Chapter 2

Inventory Control
Inventory Control:
Operation of a realistic Inventory System:
Most of the industrial scenario's operates either with Purchase model
without shortages or Manufacturing model without shortages with certain
real time considerations

Consider the purchase model of an inventory system, shown in the diagram

Q* is the economic order size and t* is the cycle time

Inventory Control:
If the system is operated as such (as shown) without any provision to take
care of fluctuations in demand and lead time, we will encounter shortage
situation very often.

Even if the model is considered with constant demands and constant lead
time, it is better to place the order before the end of cycle time so that the
items are received exactly at the end of the present cycle or at the
beginning of the next cycle.

If there is no variation in lead time and demand, then it is sufficient to have

a stock of DLT at the time of placing a new order.

Let DLT be the demand quantity during lead time.

DLT = demand rate x lead time period

= (d / day) x (LT in days)

This is shown as follows:

Inventory Control:

Reorder Level (ROL) = DLT

Reorder level is the stock level at which an order is placed so that we

receive the items against the order at the beginning of the next cycle.
Inventory Control:
If the demand is varying then the ROL is given as

ROL = DLT + SS

Where SS Safety stock which acts as a cushion to absorb the variation in

demand.
Inventory Control:
Quantity Discount:
When items are purchased in bulk, buyers are usually given discount in the
purchase price of goods. This discount may be a step function of purchase
quantity as shown below:
Quantity Purchase Price
0 <= Q1 < b1 P1
b1 < = Q2 < b2 P2
b2 < = Q3 < b3 P3
.. ..
.. ..
bn-1 <= Qn Pn

Since Carrying / Holding cost is usually given as a percentage of purchase

price, the optimal order size now needs to be calculated based on the slab
rates of the discount.

The procedure to estimate the optimal order size for such a situation is
discussed:
Inventory Control:
Quantity Discount:
Step 1: Find EOQ for the nth (last) price break
Q* = (2C0D/iPn)

If it is greater than or equal to bn-1, then the optimal order size Q* = Qn*; otherwise
go to Step 2.

Step 2: Find EOQ for the (n-1) th price break.

Qn-1* = (2C0D/iPn-1)

If it is greater than or equal to bn-2, then compute the following, and select least cost
purchase quantity as the optimal order size; otherwise go to Step 3.

(1) Total cost, TC (Qn-1*).

(2) Total cost, TC (bn-1).
Inventory Control:
Quantity Discount:
Step 3: Find EOQ for the (n-2)th price break.
Qn-2* = (2C0D/iPn-2)

If it is greater than or equal to bn-3, then compute the following and select least cost
purchase quantity; otherwise go to Step 4.
(1) Total cost, TC (Qn-2*).
(2) Total cost, TC (bn-2).
(3) Total cost, TC (bn-1).

Step 4: Continue in this manner until Qn-i* >= bn-i-1.

Then compare total costs TC (Qn-i*), TC (bn-i), TC (bn-i +1),, TC (bn-1) corresponding
to the purchase quantities Qn-i*, bn-1, bn-i+1., bn-1, respectively.

Finally, select the purchase quantity w.r.t. the minimum total cost.
Inventory Control:
Quantity Discount:

Annual demand for an item is 4800 units. Ordering cost is Rs.500 per order.
Inventory carrying cost is 24% of the purchase price per unit, per year. The price
breaks are shown as

Quantity Price (Rs.)

0 <= Q1 < 1200 10

1200 < = Q2 < 2000 9

2000 <= Q3 8

(a) Find the optimal order size.

(b) If the order is changed to Rs. 300.00 per order, find the optimal order size.
Inventory Control:
Quantity Discount:
Solution: D = 4800, C0 = 500, i = 0.24

Step 1: P3 = Rs.8.00
Q3* = (2C0D/iP3) = 1581
Since Q3* < b2 (2000), go to Step 2.

Step 2: P2 = Rs.9.00
Q2* = (2C0D/iP2) = 1491

Since Q2* > b1 (1200), find the following and select the order size w.r.t. the least cost
as the optimal order size.

TC (Q2*) = 9*4800 + ((500*4800)/1491) + ((0.24*9*1491)/2) = Rs. 46,420 (approx.)

TC (b2) = 8*4800 + ((500*4800)/2000) + ((0.24*9*2000)/2) = Rs. 46,496 (approx.)

The least cost is Rs. 46,420. Hence, the optimal order size is Q2* which is equal to
1491.
Inventory Control:
Quantity Discount:
Solution: (b) C0 = 300, D = 4800, i = 0.24

Step 1: P3= Rs. 8.00

Q3* = (2C0D/iP3) = 1125
Since Q3* < b2 (2000), go to Step 2.

Step 2: P2 = Rs.9.00
Q2* = (2C0D/iP2) = 1155
Since Q2* < b1 (1200), go to Step 3.

Step 3: P1 = Rs.10.00
Q1* = (2C0D/iP1) = 1096

Find the following and select the order size w.r.t. the least cost.
TC (Q1*) = 10*4800 + ((300*4800)/1096) + ((0.24*10*1096)/2) = Rs. 50,629
TC (b1) = 9*4800 + ((300*4800)/1200) + ((0.24*9*1200)/2) = Rs. 45,696
TC (b2) = 8*4800 + ((300*4800)/2000) + ((0.24*8*2000)/2) = Rs. 41,040

Since TC (b2) is the minimum cost, the optimal order size is b2 which is equal to 2000.
Inventory Control:
Practice Problems:

Annual demand for an item is 5400 units. Ordering cost is Rs.600 per order.
Inventory carrying cost is 30% of the purchase price per unit, per year. The price
breaks are shown as

Quantity Price (Rs.)

0 <= Q1 < 2400 12

2400 < = Q2 < 3000 10

3000 <= Q3 8

(a) Find the optimal order size.

(b) If the order is changed to Rs. 300.00 per order, find the optimal order size.
Inventory Control:
Practice Problems:

Annual demand for an item is 6000 units. Ordering cost is Rs.600 per order.
Inventory carrying cost is 18% of the purchase price per unit, per year. The price
breaks are shown as

Quantity Price (Rs.)

0 <= Q1 < 2000 20

2000 < = Q2 < 4000 15

4000 <= Q3 9

Find the optimal order size.