UNIT 4 - INVENTORY MANAGEMENT

4.1 Introduction
Inventory: Stock of goods, which must be carried and
stored in order to ensure smooth and efficient running of
affairs of production and business.
Inventories are materials and supplies that a business or
institution carries either for sale or to provide inputs or
supplies to the production process
Inventory management is responsible for planning and
controlling inventory from the raw material stage to the
customer.
 Cont..
Inventory one of the most expensive assets of many companies representing as
much as 50% of total invested capital
On one hand a firm can reduce cost by reducing inventory, on the other hand,
production may stop and customers become dissatisfied when an item is out of
stock.
Operations managers must balance inventory investment and customer service
Thus, objective of inventory management is to strike a balance between inventory
investment and customer service

A firm wishing to maximize profit will have at least the following objectives:
• Maximum customer service.
• Low-cost plant operation.
• Minimum inventory investment
4.2. Functions and types of inventory
Functions of Inventory

1. To decouple or separate various parts of the production process

• Customer demand and finished goods.
• Finished goods and component availability.
• Requirements for an operation and the output from the preceding operation.
• Parts and materials to begin production and the suppliers of materials.
2. To decouple Supply and demand: To decouple the firm from fluctuations
in demand and provide a stock of goods that will provide a selection for
customers
3.To take advantage of quantity discounts
4.To hedge against inflation
Types of Inventory
To accommodate the functions of inventory, firms maintain the following
types of inventory:
 Raw material
 Purchased but not processed
 Work-in-process
 Undergone some change but not completed
 A function of cycle time for a product
 Maintenance/repair/operating (MRO)
 Necessary to keep machinery and processes productive
 Finished goods
 Completed product awaiting shipment
 Managing inventory
The Material Flow Cycle: Most of the time work is in progress, 95 % of
the time is not productive time
Cycle time

95% 5%
Input Wait for Wait to Move Wait in queue Setup Run Output
inspection be moved time for operator time time
Elements of inventory management system

Two elements include:

1. How inventory items can be classified, ABC classifications
2. How accurate inventory records can be maintained
 1. ABC Classifications
 Divides inventory into three classes based on
annual dollar volume
 Class A - high annual dollar volume
 Class B - medium annual dollar volume
 Class C - low annual dollar volume

 Used to establish policies that focus on the few

critical parts and not the many trivial ones
 Cont..
The ABC inventory classification system answers two
questions by determining the importance of items and thus
allowing different levels of control based on the relative
importance of items.
Question 1. What is the importance of the inventory item?
Question 2. How are they to be controlled?
 Cont.. Illustrations

Percent of Annual Percent of

Item Stock Number of Volume Annual Dollar Annual Dollar
Number Items Stocked (units) x Unit Cost = Volume Volume Class

#10286 20% 1,000 $ 90.00 $ 90,000 38.8% A

72%
#11526 500 154.00 77,000 33.2% A

#12760 1,550 17.00 26,350 23%

11.3% B

#10867 30% 350 42.86 15,001 6.4% B

#10500 1,000 12.50 12,500 5.4% B

 Cont…..

Percent of Annual Percent of

Item Stock Number of Volume Annual Dollar Annual Dollar
Number Items Stocked (units) x Unit Cost = Volume Volume Class

#12572 600 $ 14.17 $ 8,502 3.7% C

#14075 2,000 .60 1,200 .5% C

#01036 50% 100 8.50 850 .4% C

#01307 1,200 .42 504 .2%

5% C

#10572 250 .60 150 .1% C

8,550 $232,057 100.0%

 Cont…

A Items
80 –
Percent of annual dollar usage

70 –
60 –
50 –
40 –
30 –
20 – B Items
10 – C Items
0 – | | | | | | | | | |

10 20 30 40 50 60 70 80 90 100
Percent of inventory items
Cont…
 Other criteria than annual dollar volume may be
used
 Anticipated engineering changes
 Delivery problems
 Quality problems
 High unit cost
Cont…

 Policies employed may include

 More emphasis on supplier development for A items
 Tighter physical inventory control for A items
 More care in forecasting A items
2. Record Accuracy
 Accurate records are a critical ingredient in production
and inventory systems
 Allows organization to focus on what is needed
 Necessary to make precise decisions about ordering,
scheduling, and shipping
 Incoming and outgoing record keeping must be accurate
 Stockrooms should be secure
4.3. Independent Versus Dependent Demand
 Independent demand - the demand for item is
independent of the demand for any other item in
inventory
 Dependent demand - the demand for item is
dependent upon the demand for some other item
in the inventory
4.4. Inventory Costs
The following costs are used for inventory management decisions:
A. Item cost.
Item cost is the price paid for a purchased item, transportation, custom
duties, and insurance. The inclusive cost is often called the landed cost.
For an item manufactured in-house, the cost includes direct material,
direct labor, and factory overhead
B. Carrying costs/holding costs. - the costs of holding or “carrying”
inventory over time.
• Stockout costs.
• Capacity-associated costs.
 Carrying cost continued…
They can be broken down into three categories:
1. Capital costs. Money invested in inventory is not available for other uses
and as such represents a lost opportunity cost.
2. Storage costs. Storing inventory requires space, workers, and equipment.
As inventory increases, so do these costs.
3. Risk costs. The risks in carrying inventory are as follows:
a. Obsolescence. Loss of product value resulting from a model or style change or
technological development.
b. Damage. Inventory damaged while being held or moved.
c. Pilferage. Goods lost, strayed, or stolen.
d. Deterioration. Inventory that rots or dissipates in storage or whose shelf life is limited.
C. Ordering costs/ Setup costs - the costs of placing an order and
receiving goods
Ordering costs are those costs that are associated with placing an order either with
the factory or with a supplier.
Ordering costs include the following:
■ Production control costs. The costs incurred are those of issuing and closing orders, scheduling,
loading, dispatching, and expediting.
■ Setup and teardown costs. Every time an order is issued, work centers have to set up to run the
order and tear down the setup at the end of the run. These costs do not depend upon the quantity
ordered but on the number of orders placed per year.
■ Lost capacity cost. Every time an order is placed at a work center, the time taken to set up is lost
as productive output time.
■ Purchase order cost. These costs include order preparation, follow-up, expediting, receiving,
authorizing payment, and the accounting cost of receiving and paying the invoice.
■ Movement or transportation cost. When an order is placed, material for the order has to be
moved from operation to operation.
 D. Stockout costs
If demand during the lead time exceeds forecast, a stockout can be
expected.
A stockout can potentially be expensive because of backorder costs, lost
sales, and possibly lost customers.
Stockouts can be reduced by carrying extra inventory to protect against those
times when the demand during lead time is greater than forecast.
E. Capacity-Associated Costs
When output levels must be changed, there may be costs for
overtime, hiring, training, extra shifts, and layoffs.
These capacity-associated costs can be avoided by leveling
production, that is, by producing items in slack periods for sale
in peak periods. However, this builds inventory in the slack
periods.
4.5. Economic Order Quantity (EOQ): Order Quantities
To achieve the objectives of providing the required level of customer
service and reducing the sum of all costs involved, two basic questions
must be answered:
1. How much should be ordered at one time? Is related to lot size
decision.
2. When should an order be placed?
 Lot-Size Decision Rules
A lot, or batch, as “a quantity produced together and sharing the same production
costs and specifications.”
Following are some common decision rules for determining what lot size to order
at one time.
a. Lot-for-lot. The lot-for-lot rule says to order exactly what is needed: no more,
no less.
 assumes a basic lot size of one, allowing the order quantity to change
whenever requirements change.
 This technique requires time- phased information such as that provided by a
material requirements plan or a master production schedule.
 Since items are ordered only when needed, this system creates no unused lot-
size inventory.
 It is often the preferred method for planning “A” items and is also used in a just-
in-time or lean environment.
 b. Fixed order quantity
• Rules specify the number of units to be ordered each time an order is
placed for an individual item
• Quantity determined through:
 sometimes arbitrary, such as 200 units at a time,
based on an economic order size calculation,
the size of a container, or
 the size of a package the material comes in.
C. Period order quantity
• Order enough quantity to satisfy future demand for a given period of time.
• Used when demand is not uniform.
ECONOMIC ORDER QUANTITY (EOQ)

Important Assumptions
1. Demand is known, constant, and independent
2. Lead time is known and constant
3. Receipt of inventory is instantaneous and complete
4. Quantity discounts are not possible
5. Only variable costs are setup and holding
6. Stockouts can be completely avoided
 Inventory Usage Over Time, based on the above
assumption

Usage rate Average

Order quantity inventory
= Q (maximum on hand
inventory
Inventory level

Q
level)
2

Minimum
inventory

0
Time
Objective of EOQ is to minimize total costs
Relevant costs The relevant costs are as follows:
■ Annual cost of placing orders.
■ Annual cost of carrying inventory.
 minimum total costs

Total cost of
holding and setup
(order)
Annual cost

Holding cost

Setup (or order)

cost

Order quantity
Case
Cont….
EOQ Determination: Trial and error
The following table shows the cost for different
orders quantities
The following figure represents the above table
The above table and figure show the
following important facts
EOQ Determination: Formula
The previous example shows EOQ occurs at an order quantity when
ordering cost equals carrying cost. Based on that the following formula is
derived:
Using the formula, calculate the EOQ for the
following case
Solution
Reorder point (ROP)
Answer the question when should an order be placed?
 EOQ answers the “how much” question
 The reorder point (ROP) tells “when” to
order
Demand Lead time for a new
ROP = per day order in days
=dxL

D
d= Number of working days in a year
Cont….
Q*
Resupply takes place as order arrives
Inventory level (units)

Slope = units/day = d

ROP
(units)

Time (days)
Example:
Demand = 8,000 units per year
250 working day year
Lead time for orders is 3 working days
D
d=
Number of working days in a year
= 8,000/250 = 32 units

ROP = d x L

= 32 units per day x 3 days = 96 units

 Quiz one 5 %
Take a piece of paper
Write your name, id no, section
 4.6.Production Order Quantity
Model
 Used when inventory builds up
over a period of time after an
order is placed
 Used when units are produced
and sold simultaneously

12 - 1
chapter 4
 Production Order Quantity
Model
Part of inventory cycle during
which production (and usage)
is taking place
Inventory level

Demand part of cycle

with no production
Maximum
inventory

t Time

chapter 4 12 - 2
 Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days

Annual inventory Holding cost

= (Average inventory level) x
holding cost per unit per year

Annual inventory
= (Maximum inventory level)/2
level

Maximum Total produced during Total used during

= –
inventory level the production run the production run

= pt – dt

chapter 4 12 - 3
 Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days

Maximum Total produced during Total used during

= –
inventory level the production run the production run
= pt – dt
However, Q = total produced = pt ; thus t = Q/p

Maximum Q Q d
inventory level = p –d =Q 1–
p p p

Maximum inventory level Q d

Holding cost = (H) = 1– H
2 2 p
chapter 4 12 - 4
 Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
D = Annual demand

Setup cost = (D/Q)S

Holding cost = 1 HQ[1 - (d/p)]
2
1
(D/Q)S = 2 HQ[1 - (d/p)]

2
2DS
Q =
H[1 - (d/p)]

2DS
Q*p =
H[1 - (d/p)]
chapter 4 12 - 5
In addition, setup cost is $10 per setup and holding cost
is $0.50 per unit per year

chapter 4 12 - 6
 Production Order Quantity
Example
D = 1,000 units p = 8 units per day
S = $10 d = 4 units per day
H = $0.50 per unit per year

2DS
Q* =
H[1 - (d/p)]

2(1,000)(10)
Q* = = 80,000
0.50[1 - (4/8)]

= 282.8 or 283 hubcaps

chapter 4 12 - 7
 Production Order Quantity
Model
Note:
D 1,000
d = 4 = Number of days the plant is in operation = 250

2DS
Q* =
annual demand rate
H 1–
annual production rate

chapter 4 12 - 8
 4.7. Materials requirement
planning
Material requirements planning (MRP) is
the system used to avoid missing parts. It
establishes a schedule (priority plan)
showing the components required at each
level of the assembly and, based on lead
times, calculates the time when these
components will be needed.

chapter 4 12 - 9
 Objectives of MRP
Material requirements planning has two major objectives: determine
requirements and keep priorities current.
Determine requirements
. It must determine the following:
 What to order.
 How much to order.
 When to order.
 When to schedule delivery.
Keep priorities current The demand for, and supply of, components
changes daily. Customers enter or change orders. Components get
used up, suppliers are late with delivery, scrap occurs, orders are
completed, and machines break down. In this ever-changing world, a
material requirements plan must be able to reorganize priorities to keep
plans current. It must be able to add and delete, expedite, delay, and
change orders.
chapter 4 12 - 10
 MRP’s Linkages to Other Manufacturing Planning and Control
Functions: Production planning and control
system

chapter 4 12 - 11
 Input to material requirement
planning system

The three primary input to MRP:

 Master production schedule
 Inventory records
 Bills of materials

chapter 4 12 - 12
 Master production schedule. The master production
schedule is a statement of which end items are to be
produced, the quantity of each, and the dates they are to be
completed. It drives the MRP system by providing the initial
input for the items needed.
Inventory records. two kinds of information needed. The
first is called planning factors and includes information
such as order quantities, lead times, safety stock, and
scrap. This information does not change often; however, it is
needed to plan what quantities to order and when to order
for timely deliveries.
The second kind of information necessary is the status of
each item: how much is available, how much is allocated,
and how much is available for future demand..

chapter 4 12 - 13
 Bills of Material: a listing of all the
subassemblies, intermediates, parts, and raw
materials that go into making the parent
assembly showing the quantities of each required
to make an assembly – The following shows an
example of bill of materials

chapter 4 12 - 14
 Bill of material structure:
format of presenting bill of materials

product tree:

chapter 4 12 - 15
 Multilevel bill and single level bill: Compare the
following with the previous single level

chapter 4 12 - 16
 A multiple bill is used when companies usually make
more than one product, and the same components are
often used in several products. See the following two
figure

chapter 4 12 - 17
chapter 4 12 - 18
 Answer

chapter 4 12 - 19
 Answer cont…

chapter 4 12 - 20
 M A T E R IA L R E Q U IR E M E N T S P L A N N IN G
PROCESS
The purpose of material requirements planning is to determine the
components needed, quantities, and due dates so items in the
master production schedule are made on time.
The basic MRP techniques to achieve the objective:
 Exploding and offsetting
 Gross and net requirements
 Releasing orders
 Capacity requirements planning
 Low-level coding and netting
 Multiple bills of material

chapter 12 - 21
 Exploding and Offsetting. Consider the following product tree.
It includes lead time
Lead time is the span of time needed to perform a process. In
manufacturing it includes time for order preparation, queuing,
processing, moving, receiving and inspecting, and any expected
delays.

chapter 4 12 - 22
  From the product tree shown above, if B
and C are available, it will take 1 week to
assemble A. Thus, the lead time for A is 1
week. Similarly, if D and E are available,
the time required to manufacture B is 2
weeks. The purchase lead times for D, E,
and C are all I week.
 In this particular product tree, the usage
quantities—the quantity of components needed
to make one of a parent—are all one. To make
an A requires one B and one C, and to make a
B requires one D and one E.

chapter 4 12 - 23
  Exploding the requirements. Exploding
is the process of multiplying the
requirements by the usage quantity and
recording the appropriate requirements
throughout the product tree.
 Offsetting. Offsetting is the process of placing
the exploded requirements in their proper
periods based on lead time. For example, if 50
units of A are required in week 5 (planned order
receipt), the order to assemble the As must be
released(planned order Release) in week 4,
and 50 Bs and 50 Cs must be available in week
4. SEE the following table

chapter 4 12 - 24
 Exploding and Offsetting. The following table shows
time phased inventory record.

chapter 4 12 - 25
 Example
Using the product tree and lead times shown
blow, complete the following table to determine
the planned order receipts and releases. There
are 50 As required in week 5 and 100 in week
6. Complete the table that follows:

chapter 4 12 - 26
chapter 4 12 - 27
 answer

chapter 4 12 - 28
 Gross and Net Requirements
When inventory of items exist at
beginning must be included when
calculating quantities to be produced.

Example Problem
Complete the following table. Lead time for the part is 2
weeks. The order quantity (lot size) is 100 units.

chapter 4 12 - 29
 Cont..

chapter 4 12 - 30
 Answer

chapter 4 12 - 31
 Example 2: Consider how the following table
changes with availability of inventory.

chapter 4 12 - 32
 Note the above table is based on the
following product structure

chapter 4 12 - 33
 Suppose there are 10 Bs and 20 As inventory, see
how it change the plan as follows:

chapter 4 12 - 34
 Scheduled receipts are orders placed on
manufacturing or on a vendor and
represent a commitment to make or buy.
The scheduled receipts row shows the
quantities ordered and when they are
expected to be completed and available.
They are generally expected to be due at
the start of the period for which they are
scheduled.

chapter 4 12 - 35
 Example problem: Complete the following
table Lead time for the item is 2 weeks and
the order quantity is 200.

chapter 4 12 - 36
 Answer:

chapter 4 12 - 37
 Quantity Discount Models
 Reduced prices are often available when
larger quantities are purchased
 Trade-off is between reduced product cost
and increased holding cost

Total cost = Setup cost + Holding cost + Product cost

D Q
TC = S+ H + PD
Q 2

chapter 4 12 - 38
 Quantity Discount Models
A typical quantity discount schedule

Discount Discount
Number Discount Quantity Discount (%) Price (P)
1 0 to 999 no discount $5.00
2 1,000 to 1,999 4 $4.80

3 2,000 and over 5 $4.75

Table 12.2

chapter 4 12 - 39
 Quantity Discount Models
Steps in analyzing a quantity discount
1. For each discount, calculate Q*
2. If Q* for a discount doesn’t qualify,
choose the smallest possible order size
to get the discount
3. Compute the total cost for each Q* or
adjusted value from Step 2
4. Select the Q* that gives the lowest total
cost
chapter 4 12 - 40
 Quantity Discount Models
Total cost curve for discount 2
Total cost
curve for
discount 1
Total cost $

Total cost curve for discount 3

b
a Q* for discount 2 is below the allowable range at point a
and must be adjusted upward to 1,000 units at point b

1st price 2nd price

break break

0 1,000 2,000
Figure 12.7
Order quantity
chapter 4 12 - 41
 Quantity Discount Example
Calculate Q* for every discount 2DS
Q* =
IP
2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)

2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80)

2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75)
chapter 4 12 - 42
 Quantity Discount Example
Calculate Q* for every discount 2DS
Q* =
IP
2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)

2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80) 1,000 — adjusted
2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75) 2,000 — adjusted
chapter 4 12 - 43
 Quantity Discount Example
Annual Annual Annual
Discount Unit Order Product Ordering Holding
Number Price Quantity Cost Cost Cost Total
1 $5.00 700 $25,000 $350 $350 $25,700

2 $4.80 1,000 $24,000 $245 $480 $24,725

3 $4.75 2,000 $23.750 $122.50 $950 $24,822.50

Table 12.3
Choose the price and quantity that gives
the lowest total cost
Buy 1,000 units at $4.80 per unit

chapter 4 12 - 44
 Probabilistic Models and
Safety Stock
 Used when demand is not constant
or certain
 Use safety stock to achieve a desired
service level and avoid stockouts

ROP = d x L + ss

Annual stockout costs = the sum of the units short

x the probability x the stockout cost/unit
x the number of orders per year

chapter 4 12 - 45
 Safety Stock Example
ROP = 50 units Stockout cost = $40 per frame
Orders per year = 6 Carrying cost = $5 per frame per year

Number of Units Probability

30 .2
40 .2
ROP  50 .3
60 .2
70 .1
1.0
chapter 4 12 - 46
 Safety Stock Example
ROP = 50 units Stockout cost = $40 per frame
Orders per year = 6 Carrying cost = $5 per frame per year

Safety Additional Total

Stock Holding Cost Stockout Cost Cost

20 (20)($5) = $100 $0 $100

10 (10)($5) = $ 50 (10)(.1)($40)(6) = $240 $290

0 $ 0 (10)(.2)($40)(6) + (20)(.1)($40)(6) = $960 $960

A safety stock of 20 frames gives the lowest total cost

ROP = 50 + 20 = 70 frames
chapter 4 12 - 47
 Probabilistic Demand

Minimum demand during lead time

Inventory level

Maximum demand during lead time

Mean demand during lead time

ROP = 350 + safety stock of 16.5 = 366.5

ROP 
Normal distribution probability of
demand during lead time
Expected demand during lead time (350 kits)

Safety stock 16.5 units

0 Lead
time Time
Figure 12.8 Place Receive
order order
chapter 4 12 - 48
 Probabilistic Demand
Use prescribed service levels to set safety
stock when the cost of stockouts cannot be
determined

ROP = demand during lead time + ZsdLT

where Z = number of standard deviations

sdLT = standard deviation of demand
during lead time

chapter 4 12 - 49
 Probabilistic Demand

Probability of Risk of a stockout

no stockout (5% of area of
95% of the time normal curve)

Mean ROP = ? kits Quantity

demand
350
Safety
stock
0 z
Number of
standard deviations
chapter 4 12 - 50
 Probabilistic Example
Average demand = m= 350 kits
Standard deviation of demand during lead time = sdLT = 10 kits
5% stockout policy (service level = 95%)

Using Appendix I, for an area under the curve

of 95%, the Z = 1.65

Safety stock = ZsdLT = 1.65(10) = 16.5 kits

Reorder point = expected demand during lead time

+ safety stock
= 350 kits + 16.5 kits of safety stock
= 366.5 or 367 kits
chapter 4 12 - 51
 Other Probabilistic Models
When data on demand during lead time is
not available, there are other models
available

1. When demand is variable and lead

time is constant
2. When lead time is variable and
demand is constant
3. When both demand and lead time
are variable

chapter 4 12 - 52
 Other Probabilistic Models
Demand is variable and lead time is constant

ROP = (average daily demand

x lead time in days) + ZsdLT

where sd = standard deviation of demand per day

sdLT = sd lead time

chapter 4 12 - 53
 Probabilistic Example
Average daily demand (normally distributed) = 15
Standard deviation = 5
Lead time is constant at 2 days Z for 90% = 1.28
90% service level desired From Appendix I

ROP = (15 units x 2 days) + ZsdLT

= 30 + 1.28(5)( 2)
= 30 + 9.02 = 39.02 ≈ 39

Safety stock is about 9 iPods

chapter 4 12 - 54
 Other Probabilistic Models
Lead time is variable and demand is constant

ROP = (daily demand x average lead

time in days)
= Z x (daily demand) x sLT

where sLT = standard deviation of lead time in days

chapter 4 12 - 55
 Probabilistic Example
Z for 98% = 2.055
Daily demand (constant) = 10 From Appendix I
Average lead time = 6 days
Standard deviation of lead time = sLT = 3
98% service level desired

ROP = (10 units x 6 days) + 2.055(10 units)(3)

= 60 + 61.65 = 121.65

Reorder point is about 122 cameras

chapter 4 12 - 56
 Other Probabilistic Models
Both demand and lead time are variable

ROP = (average daily demand

x average lead time) + ZsdLT

where sd = standard deviation of demand per day

sLT = standard deviation of lead time in days
sdLT = (average lead time x sd2)
+ (average daily demand)2 x sLT2

chapter 4 12 - 57
 Probabilistic Example
Average daily demand (normally distributed) = 150
Standard deviation = sd = 16
Average lead time 5 days (normally distributed)
Standard deviation = sLT = 1 day
95% service level desired Z for 95% = 1.65
From Appendix I

ROP = (150 packs x 5 days) + 1.65sdLT

= (150 x 5) + 1.65 (5 days x 162) + (1502 x 12)
= 750 + 1.65(154) = 1,004 packs

chapter 4 12 - 58
 Single Period Model
 Only one order is placed for a product
 Units have little or no value at the end of
the sales period

Cs = Cost of shortage = Sales price/unit – Cost/unit

Co = Cost of overage = Cost/unit – Salvage value

Cs
Service level =
Cs + Co

chapter 4 12 - 59
 Single Period Example
Average demand =  = 120 papers/day
Standard deviation =  = 15 papers
Cs = cost of shortage = $1.25 - $.70 = $.55
Co = cost of overage = $.70 - $.30 = $.40

Cs
Service level =
Cs + Co
Service
.55 level
= 57.8%
.55 + .40
.55
= = .578  = 120
.95
Optimal stocking level

chapter 4 12 - 60
 Single Period Example

From Appendix I, for the area .578, Z  .20

The optimal stocking level

= 120 copies + (.20)()

= 120 + (.20)(15) = 120 + 3 = 123 papers

The stockout risk = 1 – service level

= 1 – .578 = .422 = 42.2%

chapter 4 12 - 61
 Fixed-Period (P) Systems
 Orders placed at the end of a fixed period
 Inventory counted only at end of period
 Order brings inventory up to target level

 Only relevant costs are ordering and holding

 Lead times are known and constant
 Items are independent from one another

chapter 4 12 - 62
 Fixed-Period (P) Systems
Target quantity (T)

Q4
Q2
On-hand inventory

Q1 P
Q3

Time Figure 12.9

chapter 4 12 - 63
 Fixed-Period (P) Example
3 jackets are back ordered No jackets are in stock
It is time to place an order Target value = 50

Order amount (Q) = Target (T) - On-

hand inventory - Earlier orders not yet
received + Back orders
Q = 50 - 0 - 0 + 3 = 53 jackets

chapter 4 12 - 64
 Fixed-Period Systems

 Inventory is only counted at each

review period
 May be scheduled at convenient times
 Appropriate in routine situations
 May result in stockouts between
periods
 May require increased safety stock

chapter 4 12 - 65
 All rights reserved. No part of this publication may be reproduced, stored in a retrieval
system, or transmitted, in any form or by any means, electronic, mechanical, photocopying,
recording, or otherwise, without the prior written permission of the publisher.
Printed in the United States of America.

chapter 4 12 - 66