Inventory Costs

 Capital cost or opportunity cost

 Customer priorities
 Unexpected orders/spare requirement
 Cost of lost sales
 Storage space cost: includes handling costs and rent
 Inventory service cost: includes insurance and taxes
 Inventory risk cost:
 Shelf-life
 Product obsolescence
 Material price variation
 Inventory Costs
 In-transit inventory cost:
 does not include storage space cost, taxes and insurance
 Obsolescence and deterioration are lesser risks
 Generally costs less than carrying in the warehouse
 Carrying cost vs order costs
 Inventory Costs
 Classifying inventory:
 1951 GE suggestion:
 Relative sales volume, cash flows, lead time or stock-
out costs
 80-20 rule (Pareto's Law)
 ABC classification of inventories
 20% items 80% sales
 50% items 15% sales
 30% items 5% sales
 Inventory Costs
Casey-Lynn Corporation
Product# Units sold Price/unit Profit/unit
SR101 12386 275 82.50
SR103 784 1530 459.00
SR105 1597 579 173.30
SR201 48 2500 975.00
SR203 2 3000 1200.00
SR205 9876 450 149.00
SR301 673 600 180.00
SR303 547 725 200.00
SR305 3437 917 240.00
SR500 78 1000 312.00
Do an ABC inventory analysis based on revenue and profits.
Managing Inventory

 Fixed Order Quantity Approach

 Economic order quantity approach
 Conditions of certainty
 Conditions of uncertainty
 Probability
 Normal distribution
 If demand is erratic mini-max approach is suitable
 Safety stock approach
EOQ
 R=Annual rate of demand in units
 Q=Quantity ordered lot size
 A=Cost of placing order Rs per order
 V=Value or cost of one unit of inventory
 W=Carrying cost per Rs value of inventory per
year (% of product value)
 TAC=Total annual cost=½QV*W + A(R/Q)
 EOQ=d(TAC)/dQ=√((2R*A)/(V*W))
EOQ
 R=3600 units
 A=Rs200 per order
 V=Rs100 per unit of inventory
 W=25%
 EOQ=?
Inventory at Multiple Locations
(The Square Root Law)
 n1=number of existing facilities
 n2=number of future facilities
 X1=total inventory in existing facilities
 X2=total inventory in future facilities
 X2=(x1)(√n2/n1)
Managing Inventory
 Additional approaches:
 KANBAN
 JIT
 Two-bin system
 Reducing lead times
 MRP System
 Impact of 'Pull' and 'Push' on inventory
 Nittany Fans
 Annual demand: 36000 fans
 Fan value: $4000
 Inventory carrying cost: 25%
 Ordering cost=$200
 In-transit inventory carrying cost = 15%
 Order cycle time using rail=4 days
 Order cycle time using motor carrier=2 days
 Rail rate=$10/ton
 Motor rate=$12.5/ton
 Weight of fan(including packing)=100kg
 Nittany Fans

 What is the EOQ for Nittany Fans in units?

 What is the total cost (not considering transportation
related costs) of the EOQ?
 What is the total cost of using rail transportation?
 What is the cost of using motor transportation?
 What alternative should Nittany use?