Inventory Planning and

Control
(Inventory Management)

Lokesh Vijayvargy, JIM Jaipur 1

 Inventory System
Inventory is the stock of any item or resource used in an
organization and can include: 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
Inventory planning of independent demand items must
address the following two key questions:
How much?
When? Lokesh Vijayvargy, JIM Jaipur 2
 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

Lokesh Vijayvargy, JIM Jaipur 3

Inventory

Lokesh Vijayvargy, JIM Jaipur 4

 Types of Inventory

Cyclic Inventory: Periodic replenishment causes

cyclic inventory
Seasonal Inventory: Seasonality in demand is
absorbed using inventory
Pipeline Inventory: Exists due to lead time
Safety Stock: Used to absorb fluctuations in
demand due to uncertainty

Lokesh Vijayvargy, JIM Jaipur 5

 Costs in Inventory Planning
(Carrying Cost)
Interest for short-term borrowals for working
capital
Cost of stores and warehousing
Administrative costs related to maintaining
and accounting for inventory
Insurance costs, cost of obsolescence,
pilferage, damages and wastage
All these costs are directly related to the
level of inventory
Lokesh Vijayvargy, JIM Jaipur 6
 Costs in Inventory Planning
(Ordering Cost)
Search and identification of appropriate sources
of supply
Price negotiation, contracting and purchase
order generation
Follow-up and receipt of material
Eventual stocking in the stores after necessary
accounting and verification
A larger order quantity will require less number
of orders to meet a known demand and vice
versa
Lokesh Vijayvargy, JIM Jaipur 7
 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

Lokesh Vijayvargy, JIM Jaipur 8

 Inventory Control Systems

Continuous system (fixed-order-

quantity)
constant amount ordered when
inventory declines to
predetermined level
Periodic system (fixed-time-
period)
order placed for variable amount
after fixed passage of time
Lokesh Vijayvargy, JIM Jaipur 9
Continuous system (fixed-
order-quantity)

Lokesh Vijayvargy, JIM Jaipur 10

 Economic Order Quantity
(EOQ) Models
EOQ Model
optimal order quantity that will minimize total
inventory costs
EOQ model with price discount
Production quantity model

Lokesh Vijayvargy, JIM Jaipur 11

 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

Lokesh Vijayvargy, JIM Jaipur 12

 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

Lokesh Vijayvargy, JIM Jaipur 13

 EOQ Cost Model
Co - cost of placing order D - annual demand
Cc - annual per-unit carrying cost Q - order quantity

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

Lokesh Vijayvargy, JIM Jaipur 14

 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

Lokesh Vijayvargy, JIM Jaipur 15

 EOQ Cost Model
Deriving Qopt Proving equality of
costs at optimal point
CoD CcQ
TC = +
Q 2 CoD CcQ
=
TC CoD Cc Q 2
= +
Q Q2 2
2CoD
C0D Cc Q2 =
Cc
0= +
Q2 2
2CoD
2CoD Qopt =
Qopt = Cc
Cc

Lokesh Vijayvargy, JIM Jaipur 16

 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
Lokesh Vijayvargy, JIM Jaipur 17
EXAMPLE:
ELECTRONIX STOCKS AND SELLS PC’S. IT COSTS
RS.2500 EACH TIME IT PLACES AN ORDER WITH THE
MANUFACTURER. ANNUAL COST OF CARRYING THE
PC’S IN INVENTORY IS RS.180. THE STORE MANAGER
ESTIMATES THAT THE ANNUAL DEMAND FOR THE
PC’S WILL BE 200 UNITS. DETERMINE THE OPTIMAL
ORDER QUANTITY AND THE TOTAL MINIMUM
INVENTORY COSTS.
Q* =
TC* =
NO. OF ORDERS / YEAR =
ORDER CYCLE TIME =

Lokesh Vijayvargy, JIM Jaipur 18

 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

Lokesh Vijayvargy, JIM Jaipur 19

 QUANTITY DISCOUNTS
TO DETERMINE IF AN ORDER SIZE WITH DISCOUNT IS
MORE COST EFFECTIVE THAN OPTIMAL Q.
D Q
TC  CO  C C  P .D ANNUAL DEMAND
Q 2
PRICE/UNIT

TC
TC(d1)
TC(d2)

Ordering Cost

Q(d) Q* Q(d2) ORDER SIZE PRICE

CO = Rs.2,500 0 - 99 Rs. 24,000
CC = Rs 100 100 - 199 Rs.22,000
D = 200/yr. Lokesh Vijayvargy, JIM Jaipur >200 20 21,000
Rs.
 QUANTITY DISCOUNTS WITH
CONSTANT CARRYING COSTS

2CO D 2  2500  200

Q*    10000  100
CC 100
CO D CCQ * 2500  200 100  100
TC100    P.D    22000  200
Q* 2 100 2
 5000  5000  4400000  RS.44,10,000
2500  200 100  200
TC 200    21000  200
200 2
 2500  10000  4200000  RS.42,12,500

Lokesh Vijayvargy, JIM Jaipur 21

 Quantity Discount: Example
QUANTITY PRICE
Co = Rs. 2,500
1 – 49 1,400 Cc = Rs. 190 per computer
50 - 89 1,100 D = 200
90+ 900

2CoD 2(2500)(200)
Qopt = = = 72.5 PCs
Cc 190

For Q = 72.5 CoD CcQopt

TC = + 2 + PD = Rs.233,784
Qopt

For Q = 90 CcQ
CoD
TC = + 2 + PD = Rs. 194,105
Q

Lokesh Vijayvargy, JIM Jaipur 22

HOW MUCH TO ORDER Q*
WHEN TO ORDER R
REORDER POINT : THE REORDER POINT IS
THE LEVEL OF INVENTORY AT WHICH A NEW
ORDER SHOULD BE PLACED.
THE REORDER POINT FOR OUR BASIC EOQ
MODEL WITH CONSTANT DEMAND AND A
CONSTANT LEAD TIME TO RECEIVE AN
ORDER IS EQUAL TO THE AMOUNT
DEMANDED DURING THE LEAD TIME,
R = d. L
WHERE d = demand rate / period & L = Lead time
Lokesh Vijayvargy, JIM Jaipur 23
EXAMPLE : IF THE ANNUAL DEMAND
OF AN ITEM IS 10000 UNITS AND THE
LEAD TIME TO RECEIVE AN ORDER IS
10 DAYS, DETERMINE THE RE-ORDER
POINT.
Solution: R = dL = (10000/365)*10
WHEN THE INVENTORY LEVEL FALLS
TO 274, A NEW ORDER IS PLACED. RE-
ORDER POINT IS NOT RELATED TO
OPTIMAL ORDER QUANTITY OR ANY
OF THE INVENTORY COSTS.
Lokesh Vijayvargy, JIM Jaipur 24
SAFETY STOCKS: REALISTICALLY,
DEMAND-AND, LEAD TIME ARE
UNCERTAIN. THE INVENTORY LEVEL
MIGHT BE DEPLETED AT A SLOWER
OR FASTER RATE DURING LEAD TIME.
STOCK OUT: A STOCKOUT IS AN
INVENTORY SHORTAGE.
SAFETY STOCK: IS A BUFFER ADDED
TO THE INVENTORY ON HAND DURING
LEAD TIME.
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SERVICE LEVEL: ESTABLISH A SAFETY STOCK
THAT WILL MEET A SPECIFIED SERVICE
LEVEL. THE SERVICE LEVEL IS THE
PROBABILITY THAT THE INVENTORY
AVAILABLE DURING THE LEAD TIME WILL
MEET DEMAND i.e. THE PROBABILITY THAT A
STOCK OUT WILL NOT OCCUR.
A SERVICE LEVEL OF 90% MEANS THAT THERE
IS A 0.90 PROBABILITY THAT DEMAND WILL BE
MET DURING THE LEAD TIME, AND THE
PROBABILITY THAT A STOCKOUT WILL
OCCUR IS 10%
SERVICE LEVEL = f (CARRYING COSTS FOR
EXTRA SAFETY STOCKS & LOST SALES IF
DEMAND IS NOTLokesh
MET)Vijayvargy, JIM Jaipur 26
 REORDER POINT WITH VARIABLE DEMAND:

Q
INVENTORY LEVEL

R
REORDER
POINT

LT LT
TIME
INVENTORY LEVEL

Q
R

SAFETY
Q STOCK
LT LT
TIME
Lokesh Vijayvargy, JIM Jaipur 27
 Reorder Point with Variable demand
TO COMPUTE REORDER POINT WITH SAFETY STOCK THAT WILL
MEET A SPECIFIC SERVICE LEVEL, ASSUME THAT THE DEMAND
(LT) IS UNCERTAIN AND CAN BE DESCRIBED BY A NORMAL
DISTRIBUTION. THE AVERAGE DEMAND FOR THE LEAD TIME IS
THE SUM OF THE AVERAGE DAILY DEMANDS FOR THE DAYS OF
THE LT, WHICH IS ALSO THE PRODUCT OF THE AVERAGE DAILY
DEMANDS MULTIPLIED BY THE LEAD TIME. LIKEWISE, THE
VARIANCE OF THE DISTRIBUTION IS THE SUM OF THE DAILY
VARIANCES FOR THE NUMBER OF DAYS IN THE LEAD TIME.
THE REORDER POINT R  dL   d L
WHERE d  AVERAGE DAILY DEMAND
L  LEAD TIME
  NO. OF S.D CORRESPONDING
TO THE SERVICE LEVEL PROBABILITY
 d  S.D. OF DAILY DEMAND
 d L  SAFETY STOCK
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 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
d = 5 yards per day

For a 95% service level, z = 1.65

R = dL + z d L Safety stock = z d L
= 30(10) + (1.65)(5)( 10) = (1.65)(5)( 10)
= 326.1 yards = 26.1 yards

Lokesh Vijayvargy, JIM Jaipur 29

 Selective Control of Inventories
Alternative Classification Schemes
ABC Classification (on the basis of consumption value)
XYZ Classification (on the basis of unit cost of the item)
High Unit cost (X Class item)
Medium Unit cost (Y Class item)
Low unit cost (Z Class item)

FSN Classification (on the basis of movement of inventory)

Fast Moving
Slow Moving
Non-moving

VED Classification (on the basis of criticality of items)

Vital
Essential
Desirable

On the basis of sources of supply

Imported
Indigenous (National Suppliers)
Indigenous (Local Suppliers)
Lokesh Vijayvargy, JIM Jaipur 30
 ABC Classification
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

Lokesh Vijayvargy, JIM Jaipur 31

 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

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 ABC Classification:
Example (cont.)
TOTAL % OF TOTAL % OF TOTAL
PART PART
VALUE UNIT
VALUECOSTQUANTITY
ANNUAL USAGE
% CUMMULATIVE
9 1
$30,600 35.9$ 60 6.0 90 6.0
8 16,000
2 18.7 350 5.0 40 11.0
2 14,000 16.4 4.0
A 15.0
3 30 130
1 5,400 6.3 9.0 24.0
4 4
4,800 5.680 6.0 B60 30.0
3 5
3,900 4.630 10.0 100 40.0
6 6
3,600 4.220 % OF TOTAL
18.0 % OF TOTAL
180 58.0
CLASS ITEMS VALUE QUANTITY
5 3,000
7 3.510 13.0 170 71.0
10 2,400
A 9, 8, 22.8 12.0
71.0 C 83.0
8 320 50 15.0
7 1,700
B 1, 4, 32.0 17.0
16.5 100.0
25.0
C9 6, 5, 10,510
7 12.5 60 60.0
$85,400
10 20 120
Example 10.1

Lokesh Vijayvargy, JIM Jaipur 33