Chapter Outline

Inventory Control

Introduction

(Production Planning & Control)

Economic
Order
Quantity

ABC Analysis

IE 2353
Pratya Poeri Suryadhini

EOQ
Probabilistic

Inventory as an Important Asset

Inventory can be the most expensive and the most important asset for
an organization

Inventory as a
percentage of total assets

Economic
Manufacturing
Quantity

Inventory Planning and Control

Planning on
what Inventory
to Stock and
How to
Acquire It

Forecasting
Parts/Product
Demand

Controlling
Inventory
Levels

Inventory
40%

Other Assets
60%

Feedback
Measurements to
Revise Plans and
Forecasts
Fig. 6.1 Inventory Planning & Control

The Inventory Process

Suppliers

Customers

Inventory Decisions
Two fundamental decisions in controlling inventory:

1. How much to order

Inventory Storage

Raw
Materials

2. When to order

Finished
Goods

Overall goal is
to minimize
total inventory cost

Fabrication
and
Assembly
Inventory Processing

Work in
Process

Inventory Costs

1
Holding
Cost

Cost of capital
Taxes
Insurance
Spoilage
Theft
Obsolescence
Salaries/wages for warehouse employees
Utilities/building costs for the warehouse
Supplies (e.g., forms, paper) for the
warehouse

2
Order Cost

Developing and sending purchase orders

Processing and inspecting incoming inventory
Bill paying
Inventory inquiries
Utilities, phone bills, etc., for the purchasing
department
Salaries/wages for purchasing department
employees
Supplies (e.g., forms and paper) for the
purchasing department

3
Penalty
Cost

Shortage / Stock-out

Types of Inventories

Inventory Usage Over Time

Raw Materials

Component

Work - in - process

Fig. 6.2 Sawtooth Inventory Curve

Costs as Functions of Order Quantity

Costs as Functions of Order Quantity

Annual
Cost

Inventory Cost versus Order Quantity

Minimum Cost

Carrying (holding)
Cost Curve

Ordering (set-up)
Cost Curve

Q*
Fig. 6.3 Cost as function of order quantity view # 1

Order Quantity

$ Cost

Total Cost Curve

Quantity
Fig. 6.4 Cost as function of order quantity view # 2

EOQ : Basic Assumptions

1

Steps in Finding the Optimum Inventory

Demand is known and constant.

Develop an expression for the ordering cost.

Lead time is known and constant.

Develop and expression for the carrying cost.

Receipt of inventory is instantaneous.

Quantity discounts are not possible

Set the ordering cost equal to the carrying cost.

The only variable costs: set-up or placing an order, and holding or storing inventory
over time.
Stock-outs can be completely avoided if orders are placed at the appropriate time.

Solve this equation for the optimal order quantity, Q*.

Setting the Equations Equal to Solve for

Q*

Developing the EOQ

Annual ordering cost:

Annual demand
Number of units per order
D
Co
Q

Annual holding or carrying cost:

Average Inventory * Carrying Cost Per Year

Ct

dCt
dQ

D
Co
Q

Q
Ch
2

D
C0
Q2

Ch
2

Q2

2D C o
Ch

Q*

2D C o
Ch

Q
Ch
2

Total inventory cost:

Ct

D
Q
Co
Ch
Q
2

EOQ

Per Unit vs. Percentage Carrying Cost

Per Unit Carrying Cost:

Typically, carrying cost, Ch, is stated in

per unit $ cost
per year

Sometimes, an annual Interest rate, I, is cited and Ch

must be calculated

Percentage Carrying Cost:

Denominator
Change

I multiplied by C (unit cost)

IC then replaces Ch

The Reorder Point (ROP) Curve

Inputs and Outputs of the EOQ Model

Output Values

Annual Demand
(D)

Economic Order
Quantity (EOQ)

Ordering Cost
(Co)

Avg. Inventory (Q/2)

Carrying Cost
(Ch)
Lead Time
(L)
Demand Per Day
(d)

EOQ
Models

# of Orders
(D/Q)
Cycle Time
(Q/(D x 360))

ROP = (Demand per day) x (Lead time for a new order, in days)
= dxL
Q*
Inventory Level (Units)

Input Values

Slope = Units/Day = d

ROP
(Units)

Reorder Point
(ROP)
Fig. 6.5 Reorder point curve

Lead Time (Days)

Inventory Control and the Production

Process

Suspension of the
Instantaneous Receipt Assumption

Production Quantity EOQ

Annual Carrying Cost:

Inventory Level

Production Portion of Cycle (t) = Q/p

Maximum
Inventory
Level

Q*
Demand
Portion
of Cycle

Annual Setup or Ordering Cost:

Demand
Portion
of Cycle

Setup Cost:
Time
Ordering Costs:

Fig. 6.6 Production Run Model

Production Quantity EOQ

If production is not the cause of delayed receipts, use the same

model but replace Cs with Co

Brown Manufacturing Example

Annual demand (D) = 10,000 units

Setup cost (Cs) = $100
Carrying cost (Ch) = $0.50 per unit per year
Production rate (p) = 80 units daily
Demand rate (d) = 60 units daily
Refrigeration operational days = 167 days per year

Brown Manufacturing Example continued

How many refrigeration units should Brown produce in
each batch?

Brown Manufacturing Example continued

1. What is Qp*?

i.e., What is Qp*?

How long should the production cycle last ?

i.e., What is Q/p?

Q*p = 4,000 units

Brown Manufacturing Example continued

2. How long should the production cycle last ? What is t
(Q/p)?

Q*p = 4,000 units

p = 80 units per day
t = Q/p = 4,000/80 = 50 days
Production runs will cover 50 days and produce 4,000
units