Inventory Management

K.U.B.S
Additional Inventory Management Processes &
Concepts
Total Cost of the System

Total Cost = Holding Cost + Ordering Cost

Break Up of Ordering Cost:

 Item Cost
 Transportation Cost
 Custom Duties
 Insurance

 Order Placing Cost – e.g. Purchase order cost, all kinds of

clerical cost, communication cost.
Transportation

Transportation refers to the

movement of products from
Airways Carriers
one location to another. Modes
of transportation are;
Water Carriers

Pipelines Carriers

Motor Carriers

Railroads Carriers
Transportation Cost
The amount charged for the transportation is based on the
rate a carrier changes from point A to point B.

Terminologies:
 FTL - Full Truck Load (Full capacity utilized of the carrier)
 Transportation costs are a part of the ordering cost.

 LTL - Less Than Truck Load

 Transportation costs are a part of the unit cost.
 LTL rates are first based upon product class published by – NMFC
(National Motor Freight Classification)
Then the carrier’s tariff is used based on the origin and
destination -NMFTA (National Motor Freight Traffic Association).
 Continuous Review System (Q-System)

IP IP IP
Order Order
Order
received
received received
Order
received
On-hand inventory

Q Q Q

ROP
Order Order Order
placed placed placed

Safety Stock
0
L1 L2 L3 Time
TBO1 TBO2 TBO3
Periodic Review System (P- System)

T
IP IP IP
Order Order Order
received received received
On-hand inventory

Q1 Q3
OH Q2 OH
IP1
IP3
Order Order
placed placed
IP2

Time
P P
Protection interval
 Multi – Item Inventory Management (Q,ROP)

Q1 Q2 Q3
Ite Ite Ite
m m m
1 2 3

ROP
 Multi – Item Inventory Management (Q,ROP)

Q
Ite Ite Ite
m m m
1 2 3

ROP
d x L + Safety Stock

Stock Out
 Multi – Item Inventory Management (P,T) or
(T, OUL)
???
T
Ite
m
4
Ite Ite Ite
m m m
1 2 3

P – Periodic Interval
 Multi – Item Inventory Management (P,Q,ROP)

Q
Ite Ite Ite Ite
m m m m
1 2 3 4

ROP

P – Periodic Interval
Multi – Item Inventory Management (Cont.)

Constraints:

 Filling the transport unit

 Not exceeding the capacity of the facility

 Inventory investment (Capital available)

 Service Level
Echelon Models - Inventory Management

There are two Echelon inventory optimization models;

1. Single Echelon Inventory Optimization:

Each facility is considered as an “island”. So each facility is forced to
keep safety stock to cover against any uncertainty in demand and
lead time. There is no strategic decisions are involved in the single
echelon inventory optimization. It only represents an elementary
level inventory optimization method.

2. Multi-echelon inventory optimization:

Each facility is considered as a member of the network. Strategic
decisions are involved to determine which facility should hold safety
stock.
Multi – Echelon Inventory Optimization (Cont.)
Multi – Echelon Inventory Optimization (Cont.)
Multi – Echelon Inventory Optimization (Cont.)

Third Party Logistics Network

Multi – Echelon Inventory Optimization (Cont.)

MEIO takes a whole view of the supply chain and delivers the best
possible tradeoff between service levels and inventory for each SKU at each
inventory stocking location, from raw material supplier to final consumer. 
In other words, it optimizes inventory across all tiers of the supply chain.

Inventory Optimization
Is MEIO a Tactical or Strategic Tool?

MEIO can answer both tactical and strategic questions.

Tactical Level:
MEIO can provide optimal inventory levels for every SKU at every
location for every time period in order to immediately lower the
total supply chain inventory cost.

Strategic Level:
MEIO can be used to conduct “What if?” analysis. For example,
MEIO can be used to determine which product to postpone, which
product to outsource, and what happens when demand changes
or when supplier lead time variation changes.
Newsvendor Model

It is not always possible to exactly forecast the customer

demands.
 Demand is uncertain

 By using the past data, we can determine a distribution function to

represent the demand.

Challenge: We have to determine the order size (Q) before the demand
is known.

If we order too much, then we have extra inventory.

If we order too little, then we lose sale.
Newsvendor Model

What we already know?

 Selling Price of the Item (P)
 Purchasing or Producing cost (C)

 Salvage value (S)

Newsvendor Model
Cases:
There are three cases (Suppose demand is represented by d and order
quantity represent by Q).

1. Demand is bigger than the order quantity (d > Q)

 Underage Cost (Cu) = Selling Price – Purchasing Cost = P – C

2. Demand is less than order quantity (d < Q)

 Overage Cost (Co) = Purchasing Cost – Salvage Value = C - S

3. Demand is equal to order quantity ( d = Q)

F actor
cal
Criti
In Stock Probability = Cu / (Cu + Co)
Example
Purchasing Cost (C) = Rs. 15.0, Selling Price (P) = Rs.27.0 Demand Probability
Salvage Value (S) = Rs 5.0 20 0.05
Marginal Profit = P – C = 27.0-15.0 = Rs. 12.0 21 0.15
Marginal Loss = C – S = 15.0- 5.0 = Rs.10.0 22 0.20
23 0.40
For Supply 20: 24 0.20
Profit = 20 x 12 = Rs.240
For Supply 21:
Profit = 240 + 12(0.95) – 10 (0.05) = Rs.250.90
For Supply 22:
Profit = 250.90 + 12(0.8) – 10(0.2) = Rs. 258.50
For Supply 23:
Profit = 258.50 + 12(0.6) – 10(0.4) = Rs. 261.70
For Supply 24:
Profit = 261.70 + 12(0.2) – 10(0.8) = Rs. 256.10
Newsvendor Problem
If we assume that the newspaper boy pays Rs. 10 per paper, he
sells it for Rs. 30, and Salvage value is Rs. 5 How many newspapers
(Q) should he order if the demand is normally distributed with a
mean of 90 and standard deviation of 10?

d = 90, σd = 10
Underage Cost (Cu) = Selling Price – Purchasing Cost = 30 - 10 = Rs. 20
Overage Cost (Co) = Purchasing Cost – Salvage Value = 10 – 5 = Rs. 5

In stock Probability = Cu / (Cu + Co) = 20 / (20+5) = 0.8 = 80%

Z = 0.84 (from table against SL = 80%)

Q= d+z σd = 90 + 0.84 * 10 = 98.40 ~ 99 newspapers

Distribution Requirement Planning
 DRP’s logic is similar to MRP’s.
 Also known as Distribution replenishment planning.

For Example;
 Toyota works with one distributor in each country.
Distribution Requirement Planning (Cont.)

Inputs:
 Forecast demands

 Current inventory levels

 Target safety stock

 Recommended replenishment quantities

 Replenishment lead times

Storage of Inventory (In Factories)

If inventory is held centrally within a factory, every time

a part is needed for production.
 The worker or robot has to leave the workstation to retrieve it,
or here is labor dedicated to keeping workstations in stock.
 There is an additional “touch”.
 The number of times inventory is touched is often correlated
with shrink, damage, and labor.
 In a factory, the idea of storing inventory, at the workstation
that will need it for production makes sense in terms of
production lead time minimization and also errors in using the
wrong parts and damage.
Storage of Inventory (In Warehouses)

Fixed location Storage:

 Minimizes errors in terms of put away and picking.

Random location storage:

 When space is available, it is used for the inventory.
 Chances of error increases.
 Time increased to find out item or items.
Storage of Inventory (In Retail Stores)
 Most of the storage in retail backrooms is based on the random
location strategy.
 Storage of inventory in retail backrooms is one of the most
difficult inventory storage management problems in the
industry.

Why???
it is difficult to find specific SKUs in retail backrooms
Because
there are typically so many different SKUs in a retail store, and
many times these SKUs are rotating, new products are
introduced, and some SKUs are discontinued.
Inventory Record Management
 Inventory records are a main part of any inventory
management system.
 If inventory records are inaccurate;

 If the firm uses a (Q,ROP) or Q inventory replenishment system,

it will not order at the correct time.
 If the firm uses a (P,T) P replenishment system, it will not order
the correct quantity.