1

Inventory Management
and
Control
 2

AMAZON.com

• Jeff Bezos, in 1995, started AMAZON.com as

a “virtual” retailer – no inventory, no
warehouses, no overhead; just a bunch of
computers.
• Growth forced AMAZON.com to excel in
inventory management!
• AMAZON is now a worldwide leader in
warehouse management and automation.
 3

Order Fulfillment at AMAZON (1 of 2)

1. You order items; computer assigns your order to
distribution center [closest facility that has the
product(s)]
2. Lights indicate products ordered to workers who
retrieve product and reset light.
3. Items placed in crate with items from other orders,
and crate is placed on conveyor. Bar code on item
is scanned 15 times – virtually eliminating error.
 4

Order Fulfillment at AMAZON (2 of 2)

4. Crates arrive at a central point where items are

boxed and labeled with new bar code.
5. Gift wrapping done by hand (30 packages per
hour)
6. Box is packed, taped, weighed and labeled
before leaving warehouse in a truck.
7. Order appears on your doorstep within a week
 5

Inventory
Defined
• Inventory is the stock of any item or resource
held to meet future demand and can include: raw
materials, finished products, component parts,
supplies, and work-in-process
 6

Inventory Classifications

Inventory

Process Number & Demand

Other
stage Value Type

Raw Material A Items

Independent Maintenance
WIP B Items
Dependent Operating
Finished Goods C Items
 7

Independent vs. Dependent Demand

Independent Demand (Demand for the final end-product
or demand not related to other items; demand created by
external customers)
Finished Independent demand is uncertain
product A Dependent demand is certain
Dependent
B(4) C(2) Demand
(Derived demand
for component
D(1) E(2)
E(1 B(1) E(3) parts,
)
subassemblies,
raw materials, etc-
Component parts used to produce
final products)
 8

Inventory Models
• Independent demand – finished goods, items that
are ready to be sold
– E.g. a computer
• Dependent demand – components of finished
products
– E.g. parts that make up the computer
 9

Types of Inventories (1 of 2)

• Raw materials & purchased parts

• Partially completed goods called
work in progress
• Finished-goods inventories (manufacturing
firms)
or merchandise
(retail stores)
 10

Types of Inventories (2 of 2)
• Replacement parts, tools, & supplies
• Goods-in-transit to warehouses or customers
 11

The Material Flow Cycle (1 of 2)

 12

The Material Flow Cycle (2 of 2)

Wait Move Queue Setup Run
Input Time Time Time Time Time Output

Cycle Time

Run time: Job is at machine and being worked on

Setup time: Job is at the work station, and the work station is
being "setup."
Queue time: Job is where it should be, but is not being
processed because other work precedes it.
Move time: The time a job spends in transit
Wait time: When one process is finished, but the job is waiting
to be moved to the next work area.
Other: "Just-in-case" inventory.
 13

Performance Measures

• Inventory turnover (the ratio of annual cost

of goods sold to average inventory
investment)
• Days of inventory on hand (expected
number of days of sales that can be supplied
from existing inventory)
 14

Functions of Inventory (1 of 2)
1. To “decouple” or separate various parts of the
production process, ie. to maintain independence of
operations
2. To meet unexpected demand & to provide high
levels of customer service
3. To smooth production requirements by meeting
seasonal or cyclical variations in demand
4. To protect against stock-outs
 15

Functions of Inventory (2 of 2)
5. To provide a safeguard for variation in raw material
delivery time
6. To provide a stock of goods that will provide a
“selection” for customers
7. To take advantage of economic purchase-order size
8. To take advantage of quantity discounts
9. To hedge against price increases
 16

Disadvantages of Inventory
• Higher costs
– Item cost (if purchased)
– Ordering (or setup) cost
– Holding (or carrying) cost
• Difficult to control
• Hides production problems
• May decrease flexibility
 17

Inventory Costs
 Holding (or carrying) costs
 Costs for storage, handling, insurance, etc
 Setup (or production change) costs
 Costs to prepare a machine or process for
manufacturing an order, eg. arranging specific
equipment setups, etc
 Ordering costs (costs of replenishing inventory)
 Costs of placing an order and receiving goods
 Shortage costs
 Costs incurred when demand exceeds supply
 18

Holding (Carrying) Costs

• Obsolescence
• Insurance
• Extra staffing
• Interest
• Pilferage
• Damage
• Warehousing
• Etc.
 19

Inventory Holding Costs

(Approximate Ranges)
Cost as a
Category % of Inventory Value
Housing costs (building rent, depreciation, 6%
operating cost, taxes, insurance) (3 - 10%)

Material handling costs (equipment, lease or 3%

depreciation, power, operating cost) (1 - 3.5%)
3%
Labor cost from extra handling (3 - 5%)
Investment costs (borrowing costs, taxes,
and insurance on inventory) 11%
(6 - 24%)
Pilferage, scrap, and obsolescence
3%
(2 - 5%)
Overall carrying cost 26%
 20

Ordering Costs

• Supplies
• Forms
• Order processing
• Clerical support
• etc.
 21

Setup Costs

• Clean-up costs
• Re-tooling costs
• Adjustment costs
• etc.
 22

Shortage Costs

• Backordering cost
• Cost of lost sales
 23

Inventory Control System

Defined
 An inventory system is the set of policies and
controls that monitor levels of inventory and
determine what levels should be maintained, when
stock should be replenished and how large orders
should be
 Answers questions as:
 When to order?
 How much to order?
 24

Objective of Inventory Control

To achieve satisfactory levels of customer

service while keeping inventory costs within
reasonable bounds
Level of customer service
Costs of ordering and carrying inventory
 25

Requirements of an Effective Inventory

Management
A system to keep track of inventory
A reliable forecast of demand
Knowledge of lead times
Reasonable estimates of
 Holding costs
 Ordering costs
 Shortage costs
A classification system
 26

Inventory Counting (Control) Systems

• Periodic System
Physical count of items made at periodic intervals; order
is placed for a variable amount after fixed passage of time
• Perpetual (Continuous) Inventory System
System that keeps track
of removals from inventory
continuously, thus
monitoring current levels of
each item (constant amount is ordered
when inventory declines to a
predetermined level)
 27

Inventory Models
 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-Time Period Models
• Time triggered (Example: Monthly sales call by
sales representative)
 28

Single-Period Inventory Model

 29

Single Period Model

• Single period model: model for ordering of
perishables and other items with limited useful
lives
• Shortage cost: generally the unrealized profits
per unit
• Excess cost: difference between purchase cost
and salvage value of items left over at the end
of a period
 30

Single Period Model

• Continuous stocking levels
– Identifies optimal stocking levels
– Optimal stocking level balances unit shortage
and excess cost
• Discrete stocking levels
– Service levels are discrete rather than
continuous
– Desired service level is equaled or exceeded
 31

Single-Period Model
This
Thismodel
modelstates
statesthat
thatwe
we
Cuu should
shouldcontinue
continueto toincrease
increase

P the
thesize
long
sizeof
longasasthe
ofthe
theinventory
inventoryso
theprobability
probabilityof
of
so

Coo  Cuu selling

sellingthe
equal
equalto
thelast
toor
lastunit
unitadded
orgreater
addedisis
greaterthan
thanthe
the
ratio
ratioof:
of:Cu/Co+Cu
Cu/Co+Cu
Where :
Co  Cost per unit of demand over estimated
Cu  Cost per unit of demand under estimated
P  Probability that the unit will be sold
 32

Optimal Stocking Level

Cs Cs = Shortage cost per unit
Service level =
Cs + Ce Ce = Excess cost per unit

Ce Cs

Service Level

Quantity

So
Balance point
 33

Single Period Example 1

• Ce = $0.20 per unit
• Cs = $0.60 per unit
• Service level = Cs/(Cs+Ce) = .6/(.6+.2)
• Service level = .75
Ce Cs

Service Level = 75%

Quantity

Stockout risk = 1.00 – 0.75 = 0.25

 34

Single Period Model Example 2

Our college basketball team is playing in a
tournament game this weekend. Based on our
past experience we sell on average 2,400 shirts
with a standard deviation of 350. We make
$10 on every shirt we sell at the game, but lose
$5 on every shirt not sold. How many shirts
should we make for the game?
Cu = $10 and Co = $5; P ≤ $10 / ($10 + $5) = .667
Z.667 = .432
therefore we need 2,400 + .432(350) = 2,551 shirts
 35

Multi-Period Inventory Models

Fixed-Order Quantity Models (Types of)

Economic Order Quantity Model
Economic Production Order Quantity (Economic
Lot Size) Model
Economic Order Quantity Model with Quantity
Discounts
Fixed Time Period (Fixed Order Interval) Models
 36

Fixed Order Quantity Models:

Economic Order Quantity Model
 37

Economic Order Quantity Model

Assumptions (1 of 2):
• Demand for the product is known with certainty, is
constant and uniform throughout the period
• Lead time (time from ordering to receipt) is known
and constant
• Price per unit of product is constant (no quantity
discounts)
• Inventory holding cost is based on average inventory
 38

Economic Order Quantity Model

Assumptions (2 of 2):
• Ordering or setup costs are constant
• All demands for the product will be satisfied (no
back orders are allowed)
• No stockouts (shortages) are allowed
• The order quantity is received all at once.
(Instantaneous receipt of material in a single lot)

The goal is to calculate the order quantitiy that

minimizes total cost
 39

Basic Fixed-Order Quantity Model and

Reorder Point Behavior
1. You receive an order quantity Q. 4. The cycle then repeats.

Number
of units
on hand Q Q Q
(Inv.
Level)
R
L L
2. You start using
them up over time. 3. When you reach down to
Time a level of inventory of R,
R = Reorder point
Q = Economic order quantity you place your next Q
L = Lead time sized order.
 40

EOQ Model

Inventory Level
Order Average
Quantity
Demand Inventory
rate
(Q) (Q/2)

Reorder
Point
(ROP)

Order placed Order received Time

Lead Time
 41

EOQ Cost Model: How Much to Order?

By adding the holding and ordering costs together, we
determine the total cost curve, which in turn is used to find
the optimal order quantity that minimizes total costs
Annual
cost ($) Total Cost
Slope = 0

HQ
Minimum Carrying Cost =
2
total cost

SD
Ordering Cost =
Q

Optimal order Order Quantity, Q

Qopt
 42

Why Holding Costs Increase?

• More units must be stored if more are ordered

Purchase Order Purchase Order

Description Qty. Description Qty.
Microwave 1 Microwave 1000

Order quantity Order quantity

 43

Why Ordering Costs Decrease ?

Cost is spread over more units
Example: You need 1000 microwave ovens
1 Order (Postage $ 0.33) 1000 Orders (Postage $330)

Purchase Order PurchaseOrder

Purchase Order
Description PurchaseOrder
Description
Purchase OrderQty.
Qty. Description Qty.
Qty.
Microwave 1000 Description
Microwave Qty. 11
Description
Microwave
Microwave
Microwave 11
Order quantity
 44

Basic Fixed-Order Quantity (EOQ)

TC=Total
TC=Totalannual
annual
Model Formula cost
cost
D =Annual demand
D =Annual demand
Total Annual Annual Annual CC=Cost
=Costperperunit
unit
Annual = Purchase + Ordering + Holding QQ=Order
=Orderquantity
quantity
Cost Cost Cost Cost SS=Cost
=Costofofplacing
placing
an
anorder
orderororsetup
setup
cost
cost
RR=Reorder
=Reorderpoint
point
LL=Lead
=Leadtime
time
H=Annual
H=Annualholding
holding

D
D Q
Q
and
andstorage
per
storagecost
perunit
unitof
cost
ofinventory
TC
TC == DC
DC ++ SS++ H H
inventory

Q
Q 22
 45

EOQ Cost Model

Using calculus, we take the first derivative of the total cost
function with respect to Q, and set the derivative (slope) equal to
zero, solving for the optimized (cost minimized) value of Qopt
Deriving Qopt SD Proving equality
Annual ordering cost = of costs at
Q
SD HQ optimal point
TC = +
Q 2 HQ SD HQ
Annual carrying cost = =
SD H 2
TC Q 2
= +
Q Q2 2 SD HQ
Total cost = + 2S D
SD H Q 2 Q =
2

0= + H
Q2 2
2SD
2SD Qopt =
Qopt = H
H
 46

Deriving the EOQ

How much to order?:
2DS
2DS 2(Annual
2(Annual Dem
Demand)(Order
and)(Order oror Setup
Setup Cost)
Cost)
QQOPT =
OPT =
==
HH Annual
Annual Holding
Holding Cost
Cost

When to order?
__
We
Wealso
alsoneed
needaa RReorder
eorder point,
point, RR == dd LL
reorder
reorderpoint
pointto
totell
tell
_

us d = average daily demand (constant)

uswhen
whentotoplace
placean
an
order
order L = Lead time (constant)
 47

EOQ Model Equations

Optimal Order Quantity = Q* = 2 ×D ×S

H
Expected Number of Orders = N =
D
Q*
Expected Time Between Orders Working Days / Year
=T =
N
D
d =
Working Days / Year

ROP = d × L
 48

EOQ Example 1 (1 of 3)

Given
Given the
the information
information below,
below, what
what are
are the
the EOQ
EOQ and
and
reorder
reorder point?
point?
Annual Demand = 1,000 units
Days per year considered in average daily demand = 365
Cost to place an order = $10
Holding cost per unit per year = $2.50
Lead time = 7 days
Cost per unit = $15
 49

EOQ Example 1(2 of 3)

2DS
2DS = 2(1,000
2(1,000 )(10)
)(10) = 89.443 units or 90 units
Q
QOPT =
OPT = H = 2.50 = 89.443 units or 90 units
H 2.50

1,000
1,000 units
units // year
year = 2.74 units / day
dd == = 2.74 units / day
365 days / year
365 days / year

__
Reorder
Reorderpoint,
point, RR == dd LL== 2.74units
2.74units//day
day(7days)
(7days)==19.18
19.18 or
or 20
20 units
units

In
Insummary,
summary,youyouplace
placean
anoptimal
optimalorder
orderof
of90
90units.
units. In
Inthe
the
course
courseof
ofusing
usingthe
theunits
unitsto
tomeet
meetdemand,
demand,when
whenyou
youonly
only
have
have20
20units
unitsleft,
left,place
placethe
thenext
nextorder
orderof
of90
90units.
units.
 50

EOQ Example I(3 of 3)

Orders per year = D/Qopt Order cycle time= 365/(D/Qopt)
= 1000/90 = 365/11
= 11 orders/year = 33.1days

SD + HQ
TCmin =
Q 2
(10)(1,000) (2,5)(90)
TCmin = +
90 2

TCmin = $ 111 + $111 = 22 $

 51

EOQ Example 2(1 of 2)

Determine
Determine thethe economic
economic order
order quantity
quantity
and
and the
the reorder
reorder point
point given
given the
the following…
following…

Annual Demand = 10,000 units

Days per year considered in average daily demand =
365
Cost to place an order = $10
Holding cost per unit per year = 10% of cost per unit
Lead time = 10 days
Cost per unit = $15
 52

EOQ Example 2(2 of 2)

2DS
2DS 2(10,000
2(10,000 )(10)
)(10) = 365.148 units, or 366 units
Q
QOPT = =
OPT = H = 1.50 = 365.148 units, or 366 units
H 1.50

10,000
10,000 units
units// year
year = 27.397 units / day
dd == = 27.397 units / day
365 days / year
365 days / year

__
RR == dd LL== 27.397
27.397 units
units//day
day (10
(10 days)
days)== 273.97
273.97 or
or 274
274 units
units

Place
Place an
an order
order for
for 366
366 units.
units. When
When in in the
the course
course of
of
using
using the
the inventory
inventory you
you are
are left
left with
with only
only 274
274 units,
units,
place
place the
the next
next order
order of
of 366
366 units.
units.
 53

EOQ Example 3
H = $0.75 per yard S = $150 D = 10,000 yards

2SD SD HQ
Qopt = TCmin = +
H Q 2
2(150)(10,000) (150)(10,000) (0.75)(2,000)
Qopt = TCmin = +
(0.75) 2,000 2

Qopt = 2,000 yards 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
 54

When to Reorder with EOQ Ordering ?

• Reorder Point – is the level of inventory at which a new
order is placed
ROP = d . L
• Safety Stock - Stock that is held in excess of expected
demand due to variable demand rate and/or lead time.
• Service Level - Probability that demand will not exceed
supply during lead time (probability that inventory
available during lead time will meet demand) 1 -
Probability of stockout
 55

Reorder Point Example

Demand = 10,000 yards/year

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

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

 56

Determinants of the Reorder Point

• The rate of demand

• The lead time
• Demand and/or lead time variability
• Stockout risk (safety stock)
 57

Probabilistic Models
 Answer how much & when to order
 Allow demand to vary
 Follows normal distribution
 Other EOQ assumptions apply
 Consider service level & safety stock
 Service level = 1 - Probability of stockout
 Higher service level means more safety stock
 More safety stock means higher ROP
 58

Safety Stock
Quantity

Maximum probable demand

during lead time

Expected demand
during lead time

ROP

Safety stock
LT Time
Safety stock reduces risk of
stockout during lead time
 59

Variable Demand with

a Reorder Point

Q
Inventory level

Reorder
point, R

0
LT LT
Time
 60

Reorder Point with a Safety Stock

Inventory level

Q
Reorder
point, R

Safety Stock
0
LT LT
Time
 61

Reorder Point With Variable Demand

R = dL + zd L
where
d = average daily demand
L = lead time
d = the standard deviation of daily demand
z = number of standard deviations
corresponding to the service level
probability
zd L = safety stock
 62

Reorder Point for Service Level

Probability of
meeting demand during
lead time = service level

Probability of
a stockout

Safety stock
zd L

dL R
Expected Demand

The reorder point based on a normal distribution of LT demand

 63

Reorder Point for Variable Demand

(Example)
The carpet store wants a reorder point with a
95% service level and a 5% stockout probability
d = 30 yards per day
L = 10 days
d = 5 yards per day

For a 95% service level, z = 1.65

R = dL + z d L Safety stock = z d L
= 30(10) + (1.65)(5)( 10) = (1.65)(5)( 10)
= 326.1 yards = 26.1 yards
 64

Fixed Order Quantity Models:

-Noninstantaneous Receipt-
Production Order Quantity
(Economic Lot Size)
Model
 65

Production Order Quantity Model

 Production done in batches or lots
 Capacity to produce a part exceeds that part’s usage or
demand rate
 Allows partial receipt of material
 Other EOQ assumptions apply
 Suited for production environment
 Material produced, used immediately
 Provides production lot size
 Lower holding cost than EOQ model
 Answers how much to order and when to order
 66

EOQ POQ Model

When To Order
Both production
and usage take Usage only takes
Maximum place
place
inventory
level
Inventory Level

Time
 67

EOQ POQ Model

When To Order
Inventory Level
Optimal Average
Order Inventory
Quantity
(Q*)

Reorder
Point
(ROP)

Time
Lead Time
 68

POQ Model Inventory Levels (1 of 2)

Inventory Level

Production portion of Maximum

cycle inventory
level
Demand portion of cycle with
no supply

Time
Supply Supply
Begins Ends
 69

POQ Model Inventory Levels (2 of 2)

Inventory Level
Inventory level with no demand

Production Max. Inventory

Q* Portion of Q·(1- u/p)
Cycle Average
inventory
Q/2(1- u/p)

Time
Supply Supply Demand portion of
Begins Ends cycle with no supply
 70

POQ Model Equations

= Q* = 2*D*S
Production Order Quantity
p
( )
H* 1 -
u
p

Maximum inventory level = Q* ( 1 -

u
p )
D D = Demand per year
Setup Cost = * S
Q S = Setup cost
H = Holding cost
Holding Cost = 1/2 * H * Q
( )
1-
u
p
d = Demand per day
p = Production per day
2 DS p
Q0 
H p u
 71

Production Order Quantity Example

(1 of 2)
H = $0.75 per yard S = $150 D = 10,000 yards
u = 10,000/311 = 32.2 yards per day p = 150 yards per day

2SD 2(150)(10,000)
POQopt = = = 2,256.8 yards
H 1- u 32.2
0.75 1 -
p 150

SD HQ u
TC = Q + 2 1 - p = $1,329

Q 2,256.8
Production run = = = 15.05 days per order
p 150
 72

Production Quantity Example

(2 of 2)
H = $0.75 per yard S = $150 D = 10,000 yards
u= 10,000/311 = 32.2 yards per day p = 150 yards per day

2Co D 10,000
2(150)(10,000)
D
Number of production runs = = = 4.43 runs/year
Qopt = = Q 2,256.8 = 2,256.8 yards
32.2
Cc 1 - d 0.75 1 -
p 150
u 32.2
Maximum inventory level = Q 1 - = 2,256.8 1 -
p 150
Co D CcQ d
TC = + = 1,772 yards
1 - p = $1,329
Q 2

Q 2,256.8
Production run = = = 15.05 days per order
p 150
 73

Fixed-Order Quantity Models:

Economic Order Quantity Model
with Quantity Discounts
 74

Quantity Discount Model

• Answers how much to order & when to order
• Allows quantity discounts
– Price per unit decreases as order quantity
increases
– Other EOQ assumptions apply
• Trade-off is between lower price & increased
holding cost
Total cost with purchasing cost
SD iC Q
TC = + + PD Where P: Unit Price
Q 2
 75

Price-Break Model Formula

Based on the same assumptions as the EOQ model,
the price-break model has a similar Qopt formula:

2DS 2(Annual Demand)(Order or Setup Cost)

Q OPT = =
iC Annual Holding Cost

i = percentage of unit cost attributed to carrying inventory

C = cost per unit

Since “C” changes for each price-break, the formula above will
have to be used with each price-break cost value
 76

Total Costs with PD

Cost

Adding Purchasing cost TC with PD

doesn’t change EOQ

TC without PD

PD

0 EOQ Quantity
 77

Total Cost with Constant Carrying Costs

TCa
Total Cost

TCb
Decreasing
TCc Price

CC a,b,c

OC

EOQ Quantity
 78

Quantity Discount – How Much to Order?

 79

Price-Break Example 1 (1 of 3)

ORDER SIZE PRICE

0 - 99 $10
100 - 199 8 (d1)
200+ 6 (d2)

For this problem holding cost is given as a constant value,

not as a percentage of price, so the optimal order quantity is
the same for each of the price ranges. (see the figure)
 80

Price Break Example 1 (2 of 3)

TC = ($10 )

TC (d1 = $8 )

TC (d2 = $6 )
Inventory cost ($)

Carrying cost

Ordering cost

Q(d1 ) = 100 Qopt Q(d2 ) = 200

 81

Price Break Example 1 (3 of 3)

TC = ($10 )

TC (d1 = $8 )

TC (d2 = $6 )
Inventory cost ($)

Carrying cost

Ordering cost

Q(d1 ) = 100 Qopt Q(d2 ) = 200

The lowest total cost is at the second price break
 82

Price Break Example 2

QUANTITY PRICE
S = $2,500
1 - 49 $1,400 H = $190 per computer
50 - 89 1,100 D = 200
90+ 900

2SD 2(2500)(200)
Qopt = = = 72.5 PCs
H 190

For Q = 72.5
SD H Qopt
TC = + + PD = $233,784
Qopt 2

For Q = 90
SD HQ
TC = + + PD = $194,105
Q 2
 83

Price-Break Example 3
(1 of 4)
AA company
company has has aa chance
chance to to reduce
reduce their
their inventory
inventory
ordering
ordering costs
costs byby placing
placing larger
larger quantity
quantity orders
orders using
using the
the
price-break
price-break order
order quantity
quantity schedule
schedulebelow.below. What
What should
should
their
their optimal
optimal order
order quantity
quantity be be ifif this
this company
company purchases
purchases
this
this single
single inventory
inventory item
item with
with anan e-mail
e-mail ordering
ordering cost
cost of
of
$4,
$4, aa carrying
carrying cost
cost rate
rate of
of 2%
2% ofof thethe inventory
inventory cost
cost of
of the
the
item,
item, and
and an
an annual
annual demand
demand of of 10,000
10,000 units?
units?

Order Quantity(units) Price/unit($)

0 to 2,499 $1.20
2,500 to 3,999 1.00
4,000 or more .98
 84

Price-Break Example (2 of 4)
First, plug data into formula for each price-break value of “C”
Annual Demand (D)= 10,000 units Carrying cost % of total cost (i)= 2%
Cost to place an order (S)= $4 Cost per unit (C) = $1.20, $1.00, $0.98

Next, determine if the computed Qopt values are feasible or not

2DS 2(10,000)(4)
Interval from 4000 & more, the Q OPT = = = 2,020 units
Qopt value is not feasible iC 0.02(0.98)

Interval from 2500-3999, the 2DS 2(10,000)(4)

Q OPT = = = 2,000 units
Qopt value is not feasible iC 0.02(1.00)

Interval from 0 to 2499, the 2DS 2(10,000)(4)

Qopt value is feasible
Q OPT = = = 1,826 units
iC 0.02(1.20)
 85

Price-Break Example 2 (3 of 4)
Since
Sincethe
thefeasible
feasiblesolution
solution occurred
occurredininthe
thefirst
firstprice-
price-
break,
break,itit means
means that
thatall
all the
theother
othertrue
trueQQopt values occur
opt values occur
at
at the
thebeginnings
beginningsof ofeach
eachprice-break
price-breakinterval.
interval. Why?
Why?
Because
Becausethe
thetotal
total annual
annualcost
costfunction
functionis
is
Total aa“u”
“u”shaped
shapedfunction
function
annual
costs So
Sothe
thecandidates
candidates
for
forthe
theprice-
price-
breaks
breaksare
are1826,
1826,
2500,
2500,and
and4000
4000
units
units
0 1826 2500 4000 Order Quantity
 86

Price-Break Example 2 (4 of 4)
Next,
Next,we
weplug
plugthe
thetrue
trueQQopt values into the total cost annual cost
opt values into the total cost annual cost
function
functionto
todetermine
determinethe
thetotal
totalcost
cost under
under each
each price-break
price-break
D
D Q
Q iC
TC = DC +
TC = DC + S
S++ iC
Q
Q 2
2
TC(0-2499)=(10000*1.20)+(10000/1826)*4+(1826/2)(0.02*1.20)
TC(0-2499)=(10000*1.20)+(10000/1826)*4+(1826/2)(0.02*1.20)
==$12,043.82
$12,043.82
TC(2500-3999)=
TC(2500-3999)=$10,041
$10,041
TC(4000&more)=
TC(4000&more)=$9,949.20
$9,949.20

Finally,
Finally,we
weselect
selectthe
theleast
least costly
costlyQQopt , which in this
opt, which in this
problem
problem occurs
occursin
in the
the4000
4000 &&more
more interval.
interval. In
In
summary,
summary, our
ouroptimal
optimal order
orderquantity
quantityis is4000
4000units
units
 87

Multi-period Inventory Models:

Fixed Time Period
(Fixed-Order- Interval)
Models
 88

Fixed-Order-Interval Model

 Orders are placed at fixed time intervals

 Order quantity for next interval? (inventory is brought
up to target amount, amount ordered varies)
 Suppliers might encourage fixed intervals
 Requires only periodic checks of inventory levels (no
continous monitoring is required)
 Risk of stockout between intervals
 89

Inventory Level in a Fixed Period

System
Various amounts (Qi) are ordered at regular time intervals
(p) based on the quantity necessary to bring inventory up to
target maximum

Target maximum

Q1 Q2 Q4
Q3
d Inventory

p p p

Time
 90

Fixed-Interval Benefits
Tight control of inventory items
Items from same supplier may yield savings in:
 Ordering
 Packing
 Shipping costs
May be practical when inventories cannot be
closely monitored
 91

Fixed-Interval Disadvantages
 Requires a larger safety stock
 Increases carrying cost
 Costs of periodic reviews
 92

Fixed-Time Period Model with Safety Stock

Formula
qq==Average
Averagedemand
demand++Safety
Safetystock
stock––Inventory
Inventorycurrently
currentlyon
onhand
hand
qq==dd(T L)++ZZTT++LL --II
(T++L)

Where
Where::
qq==quantitiy
quantitiyto
tobe
beordered
ordered
TT==the
thenumber
numberofof days
daysbetween
betweenreviews
reviews
LL==lead
leadtime
timein
indays
days
dd==forecast
forecast average
averagedaily
dailydemand
demand
zz==the
thenumber
numberofof standard
standarddeviations
deviationsfor
foraaspecified
specifiedservice
serviceprobabilit
probabilityy
TT++LL ==standard
standarddeviation
deviationofof demand
demandover
overthe
thereview
reviewand
andlead
leadtime
time
II==current
currentinventory
inventorylevel
level(includes
(includesitems
itemson
onorder)
order)
 93

Fixed-Time Period Model:

Determining the Value of T+L

   
T+
T+LL 22
T+T+LL == 
i i 11
ddi
i

Since
Sinceeach
eachday
dayisisindependent anddd isisconstant,
independentand constant,
T+T+LL == (T + L) 22
(T + L)dd

The standard deviation of a sequence of random

events equals the square root of the sum of the
variances
 94

Order Quantity for a

Periodic Inventory System

where Q = d(tb + L) + zd T+L -I

d = average demand rate
T = the fixed time between orders
L = lead time
d = standard deviation of demand

zd tb + L = safety stock

I = inventory level
z = the number of standard deviations
for a specified service level
 95

Fixed-Period Model with Variable

Demand (Example 1)

d = 6 bottles per day

d = 1.2 bottles
tb = 60 days
L = 5 days
I = 8 bottles
z = 1.65 (for a 95% service level)

Q = d(tb + L) + zd tb + L - I
= (6)(60 + 5) + (1.65)(1.2) 60 + 5 - 8
 96

Fixed-Time Period Model with

Variable Demand (Example 2)(1 of 3)
Given
Given the
the information
information below,
below, how
how many
many units
units
should
should be
be ordered?
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 standard
deviation of daily demand is 4 units.
 97

Fixed-Time Period Model with Variable

Demand (Example 2)(2 of 3)

T+T+LL == (T L) ==
(T++ L)dd
22
 30 10  44  == 25.298
30++10
22
25.298

So,
So, by
by looking
looking at
at the
the value
value from
from the
the Table,
Table, we
we have
have aa
probability
probability of
of 0.9599,
0.9599, which
which isisgiven
given by
by aazz==1.75
1.75
 98

Fixed-Time Period Model with Variable

Demand (Example 2) (3 of 3)
qq==dd(T L)++ZZTT++LL --II
(T++L)

qq==20(30
20(30++10)
10)++(1.75)(25.
(1.75)(25.298)
298)--200
200

80044.272
qq==800 44.272--200
200==644.272,
644.272,or
or645
645units
units

So,
So, to
to satisfy
satisfy 96
96 percent
percent of
of the
the demand,
demand,
you
you should
should place
place an
an order
order of
of 645
645 units
units at
at
this
this review
review period
period
 99

Miscellaneous Systems:
Optional Replenishment System
Maximum Inventory Level, M

q=M-I

Actual Inventory Level, I

M

Q = minimum acceptable order quantity

If q > Q, order q, otherwise do not order any.

 100

ABC Classification System

• Demand volume and value of items vary
• Items kept in inventory are not of equal importance in
terms of:
– dollars invested
– profit potential
– sales or usage volume
– stock-out penalties
 101

ABC Classification System

Classifying inventory according to some
measure of importance and allocating control
efforts accordingly.
A - very important
B - mod. important High
A
C - least important Annual
$ value B
of items

Low C
Low High
Percentage of Items
 102

ABC Analysis

 Classify inventory into 3 categories typically

on the basis of the dollar value to the firm
$ volume = Annual demand x Unit cost
 A class, B class, C class Policies based on
ABC analysis
– Develop class A suppliers more carefully
– Give tighter physical control of A items
– Forecast A items more carefully
 103

Classifying Items as ABC

% Annual $ Usage Class % $ Vol % Items
100 A 70-80 5-15
B 15 30
80
C 5-10 50-60
60
40
A
B
20 C
0
0 50 100
% of Inventory Items
 104

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
 105

ABC Classification
TOTAL % OF TOTAL % OF TOTAL
PART PART UNIT
VALUE VALUECOSTQUANTITY
ANNUAL USAGE
% CUMMULATIVE
9 1
$30,600 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 40 11.0
2 14,000 16.4 4.0 15.0
3 30 130
1 5,400 6.3 9.0 24.0
4 4
4,800 5.680 6.0 60 30.0
3 5
3,900 4.630 10.0 100 40.0
6 6
3,600 4.220 18.0 180 58.0
5 3,000
7 3.510 13.0 170 71.0
10 2,400 2.8 12.0 83.0
8 320 50
7 1,700 2.0 17.0 100.0
9 510 60
$85,400
10 20 120
 106

ABC Classification
TOTAL % OF TOTAL % OF TOTAL
PART PART UNIT
VALUE VALUECOSTQUANTITY
ANNUAL USAGE
% CUMMULATIVE
9 1
$30,600 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 A
40 11.0
2 14,000 16.4 4.0 15.0
3 30 130
1 5,400 6.3 9.0 24.0
4 5.680 60
4 4,800 6.0 B 30.0
3 5
3,900 4.630 10.0 100 40.0
6 6
3,600 4.220 18.0 180 58.0
5 3,000
7 3.510 13.0 170 71.0
10 2,400
8 2.8
320 12.0 C
50 83.0
7 1,700 2.0 17.0 100.0
9 510 60
$85,400
10 20 120
 107

ABC Classification
TOTAL % OF TOTAL % OF TOTAL
PART PART UNIT
VALUE VALUECOSTQUANTITY
ANNUAL USAGE
% CUMMULATIVE
1
9 $30,600 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 A
40 11.0
2 14,000 16.4 % OF TOTAL4.0 15.0
3 30 130
% OF TOTAL
1 CLASS
5,400 ITEMS 6.3 VALUE9.0 24.0
QUANTITY
4 5.680 60
4 4,800 6.0 B 15.030.0
3 5
A3,900 9, 8, 2 4.630 71.010.0 100 40.0
6 B3,600
6 1, 4, 3 4.220 16.518.0 180 25.058.0
5 C3,000 6, 5, 10,3.5
7 12.513.0 60.071.0
7 10 170
10 2,400
8 2.8
320 12.0 C
50 83.0
7 1,700 2.0 17.0 100.0
9 510 60
$85,400
10 20 120
 108

ABC Classification

100 – C
B
80 –
% of Value

60 – A
40 –

20 –

0 |– | | | | |
0 20 40 60 80 100
% of Quantity
 109

Inventory Accuracy and

Cycle Counting
• Inventory accuracy refers to how well the
inventory records agree with physical count.
• Physically counting a sample of total
inventory on a regular basis
• Used often with ABC classification
– A items counted most often (e.g., daily)
 110

Advantages of Cycle Counting

• Eliminates shutdown and interruption of production

necessary for annual physical inventories
• Eliminates annual inventory adjustments
• Provides trained personnel to audit the accuracy of inventory
• Allows the cause of errors to be identified and remedial
action to be taken
• Maintains accurate inventory records
 111

Last Words

Inventories have certain functions.

But too much inventory
- Tends to hide problems
- Costly to maintain
So it is desired
• Reduce lot sizes
• Reduce safety stocks