Inventory

Management
MENG420 CHAPTER 13
OUTLINE

▪ Elements of Inventory Management

▪ Inventory Control Systems

▪ Economic Order Quantity Models

▪ Quantity Discounts

▪ Reorder Point

▪ Order Quantity for a Periodic Inventory System

2
3
What Is Inventory?

• Stock of items kept to meet internal or external demand

• Purpose of inventory management

o how many units to order
o when to order

4
SUPPLY CHAIN MANAGEMENT

5
ROLE OF INVENTORY IN SUPPLY CHAIN MANAGEMENT

6
ROLE OF INVENTORY IN SUPPLY CHAIN MANAGEMENT

• Bullwhip effect
o demand information is distorted as it moves away from
the end-use customer

o higher safety stock inventories are stored to compensate

• Seasonal or cyclical demand

7
ROLE OF INVENTORY IN SUPPLY CHAIN MANAGEMENT

• Inventory provides independence from vendors

• Take advantage of price discounts
• Inventory provides independence between stages
and avoids work stoppages

8
INVENTORY AND QUALITY MANAGEMENT IN THE SUPPLY CHAIN

• Customers usually perceive quality service as availability of goods they

want when they want them

• Inventory must be sufficient to provide high-quality customer service

in QM

9
10
Forms of Inventory

• Raw materials

• Purchased parts and supplies

• Work-in-process (partially completed) products (WIP)

• Items being transported

• Tools and equipment

11
Starting point of Inventory Management

12
Two Forms of Demand

▪ Dependent ▪ Independent

? 13
Two Forms of Demand

▪ Dependent ▪ Independent

▪ Demand for items used to ▪ Demand for items used by

produce final products external customers

▪ Tires for autos are a ▪ Cars, appliances,

dependent demand item computers, and houses are
examples of independent
demand inventory

14
Inventory Costs

15
Inventory Costs

16
Inventory Control Systems

The objective of inventory management is to employ an

inventory control system that will indicate how much should be

ordered and when orders should take place so that the sum of

the three inventory costs just described will be minimized

17
Inventory Control Systems
• Continuous system (fixed-order-quantity)
o constant amount ordered when inventory declines to
predetermined level

o Supermarket

• Periodic system (fixed-time-period)

o order placed for variable amount after fixed passage of time

o Library
18
ABC CLASSIFICATION
The ABC Classification System

20
 The ABC Classification System

Class A
o 5 – 15 % of units
o 70 – 80 % of value

• Class B
o 30 % of units
o 15 % of value

• Class C
o 50 – 60 % of units
o 5 – 10 % of value

21
The ABC Classification System

22
The ABC Classification System
The maintenance department for a small manufacturing firm has responsibility for maintaining
an inventory of spare parts for the machinery it services. The parts inventory, unit cost, and
annual usage are as follows. The department manager wants to classify the inventory parts
according to the ABC system to determine which stocks of parts should most closely be
monitored
PART UNIT COST ANNUAL USAGE
1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120 23
The ABC Classification

PART UNIT COST ANNUAL USAGE TOTAL VALUE

1 $ 60 90 5,400
2 350 40 14,000
3 30 130 3,900
4 80 60 4,800
5 30 100 3,000
6 20 180 3,600
7 10 170 1,700
8 320 50 16,000
9 510 60 30,600
10 20 120 2,400
1000
24
The ABC Classification

PART TOTAL VALUE % OF TOTAL VALUE % OF TOTAL QUANTITY % CUMMULATIVE

9 $30,600 35.9 6.0 6.0
8 16,000 18.7 5.0 A 11.0
2 14,000 16.4 4.0 15.0
1 5,400 6.3 9.0 24.0
4 4,800 5.6 6.0 B 30.0
3 3,900 4.6 13.0 43.0
6 3,600 4.2 18.0 61.0
5 3,000 3.5 13.0 71.0
10 2,400 2.8 12.0 C 83.0
7 1,700 2.0 17.0 100.0
$85,400

% OF TOTAL VALUE of 9 = 30600/85400 = 35.9 % OF TOTAL QUANTITY of 9 = 60/1000 = 6

25
The ABC Classification

CLASS ITEMS % OF TOTAL % OF TOTAL

VALUE QUANTITY
A 9, 8, 2 71.0 15.0
B 1, 4, 3 16.5 28.0
C 6, 5, 10, 7 12.5 60.0
26
EOQ MODEL
 Economic Order Quantity (EOQ) Models
• EOQ
o continuous inventory system
o optimal order quantity that will minimize total inventory costs

• Basic EOQ model

o Demand is known with certainty and is constant over time
o No shortages are allowed
o Lead time for the receipt of orders is constant
o Order quantity is received all at once

• Order cycle

o the time between receipt of orders in an inventory system

28
Inventory Order Cycle

29
 EOQ Cost Model

Co - cost of placing order, cost per order D - annual demand

Cc - annual per-unit carrying cost Q - order quantity

D/Q - number of orders

Co and D are constant parameters

Q/2 - average inventory level

30
EOQ Cost Model

31
EOQ Cost Model

32
 EOQ Cost Model

Proving equality of costs at optimal point

33
 EOQ Cost Model

The ePaint Store stocks paint in its warehouse and sells it

online on its Internet Web site. The store stocks several
brands of paint; however, its biggest seller is Sharman-Wilson
Iron coat paint. The company wants to determine the optimal
order size and total inventory cost for Iron coat paint given an
estimated annual demand of 10,000 gallons of paint, an
annual carrying cost of $0.75 per gallon, and an ordering cost
of $150 per order. They would also like to know the number of
orders that will be made annually and the time between
orders (i.e., the order cycle)

34
 EOQ Cost Model
The ePaint Store stocks paint in its warehouse and sells it online on its Internet Web site. The store stocks
several brands of paint; however, its biggest seller is Sharman-Wilson Iron coat paint. The company wants
to determine the optimal order size and total inventory cost for Iron coat paint given an estimated annual
demand of 10,000 gallons of paint, an annual carrying cost of $0.75 per gallon, and an ordering cost of
$150 per order. They would also like to know the number of orders that will be made annually and the time
between orders (i.e., the order cycle)

35
 EOQ Cost Model
The ePaint Store stocks paint in its warehouse and sells it online on its Internet Web site. The store stocks
several brands of paint; however, its biggest seller is Sharman-Wilson Iron coat paint. The company wants to
determine the optimal order size and total inventory cost for Iron coat paint given an estimated annual demand
of 10,000 gallons of paint, an annual carrying cost of $0.75 per gallon, and an ordering cost of $150 per order.
They would also like to know the number of orders that will be made annually and the time between orders (i.e.,
the order cycle for 311 working days in a year))

36
PRODUCTION QUANTITY MODEL
 Production Quantity Model
o Order is received gradually, as inventory is simultaneously being depleted

• non-instantaneous receipt model

• assumption that Q is received all at once is relaxed

o p - daily rate at which an order is received over time, the production rate

o d - daily rate at which inventory is demanded

• Order cycle
o the time between receipt of orders in an inventory system

38
Production Quantity Model

39
Production Quantity Model

40
Production Quantity Model

41
42
43
44
QUANTITY DISCOUNT
QUANTITY DISCOUNT

46
QUANTITY DISCOUNT

47
QUANTITY DISCOUNT WITH CONSTANT CARRYING COST

48
Avtek, a distributor of audio and video equipment, wants to reduce a large
stock of televisions. It has offered a local chain of stores a quantity discount
pricing schedule, as follows: The annual carrying cost for the stores for a TV
is $190, the ordering cost is $2,500, and annual demand for this particular
model TV is estimated to be 200 units. The chain wants to determine if it
should take advantage of this discount or order the basic EOQ order size.

QUANTITY PRICE
1 −49 $1,400
50−89 1,100
90+ 900

49
Avtek, a distributor of audio and video equipment, wants to reduce a large stock of televisions. It has offered a local
chain of stores a quantity discount pricing schedule, as follows: The annual carrying cost for the stores for a TV is
$190, the ordering cost is $2,500, and annual demand for this particular model TV is estimated to be 200 units. The
chain wants to determine if it should take advantage of this discount or order the basic EOQ order size.

2C 0 D
Qopt = =
Cc

50
Avtek, a distributor of audio and video equipment, wants to reduce a large stock of televisions. It has offered a local
chain of stores a quantity discount pricing schedule, as follows: The annual carrying cost for the stores for a TV is
$190, the ordering cost is $2,500, and annual demand for this particular model TV is estimated to be 200 units. The
chain wants to determine if it should take advantage of this discount or order the basic EOQ order size.

2C oD 2 ( 2500 )( 200 )
Qopt = = = 72.5TVs
Cc 190

51
Avtek, a distributor of audio and video equipment, wants to reduce a large stock of televisions. It has offered a local
chain of stores a quantity discount pricing schedule, as follows: The annual carrying cost for the stores for a TV is
$190, the ordering cost is $2,500, and annual demand for this particular model TV is estimated to be 200 units. The
chain wants to determine if it should take advantage of this discount or order the basic EOQ order size.

2C oD 2 ( 2500 )( 200 )
Qopt = = = 72.5TVs
Cc 190

C 0 D C c Qopt
For Q = TC = + + PD =
Qopt 2

52
Avtek, a distributor of audio and video equipment, wants to reduce a large stock of televisions. It has offered a local
chain of stores a quantity discount pricing schedule, as follows: The annual carrying cost for the stores for a TV is
$190, the ordering cost is $2,500, and annual demand for this particular model TV is estimated to be 200 units. The
chain wants to determine if it should take advantage of this discount or order the basic EOQ order size.

2C oD 2 ( 2500 )( 200 )
Qopt = = = 72.5TVs
Cc 190

For Q = 72.5
C 0 D CC Qopt
TC = + + PD = $233,784
Qopt 2
53
Avtek, a distributor of audio and video equipment, wants to reduce a large stock of televisions. It has offered a local
chain of stores a quantity discount pricing schedule, as follows: The annual carrying cost for the stores for a TV is
$190, the ordering cost is $2,500, and annual demand for this particular model TV is estimated to be 200 units. The
chain wants to determine if it should take advantage of this discount or order the basic EOQ order size.

2C oD 2 ( 2500 )( 200 )
Qopt = = = 72.5TVs
Cc 190

For Q = 90 C0 D C0Q
TC = + + PD =
Q 2
54
Avtek, a distributor of audio and video equipment, wants to reduce a large stock of televisions. It has offered a local
chain of stores a quantity discount pricing schedule, as follows: The annual carrying cost for the stores for a TV is
$190, the ordering cost is $2,500, and annual demand for this particular model TV is estimated to be 200 units. The
chain wants to determine if it should take advantage of this discount or order the basic EOQ order size.

2C oD 2 ( 2500 )( 200 )
Qopt = = = 72.5TVs
Cc 190

For Q = 90
C 0 D CC Q
TC = + + PD = $194,105
Q 2
55
Avtek, a distributor of audio and video equipment, wants to reduce a large stock of televisions. It has offered a local
chain of stores a quantity discount pricing schedule, as follows: The annual carrying cost for the stores for a TV is
$190, the ordering cost is $2,500, and annual demand for this particular model TV is estimated to be 200 units. The
chain wants to determine if it should take advantage of this discount or order the basic EOQ order size.

56
Avtek, a distributor of audio and video equipment, wants to reduce a large stock of televisions. It has offered a local
chain of stores a quantity discount pricing schedule, as follows: The annual carrying cost for the stores for a TV is
$190, the ordering cost is $2,500, and annual demand for this particular model TV is estimated to be 200 units. The
chain wants to determine if it should take advantage of this discount or order the basic EOQ order size.

Total cost is lower ($194,105 < $233,784), the maximum discount price should
be taken, and 90 units should be ordered.
57
REORDER POINT

SAFETY STOCK
REORDER POINT

59
 REORDER POINT

• Inventory level at which a new order is placed

R = dL
where
d = demand rate per period

L = lead time

60
 REORDER POINT

The ePaint Internet Store in Example 13.2 is open 311

days per year. If annual demand is 10,000 gallons of
Ironcoat paint and the lead time to receive an order is
10 days, determine the reorder point for paint

61
The ePaint Internet Store is open 311 days per year. If annual demand is 10,000 gallons
of Ironcoat paint and the lead time to receive an order is 10 days, determine the reorder
point for paint

62
Variable Demand with a Reorder Point

322 Gallons

63
Reorder Point with a Safety Stock

64
Reorder Point With Variable
Demand
Reorder Point with a Safety Stock

66
How to Calculate the Safety Stock?

67
Reorder Point With Variable Demand

68
Reorder Point With Variable Demand

69
 Reorder Point With Variable Demand

For the ePaint Internet Store, let us assume that daily demand for
Ironcoat paint is normally distributed with an average daily demand of
30 gallons and a standard deviation of 5 gallons of paint per day. The
lead time for receiving a new order of paint is 10 days. Determine the
reorder point and safety stock if the store wants a service level of
95%—that is, the probability of a stockout is 5%

70
For the ePaint Internet Store, let us assume that daily demand for Ironcoat paint is
normally distributed with an average daily demand of 30 gallons and a standard
deviation of 5 gallons of paint per day. The lead time for receiving a new order of
paint is 10 days. Determine the reorder point and safety stock if the store wants a
service level of 95%—that is, the probability of a stockout is 5%

71
72
For the ePaint Internet Store, let us assume that daily demand for Ironcoat paint is normally
distributed with an average daily demand of 30 gallons and a standard deviation of 5 gallons
of paint per day. The lead time for receiving a new order of paint is 10 days. Determine the
reorder point and safety stock if the store wants a service level of 95%—that is, the probability
of a stockout is 5%

73
Periodic Inventory System
Periodic Inventory System

75
 Order Quantity for a Periodic Inventory System

Q = d (tb + L) + z d tb + L  − l

Fixed-Period Model With Variable Demand 76

 Fixed-Period Model With Variable Demand

The KVS Pharmacy stocks a popular brand of over-the-counter flu

and cold medicine. The average demand for the medicine is 6
packages per day, with a standard deviation of 1.2 packages. A
vendor for the pharmaceutical company checks KVS’s stock every 60
days. During one visit the store had 8 packages in stock. The lead
time to receive an order is 5 days. Determine the order size for this
order period that will enable KVS to maintain a 95% service level.

77
 Fixed-Period Model With Variable Demand
The KVS Pharmacy stocks a popular brand of over-the-counter flu and cold
medicine. The average demand for the medicine is 6 packages per day, with a
standard deviation of 1.2 packages. A vendor for the pharmaceutical company
checks KVS’s stock every 60 days. During one visit the store had 8 packages in
stock. The lead time to receive an order is 5 days. Determine the order size for this
order period that will enable KVS to maintain a 95% service level.

▪ d = 6 packages per day

▪ σd = 1.2 packages
▪ tb = 60 days
▪ L = 5 days
▪ I = 8 packages
▪ z = 1.65 (for a 95% service level)

78
Fixed-Period Model With Variable Demand
Q = d (tb + L) + z d tb + L  − l

Q = d (tb + L) + z d tb + L  − l

= ( 6 )( 60 + 5) + (1.65) (1.2) 60 + 5  − 8

= 397.96packages

79
COVERED TOPICS

▪ Elements of Inventory Management

▪ Inventory Control Systems

▪ Economic Order Quantity Models

▪ Quantity Discounts

▪ Reorder Point

▪ Order Quantity for a Periodic Inventory System

80
THANK YOU