Inventory Management

What Is Inventory?

• Stock of items kept to meet future demand

• Purpose of inventory management

• how many units to order
• when to order

13-2
 Types of Inventory

▶ Raw material
▶ Purchased but not processed
▶ Work-in-process (WIP)
▶ Undergone some change but not completed
▶ A function of cycle time for a product
▶ Maintenance/repair/operating (MRO)
▶ Necessary to keep machinery and processes productive
▶ Finished goods
▶ Completed product awaiting shipment

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Demand Types
Independent demand – the
demands for various items are
unrelated to each other
• For example, a workstation may
produce many parts that are
unrelated but meet some external
demand requirement
Dependent demand – the need for
any one item is a direct result of the
need for some other item
• Usually a higher-level item of
which it is part
 Inventory Costs

• Carrying cost
• cost of holding an item in inventory
• Ordering cost
• cost of replenishing inventory
• Shortage cost
• temporary or permanent loss of sales when demand cannot be met

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 Inventory Control Systems

• Continuous system (fixed-order-quantity)

• constant amount ordered when inventory declines to predetermined
level
• Periodic system (fixed-time-period)
• order placed for variable amount after fixed passage of time

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 Continuous system Continuous system
Fixed-Order Quantity Fixed-Time Period

• Inventory remaining must be – Counting takes place only at the

continually monitored end of the review period
• Has a smaller average – Has a larger average inventory
inventory – Favors less expensive items
• Favors more expensive – Is sufficient for less-important
items items
• Is more appropriate for – Requires less time to maintain
important items – Is less expensive to implement
• Requires more time to
maintain – but is usually
more automated
• Is more expensive to
implement
Comparison
 ABC Classification

• Class A
• 5 – 15 % of units
• 70 – 80 % of value
• Class B
• 30 % of units
• 15 % of value
• Class C
• 50 – 60 % of units
• 5 – 10 % of value

13-9
 ABC Classification

PART UNIT COST ANNUAL USAGE

1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120

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 ABC Classification

TOTAL % OF TOTAL % OF TOTAL

PART VALUE VALUE QUANTITY % CUMMULATIVE
9 $30,600 35.9 6.0 6.0
8 16,000 18.7 5.0 11.0
2 14,000 16.4 4.0
A 15.0
1 5,400 6.3 9.0 24.0
4 4,800 5.6 6.0 B 30.0
3 3,900 4.6 13.0 43.0
6 3,600 4.2 18.0 61.0
5 3,000 3.5 13.0 71.0
10 2,400 2.8 12.0 C 83.0
7 1,700 2.0 17.0 100.0
$85,400

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 ABC Classification

% OF TOTAL % OF TOTAL
CLASS ITEMS VALUE QUANTITY
A 9, 8, 2 71.0 15.0
B 1, 4, 3 16.5 28.0
C 6, 5, 10, 7 12.5 60.0

Example 10.1
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 Economic Order Quantity
(EOQ) Models
• EOQ
• continuous inventory system
• optimal order quantity that will minimize total inventory costs
• Basic EOQ model
• Production quantity model
• Order cycle
• the time between receipt of orders in an inventory system

13-13
 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
• Only variable cost is holding and ordering cost
• Quantity discounts are not allowed

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Inventory Order Cycle

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 EOQ Cost Model

Co - cost of placing order D - annual demand

Cc - annual per-unit carrying cost Q - order quantity

CoD
Annual ordering cost =
Q
CcQ
Annual carrying cost =
2
CoD CcQ
Total cost = +
Q 2

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 EOQ Cost Model

Deriving Qopt Proving equality of

costs at optimal point
CoD CcQ
TC = +
Q 2 CoD CcQ
=
TC Co D Cc Q 2
= – Q2 +
Q 2
2CoD
C0D Cc Q2 =
Cc
0 = – Q2 +
2
2CoD
2CoD Qopt =
Qopt = Cc
Cc

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EOQ Cost Model

13-18
 EOQ Example

Cc = $0.75 per gallon Co = $150 D = 10,000 gallons

2CoD CoD CcQ

Qopt = TCmin = +
Cc Q 2

Qopt = TCmin =

Qopt = TCmin =

Orders per year = D/Qopt Order cycle time =

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 EOQ Example

Cc = $0.75 per gallon Co = $150 D = 10,000 gallons

2CoD CoD CcQ

Qopt = TCmin = +
Cc Q 2
2(150)(10,000) (150)(10,000) (0.75)(2,000)
Qopt = (0.75) TCmin = 2,000 + 2

Qopt = 2,000 gallons TCmin = $750 + $750 = $1,500

Orders per year = D/Qopt Order cycle time = 311 days/(D/Qopt)

= 10,000/2,000 = 311/5
= 5 orders/year = 62.2 store days

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 Production Quantity Model

• 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,
the production rate
• d - daily rate at which inventory is demanded

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Production Quantity Model

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 Production Quantity Model

p = production rate d = demand rate

Maximum inventory level = Q - Q d

p

=Q1- d 2CoD
p
Qopt = d
Q d Cc 1 -
Average inventory level = 1- p
2 p

CoD CcQ d
TC = Q + 2 1 - p

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 Production Quantity Model

Cc = $0.75 per gallon Co = $150 D = 10,000 gallons

d = 10,000/311 = 32.2 gallons per day p = 150 gallons per day

2CoD
Qopt = =
Cc 1 - d
p

CoD CcQ d
TC = Q + 2 1 - p =

Q
Production run = =
p

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 Production Quantity Model

D
Number of production runs = =
Q

d
Maximum inventory level = Q 1 - =
p

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 Production Quantity Model

Cc = $0.75 per gallon Co = $150 D = 10,000 gallons

d = 10,000/311 = 32.2 gallons per day p = 150 gallons per day

2CoD 2(150)(10,000)
Qopt = = = 2,256.8 gallons
Cc 1 - d 0.75 1 -
32.2
p 150

CoD CcQ d
TC = Q + 2 1 - p = $1,329

Q 2,256.8
Production run = = = 15.05 days per order
p 150

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 Production Quantity Model

D 10,000
Number of production runs = = = 4.43 runs/year
Q 2,256.8

d 32.2
Maximum inventory level = Q 1 - = 2,256.8 1 -
p 150
= 1,772 gallons

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 Reorder Point

• Inventory level at which a new order is placed

R = dL
where

d = demand rate per period

L = lead time

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 Reorder Point

Demand = 10,000 gallons/year

Store open 311 days/year
Daily demand =
Lead time = L = 10 days

R = dL =

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 Reorder Point

Demand = 10,000 gallons/year

Store open 311 days/year
Daily demand = 10,000 / 311 = 32.154
gallons/day
Lead time = L = 10 days

R = dL = (32.154)(10) = 321.54 gallons

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 Safety Stock
• Safety stock
• buffer added to on hand inventory during lead time
• Stockout
• an inventory shortage
• Service level
• probability that the inventory available during lead time will meet
demand
• P(Demand during lead time <= Reorder Point)

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 Quantity Discounts

Price per unit decreases as order

quantity increases
CoD CcQ
TC = + + PD
Q 2
where
P = per unit price of the item
D = annual demand

13-32
Quantity Discount Model

13-33
 Quantity Discount

QUANTITY PRICE
Co = $2,500
1 - 49 $1,400 Cc = $190 per TV
50 - 89 1,100 D = 200 TVs per year
90+ 900

2CoD
Qopt = =
Cc

For Q = CoD CcQopt

TC = + 2 + PD =
Qopt

For Q = 90 CoD CcQ

TC = + 2 + PD =
Q

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 Quantity Discount

QUANTITY PRICE
Co = $2,500
1 - 49 $1,400 Cc = $190 per TV
50 - 89 1,100 D = 200 TVs per year
90+ 900

2CoD 2(2500)(200)
Qopt = = = 72.5 TVs
Cc 190

For Q = 72.5 CoD CcQopt

TC = + 2 + PD = $233,784
Qopt

For Q = 90 CoD CcQ

TC = + 2 + PD = $194,105
Q

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