Chapter # 6

Inventory Management & Control

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Inventories in the Supply Chain

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Inventory Management

Inventories are stocks of goods and materials that are

maintained to satisfy normal demand patterns

Inventory management
Decisions drive other logistics activities
Different functional areas have different inventory objectives
Inventory costs are important to consider
Inventory turnover

9-3

Inventory Management
Inventory management (continued)
Inventory costs are important to consider
Inventory turnover:
cost of goods sold divided by average inventory at cost

cost of goods sold = inventory turnover

average inventory
$200,000 = inventory is sold 4 times per year
$ 50,000
Compare with competitors or benchmarked companies
9-4

Inventory Management

Low inventory turnover

high inventory carrying costs, little (or no) stockout costs

High inventory turnover

low inventory carrying costs, high stockout costs

Managing the tradeoff is important to maintain service

levels

9-5

Types of Inventory:
How Inventory is Used

Psychic stock (stimulates demand)

Stimulate demand by keeping inventory on shelves at Retail

Lot-Size or Cycle or base stock

Normal demand during order cycle, take advantage of quantity
discounts or purchasing efficiencies

Safety or buffer stock

To guard against demand fluctuations

Pipeline or in-transit stock

Inventory at various nodes

Speculative or hedge inventory protects against some

future event, e.g. labor strike
Seasonal demand, projected price increase or shortage
9-6

Inventory-Related Costs

Inventory carrying (holding) costs

Obsolescence (Expiries / new models / technology)

Inventory shrinkage (Damage, Loss or Theft)
Storage costs (Space occupancy)
Handling costs (Labor, receive, store / retrieve)
Insurance costs (Insure inventory)
Taxes
Interest charges
Opportunity cost (Speculative inventory)

Stockouts
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Stockout Situation
Customer Response
The customer says, Ill be back, and this proves to be
so.
2. The customer says, Call me when its in.
3. The customer buys a substitute products that yields a
higher profit for the seller
4. The customer buys a substitute products that yields a
lower profit for the seller
5. The customer places an order for the item that is out of
stock (a back order) and ask to have the item delivered
when it arrives
6. The customer goes to a competitor only for this
purchase
7. The customer goes to a competitor for this and all
future purchases.
1.

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Independent vs. Dependent Demand

Independent demand items are finished goods or other

items sold to someone outside the company. It is influenced
by market conditions. (Cars, Bicycles, Refrigerators, Washing
Machines)

Dependent demand items are materials or component

parts used in the production of another item i.e. finished
product. The dependent demand items could be
(subassemblies, components, spares, etc.)

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Independent vs. Dependent Demand

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Objectives of Inventory
Management

Provide acceptable level of customer service (on-time

delivery).

Allow cost-efficient operations.

To maintain a minimum investment in inventories to

maximize the profitability.

To meet unforeseen future demand due to variation in

forecast figures and actual figures.

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Relevant Inventory Costs

Item Cost

Cost per item plus any other direct costs

associated with getting the item to the plant

Holding
Costs

Capital, storage, and risk cost typically stated

as a % of the unit value,
e.g. 15-25%

Ordering
Cost

Fixed, constant dollar amount incurred for each

order placed

Shortage
Costs

Loss of customer goodwill, back order

handling, and lost sales
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Inventory Management:
Special Concerns

Defining stock-keeping units (SKUs)

Dead inventory
Deals
Substitute items
Complementary items
Informal arrangements outside the distribution
channel
Repair/replacement parts
Reverse logistics
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Order Quantity Strategies

Lot-for-lot

Order exactly what is needed for the next

period

Fixed-order
quantity

Order a predetermined amount each time

an order is placed

Min-max
system

When on-hand inventory falls below a

predetermined minimum level, order
enough to refill up to maximum level

Order n
periods

Order enough to satisfy demand for the

next n periods

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SKU and Inventory Database

Design.
SKU (Stock Keeping Unit) : An individual item in a
specific inventory location.
Inventory Database Design.
Item identification.
Item description.
Stock location.
On-hand balances at each stock location.
On-order information by due date.
Reorder and safety stock information.
Financial information.
Usage.
Classification information.
Sourcing.
Lead-time.

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EOQ Mathematical Model for

Determining Order Quantity

Economic Order Quantity (EOQ or Q

System)
An optimizing method used for determining order
quantity and reorder points
Part of continuous review system which tracks onhand inventory each time a withdrawal is made

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Comparison of Q & P System

Continuous Review System (Q)

A system designed to track the remaining inventory of
an item each time a withdrawal is made, to determine
whether it is a time to replenish or not.

Periodic Review System (P)

A system in which an items inventory position is
reviewed periodically rather than continuously.

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Economic Order Quantity

EOQ Assumptions:
Demand is known & constant no safety stock is required
Lead time is known & constant
No quantity discounts are
available

Ordering (or setup) costs are

constant
All demand is satisfied (no
shortages)

The order quantity arrives in a

single shipment

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When to Order

Fixed order quantity system

Time fluctuate, but size constant

Fixed order interval system

Time constant, but size fluctuate

Reorder point (ROP)

ROP = DD x RC (under certainty)
ROP = (DD x RC) + SS (under uncertainty)
Where,
DD = daily demand
RC = length of replenishment cycle
SS = safety stock
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How Much to Reorder

Economic order quantity (EOQ) in dollars

EOQ = 2AB/C

Where
EOQ
A
B
C

= the most economic order size, in dollars

= annual usage, in dollars
= administrative costs per order of placing the
order
= carrying costs of the inventory (%)

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How Much to Reorder

Economic order quantity (EOQ) in dollars

EOQ = 2AB/C

EOQ
EOQ
EOQ

=
=

2 x 1000 x 25 /.20
250,000
$500 Order Size

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How Much to Reorder

Economic order quantity (EOQ) in units

EOQ = 2DB/IC

Where,
EOQ
= the most economic order size, in units
A or D = annual demand, in units
B
= administrative costs per order of placing the
order
C
= carrying costs of the inventory (%)
I
= dollar value of the inventory, per unit

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How Much to Reorder

Economic order quantity (EOQ) in units

EOQ = 2DB/IC

EOQ
EOQ
EOQ

=
=
=

2 x 200 x 25 / .20x 5
10,000 / 1
100 Units

9-23

Fig 9-2: Determining EOQ by

Use of a Graph

9-24

EOQ: Total Cost Equation

TC EOQ

D Q
S H
Q 2

Where
TC total annual cost
D annual demand
Q quantity t o be ordered
H annual holding cost
S ordering or setup cost
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EOQ Total Costs

Total annual costs = annual ordering costs + annual holding costs

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The EOQ Formula

Minimize the TC by ordering the EOQ:

2 DS
EOQ
H
Where,
D = Annual Demand
S = Ordering or Setup Cost
H = Annual holding Cost

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ABC Inventory Classification

ABC classification is a method for determining level of
control and frequency of review of inventory items
A Pareto analysis can be done to segment items into
value categories depending on annual dollar volume
A Items typically 20% of the items accounting for 80%
of the inventory value-use Q system
B Items typically an additional 30% of the items
accounting for 15% of the inventory value-use Q or P
C Items Typically the remaining 50% of the items
accounting for only 5% of the inventory value-use P

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80/20 Rule (Pareto Analysis)

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ABC Classification System

Classifying inventory according to some measure of importance and allocating
control efforts accordingly.

A - very important
B - mod. important
C - least important

High

Annual
$ value
of items

B
C

Low
Low

High
Percentage of Items

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Inventory Record Accuracy

Inaccurate inventory records can cause:
Lost sales
Disrupted operations
Poor customer service
Lower productivity
Planning errors and expediting

Two methods are available for checking record

accuracy
Periodic counting-physical inventory
Cycle counting-daily counting of pre-specified items provides
the following advantages:
Timely detection and correction of inaccurate records
Elimination of lost production time due to unexpected stock outs
Structured approach using employees trained in cycle counting

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Inventory Counting Systems

Periodic System
Physical count of items made at periodic intervals
Perpetual Inventory System

System that keeps track

of removals from inventory
continuously, thus
monitoring
current levels of
each item

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Inventory Counting Systems

(Contd)
Two-Bin System - Two containers of inventory; reorder when the first is
empty

Universal Bar Code - Bar code

printed on a label that has
information about the item
to which it is attached

214800
232087768

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Cycle Counting
A physical count of items in inventory
Cycle counting management
How much accuracy is needed?
When should cycle counting be performed?
Who should do it?

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The Inventory Cycle

Q

Usage
rate

Quantity
on hand

Profile of Inventory Level Over Time

Reorder
point

Receive
order

Place Receive Place Receive

order order
order order

Time

Lead time
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Quantity

Safety Stock

Maximum probable demand

during lead time
Expected demand
during lead time

ROP
Safety stock
Safety stock reduces risk of
stockout during lead time

Time

LT
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Fixed-Order-Interval Model

Orders are placed at fixed time intervals

Order quantity for next interval?
Suppliers might encourage fixed intervals
May require only periodic checks of inventory
levels
Risk of stockout
Fill rate the percentage of demand filled by the
stock on hand

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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

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

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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

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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

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Operations Strategy

Too much inventory

Tends to hide problems
Easier to live with problems than to eliminate them
Costly to maintain

Wise strategy
Reduce lot sizes
Reduce safety stock

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Sources: Supply Chain Logistics Management Cooper et al

APICS CSCP 13th Edition
Supply Chain Council
By: Yahya Rasheed Surya

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