Inventory Managment Workshop

Sofía Córdoba Jurado y Mariana Guzmán Sánchez

23 sept-22

New Wave Shelving’s

The classification for New Wave Shelving’s 19 component items, using the ABC inventory classification
system by annual usage value, is shown in table 1. This system indicates that the first 3 items on the list
(16% of total items) represent 80% of the total value of inventory use and are classified in group A as
high value items which require close monitoring. The following 6 items (32% of total items) contribute
14% of total inventory usage value and are therefore classified in group B, being moderately expensive
items with simple necessary control. The last 10 items (53% of total items) represent only 5% of total
inventory usage value and are placed in group C, being low value items.
With this, it is clear that the company must focus on the three A items, as those are the most relevant in
terms of total value, even though these represent less than 20% of the total items of the business.
Table 1. ABC inventory classification by annual usage value
Cumulative Cumulative
Annual value
ID Description proportion from proportion from Type
($US)
total quantity total value
b1 Copper coil 5% $ 325.000,00 55,0% A
a2 Steel bumper 11% $ 94.500,00 71,0% A
b2 Copper panel 16% $ 62.500,00 81,5% A
b3 Copper brace 1 21% $ 18.750,00 84,7% B
b4 Copper brace 2 26% $ 18.750,00 87,9% B
a3 Steel clamp 32% $ 17.500,00 90,8% B
a1 Steel panel 37% $ 12.500,00 92,9% B
d3 Plastic panel 42% $ 6.500,00 94,0% B
c1 Rubber bumper 47% $ 6.375,00 95,1% B
d1 Plastic fastener kit 53% $ 5.250,00 96,0% C
c2 Rubber foot 58% $ 4.875,00 96,8% C
a4 Steel brace 63% $ 4.000,00 97,5% C
c4 Rubber seal 2 68% $ 3.500,00 98,1% C
d5 Plastic coil 74% $ 2.700,00 98,6% C
d4 Plastic bumper 79% $ 2.500,00 99,0% C
c3 Rubber seal 1 84% $ 1.500,00 99,2% C
c5 Rubber seal 3 89% $ 1.500,00 99,5% C
d2 Plastic handle 95% $ 1.500,00 99,7% C
d6 Plastic foot 100% $ 1.500,00 100,0% C

Colombian Coffee Coffeehouse

Since the demand (280 pounds/year), lead time (3 weeks), price per unit of product ($2,4 US/pound), cost
of maintaining inventory ($0,48 US/pound year) and placing orders ($45 US/order) are known, there are
no shortages and delivery of orders is immediate, the EOQ (Economic Order Quantity) model is used to
determine the appropriate inventory policy.
With this initial data it is determined that the optimal order size is 229 pounds of coffee, the time between
placement of orders is 295 days, and the average annual cost of holding and setup due to this product is
$54.99 US for each one, obtaining a total annual cost of $109.98 US. Also, the reorder level is 16 pounds
of coffee, at which point a new order should be placed.
If the setup cost lowers to only $15 US the average annual cost of holding and setup are $31,75 US for
each one, resulting in a total annual cost of $63,50 US. This represents a difference of $46,48 US, which
is equivalent to an error of 73,21%.
With these results, it is evident that a decrease in order placement costs directly impacts the optimal order
size. This is because since it is cheaper to place orders, more orders can be placed per year, thus also
decreasing the amount held in inventory. The latter causes inventory holding costs to decrease as well.
This also highlights the importance of having an adequate estimate of costs, since in this case, the price
difference generates an error of more than 70%, which is very significant.

Brushing Up on Inventory Control

Inventory control in the company is failing as toothbrushes are selling out very quickly, leaving them out
of stock for other customers. To begin solving this, the optimal inventory policy that satisfies the problem
conditions is the EOQ (economic order quantity) model since the demand and lead time are known.
Additionally, the price per unit and the cost to place an order are constant, and the receipt of inventory is
instantaneous and complete. However, at points C and D, it is necessary to switch to the EOQ model with
shortages since not all product demands are being met, and it is necessary to contemplate backorders.
A. Considering that the demand is 3.000 toothbrushes per year, the cost of preparing an order is $6,25
US, the cost per unit is $1,25 US, and the annual holding rate is 12%, the optimal order size is 500
toothbrushes, and these must be ordered every 2 months. Adding the annual ordering costs ($37,50
US) with the holding costs ($37,50 US), the total cost per year with this policy is $75,00 US. This
inventory policy will satisfy the demand at Dawningale Drugstore, keeping enough toothbrushes in
stock for their loyal customers.
B. If the lead time is 6 days, the optimal order size is still 500 toothbrushes, and, due to the distance, it
is necessary to place the new order when there are 50 toothbrushes in stock.
C. The case indicates that there is a cost for keeping an order unit on backorder (C B), so it is necessary
to switch to the EOQ model with shortages. Considering this, the new optimal order size is 524
toothbrushes, which is larger since the customer, not finding the product he wants, may come later,
or on the contrary, go to buy it from the competition.
With this, the planned back-order size is 48 toothbrushes, this represents the maximum shortage
under this optimal inventory policy. According to this, a new order must be placed when the stock is
down to 2 toothbrushes.
With this inventory policy, the ordering annual cost results in $35,75 US, and the holding cost in
$32,50 US, being logical since more units are being ordered and stored, and the shortage annual cost
is $3,25 US, generating a total annual cost of $71,51 US. This is in fact a lower total cost than the
one obtained with an inventory policy which does not allow planned shortages, so John would save
money by allowing these planned shortages to occur.
D. At this point, it is important to understand the difference and impact of having a shortage cost of
$0,85 US or $25 US per toothbrush per year, for this the EOQ model with planned shortages is used
 again. In the first scenario, the optimal order size is higher (524 toothbrushes) which implies there
are less orders placed per year as the company can afford to have more shortages since the cost of
these is very low. On the contrary, in the second scenario the optimal order size is 501 toothbrushes,
requiring more orders placed per year, because losing customers and sales due to shortages is much
more expensive.
In the same way, as the maximum planned back-order depends on the shortage cost, in the first
scenario this value is higher, with 81 toothbrushes, while on the second it’s only 3 toothbrushes. In
other words, the higher the cost of keeping a unit on backorder, the lower the cycle time between
orders will be, to avoid generating higher costs.
With a shortage cost of $0.85 US, the reorder point is negative (-31 toothbrushes), and in this case,
it is assumed that shortages are being accepted before placing the new order, while having a
shortage cost of $25 US, the reorder point is 47 toothbrushes on stock, meaning the order is placed
before the inventory runs out.
Finally, although the difference in the total annual costs is not dramatic, it is possible to appreciate
that the larger the shortage cost per unit is, the higher the total costs will be. For the first scenario,
with a shortage cost of $0,85 US the total inventory cost per year is $69,15 US, while with a
shortage cost $25 US the price is $74,78 US.
For the drugstore inventory policy decisions it is important to estimate adequately the shortages cost,
because with the lower value effectively the EOQ model with shortages generates a lower total annual
cost than a policy without shortages. While in the second scenario the cost of the policy with shortages is
identical to the one without shortages, and according to John in the case, it might be better to avoid
shortages in order not to have problems with customers. In order to make a well-informed decision it is
necessary to better investigate the cost estimate for the shortages, and make the decision considering the
costs and the customer service that will be provided by the company.