Inventory Management

Satchidananda Tripathy
Inventory
Definition:
The term Inventory includes all the materials a business holds, such as raw
materials, work-in-progress items, finished goods, packaging materials, and spare
parts to meet an un expected demand or distribution in the future.
Essentially, it’s the stock of goods maintained to meet future demand.
 Manufacturing firms carry supplies of raw materials, purchased parts, partially finished items, and finished
goods, as well as spare parts for machines, tools, and other supplies.
 Department stores carry clothing, furniture, carpeting, stationery, cosmetics, gifts, cards, and toys. Some
also stock sporting goods, paints, and tools.
 Hospitals stock drugs, surgical supplies, life-monitoring equipment, sheets and pillow cases, and more.
 Supermarkets stock fresh and canned foods, packaged and frozen foods, household supplies, magazines,
baked goods, dairy products, produce, and other items.
 Functions of Inventory
To understand why firms have inventories at all, you need to be aware of
the various functions of inventory
To meet anticipated customer demand
To smooth production requirements
To decouple operations
To reduce the risk of stock outs
To take advantage of order cycles
To hedge against price increases
To permit operations
To take advantage of quantity discounts
Different kinds of inventories
Raw materials and purchased parts.
Partially completed goods, called work-in-process (WIP).
Finished-goods inventories (manufacturing firms)
or merchandise (retail stores).
Tools and supplies.
Maintenance and repairs (MRO) inventory.
Goods-in-transit to warehouses, distributors,
or customers (pipeline inventory).
Needs of inventory Management

Decision of

 Which items to buy

 When to buy them
 What quantities to buy

 For small organisation (SME) Are based on intuition of purchase manager.

 For large organisation its need to be scientifically determined the Inventory.

“Inventory is a necessary evil”

System of mismanaged Inventory
 Objective of Inventory Management
Inadequate control of inventories can result in both under- and overstocking of items.
The overall objective of inventory management is to achieve satisfactory levels of
customer service while keeping inventory costs within reasonable bounds.

“Inventory is a necessary evil”

The two basic issues (decisions) for inventory management

1. When to order
2. How much to order
Managers have a number of performance measures they can use to judge the effectiveness of inventory
management

 The most obvious, of course, are costs and customer satisfaction, which they might measure by the number
and quantity of backorders and/or customer complaints.
 Another useful measure is days of inventory on hand, a number that indicates the expected number of days
of sales that can be supplied from existing inventory.
How much to order: economic order quantity models
The question of how much to order can be determined by using an economic order quantity (EOQ) model.

Economic order quantity (EOQ): The order size that minimizes total annual cost

EOQ models identify the optimal order quantity by minimizing the sum of
certain annual costs that vary with order size and order frequency.

Three order size models are :

1. The basic economic order quantity model

2. The economic production quantity model
3. The quantity discount model
 Inventory Costs
Four basic costs are associated with inventories: purchase, holding, ordering, and shortage
Purchase cost: The amount paid to buy the inventory.
Holding (carrying) cost: The cost to carry an item in inventory for a length of time, usually a year.
(Costs include interest, insurance, taxes (in some states), depreciation, obsolescence, deterioration, spoilage,
pilferage, breakage, tracking, picking, warehousing costs (heat, light, rent, workers, equipment, security) and
Opportunity costs ( cost associated with having funds that could be used elsewhere tied up in inventory).
Holding costs are stated in either of two ways: as a percentage of unit price or as a dollar amount per unit.
Ordering costs: The cost of ordering and receiving inventory.
(cost to determining how much is needed, preparing invoices, inspecting goods upon arrival for quality and
quantity, and moving the goods to temporary storage).
Ordering costs are generally expressed as a fixed dollar amount per order, regardless of order size.
Setup costs: The cost involved in preparing equipment for a job.
(e.g., preparing equipment for the job by adjusting the machine, changing cutting tools) are analogous to
ordering costs)
Shortage costs: The cost resulting when demand exceeds the supply of inventory; often unrealized profit per
unit.
(costs can include the opportunity cost of not making a sale, loss of customer goodwill, late charges,
backorder costs, and similar costs.
 Determination of EOQ

The inventory cycle: profile of inventory level over time

Average inventory level and number of orders per year are inversely related:
As one increases, the other decreases
Basic Economic Order Quantity (EOQ) Model
 It is used to identify a fixed order size that will minimize the sum of the annual
costs of holding inventory and ordering inventory.
 The optimal order quantity to be determined is known as ‘Economic Order
Quantity’ (EOQ).
 This is also known as Wilson’s Lot Size Formula or Harris Formula.
Assumptions of the basic EOQ model

1. Average demand is continuous and constant.

2. Annual demand requirements are known.
3. Lead time is known and constant.
4. Independence between inventory items.
5. The order quantity, EOQ , is equal to the delivery quantity.
6. The purchase price and cost parameters are constant.
 Carrying cost, ordering cost, and total cost curve

The total annual cost (TC) associated with

carrying and ordering inventory when Q
The average inventory is simply half of the order quantity: The amount Because the number of orders per year, D/Q, units are ordered each time is
on hand decreases steadily from Q units to 0, for an average of (Q + 0 ) / decreases as Q increases, annual ordering
2 , or Q / 2 . cost is inversely related to order size
Mathematical derivation of EOQ
For determining the minimum point of the total-cost curve by differentiating TC with respect to Q, setting
the result equal to zero, and solving for Q.

• For minimization of TC,

i. Necessary condition :

ii. Sufficient condition:

= >0

(second derivative is positive, which indicates a minimum has been obtained)

The total-cost curve is U-shaped (i.e., convex, with one minimum) and that it reaches its
minimum at the quantity where carrying and ordering costs are equal.
Approximation of EOQ

How good is this “approximate” EOQ in terms of minimizing cost?

This is particularly true for quantities larger than the real EOQ, because the total cost curve rises very slowly to
the right of the EOQ.
Examples # 01

A local distributor for a national tire company expects to sell approximately

9,600 steel belted
radial tires of a certain size and tread design next year. Annual carrying cost is
$16 per tire, and ordering cost is $75. The distributor operates 288 days a year.

a. What is the EOQ?

b. How many times per year does the store reorder?
c. What is the length of an order cycle?
d. What will the total annual cost be if the EOQ quantity is ordered?
Solution
Example:#02
 Economic Production Quantity (EPQ)
• The EOQ model as presented is for an inventory item that is purchased from outside. A purchase
or replenishment order is placed with order quantity, Q stated.

• However for self-supply situation, EOQ model is not applicable.

• In a self-supply situation, the item is being produced internally rather than procured from
external supplier. When the production begins, a constant number of units are supposed to be
added to the inventory each day till the time the production run is completed.
The assumptions are:
1. Only one product is involved
2. Annual demand is known
3. The usage rate is constant
4. Usage occurs continually, but production occurs periodically
5. The production rate is constant when production is occurring
6. Lead time is known and constant
7. There are no quantity discounts
EPQ with incremental inventory buildup
• For each production run for given production cost, the production system (say, a machine)
has to have a setup for which a setup cost is to be incurred.

• Let us assume,

Q = total (order) quantity

tp = production run time
p = production rate
u = demand rate
S = setup cost per setup
H= holding cost per unit per year
• Maximum inventory in a production cycle is given by
maximum inventory = tp (p - u)
tp = Q/p
Hence, average inventory =

• Total variable cost = setup cost + holding cost

=
• Setting the first derivative of the total cost expression with respect to the decision variable, Q to
zero, as a necessary condition, the optimal order quantity, Q* is determined as

and the optimal total cost is given by

The cycle time (the time between setups of consecutive runs):

The run time (the production phase of the cycle):

 Publication
Journal Papers :

 Tripathy, S., Kumar, A., and Mahanty, B. (2023), “Short-lived Product Returns Forecasting When Customers are Unwilling to Return the Product: A Grey- Graphical Evaluation and Review
Technique” Technological Forecasting & Social Change https://doi.org/10.1016/j.techfore.2023.122755 ( IF =12)
 Tripathy, S., Kumar, A., and Goswami, M (2024), “Optimal Pricing Strategy for Multiple Generations of New and Remanufactured Short-Lived Products Considering Consumer Behavior and
Market Dynamics,” Transportation Research Part E: Logistics and Transportation Review (Under Review).
 Tripathy, S., Gaula, A.K., “Optimal pricing strategy for new and remanufactured short-lived products across a generation considering consumer psychological behavior: An Industry I5.0
approach”. (Under review in Benchmarking: An International Journal )
 Tripathy, S., “Sentiment and Specification-Driven Exchange Pricing model for Short-lived product: A case study on a Smartphone.” (Under Pipeline)
 Tripathy, S., “Assessing the remanufacturing viability of product components: A Critical Reusability Index for Short-Lived Products.” (Under Pipeline)
Conference Proceeding :

 Tripathy, S., and Kumar, A. (2023), “Enhancing Short Life Cycle Remanufacturing Through Spare Parts Reuse: Managing Uncertainty and Component Commonality Across Multiple,” CIE 50,
October 30-November 2, 2023, American University of Sharjah, UAE

 Tripathy, S., Kumar, A., and Mahanty, B., (2023), “Mitigating Uncertainty in Short Life Cycle Remanufacturing: Leveraging Spare Parts Reuse in Multiple Generations” IEEM2023, Dec, 18-21,
2023, Marina Bay Sand, Singapore https://doi.org/10.1109/IEEM58616.2023.10406930

 Tripathy, S., and Kumar, A., (2021) “Predicting the exchange price of the returned core using data mining approach: A case study on smartphones,” POMS India International Conference 2021,
December 22 – 24, 2021, SPJIMR, Mumbai, India

Book chapter :

 Tripathy, S., and Kumar, A. (2023). Quantifying the Quality Grade of the Return Mobile Phone. Springer Nature Singapore https://doi.org/10.1007/978-981-99-1019-9.