1GE303 Operations

Management

Inventory Management

Topics
Inventory System Defined
Inventory Purpose

Inventory Costs
Single-Period Inventory Model

Multi-Period Inventory: Fixed-Order Quantity Model

Multi-Period Inventory: Fixed-Time Period Model

Inventory
Visualize it as stacks of money seating on

forklifts, shelves, trucks, etc.

It is, for some business, the largest asset on the

balance sheet at any given time

In the US the average cost of inventory is about

30-35% of its value

Is company carries $20 million it costs about $6-7

million per year

Inventory System
Inventory is the stock of any item or resource

used in an organization and can include: raw

materials, finished products, component parts,

supplies, and work-in-process
An inventory system is the set of policies and

controls that monitor levels of inventory and

determines what levels should be maintained,

when stock should be replenished, and how large

orders should be

Purposes of Inventory
1. Economies of scale (economic purchase-order

size, longer production runs, etc.)

2. Uncertainty (unexpected demand, system

failures, supplier reliability)

3. To maintain independence of operations
4. Speculation (change in costs over time)
5. Smoothing (variation in product demand)
6. To allow flexibility in production scheduling
7. Transportation and logistics

Inventory Costs
Holding (or carrying) costs

Opportunity, storage, handling, insurance, breakage,

deterioration, etc.

Setup (or production change) costs

Costs for arranging specific equipment setups, etc.

Ordering costs

Costs of someone placing an order, etc.

Shortage costs

Costs of canceling an order, etc.

Inventory Systems
Type of demand

Independent vs. dependent

Stochastic vs. deterministic

Number of periods

Single-period

Multi-period

Inventory Systems
Lead time time between order placement and its

arrival
Review time Continuous or Periodic
Excessive demand Backordered or Lost
Inventory changes over time perishability and

obsolescence

Inventory Systems
Single-Period Inventory Model (Newsboy Model)

One time purchasing decision (Examples: vendor

selling t-shirts at a football game, newspapers,
room/ticket booking)

Balance the costs of inventory overstock and

understock

Multi-Period Inventory Models

Fixed-Order Quantity Models - Event triggered

Fixed-Time Period Models - Time triggered

Single-Period
Assumptions

The product life is one period of finite length

Only one procurement at the beginning of the period

Stochastic demand with known probability distribution

function (pdf)

No backorder

Notation
c buying cost

s selling price

h holding cost

p shortage cost (<0, salvage)

Q order quantity x demand (pdf f(x))

Single-Period
Profit

, =

,
p 0,

0,

= + cost of understocking (lost sales + shortage)

= + cost of overstocking (buying + holding)

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Single-Period
Expected profit (continuous)
+

( , ) =

, ()

which can be shown to be

Its maximum is obtained by equating its partial derivative to 0

+

=
=
+ + +
= + is cost of understocking
= + is the cost of overstocking
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Standard Normal Curve

This area is 0.5

( )
0 0.35
Reads directly .1368

0.35 = .5 + .1368
= .6368
0.35 =
1 0.35
= 1 .5 + .1368
= 1 .6368 = .3632
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Single-Period
Example (continuous)
The weekly demand for a newspaper at a newsstand is normally
distributed with a mean = 300and standard deviation = 50
(approximately). The newsstand buys (c) the papers for 1.9 each
and sells (s) them for 2.5. Unsold papers can be salvaged (-h) at
the end of the week for 1.5 each. How many papers should the
newsstand buy in order to maximize the expected profit?

0.6
=
=
= 0.6, = 2.5 1.9 + 0, = 1.9 1.5 + 0
+
1

300
50

0.225

300
,
50

= 0.6 0.5 = 0.1, from a table = 0.255

so 300 + 0.225 50 = 312.2 Order 313 papers

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Single-Period
Expected profit (discrete case)

( )() +
=0

( ) ()
=+1

its maximum is obtained by equating its partial derivative to 0

=

Or, using the marginal costs argument: =

Q should increase as long as the probability of selling the last unit
added is at least the one given by found ratio, that is is the
smallest Q ensuring

Single-Period
Example (discrete)
# weeks
# papers
P(x)
F(x)
Solve
the same
example,
but now

4 that295
0,077
0,08
consider
the demand
distribution
0,192
0,27
was10
obtained298
using the
empirical
data
300
from5last year.

0,096 0,37
10
302 0,192 0,56
How papers should we order to
10
303 0,192 0,75
maximize
expected
value of0,92
profit?
9 the306
0,173
4
310 0,077
1
Ratio is s before 0.6

# weeks # papers

4
10
5
10
10
9
303
4

295
298
300
302
303
306
310

Review Question
Single-Period