Inventory Management

Lecture Outline
Elements of Inventory Management
Inventory Control Systems
Economic Order Quantity Models
Quantity Discounts
Reorder Point
Order Quantity for a Periodic Inventory
System

13-2
 What Is Inventory?
Stock of items kept to meet future
demand
Purpose of inventory management
how many units to order
when to order

13-3
 Supply Chain Management
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

13-4
Quality Management in the Supply Chain

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

13-5
 Types of Inventory
Raw materials
Purchased parts and supplies
Work-in-process (partially completed)
products (WIP)
Items being transported
Tools and equipment

13-6
 Two Forms of Demand
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

13-7
 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

13-8
 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

13-9
 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

13-10
 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

13-11
 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 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 C 83.0
7 1,700 2.0 17.0 100.0
$85,400

Example 10.1
13-12
 ABC Classification

% 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

Example 10.1
13-13
 Economic Order Quantity
(EOQ) Models
EOQ
optimal order quantity that will
minimize total inventory costs
Basic EOQ model
Production quantity model

13-14
 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

13-15
 Inventory Order Cycle

Order quantity, Q
Demand Average
rate inventory
Inventory Level

Q
2

Reorder point, R

0 Lead Lead Time

time time
Order Order Order Order
placed receipt placed receipt

13-16
 EOQ Cost Model
Co - cost of placing order D - annual demand
Cc - annual per-unit carrying cost Q - order quantity

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

13-17
 EOQ Cost Model
Deriving Qopt Proving equality of
costs at optimal point
Co D CcQ
TC = +
Q 2 Co D CcQ
Co D Cc =
TC Q 2
= +
Q Q2 2 2CoD
C0 D Cc Q =2
Cc
0= +
Q2 2
2CoD
2CoD Qopt =
Qopt = Cc
Cc

13-18
 EOQ Cost Model
Annual
cost ($) Total Cost
Slope = 0
Cc Q
Minimum Carrying Cost = 2
total cost

CoD
Ordering Cost = Q

Optimal order Order Quantity, Q

Qopt

13-19
 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

13-20
 Production Quantity Model
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

13-21
 Production Quantity Model
Inventory
level

Maximum
Q(1-d/p) inventory
level

Average
Q inventory
(1-d/p)
2 level

0
Begin End Time
order order
Order
receipt receipt
receipt period

13-22
 Production Quantity
Model
p = production rate d = demand rate

Maximum inventory level =Q - Q d

p

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

CoD CcQ d
TC = + 1- p
Q 2

13-23
 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 = d = = 2,256.8 gallons
32.2
Cc 1 - 0.75 1 -
p 150

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

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

13-24
 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

13-25
Solution of EOQ Models With
Excel

The optimal order

size, Q, in cell D8

13-26
Solution of EOQ Models With
Excel

The formula for Q

in cell D10

=(D4*D5/D10)+(D3*D10/2)*(1-(D7/D8))

=D10*(1-(D7/D8))

13-27
Solution of EOQ Models With OM Tools

13-28
 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

13-29
 Quantity Discount Model
ORDER SIZE PRICE
0 - 99 $10 TC = ($10 )
100 199 8 (d1)
200+ 6 (d2)
TC (d1 = $8 )

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

Carrying cost

Ordering cost

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

13-30
 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 Co D CcQopt

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

For Q = 90 Co D CcQ
TC = + + PD = $194,105
Q 2

13-31
Quantity Discount Model With Excel

=IF(D10>B10,D10,B10) =(D4*D5/E10)+(D3*E10/2)+C10*D5

13-32
 Reorder Point
Inventory level at which a new order is placed

R = dL
where

d = demand rate per period

L = lead time

13-33
 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

13-34
 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)

13-35
Variable Demand With Reorder
Point
Q
Inventory level

Reorder
point, R

0
LT LT
Time

13-36
 Reorder Point With Safety
Inventory level
Stock

Q
Reorder
point, R

Safety Stock
0
LT LT
Time
13-37
Reorder Point With Variable Demand

R = dL + zd 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
zd L =safety stock

13-38
Reorder Point For a Service
Level
Probability of
meeting demand during
lead time = service level

Probability of
a stockout

Safety stock
zd L

dL R
Demand

13-39
Reorder Point For Variable Demand

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 Safety stock= z d L
= 30(10) + (1.65)(5)( 10) = (1.65)(5)( 10)
= 326.1 gallons = 26.1 gallons

13-40
Determining Reorder Point with Excel

The reorder point

formula in cell E7

13-41
 Order Quantity for a
Periodic Inventory System

Q = d(tb + L) + zd tb + L - I

where
d= average demand rate
tb= the fixed time between orders
L= lead time
d= standard deviation of demand

zd tb + L= safety stock
I= inventory level

13-42
Periodic Inventory System

13-43
 Fixed-Period Model With
Variable Demand
d= 6 packages per day
d= 1.2 packages
tb= 60 days
L= 5 days
I= 8 packages
z= 1.65 (for a 95% service level)

Q= d(tb + L) + zd tb + L - I
= (6)(60 + 5) + (1.65)(1.2) 60 + 5 - 8
= 397.96 packages

13-44
Fixed-Period Model with Excel

Formula for order

size, Q, in cell D10

13-45