Supply Chain

Management

Inventory
LECTURE 8
Management
Dr. Surya Prakash
Inventory Management

Chapter 10
Outline

• Know about inventory

• Role of Cycle Inventory in a Supply Chain
• Safety Inventory
• Managing Multi-Echelon Cycle Inventory
• Estimating Cycle Inventory Costs
• Inventory optimization
Role of Inventory in the Supply Chain
Role of Cycle Inventory in a Supply Chain

A lot or batch size is the quantity that a stage of a supply chain either produces or
purchases at a time.

Example, a computer store that sells an average of four printers a day.

The store manager, however, orders 80 printers each time he places an order.

The lot or batch size = 80 printers.

An average of 20 days before the store sells the entire lot and purchases a
replenishment lot.

The computer store holds an inventory of printers because the manager purchases
a lot size larger than the store’s daily sales.

Cycle inventory is the average inventory in a supply chain due to either production
or purchases in lot sizes that are larger than those demanded by the customer.
 Q: Quantity in a lot or batch size

D: Demand per unit time

Here, it is assumed that the impact of demand variability and assume that demand
is stable.
Let us consider the cycle inventory of jeans at Jean-Mart, a department store. The
demand for jeans D =100 pairs per day.
The store manager purchases in lots of Q 1,000 pairs. It takes 10 days for an entire lot
to be sold.
The inventory profile of jeans at Jean-Mart is a plot depicting the level of inventory over
time, as shown in Figure 11-1.

Over these 10 days, the inventory of jeans at Jean-Mart declines steadily from 1,000
units (when the lot arrives) to 0 (when the last pair is sold).
Role of Cycle Inventory in a Supply Chain

• Lot Size/Batch Size: Quantity that a supply chain stage either

produces or orders at a given time.

• Cycle inventory: Average inventory that builds up in the

supply chain because a supply chain stage either produces or
purchases in lots that are larger than those demanded by the
customer

Q = lot/batch size of an order

D = demand per unit time

Cycle inventory = Q/2

 Cycle inventory = Q/2

• Cycle inventory depends directly on lot size

• Avg. flow time is the time that elapses b/w the point at
which material enters the supply chain to the point at
which it exits.

• Average flow time = Avg inventory / Avg flow rate

(Taking avg flow rate = demand)

• Average flow time from cycle inventory = Q/(2D)

• For jeans at Jean-Mart, a department store. The
demand for jeans is relatively stable at D = 100
pairs of jeans per day. The store manager at Jean-
Mart currently purchases in lots of Q = 1,000 pairs.

• Find Cycle inventory Answer-

• Average flow time 500
5 days

Cycle inventory at the Jean-Mart store thus adds five days to the average
amount of time that jeans spend in the supply chain.
Inferences
• It means-

Cycle inventory adds 5 days to the time a unit spends in the supply chain

• Larger the cycle inventory, larger is the time b/w when the product is
produced and when it is sold.

• Lower cycle inventory is better because:

• Average flow time is lower

• Working capital requirements are lower
• Lower inventory holding costs
Cycle Inventory and Costs
• Cycle inventory is held primarily to take advantage of economies of
scale in the supply chain
• Supply chain costs influenced by lot size:
• Material cost/price paid per unit purchase = C
• Fixed ordering cost = S
• Holding cost = H = hC (h = cost of holding a unit in inventory for
one year)
• Primary role of cycle inventory is to allow different stages to purchase
product in lot sizes that minimize the sum of material, ordering, and
holding costs.

• Ideally, cycle inventory decisions should consider costs across the

entire supply chain, but in practice, each stage generally makes its
own supply chain decisions – increases total cycle inventory and total
costs in the supply chain
 Economies of Scale – How?

• How do you decide whether to go shopping at a Kirana store or at Big

Bazaar? (Amount of purchase)

• Lot sizing for a single product

• Aggregating multiple products in a single order

• Lot sizing with multiple products or customers

• Lots are ordered and delivered independently for each product

• Lots are ordered and delivered jointly for all products
• Lots are ordered and delivered jointly for a subset of products
Thus,

• Any stage of the supply chain exploits economies of scale in its replenishment
decisions in the following three typical situations:

• 1. A fixed cost is incurred each time an order is placed or produced.

• 2. The supplier offers price discounts based on the quantity purchased per lot.
• 3. The supplier offers short-term price discounts or holds trade promotions.
Lot Sizing- EOQ

Let us consider-

Annual demand = D
Annual material cost = CD
Annual order cost = (D/Q)S
Annual holding cost = (Q/2)H = (Q/2)hC
Total annual cost = TC = CD + (D/Q)S + (Q/2)hC
Figure in next slide shows variation in different costs for different
lot sizes

Number of orders per year = D/Q

 Effect of Lot Size on Costs

Cost

Total Cost

Holding Cost

Ordering Cost

Material Cost

Lot size
EOQ- Q*

H = hC
2 DS
Q* =
H
DH
n* =
2S
Obtained by first derivative of the total cost with respect
to Q and setting it equal to 0
Example
Example of Best Buy Computers
Demand, d = 1000 computers/month

Or D = 12,000 computers per year

Unit cost, C = $500
Holding cost fraction, h = 0.2
Fixed cost, S = $4,000/order
Q* = Sqrt[(2)(12000)(4000)/(0.2)(500)] = 980 computers

Avg. Cycle inventory = Q*/2 = 490

For a lot size of Q* = 980, the store manager evaluates

•You can investigate few more things to
understand costs…………………………..
Using a lot size of 1,100 (instead of 980) increases annual costs to $98,636
(from $97,980). Even though the order size is more than 10 percent larger
than the optimal order size Q*, total cost increases by only 0.67 percent.
Example 2
If desired lot size = Q* = 200 units, what would S have to
be?

D = 12000 units
C = $500
h = 0.2
Use EOQ equation and solve for S:
S = [hC(Q*)2]/2D = [(0.2)(500)(200)2]/(2)(12000) =
$166.67
Key Points from EOQ Model
• In deciding the optimal lot size, the tradeoff is between
setup (order) cost and holding cost.

• If demand increases by a factor of 4, it is optimal to increase

batch size by a factor of 2 and produce (order) twice as
often.

• If lot size is to be reduced, one has to reduce fixed order

cost. To reduce lot size by a factor of 2, order cost has to be
reduced by a factor of 4.

If demand at Best Buy increases to 4,000 computers a month (demand has increased by a
factor of 4), the EOQ formula shows that the optimal lot size doubles and the number of
orders placed per year also doubles. In contrast, average flow time decreases by a factor of
2.
Estimating Cycle Inventory-Related Costs in
Practice

• Inventory holding cost

• Cost of capital
• Obsolescence cost
• Handling cost
• Occupancy cost
• Miscellaneous costs
• Order cost
• Buyer time
• Transportation costs
• Receiving costs
• Other costs
 Inventory Control/Monitor Methods

• ABC Analysis
• FSN Analysis
• VED Analysis
• LIFO/FIFO

• Why inventory control ??????? Balance between OVER STCOK------ OUT of Stock
ABC Analysis (Based On Annual Cost)

• Rule is 80-20 is
used
• Significant few