Inventory

Management
PRODUCTION PLANNING AND INVENTORY
CONTROL
Definition
• Stock consists of all the goods and materials that are stored by an
organization. It is a store of items that is kept for future use.
• An inventory is a list of the items held in stock.

Raw Material Spare Part

Component, Sub- Other supplies

assembly, Work In (i.e. oil,
Process paper)
Finished Product
Type of Inventory
Raw
Material

Finished
Product

Work in
Process

Spare Part
 Type of Inventory

Inputs Outputs
• Raw Materials • Finished Goods
• Purchased parts • Scrap and Waste
• Maintenance and Process
Repair Materials (in warehouses, or “in
transit”)

In Process
• Partially Completed
Products and
Subassemblies

(often on the factoryfloor)

Function of Inventory
• allow for demands that are larger than expected, or at unexpected times;
• allow for deliveries that are delayed or too small;
• allow for mismatches between the best rate of supply and actual rate of
demand;
• avoid delays in passing products to customers;
• take advantage of price discounts on large orders;
• allow the purchase of items when the price is low and expected to rise;
• allow the purchase of items that are going
out of production or are difficult to find;
• make full loads for delivery and
reduce transport costs;
• give cover for emergencies
Stock Cycle
Stock Cycle
 Stock Cycle

A customer is anyone or
anything whose demand is
Usually deliveries from met by removing units from
suppliers are relatively large stock (internal or external)
and infrequent, while
demands from customers are
smaller and more numerous A supplier is anyone or
anything that replenishes or
adds to stock, and again it can
be either internal or external.
Stock Cycle
 Inventory Cost
Holding(carrying Cost)
• Capital cost
• Warehouse cost, etc.
Holding
Ordering Cost
Cost
Ordering Cost
• Biaya administrasi pemesanan
• Pengujian kualitas Stockout
Cost
• Material handling
Stockout Cost
• Biaya transportasi, etc.
• Biaya yang muncul sebagai
akibat dari kekurangan stock
• Lost sales, back order, rush order

Inventory Cost
Ordering Cost
• Biaya yang muncul timbul dalam pemesanan barang
• Biaya ini dapat dibagi dalam dua kategori
• Biaya administrasi pemesanan (besarnya tidak tergantung pada banyaknya barang
yang dipesan)
• Inbound Logistics Costs : biaya yang terkait dengan tranportasi dan penerimaan
barang(unloading dan inspecting)

• Besarnya ordering cost sangat tergantung pada material yang

dipesan, supplier, metode pengiriman, karakteristik material.
Holding Cost
• Biaya Simpan merupakan biaya variable (variabel cost) yaitu biaya
yang besarnya proporsional dengan banyaknya barang yang disimpan
• Holding cost dapat dikategorikan dalam:
o Capital costs (or financing charges) yaitu komponen biaya yang terbesar
dalam holding cost dan sering diabaikan
o Storage space costs
o Inventory services costs
o Inventory risk costs

• Estimasi cepat yang dapat dilakukan adalah holding cost tidak kurang
dari 25% dari nilai inventory. (Capital costs 15%, Storage space costs
2%, Inventory service costs 2%, Inventory risks costs 6%)
Holding Cost
Range komponen holding Cost
• Cost of Money 6% - 12%
• Taxes 2% - 6%
• Insurance 1% - 3%
• Warehouse Expenses 2% - 5%
• Physical Handling 2% - 5%
• Clerical & Inventory Control 3% - 6%
• Obsolescence 6% - 12%
• Deterioration & Pilferage 3% - 6%
Holding cost umumnya mencapai 25%-55% dari nilai inventory
Inventory Management
Performance
• Nilai performance yang dicatat dan dijadikan laporan hanya nilai
inventory.
• Perlu lebih banyak indikator yang diukur antara lain
o inventory turnover ratio,
o service level,
o akurasi catatan,
o dan besarnya deadstock.
Inventory Turnover Ratio
• Material dengan nilai inventory yang lebih tinggi tidak selalu mengindikasikan
pengelolaan inventory yang lebih buruk → Harus dilihat juga rata-rata
kebutuhan(demand) atas material tersebut!
• Dapat digunakan untuk melihat stock investment yang diperlukan untuk
menjalankan bisnis dengan rata-rata permintaan tertentu.

Contoh :
• Perusahaan membeli barang dengan harga rp.1000 per unit dan akan dijual
dengan harga 150 per unit, penjualan dalam setahun mencapai 1000 unit. Rata-
rata persediaan adalah 150 unit. Berapakah inventory turnover ratio dan stock
investment yang diperlukan?
• Turnover ratio = 1000/ 150 = 6.67
• Stock investment = 150 x 1000 = 150.000
Service Level
• There are several ways of measuring the service level:
• percentage of orders completely satisfied from stock;
• percentage of units demanded that are delivered from stock;
• percentage of units demanded that are delivered on time;

• Fill Rate
• Fill Rate adalah presentase banyaknya unit yang diminta dengan
banyaknya unit yang dapat dipenuhi
• Fill rate lebih menekankan pada jumlah unit sedangkan service level lebih
pada jumlah order
Economic Order Quantity
Penentuan Ukuran pemesanan dilakukan untuk meminimalkan biaya
inventory (Tidak hanya ordering cost atau holding cost namun total
inventory cost)

Ordering
Cost

Holding
Cost
Economic Order Quantity
Rata-rata inventori = Q/2

100 = 200/2
Economic Order Quantity

▪ Qo : Economic OrderQuantity
▪ RC : Reorder Cost
▪ D : Demand
▪ HC : Holding Cost
▪ UC : Unit Cost
Economic Order Quantity
Contoh :
Perusahaan pada setiap tahun membeli material jenis tertentu
sebanyak 6000 unit dalam setahun. Ordering Cost adalah 125. Holding
Cost adalah 6. Berapakah EOQ ?

Frekuensi kedatangan barang dalam setahun : D/Q0 = 6000/500 = 12

kali dalam setahun → setiap bulan ada penerimaan barang sebanyak
500 unit
Economic Order Quantity

• This chart suggests

that the variable cost
is very stable around
the EOQ.

• EOQ gives a good

guideline on order
size that we should
consider to place
Economic Order Quantity
• Inventory model with deterministic demand
• Represent trade off between inventory cost and order cost
• Model Assumption:
o the demand is known exactly, is continuous and is constant over time;
o all costs are known exactly and do not vary;
o no shortages are allowed;
o lead time is zero – so a delivery is made as soon as the order is placed.
Biaya Persediaan
Total cost

Minimum
total cost
Annual cost

Holding cost
curve

Setup (ororder)
cost curve
Optimal Orderquantity
order
quantity
Formulasi Model
Q = Jumlah pesanan setiap kali pemesanan
Q* = Jumlah pesanan optimal (EOQ)
𝜆 = demand (unit/tahun)
K = Biaya Pesan (Rp/pesan)
h = Biaya simpan per unit per tahun
c = harga barang per unit
TC = Biaya total persediaan
Inventory Cost

Biaya Biaya Biaya

Biaya
pembelian
pesan simpan persediaan
persediaan
Cost Component
Biaya pesan per tahun
= (Jumlah order yang dilakukan per tahun) x (Biaya pesan per
order)
𝐷𝑒𝑚𝑎𝑛𝑑 𝑡𝑎ℎ𝑢𝑛𝑎𝑛
= 𝑆𝑒𝑡𝑢𝑝 𝑜𝑟𝑑𝑒𝑟 𝑐𝑜𝑠𝑡
𝐽𝑢𝑚𝑙𝑎ℎ 𝑝𝑒𝑠𝑎𝑛𝑎𝑛 𝑠𝑒𝑡𝑖𝑎𝑝 𝑝𝑒𝑠𝑎𝑛
𝜆
= (K)
𝑄
Cost Component
Biaya simpan per tahun
= (Rata-rata tingkat persediaan) x (Biaya simpan per unit per tahun)
𝐽𝑢𝑚𝑙𝑎ℎ 𝑝𝑒𝑠𝑎𝑛
= 𝐵𝑖𝑎𝑦𝑎 𝑠𝑖𝑚𝑝𝑎𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑝𝑒𝑟 𝑡𝑎ℎ𝑢𝑛
2
𝑄
= (ℎ)
2

Biaya pembelian persediaan per tahun

=(demand per tahun) x (Harga per unit)
= 𝜆𝑐
Inventory Cost
Biaya persediaan tahunan= biaya pesan per tahun + biaya simpan per
tahun + biaya pembelian persediaan

𝜆 𝑄
𝑇𝐶 = 𝐾 + ℎ + 𝜆𝑐
𝑄 2

Biaya persediaan per tahun minimum diperoleh dengan Menurunkan

fungsi biaya persediaan di atas terhadap Q dan Mencari nilai Q pada
nilai biaya = 0

𝜕𝑇𝐶(𝑄)
=0 2𝐾𝜆
𝜕𝑄 𝑄=
ℎ
Model EOQ dengan Lead Time
Model EOQ dasar membuat asumsi lead time = 0
Pada kenyataan ada lead time
Bagaimana model EOQ bila lead time  0 dan besar lead time tetap ?
Reorder Point

• The reorder point (ROP) is

defined to be the
inventory level at which a
new order should be
placed.
• The when-to-order
decision is usually
expressed in terms of a
reorder point.
Penentuan Reorder Point R
Demand Lead time pemesanan
R= per hari dalam hari

= d xL


d=
Number of working days in ayear
 Uncertain Demand
Ideal Shortage

Shortage

Unused
• The ideal case, when actual demand during lead
Stock
time exactly matches expectations
• Unused stock when demand during lead time is
less than expected
• Shortages when demand during lead time is
greater than expected
Safety Stock
• Safety Stock (SS) is stock that is held in excess of expected demand
due to variable demand rate and/or variable lead time
• The higher the variance (i.e. demand, lead time, delivery), the higher
safety stock which is required to achieve the expected service level
• Service level (SL) is the probability that demand will not exceed
supply during lead time (i.e. the probability of no stockout). So the
risk of stockout is 1 - SL.
• Service level is defined differently for different type of material. The
more important material will have higher service level, which will
increase safety stock. Many companies define service level of 95%
 Safety Stock
• The mean lead time demand is LT ×
D, and standard deviation is σ ×
√LT.
• The SL gives the probability that
lead time demand is below the
reorder level, so we can use the
Normal distribution to determine
SS level
• Z is the number of standard
deviations from the mean that
correspond to the specified SL
• A 95% service level, for example,
has a probability of 0.05 that lead
time demand is higher than safety
stock
Safety Stock = Z × standard deviation of lead time
Safety Stock = Z × σ × √LT
Reorder Level
• Reorder level is a level of stock where the company should place an order
• Reorder level is determined by considering Lead Time, Demand, and Service
Level
• Example : In the past 50 stock cycles demand in the lead time for an item has
been as follows:

• Demand of 40 unit recurring for 14 times, demand of 20 unit recurring for 5

times and so on.
• What is the reorder level to achieve 98% service level?
Reorder Level
What is the reorder level to achieve 98% service level?

If the company place an order when the stock level

reaches 70 unit, then the probability of the company
to not having stockout is 98%
Reorder Level
• Another approach to determined reorder level is by using the following
equation:
Reorder level = lead time demand + safety stock
= (LT x D) + (Z x σ x 𝐋𝐓)
• Where
• LT: Lead Time
• D: Demand
• Z: Normal distribution z-value

• The table shows how higher values

of Z give higher safety stocks and lower
probabilities of shortages
Reorder Level

• Company will place order of

reorder quantity if stock
level has reached reorder
level

• Reorder Level = lead time

demand + safety stock
Inventory Management
• Inventory Management deals with the determination of order time and
order quantity. It can be done with several approaches.
• Every SKU (Stock Keeping Unit) has an associated methodology which is
adjusted based on SKU value, supplier characteristic and SKU demand
characteristic
• There are two methodology commonly used:
o Continuous Review
o Periodic Review
• It is also possible to use hybrid method of above methodology:
o Continuous Review with reorder level
o Reorder Level and Target Stock
Continuous Review
• We place an order of fixed size (EOQ) whenever stock falls to a certain level (below or
at reorder level)
• Allow supplier to select sufficient delivery vehicle which have enough capacity for the
EOQ
• Safety stock required to cover demand during lead time (LT) so it can lower average
stock
Continuous Review
Example: Company “X” find that demand for an item is Normally
distributed with a mean of 2,000 units a year and standard deviation of
400 units. Unit cost is €100, reorder cost is €200, holding cost is 20 per
cent of value a year and lead time is fixed at 3 weeks. Describe an
ordering policy that gives a 95 per cent service level. What is the cost of
the safety stock?

Solution:
D = 2,000 a year
σ = 400
UC = €100 a unit
RC = €200 an order
HC = 0.2 of value held a year = €20 a unit a year
LT = 3 weeks
Continuous Review
• Reorder size, Qo = 2 × RC × D/HC = 2 × 200 × 2,000/20 = 200 units
• Reorder level, ROL = LT × D + safety stock = 3 × 2,000/52 + SS = 115 + SS
• For a 95% service level Z = 1.64 standard deviations from the mean, so:

• Safety stock = Z × σ × 𝐿𝑇 = 1.64 × 400 × 3/52 = 158.

• The ordering policy is to order 200 units whenever stock declines to (115 +
158 =) 273 units.
• Orders should arrive, on average, when there are 158 units left. The
expected cost of the safety stock is:
• safety stock × holding cost = 158 × 20 = €3,160 a year
 Continuous Review
Two Bin System Three Bin System
Demand is fulfilled from Bin 1. Demand is fulfilled from Bin 1.
If bin 1 is empty, then it is time to If bin 1 is empty, then it is time to
place an order. While waiting the place an order. While waiting the
order to arrive, demand is fulfilled order to arrive, demand is fulfilled
from bin 2. from bin 2. If bin 2 is empty but order
has not arrived yet, then emergency
order might need to be placed.

Bin 1: Rest of the Stock Bin 1: Rest of the Stock

Bin 2 : Bin 3 : Bin 2 :
Safety stock + lead time Safety Lead time
demand stock demand
Periodic Review
• With periodic review, the stock level is examined at a specified time, and the
amount needed to bring this up to a target level is ordered.
• Requires higher safety stock compared to continuous review because safety stock
needs to cover Lead Time and Review Interval
• It is easier to plan receiving and delivery
because it is routinely applied
• Allows to combine different materials
type in single order. This can reduce
transportation cost and could
potentially get a discount
Periodic Review
Company “Y” produced an item which is Normally distributed with a mean
of 1,000 units a month and standard deviation of 100 units. They check
stock every three months and lead time is constant at one month. They use
an ordering policy that gives a 95 per cent service level, and wanted to
know how much it would cost to raise this to 98 per cent if the holding cost
is £20 a unit a month?
Solution
D = 1,000 units a month
σ = 100 units
HC = £20 a unit a month
T = 3 months
LT = 1 month
Periodic Review
For a 95 per cent safety stock Z is 1.64. Then:
• safety stock = Z × σ × (T + LT)= 1.64 × 100 × (3+1) = 328 units
• target stock level = D × (T + LT) + safety stock
= 1,000 × (3 + 1) + 328
= 4,328 units
• Every three months, when it is time to place an order, the company examines
the stock on hand and places an order for:
order size = 4,328 − stock on hand

• If, for example, there were 1,200 units in stock the order would be for 4,328
− 1,200 = 3,128 units.
• The cost of holding the safety stock = SS × HC = 328 × 20 = £6,560 a month
Continuous vs Periodic
Reorder Level and Target Stock
• This is a variation of the fixed order quantity method (Continuous Review) which is
useful when individual orders are large and might take the stock level well below the
reorder level.
• When stock falls below the reorder level, we order an amount that will raise current
stock to a target level (Target Stock – Stock Level).
• If stock still at reorder point, we order with EOQ
• This is sometimes called the min-max system as gross stock varies between a minimum
(the reorder level) and a maximum (the target stock level).
Periodic Review with Reorder Level
• This is similar to the
standard periodic review
method, but we only
place an order if stock on
hand is below a specified
reorder level.
• If the stock on hand is
above the reorder level,
we do not place an order
this period, but wait until
next period.
Price Discount
• The most common variation in cost occurs when a supplier offers a
reduced price on all units for orders above a certain size.
• There is often more than one discounted price, giving the pattern of
unit cost shown in the following table:
Price Discount

The continuous line shows

the section of the total cost
curve that applies to this unit
cost, while the broken line
shows the part of the curve
that does not apply.
Price Discount

• If we now consider the

next highest unit cost,
UC2, we can draw a
second total cost curve.

• As UC2 is less than UC1,

this second curve will
always be lower than the
original one.
Price Discount
Price Discount
• Every set of cost curves will
have at least one valid
minimum, and a variable
number of invalid minima

• A valid minimum is within

the range of valid order
quantities for this particular
unit cost.

• An invalid minimum falls

outside the valid order
range for this particular unit
cost.
 Price Discount

• There are only two possible positions for the overall minimum cost: it is either at a valid
minimum, or else at a cost break point
• To find the lowest cost, we find the cost at the valid minimum and compare this with the
cost at each break point to the right of this valid minimum. The optimal order quantity
corresponds to the lowest of these costs.
Quantity Discount Model
• Procedure for finding the best order size:
1. For every discount price, calculate Q* with EOQ equation
2. If calculated Q* value is not within associated discount interval, choose Q with
lowest cost in the interval
3. Calculate total cost for each Q* or adjusted Q* from step 2
4. Choose Q* which gives the lowest total cost

• Total cost, TCo, for an optimal order quantity, Qo, is:

TCo = UC × D + HC × Qo
• While the total cost, TC, for any other order quantity, Q, is:
𝑹𝑪𝒙𝑫 𝑯𝑪𝒙𝑸
TC = UC × D + +
𝑸 𝟐
Price Discount: Example
The annual demand for an item is 2,000 units, each order costs £10 and
the annual holding cost is 40 per cent of unit cost. The unit cost
depends on the quantity ordered as follows:
• £1 for order quantities less than 500
• £0.80 for quantities between 500 and 999
• £0.60 for quantities of 1,000 or more.
What is the optimal order size?
Price Discount: Example
Known variables are:
• D = 2,000 units a year
• RC = £10 an order
• HC = 0.4 × UC a unit a year
• UC varies and is either £1, £0.80 or £0.60

• Then, we can start working on the solution for each discount interval / cost curve
1. Taking the lowest cost curve:
UC = £0.60, valid for Q of 1,000 or more
Qo = 2 × RC × D/HC = (2 × 10 × 2,000/0.4x0.6) = 408.2
• This is an invalid minimum as Qo is not greater than 1,000.
• Calculate the cost of the break-point at the lower end of the valid range (i.e. Q=1,000):
TC = order cost + holding cost + purchase cost per year
= (RC × D)/Q + (HC × Q)/2 + (UC × D)
= (10 × 2,000)/1,000 + (0.4 × 0.60 × 1,000)/2 + (0.60 × 2,000)
= £1,340 a year
Price Discount: Example
2. Taking the next lowest cost curve:
UC = £0.80, valid for Q between 500 and 1,000
Qo = 2 × RC × D/HC = (2 × 10 × 2,000/0.4x0.8) = 353.6 → This is an invalid minimum as
Qo is not between 500 and 1,000.
Calculate the cost of the break-point at the lower end of the valid range (i.e.Q = 500):
TC = (RC × D)/Q + (HC × Q)/2 + (UC × D)
= (10 × 2,000)/500 + (0.4 × 0.80 × 500)/2 + (0.80 × 2,000)
= £1,720 a year
3. Taking the next lowest cost curve:
UC = £1.00 valid for Q less than 500
Qo = 2 × RC × D/HC = (2 × 10 × 2,000/0.4x1.00) = 316.2 → This is a valid minimum as
Qo is less than 500.
Calculate the cost at this valid minimum:
TCo = (UC × D) + (HC × Qo)
= (1 × 2,000) + (0.4 × 1.00 × 316.2) = £2,126.48 a year
Price Discount: Example

Choice is:
point A
Q = 1,000 cost = £1,340 p.a.
point B
Q = 500 cost = £1,720 p.a.
point C
Q = 316.2 cost= £2,126.49 p.a.

→ the solution is to purchase

1000 unit at £0.60 /unit
Example: Discount Quantity
Assume that the following table is the discount price offered by a
supplier to company X. Annual demand is known at 5000 pcs, each order
costs $49 and the annual holding cost is 20 per cent of unit cost. What is
the optimal order size?

Price Discount Quantity Discount (%) Price/unit

Break
1 0 - 999 no discount $5.00
2 1,000 - 1,999 4 $4.80
3 Q >= 2,000 5 $4.75
Quantity Discount Models
Example: Discount Quantity
Calculate Q* for each price in discount interval

2(5000)(49)
𝑄1∗ = = 700 𝑐𝑎𝑟𝑠/𝑜𝑟𝑑𝑒𝑟
(0.2)(5.00)

2(5000)(49)
𝑄2∗ = = 714 𝑐𝑎𝑟𝑠/𝑜𝑟𝑑𝑒𝑟
(0.2)(4.80)

2(5000)(49)
𝑄3∗ = = 718 𝑐𝑎𝑟𝑠/𝑜𝑟𝑑𝑒𝑟
(0.2)(4.75)
Quantity Discount Models
Example: Discount Quantity
Example: Discount Quantity
Calculate Q* for each price in discount interval

2(5000)(49)
𝑄1∗ = = 700 𝑐𝑎𝑟𝑠/𝑜𝑟𝑑𝑒𝑟
(0.2)(5.00)

2(5000)(49)
𝑄2∗ = = 714 𝑐𝑎𝑟𝑠/𝑜𝑟𝑑𝑒𝑟
(0.2)(4.80)
1000 - adjusted
2(5000)(49)
𝑄3∗ = = 718 𝑐𝑎𝑟𝑠/𝑜𝑟𝑑𝑒𝑟
(0.2)(4.75)
2000 - adjusted
Example: Discount Quantity
Total cost = order cost + holding cost + purchase cost per year

• Q1 = 700 (EOQ at $5 price)

TC = 350 + 350 + 25,000 = 25,700

• Q2 = 1000 (EOQ < min order quantity for discount)

TC=245 + 480 + 24,000 (quantity discount) = 24,725

• Q3 = 2000 (EOQ < min order quantity for discount);

TC=122.5 + 950 + 23,750 = 24,822
Example: Discount Quantity
Choose the price and quantity which will the lowest total cost. In this
case, the solution is to purchase 1000 unit at $4.80/unit.

Discount Unit Annual Annual Annual

Order Product Ordering Holding Total
Number Price
Quantity Cost Cost Cost
1 $5.00 700 $25,000 $350 $350 $25,700

2 $4.80 1,000 $24,000 $245 $480 $24,725

3 $4.75 2,000 $23.750 $122.50 $950 $24,822.50

ABC analysis of stocks
• Inventory control can take a lot of effort. For items with low value,
this effort is not worthwhile.
• It would be useful to find the amount of effort worth putting into the
control of any item. An ABC analysis gives some guidelines for this.
• In most of the organizations inventory is categorized according to ABC
Classification Method, which is based on pareto principle. Here the
inventory is classified based on the value of the units. The principle
applied here is based on 80/20 principles.
ABC analysis of stocks
• In particular, ABC analyses define the following:
o A items are the few most expensive ones that need special care.
o B items are ordinary ones that need standard care.
o C items are the large number of cheap items that need little care.

• An ABC analysis starts by taking each item and multiplying the

number of units used in a year by the unit cost. This gives the total
annual use of items in terms of value.
ABC analysis of stocks
 Example: ABC Classification
Item Annual Usage in Unit Cost-$ Usage in Percentage
No. Units Dollars of Total
Dollar
Usage
1 5,000 1.50 7,500 2.9%
2 1,500 8.00 12,000 4.7%
3 10,000 10.50 105,000 41.2%
4 6,000 2.00 12,000 4.7%
5 7,500 0.50 3,750 1.5%
6 6,000 13.60 81,000 32.0%
7 5,000 0.75 3,750 1.5%
8 4,500 1.25 5,625 2.2%
9 7,000 2.50 17,500 6.9%
10 3,000 2.00 6,000 2.4%
Total $254,725 100.0%

The inventory is classified based on the value of the units.

The principle applied here is based on 80/20
Advantages of ABC
Classification
• This kind of categorization of inventory helps one manage the entire
volume and assign relative priority to the right category.
• It helps the managers and inventory planners to maintain accurate
records and draw management’s attention to the issue on hand to
facilitate instant decision-making.
• A Category Items: Helps one identify these stocks as high value items
and ensure tight control in terms of process control, physical security as
well as audit frequency.
• B Category Items: These can be given second priority with lesser
frequency of review and less tightly controls with adequate
documentation, audit controls in place.
• C Category Items: Can be managed with basic and simple records.
Inventory quantities can be larger with very few periodic reviews.