Qtkd-704015-Qtccu CH2

Charter 2
INVENTORY MANAGEMENT
Mã MH : 704015
Bộ môn: KDQT- K.QTKD
Learning objectives
 Define the term inventory and list the major reasons for
holding inventories; and list the main requirements for effective
inventory management;
 Apply EOQ and EPL model in inventory management;
 Apply centralized and decentralized techniques in operating
inventory;
Apply information management and risk pooling in controlling
inventory.
12/7/2016 704015- Chapter 2 Inventory Management 2

2.1 Inventory introduction
2.1.1 What is inventory

 Stock of items kept to meet future demand;
 One of the most expensive assets of many companies
representing as much as 50% of total invested capital;
 Operations management must balance inventory
investment and customer service;

Why Is Inventory Important?
• GM’s production and distribution network
– 20,000 supplier plants; 133 parts plants;31 assembly
plants;11,000 dealers
• Freight transportation costs: $4.1 billion (60% for material
shipments)
• GM inventory valued at $7.4 billion (70%WIP; Rest Finished
Vehicles)
• Decision tool to reduce:
– combined corporate cost of inventory and transportation.
• 26% annual cost reduction by adjusting:
– Shipment sizes (inventory policy)
– Routes (transportation strategy)
Why Is Inventory Required?
• Uncertainty in customer demand
– Shorter product lifecycles
– More competing products
• Uncertainty in supplies
– Quality/Quantity/Costs/Delivery Times
• Delivery lead times
• Incentives for larger shipments

2.2 Single Stage Inventory Control
• Single supply chain stage
• Variety of techniques
– Economic Lot Size Model
– Demand Uncertainty
– Single Period Models
– Initial Inventory
– Multiple Order Opportunities
– Continuous Review Policy
– Variable Lead Times
– Periodic Review Policy
– Service Level Optimization
2.2.1. Economic Lot Size Model
Also called as Economic Order Quantity (EOQ)
FIGURE 2-3: Inventory level as a function of time

Assumptions
• D items per year: annual demand, d: daily demand rate
• Q items per order: Order quantities are fixed, i.e., each time the
warehouse places an order, it is for Q items.
• K, fixed setup cost, incurred every time the warehouse places
an order.
• h, inventory carrying cost accrued per unit held in inventory per
year that the unit is held (also known as, holding cost)
• Lead time = 0
(the time that elapses between the placement of an order and
its receipt)
• Initial inventory = 0
• Planning horizon is long (infinite).
Deriving EOQ
• Economic Order Quantity: 2 KD

Q *

h
• Inventory holding cost: h*Q/2

• Set-up cost (or ordering cost) = K*D/Q
• Cycle time T =Q/d

EOQ: Costs
FIGURE 2-4: Economic lot size model: total cost per unit time
Sensitivity Analysis
Total inventory cost relatively insensitive to order quantities
Actual order quantity: Q

Q is a multiple b of the optimal order quantity Q*.
For a given b, the quantity ordered is Q = bQ*
b .5 .8 .9 1 1.1 1.2 1.5 2

Increase in 25% 2.5% 0.5% 0 .4% 1.6% 8.9% 25%
cost
Your turn
Assume that the warehouse works 50 weeks/year

Your turn
A rice exporter buys rice from the only supplier. The demand of rice is certain
throughout the year. Last year, the exporter exported 1,000 tons of rice. Ordering cost is
$150 per order. The annual holding cost is 10% of the purchase cost. The exporter pays
$500 per ton to the supplier.
a. What should the economic order quantity be?
b. What is the total annual holding cost?
c. What is the total annual ordering cost?
Quantity Discount Models Example
QUANTITY
PRICE RANGE ORDERED PRICE PER UNIT
$
Initial price 1 to 119
98
Discount price $
120 to 1,499
1 96
Discount price $
1,500 and over
2 94
Furthermore, setup cost is $200 per order, annual demand is 5,200 units, and
annual inventory carrying charge as a percent of cost, H , is 28%. What order
quantity will minimize the total inventory cost?
14
SOLUTION:
K= $200; D= 5,200 units; H= 28%*P.
• Compute EOQ with price P = $98

EOQ = (2*200*5200/0.28*98)^1/2 = 276 units  not belong to [1, 119]  We
choose Q =1  Total cost = K*D/Q + H*Q/2 + P*D = $1,549,613 (1)
• Compute EOQ with price P = $ 96

EOQ = 279 units  belong to [120, 1499]  We choose Q = 279  Total cost =
$506,677 (2)
• Compute EOQ with price P = $ 94

EOQ = 282 units  Not belong to [1,500 and over]  We choose Q = 1500 
Total cost = $509,233 (3)
Compare (1), (2), (3)  We choose Q = 279 units because it gives the lowest
cost. 15
Your turn
Company X orders spare parts to company Y. Forecasts based on historical data indicate that Company X
will need to purchase 750,000 units of the special security chip annually. Company Y has a minimum
order quantity of 1,500 units, and offers a sliding price scale based on the quantity in each order, as
follows.
Order quantity Unit price
1,500 – 9,999 $4.0
10,000 – 29,999 $3.5
30,000 + $3.3
The purchasing department of Company X indicates that this company has to pay $300 for each order placed, and this company has
an annual inventory carrying cost equals to 8 percent of the value of inventory. What is the economic order quantity?
Your turn
Demand for the Child Cycle at Best Buy is 500 units per month.
Best Buy incurs a fixed order placement, transportation, and
receiving cost of $4,000 each time an order is placed. Each
cycle costs $500 and the retailer has a holding cost of 20
percent. Evaluate the number of computers that the store
manager should order in each replenishment lot?
2.2.2. Demand Uncertainty
• The forecast is always wrong
– It is difficult to match supply and demand
• The longer the forecast horizon, the worse the forecast
– It is even more difficult if one needs to predict
customer demand for a long period of time
• Aggregate forecasts are more accurate.
– More difficult to predict customer demand for
individual SKUs
– Much easier to predict demand across all SKUs within
one product family
2.2.3. Single Period Models
Short lifecycle products

• One ordering opportunity only
• Order quantity to be decided before
demand occurs
– Order Quantity > Demand => Dispose excess
inventory
– Order Quantity < Demand => Lose sales/profits

Single Period Models
• Using historical data
– determine probability of all scenarios
• Given a specific inventory policy
– determine the profit associated with a particular scenario
– given a specific order quantity
• weight each scenario’s profit by its probability
• determine the expected profit for a particular ordering
quantity.
• Order the quantity that maximizes the average profit.

Single Period Model - Example
Demand 8000 10000 12000 14000 16000 18000
Probability 11% 11% 28% 22% 18% 10%
• Fixed production cost: $100,000

• Variable production cost per unit: $80.
• During the summer season, selling price: $125 per unit.
• Salvage value: Any swimsuit not sold during the summer season is sold to a discount store for $20.
The company should produce 9000 units or 16000 units if:

1. The manager is the risk-taker?
2. The manager is the risk-avoider?

Your turn
Demand 8000 10000 12000 14000 16000 18000 • Fixed production cost: $100,000
• Variable production cost per unit: $80.
Prob 11% 11% 28% 22% 18% 10% • During the summer season, selling price: $125 per
unit.
• Salvage value: Any swimsuit not sold during the
PRODUCE 9.000 UNITS
summer season is sold to a discount store for $20.
Demand 8000 10000 12000 14000 16000 18000
Profit = 8000*125 = 30500 = 305 = 305 = 305

+ 1000*20 – 9000*125
– (100000 0 000 000 000
(100000 +  Expected profit = 200000*11% + 305000*89%
80*9000) + 80*9000)
= 200 000 = 305 000 = 293 450
PRODUCE 16.000 UNITS

Demand 8000 10000 12000 14000 16000 18000
Profit =8000*125+
8000*20 -
=10000*125
+6000*20 -
=12000*125
+4000*20 -
=14000*125
+2000*20 -
=16000*125
- (100000 +
620 000  Expected profit = -220000*11% -10000*11%
(100000 + (100000 + (100000 + (100000 + 80*16000) +200000*28%+410000*22%+620000*28%
80*16000) 80*16000) 80*16000) 80*16000) = 620 000
= -220 000 = -10 000 = 200 000 = 410 000 =294 500
Two Scenarios
• Manufacturer produces 10,000 units while demand ends at 12,000
swimsuits
Profit
= 125(10,000) - 80(10,000) - 100,000
= $350,000
• Manufacturer produces 10,000 units while demand ends at 8,000
swimsuits
Profit
= 125(8,000) + 20(2,000) - 80(10,000) - 100,000
= $140,000

Probability of Profitability Scenarios
with Production = 10,000 Units
• Probability of demand being 8000 units = 11%
– Probability of profit of $140,000 = 11%
• Probability of demand being 12000 units = 27%
– Probability of profit of $140,000 = 27%
• Total profit = Weighted average of profit scenarios

Order Quantity that
Maximizes Expected Profit
FIGURE 2-6: Average profit as a function of production quantity

Relationship Between Optimal Quantity
and Average Demand
• Marginal profit = Selling Price - Variable Cost
• Marginal cost = Variable Cost - Salvage Value
If Marginal Profit > Marginal Cost  Optimal Quantity > Average

Demand
If Marginal Profit < Marginal Cost  Optimal Quantity < Average

Demand

For the Swimsuit Example
• Average demand = 13,000 units.

• Optimal production quantity = 12,000 units.
• Marginal profit = $45
• Marginal cost = $60.
• Thus, Marginal Cost > Marginal Profit
=> optimal production quantity < average
demand.
Risk-Reward Tradeoffs
• Optimal production quantity maximizes average profit is
about 12,000
• Producing 9,000 units or producing 16,000 units will lead
to about the same average profit of $294,000.
• If we had to choose between producing 9,000 units and
16,000 units, which one should we choose?

FIGURE 2-7: A frequency histogram of profit

• Production Quantity = 9000 units
– Profit is:
• either $200,000 with probability of about 11 %
• or $305,000 with probability of about 89 %
• Production quantity = 16,000 units.
– Distribution of profit is not symmetrical.
– Losses of $220,000 about 11% of the time
– Profits of at least $410,000 about 50% of the time
• With the same average profit, increasing the production quantity:
Increases the possible risk; Increases the possible reward
Observations
• The optimal order quantity is not necessarily equal to
forecast, or average, demand.
• As the order quantity increases, average profit typically
increases until the production quantity reaches a certain
value, after which the average profit starts decreasing.
• Risk/Reward trade-off: As we increase the production
quantity, both risk and reward increases.

2.2.5. Multiple Order Opportunities
REASONS
• To balance annual inventory holding costs and annual fixed order costs.
• To satisfy demand occurring during lead time.
• To protect against uncertainty in demand.
TWO POLICIES
• Continuous review policy
– inventory is reviewed continuously
– an order is placed when the inventory reaches a particular level or reorder point.
– inventory can be continuously reviewed (computerized inventory systems are used)
• Periodic review policy

– inventory is reviewed at regular intervals
– appropriate quantity is ordered after each review.
– it is impossible or inconvenient to frequently review inventory and place orders if necessary.

2.2.6. Continuous Review Policy
• Daily demand is random and follows a normal distribution.
• Every time the distributor places an order from the manufacturer, the distributor
pays a fixed cost, K, plus an amount proportional to the quantity ordered.
• Inventory holding cost is charged per item per unit time.
• Inventory level is continuously reviewed, and if an order is placed, the order
arrives after the appropriate lead time.
• If a customer order arrives when there is no inventory on hand to fill the order
(i.e., when the distributor is stocked out), the order is lost.
• The distributor specifies a required service level.

Continuous Review Policy
• AVG = Average daily demand faced by the distributor
• STD = Standard deviation of daily demand faced by the
distributor
• L = Replenishment lead time from the supplier to the
distributor in days
• h = Cost of holding one unit of the product for one day at the
distributor
• α = service level. This implies that the probability of stocking
out is 1 - α

• (Q,R) policy – whenever inventory level
falls to a reorder level R, place an order for
Q units
• What is the value of R?

• Average demand during lead time: L x AVG
• Safety stock: z  STD  L
• Reorder Level, R: L  AVG  z  STD  L
2 K  AVG
• Order Quantity, Q: Q 
h

Service Level & Safety Factor, z
Service Level 90% 91% 92% 93% 94% 95% 96% 97% 98% 99% 99.9%
z 1.29 1.34 1.41 1.48 1.56 1.65 1.75 1.88 2.05 2.33 3.08
z is chosen from statistical tables to ensure

that the probability of stockouts during lead time is exactly 1 - α
Inventory Level Over Time
FIGURE 2-9: Inventory level as a function of time in a (Q,R) policy
z  STD  L
Inventory level before receiving an order =
Q  z  STD  L
Inventory level after receiving an order =
2  z  STD 
Q
Average704015-
Inventory = L
12/7/2016 Chapter 2 Inventory Management 43
Continuous Review Policy Example
Instructions:
K = $4,500
h = 18% x $250 / 52
L = 2 weeks
Expected service level = 97%  z = 1.88
AVG (monthly) = 191.17  AVG (weekly) =
191.17 / 4.3 = 44.45 (Note: month/week = 30/7
=4.3)
STD (monthly) = 66.53  STD (weekly) = 66.53 /
√4.3 = 32.08

2.2.7. Variable Lead Times
• Average lead time, AVGL
• Standard deviation, STDL.
• Reorder Level, R:
R  AVG  AVGL  z AVGL  STD 2  AVG 2  STDL2
Amount of safety stock= z AVGL  STD 2  AVG 2  STDL2
2 K  AVG
Q 
Order Quantity = h

2.2.8. Periodic Review Policy
• Inventory level is reviewed periodically at regular intervals
• An appropriate quantity is ordered after each review
• Two Cases:
– Short Intervals (e.g. Daily)
• Define two inventory levels s and S
• During each inventory review, if the inventory position falls below s, order enough to
raise the inventory position to S.
• (s, S) policy
– Longer Intervals (e.g. Weekly or Monthly)
• May make sense to always order after an inventory level review.
• Determine a target inventory level, the base-stock level
• During each review period, the inventory position is reviewed
• Order enough to raise the inventory position to the base-stock level.
• Base-stock level policy

(s,S) policy
• Calculate the Q and R values as if this

were a continuous review model
• Set s equal to R
• Set S equal to R+Q.

Base-Stock Level Policy
• Determine a target inventory level, the base-stock level

• Each review period, review the inventory position is reviewed and order
enough to raise the inventory position to the base-stock level
• Assume:
r = length of the review period
L = lead time
AVG = average daily demand
STD = standard deviation of this daily demand.

• Average demand during an interval of r + L
days = (r  L)  AVG
• Safety Stock = z  STD  r  L
• Average inventory level =
(r*AVG)/2 + ( z  STD  r  L)

FIGURE 2-10: Inventory level as a function of time in a periodic review

policy

Base-Stock Level Policy Example
A distributor places an order every 3 weeks. The lead-time of an order

is 2 weeks. When a order is placed, it needs $4500. The average value
and standard deviation of weekly demand are 44.58 and 32.08
respectively. The distributor needs to serve the customers at the level
of 97% (z=1.88).
Compute the average inventory level?

Base-Stock Level Policy Example
• Assume:
– distributor places an order for TVs every 3 weeks
– Lead time is 2 weeks
– Base-stock level needs to cover 5 weeks
• Average demand = 44.58 x 5 = 222.9
• Safety stock = 1.9  32.8  5
• Base-stock level = 223 + 136 = 359
• Average inventory level = 344 .58
 1.9  32.08  5  203.17
2
• Distributor keeps 5 (= 203.17/44.58) weeks of supply.

2.2.9. Service Level Optimization
• Optimal inventory policy assumes a specific service level
target.
• What is the appropriate level of service?
– May be determined by the downstream customer
• Retailer may require the supplier, to maintain a specific
service level
• Supplier will use that target to manage its own
inventory
– Facility may have the flexibility to choose the appropriate
level of service

Service Level Optimization
FIGURE 2-11:
Service level
inventory versus
inventory level as a
function of lead
time

Trade-Offs
• Everything else being equal:
– the higher the service level, the higher the inventory
level.
– for the same inventory level, the longer the lead time
to the facility, the lower the level of service provided by
the facility.
– the lower the inventory level, the higher the impact of
a unit of inventory on service level and hence on
expected profit
Retail Strategy
• Given a target service level across all products determine
service level for each SKU so as to maximize expected
profit.
• Everything else being equal, service level will be higher
for products with:
– high profit margin
– high volume
– low variability
– short lead time

Profit Optimization and Service Level
FIGURE 2-12: Service level optimization by SKU

Profit Optimization and Service Level
• Target inventory level = 95% across all products.
• Service level > 99% for many products with high profit
margin, high volume and low variability.
• Service level < 95% for products with low profit margin,
low volume and high variability.

Continuous Review Policy Example
The following table provides historical data of a typical product of ABC. The table includes weekly demand
information of the product for the last 4 weeks in each market area.
Table 1: Weekly demand in thousand units
Week 1 2 3 4
Market A 13 11 20 19
Market B 15 10 20 14
The weekly demand follow normal distribution. It costs $1,200 whenever a warehouse places an order. The
annual holding costs is $65 per unit. It usually takes 3 weeks for the factory to fulfill an order. The service levels
of two market is now 96%. ABC has considered an alternative distribution strategy in which the two regional
warehouses are replaced with one single and central warehouse to fulfill all customer orders. The CEO insists
that the alternative strategy can increase the service level to 98% (which has the corresponding service factor
of 2.05).
Calculate the average inventory of each system. Should ABC adopt the alternative system?
System 1: Two regional warehouses serve two markets (thousand units)
K=$1,200
Week 1 2 3 4
h (weekly) = $65/52
L = 3 weeks Market A 13 11 20 19
Z = 2.05 Market B 15 10 20 14
2 K  AVG
Q  AVG (A) = 15.75 AVG (B) = 14.75 Average inventory (system 1) =
h
STD (A) = 4.43 STD (B) = 4.11 Average inventory (A) + Average
Q (A) = 173.9 (thousand units) Q (B) = 168.29 (thousand units) inventory (B)
Average inventory (A) = 102.68 Average inventory (B) = 98.74 = 201.42 (thousand units) (1)
(thousand units) (thousand units)
System 2: One central warehouse serves two markets
Week 1 2 3 4
Market A+B 28 21 40 33
AVG (A+B) = 30.5

STD (A+B) = 8.02
Q (A+B) = 241.99 (thousand units)
Average inventory (system 2) = 149.47 (thousand units) (2)
Since (2)< (1)  ABC should adopt the alternative system (system 2)
2.3 Risk Pooling
Inventory risk pooling is the concept that the variability in demand for raw
materials is reduced by aggregating demand across multiple products. When
properly employed, a business can use risk pooling to maintain
lower inventory levels while still avoiding stockout conditions.

2.3 Risk Pooling
• Demand variability is reduced if one aggregates demand across
locations.
• More likely that high demand from one customer will be offset by low
demand from another.
• Reduction in variability allows a decrease in safety stock and
therefore reduces average inventory.
Warehouse 1 Ho Chi Minh city

Capacity 500 Demand 800 Ho Chi Minh city Central warehouse Binh Duong
Demand 800 Capacity 1000 Demand 200
Warehouse 2 Binh Duong
Capacity 500 Demand 200

2.3 Risk Pooling
Three types of risk pooling
 Across locations
 Across time
 Across products
Example:
Risk pooling across locations: combining several warehouses into a single central
warehouse.
Risk pooling across time: using quarterly demand forecasts instead of monthly
forecasts to do capacity planning.
Risk pooling across products: designing products with maximum commonality and
delaying product differentiation in the supply chain as much as possible.

Demand Variation
• Standard deviation measures how much

demand tends to vary around the average
– Gives an absolute measure of the variability
• Coefficient of variation is the ratio of
standard deviation to average demand
– Gives a relative measure of the variability,
relative to the average demand
Critical Points
• The higher the coefficient of variation, the greater the benefit
from risk pooling
– The higher the variability, the higher the safety stocks kept by
the warehouses. The variability of the demand aggregated by
the single warehouse is lower
• Reallocation of items from one market to another easily

accomplished in centralized systems. Not possible to do in
decentralized systems where they serve different markets

Critical Points
• The benefits from risk pooling depend on the behavior of the
demand from one market relative to demand from another
– risk pooling benefits are higher in situations where demands
observed at warehouses are negatively correlated
Ho Chi Minh city Long An

Demand 800 Demand 200
Binh Duong Tien Giang

Negative correlation Positive correlation

 Benefit from risk  No benefit from risk
pooling pooling

2.4 Centralized vs. Decentralized
Systems
• Safety stock: lower with centralization
• Service level: higher service level for the same inventory
investment with centralization
• Overhead costs: higher in decentralized system
• Customer lead time: response times lower in the
decentralized system
• Transportation costs: not clear. Consider outbound and
inbound costs.

2.5 Managing Inventory in the Supply Chain
• Inventory decisions are given by a single decision maker
whose objective is to minimize the system-wide cost
• The decision maker has access to inventory information at
each of the retailers and at the warehouse
• Echelons and echelon inventory
– Echelon inventory at any stage or level of the system
equals the inventory on hand at the echelon, plus all
downstream inventory (downstream means closer to the
customer)

Echelon Inventory
FIGURE 2-13: A serial supply chain

Reorder Point with Echelon Inventory
• Le = echelon lead time,
– lead time between the retailer and the distributor plus
the lead time between the distributor and its supplier,
the wholesaler.
• AVG = average demand at the retailer
• STD = standard deviation of demand at the retailer
• Reorder point
R  Le  AVG  z  STD  Le

4-Stage Supply Chain Example
• Average weekly demand faced by the retailer is 45
• Standard deviation of demand is 32
• At each stage, management is attempting to maintain a service level of 97% (z=1.88)
• Lead time between each of the stages, and between the manufacturer and its suppliers is 1
week
Reorder Points at Each Stage

R  Le  AVG  z  STD  Le
Manufacturer  Wholesaler  Distributor  Retailer
• For the retailer, R=1*45+1.88*32*√1 = 105
• For the distributor, R=2*45+1.88*32*√2 = 175
• For the wholesaler, R=3*45+1.88*32*√3 = 239
• For the manufacturer, R=4*45+1.88*32*√4 = 300

More than One Facility at Each Stage
• Follow the same approach
• Echelon inventory at the warehouse is
the inventory at the warehouse, plus
all of the inventory in transit to and in
stock at each of the retailers.
• Similarly, the echelon inventory
position at the warehouse is the
echelon inventory at the warehouse,
plus those items ordered by the
warehouse that have not yet arrived
minus all items that are backordered.
2.6 Practical Issues
• Periodic inventory review.
• Tight management of usage rates, lead times, and safety stock.
• Reduce safety stock levels.
• Introduce or enhance cycle counting practice.
• ABC approach.
• Shift more inventory or inventory ownership to suppliers.
• Quantitative approaches.
FOCUS: not reducing costs but reducing inventory levels.
Significant effort in industry to increase inventory turnover
Annual _ Sales
Inventory _ Turnover _ Ratio 
Average _ Inventory _ Level
Inventory Turnover Ratios for Different
Manufacturers
Industry Upper quartile Median Lower quartile
Electronic components and 8.1 4.9 3.3

accessories
Electronic computers 22.7 7.0 2.7
Household audio and video 6.3 3.9 2.5

equipment
Paper Mills 11.7 8.0 5.5

Industrial chemicals 14.1 6.4 4.2
Bakery products 39.7 23.0 12.6

Books: Publishing and 7.2 2.8 1.5
printing

2.7 Forecasting
RULES OF FORECASTING
• The forecast is always wrong.
• The longer the forecast horizon, the
worse the forecast.
• Aggregate forecasts are more accurate.

Utility of Forecasting
• Part of the available tools for a manager

• Despite difficulties with forecasts, it can be
used for a variety of decisions
• Number of techniques allow prudent use of
forecasts as needed

Techniques
• Judgment Methods
– Sales-force composite
– Experts panel
– Delphi method
• Market research/survey
• Time Series: Moving Averages; Exponential Smoothing
• Trends
– Regression
– Holt’s method
• Seasonal patterns – Seasonal decomposition
• Trend + Seasonality – Winter’s Method
• Causal Methods
The Most Appropriate Technique(s)
• Purpose of the forecast

• How will the forecast be used?
• Dynamics of system for which forecast will
be made
• How accurate is the past history in
predicting the future?
SUMMARY
• Matching supply with demand a major challenge
• Forecast demand is always wrong
• Longer the forecast horizon, less accurate the forecast
• Aggregate demand more accurate than disaggregated
demand
• Need the most appropriate technique
• Need the most appropriate inventory policy

Production order quantity (POQ) Model
Inventory Level
Inventory level with no demand
Max. Inventory
Production Q·(1- d/p)
Q* Portion of Average inventory
Cycle Q/2(1- d/p)
Time
Supply Supply Demand portion of
Begins Ends cycle with no supply
Production order quantity (POQ) Model
2xKxD
Production Order Quantity = Q* =
( )
d
H 1-
p
Maximum inventory level = Q* ( 1 -

d
p )
D D = Demand per year
Setup Cost = * K
Q K = Setup cost
H = Holding cost
Holding Cost = 1/2 x H x Q
( )
1-
d
p
d = Demand per day
p = Production per day
Task
Non-Slip Tile Company (NST) has been using production runs of 100,000 tiles,
10 times per year to meet the demand of 1,000,000 tiles annually. The set-up
cost is $5,000 per run and holding cost is estimated at 10% of the
manufacturing cost of $1 per tile. The production capacity of the machine is
500,000 tiles per month. The factory is open 365 days per year. What is the
production order quantity? Set up cost? Holding cost? Average inventory?
D = 1,000,000 tiles  d = D/365 = 2740 tiles
K = $5,000
H = 10% x $1 = $0.1 per tile per year
p = 500,000/30 = 16667 tiles
Q=?

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Charter 2

12/7/2016 704015- Chapter 2 Inventory Management 2

2.1.1 What is inventory

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Also called as Economic Order Quantity (EOQ)

FIGURE 2-3: Inventory level as a function of time

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• Economic Order Quantity: 2 KD

• Inventory holding cost: h*Q/2

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Actual order quantity: Q

b .5 .8 .9 1 1.1 1.2 1.5 2

Assume that the warehouse works 50 weeks/year

K= $200; D= 5,200 units; H= 28%*P.

• Compute EOQ with price P = $98

• Compute EOQ with price P = $ 96

• Compute EOQ with price P = $ 94

Short lifecycle products

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• Fixed production cost: $100,000

The company should produce 9000 units or 16000 units if:

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Profit = 8000*125 = 30500 = 305 = 305 = 305

PRODUCE 16.000 UNITS

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FIGURE 2-6: Average profit as a function of production quantity

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If Marginal Profit > Marginal Cost  Optimal Quantity > Average

If Marginal Profit < Marginal Cost  Optimal Quantity < Average

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• Average demand = 13,000 units.

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FIGURE 2-7: A frequency histogram of profit

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• Periodic review policy

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z is chosen from statistical tables to ensure

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Amount of safety stock= z AVGL  STD 2  AVG 2  STDL2

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• Calculate the Q and R values as if this

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• Determine a target inventory level, the base-stock level

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FIGURE 2-10: Inventory level as a function of time in a periodic review

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A distributor places an order every 3 weeks. The lead-time of an order

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