a percentage of price,
determine the best purchase quantity with the following
procedure;
• Beginning with the lowest price, compute the EOQs for each
price range until a feasible EOQ is found;
• If the EOQ for the lowest price is feasible, it is the optimal
order quantity. If the EOQ is not the lowest price range,
compare the total cost at the price break for all lower prices
with the total cost of the largest feasible EOQ. The quantity
that yields the lowest total cost is the optimum.
IE 5
• Surge Electric uses 4,000 toggle
switches a year. Switches are priced
as follows: 1 to 499, 90 cents each;
500 to 999, 85 cents each; and 1,000
or more, 82 cents of purchase prices
per unit on an annual basis.
Determine the optimal order quantity
and the total annual cost.
When to Reorder with EOQ Ordering
EOQ models answer the question of how much
to order, but not the question of when to
order. The latter is the function of models
that identify the reorder point (ROP) in
terms of quantity: the reorder point occurs
when the quantity on hand drops to a
predetermined amount. The amount that
generally includes expected demand during
lead time and perhaps an extra cushion of
stock, which serves to reduce the
probability of experiencing a stock-out
during lead time.
The basic concern of the manager is to place an
order when the amount of inventory on hand is
sufficient to satisfy demand during the time it
takes to receive that order. There are four
determinants of the reorder point quantity;
2. The rate of demand;
3. The length of lead time;
4. The extent of demand and/or lead time
variability;
5. The degree of stock-out risk acceptable to
management.
 IE 6

6. Tingly takes Two-a-Day vitamins, which are delivered

to his home by a route man seven days after an
order is called in. At what point should Tingly
telephone his order in?

Safety Stock – a stock that is held in excess of

expected demand rate due to variable
demand rate and/or lead time.
Service Level – Probability that demand will not exceed
supply during lead time.
The amount of safety stock that is
appropriately for a given situation
depends on the following factors;
2. The average demand rate and
average lead time.
3. Demand and lead time variability.
4. The desired service level.
 IE 7
7. Suppose that the manager of a construction supply
house determined from the historical records that
the lead time demand for sand averages 50 tons. In
addition, suppose the manager determined that
demand during lead time could be described by a
normal distribution that has a mean of 50 tons and
a standard deviation of 5 tons. Answer these
questions, assuming that the manager is willing to
accept a stock-out risk of no more than 3 percent.
b. What value of z is appropriate?
c. How much safety stock should be held?
d. What reorder point should be used?
 IE 8
8. A restaurant uses an average of 50 jars of a special
sauce each week. Weekly usage of sauce has a
standard deviation of 3 jars. The manager is willing
to accept no more than a 10 percent risk of a stock-
out during lead time, which is two weeks. Assume
the distribution of usage is normal.
b. Which formula is appropriate to this situation?
c. Determine the value of z.
d. Determine the ROP.
 IE 9

1. The housekeeping department of a motel uses

approximately 400 washcloths per day. The actual
amount tends to vary with the number of guests on
any given night. Usage can be approximated by a
normal distribution that has a mean of 400 and a
standard deviation of 9 washcloths per day. A linen
supply company delivers towels and washcloths with a
lead time of three days. If the motel policy is to
maintain a stock-out risk of 2 percent, what is the
minimum number of washcloths that must be on hand
at reorder time, and how much of that amount can be
considered safety stock?
IE 10

2. The motel in the preceding example uses

approximately 600 bars of soap each day, and
this tends not to vary by more than a few bars
either way. Lead time for soap delivery is
normally distributed with a mean of six days
and standard deviation of two days. A service
level of 90 percent is desired. Find the ROP.
IE 10

3. The motel replaces broken glasses at a

rate of 25 per day. In the past, this
quantity has tended to vary normally and
have a standard deviation of 3 glasses per
day. Glasses are ordered from a Cleveland
supplier. Lead time is normally distributed
with an average of 10 days and a standard
deviation of 2 days. What ROP should be
used to achieve a service level of 95
percent?
 IE 11

4. The manager of a store that sells office supplies has decided

to set an annual service level of 96 percent for a certain
model of telephone answering equipment. The store sells
approximately 300 of this model a year. Holding cost is $5
per unit annually, ordering cost is $25, σdLT= 7.
stock of the chemical?

a. What average number of units short per year will be

consistent with the specified annual service level?
b. What average number of units short per cycle will
provide the desired annual service level?
c. What lead time service level is necessary for the 96
percent annual service level?
IE 13

5. A lab orders a number of chemicals from the same supplier

every 30 days. Lead time is 5 days. The assistant manager
of the lab must determine how much of one of these
chemicals to order. A check of stock revealed that eleven
25-ml jars are on hand. Daily usage of the chemical is
approximately normal with a mean of 15.2 ml per day and
standard deviation of 1.6 ml per day. The desired service
level for this chemical is 95 percent.
How many bottles of the chemical should be ordered?
What is the average amount of safety