Inventory Management

Production & Operations Management

INVENTORY
CONTROL SYSTEMS
Inventory Management

INVENTORY POSITION IP = OH + SR – BO
Production & Operations Management

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
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Inventory Management

INVENTORY POSITION IP = OH + SR – BO
Production & Operations Management

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.
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Inventory Management

INVENTORY CONTROL SYSTEMS

Production & Operations Management

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.
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Inventory Management
Production & Operations Management

SINGLE-PERIOD
INVENTORY SYSTEM

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Inventory Management

SINGLE-PERIOD INVENTORY SYSTEM

Production & Operations Management

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.
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Inventory Management

SINGLE-PERIOD INVENTORY SYSTEM

Production & Operations Management

Inventory Quantity stocked

position,
Demand
Demand

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

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.

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Inventory Management

SINGLE-PERIOD INVENTORY SYSTEM

Production & Operations Management

Inventory Quantity stocked

position,
Demand
Demand

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

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

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Inventory Management

SINGLE-PERIOD INVENTORY SYSTEM

Production & Operations Management

Inventory Quantity stocked

position,
Demand
Demand

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

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
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Inventory Management

SINGLE-PERIOD INVENTORY SYSTEM

Production & Operations Management

Inventory Quantity stocked

position,
Demand
Demand

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

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∗ ).

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Inventory Management
Production & Operations Management

CONTINUOUS
REVIEW SYSTEM

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Inventory Management

CONTINUOUS REVIEW (Q, r) SYSTEM

Production & Operations Management

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.
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Inventory Management

CONTINUOUS REVIEW (Q, r) SYSTEM

Production & Operations Management

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.
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Inventory Management

CONTINUOUS REVIEW (Q, r) SYSTEM

Production & Operations Management

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
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Inventory Management

CONTINUOUS REVIEW (Q, r) SYSTEM

Production & Operations Management

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 .
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Inventory Management

CONTINUOUS REVIEW (Q, r) SYSTEM

Production & Operations Management

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 .

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Inventory Management
Production & Operations Management

PERIODIC REVIEW
SYSTEM

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Inventory Management

PERIODIC REVIEW SYSTEM

Production & Operations Management

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.

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Inventory Management

PERIODIC REVIEW SYSTEM

Production & Operations Management

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
Inventory Management

PERIODIC REVIEW SYSTEM

Production & Operations Management

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.
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Inventory Management

PERIODIC REVIEW SYSTEM

Production & Operations Management

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
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Inventory Management

PERIODIC REVIEW SYSTEM

Production & Operations Management

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.

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Inventory Management

PERIODIC REVIEW SYSTEM

Production & Operations Management

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)
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Inventory Management

PERIODIC REVIEW SYSTEM

Production & Operations Management

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 .

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Inventory Management

PERIODIC REVIEW SYSTEM

Production & Operations Management

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.
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Inventory Management

PERIODIC REVIEW SYSTEM

Production & Operations Management

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 .

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Inventory Management

PERIODIC REVIEW SYSTEM

Production & Operations Management

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 .
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Inventory Management

PERIODIC REVIEW SYSTEM

Production & Operations Management

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
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Inventory Management
Production & Operations Management

BASE STOCK
SYSTEM

29
Production & Operations Management

-2
-1
0
1
2
3
4
5

No Order placed
Inventory Management

Order placed for 1 unit

Order placed for 1 unit

1 unit replenishment received

Order placed for 1 unit

Order placed for 1 unit

1 unit replenishment received

Order placed for 1 unit

Order placed for 1 unit
BASE STOCK SYSTEM

1 unit replenishment received

 Used for high value, low demand goods.

Order placed for 1 unit

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

Order placed for 1 unit

r=3

1 unit replenishment received

1 unit replenishment received

1 unit replenishment received

1 unit replenishment received

Time (t)

Order placed for 1 unit

 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.

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Production & Operations Management

-2
-1
0
1
2
3
4
5

No Order placed
Inventory Management

Order placed for 1 unit

Order placed for 1 unit

1 unit replenishment received

Order placed for 1 unit

Order placed for 1 unit

1 unit replenishment received

Order placed for 1 unit

the lead time demand (LD).

Order placed for 1 unit
BASE STOCK SYSTEM

1 unit replenishment received

Order placed for 1 unit

Order placed for 1 unit

Order placed for 1 unit

r=3

1 unit replenishment received

1 unit replenishment received

1 unit replenishment received

1 unit replenishment received

Time (t)

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

Order placed for 1 unit

 Unit holding cost 𝑐ℎ and backordering cost 𝑐𝑏 are considered.

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Production & Operations Management

-2
-1
0
1
2
3
4
5

No Order placed

𝐼𝑃∗
Inventory Management

Order placed for 1 unit

=
Order placed for 1 unit

𝐹 −1 (
1 unit replenishment received

𝑐𝑏
Order placed for 1 unit

𝑐ℎ + 𝑐𝑏
)
Order placed for 1 unit
1 unit replenishment received

Order placed for 1 unit

Order placed for 1 unit
BASE STOCK SYSTEM

1 unit replenishment received

Order placed for 1 unit

Order placed for 1 unit

Order placed for 1 unit

r=3

1 unit replenishment received

1 unit replenishment received

1 unit replenishment received

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

where F is the cumulative distribution

1 unit replenishment received

Time (t)

Order placed for 1 unit

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Inventory Management
Production & Operations Management

INVENTORY
CONTROL SYSTEMS
IN SUMMARY

33
Inventory Management

INVENTORY CONTROL SYSTEMS

Production & Operations Management

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.
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Inventory Management

INVENTORY CONTROL SYSTEMS

Production & Operations Management

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.
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Inventory Management

INVENTORY CONTROL SYSTEMS

Production & Operations Management

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.

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Production & Operations Management Inventory Management

THANK YOU

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