COURSE NAME

Inventory management
LOREM IPSUM DOLOR SIT AMET

Introduction
Inventory management is at the core of all supply chain and logistics management. There
are many reasons for holding inventory including minimizing the cost of controlling a
system, buffering against uncertainties in demand, supply, delivery and manufacturing, as
well as covering the time required for any process. Having inventory allows for a smoother
operation in most cases since it alleviates the need to create products from scratch for
each individual demand.

Objectives of Inventory Management to balance between the level of customer service

and the costs of ordering and carrying inventories

Reasons to Hold Inventory

 ● Buffer against uncertainties such as demand, supply, delivery, and manufacturing.
● Cover process time
● Allow for uncoupling of processes
● Anticipation/Speculation delayed differentiation)
● Take advantage of quantity discounts(Economies of scale)
● Minimize control costs

fundamental decisions

the timing and size of orders (i.e inventory policy).

To be effective

● A system to keep track of the inventory on hand and on order.

● A reliable forecast of demand that includes an indication of possible forecast error.
● Knowledge of lead times and lead time variability.
● Reasonable estimates of inventory holding costs, ordering costs, and shortage costs.
● A classification system for inventory items.

Inventory Classification

● Financial/Accounting Categories: Raw Materials, Work in Progress (WIP),

Components/Semi-Finished-Goods and Finished Goods.
● Functional: Cycle Stock–Safety Stock–Pipeline Inventory

Inventory cost

Total cost = Purchase (Unit Value) Cost + Order (Set Up) Cost + Holding (Carrying) Cost +
Shortage (stock-out) Cost

• Purchase: Cost per item or total landed cost for acquiring product.

• Ordering: It is a fixed cost and contains the cost to place, receive and process a batch of
goods including processing invoicing, auditing, labor, etc. In manufacturing this is the set up
cost for a run.

• Holding: Costs required to hold inventory such as storage cost (warehouse space), service
costs (in-surance, taxes), risk costs (lost, stolen, damaged, obsolete), and capital costs
(opportunity cost of alternative investment).

• Shortage: Costs of not having an item in stock (on-hand inventory) to satisfy a demand
when it occurs, including backorder, lost sales, lost customers, and disruption costs. Also
known as the penalty cost.

Inventory models

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The inventory models described in this chapter relate primarily to what are referred to as
independent-demand items, that is, items that are ready to be sold or used. Aggregate
Planning describes models that are used for dependent-demand items, which are
components of finished products, rather than the finished products themselves.

Inventory models come in all shapes. We will focus on models for only a single product at a
single location. Essentially each inventory model is determined by three key variables:

demand:deterministic

Continuous Review Periodic Review

Fixed EOQ,EPQ
Quantity

Variable
Quantity

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 INVENTORY MODELS
Economic Order Quantity (EOQ)
The EOQ model is a simple
deterministic model with an
infinite horizon that illustrates the
trade-offs between ordering and
inventory costs is a
robust/insensitive model.

Assumptions:
● Demand and Lead time
are uniform and
deterministic.
● Planned shortages are
not allowed.
Inventory Replenishment
Policy:
● Order Q∗units every
T∗time periods.
● Order Q∗units when
inventory on hand (IOH)
is DL.

The EOQ Model with Planned Shortages

If the cost of holding
inventory is high relative to
these shortage costs, then
lowering the average
inventory level by
permitting occasional brief
shortages may be a sound
business decision under
one condition the
customers are able and
willing to accept.

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 Finite Replenishment or Economic Production Quantity
(EPQ)
EPQ is a model where P < D,
this means the rate of
production is slower than the
rate of demand and that you
will never have enough
inventory to satisfy demand
with the same
Assumptions:
As the EOQ
Inventory Replenishment
Policy:

The single period inventory (Newsvendor)

A trade-off is needed between
(1) the risk of being short and
the risk of having an excess.
This is accomplished by
minimizing the expected value
(in the statistical sense) of the
sum of these costs.
Assumptions:
● Each application
involves a single
perishable product.
● Each application
involves a single time
period
● The demand is a
random variable D
Inventory Replenishment
Policy:
Order Q∗at start of period where
P[x ≤ Q]=CR

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 Continuous Review Policy (s,Q)
This is also known as the
Order-Quantity policy and is
essentially a two-bin
system. The reoder point is
the sum of the expected
demand over the lead-time
plus the RMSE of the
forecast error over
lead-time multiplied by
some safety factor k.
Assumptions:
Probabilistic Demand with
infinite horizon
Inventory Replenishment
Policy:
Order Q∗when IP ≤ s

Periodic Review Policy (R,S)

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This is also known as the
Order Up To policy and is
essentially a two-bin
system. This means the
order quantity will be S∗−
IP. The order up to point,
S∗, is the sum of the
expected demand over the
lead-time and the
replenishment time plus the
RMSE of the forecast error
over lead plus
replenishment time
multiplied by some safety
factor k.
Assumptions:
Probabilistic Demand with
infinite horizon
Inventory Replenishment
Policy:
Order up to S units every R
time periods

Base Stock Policy

The Base Stock policy is a Optimal Base Stock, S∗: S∗=
one-for-one policy. If I sell µDL+ kLOSσDL • Level of
Service (LOS): LOS = P[µDL≤ S∗]
four items, I order four items
= CR = cs (cs+ce)
to replenish the inventory.
Assumptions:
Probabilistic Demand with
infinite horizon
Inventory Replenishment
Policy:
Order what was demanded
when it was demanded in the
quantity it was demanded

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Aggregating multiple products

lot Sizing with multiple products or Customers

● First Approach: No Aggregation

This implies that each product is ordered individually without considering bulk or grouped
orders. This may result in high costs, possibly due to higher order processing costs or
shipping expenses for individual items.

● Second Approach: Aggregating All Products in Each Order

This approach involves combining all products into a single order. While it can streamline
the ordering process, it may lead to inefficiencies if low-demand products are consistently
aggregated with high-demand products. This can increase overall costs, especially if the
low-demand products have high product-specific order costs.

● Third Approach: Optimized Aggregation Considering Product Demand

This approach suggests a more strategic approach to aggregation, considering the demand
for each product. Low-demand products are ordered less frequently than high-demand
products. This strategy aims to reduce the product-specific order costs associated with
low-demand products, potentially resulting in overall cost savings.

Quantity discounts

all unit Quantity discounts

marginal unit Quantity discounts

multi echelon Inventory management

Safety inventory

Measuring product availability

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1. Product fill rate (fr) is the fraction of product demand that is satisfied from product in
inventory. Fill rate is equivalent to the probability that product demand is supplied from
available inventory.

2. Order fill rate is the fraction of orders that are filled from available inventory.

3. Cycle service level (CSL) is the fraction of replenishment cycles that end with all the
customer demand being met.

A goal of any supply chain manager is to reduce the level of safety inventory required in a
way that does not adversely affect product availability. The previous discussion highlights
two key managerial levers that may be used to achieve this goal: 1. Reduce the supplier
lead time L:

2. Reduce the underlying uncertainty of demand (represented by sD):

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