Chapter 2

(A) Fixed Order Quantity Model

(Q Model)
With Safety Stock

In this model, a definite/fixed quantity of materials is ordered, in case the stock on hand

reaches the re-order point. Here, the fixed order quantity is considered as EOQ.

(A) Fixed Order Quantity Model

(Q Model)

Without Safety Stock

In this model, there is assumption that inventory attenuate at constant rate, and in such case

the stock order when reaches the re-order point.

Fixed Time Period Model

(P Model)

Under fixed time period model, inventory is going to count at particular times, may be

week or a month.

Counting inventories and placing orders periodically are desirable in situations, when

vendor make routine visits to customers and take orders for their complete line of

product.

Under this method, the stock position of every items are regularly checked at review

periods then placing the order.

Types of Inventories - Independent and Dependant Demand Inventories

Inventory Management deals essentially with balancing the inventory levels. Inventory is

categorized into two types based on the demand pattern, which creates the need for inventory.

The two types of demand are Independent Demand and Dependant Demand for inventories.

 Independent Demand

An inventory of an item is said to be falling into the category of independent demand

when the demand for such an item is not dependant upon the demand for another item.

Finished goods Items, which are ordered by External Customers or manufactured for

stock and sale, are called independent demand items.

Independent demands for inventories are based on confirmed Customer orders,

forecasts, estimates and past historical data.

 Dependant Demand
 If the demand for inventory of an item is dependant upon another item, such demands

are categorized as dependant demand.

Raw materials and component inventories are dependant upon the demand for

Finished Goods and hence can be called as Dependant demand inventories.

Take the example of a Car. The car as finished goods is an held produced and held in

inventory as independent demand item, while the raw materials and components used

in the manufacture of the Finished Goods - Car derives its demand from the demand

for the Car and hence is characterized as dependant demand inventory.

This differentiation is necessary because the inventory management systems and

process are different for both categories.

While Finished Goods inventories which is characterized by Independent demand, are

managed with sales order process and supply chain management processes and are

based on sales forecasts, the dependant demand for raw materials and components to

manufacture the finished goods is managed through MRP -Material Resources

Planning or ERP - Enterprise Resource Planning using models such as Just In Time,

Kanban and other concepts. MRP as well as ERP planning depends upon the sales

forecast released for finished goods as the starting point for further action.

Managing Raw Material Inventories is far more complicated than managing Finished Goods

Inventory. This involves analyzing and co-coordinating delivery capacity, lead times and

delivery schedules of all raw material suppliers, coupled with the logistical processes and

transit timelines involved in transportation and warehousing of raw materials before they are

ready to be supplied to the production shop floor. Raw material management also involves
periodic review of the inventory holding, inventory counting and audits, followed by detailed

analysis of the reports leading to financial and management decisions.

Inventory planners who are responsible for planning, managing and controlling Raw Material

inventories have to answer two fundamental questions, which can also be termed as two basic

inventory decisions.

a. Inventory planners need to decide how much of Quantity of each Item is to be ordered

from Raw Material Suppliers or from other Production Departments within the

Organization.

b. When should the orders be placed ?

A bill of materials or product structure is a list of the raw materials, sub-assemblies,

intermediate assemblies, sub-components, parts, and the quantities of each needed to

manufacture an end product.

A master production schedule is a plan for individual commodities to be produced in each

time period such as production, staffing, inventory, etc. It is usually linked to manufacturing

where the plan indicates when and how much of each product will be demanded.
Deterministic Model

A deterministic circumstance is one in which the system parameters can be ascertained

precisely. This is also known as a situation of sureness since it is realized that whatever are

ascertained, things are sure to occur the same way. Also the information about the system

under thought should be whole so that the parameters can be determined with confidence. But

this kind of system rarely exists, and it is for sure that some uncertainty is always associated

with the system.

Method based on the assumption that all parameters and variable associated with an

inventory are known or can be computed with certainty, and that the replenishment lead time

is constant and independent of the demand.

Since it conceives the system to be deterministic, it automatically means that one has full

information about the system.

Probabilistic situation is also called a situation of uncertainty. Though this exists

everywhere, the uncertainty always makes us uncomfortable. So people keep trying to

minimize uncertainty.
These probabilistic model are based on real world because lead time and demand is not

constant at all times.

The service level is the complement of the probability of a stock out.

Deterministic Model

When demand pattern is fixed

When demand pattern is varying

When demand pattern is fixed

Assumptions

Demand is constant

Lead time constant

Ordering cost constant

No stockout /shortage is allowed

When demand pattern is varying

Then economic order quantity included the safety stock

Safety stock= (Max inventory x max lead time) – (Min inventory consumption x min lead

time)

Probabilistic situation is also known as a situation of uncertainty. Although this is present

everywhere, the vagueness always makes us comfortless. So people keep attempting to lessen

uncertainty.
Probabilistic inventory prototypes consisting of probabilistic demand and supply are more

suitable in many real circumstances. But, such models also create larger trouble in analysis

and often become uncontrollable.

Single Period Model

It describes a situation in which one order is placed for a product. At the end of the sales

period, any remaining product has little or no value.

Further it is also called “newsstand problem”.

If the normal distribution is assumed and we stocked and sold an average rate then we have

to consider standard deviation and consider the two marginal cost.

Cs = Cost of shortage (we underestimated) = Sales price per unit – cost per unit

Co = Cost of overage (we overestimated0 = Cost per unit – Salvage value per unit

Then the service level

Service level = Cs

Cs + Co

Thus order quantity increases untill the service level is equal or more than the ratio of SL.

Probabilistic situation is also known as a situation of uncertainty. Although this is present

everywhere, the vagueness always makes us comfortless. So people keep attempting to lessen

uncertainty.

Probabilistic inventory prototypes consisting of probabilistic demand and supply are more

suitable in many real circumstances. But, such models also create larger trouble in analysis

and often become uncontrollable.

Fixed Period System

In this system, same fixed amount is added to inventory every time an order for an item is

placed. Whenever inventory decreases to ROP, new order is placed.

ROP = daily demand x order lead time, if may included safety stock.

Q Walmart purchases 8000 bottle carrots each year from pepsico. The unit cost of each bottle

carrot is Rs10, cost of carrying one bottle carrots in inventory for a year is Rs3. Ordering

cost is Rs30 per order. What are the (a) optimal order quantity; (b) expected number of order

placed each year; (c) expected time between orders? Assume that Walmart operates on a 200-

day working year?

Answer With ...... Orders placed each year, an order for ..........bottle carrots is placed

every ....... Working days.

Q Annual demand for pizza packages at Pizza hut shop is 10,000 units. Pizza hut operates his

business 300 days per year and find that deliveries from his supplier generally take 5 working

days. Calculate the reorder point for the pizza hut?

Case 1 Demand is variable and lead time is constant

Q. Average daily demand of pizza at a pizza hut outlet is 15 units with a standard deviation

of 5 units. The lead time is constant at 2 days. Find ROP if management wants a 90% service

level (Z values of 90% (normal table refer) is 1.28)?

Case 2 Lead time is variable and demand is constant

Q Dominos catering sells 10 pizza a days (almost a constant quantity). Lead time for pizza is

normally distributed with a mean time of 6 days and a standard deviation of 1 day. A 98%

service level is set (Z = 2.055) Find ROP?

Case3 Both demand and lead time are variable

Q Dominos pizza 150 packs are sold per day, following a normal distribution with standard

deviation of 16 packs. Pizza material are ordered from an out of state distributor, lead time is

normally distributor with an average of 5 days and a standard deviation of 1 day. Maintain 95%

service level (Z = 1.65). Find ROP?

Also known as the Toyota Production System, JIT is a common inventory management

technique and type of lean methodology designed to increase efficiency, cut costs and

decrease waste by receiving goods only as they are needed. JIT was originally formed in

Japan as a response to the country’s limited natural resources, leaving little room for wastage.

Today, Just in Time systems are used by many businesses.

The rise of drop shipping has made JIT inventory management more appealing for retailers,

as it allows them to sell a product before buying it, then purchase the item from a third party

and have it shipped directly to the customer.

 The just-in-time (JIT) inventory system is a management strategy that minimizes

inventory and increases efficiency.

 Just-in-time (JIT) manufacturing is also known as the Toyota Production

System (TPS) because the car manufacturer Toyota adopted the system in the 1970s.

 Kanban is a scheduling system often used in conjunction with JIT to avoid

overcapacity of work in process.

 The success of the JIT production process relies on steady production, high-quality

workmanship, no machine breakdowns, and reliable suppliers.

 JIT inventory management strategy has a number of potential benefits for businesses:

 Lower inventory holding costs – with inventory purchased or produced at short

notice there’s no need to have unsold inventory taking up valuable warehouse space.

 Improved cash flow – without the need to store large volumes of inventory at all

times, capital expenditure is reduced, and cash can be invested elsewhere.

 Less dead stock – because inventory levels rely on customer demand, there’s less risk

of unwanted stock left sitting in your warehouse.

 On the flipside, though, Just in Time inventory management isn’t without its potential

disadvantages:

 Problems with order fulfilment – if a customer orders a product and you don’t yet

have it in stock, you run the risk of not being able to fulfil the order in a timely

fashion.

 Little room for error – doing JIT right means having accurate demand forecasts and

insights into customers’ buying habits at all times. Any miscalculation could have a

significant negative impact on business operations.

  Price shocks – with a Just in Time system, you don’t have the luxury of waiting

around for the best prices on goods.

 Kellogg’s

 Given that Kellogg’s produces mostly perishable goods, it shouldn’t come as a

surprise that they use the Just in Time inventory management method as an efficient

stock management system. Kellogg’s makes sure that just enough products are made

to fulfil orders and limited stock is kept on hand.

Just-in-Time Cross-Docking in Walmart’s Inventory Management

Walmart uses different methods to manage its inventory. Just-in-time inventory is the

application of the just-in-time (JIT) method to inventory management. This method involves

measures and activities for the operational objective of minimizing storage and related costs.
At Walmart, the just-in-time inventory method is applied in the form of cross-docking. In

cross-docking, suppliers’ trucks and the company’s trucks meet at the company’s warehouses

or merchandise distribution centers. Goods are transferred from the suppliers’ trucks directly

to Walmart’s trucks, which deliver the goods to the stores.

The main benefit of cross-docking at Walmart’s warehouses is the minimization of inventory

size. Fewer goods are stored at the warehouses. A smaller inventory is less costly to maintain.

Also, cross-docking enables Walmart to quickly deliver goods to the stores. This condition

enables the firm to rapidly respond to fluctuations in demand and related changes in the

market. Thus, this method of inventory management supports Walmart’s operational

efficiency and business resilience.

Lot Sizing Techniques

 Lot Size decision related to

 Purchase order and cost associated with that

 Carrying cost

 Inventory levels

 Capacity requirements

 EOQ

 Fixed Order Quantity

 Period of Supply (Lot size equal to net requirement for a specified period into future)

 Lot for lot (discrete order quantity) (Planned orders equal to net requirements in each

period) (No extra inventory) (Perishable food)

 Period Order Quantity (Calculate fixed number of period requirements for each order

through EOQ)

 Least Unit Cost (identify lowest unit lot via ordering/carrying cost)

 Least total Cost (Select those lost that are most nearly equal)