Inventory

Modeling

Date : 17 June 2024

Time: 9:00 – 12:00 p.m. Using MS Excel
Prof : Rolando A. Austria
Contact Info: and POM-QM
E-mail:rolando.austria@pcu.edu.ph
Mobile#: +639209113581 V5.3
 Outline
◆ Inventory
◆ Inventory Classifications
◆ Types of Inventories
◆ Four main categories
◆ Other types
◆ Inventory Models
◆ Demonstration
 Learning Objectives
When you complete this module you
should be able to:
1. Describe the different types and
use of inventory.
2. Describe the objectives of
inventory management
3. Calculate order quantities for
single-period inventory
4. Perform ABC inventory control and
analysis
 Inventory Defined
◆ Inventory is the stock of any item or
resource held to meet future
demand and can include: raw
materials, finished products,
component parts, supplies, and
work-in-process
 Inventory Management at
Amazon.com
◆ Amazon.com started as a “virtual”
retailer – no inventory, no warehouses,
no overhead; just computers taking
orders to be filled by others
◆ Growth has forced Amazon.com to
become a world leader in warehousing
and inventory management
 Inventory Management at
Amazon.com
1) Each order is assigned by computer to the
closest distribution center that has the
product(s)
2) A “flow meister” at each distribution
center assigns work crews
3) Lights indicate products that are to be
picked and the light is reset
4) Items are placed in crates on a conveyor,
bar code scanners scan each item 15 times
to virtually eliminate errors
 Inventory Management at
Amazon.com
5) Crates arrive at central point where items
are boxed and labeled with new bar code
6) Gift wrapping is done by hand at 30
packages per hour
7) Completed boxes are packed, taped,
weighed and labeled before leaving
warehouse in a truck
8) Order arrives at customer within 1 - 2 days
 Inventory Classifications

Inventory

Process Number Demand

Other
stage & Value Type

Raw Material A Items

Independent Maintenance
WIP B Items
Dependent Operating
Finished Goods C Items
 Independent vs. Dependent
Demand
Independent Demand (Demand for the final end-product
or demand not related to other items; demand created by
external customers)
Finished Independent demand is uncertain
product A Dependent demand is certain
Dependent
B(4) C(2) Demand
(Derived demand
for component
D(1) E(1
E(2) B(1) E(3) parts,
)
subassemblies,
raw materials, etc-
Component parts used to produce
final products)
 Inventory Models
• Independent demand – finished goods,
items that are ready to be sold
– E.g. a computer
• Dependent demand – components of
finished products
– E.g. parts that make up the computer
 Types of Inventories (1 of 2)
1) Raw materials & purchased parts
2) Partially completed goods called
work in progress(WIP)
3) Merchandise and supplies
4) Finished-goods inventories
(manufacturing firms) or merchandise
(retail stores)
Types of Inventories (2 of 2)
Inventory Management
 Inventory Management

▶One of the most expensive assets

of many companies representing
as much as 50% of total invested
capital
▶Operations managers must
balance inventory investment and
customer service
ABC Inventory Classification
◼ ABC classification is a method for determining
level of control and frequency of review of inventory
items
◼ A Pareto analysis can be done to segment items into
value categories depending on annual dollar volume
◼ A Items – typically 20% of the items accounting for
80% of the inventory value-use Q system
◼ B Items – typically an additional 30% of the items
accounting for 15% of the inventory value-use Q or P
◼ C Items – Typically the remaining 50% of the items
accounting for only 5% of the inventory value-use P
ABC Inventory Classification
Percent of Percent of
Item Number of Annual Annual Annual
Stock Items Volume Unit Dollar Dollar
Number Stocked (units) x Cost = Volume Volume Class
#10286 20% 1,000 $ 90.00 $ 90,000 38.8% 72% A

#11526 500 154.00 77,000 33.2% A

#12760 1,550 17.00 26,350 11.3% B

#10867 30% 350 42.86 15,001 6.4% 23% B

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

ABC Inventory Classification
Percent of Percent of
Item Number of Annual Annual Annual
Stock Items Volume Unit Dollar Dollar
Number Stocked (units) x 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% 5% C

#01307 1,200 .42 504 .2% C

#10572 250 .60 150 .1% C

ABC Inventory Classification
Percent of annual dollar usage

A Items
80 –
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

ABC Inventory Classification

 Other criteria than annual dollar

volume may be used
 Anticipated engineering
changes
 Delivery problems
 Quality problems
 High unit cost
ABC Inventory Classification

 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
 Single-Period Inventory
Model
• In a single-period model, items are
received in the beginning of a period and
sold during the same period. The unsold
items are not carried over to the next
period.
• The unsold items may be a total waste, or
sold at a reduced price, or returned to the
producer at some price less than the
original purchase price.
• The revenue generated by the unsold
items is called the salvage value.
(Newsboy Problem)
•Single period model: It is used to
handle ordering of perishables
(fresh fruits, flowers) and other
items with limited useful lives
(newspapers, spare parts for
specialized equipment).
 Shortage cost (Cost of
Understocking)
• Shortage cost: generally, this cost
represents unrealized profit per unit
(Cu=Revenue per unit – Cost per
unit)
• If a shortage or stockout cost relates
to a spare part for a machine, then
shortage cost refers to the actual
cost of lost production.
 Excess cost (Cost of Over
Stocking)
• Excess cost (Ce): difference
between purchase cost and
salvage value of items left
over at the end of a period.
• If there is a cost associated
with disposing of excess
items, the salvage cost will
be negative.
 Single Period Model
Given the costs of
overestimating/underestimating
demand and the probabilities of
various demand sizes the goal is
to identify the order quantity or
stocking level that will minimize
the long-run excess (overstock)or
shortage costs (understock).
Single-Period Models (Demand Distribution)

Demand may be discrete or continuous. The

demand of computer, newspaper, etc. is usually an
integer. Such a demand is discrete. On the other
hand, the demand of gasoline is not restricted to
integers. Such a demand is continuous. Often, the
demand of perishable food items such as fish or
meat may also be continuous.
• Consider an order quantity Q
• Let p = probability (demand<Q)
= probability of not selling the Qth item.
• So, (1-p) = probability of selling the Qth item.
 Single-Period Models (Discrete
Demand/Discrete Distribution)
Example : Demand for cookies:
Demand(dozen) Probability of Demand
1,800 0.05
2,000 0.10
2,200 0.20
2,400 0.30
2,600 0.20
2,800 0.10
3,000 0,05

Selling price=$0.69, cost=$0.49, salvage value=$0.29

What is the optimal number of cookies to make?

 Single-Period Models (Discrete
Demand)
Cs= 0.69 - 0.49 = $0.2; Ce = 0.49 - 0.29 = $0.2

Order maximum quantity, Q such that

Cs
p= Probability Cutoff
C s + Ce
pc = 0.2/(0.2 + 0.2) = 0.2/0.4 = 0.50

Demand, Q Probability(demand) Cumulative Probability 1-Probability Rem

1,800 0.05 0.05 1 >= pc
2,000 0.10 0.15 0.95 >= pc
2,200 0.20 0.35 0.85 >= pc
2,400 0.30 0.65 0.65 >= pc
2,600 0.20 0.85 0.35 <= pc
2,800 0.10 0.95 0.15 <= pc
3,000 0.05 1.00 0.05 <= pc

Thus, 2400 is the optimal number of cookies to make

 Single-Period Models (Continuous
Demand – Normal Distribution)

❑A continuous probability
distribution wherein values lie in
a symmetrical fashion mostly
situated around the mean.
 Single-Period Models (Continuous
Demand)
Example : The J&B Card Shop sells calendars. The once-a-
year order for each year’s calendar arrives in September.
The calendars cost $1.50 and J&B sells them for $3 each.
At the end of July, J&B reduces the calendar price to $1
and can sell all the surplus calendars at this price. How
many calendars should J&B order if the September-to-
July demand can be approximated by normal distribution
with  = 500 and =120.
 Single-Period Models (Continuous
Demand/Normal Distribution)

Excess cost
ce =Purchase price - Salvage value = 1.5 – 1 = $0.50

Shortage cost
cs =Selling price - Purchase price = 3 - 1.5 = $1.50
 Single-Period Models (Continuous
Demand/Normal Distribution)
Solution to Example : ce = $0.50, cs = $1.50
cs 1.50
= = 0.75
ce + cs 1.50 + 0.50
Single-Period Models (Continuous
Demand/Normal Distribution)
Now, find the Q so that p = 0.75
Normal Distribution Table
Single-Period Models (Continuous
Demand/Normal Distribution)

From previous slide using the Normal

Distribution Table, for the area 0.75 Z  0.68

Q = So = mean + zσ
= 500 + .68(120)
= 582 calendars
 Single-Period Example
Average demand =  = 120 papers/day
Standard deviation =  = 15 papers
Cs = cost of shortage = $1.25 – $.70 = $.55
Ce = cost of overage = $.70 – $.30 = $.40
Cs
Service level =
Cs + Ce
.55
=
.55 + .40
.55
= = .579
.95
 Single-Period Example
From previous slide using the Normal Distribution Table,
for the area .579, Z  0.20
The optimal stocking level
= 120 copies + (0.20)()
= 120 + (.20)(15) = 120 + 3 = 123 papers

The stockout risk = 1 – Service level

= 1 – .579 = .422 = 42.2%

 Last Words

Inventories have certain functions.

But too much inventory
- Tends to hide problems
- Costly to maintain
So it is desired
• Reduce lot sizes
• Reduce safety stocks
 Inventory
Modeling

Demonstration:
Date : 17 June 2024 Using MS Excel
Time: 9:00 – 12:00 p.m.
Prof : Rolando A. Austria and POM-QM V5.3
Contact Info:
E-mail:rolando.austria@pcu.edu.ph to solve Inventory
Mobile#: +639209113581
Modelling Problem