UNIT-6

Basic Inventory systems

 Learning Objectives

 Elements of Inventory Management

 Inventory Control Systems
 Economic Order Quantity Models
 Quantity Discounts
 Reorder Point
 Safety stocks
 What Is Inventory?

 Stock of items kept to meet future

demand
 Purpose of inventory management
 how many units to order
 when to order
 Types of Inventory

 Raw materials
 Purchased parts and supplies
 Work-in-process (partially completed)
products (WIP)
 Items being transported
 Tools and equipment
 Inventory and 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 stop-pages
 Two Forms of Demand
 Dependent
 Demand for items used to produce
final products
 Tires stored at a Goodyear plant are
an example of a dependent demand
item
 Independent
 Demand for items used by external
customers
 Cars, appliances, computers, and
houses are examples of independent
demand inventory
 Inventory and Quality
Management

 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 TQM
 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
 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
 Economic Order Quantity
(EOQ) Models

 EOQ
 optimal order quantity that will
minimize total inventory costs
 Basic EOQ model
 Production quantity model
 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
 Inventory Order Cycle
Order quantity, Q
Demand
rate
Inventory Level

Reorder point, R

0 Lead Lead Time

time time
Order Order Order Order
placed receipt placed receipt
 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
 EOQ Cost Model

Deriving Qopt Proving equality of

costs at optimal point
CoD CcQ
TC = +
Q 2 Co D CcQ
=
TC CoD Cc Q 2
= +
Q Q2 2
2CoD
C0D Cc Q2 =
Cc
0= +
Q2 2
2CoD
2CoD Qopt =
Qopt = Cc
Cc
 EOQ Cost Model (cont.)
Annual
cost ($) Total Cost
Slope = 0
CcQ
Minimum Carrying Cost =
2
total cost

CoD
Ordering Cost = Q

Optimal order Order Quantity, Q

Qopt
 EOQ Example
Cc = $0.75 per yard Co = $150 D = 10,000 yards

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 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
 Production Quantity
Model

 An inventory system in which an 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
 Production Quantity Model
(cont.)
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
 Production Quantity Model
(cont.)
p = production rate d = demand rate

Maximum inventory level = Q - Q d

p

=Q1- d 2CoD
p
Qopt = d
Q d Cc 1 -
Average inventory level = 1- p
2 p

CoD CcQ d
TC = Q + 2 1 - p
 Production Quantity Model:
Example
Cc = $0.75 per yard Co = $150 D = 10,000 yards
d = 10,000/311 = 32.2 yards per day p = 150 yards per day

2CoD 2(150)(10,000)
Qopt = = = 2,256.8 yards
Cc 1 - d 0.75 1 -
32.2
p 150

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

Q 2,256.8
Production run = = = 15.05 days per order
p 150
 Production Quantity Model:
Example (cont.)

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 yards
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
 Quantity Discount Model (cont.)
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

 Quantity Discount: Example
QUANTITY PRICE
Co = $2,500
1 - 49 $1,400 Cc = $190 per computer
50 - 89 1,100 D = 200
90+ 900

2CoD 2(2500)(200)
Qopt = = = 72.5 PCs
Cc 190

For Q = 72.5 Co D CcQopt

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

For Q = 90 CoD CcQ

TC = + 2 + PD = $194,105
Q
 Reorder Point
Level of inventory at which a new order
is placed

R = dL
where
d = demand rate per period
L = lead time
 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

 Safety Stocks

 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
 Safety Stocks

 Demand rate fluctuates while lead time is

constant
 Lead time fluctuates while demand rate
is constant
 Safety stock as a remedy to fluctuations
 Summary

 Inventory is the stock of idle resources that has some

future use
 In process inventory is the stock of items that is waiting
to be processed
 Organizations target to achieve optimal level inventory
 Carrying cost or holding cost is the cost associated
with storing the inventory
 Ordering cost is the average cost of placing an order to
the supplier
 Summary ( Contd….)

 Set up cost is the cost of setting up machines between

two successive production runs
 EOQ Model attempts to find the economic order qty
that minimizes the overall cost
 Inventory turnover is a good measure of inventory
performance and represents the number of inventory
cycles
 Safety stock acts as a hedge against the situation of
stock out