What is Inventory?

Definition--The stock of any item or resource used in an organization

Raw materials Finished products Component parts Supplies Work in process

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Inventory System Purpose

The set of policies and controls that determine what inventory levels should be maintained, when stock should be replenished, and how large orders should be

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Purposes of Inventory
1. To maintain independence of operations

2. To meet variation in product demand

3. To allow flexibility in production scheduling

4. To provide a safeguard for variation in raw material delivery time

5. To take advantage of economic purchaseorder size
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Inventory Costs

Holding (or carrying) costs Setup (or production change) costs Ordering costs Shortage (or backlog) costs
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Independent vs. Dependent Demand

Independent Demand (Demand not related to other items) Dependent Demand (Derived/Calculated)

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Classifying Inventory Models

Fixed-Order Quantity Models

Event triggered Make exactly the same amount Use re-order point to determine timing

Fixed-Time Period Models

Time triggered Count the number needed to re-order

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Inventory Control

Inventory
Fixed Order Quantity Models
Constant Demand EOQ w/ Quantity Discounts Calculate Total costs Select Q and find R Uncertainty in Demand

Inventory Models
Single Period Models

Fixed Time Period Models

Simple EOQ Find the EOQ and R

EOQ w/usage Determine p and d Find the EOQ and R

Fixed-Order Quantity Models

Assumptions

Demand for the product is constant and uniform throughout the period Lead time (time from ordering to receipt) is constant Price per unit of product is constant Inventory holding cost is based on average inventory Ordering or setup costs are constant All demands for the product will be satisfied (No back orders are allowed)
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EOQ Model--Basic Fixed-Order Quantity Model

Inventory Level

Q R

L
Time
R = Reorder point Q = Economic order quantity L = Lead time
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Basic Fixed-Order Quantity Model

Total Annual Cost =
Annual Annual Purchase + Ordering + Cost Cost Annual Holding Cost

Derive the Total annual Cost Equation, where:

TC - Total annual cost D - Annual demand (and d-bar = average daily demand = D/365) C - Cost per unit Q - Order quantity S - Cost of placing an order or setup cost R - Reorder point L - Lead time H - Annual holding and storage cost per unit of inventory
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Cost Minimization Goal

C O S T

Total Cost Holding Costs Annual Cost of Items (DC) Ordering Costs
QOPT Order Quantity (Q)

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Deriving the EOQ

Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero
2DS 2(Annual Demand)(Or der or Setup Cost) QOPT = = H Annual Holding Cost
Reorder Point, R = dL
_

d = average demand per time unit L = Lead time (constant)

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EOQ Example
Annual Demand (D) = 1,000 units Days per year considered in average daily demand = 365 Cost to place an order (S) = $10 Holding cost per unit per year (H) = $2.40 Lead time (L) = 7 days Cost per unit (C) = $15

Determine the economic order quantity and the reorder point.

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Solution
Q OPT = 2DS = H 2(1,000 )(10) = 91.287 units 2.40
91 or 92 units???

1,000 units / year d = = 2.74 units / day 365 days / year Why do we round up?
_

R eorder point, R = d L = 2.74units / day (7days) = 19.18 or 20 units

When the inventory level reaches 20, order 91 units.

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Problem

Retailer of Satellite Dishes

D = 1000 units S = $ 25 H = $ 100

How much should we order?

What are the Total Annual Stocking Costs?

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EOQ with Quantity Discounts

What if we get a price break for buying a larger quantity? To find the lowest cost order quantity:

Since C changes for each price-break, H=iC Where, i = percentage of unit cost attributed to carrying inventory and , C = cost (or price) per unit Find the EOQ at each price break. Identify relevant and feasible order quantities. Compare total annual costs The lowest cost wins.
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EOQ with Quantity Discounts Example

Copper may be purchased for $ .82 per pound for up to 2,499 pounds $ .81 per pound for 2,500 to 5,000 pounds $ .80 per pound for orders greater than 5,000 pounds Demand (D) = 50,000 pounds per year Holding costs (H) are 20% of the purchase price per unit

Ordering costs (S) = $30

How much should the company order to minimize total costs?

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Problem 28

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(Costs in $,000)

Feasible 42 <2500 <2500 - 4999 41

>5000

40 0 20 40 60 80 100

(Order Quantity 100's of units)

Inventory Control

Inventory
Fixed Order Quantity Models
Constant Demand Uncertainty in Demand

Inventory Models
Single Period Models

Fixed Time Period Models

Find the L Find Z Safety Stock Find the EOQ and R

What if demand is not Certain?

Use safety stock to cover uncertainty in demand. Given: service probability which is the probability demand will NOT exceed some amount. The safety stock level is set by increasing the reorder point by the amount of safety stock. The safety stock equals zL where, L = the standard deviation of demand during the lead time.
For example for a 5% chance of running out z 1.65
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Problem
Annual Demand = 25,750 or 515/wk @ 50 wks/year Annual Holding costs = 33% of item cost ($10/unit) Ordering costs are $250.00 d = 25 per week Leadtime = 1 week Service Probability = 95% Find: a.) the EOQ and R b.) annual holding costs and annual setup costs c.) Would you accept a price break of $50 per order for lot sizes that are larger than 2000?
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Inventory Control

Inventory
Fixed Order Quantity Models

Inventory Models
Single Period Models

Fixed Time Period Models

Current Inventory Find theT+L Find Z

Find order quantity (q)

Fixed-Time Period Models

Check the inventory every review period and then order a quantity that is large enough to cover demand until the next order will come in.

The model assumes uncertainty in demand with safety stock added to the order quantity.
More exposure to variability than fixed-order models
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Fixed-Time Period Model with Safety Stock Formula

q = Average demand + Safety stock - Inventory currently on hand

q = d(T + L) + Z T + L - I Where : q = quantity to be ordered T = the number of days between reviews L = lead time in days d = forecast average daily demand z = the number of standard deviations for a specified service probabilit y T + L = standard deviation of demand over thereview and lead time I = currentinventory level (includes items on order)
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Determining the Value of T+L

T +L =
T +L i 1

di

Since each day is independen t and d is constant,

T + L = (T + L) d

The standard deviation of a sequence of random events equals the square root of the sum of the variances.
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Example of the Fixed-Time Period Model

Given the information below, how many units should be ordered?

Average daily demand for a product is 20 units. The review period is 30 days, and lead time is 10 days. Management has set a policy of satisfying 96 percent of demand from items in stock. At the beginning of the review period there are 200 units in inventory. The daily demand standard deviation is 4 units.

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Example of the Fixed-Time Period Model: Solution

T+ L =
(T + L) d 2 =

30 + 10 4 2 = 25.298

q = d(T + L) + Z T + L - I q = 20(30 + 10) + (1.75)(25. 298) - 200 q = 800 44.272 - 200 = 644.272, or 645 units
So, to satisfy 96 percent of the demand, you should place an order of 645 units at this review period.
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Problem
A pharmacy orders antibiotics every two weeks (14 days). the daily demand equals 2000 the daily standard deviation of demand = 800 lead time is 5 days service level is 99 % present inventory level is 25,000 units

What is the correct quantity to order to minimize costs?

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Inventory Control

Inventory
Fixed Order Quantity Models
Constant Demand Uncertainty in Demand

Inventory Models
Single Period Models

Fixed Time Period Models

Single Period Model for items w/obsolescence (newsboy problem)

For a single purchase
Amount to order is when marginal profit (MP) is equal to marginal loss (ML). Adding probabilities (P = probability of that unit being sold) for the last unit ordered we want P(MP)(1-P)ML or P ML /(MP+ML)

Increase order quantity as long as this holds.

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SinglePeriod Model (Text Prob. #21)

Famous Alberts Cookie King
Demand Probability of (dozen) Demand
1,800
2,000 2,200 2,400 2,600 2,800 3,000
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0.05
0.10 0.20 0.30 0.20 0.10 0.05

Each dozen sells for $0.69 and costs $0.49 with a salvage value of $0.29.

How many cookies should he bake?

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ABC Classification System

Items kept in inventory are not of equal importance in terms of:

dollars invested profit potential

% of $ Value 30
0

60

A B C

sales or usage volume

stock-out penalties

% of Use

30

60

So, identify inventory items based on percentage of total dollar value, where A items are roughly top 15 %, B items as next 35 %, and the lower 50% are the C items.
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Inventory Accuracy and Cycle Counting

Inventory accuracy

Do inventory records agree with physical count?

Cycle Counting
Frequent counts When? (zero balance, backorder, specified level of activity, level of important item, etc.)

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