1

Inventory Management
and
Control
 2

AMAZON.com

• Jeff Bezos, in 1995, started AMAZON.com as

a “virtual” retailer – no inventory, no
warehouses, no overhead; just a bunch of
computers.
• Growth forced AMAZON.com to excel in
inventory management!
• AMAZON is now a worldwide leader in
warehouse management and automation.
 3

Order Fulfillment at AMAZON (1 of 2)

1. You order items; computer assigns your order

to distribution center [closest facility that has
the product(s)]
2. Lights indicate products ordered to workers
who retrieve product and reset light.
3. Items placed in crate with items from other
orders, and crate is placed on conveyor. Bar
code on item is scanned 15 times – virtually
eliminating error.
 4

Order Fulfillment at AMAZON (2 of 2)

4. Crates arrive at a central point where items are

boxed and labeled with new bar code.
5. Gift wrapping done by hand (30 packages per
hour)
6. Box is packed, taped, weighed and labeled
before leaving warehouse in a truck.
7. Order appears on your doorstep within a week
 5

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
 6

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
 7

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(2)
E(1 B(1) E(3) parts,
)
subassemblies,
raw materials, etc-
Component parts used to produce
final products)
 8

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
 9

Types of Inventories (1 of 2)

• Raw materials & purchased parts

• Partially completed goods called
work in progress
• Finished-goods inventories
(manufacturing firms)
or merchandise
(retail stores)
 10

Types of Inventories (2 of 2)
• Replacement parts, tools, & supplies
• Goods-in-transit to warehouses or customers
 11

The Material Flow Cycle (1 of 2)

 12

The Material Flow Cycle (2 of 2)

Wait Move Queue Setup Run
Input Time Time Time Time Time Output

Cycle Time

Run time: Job is at machine and being worked on

Setup time: Job is at the work station, and the work station is
being "setup."
Queue time: Job is where it should be, but is not being
processed because other work precedes it.
Move time: The time a job spends in transit
Wait time: When one process is finished, but the job is waiting
to be moved to the next work area.
Other: "Just-in-case" inventory.
 13

Performance Measures

• Inventory turnover (the ratio of annual cost

of goods sold to average inventory
investment)
• Days of inventory on hand (expected
number of days of sales that can be supplied
from existing inventory)
 14

Functions of Inventory (1 of 2)
1. To “decouple” or separate various parts of the
production process, ie. to maintain
independence of operations
2. To meet unexpected demand & to provide high
levels of customer service
3. To smooth production requirements by meeting
seasonal or cyclical variations in demand
4. To protect against stock-outs
 15

Functions of Inventory (2 of 2)
5. To provide a safeguard for variation in raw
material delivery time
6. To provide a stock of goods that will provide a
“selection” for customers
7. To take advantage of economic purchase-order
size
8. To take advantage of quantity discounts
9. To hedge against price increases
 16

Disadvantages of Inventory

• Higher costs
– Item cost (if purchased)
– Ordering (or setup) cost
– Holding (or carrying) cost
• Difficult to control
• Hides production problems
• May decrease flexibility
 17

Inventory Costs
Holding (or carrying) costs
 Costs for storage, handling, insurance, etc
Setup (or production change) costs
 Costs to prepare a machine or process for
manufacturing an order, eg. arranging specific
equipment setups, etc
Ordering costs (costs of replenishing inventory)
 Costs of placing an order and receiving goods
Shortage costs
 Costs incurred when demand exceeds supply
 18

Holding (Carrying) Costs

• Obsolescence
• Insurance
• Extra staffing
• Interest
• Pilferage
• Damage
• Warehousing
• Etc.
 19

Inventory Holding Costs

(Approximate Ranges)
Cost as a
Category % of Inventory Value
Housing costs (building rent, depreciation, 6%
operating cost, taxes, insurance) (3 - 10%)

Material handling costs (equipment, lease or 3%

depreciation, power, operating cost) (1 - 3.5%)
3%
Labor cost from extra handling (3 - 5%)
Investment costs (borrowing costs, taxes,
and insurance on inventory) 11%
(6 - 24%)
Pilferage, scrap, and obsolescence 3%
(2 - 5%)
Overall carrying cost 26%
 20

Ordering Costs

• Supplies
• Forms
• Order processing
• Clerical support
• etc.
 21

Setup Costs

• Clean-up costs
• Re-tooling costs
• Adjustment costs
• etc.
 22

Shortage Costs

• Backordering cost
• Cost of lost sales
 23

Inventory Control System

Defined
An inventory system is the set of policies and
controls that monitor levels of inventory and
determine what levels should be maintained,
when stock should be replenished and how large
orders should be
Answers questions as:
 When to order?
 How much to order?
 24

Objective of Inventory Control

To achieve satisfactory levels of customer

service while keeping inventory costs within
reasonable bounds
Level of customer service
Costs of ordering and carrying inventory
 25

Requirements of an Effective Inventory

Management
A system to keep track of inventory
A reliable forecast of demand
Knowledge of lead times
Reasonable estimates of
 Holding costs
 Ordering costs
 Shortage costs
A classification system
 26

Inventory Counting (Control) Systems

• Periodic System
Physical count of items made at periodic intervals;
order is placed for a variable amount after fixed
passage of time
• Perpetual (Continuous) Inventory System
System that keeps track
of removals from inventory
continuously, thus
monitoring current levels of
each item (constant amount is
ordered when inventory
declines to a predetermined level)
 27

Inventory Models
 Single-Period Inventory Model
 One time purchasing decision (Example: vendor
selling t-shirts at a football game)
 Seeks to balance the costs of inventory overstock
and under stock
 Multi-Period Inventory Models
 Fixed-Order Quantity Models
• Event triggered (Example: running out of stock)
 Fixed-Time Period Models
• Time triggered (Example: Monthly sales call by
sales representative)
 28

Single-Period Inventory Model

 29

Single Period Model

• Single period model: model for ordering of
perishables and other items with limited
useful lives
• Shortage cost: generally the unrealized profits
per unit
• Excess cost: difference between purchase cost
and salvage value of items left over at the end
of a period
 30

Single Period Model

• Continuous stocking levels
– Identifies optimal stocking levels
– Optimal stocking level balances unit shortage
and excess cost
• Discrete stocking levels
– Service levels are discrete rather than
continuous
– Desired service level is equaled or exceeded
 31

Single-Period Model
This model states that we
Cu should continue to increase

P the size of the inventory so

long as the probability of
Co  Cu selling the last unit added is
equal to or greater than the
ratio of: Cu/Co+Cu
Where :
Co  Cost per unit of demand over estimated
Cu  Cost per unit of demand under estimated
P  Probabilit y that the unit will be sold
 32

Optimal Stocking Level

Cs Cs = Shortage cost per unit
Service level =
Cs + Ce Ce = Excess cost per unit

Ce Cs

Service Level

Quantity

So
Balance point
 33

Single Period Example 1

• Ce = $0.20 per unit
• Cs = $0.60 per unit
• Service level = Cs/(Cs+Ce) = .6/(.6+.2)
• Service level = .75
Ce Cs

Service Level = 75%

Quantity

Stockout risk = 1.00 – 0.75 = 0.25

 34

Single Period Model Example 2

Our college basketball team is playing in a
tournament game this weekend. Based on our
past experience we sell on average 2,400 shirts
with a standard deviation of 350. We make $10
on every shirt we sell at the game, but lose $5
on every shirt not sold. How many shirts
should we make for the game?
Cu = $10 and Co = $5; P ≤ $10 / ($10 + $5) = .667
Z.667 = .432
therefore we need 2,400 + .432(350) = 2,551 shirts
 35

Multi-Period Inventory Models

Fixed-Order Quantity Models (Types of)

Economic Order Quantity Model
Economic Production Order Quantity (Economic
Lot Size) Model
Economic Order Quantity Model with Quantity
Discounts
Fixed Time Period (Fixed Order Interval) Models
 36

Fixed Order Quantity Models:

Economic Order Quantity Model
 37

Economic Order Quantity Model

Assumptions (1 of 2):
• Demand for the product is known with certainty,
is constant and uniform throughout the period
• Lead time (time from ordering to receipt) is
known and constant
• Price per unit of product is constant (no quantity
discounts)
• Inventory holding cost is based on average
inventory
 38

Economic Order Quantity Model

Assumptions (2 of 2):
• Ordering or setup costs are constant
• All demands for the product will be satisfied (no
back orders are allowed)
• No stockouts (shortages) are allowed
• The order quantity is received all at once.
(Instantaneous receipt of material in a single lot)

The goal is to calculate the order quantitiy that

minimizes total cost
 39

Basic Fixed-Order Quantity Model and

Reorder Point Behavior
1. You receive an order quantity Q. 4. The cycle then repeats.

Number
of units
on hand Q Q Q
(Inv.
Level)
R
L L
2. You start using
them up over time. 3. When you reach down to
Time a level of inventory of R,
R = Reorder point
Q = Economic order quantity you place your next Q
L = Lead time sized order.
 40

EOQ Model

Inventory Level
Order Average
Quantity
Demand Inventory
rate
(Q) (Q/2)

Reorder
Point
(ROP)

Order placed Order received Time

Lead Time
 41

EOQ Cost Model: How Much to Order?

By adding the holding and ordering costs together, we
determine the total cost curve, which in turn is used to find
the optimal order quantity that minimizes total costs
Annual
cost ($) Total Cost
Slope = 0
HQ
Minimum Carrying Cost =
2
total cost

SD
Ordering Cost = Q

Optimal order Order Quantity, Q

Qopt
 42

Why Holding Costs Increase?

• More units must be stored if more are

ordered

Purchase Order Purchase Order

Description Qty. Description Qty.
Microwave 1 Microwave 1000

Order quantity Order quantity

 43

Why Ordering Costs Decrease ?

Cost is spread over more units
Example: You need 1000 microwave ovens
1 Order (Postage $ 0.33) 1000 Orders (Postage $330)

Purchase Order PurchaseOrder

Purchase Order
Description
PurchaseOrder
OrderQty.
Description
Purchase
Qty. Description Qty.
Qty.
Microwave 1000 Description
Microwave Qty. 11
Description
Microwave
Microwave
Microwave 11
Order quantity
 44

Basic Fixed-Order Quantity (EOQ)

TC=Total annual
Model Formula cost
D =Annual demand
Total Annual Annual Annual C =Cost per unit
Annual = Purchase + Ordering + Holding Q =Order quantity
Cost Cost Cost Cost S =Cost of placing
an order or setup
cost
R =Reorder point
L =Lead time
H=Annual holding
and storage cost
D Q per unit of inventory
TC = DC + S + H
Q 2
 45

EOQ Cost Model

Using calculus, we take the first derivative of the total cost
function with respect to Q, and set the derivative (slope) equal to
zero, solving for the optimized (cost minimized) value of Qopt
Deriving Qopt SD Proving equality
Annual ordering cost = of costs at
Q
SD HQ optimal point
TC = + HQ
Q 2 SD HQ
Annual carrying cost = =
2
TC SD H Q 2
= 2 +
Q Q 2 SD HQ
2S D
Total cost = +
SD H Q 2 Q2 =
H
0= +
Q2 2
2SD
2SD Qopt =
Qopt = H
H
 46

Deriving the EOQ

How much to order?:
2DS 2(Annual D em and)(Order or Setup Cost)
Q OPT = =
H Annual Holding Cost

When to order?
_
We also need a R eo rd er p o in t, R = d L
reorder point to tell _

us when to place an d = average daily demand (constant)

order L = Lead time (constant)
 47

EOQ Model Equations

Optimal Order Quantity = Q* = 2 ×D ×S

H
Expected Number of Orders = N = D
Q*
Working Days / Year
Expected Time Between Orders =T =
N
D
d =
Working Days / Year

ROP = d × L
 48

EOQ Example 1 (1 of 3)

Given the information below, what are the EOQ and

reorder point?

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
 49

EOQ Example 1(2 of 3)

2D S 2(1,000 )(10)
Q O PT = = = 89.443 units or 90 u n its
H 2.50

1,000 units / year

d = = 2.74 units / day
365 days / year

_
R eo rd er p o in t, R = d L = 2 .7 4 u n its / d ay (7 d ays) = 1 9 .1 8 o r 2 0 u n its

In summary, you place an optimal order of 90 units. In the

course of using the units to meet demand, when you only
have 20 units left, place the next order of 90 units.
 50

EOQ Example I(3 of 3)

Orders per year = D/Qopt Order cycle time= 365/(D/Qopt)
= 1000/90 = 365/11
= 11 orders/year = 33.1days

SD + HQ
TCmin =
Q 2
(10)(1,000) (2,5)(90)
TCmin = +
90 2

TCmin = $ 111 + $111 = 22 $

 51

EOQ Example 2(1 of 2)

Determine the economic order quantity
and the reorder point given the following…

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
 52

EOQ Example 2(2 of 2)

2D S 2 (1 0 ,0 0 0 )(1 0 )
Q OPT = = = 3 6 5 .1 4 8 u n its, o r 3 6 6 u n its
H 1 .5 0

10,000 units / year

d= = 27.397 units / day
365 days / year

_
R = d L = 27.397 units / day (10 days) = 273.97 or 274 u n its

Place an order for 366 units. When in the course of

using the inventory you are left with only 274 units,
place the next order of 366 units.
 53

EOQ Example 3
H = $0.75 per yard S = $150 D = 10,000 yards

2SD SD HQ
Qopt = TCmin = +
H Q 2
2(150)(10,000) (150)(10,000) (0.75)(2,000)
Qopt = (0.75) TCmin = 2,000 + 2

Qopt = 2,000 yards TCmin = $750 + $750 = $1,500

Orders per year = D/Qopt Order cycle time =311 days/(D/Qopt)

= 10,000/2,000 = 311/5
= 5 orders/year = 62.2 store days
 54

When to Reorder with EOQ Ordering ?

• Reorder Point – is the level of inventory at which a
new order is placed
ROP = d . L
• Safety Stock - Stock that is held in excess of
expected demand due to variable demand rate
and/or lead time.
• Service Level - Probability that demand will not
exceed supply during lead time (probability that
inventory available during lead time will meet
demand) 1 - Probability of stockout
 55

Reorder Point Example

Demand = 10,000 yards/year

Store open 311 days/year
Daily demand = 10,000 / 311 = 32.154 yards/day
Lead time = L = 10 days

R = dL = (32.154)(10) = 321.54 yards

 56

Determinants of the Reorder Point

• The rate of demand

• The lead time
• Demand and/or lead time variability
• Stockout risk (safety stock)
 57

Probabilistic Models
Answer how much & when to order
Allow demand to vary
 Follows normal distribution
 Other EOQ assumptions apply
Consider service level & safety stock
 Service level = 1 - Probability of stockout
 Higher service level means more safety stock
 More safety stock means higher ROP
 58

Safety Stock
Quantity

Maximum probable demand

during lead time

Expected demand
during lead time

ROP

Safety stock
LT Time
Safety stock reduces risk of
stockout during lead time
 59

Variable Demand with

a Reorder Point

Q
Inventory level

Reorder
point, R

0
LT LT
Time
 60

Reorder Point with a Safety Stock

Inventory level

Q
Reorder
point, R

Safety Stock
0
LT LT
Time
 61

Reorder Point With Variable Demand

R = dL + zd L
where
d = average daily demand
L = lead time
d = the standard deviation of daily demand
z = number of standard deviations
corresponding to the service level
probability
zd L = safety stock
 62

Reorder Point for Service Level

Probability of
meeting demand during
lead time = service level

Probability of
a stockout

Safety stock
zd L

dL R
Expected Demand

The reorder point based on a normal distribution of LT demand

 63

Reorder Point for Variable Demand

(Example)
The carpet store wants a reorder point with a
95% service level and a 5% stockout probability
d = 30 yards per day
L = 10 days
d = 5 yards per day

For a 95% service level, z = 1.65

R = dL + z d L Safety stock = z d L
= 30(10) + (1.65)(5)( 10) = (1.65)(5)( 10)
= 326.1 yards = 26.1 yards
 64

Fixed Order Quantity Models:

-Noninstantaneous Receipt-
Production Order Quantity
(Economic Lot Size)
Model
 65

Production Order Quantity Model

Production done in batches or lots
Capacity to produce a part exceeds that part’s
usage or demand rate
Allows partial receipt of material
 Other EOQ assumptions apply
Suited for production environment
 Material produced, used immediately
 Provides production lot size
Lower holding cost than EOQ model
Answers how much to order and when to order
 66

EOQ POQ Model

When To Order
Both production
and usage take Usage only takes
Maximum place
place
inventory
level
Inventory Level

Time
 67

EOQ POQ Model

When To Order
Inventory Level
Optimal Average
Order Inventory
Quantity
(Q*)

Reorder
Point
(ROP)

Time
Lead Time
 68

POQ Model Inventory Levels (1 of 2)

Inventory Level

Production portion of Maximum

cycle inventory
level
Demand portion of cycle with
no supply

Time
Supply Supply
Begins Ends
 69

POQ Model Inventory Levels (2 of 2)

Inventory Level
Inventory level with no demand

Production Max. Inventory

Q* Portion of Q·(1- u/p)
Cycle Average
inventory
Q/2(1- u/p)

Time
Supply Supply Demand portion of
Begins Ends cycle with no supply
 70

POQ Model Equations

= Q* = 2*D*S
Production Order Quantity

( )
p u
H* 1 -
p

Maximum inventory level = Q* ( 1 -

u
p )
D D = Demand per year
Setup Cost = * S
Q S = Setup cost
H = Holding cost
Holding Cost = 1/2 * H * Q
( )
1-
u
p
d = Demand per day
p = Production per day
2DS p
Q0 
H p u
 71

Production Order Quantity Example

(1 of 2)
H = $0.75 per yard S = $150 D = 10,000 yards
u = 10,000/311 = 32.2 yards per day p = 150 yards per day

2SD 2(150)(10,000)
POQopt = = = 2,256.8 yards
H 1- u 0.75 1 -
32.2
p 150

SD HQ u
TC = Q + 2 1 - p = $1,329

Q 2,256.8
Production run = = = 15.05 days per order
p 150
 72

Production Quantity Example

(2 of 2)
H = $0.75 per yard S = $150 D = 10,000 yards
u= 10,000/311 = 32.2 yards per day p = 150 yards per day

2CoD 10,000
2(150)(10,000)
D
Number of production runs = = = 4.43 runs/year
Qopt = = Q 2,256.8 = 2,256.8 yards
Cc 1 - d 0.75 1 -
32.2
p 150
u 32.2
Maximum inventory level = Q 1 - = 2,256.8 1 -
p 150
CoD CcQ d
TC = Q + 2 1 - p = $1,329 = 1,772 yards

Q 2,256.8
Production run = = = 15.05 days per order
p 150
 73

Fixed-Order Quantity Models:

Economic Order Quantity Model
with Quantity Discounts
 74

Quantity Discount Model

• Answers how much to order & when to order
• Allows quantity discounts
– Price per unit decreases as order quantity
increases
– Other EOQ assumptions apply
• Trade-off is between lower price & increased
holding cost
Total cost with purchasing cost
SD iC Q
TC = + + PD Where P: Unit Price
Q 2
 75

Price-Break Model Formula

Based on the same assumptions as the EOQ model,
the price-break model has a similar Qopt formula:

2DS 2(Annual Demand)(Or der or Setup Cost)

Q OPT = =
iC Annual Holding Cost

i = percentage of unit cost attributed to carrying inventory

C = cost per unit

Since “C” changes for each price-break, the formula above will
have to be used with each price-break cost value
 76

Total Costs with PD

Cost

Adding Purchasing cost TC with PD

doesn’t change EOQ

TC without PD

PD

0 EOQ Quantity
 77

Total Cost with Constant Carrying Costs

TCa
Total Cost

TCb
Decreasing
TCc Price

CC a,b,c

OC

EOQ Quantity
 78

Quantity Discount – How Much to Order?

 79

Price-Break Example 1 (1 of 3)

ORDER SIZE PRICE

0 - 99 $10
100 - 199 8 (d1)
200+ 6 (d2)

For this problem holding cost is given as a constant value,

not as a percentage of price, so the optimal order quantity is
the same for each of the price ranges. (see the figure)
 80

Price Break Example 1 (2 of 3)

TC = ($10 )

TC (d1 = $8 )

TC (d2 = $6 )
Inventory cost ($)

Carrying cost

Ordering cost

Q(d1 ) = 100 Qopt Q(d2 ) = 200

 81

Price Break Example 1 (3 of 3)

TC = ($10 )

TC (d1 = $8 )

TC (d2 = $6 )
Inventory cost ($)

Carrying cost

Ordering cost

Q(d1 ) = 100 Qopt Q(d2 ) = 200

The lowest total cost is at the second price break
 82

Price Break Example 2

QUANTITY PRICE
S = $2,500
1 - 49 $1,400 H = $190 per computer
50 - 89 1,100 D = 200
90+ 900

2SD 2(2500)(200)
Qopt = = = 72.5 PCs
H 190

For Q = 72.5 SD H Qopt

TC = + 2 + PD = $233,784
Qopt

For Q = 90 SD HQ
TC = + 2 + PD = $194,105
Q
 83

Price-Break Example 3
(1 of 4)
A company has a chance to reduce their inventory
ordering costs by placing larger quantity orders using the
price-break order quantity schedule below. What should
their optimal order quantity be if this company purchases
this single inventory item with an e-mail ordering cost of
$4, a carrying cost rate of 2% of the inventory cost of the
item, and an annual demand of 10,000 units?

Order Quantity(units) Price/unit($)

0 to 2,499 $1.20
2,500 to 3,999 1.00
4,000 or more .98
 84

Price-Break Example (2 of 4)
First, plug data into formula for each price-break value of “C”
Annual Demand (D)= 10,000 units Carrying cost % of total cost (i)= 2%
Cost to place an order (S)= $4 Cost per unit (C) = $1.20, $1.00, $0.98

Next, determine if the computed Qopt values are feasible or not

2DS 2(10,000)( 4)
Interval from 4000 & more, the Q OPT = = = 2,020 units
Qopt value is not feasible iC 0.02(0.98)

Interval from 2500-3999, the 2DS 2(10,000)( 4)

Q OPT = = = 2,000 units
Qopt value is not feasible iC 0.02(1.00)

Interval from 0 to 2499, the 2DS 2(10,000)(4)

Qopt value is feasible
Q OPT = = = 1,826 units
iC 0.02(1.20)
 85

Price-Break Example 2 (3 of 4)
Since the feasible solution occurred in the first price-
break, it means that all the other true Qopt values occur
at the beginnings of each price-break interval. Why?

Because the total annual cost function is

Total a “u” shaped function
annual
costs So the candidates
for the price-
breaks are 1826,
2500, and 4000
units

0 1826 2500 4000 Order Quantity

 86

Price-Break Example 2 (4 of 4)
Next, we plug the true Qopt values into the total cost annual cost
function to determine the total cost under each price-break
D Q
TC = DC + S+ iC
Q 2
TC(0-2499)=(10000*1.20)+(10000/1826)*4+(1826/2)(0.02*1.20)
= $12,043.82
TC(2500-3999)= $10,041
TC(4000&more)= $9,949.20

Finally, we select the least costly Qopt, which in this

problem occurs in the 4000 & more interval. In summary,
our optimal order quantity is 4000 units
 87

Multi-period Inventory Models:

Fixed Time Period
(Fixed-Order- Interval)
Models
 88

Fixed-Order-Interval Model

Orders are placed at fixed time intervals

Order quantity for next interval? (inventory is
brought up to target amount, amount ordered
varies)
Suppliers might encourage fixed intervals
Requires only periodic checks of inventory
levels (no continous monitoring is required)
Risk of stockout between intervals
 89

Inventory Level in a Fixed Period

System
Various amounts (Qi) are ordered at regular time intervals
(p) based on the quantity necessary to bring inventory up
to target maximum

Target maximum
Q1 Q2 Q4
Q3
d Inventory

p p p

Time
 90

Fixed-Interval Benefits
Tight control of inventory items
Items from same supplier may yield savings
in:
 Ordering
 Packing
 Shipping costs
May be practical when inventories cannot
be closely monitored
 91

Fixed-Interval Disadvantages
 Requires a larger safety stock
 Increases carrying cost
 Costs of periodic reviews
 92

Fixed-Time Period Model with Safety Stock

Formula
q = Average demand + Safety stock – Inventory currently on hand

q = d(T + L) + Z  T + L - I

Where :
q = quantitiy to be ordered
T = the number of days between reviews
L = lead time in days
d = forecast average daily demand
z = the number of standard deviations for a specified service probabilit y
 T + L = standard deviation of demand over the review and lead time
I = current inventory level (includes items on order)
 93

Fixed-Time Period Model:

Determining the Value of T+L

  
T+ L 2
 T+ L = di
i 1

Since each day is independent and  d is constant,

 T+ L = (T + L) d 2

The standard deviation of a sequence of random

events equals the square root of the sum of the
variances
 94

Order Quantity for a

Periodic Inventory System

where Q = d(tb + L) + zd T+L -I

d = average demand rate
T = the fixed time between orders
L = lead time
d = standard deviation of demand
zd tb + L = safety stock
I = inventory level
z = the number of standard deviations
for a specified service level
 95

Fixed-Period Model with Variable

Demand (Example 1)

d = 6 bottles per day

d = 1.2 bottles
tb = 60 days
L = 5 days
I = 8 bottles
z = 1.65 (for a 95% service level)

Q = d(tb + L) + zd tb + L - I
= (6)(60 + 5) + (1.65)(1.2) 60 + 5 - 8
= 397.96 bottles
 96

Fixed-Time Period Model with

Variable Demand (Example 2)(1 of 3)
Given the information below, how many units
should be ordered?
Average daily demand for a product is 20 units.
The review period is 30 days, and lead time is
10 days. Management has set a policy of
satisfying 96 percent of demand from items in
stock. At the beginning of the review period
there are 200 units in inventory. The standard
deviation of daily demand is 4 units.
 97

Fixed-Time Period Model with Variable

Demand (Example 2)(2 of 3)

 T+ L = (T + L) d =
2
 30 + 10  4  2 = 25.298

So, by looking at the value from the Table, we have a

probability of 0.9599, which is given by a z = 1.75
 98

Fixed-Time Period Model with Variable

Demand (Example 2) (3 of 3)
q = d(T + L) + Z  T + L - I

q = 20(30 + 10) + (1.75)(25. 298) - 200

q = 800  44.272 - 200 = 644.272, or 645 units

So, to satisfy 96 percent of the demand,

you should place an order of 645 units at
this review period
 99

Miscellaneous Systems:
Optional Replenishment System
Maximum Inventory Level, M

q=M-I

Actual Inventory Level, I

M
I

Q = minimum acceptable order quantity

If q > Q, order q, otherwise do not order any.

 100

ABC Classification System

• Demand volume and value of items vary

• Items kept in inventory are not of equal
importance in terms of:
– dollars invested
– profit potential
– sales or usage volume
– stock-out penalties
 101

ABC Classification System

Classifying inventory according to some

measure of importance and allocating control
efforts accordingly.
A - very important
B - mod. important High
A
C - least important Annual
$ value B
of items

Low C
Low High
Percentage of Items
 102

ABC Analysis

Classify inventory into 3 categories typically

on the basis of the dollar value to the firm
$ volume = Annual demand x Unit cost
A class, B class, C class Policies based on
ABC analysis
– Develop class A suppliers more carefully
– Give tighter physical control of A items
– Forecast A items more carefully
 103

Classifying Items as ABC

% Annual $ Usage Class % $ Vol % Items
100 A 70-80 5-15
B 15 30
80
C 5-10 50-60
60
40
A
B
20 C
0
0 50 100
% of Inventory Items
 104

ABC Classification
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
 105

ABC Classification
TOTAL % OF TOTAL % OF TOTAL
PART PART
VALUE UNIT
VALUECOSTQUANTITY
ANNUAL USAGE
% CUMMULATIVE
9 1
$30,600 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 40 11.0
2 14,000 16.4 4.0 15.0
3 30 130
1 5,400 6.3 9.0 24.0
4 4
4,800 5.680 6.0 60 30.0
3 5
3,900 4.630 10.0 100 40.0
6 6
3,600 4.220 18.0 180 58.0
5 3,000
7 3.510 13.0 170 71.0
10 2,400 2.8 12.0 83.0
8 320 50
7 1,700 2.0 17.0 100.0
9 510 60
$85,400
10 20 120
 106

ABC Classification
TOTAL % OF TOTAL % OF TOTAL
PART PART
VALUE UNIT
VALUECOSTQUANTITY
ANNUAL USAGE
% CUMMULATIVE
9 1
$30,600 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 A
40 11.0
2 14,000 16.4 4.0 15.0
3 30 130
1 5,400 6.3 9.0 24.0
4 4
4,800 5.680 6.0 60 30.0
B
3 5
3,900 4.630 10.0 100 40.0
6 6
3,600 4.220 18.0 180 58.0
5 3,000
7 3.510 13.0 170 71.0
10 2,400
8 2.8
320 12.0 C
50 83.0
7 1,700 2.0 17.0 100.0
9 510 60
$85,400
10 20 120
 107

ABC Classification
TOTAL % OF TOTAL % OF TOTAL
PART PART
VALUE UNIT
VALUECOSTQUANTITY
ANNUAL USAGE
% CUMMULATIVE
1
9 $30,600 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 A
40 11.0
2 14,000 16.4 % OF TOTAL4.0 15.0
3 30 130
% OF TOTAL
1 CLASS
5,400 ITEMS 6.3 VALUE9.0 24.0
QUANTITY
4 4
4,800 5.680 6.0 60
B 15.030.0
3 5
A3,900 9, 8, 2 4.630 71.010.0 100 40.0
6 B3,600
6 1, 4, 3 4.220 16.518.0 180 25.058.0
5 C3,000 6, 5, 10,3.5
7 12.513.0 60.071.0
7 10 170
10 2,400
8 2.8
320 12.0 C
50 83.0
7 1,700 2.0 17.0 100.0
9 510 60
$85,400
10 20 120
 108

ABC Classification
100 – C
B
80 –
% of Value

60 –
A
40 –

20 –

0 |– | | | | |
0 20 40 60 80 100
% of Quantity
 109

Inventory Accuracy and

Cycle Counting
• Inventory accuracy refers to how well the
inventory records agree with physical count.
• Physically counting a sample of total
inventory on a regular basis
• Used often with ABC classification
– A items counted most often (e.g., daily)
 110

Advantages of Cycle Counting

• Eliminates shutdown and interruption of

production necessary for annual physical
inventories
• Eliminates annual inventory adjustments
• Provides trained personnel to audit the accuracy
of inventory
• Allows the cause of errors to be identified and
remedial action to be taken
• Maintains accurate inventory records
 111

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