MPEN 425:PRODUCTION

PLANNING AND CONTROL II

LECTURE SEVEN

INVENTORY MANAGEMENT
 Outline

Elements of Inventory Management

Inventory and Supply Chain Management

Inventory Control Systems

Economic Order Quantity Models

Reorder Point

Classification of Inventories:
ABC, VED
 What is inventory?
A physical resource that a
firm holds in stock with
the intent of selling it or
transforming it into a
more valuable state.

Purpose of inventory
management
• How many units to order?
• when to order? discount
 Types of Inventories
Raw materials

Purchased parts and supplies

Finished Goods

Work-in-process (partially completed products )

Items being transported

Tools and equipment
 Nature of Inventories

Raw Materials – Basic inputs that are converted into finished product
through the manufacturing process

Work-in-progress – Semi-manufactured products need some more

works
before they become finished goods for sale

Finished Goods – Completely manufactured products ready for sale

Supplies – Office and plant materials not directly enter production but are
necessary for production process and do not involve significant investment.
Inventory and Supply Chain Management
• demand information is distorted as it moves away from
the end-use customer(forecast)
Bullwhip effect • higher safety stock inventories are stored to
compensate

Seasonal or cyclical demand

Sale of umbrella , dominos sale in weekend

Inventory provides independence from vendors

Take advantage of price discounts

Inventory provides independence between stages and avoids work stoppages

WIP inventories
 Two Forms of Demand

Dependent Independent
(not used by customer directly) • Demand for items used by
• Demand for items used to external customers
produce final products • Cars, computers, and
• Tires stored at a plant are houses are examples of
an example of a dependent independent demand
demand item inventory
Inventory and Quality Management

Customers usually perceive quality service as

availability of goods when they want them

Inventory must be sufficient to provide high-

quality customer service
 Inventory Costs

Carrying cost

• cost of holding an item in inventory

Ordering cost

• cost of replenishing inventory

Shortage cost

• temporary or permanent loss of sales when

demand cannot be met
 Inventory Control Systems

• constant amount ordered

Continuous system
(fixed-order-quantity)
when inventory declines
to predetermined level

• order placed for variable

Periodic system
amount after fixed
(fixed-time-period) passage of time
Economic Order Quantity (EOQ) Models

• We want to determine the optimal number of

EOQ units to order so that we minimize the total cost

associated with the purchase, delivery and
storage of the product.

Basic EOQ model

Production quantity
Assumptions of Basic EOQ Model

Demand is known, constant, and independent

Lead time is known and constant

Order quantity received is instantaneous and

complete

No shortage is allowed
 Inventory Order Cycle

Order quantity, Q
Demand
rate
Inventory Level

Reorder point, R

0 Lead Lead Time

time time
Order Order Order
placedreceipt Order placed
receipt
 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
C cQ
Annual carrying cost =
2
Co D
Total cost =

C cQ Q +
 EOQ Cost Model

Deriving Qopt Proving equality of

costs at optimal
C oD point
C cQ Co D
TC = + =
Q C cQ Q
2
Q Q2 2 2 D
2C o
- C0 D + C c Q2
=
Cc
TC0 = Q-2 CoD 2
= +
2CoD
Cc 2CoD
Qopt = Cc
Qopt = Cc
 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
Production Quantity Model
An inventory system in which an order is received gradually, as
inventory is simultaneously being depleted

Also known as non-instantaneous receipt model

Now replenishment not at once

Assumption

• Q is received all at once is relaxed

• p - daily rate at which an order is received over time, or
production rate
• d - daily rate at which inventory is demanded
 Production Quantity Model (cont.)

p = production rate d = demand rate

Maximum inventory level = Q - Q

p d

= Q 1 - pd 2CoD

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

Co D d
TC = + 1- p
C cQ Q
2
 Quantity Discounts

Price per unit decreases as order quantity

increases

CoD
TC = + + PD
Q 2
CcQ

P = per unit price of the item

where
D = annual demand
 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 Q(d2 ) = 200

Qopt
 Reorder Point

Level of inventory at which a new order is placed

R = dL

• d = demand rate per period

where • L = lead time
 Variable Demand with a Reorder Point

Q
Inventory level

Reorder
point,
R

0 LT LT
Time
Inventory level
Reorder Point with a Safety Stock

Q
Reorder
point,
R

Safety Stock
0
LT LT
Time
 Classifying Inventory Items
ABC Classification (Pareto Principle)

In any Retail organization there are large numbers of

inventories to be maintained. It is not practical to have
very stringent inventory control system for each & every
item. So with the modus of having an effective Purchase
& stores control we implement ABC Inventory
Classification model Known as Always Better Control
(ABC) based upon Pareto rule ( 80/20 rule)
 ABC Analysis
Divides inventory into three classes based on
Consumption Value
Consumption Value = (Unit price of an item) (No. of units consumed per annum)

 Class A - High Consumption Value

 Class B - Medium Consumption Value
 Class C - Low Consumption Value
 ABC Analysis

Percent of Percent of
Item Number Annual Annual Annual
Stock of Items Unit Consump consumpti
Number Stocked Volum x = tion on value
e Cost value
(units) Class
#10286 20% 1,000 $ 90.00 $ 90,000 38.8%

A
 72%
#11526 500 154.00 77,000 33.2% A

#12760 1,550 17.00 26,350 11.3% B

 23%
#10867 30% 350 42.86 15,001 6.4%

B
#10500 1,000 12.50 12,500 5.4% B
 ABC Analysis

Percent of Percent of
Item Number Annual Annual Annual
Stock of Items Unit cons. cons.
Number Stocked Volum x = value value Class
e Cost
(units)
#12572 600 $ 14.17 $ 8,502 3.7% C

#14075 2,000 .60 1,200 .5% C

#01036 50% 100 8.50 850 .4%  5% C

#01307 1,200 .42 504 .2% C

#10572 250 .60 150 .1% C

8,550 $232,057 100.0%

 ABC Analysis
A Items
80 –
% of Consumption Value

70 –
60 –
50 –
40 –
30 –
20 – B Items
10 – C Items
| | | | | | | | | |

10 20 30 40 50 60 70 80 90 100
% of inventory items
Inventory Management Policy
A Items:
very tight control, complete and accurate records, frequent review via EOQ model.

B Items:
less tightly controlled, good records, regular review

C Items:
simplest controls possible, minimal records, large inventories, periodic review and reorder

Some time with the view of doing Lean inventory management

Within ABC category VED ( Vital , essential & desirable factor) is introduced with the
view of further having effective control of inventory on the basis if its being critical.

V (Vital) is the inventory where neither Substitute nor Variation Gap is allowed .
E (Essential) is the inventory which allows either of the one to be changed
D (Desirable ) is the one which can have variation in both of the parameters
 References
:
• Cox, James F., III, and John H. Blackstone, Jr. APICS
Dictionary. 9th ed. Falls Church VA: American Production and
Inventory Control Society, 1998.
• Anupindi, Ravi, et al. Managing Business Process Flows:
Principles of Operations Management. 2nd ed. Upper Saddle
River, NJ: Pearson Prentice Hall, 2004.
• Meredith, Jack R., and Scott M. Shafer. Operations
Management for MBAs. 2nd ed. New York: John Wiley & Sons
Inc., 2002.
• Stevenson, William J. Production/Operations
Management. 8th ed. Boston: Irwin/McGraw-Hill, 2005.
Thank You