I nventory Management

Amazon.com
Amazon.com started as a virtual
retailer no inventory, no
warehouses, no overhead; just
computers taking orders to be filled
by others
Growth has forced Amazon.com to
become a world leader in
warehousing and inventory
management
Inventory
One of the most expensive assets of
many companies representing as
much as 50% of total invested
capital
Operations managers must balance
inventory investment and customer
service
What Is Inventory?
Stock of items kept to meet future
demand
Working Capital
Def. - A physical resource that a firm
holds in stock with the intent of selling it
or transforming it into a more valuable
state.

Inventory by Nature of Material
Raw Materials
Works-in-Process
Finished Goods
Maintenance, Repair and Operating (MRO)
Inventory (Uses of Material)
Transaction Inventory
Speculative Inventory
Precautionary Inventory
Functional Classification Of
Inventory
Based on utility, all inventory can be in one or
more of the following categories
Working stock
Safety stock
Anticipation stock
Pipeline stock
Decoupling stock
Psychic stock
Inventory Costs
Carrying cost
cost of holding an item in inventory
Ordering /Procurement cost
cost of replenishing inventory
Shortage cost
temporary or permanent loss of sales
when demand cannot be met
Procurement Costs
Order processing
Shipping
Handling
Carrying Costs
Working Capital (opportunity) costs
Inventory risk costs( spoilage, breakage,
detoriation,obsolescence)
Space costs
Inventory service costs
Insurance & Taxes
Out-of-Stock Costs
Lost sales cost
Back-order cost

Inventory Management
If company holds too little Inventory
too frequent ordering
loss of quantity discount
higher transportation charges
likely shortage in future
If company holds too much Inventory
carrying/holding charges
storage
obsolescence, depreciation
Involvement of working capital


Objectives of Inventory
Managment
1) Maximize the level of customer service
by avoiding under stocking.(How much to
order?)
2) Promote efficiency in production and
purchasing by minimizing the cost of
providing an adequate level of customer
service.(When to order?)
Design of Inventory Mgmt.
Systems: Micro Issues
Order Quantity
Economic Order Quantity
Order Timing
Reorder Point
Inventory Systems
Single-Period Inventory Model
One time purchasing decision (Example:
vendor selling t-shirts at a football game)
Seeks to balance the costs of inventory
overstock and under stock

Multi-Period Inventory Models
Fixed-Order Quantity Models
Event triggered (Example: running out of
stock)
Fixed Order Quantity Systems
Behavior of Economic Order Quantity
(EOQ) Systems
Determining Order Quantities
Determining Order Points
Behavior of EOQ Systems
As demand for the inventoried item occurs,
the inventory level drops
When the inventory level drops to a critical
point, the order point, the ordering process is
triggered
The amount ordered each time an order is
placed is fixed or constant
When the ordered quantity is received, the
inventory level increases
. . . more
Basic Fixed-Order Quantity Model
and Reorder Point Behavior
R = Reorder point
Q = Economic order quantity
L = Lead time
L
L
Q Q Q
R
Time
Number
of units
on hand
1. You receive an order quantity Q.
2. Your start using
them up over time.
3. When you reach down to a level
of inventory of R, you place your next
Q sized order.
4. The cycle then repeats.
Inventory Order Cycle
Demand
rate
Time
Lead
time
Lead
time
Order
placed
Order
placed
Order
receipt
Order
receipt
I
n
v
e
n
t
o
r
y

L
e
v
e
l

Reorder point, R
Order quantity, Q
0
Determining Order Quantities
Basic EOQ
EOQ for Production Lots
EOQ with Quantity Discounts
Assumptions of Basic
EOQ Model
Demand is known with certainty and
is constant over time
No shortages are allowed
Lead time for the receipt of orders is
constant
Order quantity is received all at once
Quantity Discount does not exist
Average Invenory is half of total
inventory
EOQ Cost Model
C
o
- cost of placing order D - annual demand
C
c
- annual per-unit carrying cost Q - order quantity
Annual ordering cost =
C
o
D
Q
Annual carrying cost =
C
c
Q
2
Total cost = +
C
o
D
Q
C
c
Q
2
EOQ Cost Model
Proving equality of costs at optimal point
=
C
o
D
Q
C
c
Q
2
Q
2
=
2C
o
D
C
c
Q
opt
=
2C
o
D
C
c
Cost Minimization Goal
Ordering Costs
Holding
Costs
Order Quantity (Q)
C
O
S
T
Annual Cost of
Items (DC)
Total Cost
Q
OPT
By adding the item, holding, and ordering costs
together, we determine the total cost curve, which in
turn is used to find the Q
opt
inventory order point that
minimizes total costs
Example: Electronic Village stocks and sells
a particular brand of personal computer. It
costs the store Rs450 each time it places an
order with the manufacturer for the personal
computers. The annual cost of carrying the
PCs in inventory is Rs170. The store
manager estimates that annual demand for
the PCs will be 1200 units.
Determine the optimal order quantity and the
total minimum inventory cost.

Example: Basic EOQ
Zartex Co. produces fertilizer to sell to
wholesalers. One raw material calcium nitrate
is purchased from a nearby supplier at $22.50
per ton. Zartex estimates it will need 5,750,000
tons of calcium nitrate next year.
The annual carrying cost for this material is
40% of the acquisition cost, and the ordering
cost is $595.
a) What is the most economical order
quantity?
b) How many orders will be placed per year?
c) How much time will elapse between orders?
Example 10.2
Electronic Village stocks and sells a particular
brand of personal computer. It costs the store
Rs450 each time it places an order with the
manufacturer for the personal computers. The
annual cost of carrying the PCs in inventory is
Rs170. The store

manager estimates that annual demand for the
PCs will be 1200 units. Determine the optimal
order quantity and the total minimum inventory
cost.

Reorder Point
Quantity to which inventory is allowed to drop
before replenishment order is made

Need to order EOQ at the Reorder Point:

ROP = D X LT
D = Demand rate per period
LT = lead time in periods

Example
The I-75 Discount Carpet Store is open
311 days per year. If annual demand is
10,000 yards of Super Shag Carpet and
the lead time to receive an order is 10
days, determine the reorder point for
carpet.


Example
Item X is a standard item stocked in a companys
inventory of component parts. Each year the firm,
on a random basis, uses about 2000 of item X,
which costs Rs25 each. Storage costs, which
include insurance and cost of capital, amount to
Rs5 per unit of average inventory. Every time an
order is placed for more item X, it costs Rs10.
(a) Whenever item X is ordered, what should the order size
be?
(b) What is the annual cost for ordering item X?
(c) What is the annual cost for storing item X?

Production Quantity
Model(EOQ for lot)
An inventory system in which an order is
received gradually, as inventory is
simultaneously being depleted
Non-instantaneous receipt model
assumption that Q is received all at once is relaxed
p - daily rate at which an order is received over
time, production rate
d - daily rate at which inventory is demanded
Assumptions of Production
Quantity Model
Demand is known with certainty and is constant
over time
No safety stock
No shortages are allowed
Lead time for the receipt of orders is constant
Goods are supplied (p)at and consumed (d)at
uniform rate,
Supply rate is greater than usage rate.
Quantity Discount does not exist
Production Quantity Model
(cont.)
p = supply rate d = consumption rate
Maximum inventory level =( p- d)

= Q 1 -
Q
p
d
p
Average inventory level = 1 -
Q
2
d
p
Annual carrying cost= 1 -
Q
2
d
p
C
c
Production Quantity Model
(cont.)
p = supply rate d = consumption rate
Annual ordering cost=


TC = + 1 -
d
p
C
o
D
Q
C
c
Q
2
Q
opt
=
2C
o
D

C
c
1 -
d
p
C
o
D
Q
Production Quantity Model
(cont.)
Q(1-d/p)
Inventory
level
(1-d/p)
Q
2
Time
0
Order
receipt period
Begin
order
receipt
End
order
receipt
Maximum
inventory
level
Average
inventory
level
(p-d)
Production Quantity Model:
Example
C
c
= $0.75 per yard C
o
= $150 D = 10,000 yards
d = 10,000/311 = 32.2 yards per day p = 150 yards per day
Q
opt
= = = 2,256.8 yards
2C
o
D

C
c
1 -
d
p
2(150)(10,000)

0.75 1 -
32.2
150
TC = + 1 - = $1,329
d
p
C
o
D
Q
C
c
Q
2
Production run = = = 15.05 days per order
Q
p
2,256.8
150
Production Quantity Model:
Example (cont.)
Number of production runs = = = 4.43 runs/year
D
Q
10,000
2,256.8
Maximum inventory level =Q 1 - = 2,256.8 1 -

= 1,772 yards
d
p
32.2
150
Example
I-75 Outlet Store has its own manufacturing facility in
which it produces Super Shag carpet. The ordering
cost is the cost of setting up the production process
to make Super Shag carpet. Estimated annual
demand is 10,000 meters of carpet, and annual
carrying cost is Rs0.75 per meter. The manufacturing
facility operates the same days the store is open
(i.e., 311 days) and produces 150 meters of the
carpet per day. Determine the optimal order size,
total inventory cost, the length of time to receive an
order, the number of orders per year, and the
maximum inventory level.


Example: EOQ for Production Lots
Highland Electric Co. buys coal from
Cedar Creek Coal Co. to generate electricity.
CCCC can supply coal at the rate of 3,500
tons per day for $10.50 per ton. HEC uses the
coal at a rate of 800 tons per day and operates
365 days per year.HECs annual carrying cost
for coal is 20% of the acquisition cost, and the
ordering cost is $5,000.
a) What is the economical production lot size?
b) What is HECs maximum inventory level for coal?
Quantity Discounts
Price per unit decreases as order
quantity increases
TC = + + PiD
C
o
D
Q
C
c
Q
2
where
P i=
PO= if Q<q1
P1= if q1<Q<q2
P2= if q2<Q<q3
.
.
.
P n-1= if Q>=qn
Quantity Discounts
Price per unit decreases as order
quantity increases
where
P i=
PO= if Q<q1
P1= if q1<Q<q2
P2= if q2<Q<q3
.
.
.
P n-1= if Q>=qn
2C
o
D

C
c
Qoptm=
Where
C
c
= I *Pi
I =carrying cost %
Quantity Discount Model (cont.)
Q
opt
Carrying cost
Ordering cost
I
n
v
e
n
t
o
r
y

c
o
s
t

(
$
)

Q(d
1
) = 100 Q(d
2
) = 200
TC (d
2
= $6 )
TC (d
1
= $8 )
TC = ($10 )
ORDER SIZE PRICE
0 - 99
$10
100 199 8 (d
1
)
200+ 6 (d
2
)
Price-Break Example Problem Data
(Part 1)
A company has a chance to reduce their inventory
ordering costs by placing larger quantity orders using
the price-break order quantity schedule below. What
should their optimal order quantity be if this company
purchases this single inventory item with an e-mail
ordering cost of Rs4, a carrying cost rate of 2% of the
inventory cost of the item, and an annual demand of
10,000 units?
Order Quantity(units) Price/unit(Rs)
0 to 2,499 Rs1.20
2,500 to 3,999 1.00
4,000 or more .98
Price-Break Example Solution (Part 2)
units 1,826 =
0.02(1.20)
4) 2(10,000)(
=
C
2DC
= Q
c
OPT
0
Annual Demand (D)= 10,000 units
Cost to place an order (S)= Rs4
First, plug data into formula for each price-break value of C
units 2,000 =
0.02(1.00)
4) 2(10,000)(
=
C
2DC
= Q
c
o
OPT
units 2,020 =
0.02(0.98)
4) 2(10,000)(
=
C
2DC
= Q
c
o
OPT
Carrying cost % of total cost (i)= 2%
Cost per unit (C) = $1.20, $1.00, $0.98
Interval from 0 to 2499,
the Q
opt
value is feasible
Interval from 2500-3999, the
Q
opt
value is not feasible
Interval from 4000 & more,
the Q
opt
value is not feasible
Next, determine if the computed Q
opt
values are feasible or not
Price-Break Example Solution (Part 4)
c o i C
2
Q
+ C
Q
D
+ DP = TC
Next, we plug the true Q
opt
values into the total cost annual
cost function to determine the total cost under each price-
break
TC(0-2499)=(10000*1.20)+(10000/1826)*4+(1826/2)(0.02*1.20)
= Rs12,043.82
TC(2500-3999)= Rs10,041
TC(4000&more)= Rs9,949.20
Finally, we select the least costly Q
opt
, which is this problem
occurs in the 4000 & more interval. In summary, our optimal
order quantity is 4000 units
Quantity Discount: Example
A hardware store procures and sells hardware items.Information
on a item s give here:
Expected annual sales=8,000 units
Ordering cost=Rs.180 per order
Holding cost=10% of the average inventory value.
Items can be purchased to the following schedule:
LOT SIZE UNIT PRICE(In
Rs.)
1-999 Rs 22.00
1,000-1,499 Rs.20.00
1,500-1999 Rs.19.00
2,000 and above Rs. 18.50
We are require to determine the best order size.