Inventory Control

Model

Inventory as an Important Asset
Inventory can be the most expensive and
the most important asset for an
organization
Other Assets
60%
Inventory
40%
Inventory as a
percentage of total assets
The Inventory Process
Suppliers Customers
Finished
Goods
Raw
Materials
Work in
Process
Fabrication
and
Assembly
Inventory Storage
Inventory Processing
Importance of Inventory Control
Five Functions of Inventory
Decoupling
Storing resources
Adapting to irregular supply and demand
Enabling the company to take advantage
of quantity discounts
Avoiding stockouts and shortages
Inventory Decisions
How much to order
When to order

wish to minimize total inventory cost
Inventory Costs
Cost of the items
Cost of ordering
Cost of carrying, or holding inventory
Cost of safety stock
Cost of stockouts
Ordering Costs
Developing and sending purchase orders
Processing and inspecting incoming inventory
Bill paying
Inventory inquiries
Utilities, phone bills, etc., - purchasing
department.
Salaries/wages - purchasing department
employees
Supplies (e.g., forms and paper) - purchasing
department
Carrying Costs
Cost of capital
Taxes
Insurance
Spoilage
Theft
Obsolescence
Salaries/wages - warehouse employees
Utilities/building costs - warehouse
Supplies (e.g., forms, paper) - warehouse
Inventory Usage Over Time

Costs as Functions of Order
Quantity
Annual
Cost
Order Quantity Q
*
Total Cost Curve
Carrying (holding)
Cost Curve
Ordering (set-
up)
Cost Curve
Minimum
Cost
Costs as Functions of Order
Quantity
Order Cost
Minimum Cost
Inventory Cost versus Order Quantity
Quantity
$

C
o
s
t

Optimal Quantity
Steps in Finding the Optimum
Inventory
Develop an expression for the ordering
cost.
Develop and expression for the
carrying cost.
Set the ordering cost equal to the
carrying cost.
Solve this equation for the optimum
desired.
EOQ : Basic Assumptions
Demand is known and constant
Lead time is known and constant
Receipt of inventory is instantaneous
Quantity discounts are not possible
The only variable costs are the cost of setting
up or placing an order, and the cost of holding
or storing inventory over time
Stockouts can be completely avoided if orders
are placed at the appropriate time
Annual ordering cost:



Annual holding or carrying cost:


Material Cost: DC
Total inventory cost:
Developing the EOQ
o
C
Q
D
=
=
order per units of Number
demand Annual
h
C
2
Q

Year Per Cost Carrying * Inventory Average
=
=
h o t
C
2
Q
C
Q
D
TC + + = DC
EOQ
h
C
2DC
*
Q
=
Per Unit Carrying Cost:
Percentage Carrying Cost:
IP
DC
Q
*
0
2
=
0
Inputs and Outputs of the
EOQ Model
EOQ
Models
Input Values Output Values
Annual Demand
(D)
Ordering Cost
(C
o
)
Carrying Cost
(C
h
)
Lead Time
(L)
Demand Per Day
(d)
Economic
Order
Quantity
(EOQ)
Reorder
Point
(ROP)
The Reorder Point (ROP) Curve
ROP = (Demand per day) x (Lead time for a new order, in days)
= d x L
I
n
v
e
n
t
o
r
y

L
e
v
e
l

(
U
n
i
t
s
)

Q*
ROP
(Units)
Slope = Units/Day = d
Lead Time (Days)
L
Inventory Control and the
Production Process
I
n
v
e
n
t
o
r
y

L
e
v
e
l

Demand
Portion
of Cycle
Demand
Portion
of Cycle
Maximum
Inventory
Level
Time
Production
Portion of
Cycle
Production Quantity EOQ
Annual Carrying Cost:



Annual Ordering Cost:

~ Setup Cost:



~ Ordering Costs:

h
C
p
d Q
) 1 (
2

s
C
Q
D
o
C
Q
D
Production Quantity EOQ
|
|
.
|

\
|

=
p
d
1 C
2DC
Q
h
o
*
p
Quantity Discount Models
Quantity Discount Steps
1. Calculate Q for each discount
2. Adjust Q upward if quantity is too low
for discount
3. Compute total cost for each discount
4. Select Q with the the lowest total cost
The Use of Safety Stock
I
n
v
e
n
t
o
r
y

o
n


H
a
n
d

I
n
v
e
n
t
o
r
y

o
n


H
a
n
d

Stockout
Time
Stockout
is avoided
Time
Safety Stock
The Use of Safety Stock
Known stockout costs:
Given probability of demand, find total
cost for each safety stock alternative
Unknown stockout costs:
Set service level; use normal distribution
Service Level versus Carrying
Costs