Inventory Management

Elements of Inventory Management

Inventory Control Systems
Economic Order Quantity Models
Quantity Discounts
Reorder Point
Order Quantity for a Periodic Inventory
System
1
3-2
Stock of items kept to meet future demand
Purpose of inventory management
how many units to order
when to order
1
3-3
Bullwhip effect
demand information is distorted as it moves away
from the end-use customer
higher safety stock inventories to are stored to
compensate
Seasonal or cyclical demand
Inventory provides independence from
vendors
Take advantage of price discounts
Inventory provides independence between
stages and avoids work stoppages
1
3-4
Customers usually perceive quality service as
availability of goods they want when they
want them
Inventory must be sufficient to provide high-
quality customer service in QM
1
3-5
Raw materials
Purchased parts and supplies
Work-in-process (partially completed)
products (WIP)
Items being transported
Tools and equipment
1
3-6
Dependent
Demand for items used to produce final
products
Tires for autos are a dependent demand item
Independent
Demand for items used by external
customers
Cars, appliances, computers, and houses are
examples of independent demand inventory

1
3-7
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

1
3-8
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

1
3-9
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
1
3-
10
1
3-
11
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
PART UNIT COST ANNUAL USAGE
1
3-
12
Example 10.1
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 15.0
1 5,400 6.3 9.0 24.0
4 4,800 5.6 6.0 30.0
3 3,900 4.6 10.0 40.0
6 3,600 4.2 18.0 58.0
5 3,000 3.5 13.0 71.0
10 2,400 2.8 12.0 83.0
7 1,700 2.0 17.0 100.0
TOTAL % OF TOTAL % OF TOTAL
PART VALUE VALUE QUANTITY % CUMMULATIVE
A
B
C
$85,400
1
3-
13
Example 10.1
% OF TOTAL % OF TOTAL
CLASS ITEMS VALUE QUANTITY
A 9, 8, 2 71.0 15.0
B 1, 4, 3 16.5 25.0
C 6, 5, 10, 7 12.5 60.0
EOQ
optimal order quantity that will
minimize total inventory costs
Basic EOQ model
Production quantity model


1
3-
14
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

1
3-
15
1
3-
16
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
Average
inventory
Q
2
1
3-
17
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
1
3-
18
TC = +
C
o
D
Q
C
c
Q
2
= +
C
o
D
Q
2

C
c

2
TC
Q
0 = +
C
0
D
Q
2

C
c

2
Q
opt
=
2C
o
D
C
c
Deriving Q
opt
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
1
3-
19
Order Quantity, Q
Annual
cost ($)
Total Cost
Carrying Cost =
C
c
Q
2
Slope = 0
Minimum
total cost
Optimal order
Q
opt
Ordering Cost =
C
o
D
Q
1
3-
20
C
c
= $0.75 per gallon C
o
= $150 D = 10,000 gallons
Q
opt
=
2C
o
D
C
c
Q
opt
=
2(150)(10,000)
(0.75)
Q
opt
= 2,000 gallons
TC
min
= +
C
o
D
Q
C
c
Q
2
TC
min
= +
(150)(10,000)
2,000
(0.75)(2,000)
2
TC
min
= $750 + $750 = $1,500
Orders per year = D/Q
opt

= 10,000/2,000
= 5 orders/year
Order cycle time = 311 days/(D/Q
opt
)
= 311/5
= 62.2 store days
Order is received gradually, as inventory is
simultaneously being depleted
AKA 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, a.k.a. production rate
d - daily rate at which inventory is
demanded
1
3-
21
1
3-
22
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
1
3-
23
p = production rate d = demand rate
Maximum inventory level = Q - d

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

C
c
1 -

d
p
1
3-
24
C
c
= $0.75 per gallon C
o
= $150 D = 10,000 gallons
d = 10,000/311 = 32.2 gallons per day p = 150 gallons per day
Q
opt
= = = 2,256.8 gallons
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
1
3-
25
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 gallons
d
p
32.2
150
1
3-
26
The optimal order
size, Q, in cell D8
1
3-
27
The formula for Q
in cell D10
=(D4*D5/D10)+(D3*D10/2)*(1-(D7/D8))
=D10*(1-(D7/D8))
1
3-
28
1
3-
29
Price per unit decreases as order
quantity increases
TC = + + PD
C
o
D
Q
C
c
Q
2
where
P = per unit price of the item
D = annual demand
1
3-
30
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
)
1
3-
31
QUANTITY PRICE

1 - 49 $1,400
50 - 89 1,100
90+ 900
C
o
= $2,500
C
c
= $190 per TV
D = 200 TVs per year
Q
opt
= = = 72.5 TVs
2C
o
D
C
c
2(2500)(200)
190
TC = + + PD = $233,784
C
o
D
Q
opt

C
c
Q
opt

2
For Q = 72.5
TC = + + PD = $194,105
C
o
D
Q
C
c
Q
2
For Q = 90
1
3-
32
=(D4*D5/E10)+(D3*E10/2)+C10*D5 =IF(D10>B10,D10,B10)
1
3-
33
Inventory level at which a new order is placed
R = dL
where

d = demand rate per period
L = lead time
1
3-
34
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
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)

1
3-
35
1
3-
36
Reorder
point, R
Q
LT
Time
LT
I
n
v
e
n
t
o
r
y

l
e
v
e
l

0
1
3-
37
Reorder
point, R
Q
LT
Time
LT
I
n
v
e
n
t
o
r
y

l
e
v
e
l

0
Safety Stock
1
3-
38
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

1
3-
39
Probability of
meeting demand during
lead time = service level
Probability of
a stockout
R
Safety stock
dL
Demand
z
d
L
1
3-
40
The paint store wants a reorder point with a 95%
service level and a 5% stockout probability
d = 30 gallons per day
L = 10 days

d
= 5 gallons per day
For a 95% service level, z = 1.65
R = dL + z
d
L
= 30(10) + (1.65)(5)( 10)
= 326.1 gallons

Safety stock = z
d
L
= (1.65)(5)( 10)
= 26.1 gallons
1
3-
41
The reorder point
formula in cell E7
1
3-
42
Q = d(t
b
+ L) + z
d
t
b
+ L - I
where

d = average demand rate
t
b
= the fixed time between orders
L = lead time

d
= standard deviation of demand
z
d
t
b
+ L = safety stock
I = inventory level
1
3-
43
1
3-
44
d = 6 packages per day

d
= 1.2 packages
t
b
= 60 days
L = 5 days
I = 8 packages
z = 1.65 (for a 95% service level)

Q = d(t
b
+ L) + z
d
t
b
+ L - I
= (6)(60 + 5) + (1.65)(1.2) 60 + 5 - 8
= 397.96 packages
1
3-
45
Formula for order
size, Q, in cell D10