Inventory

Management

Chapter 10—Inventory Management

Learning Objectives
 Be Able To Apply Concepts Listed In
Learning Goals
 Be Able To Use Formulas Listed In
The Equation Summary of Chapter

Chapter 14—Inventory Management 1

Inventory Costs
 Interest or
Opportunity Costs
 Storage and
Handling Costs
 Taxes, Insurance, and
Shrinkage Costs
 Ordering and Setup Costs
 Transportation Costs
Chapter 10—Inventory Management
Types of Inventory
Cycle Inventory
Q+0
Average cycle inventory =
2

Chapter 10—Inventory Management

Types of Inventory
Cycle Inventory
Q
Average cycle inventory =
2

Safety Stock Inventory

Chapter 10—Inventory Management

Types of Inventory
Cycle Inventory
Q
Average cycle inventory =
2

Safety Stock Inventory

Anticipation Inventory

Chapter 10—Inventory Management

Types of Inventory
Cycle Inventory
Q
Average cycle inventory =
2

Safety Stock Inventory

Anticipation Inventory
Pipeline Inventory

Pipeline inventory = DL = dL

Chapter 10—Inventory Management

ABC Classification

 Start With Inventoried Items Ranked by

Dollar Value in Inventory in Descending
Order
 Plot Cumulative Dollar Value in Inventory
Versus Cumulative Items in Inventory
 . . . more

Chapter 14—Inventory Management 7

ABC Classification
 Typical Observations
 A Small Percentage of Items (Class A) Make up
a Large Percentage of Inventory Value
 A Large Percentage of Items (Class C) Make up
a Small Percentage of Inventory Value
 These Classifications Determine How
Much Attention Should Be Given to
Controlling Inventory of Different Items

Chapter 14—Inventory Management 8

ABC Analysis
100 —

90 —
Percentage of dollar value
80 —

70 —

60 —

50 —

40 —

30 —

20 —

10 —

0—
10 20 30 40 50 60 70 80 90 100
Percentage of items
Chapter 10—Inventory Management
ABC Analysis
Class C
100 — Class B
90 —
Percentage of dollar value Class A
80 —

70 —

60 —

50 —

40 —

30 —

20 —

10 —

0—
10 20 30 40 50 60 70 80 90 100
Percentage of items
Chapter 10—Inventory Management
ABC Analysis
Class C
100 — Class B
90 —
Percentage of dollar value Class A
80 —

70 —

60 —

50 —

40 —

30 —

20 —

10 —

0—
10 20 30 40 50 60 70 80 90 100
Percentage of items
Chapter 10—Inventory Management
How
Much?
When!

Chapter 10—Inventory Management

Economic
Order
Quantity

Chapter 10—Inventory Management

Economic Order Quantity

Assumptions
1. Demand rate is constant
2. No constraints on lot size
3. Only relevant costs are holding and
ordering/setup
4. Decisions for items are independent
from other items
5. No uncertainty in lead time or
supply
Chapter 10—Inventory Management
Economic Order Quantity
On-hand inventory (units)

Time
Chapter 10—Inventory Management
Economic Order Quantity

Receive
order
On-hand inventory (units)

Time
Chapter 10—Inventory Management
Economic Order Quantity

Receive
order
On-hand inventory (units)

1 cycle
Time
Chapter 10—Inventory Management
Economic Order Quantity

Receive
order
On-hand inventory (units)

1 cycle
Time
Chapter 10—Inventory Management
Economic Order Quantity

Receive Inventory depletion

order (demand rate)
On-hand inventory (units)

1 cycle
Time
Chapter 10—Inventory Management
Economic Order Quantity

Receive Inventory depletion

order (demand rate)
On-hand inventory (units)

1 cycle
Time
Chapter 10—Inventory Management
Economic Order Quantity

Receive Inventory depletion

order (demand rate)
On-hand inventory (units)

Q Average
— cycle
2
inventory

1 cycle
Time
Chapter 10—Inventory Management
Economic Order Quantity
Annual cost (dollars)

Holding cost (HC)

Lot Size (Q)

Chapter 10—Inventory Management
Economic Order Quantity
Annual cost (dollars)

Holding cost (HC)

Ordering cost (OC)

Lot Size (Q)

Chapter 10—Inventory Management
Economic Order Quantity

Total cost = HC + OC
Annual cost (dollars)

Holding cost (HC)

Ordering cost (OC)

Lot Size (Q)

Chapter 10—Inventory Management
 Economic Order Quantity
Current
cost
3000 —
Annual cost (dollars)

Q D
Total cost = (H) + (S)
2 Q

2000 —
Q
Holding cost = (H)
2

1000 —
D
Ordering cost = (S)
Q

0— | | | | | | | |
50 100 150 200 250 300 350 400
Current
Lot Size (Q)
Chapter 10—Inventory Management Q
 Economic Order Quantity
Current
cost
3000 — Bird feeder costs
Q D
Annual cost (dollars)

Total cost = D(H)

= + /week)(52
(18 (S) weeks) = 936 units
2 Q
H = 0.25 ($60/unit) = $15
2000 —
S = $45 Q = EOQ
Q
2DS Holding cost
Q = D(H)
EOQ = C= (H) +2 (S)
H 2 Q
1000 —
D
Ordering cost = (S)
Q

0— | | | | | | | |
50 100 150 200 250 300 350 400
Current
Lot Size (Q)
Chapter 10—Inventory Management Q
 Economic Order Quantity
Current
cost
3000 — Bird feeder costs
Q D
Annual cost (dollars)

Total cost = D(H)

= + /week)(52
(18 (S) weeks) = 936 units
2 Q
H = 0.25 ($60/unit) = $15
2000 —
S = $45 Q = 75 units
Q
2DS Holding cost
Q = D(H)
EOQ = C= (H) +2 (S)
H 2 Q
1000 —
D
Ordering cost = (S)
Q

0— | | | | | | | |
50 100 150 200 250 300 350 400
Current
Lot Size (Q)
Chapter 10—Inventory Management Q
 Economic Order Quantity
Current
cost
3000 — Bird feeder costs
Q D
Annual cost (dollars)

Total cost = D(H)

= + /week)(52
(18 (S) weeks) = 936 units
2 Q
H = 0.25 ($60/unit) = $15
2000 —
S = $45 Q = 75 units
Q
2DS Holding cost
Q = D(H)
EOQ = C= (H) +2 (S)
H 2 Q
1000 —
C = $562 + $562 = $1124
D
Ordering cost = (S)
Q

0— | | | | | | | |
50 100 150 200 250 300 350 400
Current
Lot Size (Q)
Chapter 10—Inventory Management Q
 Economic Order Quantity
Current
cost
3000 — Bird feeder costs
Q D
Annual cost (dollars)

Total cost = D(H)

= + /week)(52
(18 (S) weeks) = 936 units
2 Q
H = 0.25 ($60/unit) = $15
2000 —
S = $45 Q = 75 units
Q
2DS Holding cost
Q = D(H)
EOQ = C= (H) +2 (S)
H 2 Q
1000 —
C = $562 + $562 = $1124
D
Ordering cost = (S)
Q

0— | | | | | | | |
50 100 150 200 250 300 350 400
Current
Lot Size (Q)
Chapter 10—Inventory Management Q
 Economic Order Quantity
Current
cost
3000 — Bird feeder costs
Q D
Annual cost (dollars)

Total cost = D(H)

= + /week)(52
(18 (S) weeks) = 936 units
2 Q
H = 0.25 ($60/unit) = $15
2000 —
S = $45 Q = 75 units
Q
2DS Holding cost
Q = D(H)
EOQ = C= (H) +2 (S)
H 2 Q
1000 —
C = $562 + $562 = $1124
D
Lowest Ordering cost = (S)
Q
cost
0— | | | | | | | |
50 100 150 200 250 300 350 400
Best Q Current
Lot Size (Q)
(EOQ) Chapter 10—Inventory Management Q
 Economic Order Quantity
Current
cost
3000 — Bird feeder costs
Q D
Annual cost (dollars)

Total cost = D(H)

= + /week)(52
(18 (S) weeks) = 936 units
2 Q
H = 0.25 ($60/unit) = $15
2000 —
S = $45 Q = 75 units

2DS D Q
EOQ = C= (H) + (S)
H Q 2
1000 —
C = $562 + $562 = $1124
Lowest
cost
0— | | | | | | | |
50 100 150 200 250 300 350 400
Best Q Current
Lot Size (Q)
(EOQ) Chapter 10—Inventory Management Q
 Economic Order Quantity
Current
cost
3000 — Birdfeeder costs
Time between orders
Q D
Annual cost (dollars)

Total cost = D(H) + /week)(52

= (18 (S) weeks) = 936 units
2 Q
HTBO EOQ = $15
= 0.25 ($60/unit)
EOQ = = 75/936 = 0.080 year
S = $45 D Q = 75 units
2000 —

2DS D Q
EOQ = C= (H) + (S)
H Q 2
1000 —
C = $562 + $562 = $1124
Lowest
cost
0— | | | | | | | |
50 100 150 200 250 300 350 400
Best Q Current
Lot Size (Q)
(EOQ) Chapter 10—Inventory Management Q
 Economic Order Quantity
Current
cost
3000 — Birdfeeder costs
Time between orders
Q D
Annual cost (dollars)

Total cost = D(H) + /week)(52

= (18 (S) weeks) = 936 units
2 Q
HTBO EOQ = $15
= 0.25 ($60/unit)
EOQ = = 75/936 = 0.080 year
S = $45 D Q = 75 units
2000 —

TBOEOQ = (75/936)(12) = 0.96 months

TBOEOQ = (75/936)(52) = 4.17 weeks

1000 —
TBOEOQ = (75/936)(365) = 29.25 days
Lowest
cost
0— | | | | | | | |
50 100 150 200 250 300 350 400
Best Q Current
Lot Size (Q)
(EOQ) Chapter 10—Inventory Management Q
 Economic Order Quantity
Current
cost
3000 —
Q D
Annual cost (dollars)

Total cost = (H) + (S)

2 Q

2000 —
Q
Holding cost = (H)
2

1000 —
D
Lowest Ordering cost = (S)
Q
cost
0— | | | | | | | |
50 100 150 200 250 300 350 400
Best Q Current
Lot Size (Q)
(EOQ) Chapter 10—Inventory Management Q
How
Much?
When!

Chapter 10—Inventory Management

 Continuous Review

Order
received
On-hand inventory

OH

Time

Chapter 10—Inventory Management

 Continuous Review

IP

Order
received
On-hand inventory

OH

R
Order
placed

L
TBO
Chapter 10—Inventory Management
 Continuous Review

IP IP IP

Order Order Order Order

received received received received
On-hand inventory

Q Q Q

OH OH OH

R
Order Order Order
placed placed placed

L L L Time
TBO TBO TBO
Chapter 10—Inventory Management
 Uncertain Demand
On-hand inventory

Time

Chapter 10—Inventory Management

 Uncertain Demand
IP
IP
Order
Order
Order received
received
received Order
On-hand inventory

received
Q
Q Q
OH

R
Order Order Order
placed placed placed

L1 L2 L3 Time
TBO1 TBO2 TBO3
Chapter 10—Inventory Management
Reorder Point / Safety Stock

Average
demand
during
lead time

Chapter 10—Inventory Management

Reorder Point / Safety Stock

Cycle-service level = 99%

Probability of stockout
(1.0 – 0.99 = 0.01)
Average
demand
during
lead time R

zL

Chapter 10—Inventory Management

Reorder Point / Safety Stock
Safety Stock/R
dL = 250
L = 22
Cycle-service level = 99%
SL = 99%
z = 2.33

Probability of stockout
(1.0 – 0.99 = 0.015)
Average
demand
during
lead time R

zL

Chapter 10—Inventory Management

Reorder Point / Safety Stock
Safety Stock/R
Safety stock = zL
= 2.33(22) = 51.3
Cycle-service level = 99%
= 51 boxes

Probability of stockout
(1.0 – 0.99 = 0.01)
Average
demand
during
lead time R

zL

Chapter 10—Inventory Management

Reorder Point / Safety Stock
Safety Stock/R
Safety stock = zL
= 2.33(22) = 51.3
Cycle-service level = 99%
= 51 boxes

Reorder point = dL + SS
= 250 + 51
= 301 boxes Probability of stockout
(1.0 – 0.99 = 0.01)
Average
demand
during
lead time R

zL

Chapter 10—Inventory Management

 Lead Time Distributions
t = 15

+
75
Demand for week 1

Chapter 10—Inventory Management

 Lead Time Distributions
t = 15

+
75
Demand for week 1
t = 15

+
75
Demand for week 2

Chapter 10—Inventory Management

 Lead Time Distributions
t = 15

+
75
Demand for week 1
t = 15

+
75
Demand for week 2
t = 15

=
75
Demand forChapter
week 310—Inventory Management
 L  t L

Lead Time Distributions  L  15 3

 L  26
t = 15
L = 26

+
75
Demand for week 1
t = 15

+ 225
Demand for
75
Demand for week 2 three-week lead time
t = 15

=
75
Demand forChapter
week 310—Inventory Management
 Lead Time Distributions
t = 15
t = 26

+ Bird feeder Lead Time Distribution

75
Demand for week 1
t = 1 week
t = 15 d = 18 L=2
t = 5 SL = 90%

+ 225
Demand for
75
Demand for week 2 three-week lead time
t = 15

=
75
Demand forChapter
week 310—Inventory Management
 Lead Time Distributions
t = 15
t = 26

+ Bird feeder Lead Time Distribution

75
Demand for week 1
t = 1 week
t = 15 d = 18 L=2
t = 5 SL = 90%

+ L = t L =5 2 = 7.1
225
Demand for
75
Demand for week 2 three-week lead time
t = 15

=
75
Demand forChapter
week 310—Inventory Management
 Lead Time Distributions
t = 15
t = 26

+ Bird feeder Lead Time Distribution

75
Demand for week 1
t = 1 week
t = 15 d = 18 L=2
t = 5 SL = 90%

+ L = t L =5 2 = 7.1
225
75 Safety stock = zL = 1.28(7.1)Demand
= 9.1 or
for9 units
Demand for week 2 three-week lead time
t = 15
Reorder point = dL + SS

=
= 2(18) + 9 = 45 units

75
Demand forChapter
week 310—Inventory Management
 Lead Time Distributions
t = 15
t = 26

+ Bird feeder Lead Time Distribution

75
Demand for week 1
t = 1 week
t = 15 d = 18 L=2
Reorder point = 2(18) + 9 = 45 units

+ 225
Demand for
75
Demand for week 2 three-week lead time
t = 15

=
75
Demand forChapter
week 310—Inventory Management
 Lead Time Distributions
t = 15
t = 26

+ Bird feeder Lead Time Distribution

75
Demand for week 1
t = 1 week
t = 15 d = 18 L=2
Reorder point = 2(18) + 9 = 45 units

C=
+
When stock drops to 45, order 75
75
($15) +
936
($45)
225
+ 9($15)
Demand for
75 2 75 three-week
Demand for week 2 lead time
t = 15
C = $562.50 + $561.60 + $135 = $1259.10

=
75
Demand forChapter
week 310—Inventory Management
 Periodic Review Systems
T
On-hand inventory

Time
P P

Chapter 10—Inventory Management

 Periodic Review Systems
T
On-hand inventory

Q1

Order
placed

Time
P P

Chapter 10—Inventory Management

 Periodic Review Systems
T
On-hand inventory

Q1

Order
placed

L Time
P P

Chapter 10—Inventory Management

 Periodic Review Systems
T
Order
received
On-hand inventory

Q1

Order
placed

L Time
P P

Chapter 10—Inventory Management

 Periodic Review Systems
T
Order Order Order
received received received
On-hand inventory

Q3
Q1
Q2

Order Order
placed placed

L L L Time
P P

Chapter 10—Inventory Management

 Periodic Review Systems
T
IP Order IP IP Order
Order
received received received
On-hand inventory

Q3
Q1 OH
OH Q2
IP1

IP3
Order Order
placed placed
IP2

L L L Time
P P
Protection interval
Chapter 10—Inventory Management
 Periodic Review Systems
T
IP Order IP IP Order
Bird Order P and T
feeder— Calculating
received received received
On-hand inventory

Q3
Q1 OH
OH Q2
IP1

IP3
Order Order
placed placed
IP2

L L L Time
P P
Protection interval
Chapter 10—Inventory Management
 Periodic Review Systems
T
IP Order IP IP Order
Bird OrderP and T
feeder—Calculating
received received received
On-hand inventory

t = Q3 level = 90%
Q15 units d = 18 L = 2 weeks cycle/service
OH
OH Q2
EOQ = 75 units D = (18 units/week)(52 weeks) = 936 units
IP1

IP3
Order Order
placed placed
IP2

L L L Time
P P
Protection interval
Chapter 10—Inventory Management
 Periodic Review Systems
T
IP Order IP IP Order
Bird OrderP and T
feeder—Calculating
received received received
On-hand inventory

t = Q3 level = 90%
Q15 units d = 18 L = 2 weeks cycle/service
OH
OH Q2
EOQ = 75 units D = (18 units/week)(52 weeks) = 936 units
IP1
EOQ 75
IP3 P= (52) = (52) = 4.2 or 4 weeks
D 936
Order Order
placed P+L = t P + L = 5 placed
6 = 12 units
IP2

L L L Time
P P
Protection interval
Chapter 10—Inventory Management
 Periodic Review Systems
T
IP Order IP IP Order
Bird OrderP and T
feeder—Calculating
received received received
On-hand inventory

t = Q3 level = 90%
Q15 units d = 18 L = 2 weeks cycle/service
OH
OH Q2
EOQ = 75 units D = (18 units/week)(52 weeks) = 936 units
IP1
EOQ 75
IP3 P= (52) = (52) = 4.2 or 4 weeks
D 936
Order Order
placed P+L = t P + L = 5 placed
6 = 12 units
IP2
T = Average demand during the protection interval + Safety stock
= d (P + L) + zP + L
L L L Time
= (18 units/week)(6 weeks) + 1.28(12 units) = 123 units
P P
Protection interval
Chapter 10—Inventory Management
 Periodic Review Systems
T
IP Order IP IP Order
Bird OrderP and T
feeder—Calculating
received received received
On-hand inventory

t = Q3 level = 90%
Q15 units d = 18 L = 2 weeks cycle/service
OH
OH Q2
EOQ = 75 units D = (18 units/week)(52 weeks) = 936 units
IP1
P = 4 weeks T = 123 units
IP3
Order Order
placed placed
IP2

L L L Time
P P
Protection interval
Chapter 10—Inventory Management
 Periodic Review Systems
T
IP Order IP IP Order
Bird OrderP and T
feeder—Calculating
received received received
On-hand inventory

t = Q3 level = 90%
Q15 units d = 18 L = 2 weeks cycle/service
OH
OH Q2
EOQ = 75 units D = (18 units/week)(52 weeks) = 936 units
IP1
P = 4 weeks T = 123 units
IP3
Order Order
placed 4(18) 936placed
IP2 C= ($15) + ($45) + 15($15)
2 4(18)

C = $540 + $585 + $225 = $1350

L L L Time
P P
Protection interval
Chapter 10—Inventory Management
Comparison of Q and P Systems

P Systems
 Convenient to administer
 Orders may be combined
 IP only required at review
Q Systems
 Individual review frequencies
 Possible quantity discounts
 Lower, less-expensive safety stocks
Chapter 10—Inventory Management