Inventory

BA 339
Mellie Pullman
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Inventory Definitions
Inventory

vs. Inventory system

Dependent vs. Independent
environments
Types
Safety

Stock
Anticipation Inventory
Hedge inventory (unusual events)
Transportation or Pipeline Inventory
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Purposes of Inventory
1. Independence of operations.
2. Variation
Product

demand

Material

Delivery Time

3. Scheduling flexibility
4. Volume Discounts
5. Material price fluctuations
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Inventory Costs
Holding
Setup

(or carrying) costs

(or production change) costs

Ordering

costs.

Shortage

costs.

Inventory Systems
Rules

to manage inventory, specifically:

timing (when to order)
sizing (how much to order)
Continuous Review or Fixed-Order Quantity
Models (Q)
Event triggered (Example: running out of
stock)
Periodic Review or Fixed-Time Period Models (P)
Time triggered (Example: Monthly sales call by
sales representative)
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Comparison of Periodic and

Continuous Review Systems
Periodic Review

Fixed order intervals

Variable order sizes
Convenient to
administer
Inventory position only
required at review

Continuous Review

Varying order intervals

Fixed order sizes (Q)
Allows individual review
frequencies
Possible quantity discounts
Lower, less-expensive
safety stocks

Inventory costs
C

= Unit cost or production cost: the

additional cost for each unit purchased or
produced.
H = Holding costs: cost of keeping items in
inventory(cost of lost capital, taxes and
insurance for storage, breakage, etc.,
handling and storing)
S = Setup or ordering costs: a fixed cost
incurred every time you place an order or a
batch is produced.
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Total costs of carrying inventory

Assumptions

demand is constant and uniform throughout the

period for your products (5 cases per day)
Price per unit is constant for the period ($16/case)
Inventory holding cost is based on an average cost.

Total

Inventory Policy Cost annually

= annual purchase cost
+ annual order cost
+ annual holding cost
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10

Total cost of Inventory Policy

=

annual purchase cost (annual demand *

Cost/item)
+ annual order cost (annual # orders * Cost to
order)
+ annual holding cost (average units held*cost
to carry one unit)

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Total Inventory Cost

Equation

Q
D
TC D * C S H
Q
2

D = yearly demand of units

C = cost of each unit
Q = quantity ordered
S = cost to place order
H = average yearly holding cost for each unit
= storage+interest*C
D/Q = number of orders per year
Q/2 = average inventory held during a given perio
assuming with start with Q and drop to zero
before next order arrives (cycle inventory).
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Deriving the EOQ :

Economic Order Quantity
Using

calculus, we take the derivative of

the total cost function and set the
derivative (slope) equal to zero

2DS
2(Annual Demand)(Order or Setup Cost)
Q EOQ =
=
H
Annual Holding Cost

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EOQ Model--Basic Fixed-Order

Quantity Model (Q)

Number
of units
on hand Q

R
L

R = Reorder point
Q = Economic order quantity
L = Lead time

L
Time

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The Reorder Point

Reorder point = (average period demand)*Lead Time periods

=
d*L

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Another EOQ Example

Annual Demand = 1,000 units

Days per year considered in average daily demand
Cost to place an order = $10
Holding cost per unit per year = $2.50
Lead time = 7 days
Cost per unit = $15

Determine the economic order quantity & reorder

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Minor Deviations Here

What

causes minor deviations from the

ideal order size?
Assumptions behind the regular EOQ
Model?

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Variations in lead time

If we have variations in lead time, how should we

change the reorder point so we rarely run out?
Reorder Point = Average demand during lead time(d*L) +
safety stock (Z* L)

L D L

where:
d
= average daily (or weekly) demand
L
= Lead time (matching days or weeks)
L = standard deviation of demand during lead time.
D = standard deviation of demand (days or weeks).

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Service Level or % of time inventory will

meet demand during lead time
Z Value

Resulting Service Level

1.28

90%

1.65

95%

2.33

99%

3.08

99.9%
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Example

Annual Demand = 1000 units

250 work days in the year
d=1000/250 = 4 units/day
Q= 200 units
L=9 days
L = 3 units
z=2 (97.7% likelihood that we wont run out during
lead time)

Reorder point= d*L +z*L

= (4*9) + (2*3) = 42 units
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P Method (periodic review)

You

have a predetermined time (P) between

orders (sales rep comes by every 10 days) or
the average time between orders from EOQ =
Q/D
How much should you order to bring inventory
level up to some predetermined level, R where:
R = restocking level
Current Inventory position = IP
Order Quantity= R-IP
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Restocking Level
Needs

to meet most demand situations

R=

Restocking level
= Average demand during lead time & review
period+ safety stock
= P+L + z* P+L

where:
P+L = average demand during lead time and review
period
z = # of standard dev from mean above the average
demand (higher z is lower probability of running out).
RP+L = standard deviation of demand during lead time
+ review period
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ABC Inventory Management

Based

on Pareto concept (80/20 rule)

and total usage in dollars of each item.
Classification of items as A, B, or C
based on usage.
Purpose is to set priorities on effort used
to manage different SKUs, i.e. to allocate
scarce management resources.
SKU: Stock Keeping Unit
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ABC Inventory Management

A items:

20% of SKUs, 80% of dollars

B items: 30 % of SKUs, 15% of dollars
C items: 50 % of SKUs, 5% of dollars
Three classes is arbitrary; could be any
number.
Percents are approximate.
Danger: dollar use may not reflect
importance of any given SKU!
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Example of SKU list for 10 items

Item

Annual
Usage in
Units

5,000

1,500

Unit Cost

Dollar Usage

1.50

Percentage
of Total
Dollar
Usage

7,500

2.9%

8.00

12,000

4.7%

10,000

10.50

105,000

41.2%

6,000

2.00

12,000

4.7%

7,500

0.50

3,750

1.5%

6,000

13.60

81,600

32.0%

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ABC Chart for SKU List

120.0%

40.0%

Percent Usage

35.0%
30.0%

100.0%

80.0%

25.0%

60.0%

20.0%
15.0%

40.0%

10.0%

20.0%

5.0%
0.0%

Cumulative % Usage

45.0%

0.0%
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Item No.
Percentage of Total Dollar Usage

Cumulative Percentage

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ABC Application
Jewelry

Store
Fine Dining Restaurant
Outdoor Retailer
Large Department Store

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