Master of Science in Automotive

Engineering

Plants and Manufacturing

Systems B

10. Inventory Management

Instructor:
Anna Corinna Cagliano
anna.cagliano@polito.it

A.Y. 2018-2019
 Outline
• Inventory Costs
• Inventory Management Models
• Basics of Material Requirement Planning 
(MRP)

1
 Outline
Inventory Costs
• Inventory Management Models
• Basics of Material Requirement Planning 
(MRP)

2
 Inventory Costs
• Procurement cost
– Purchasing cost (human resources, etc.)
– Transportation cost
• Storage cost (inventory carrying)
– Capital interest
– Material handling and store HR
– Investment amortizations (building facility, MHE 
equipment, etc.)
– Maintenance
– Shrinkage
3
 Cumulative percent economic value
ABC Classification

4
 ABC Classification
• A items
– Few items (10‐15%) account for the greatest portion 
of inventory value (70 – 80%)
– A items ask for rigorous inventory management
• C items
– Large number of items (65%‐75%) have little value 
on total (5 – 10%)
– Less rigorous policy
• B items
– Might be associated with either A or C groups as far 
as inventory management is concerned. 5
 Outline
Inventory Costs
Inventory Management Models
Basics of Material Requirement Planning 
(MRP)

6
 Why to Hold Inventory ?
• To reduce demand uncertainty
– Safety stock (stock of flexibility)
– Seasonal stock (stock of capacity)
• To separate different operations phases
– way to allow sourcing, making and delivery to 
work at different rates
– allows the different phases to be “asynchronous” 
and it absorbs upstream variations. 

7
 What Should be Decided
• Replenishment policy, i.e. how much and when to 
order
– Impacts on:
• Stock carrying costs
• Setup/order emission costs
• Stock out / downstream service costs
– Constraints:
• Production capacity and flexibility of upstream production level
• Physical space limit of warehouses.
• Control level, i.e. the detail and the frequency of 
control of the stock level of each item
– Impacts on:
• Cost of control 
– Constraints:
• Availability of resources to perform the controls (people,  8
computers, ...).
 Inventory Management –
Look Back Approach
• A target inventory level is set without looking 
ahead at the demand.
• The time and the quantity to order are 
decided only based on the current level of 
stock.
• This inventory management approach is 
basically to simply react to demand.

9
 Inventory Management –
Look Back Approach
• The look back approach should be used when 
it is hard to look ahead the demand:
– Demand is constant in time, or:
– It is impossible to foresee demand with enough 
accuracy, or:
– The upstream phase is highly flexible.

10
 Inventory Management –
Look Back Objectives
• The main objectives of the look back approach 
are to minimize costs and to maximize the 
service level for the downstream phases. 
• These objectives can be expressed as the 
minimization of a total cost function composed 
by: 
– Stock carrying costs
– Execution costs (order / setup)
– Costs of control
– Costs of poor service level at downstream phases 
(stock out costs). 11
 Inventory Management –
Look Back. Types of Models
• According to the type of control
– Continuous control
– Discrete control:  time intervals  
• According to the order placing time
– Fixed interval
– Variable interval
• According to the ordered quantity 
– Fixed quantity
– Variable quantity
• According to the type of re‐order
– Independent entries: each item is re‐ordered 
independently from the others
– Joint entries: orders for the different items are 
coordinated. 12
 Economic Order Quantity (EOQ) 
Model
• Characteristics
– Variable period of order placing
– Fixed quantity ordered
– Continuous control
– Independent entries reorder
• Objectives
– Identify the quantity Q [units] to re‐order that 
minimizes the total cost, as summation of
• ordering cost
• purchasing/production cost
• stock carrying cost
– and the conditions that determine the orders issuing
13
 The EOQ Model
Inventory Assume infinite stock
level replenishment rate

Economic
Order Quantity
Re-order Q
Point
R
INVENTORY
Safety Stock
(SS)
Time

Material
arrived
Order Lead Time
placed L
Re-order Point = demand in the LT +
Safety Stock = R = d x L + SS 14
 EOQ – Notation & Assumptions

– Total demand over a total # of periods Dtot [units]

– Demand per period  D [units/period]
– Constant setup/ordering unit cost            S [€]
– Unit selling price/production cost SP [€/unit]
– Unit cost of holding inventory (carrying unit cost) H [€/(unit*period)]
– Order lead time            L [days]
– Average daily consumption                     d = D / days
– Infinite stock replenishment rate  r [unit/day]
– Infinite capacity of warehouse
– Shipping costs included in the ordering cost
– In one year we buy exactly the total quantity of products demanded 
by customers

15
 EOQ – Steady Demand
In this example
Safety Stock = 0 200

150

Inventory  100 Q (EOQ)

level
50

0
1 2 3 4
Time

Average stock =  (Q / 2) + Safety Stock

Number of orders issued =  annual demand / Q

16
 EOQ Cost Components
• Cost of stock carrying
q
Cm  H  *# periods
2
• Cost of order placement Cs (or setup cost)
Dtot
Cs  S 
q
• Cost of purchasing Ca (or cost of production)
Ca  SP * Dtot
17
 EOQ ‐ Equation
q D tot
Total cost  H  *# periods  S   SP * D tot
2 q
q D
Total cost per period  H   S   SP * D
2 q
d q D
( H   S   SP * D )  0
dq 2 q
H SD SD SD tot
 2 0Q 2 or Q  2
2 q H H# periods
18
 EOQ – Production Lead Time
• If the time needed to produce (lead time) is long 
(some days or weeks) the production flows into 
warehouse not all at once. 
• In the meantime demand is consuming the stock. 
Inventory level profile
200
2xDxS
Inv. 150 EOQ’ =
level
100
H x (1-d/r)
50 where d = consumption rate
r = production rate = 
0
1 2
time 3 4 stock replenishment rate
19
 Reorder Point Definition
INVENTORY LEVEL

REORDER POINT
SAFETY STOCK

TIME
REORDERS PRODUCTION OR PURCHASING LT

Reorder point = demand during LT + Safety Stock =

= R = d x L + Safety Stock 20
 Safety Stock
• Safety stocks are used to prevent from stock‐
out
• The level of safety stocks depends on:
– Variation of downstream consumption (demand) 
with respect to the forecast
– Desired service level (to what extent stock‐outs 
should be avoided during the order lead time) 
– Order lead time duration
– Order lead time reliability
21
 Safety Stock
R
Inventory 
level
a

b d

time
Normal distribution of the 
demand and the order 
L1
lead time L2
Lead‐time
L
22
 Safety Stock (Probabilistic D, 
Deterministic L)
• Data:
– R reorder point in units 
– d  average daily demand 
– L lead time expressed in days (deterministic)
– k function of the expected service level  
(probability of not facing stockouts during the lead   
time) 
– L std‐dev of demand during lead time

SS  k   L
23
 Standard Deviation of Demand 
During the Lead Time
• Given the standard deviation of daily demand d, 
the standard deviation during lead time L can be 
calculated as

L  L  d
24
 Calculating k
Probability no stockout during order lead time

Probability stockout during order lead time

k Z
Probability probabilità
Probability Probability probabilità
Probability
kz F(z)
no stockout shortage
stockout kz F(z)
no stockout shortage
stockout

0,00 0,5000 50,00% 2,00 0,9772 2,28%

0,25 0,5987 40,13% 2,25 0,9878 1,22%
0,50 0,6915 30,85% 2,50 0,9938 0,62%
0,75 0,7734 22,66% 2,75 0,9970 0,30%
1,00 0,8413 15,87% 3,00 0,9987 0,13%
1,25 0,8944 10,56% 3,25 0,9994 0,06%
1,50 0,9332 6,68% 3,50 0,9998 0,02%
1,75 0,9599 4,01% 3,75 0,9999 0,01% 25
 Safety Stock (Probabilistic D, 
Probabilistic L)

2 2 2
SS  k *  d L   L
d

• k   function of service level Standard deviation
• d standard dev. of demand of demand during 
• L   average value of lead time the order lead time
• L  standard dev. of lead time
• d   average value of demand 26
 Fixed‐Time Period Model
• Characteristics
– Discontinuous control 
– Fixed‐time between reviews (T)
– Variable ordered quantity
– Independent or combined entries reorder
• Objective
– Identifying the quantity to re‐order at each review 
that allows the availability of each product to achieve 
a pre‐defined service level, called objective level (OL)
• Hypotheses
– The same as EOQ
– Probabilistic demand, probabilistic order lead time 27
 Fixed‐Time Period Model
INVENTORY LEVEL L L
Material Material
arrives arrives
OL

Order Order

INVENTORY
SS

TIME

T T
28
 Fixed‐Time Period Model
• At fixed time intervals of T days inventory level is 
reviewed and availability is calculated. Availability 
is: 
– I = current inventory level + Orders placed but not yet 
arrived
• An order q is issued equal to the difference 
between objective level OL and availability:
– q = OL  ‐ I [units]
– The objective level OL is defined in order to cover the 
demand in the time window T+L (where L is supplier’s 
OL  (T  L)  d  SS
LT):                                                   [units]
29
 Fixed‐Time Period Model
• Safety stock is calculated in the same way as in 
the EOQ model. However, the component 
derived from demand variability must prevent 
from stockouts that can happen during the 
time window (T+L). 

2 2 2
SS  k   T  L  k  (L  T) d  d  L

T+L  = Standard deviation of the demand during the 
time period (T+L)
30
Fixed Q vs. Fixed T Models
fixed quantity fixed time
‐ easy joint (combined entries) 
‐ low average stock level 
re‐orders planning
(continuous control)
‐ easy control of availiability 
‐ Minimization of relevant costs 
level (periodic control)
(OPTIMIZATION)

‐ difficult joint (combined 
entries) re‐orders planning ‐ higher average stock level 
‐ many replenishment orders  (periodic control)
(also to the same supplier)
‐ “heavy” control of availiability 
level (continuous control)

31
 Outline
Inventory Costs
Inventory Management Models
Basics of Material Requirement Planning 
(MRP)

32
 Material Requirement Planning
• Inventory Management. Look ahead criterion.
• Based on the production plan for a given
finished product (Master Production Schedule ‐
MPS), calculates for each part in the BOM of
the product:
– The quantity that needs to be purchased/produced.
– When the associated purchasing/production order
needs to be issued.
33
 Material Requirement Planning
• The following quantities are also taken into
account:
– The available inventory level for each part
– The already scheduled deliveries for each part
(units that have been ordered but not yet received).
• The MRP procedure we will see is run over a
time horizon (planning time horizon)
constituted by a number of time periods (e.g.
weeks).
• The MRP procedure is run before the planning
time horizon starts. 34
 Notation & Assumptions
• Demand: the quantity of a part that is needed at the
end of each period of the planning time horizon.
• Scheduled Deliveries: units that are scheduled to be
received at the beginning of each time period.
• Initial Inventory on Hand: the inventory level of one
part at the beginning of the planning time horizon.
• Inventory on Hand: the available inventory at the end
of each time period of the planning time horizon.
• Planned Order: how many units of a given part need to
be ordered.
• Planned Order Released: when the associated order is
issued (orders are issued at the end of a time period).
35
 MRP Procedure
• Sum
– the time period requirements of a part in order to 
produce all those finished products/sub‐assemblies 
having that part in their BOMs.
• Split
– the total part requirement per time period 
obtained above according to chosen lot‐sizing 
policy.
• Shift in Time (backward)
– the lot‐sized requirements according to the order 
lead time for each part. 36
 MRP Procedure
• It 's easier to do than to say….

37
 Example 1
 Master Production Schedule for P1:
 50 units at the end of week 5

 60 units at the end of week 7
P1  Initial inventory on hand:
 P1: 10 units 

 P2: 20 units 
P2  Scheduled deliveries:  20 units of P2 at the 
beginning of week 3 
 Order Lead Time & Lot‐sizing policy:
P3 (2)  P1: 1 week. The order can have any size. 

 P2: 2 weeks. The order can have any size. 

 P3: 3 weeks. Order size: 150 units or multiples.38
 MRP Record for P1

Initial
P1; LT=1 week; Lot-
Inventory
sizing: any order size
on Hand
Time period [week] 1 2 3 4 5 6 7
Demand 50 60
Scheduled Deliveries
Inventory on Hand 10 10 10 10 10 0 0 0
Planned Order 40 60
Planned Order Released 40 60

39
 MRP Record for P2

Initial
P2; LT=2 weeks; Lot-
Inventory
sizing: any order size
on Hand
Time period [week] 1 2 3 4 5 6 7
Demand 40 60
Scheduled Deliveries 20
Inventory on Hand 20 20 20 40 0 0 0 0
Planned Order 60
Planned Order Released 60

40
 MRP Record for P3

P3; LT=3 weeks; Lot- Initial

sizing: 150 units or Inventory
multiples on Hand
Time period [week] 1 2 3 4 5 6 7
Demand 120
Scheduled Deliveries
Inventory on Hand 0 0 0 0 30 30 30 30
Planned Order 150
Planned Order Released 150

41
 MRP Record for P3
What would happen if the order lead time for P3 
was 4 weeks?
P3; LT=4 weeks; Lot- Initial
sizing: 150 units or Inventory
multiples on Hand
Time period [week] 1 2 3 4 5 6 7
Demand 120
Scheduled Deliveries
Inventory on Hand 0 0 0 0 30 30 30 30
Planned Order 150
Planned Order Released 150

I would need to place the order before the planning 
time horizon starts (not possible!!) 42
 MRP Record for P3
The delivery of the 120 units of P3 is delayed of 1 
week
P3; LT=4 weeks; Lot- Initial
sizing: 150 units or Inventory
multiples on Hand
Time period [week] 1 2 3 4 5 6 7
Demand 120
Scheduled Deliveries
Inventory on Hand 0 0 0 0 0 30 30 30
Planned Order 150
Planned Order Released 150

The production of P2 and P1 will be delayed as well
43
 Example 2
MASTER PRODUCTION SCHEDULE
Time period [week] 1 2 3 4 5 6 7 8
Wheelbarrow Demand 40 60 60 50

Note: the container is not 
considered in the BOM for 
this exercise

Order Initial
Lot-sizing Scheduled
Part Lead Inventory
[units/order] Deliveries
Time on Hand
Handles 300 2 weeks 100 300 in week 2
Wheel sub-
200 3 weeks 220
assembly (*)
Wheel 400 1 week 50
(*) in week 5 90 wheel sub-assemblies are also required to produce
44
another product
 Example 2
HANDLES Time period [week] IIH 1 2 3 4 5 6 7 8
LT = 2 weeks Demand 80 120 120 100
Scheduled Deliveries 300
Lot-sizing = 300
Inventory on Hand 100 20 320 320 200 200 80 80 280
units/order
Planned Order 300
Planned Order Released 300

WHEEL SUB-ASS Time period [week] IIH 1 2 3 4 5 6 7 8

LT = 3 weeks Demand 40 60 90 60 50
Scheduled Deliveries
Lot-sizing = 200
Inventory on Hand 220 180 180 180 120 30 170 170 120
units/order
Planned Order 200
Planned Order Released 200

WHEEL Time period [week] IIH 1 2 3 4 5 6 7 8

LT = 1 week Demand 200
Scheduled Deliveries
Lot-sizing = 400
Inventory on Hand 50 50 50 250 250 250 250 250 250
units/order
Planned Order 400
45
Planned Order Released 400
 MRP Limitations
• The MRP procedure assumes infinite
production capacity.
• The order lead times are assumed pre‐defined
and fixed. They do not depend on the
workload.
• The MRP procedure requires a large amount
of data, a careful control, and a timely update
of information.

46