Inventory4controlsystems PDF

Inventory Management
Production & Operations Management
INVENTORY
CONTROL SYSTEMS
INVENTORY POSITION IP = OH + SR – BO
IP – Inventory Position
 Indicates the stock’s ability to satisfy future demand.
OH – On-hand Inventory
 The actual inventory present in the system.
SR – Scheduled Receipt
 Orders which have been placed but not yet received.
 Also known as ‘Open orders’.
BO – Backorder
In real life inventory control systems, the inventory

position is often used as the basis to decide how much to
order and when to order
2
INVENTORY POSITION IP = OH + SR – BO
At 9:30 am on May 2nd, 2020, Ramesh finds that his warehouse has
24 units of the SONY 16 GB USB drive in stock. His records show
that on April 15th and 23rd, orders for 12 and 18 units respectively of
this item had been placed with two different suppliers. The latter
order was received last night and added to the stock, while the
former is yet to arrive. There is no other pending receipt. His order
book shows orders from three different customers for 4 units, 8
units and 6 units respectively that are yet to be fulfilled. A fresh
order for 10 units is expected later in the day. What is the current
inventory position of the SONY 16 GB USB drive in Ramesh’s
warehouse?
OH = 24 IP = OH + SR – BO
The current
SR = 12 = 24 + 12 – 18 inventory position is
BO = 18 = 18 18 units.
3
INVENTORY CONTROL SYSTEMS

1. Single-period inventory system

 Single-period perishables such as newspaper, cooked
food.
2. Periodic Review (P) system (Periodic system)
 relatively low value, high demand items such as FMCG
retail, soft drinks retail.
3. Continuous Review (Q, r) system (Perpetual system)

 relatively medium value, medium demand items such as
automobile spare parts, intermediate goods.
4. Base stock system
 relatively high value, low demand items such as finished
goods (durables), jet engines.
4
SINGLE-PERIOD
INVENTORY SYSTEM
5
SINGLE-PERIOD INVENTORY SYSTEM

Inventory Quantity stocked

position,
Demand
Demand
Period 1 Period 2 Period 3 …. …. …. …. …. Period n …. Time
 The inventory lasts only a single time period (perishable):

does not carry forward from one period to the next.
 Demand (D) in a period is stochastic, varies randomly.
 Quantity (Q) stocked in a period is fixed as a policy.
6


position,
Demand
Demand
Unit costs of shortage and excess

 When 𝑄 < 𝐷, a shortage (or opportunity) cost, 𝑐𝑠 , exists.
 When 𝑄 > 𝐷, an excess cost, 𝑐𝑒 , comes into play.
 When 𝑄 = 𝐷, 𝑐𝑠 = 𝑐𝑒 = 0.
7


position,
Demand
Demand
𝐸 𝑃𝑟𝑜𝑓𝑖𝑡 = 𝐸 𝑎 ∗ min(𝑄, 𝐷) − 𝑏 ∗ 𝑄
𝑎 − 𝑡ℎ𝑒 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 (𝑠𝑎𝑙𝑒𝑠, 𝑠𝑐𝑟𝑎𝑝)
𝑏 − 𝑖𝑛𝑝𝑢𝑡 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
Then,
𝑐𝑠 = 𝑎 − 𝑏 the lost profit per unit (opportunity cost owing to shortage)
𝑐𝑒 = 𝑏 the input cost per unit

8


position,
Demand
Demand
Optimal stockout probability Optimal service level

∗
𝑐𝑒 ∗
𝑐𝑠
𝑝 = To maximize 𝑆𝐿 =
𝑐𝑒 + 𝑐𝑠 𝑐𝑒 + 𝑐𝑠
the expected
𝑏 profit
∗
𝑝 = ∗
𝑎−𝑏
𝑎 𝑆𝐿 =
𝑎
9


position,
Demand
Demand
Optimal order quantity

Let F be the cumulative probability distribution of the demand D.
 If D is modeled as a continuous random variable, 𝑄 ∗ = 𝐷: 𝐷 = 𝐹 −1 (𝑆𝐿∗ ).

 If D is modeled as discrete, 𝑄 ∗ is the lowest 𝐷: 𝐷 ≥ 𝐹 −1 (𝑆𝐿∗ ).
10
CONTINUOUS
REVIEW SYSTEM
11
CONTINUOUS REVIEW (Q, r) SYSTEM

Inventory
level Qmax3
Qmax1
Qmax4
Qmax2
Q Q Q Q
0
Time (t)
L1 L2 L3 L4
R1 R2 R3 R4
Across  The order quantity (Q) and the reorder point (r)
order are fixed as policies.
cycles  The review period (R) – time between consecutive
orders – can vary.
12

Inventory
level Qmax3
Qmax1
Qmax4
Qmax2
Q Q Q Q
0
Time (t)
L1 L2 L3 L4
R1 R2 R3 R4
 Use the appropriate EOQ formula to find Q (fix Q as policy).
 If stockout and backordering are permitted, then use 𝑐ℎ and

𝑐𝑏 to compute p and SL. Alternatively, fix a desired SL.
13

Inventory
level Qmax3
Qmax1
Qmax4
Qmax2
Q Q Q Q
0
Time (t)
L1 L2 L3 L4
R1 R2 R3 R4
 Using 𝜇𝐷 , 𝜎𝐷 , 𝜇𝐿 and 𝜎𝐿 , find 𝜇𝐿𝐷 and 𝜎𝐿𝐷 .

𝜇𝐿𝐷 = 𝜇𝐿 ∗ 𝜇𝐷
2
𝜎𝐿𝐷 = 𝜇𝐿 ∗ 𝜎𝐷2 + 𝜎𝐿2 ∗ 𝜇𝐷2
14

Inventory
level Qmax3
Qmax1
Qmax4
Qmax2
Q Q Q Q
0
Time (t)
L1 L2 L3 L4
R1 R2 R3 R4
Reorder point (r) Let F be the cumulative distribution function of LD.

 If LD is modeled as continuous, compute 𝑟 = 𝐿𝐷: 𝐿𝐷 = 𝐹 −1 (𝑆𝐿) else if LD
is modeled as discrete, compute 𝑟 as the lowest 𝐿𝐷: 𝐿𝐷 ≥ 𝐹 −1 𝑆𝐿 .
 In the special case when LD is modelled as normally distributed, compute
𝑟 = 𝜇𝐿𝐷 + 𝑧𝑆𝐿 ∗ 𝜎𝐿𝐷 .
15

Inventory
level Qmax3
Qmax1
Qmax4
Qmax2
Q Q Q Q
0
Time (t)
L1 L2 L3 L4
R1 R2 R3 R4
Safety stock (s)

 Generally, compute 𝑠 = 𝑟 − 𝜇𝐿𝐷 .
 If LD is normally distributed, then 𝑠 = 𝑧𝑆𝐿 ∗ 𝜎𝐿𝐷 .
16
PERIODIC REVIEW
SYSTEM
17
PERIODIC REVIEW SYSTEM

T Target Inventory
Qmax3
Qmax2 Qmax4
Inventory Qmax1
level
Q1
r1
Q2 Q3 Q4
r4
r3
r2
L1 L2 L3 L4
Time (t)
R R R
P1 P2 P3
Across  The target inventory (T) and review period (R) are
order fixed as policies.
cycles  The order quantity Q and reorder point r can vary.
18

T Target Inventory
Qmax3
Qmax2 Qmax4
Inventory Qmax1
level
Q1
r1
Q2 Q3 Q4
r4
r3
r2
L1 L2 L3 L4
Time (t)
R R R
P1 P2 P3
 Use EOQ to find the average order quantity 𝑄𝑎𝑣𝑔 .

 Actual quantity ordered (Q) varies from order to order.
 Compute review period 𝑅 = 𝑄𝑎𝑣𝑔 Τ𝜇𝐷 (fix R as a policy).
This is the time between consecutive orders. 19

T Target Inventory
Qmax3
Qmax2 Qmax4
Inventory Qmax1
level
Q1
r1
Q2 Q3 Q4
r4
r3
r2
L1 L2 L3 L4
Time (t)
R R R
P1 P2 P3
 Compute average protection period 𝜇𝑃 = 𝑅 + 𝜇𝐿 .

 Its standard deviation 𝜎𝑃 = 𝜎𝐿 , same as that of the lead time,
since R is a constant.
20

T Target Inventory
Qmax3
Qmax2 Qmax4
Inventory Qmax1
level
Q1
r1
Q2 Q3 Q4
r4
r3
r2
L1 L2 L3 L4
Time (t)
R R R
P1 P2 P3
 Using 𝜇𝐷 , 𝜎𝐷 , 𝜇𝑃 and 𝜎𝑃 , find 𝜇𝑃𝐷 and 𝜎𝑃𝐷 .

𝜇𝑃𝐷 = 𝜇𝑃 ∗ 𝜇𝐷
2
𝜎𝑃𝐷 = 𝜇𝑃 ∗ 𝜎𝐷2 + 𝜎𝑃2 ∗ 𝜇𝐷2
21

T Target Inventory
Qmax3
Qmax2 Qmax4
Inventory Qmax1
level
Q1
r1
Q2 Q3 Q4
r4
r3
r2
L1 L2 L3 L4
Time (t)
R R R
P1 P2 P3
 If stockout and backordering are permitted, then use 𝑐ℎ and

𝑐𝑏 to compute p and SL. Alternatively, use a desired SL.
22

T Target Inventory
Qmax3
Qmax2 Qmax4
Inventory Qmax1
level
Q1
r1
Q2 Q3 Q4
r4
r3
r2
L1 L2 L3 L4
Time (t)
R R R
P1 P2 P3
Target Level (T) Let F be the cumulative distribution function of PD.

 If PD is modeled as continuous, compute 𝑇 = 𝑃𝐷: 𝑃𝐷 = 𝐹 −1 (𝑆𝐿) else if PD
is modeled as discrete, compute 𝑟 as the lowest 𝑃𝐷: 𝑃𝐷 ≥ 𝐹 −1 𝑆𝐿 .
(fix T as policy)
23

T Target Inventory
Qmax3
Qmax2 Qmax4
Inventory Qmax1
level
Q1
r1
Q2 Q3 Q4
r4
r3
r2
L1 L2 L3 L4
Time (t)
R R R
P1 P2 P3
Target Level (T)

 In the special case when PD is modelled as normally distributed, compute
𝑇 = 𝜇𝑃𝐷 + 𝑧𝑆𝐿 ∗ 𝜎𝑃𝐷 .
24

T Target Inventory
Qmax3
Qmax2 Qmax4
Inventory Qmax1
level
Q1
r1
Q2 Q3 Q4
r4
r3
r2
L1 L2 L3 L4
Time (t)
R R R
P1 P2 P3
Order quantity (Q) in the current order

 Compute current order quantity as 𝑄 = 𝑇 − 𝐼, where I is the inventory
position at the time of the review. Q varies from order to order.
 Often, 𝐼 = 𝑂𝐻, the on-hand inventory itself.
25

T Target Inventory
Qmax3
Qmax2 Qmax4
Inventory Qmax1
level
Q1
r1
Q2 Q3 Q4
r4
r3
r2
L1 L2 L3 L4
Time (t)
R R R
P1 P2 P3
Average reorder point (𝝁𝒓 )

 Compute average reorder point, 𝜇𝑟 = 𝑇 − 𝑄𝑎𝑣𝑔 .
26

T Target Inventory
Qmax3
Qmax2 Qmax4
Inventory Qmax1
level
Q1
r1
Q2 Q3 Q4
r4
r3
r2
L1 L2 L3 L4
Time (t)
R R R
P1 P2 P3
Average safety stock (𝝁𝒔 )

 Compute average safety stock, 𝜇𝑠 = 𝑇 − 𝜇𝑃𝐷 .
 If PD is normally distributed, 𝜇𝑠 = 𝑇 − 𝜇𝑃𝐷 = 𝑧𝑆𝐿 ∗ 𝜎𝑃𝐷 .
27

T Target Inventory
Qmax3
Qmax2 Qmax4
Inventory Qmax1
level
Q1
r1
Q2 Q3 Q4
r4
r3
r2
L1 L2 L3 L4
Time (t)
R R R
P1 P2 P3
Two ways of computing T

 From the equations developed for 𝜇𝑟 and 𝜇𝑠 , it follows that
𝑇 = 𝜇𝑠 + 𝜇𝑃𝐷 = 𝜇𝑟 + 𝑄𝑎𝑣𝑔
28
BASE STOCK
SYSTEM
29
-2
-1
0
1
2
3
4
5
No Order placed
Order placed for 1 unit
1 unit replenishment received


BASE STOCK SYSTEM
 Used for high value, low demand goods.

 In above example, reorder point 𝑟 = 3 and 𝐼𝑃 = 4. Order placed for 1 unit

r=3

Time (t)

 Order quantity 𝑄 = 1 and inventory position 𝐼𝑃 = 𝑟 + 1 in the long run.
 Order placed each time a unit is consumed, if 𝑂𝐻 ≤ 𝑟 but not if 𝑂𝐻 > 𝑟.
30
-2
-1
0
1
2
3
4
5
No Order placed

the lead time demand (LD).

BASE STOCK SYSTEM

r=3

Time (t)
 Both lead time (L) and demand (D) are stochastic and so is

 Unit holding cost 𝑐ℎ and backordering cost 𝑐𝑏 are considered.
31
-2
-1
0
1
2
3
4
5
No Order placed
𝐼𝑃∗
=
𝐹 −1 (
𝑐𝑏
𝑐ℎ + 𝑐𝑏
)

BASE STOCK SYSTEM

r=3

function of the lead time demand LD.
 Optimal inventory position 𝐼𝑃∗ = 𝑟 ∗ + 1, is given by:
where F is the cumulative distribution

Time (t)

32
INVENTORY
CONTROL SYSTEMS
IN SUMMARY
33

Single Period Inventory System

 A fixed quantity (Q) is made available at the start of each
period and can be consumed only in that period.
 The quantity may fall short or be in excess of the period’s
demand.
 The periods are disconnected since inventory cannot be
carried forward to the next period.
Continuous Review (Q, r) system

 Lot-size (Q) and reorder point (r) are computed & fixed.
 Review happens continuously & a fresh order, Q, is placed
when inventory position reaches or falls below r.
 Time between orders (R) can vary.
34

Periodic Review (P) system

 Time between orders (R) and target inventory position (T)
are pre-determined and fixed.
 Protection period (P) helps compute T and safety stock (s).
 Review and order happens after every time interval R.
 Lot size (Q) and reorder point (r) can vary across orders.
Base stock system

 A replenishment order, with Q = 1, is issued each time a unit is
consumed.
 A base inventory position (r + 1) is fixed to meet the demand
during lead time.
35

Hybrid (r, T) System

 Combines the continuous review and periodic review systems.
 Review is done periodically as in the P system, but order is
placed only if inventory level has fallen to (or below) a pre-
determined level (r).
 Order size, Q = T – I, where T is the target inventory and I is the
current inventory position.
36
Production & Operations Management Inventory Management
THANK YOU
37

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Inventory Management

Production & Operations Management

In real life inventory control systems, the inventory

INVENTORY CONTROL SYSTEMS

1. Single-period inventory system

3. Continuous Review (Q, r) system (Perpetual system)

SINGLE-PERIOD INVENTORY SYSTEM

Inventory Quantity stocked

Period 1 Period 2 Period 3 …. …. …. …. …. Period n …. Time

 The inventory lasts only a single time period (perishable):

SINGLE-PERIOD INVENTORY SYSTEM

Inventory Quantity stocked

Period 1 Period 2 Period 3 …. …. …. …. …. Period n …. Time

Unit costs of shortage and excess

SINGLE-PERIOD INVENTORY SYSTEM

Inventory Quantity stocked

Period 1 Period 2 Period 3 …. …. …. …. …. Period n …. Time

𝑐𝑒 = 𝑏 the input cost per unit

SINGLE-PERIOD INVENTORY SYSTEM

Inventory Quantity stocked

Period 1 Period 2 Period 3 …. …. …. …. …. Period n …. Time

Optimal stockout probability Optimal service level

SINGLE-PERIOD INVENTORY SYSTEM

Inventory Quantity stocked

Period 1 Period 2 Period 3 …. …. …. …. …. Period n …. Time

Optimal order quantity

 If D is modeled as a continuous random variable, 𝑄 ∗ = 𝐷: 𝐷 = 𝐹 −1 (𝑆𝐿∗ ).

CONTINUOUS REVIEW (Q, r) SYSTEM

CONTINUOUS REVIEW (Q, r) SYSTEM

 Use the appropriate EOQ formula to find Q (fix Q as policy).

 If stockout and backordering are permitted, then use 𝑐ℎ and

CONTINUOUS REVIEW (Q, r) SYSTEM

 Using 𝜇𝐷 , 𝜎𝐷 , 𝜇𝐿 and 𝜎𝐿 , find 𝜇𝐿𝐷 and 𝜎𝐿𝐷 .

CONTINUOUS REVIEW (Q, r) SYSTEM

Reorder point (r) Let F be the cumulative distribution function of LD.

CONTINUOUS REVIEW (Q, r) SYSTEM

Safety stock (s)

PERIODIC REVIEW SYSTEM

PERIODIC REVIEW SYSTEM

 Use EOQ to find the average order quantity 𝑄𝑎𝑣𝑔 .

PERIODIC REVIEW SYSTEM

 Compute average protection period 𝜇𝑃 = 𝑅 + 𝜇𝐿 .

PERIODIC REVIEW SYSTEM

 Using 𝜇𝐷 , 𝜎𝐷 , 𝜇𝑃 and 𝜎𝑃 , find 𝜇𝑃𝐷 and 𝜎𝑃𝐷 .

PERIODIC REVIEW SYSTEM

 If stockout and backordering are permitted, then use 𝑐ℎ and

PERIODIC REVIEW SYSTEM

Target Level (T) Let F be the cumulative distribution function of PD.

PERIODIC REVIEW SYSTEM

Target Level (T)

PERIODIC REVIEW SYSTEM

Order quantity (Q) in the current order

PERIODIC REVIEW SYSTEM

Average reorder point (𝝁𝒓 )

PERIODIC REVIEW SYSTEM

Average safety stock (𝝁𝒔 )

PERIODIC REVIEW SYSTEM

Two ways of computing T

Order placed for 1 unit

Order placed for 1 unit

1 unit replenishment received

Order placed for 1 unit