UNIT- 3

INVENTORY CONTROL

Delivered By: Sarita Saxena

 What Is Inventory ?
• Stock of items kept to meet future demand
• Purpose of inventory control

What & how much of various items to be kept in

stock.
Time & quantity of various items to be produced.

Copyright 2006 John

12-2
Wiley & Sons, Inc.
 Types of Inventory

 Raw materials

 Purchased parts and supplies

 Work-in-process (partially completed) products

(WIP)
 Items being transported

 Tools and equipment

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Wiley & Sons, Inc.
 Zero Inventory ?

 Reducing amounts of raw materials and purchased

parts and subassemblies by having suppliers deliver
them directly.
 Reducing the amount of works-in process by using
just-in-time production.
 Reducing the amount of finished goods by shipping to
markets as soon as possible.
 Inventory Positions in the
Supply Chain

Raw
Materials
Works
in
Process Finished
Goods Finished
Goods
in Field
 Benefits of Inventory Control
 Improve customer service.
 Economies of purchasing.
 Economies of production.
 Transportation savings.
 Protection of material from spoilage & deterioration .
 Unplanned shocks (labor strikes, natural disasters,
surges in demand, etc.).
 To maintain independence of supply chain.
 Terms used in inventory
• Lead Time-It is the time that lapses b/w raising of
indent by the stores & receipt of materials.

 Administrative Lead Time

 Delivery Lead Time

• Safety Stock- Difference b/w amount stocked &

average expected demand.
 Types of Demand

 Dependent

Demand for items used to produce final products

Ex. : Tires stored at a Goodyear plant.

 Independent

Demand for items used by external customers

Ex. : Cars, appliances, computers, and houses.

Copyright 2006 John

12-8
Wiley & Sons, Inc.
 Inventory Costs

 Carrying cost
Cost of holding an item in inventory e.g cost related to storage.

 Ordering cost
Cost of replenishing inventory , e.g travelling expenses.

 Shortage cost
Temporary or permanent loss of sales when demand cannot be met.

Copyright 2006 John

12-9
Wiley & Sons, Inc.
 Economic Order Quantity

• EOQ
 Optimal order quantity that will minimize total
inventory (Ordering + Carrying costs)

EOQ = (2nco / ch)0.5

Copyright 2006 John

12-10
Wiley & Sons, Inc.
 Assumptions of Basic EOQ Model

 Demand is known with certainty and is constant over time.

 No shortages are allowed.

 Lead time for the receipt of orders is constant.

 Order quantity is received all at once.

Copyright 2006 John

12-12
Wiley & Sons, Inc.
 ABC Analysis
• Class A
 5 – 15 % of units
 70 – 80 % of value
• Class B
 30 % of units
 15 % of value
• Class C
 50 – 60 % of units
 5 – 10 % of value

Copyright 2006 John

12-17
Wiley & Sons, Inc.
 ABC Classification: Example

PART UNIT COST ANNUAL USAGE

1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120
Copyright 2006 John
12-18
Wiley & Sons, Inc.
 Inventory Order Cycle
Order quantity, Q
Demand
rate
Inventory Level

Reorder point, R

0 Lead Lead Time

time time
Order Order Order Order
placed receipt placed receipt

Copyright 2006 John

12-19
Wiley & Sons, Inc.
 EOQ Cost Model
Co - cost of placing order D - annual demand
Cc - annual per-unit carrying cost Q - order quantity

Co D
Annual ordering cost =
Q
CcQ
Annual carrying cost =
2
CoD CcQ
Total cost = +
Q 2

Copyright 2006 John

12-20
Wiley & Sons, Inc.
 EOQ Cost Model

Deriving Qopt Proving equality of

costs at optimal point
Co D CcQ
TC = +
Q 2 Co D CcQ
=
∂ TC CoD C Q 2
= + c
∂Q Q2 2 2CoD
Q = 2
C0 D Cc Cc
0= +
Q2 2
2CoD
2CoD Qopt =
Qopt = Cc
Cc

Copyright 2006 John

12-21
Wiley & Sons, Inc.
 EOQ Cost Model (cont.)
Annual
cost ($) Total Cost
Slope = 0

CcQ
Minimum Carrying Cost =
2
total cost

CoD
Ordering Cost =
Q

Optimal order Order Quantity, Q

Qopt

Copyright 2006 John

12-22
Wiley & Sons, Inc.
 EOQ Example

Cc = $0.75 per yard Co = $150 D = 10,000 yards

2CoD CoD CcQ

Qopt = TCmin = +
Cc Q 2

2(150)(10,000) (150)(10,000) (0.75)(2,000)

Qopt = (0.75) TCmin = 2,000 + 2

Qopt = 2,000 yards TCmin = $750 + $750 = $1,500

Orders per year = D/Qopt Order cycle time = 311 days/(D/Qopt )
= 10,000/2,000 = 311/5
= 5 orders/year = 62.2 store days
Copyright 2006 John
12-23
Wiley & Sons, Inc.
 Production Quantity
Model
• An inventory system in which an order is
received gradually, as inventory is
simultaneously being depleted
• AKA non-instantaneous receipt model
– assumption that Q is received all at once is
relaxed
• p - daily rate at which an order is received
over time, a.k.a. production rate
• d - daily rate at which inventory is
demanded
Copyright 2006 John
12-24
Wiley & Sons, Inc.
 Production Quantity Model
(cont.)
Inventory
level

Maximum
Q(1-d/p) inventory
level

Average
Q
(1-d/p) inventory
2 level

0
Begin End Time
order order
Order
receipt receipt
receipt period

Copyright 2006 John

12-25
Wiley & Sons, Inc.
 Production Quantity
Model (cont.)
p = production rate d = demand rate

Q
Maximum inventory level = Q - d
p
d
=Q1-
p 2CoD
Qopt = d
Q d Cc 1 - p
Average inventory level = 1-
2 p

CoD CcQ d
TC = + 1- p
Q 2

Copyright 2006 John

12-26
Wiley & Sons, Inc.
 Production Quantity Model:
Example
Cc = $0.75 per yard Co = $150 D = 10,000 yards
d = 10,000/311 = 32.2 yards per day p = 150 yards per day

2CoD 2(150)(10,000)
Qopt = = = 2,256.8 yards
32.2
Cc 1 - d 0.75 1 -
p 150

Co D CcQ d
TC = + 1- p = $1,329
Q 2

Q 2,256.8
Production run = = = 15.05 days per order
p 150
Copyright 2006 John
12-27
Wiley & Sons, Inc.
 Production Quantity
Model: Example (cont.)

D 10,000
Number of production runs = = = 4.43 runs/year
Q 2,256.8

d 32.2
Maximum inventory level = Q 1 - = 2,256.8 1 -
p 150
= 1,772 yards

Copyright 2006 John

12-28
Wiley & Sons, Inc.
 Quantity Discounts

Price per unit decreases as order

quantity increases

CoD CcQ
TC = + + PD
Q 2
where

P = per unit price of the item

D = annual demand
Copyright 2006 John
12-29
Wiley & Sons, Inc.
 Quantity Discount Model
(cont.)
ORDER SIZE PRICE
0 - 99 $10 TC = ($10 )
100 – 199 8 (d1)
200+ 6 (d2) TC (d1 = $8 )

TC (d2 = $6 )
Inventory cost ($)

Carrying cost

Ordering cost

Q(d1 ) = 100 Qopt Q(d2 ) = 200

Copyright 2006 John
12-30
Wiley & Sons, Inc.
 Quantity Discount:
Example
QUANTITY PRICE
Co = $2,500
1 - 49 $1,400
Cc = $190 per computer
50 - 89 1,100
D = 200
90+ 900

2 Co D 2(2500)(200)
Qopt = = = 72.5 PCs
Cc 190

For Q = 72.5
CoD CcQopt
TC = + + PD = $233,784
Qopt 2

For Q = 90
Co D CcQ
TC = + + PD = $194,105
Q 2
Copyright 2006 John
12-31
Wiley & Sons, Inc.
 Reorder Point
Level of inventory at which a new order is placed

R = dL

where

d = demand rate per period

L = lead time

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12-32
Wiley & Sons, Inc.
 Reorder Point: Example

Demand = 10,000 yards/year

Store open 311 days/year
Daily demand = 10,000 / 311 = 32.154
yards/day
Lead time = L = 10 days

R = dL = (32.154)(10) = 321.54 yards

Copyright 2006 John

12-33
Wiley & Sons, Inc.
 Safety Stocks

Safety stock
buffer added to on hand inventory during lead
time
Stockout
an inventory shortage
Service level
probability that the inventory available during lead
time will meet demand

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12-34
Wiley & Sons, Inc.
 Variable Demand with
a Reorder Point
Q
Inventory level

Reorder
point, R

0
LT LT
Time

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12-35
Wiley & Sons, Inc.
 Reorder Point with
a Safety Stock
Inventory level

Q
Reorder
point, R

Safety Stock
0
LT LT
Copyright 2006 John
Time
12-36
Wiley & Sons, Inc.
 Reorder Point With
Variable Demand

R = dL + zσ d L
where
d = average daily demand
L = lead time
σ d = the standard deviation of daily demand
z = number of standard deviations
corresponding to the service level
probability
zσ d L = safety stock
Copyright 2006 John
12-37
Wiley & Sons, Inc.
 Reorder Point for
a Service Level
Probability of
meeting demand during
lead time = service level

Probability of
a stockout

Safety stock
zσ d L

dL R
Demand

Copyright 2006 John

12-38
Wiley & Sons, Inc.
 Reorder Point for
Variable Demand

The carpet store wants a reorder point with a 95%

service level and a 5% stockout probability
d = 30 yards per day
L = 10 days
σ d = 5 yards per day

For a 95% service level, z = 1.65

R = dL + z σ d L Safety stock = z σ d L
= 30(10) + (1.65)(5)( 10) = (1.65)(5)( 10)
= 326.1 yards = 26.1 yards
Copyright 2006 John
12-39
Wiley & Sons, Inc.
 Order Quantity for a
Periodic Inventory System
Q = d(tb + L) + zσ d tb + L - I

where
d = average demand rate
tb = the fixed time between orders
L = lead time
σ d = standard deviation of demand

zσ d tb + L = safety stock
I = inventory level

Copyright 2006 John

12-40
Wiley & Sons, Inc.
 Fixed-Period Model
with Variable Demand
d = 6 bottles per day
σ d = 1.2 bottles
tb = 60 days
L = 5 days
I = 8 bottles
z = 1.65 (for a 95% service level)

Q = d(tb + L) + zσ d tb + L - I
= (6)(60 + 5) + (1.65)(1.2) 60 + 5 - 8
= 397.96 bottles
Copyright 2006 John
12-41
Wiley & Sons, Inc.