Chapter 15

Inventory Systems for Independent

Demand
• The Definition and Purpose of Inventory
• Inventory Costs
• Independent vs. Dependent Demand
• Basic Fixed Order Quantity Model
• Basic Fixed Time Period Model
• Miscellaneous Systems and Issues

2
 Inventory
• Definition--The stock of any item or
resource used in an organization
– Raw materials
– Finished products
– Component parts
– Supplies
– Work in process

3
 Purposes of Inventory
1. To maintain independence of operations
2. To meet variation in product demand
3. To allow flexibility in production
scheduling
4. To provide a safeguard for variation in
raw material delivery time
5. To take advantage of economic
purchase-order size
4
 Inventory Costs
• Holding (or carrying) costs

• Setup (or production change) costs

• Ordering costs

• Shortage costs

5
Independent vs. Dependent
Demand
Independent Demand
(Demand not related to other items)

Dependent Demand
(Derived)

E(1)

6
 Classifying Inventory Models
• Fixed-Order Quantity Models
– Event triggered

• Fixed-Time Period Models

– Time triggered

7
 Fixed-Order Quantity Models
Assumptions
• Demand for the product is constant and
uniform throughout the period

• Lead time (time from ordering to receipt) is

constant

• Price per unit of product is constant

8
 Fixed-Order Quantity Models
Assumptions
• Inventory holding cost is based on
average inventory

• Ordering or setup costs are constant

• All demands for the product will be

satisfied (No back orders are allowed)

9
 EOQ Model--Basic Exhibit 15.3
Fixed-Order Quantity Model

Number
of units
on hand Q Q Q

R
L L

Time
R = Reorder point
Q = Economic order quantity
L = Lead time
10
 Cost Minimization Goal
Total Cost

C
O
S
T Holding
Costs
Annual Cost of
Items (DC)

Ordering Costs

QOPT
Order Quantity (Q)

11
 Basic Fixed-Order
Quantity Model
Annual Annual Annual
Total Annual Cost = Purchase + Ordering + Holding
Cost Cost Cost
TC Total annual cost
D Demand
C Cost per unit
Q Order quantity
S Cost of placing an order
or setup cost
R Reorder point
L Lead time
H Annual holding and storage cost
per unit of inventory
12
 Deriving the EOQ
• Using calculus, we take the derivative of
the total cost function and set the
derivative (slope) equal to zero

13
 EOQ Example
Annual Demand = 1,000 units
Days per year considered in average daily demand = 365
Cost to place an order = $10
Holding cost per unit per year = $2.50
Lead time = 7 days
Cost per unit = $15

Determine the economic order quantity and the reorder

point.
 Solution

Why do we round up?

When the inventory level reaches 20, order 90 units.

 In-Class Exercise
Annual Demand = 10,000 units
Days per year considered in average daily demand = 365
Cost to place an order = $10
Holding cost per unit per year = 10% of cost per unit
Lead time = 10 days
Cost per unit = $15

Determine the economic order quantity and the reorder

point.
 Solution

When the inventory level reaches 274, order 366 units.

17
 Miscellaneous Systems
Bin Systems
Two-Bin System

Order One Bin of

Inventory
Full Empty
One-Bin System

Order Enough to
Refill Bin
Periodic Check
 ABC Inventory Planning
ABC classification scheme divides inventory
items into three groupings:

● ✔ High dollar volume (A)

● ✔ Moderate dollar volume (B)
● ✔ Low dollar volume (C)
ABC Inventory Planning
 ABC Classification
✔ A items constitute roughly the top 15
percent of the items
✔ B items the next 35 percent
✔ C items the last 50 percent