Inventory Management

What is Inventory?
▪ Stock of Idle resources
Raw materials
▪ Important in managing inventory
materials in
manufacturing Bought-out-parts
inventory
▪ Inventory turnover ratio Inventory
▪ COGS/ Avg. Inventory Types
Work-in-progress
▪ Inventory turn 10 vs. 20 inventory
▪ Interpret the importance?
Finished good
inventory
Uses of Inventory
Satisfy Expected Customer demand

Manage the period of high seasonal demand

Protect against price increase

Use of Inventory
Take advantage of quantity discount

Avoid stock-out

Manage lead-times

Minimize total cost by EOQ

Inventory- Certain facts

• Inventory can be visualized as stacks of money sitting on

forklifts, on shelves, and in trucks and planes while in
transit
• For many businesses, inventory is the largest asset on the
balance sheet at any given time
• Inventory can be difficult to convert back into cash
• Good to get your inventory down as far as possible
average inventory cost in the US – 30-35% of its value
• Inventory management type depends on dependent or
independent demand
Demand Types
Independent demand – the
demands for various items are not
related to each other
• a workstation may produce many parts that
are unrelated but meet some external
demand requirement
• Engine of a Toyota car & Ford Car

Dependent demand – the need for

any one item is a direct result of
the need for some other item
• Usually a higher-level item of which it is
part
• Car and Tires
Inventory management systems - Types
Inventory
Management Systems

Independent Demand Dependent Demand

For Retailers For Manufacturers

Material Just-in-Time
Requirement system (JIT)
Planning System
(MRP)
ABC EOQ For
Classification Hybrid MRP-JIT
manufacturers
of items system

Category A Category B Category C

Basic EOQ Periodic

Model Review
System
The Retailer’s Model of Inventory Management
(Economic Order Quantity, Basic EOQ Model)

Inventory
decreases at a
constant rate
In Level of Maximum
v
Inventory
e
n
t
o
r
y

L Q
e Ist IInd IIIrd IVth
v Inventory Inventory Inventory Inventory
e Cycle Cycle Cycle Cycle
l

0
t t t
Time
Ist order is placed & IInd order is placed IIIrd order is placed
immediately the & immediately the & immediately the
goods are received goods are received goods are received
Fixed-Order Quantity Models – Assumptions
• Demand - constant and uniform across
period.
• Lead time - constant.
• Price per unit - constant.
• Inventory holding/ carrying cost - based on
average inventory.
• Ordering/ setup costs -constant.
• All demands for the product will be satisfied.
Fixed-Order Quantity Model
Always order Q units when
inventory reaches reorder
point (R). Inventory is consumed at a
constant rate, with a new
order placed when the
reorder point (R) is reached
once again.

Inventory arrives after

lead time (L). Inventory is
raised to maximum level
(Q).
Economic Order Quantity (EOQ)
The optimal order
quantity (Qopt)
Example Problem
• Annual demand (D) = 1,000 units
• Ordering cost (S) = $5 per order
• Holding cost (H) = $1.25 /unit/year
• Lead time (L) = 5 days
• Cost per unit (C) = $12.50
• EOQ ?
• Total Cost ?
• Re-order Level ?
Example Problem
Average daily demand
• Annual demand (D) = 1,000 units
𝑑ҧ = 1000 = 2.74 units
• Ordering cost (S) = $5 per order 365

• Holding cost (H) = $1.25 /unit/year

• Lead time (L) = 5 days
• Cost per unit (C) = $12.50
• EOQ ?
• Total Cost ?
• Re-order Level ?
Safety Stock
Safety stock – refers to the
amount of inventory carried Inventory
in addition to expected decreases at a
demand. I
constant rate
n Level of Maximum Inventory
• Safety stock can be determined based v
on many different criteria. e
n
t
o
A common approach is to r
simply keep a certain y
Q
R E O R D E R L E V E
number of weeks of supply. L
L
e 500
v units
e
l 0
Lead IInd IIIrd
Probabilistic Approach time order is order is Time
Ist order is (10 The goods are
placed The goods are
placed The goods
placed received
days) received are received
 Fixed-Order Quantity Model with
Safety Stock
Demand is variable, but
follows a known
distribution/

After the reorder is placed, demand

during the lead time may be higher
than expected, consuming some (or
all) of the safety stock/

Avg. Inv. = ?
Example Problem

• Average daily demand

(𝑑)ҧ = 60
• Annual demand (D) = 60(365) =
21,900
• Standard deviation of demand
during lead time (σD) = 7
• Ordering cost (S) = $10 per order
• Holding cost (H) = $0.50 per unit
per year
• Lead time (L) = 6 days
Example Problem
• Average daily demand
(𝑑)ҧ = 60
• Annual demand (D) = 60(365) =
21,900
• Standard deviation of demand
during lead time (σD) = 7
• Ordering cost (S) = $10 per order
• Holding cost (H) = $0.50 per unit
per year
• Lead time (L) = 6 days
For 95%
probability,
z = 1.64.
Policy – place a new
order for 936 units
whenever stock falls
to 388 units on hand.
This results in a 95%
probability of not
stocking out during
the lead time.
Fixed-Time Period Model

• q = quantity to be ordered
• T = number of days between reviews
• L = lead time in days
• 𝑑ҧ = forecast average daily demand
• Z = number of standard deviations required for specific service level
• σT+L = standard deviation of demand during the review and lead time
• I = current inventory level (including items on order)

𝑞 = 𝑑ҧ 𝑇 + 𝐿 + 𝑧𝜎𝑇+𝐿 - I
Fixed-Time Period Model (contd.)

Time periods
are equal, but Reorder quantity varies,
ending depending upon ending
inventory inventory level. Beginning
varies. inventory is always the
same.
Example problem (fixed-time period)
• Daily demand (𝑑)ҧ of 10 units
• Daily standard deviation (𝜎𝐷 )
of 3 units
• Review period (T) of 30 days
• Lead time (L) of 14 days
• 98 percent of demand
should be met from items in
stock
• 150 units in inventory (I)
Inventory Models –A Comparison
• Fixed-Order Quantity
• Inventory remaining must be
continually monitored
• Has a smaller average
inventory
• Favors more expensive items
• Requires more time to
maintain
• Is more expensive to
implement
• Fixed-Time Period
• Monitoring takes place only
at the end of the review
period
• Has a larger average
inventory
• Favors less expensive items
• Requires less time to
maintain
• Is less expensive to
implement
Single Time Period Inventory Model
• Newsvendor Model
• Buy newspaper – Rs.2.0 per piece
• Sell newspaper – Rs.5.0 per piece
• Probability of stock out
𝑃 ≤ 𝐶 𝐶+𝐶𝑢
Co = cost per over stocking one unit
𝑢
Cu = cost per under stocking one unit
𝑜
Problem Example- Single Period model
• A company manufactures T shirts for Baseball • Service Rate ?
game at $8 per piece. During the event the 𝐶𝑢 12
company sell the T shirts for $20 per piece. = 4+12 = 0.75
𝐶𝑜+𝐶𝑢
After the game ends it can sell each shirt for
$4. The estimated demand for the upcoming • How many T shirts should
game is given below. the company produce for
Demand Probability the upcoming game ?
300 0.05
400 0.1
500 0.4
600 0.3
700 0.1
800 0.05