Inventory Control

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 Inventory Control
Inventory System Defined
Inventory Costs
Independent vs. Dependent Demand
Basic Fixed-Order Quantity Models
Basic Fixed-Time Period Model- we will omit.
Economic Production Quantity Model- we will omit.
Single Time Period Model- we will omit.
Quantity Discounts-also known as price break models.

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 Inventory System
Defined
Inventory
raw materials, finished products, component
parts, supplies, and work-in-process.

An inventory system is the set of policies

and controls that monitor levels of inventory
and determines what levels should be
maintained, when stock should be
replenished, and how large orders should be.

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 Purposes of Inventory
1. To maintain independence of operations.
2. To meet variation in product demand.
3. To allow flexibility in production scheduling.
4. To provide a safeguard for variation in raw
material delivery time.
5. To take advantage of economic purchase-
order size.

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 Inventory Costs
Holding (or carrying) costs.
Costs for storage, handling, insurance, etc.
Setup (or production change) costs.
Costs for arranging specific equipment setups,
etc.
Ordering costs.
Costs of someone placing an order, etc.
Shortage costs.
Costs of canceling an order, etc.

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Independent vs. Dependent Demand

Independent Demand (Demand not related to other

items or the final end-product)

Dependent
Demand
(Derived demand
items for
component
parts,
subassemblies,
raw materials,
etc.)

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Independent Demand

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Classifying Inventory Models
Fixed-Order Quantity Models
 Event triggered (Example: running out of
stock)

 The sale of an item reduces the inventory

position to the re order point.

Fixed-Time Period Models

Time triggered (Example: Monthly sales call
by sales representative)

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 Fixed-Order Quantity Models:
Model Assumptions (Part 1)

Demand for the product is constant and

uniform throughout the period.

Lead time (time from ordering to receipt)

is constant.

Price per unit of product is constant.

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 Fixed-Order Quantity Models:
Model Assumptions (Part 2)

Inventory holding cost is based on

average inventory.

Ordering or setup costs are constant.

All demands for the product will be

satisfied. (No back orders are allowed.)

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 Basic Fixed-Order Quantity Model and
Reorder Point Behavior

Number
of units
on hand Q Q Q

R
L L

Time
R = Reorder point
Q = Economic order quantity
L = Lead time

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 Cost Minimization Goal

Total Cost
C
O
S
T Holding
Costs
Annual Cost of
Items (DC)

Ordering Costs

QOPT
Order Quantity (Q)
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 Basic Fixed-Order Quantity (EOQ)
Model Formula
Annual Annual Annual
Total Annual Cost = Purchase + Ordering + Holding
Cost Cost Cost

TC = Total annual cost

D = Demand
D Q C = Cost per unit
TC = DC + S + H Q = Order quantity
Q 2 S = Cost of placing an order
or setup cost
R = Reorder point
L = Lead time
H = Annual holding and storage
cost per unit of inventory

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 Deriving the EOQ
2DS 2(Annual Demand)(Order or Setup Cost)
QOPT = =
H Annual Holding Cost

_
Reorder p oint, R = d L
_
d = average daily demand (constant)
L = Lead time (constant)

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 EOQ Example Problem Data
Given the information below, what are the EOQ and
reorder point?

Annual Demand = 1,000 units

Days per year considered in average daily demand = 365
Cost to place an order = $10
Holding cost per unit per year = $2.50
Lead time = 7 days
Cost per unit = $15

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 EOQ Example Solution

2DS 2(1,000 )( 10)

Q OPT = = = 89.443 un its or 90 units
H 2.50

1,000 unit s / year

d = = 2.74 unit s / day
365 days / year
_
Reorder p oint, R = d L = 2.74units / day (7days ) = 19.18 or 20 units

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Figure 12.12
Quantity Safety Stock

Maximum probable demand

during lead time

Expected demand
during lead time

ROP

Safety stock reduces risk of Safety stock

stockout during lead time LT Time

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Figure 12.13
Reorder Point
The ROP based on a normal
Distribution of lead time demand

Service level
Risk of
a stockout
Probability of
no stockout

ROP Quantity
Expected
demand Safety
stock
0 z z-scale

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 Special Purpose Model: Price-Break Model
Formula

Based on the same assumptions as the EOQ model,

the price-break model has a similar Qopt formula:

2DS 2(Annual Demand)(Order or Setup Cost)

Q OPT = =
iC Annual Holding Cost

i = annual percentage of unit cost attributed to carrying

inventory
C = cost per unit

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Price-Break Example Problem Data
(Part 1)

Order Quantity(units) Price/unit($)

0 to 2,499 $1.20
2,500 to 3,999 1.00
4,000 or more .98

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 Price-Break Example Solution (Part 2)
First, start with the lowest price per unit.
Annual Demand (D)= 10,000 units Carrying cost % of total cost (i)= 2%
Cost to place an order (S)= $4 Cost per unit (C) = $1.20, $1.00, $0.98

Next, determine if the computed Qopt values are feasible or not.

Interval from 4000 & more, the 2DS 2(10,000)( 4)

Qopt value is not feasible.
Q OPT = = = 2,020 units
iC 0.02(0.98)
Interval from 2500-3999, the 2DS 2(10,000)( 4)
Qopt value is not feasible. Q OPT = = = 2,000 units
iC 0.02(1.00)

Interval from 0 to 2499, the 2DS 2(10,000)( 4)

Q OPT = = = 1,826 units
Qopt value is feasible. iC 0.02(1.20)

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 Price-Break Example Solution (Part 3)
Next, Compare total cost for the feasible root Q and price break
Q values.

D Q
TC = DC + S+ iC
Q 2

TC(1826)=(10000*1.20)+(10000/1826)*4+(1826/2)(0.02*1.20)
= $12,043.82

TC(2500) = $10,041

TC(4000) = $9,949.20

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 Price-Break Example

Since the feasible solution occurred in the first price-break,

it means that all the other true Qopt values occur at the
beginnings of each price-break interval. Why?

Because the total annual cost function is a

Total “u” shaped function.
annual
costs

0 1826 2500 4000 Order Quantity

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 ABC Classification System
Items kept in inventory are not of equal
importance in terms of:
60
dollars invested % of
$ Value 30 A
profit potential 0 B
sales or usage volume % of 30 C
Use 60
stock-out penalties

So, identify inventory items based on percentage of total dollar

value, where “A” items are roughly top 15 %, “B” items as next
35 %, and the lower 65% are the “C” items.

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