Inventory Control

12
Inventory Management
Inventory
Independent Demand
Dependent Demand
B(4)
C(2)
D(2)
E(1)
D(3)
F(2)
Independent demand is uncertain. Dependent demand is certain.
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
Types of Inventories

Raw materials & purchased parts Partially completed goods called
work in progress
Finished-goods inventories
(manufacturing firms) or merchandise (retail stores)
Types of Inventories (Contd)

Replacement parts, tools, & supplies Goods-in-transit to warehouses or customers
Functions of Inventory
To meet anticipated demand To smooth production requirements To protect against stock-outs
Functions of Inventory (Contd)
To help hedge against price increases To permit operations
To take advantage of quantity discounts
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
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
Inventory Counting Systems
Periodic System
Physical count of items made at periodic intervals
Perpetual Inventory System
System that keeps track of removals from inventory continuously, thus monitoring current levels of each item
Inventory Counting Systems
(Contd)
Two-Bin System - Two containers of

inventory; reorder when the first is empty Universal Bar Code - Bar code printed on a label that has information about the item to which it is attached
0
214800 232087768
Key Inventory Terms
Lead time:
time interval between ordering and receiving the order
Holding (carrying) costs: cost to carry an

inventory
item in inventory for a length of time, usually a year
Ordering costs: costs of ordering and receiving

Shortage costs: costs when demand exceeds
supply
ABC Classification System

Classifying inventory according to some measure of importance and allocating control efforts accordingly.
A - very important B - mod. important C - least important
High
A B C
Low High
Annual $ value of items Low
Percentage of Items
Economic Order Quantity Models

Economic order quantity (EOQ) model
The order size that minimizes total annual cost
Economic production model
Quantity discount model
Assumptions of EOQ Model

Only one product is involved Annual demand requirements known Demand is even throughout the year Lead time does not vary Each order is received in a single delivery Inventory Level = 0 when new order just arrived There are no quantity discounts
The Inventory Cycle

Q
Quantity on hand Profile of Inventory Level Over Time
Usage rate
Reorder point
Receive order
Place Receive order order
Place Receive order order
Time
Lead time
Total Cost
Annual Annual Total cost = carrying + ordering cost cost TC =
Q H 2
DS Q
Cost Minimization Goal

Q D TC H S 2 Q
Annual Cost
Ordering Costs
QO (optimal order quantity) Order Quantity (Q)
Minimum Total Cost

The total cost curve reaches its minimum where the Carrying Cost = Ordering Cost Q H 2 = DS Q
Deriving the EOQ

Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q.
Q OPT = 2DS = H 2( Annual Demand )(Order or Setup Cost ) Annual Holding Cost
Economic Production Quantity (EPQ)
Assumptions

Only one product is involved Annual demand requirements are known Usage rate is constant Usage occurs continually, but production occurs periodically The production rate is constant Lead time does not vary There are no quantity discounts
12-21
EPQ: Inventory Profile

Q Q* Imax
Production and usage Usage only Production and usage Usage only Production and usage
Cumulative production
Amount on hand
Time
12-22
Quantity Discount Model
Quantity discount
Price reduction offered to customers for placing large orders
Total Cost Carrying Cost Ordering Cost PurchasingCost Q D H S PD 2 Q where P Unit price
12-23
Quantity Discounts
12-24
Quantity Discounts
12-25
When to Reorder
with EOQ Ordering
Reorder Point - When the quantity on Safety Stock - Stock that is held in
hand of an item drops to this amount, the item is reordered 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.
Determinants of the Reorder Point

The rate of demand The lead time Demand and/or lead time variability Stockout risk (safety stock)
Safety Stock
reduce risk of stockout during lead time
Reorder Point
The ROP based on a normal Distribution of lead time demand
Service level Risk of a stockout Probability of no stockout Expected demand 0
ROP
Safety stock z
Quantity
z-scale
Single Period Model

Single period model: model for ordering
of perishables and other items with limited useful lives profits per unit
Shortage cost: generally the unrealized Excess cost: difference between

purchase cost and salvage value of items left over at the end of a period
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
Optimal Stocking Level

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

Cs
Service Level
Quantity
Balance point
So
Example 15
Ce = $0.20 per unit Cs = $0.60 per unit Service level = Cs/(Cs+Ce) = .6/(.6+.2) Service level = .75
C e Cs
Service Level = 75%
Stockout risk = 1.00 0.75 = 0.25
Quantity
Operations Strategy
Too much inventory

Tends to hide problems Easier to live with problems than to eliminate them Costly to maintain Reduce lot sizes Reduce safety stock
Wise strategy

Inventory Control

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12

Independent demand is uncertain. Dependent demand is certain.

Independent demand finished goods, items that are ready to be sold

Dependent demand components of finished products

E.g. parts that make up the computer

Raw materials & purchased parts Partially completed goods called

Types of Inventories (Contd)

Replacement parts, tools, & supplies Goods-in-transit to warehouses or customers

To meet anticipated demand To smooth production requirements To protect against stock-outs

Functions of Inventory (Contd)

To help hedge against price increases To permit operations

To take advantage of quantity discounts

Objective of Inventory Control

Level of customer service

Effective Inventory Management

A system to keep track of inventory

Inventory Counting Systems

Perpetual Inventory System

Inventory Counting Systems

Two-Bin System - Two containers of

Key Inventory Terms

time interval between ordering and receiving the order

Holding (carrying) costs: cost to carry an

item in inventory for a length of time, usually a year

Ordering costs: costs of ordering and receiving

ABC Classification System

A - very important B - mod. important C - least important

Annual $ value of items Low

Economic Order Quantity Models

The order size that minimizes total annual cost

Economic production model

Quantity discount model

Assumptions of EOQ Model

The Inventory Cycle

Place Receive order order

Place Receive order order

Cost Minimization Goal

Minimum Total Cost

Deriving the EOQ

Economic Production Quantity (EPQ)

EPQ: Inventory Profile

Quantity Discount Model

Price reduction offered to customers for placing large orders

Service Level - Probability that demand

will not exceed supply during lead time.

Determinants of the Reorder Point

reduce risk of stockout during lead time

Single Period Model

Shortage cost: generally the unrealized Excess cost: difference between

Single Period Model

Continuous stocking levels

Discrete stocking levels

Service levels are discrete rather than continuous

Optimal Stocking Level

Cs = Shortage cost per unit Ce = Excess cost per unit

Service Level = 75%

Stockout risk = 1.00 0.75 = 0.25

Too much inventory

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