INVENTORY AND MATERIALS

MANAGEMENT
Ar. Guruprasad Mantravadi
Inventory as Both a Tangible and an
Intangible Object ?
 Inventory as Both a Tangible and an
Intangible Object
• the nature of inventory as both a tangible,physical
item actually kept within the facility (“real life” or
“shelf count”) and as an intangible item existing
within the company’s records (“paper life” or
“record count”).
• Since you frequently make purchasing, sales,
customer service, production planning, andother
decisions based on whether an item is shown as
being inhouse as per your records, an item’s paper
life can be just as important as its real life.
Inventory—Who Needs It?
 Inventory—Who Needs It?
• All organizations keep inventory. “Inventory”
includes a company’s raw materials, work in
process, supplies used in operations, and
finished goods.
• Inventory can be as simple as a bottle of glass
cleaner used as part of a building’s custodial
program or as complex as a mix of raw
materials and subassemblies used as part of a
manufacturing process.
Why is Inventory management
important ?Is it different from
Supply chain management ?
Why is Inventory management important ?

• First, many managers assume that new levels of efficiency

can be attained simply by sharing information and forming
“strategic alliances” with their supply chain partners.
These managers do not understand that “the devil is in
the details,” and that knowing what to do with the data is
as important as getting the data in the first place.
• Developing sound inventory management and production
planning and scheduling methods may seem mundane
next to strategy formulation,but these methods are a
critical element of long-term survival and competitive
advantage.
 Inventory management is important
because….
• Inventory brings with it a number of costs,
including:
• material costs
• Space
• Labor to receive, check quality, put away,
retrieve, select ,pack, ship, and account for the
item(s)
• Deterioration, damage, and obsolescence
• Theft
Definition of Inventory
APICS Dictionary (2015) defines
1

inventory as
Those stocks or items used to
support production (raw materials
and work-in-process items),
supporting activities (maintenance,
repair and operating supplies), and
customer service (finished goods and
spare parts).
So why do you need inventory?
• In a just-in-time manufacturing environment,
inventory is considered waste. However, in
environments where an organization suffers
from poor cash flow or lacks strong control
over (1) electronic information transfer among
all departments and all significant suppliers,
(2) lead times, and (3)quality of materials
received, inventory plays important roles.
• Some of the more important reasons for
obtaining and holding inventory are:
• Predictability: To engage in capacity planning
and production scheduling, you need to
control how much raw material and how many
parts and subassemblies you process at a
given time. Inventory buffers what you need
from what you process.
• Fluctuations in demand: A supply of inventory
on hand is protection. You don’t always know
how much you are likely to need at any given
time, but you still need to satisfy customer or
production demand on time. If you can see
how customers are acting in the supply chain,
surprises in fluctuations in demand are held to
a minimum.
• Unreliability of supply: Inventory protects you
from unreliable suppliers or when an item is
scarce and a steady supply is difficult to
ensure. Whenever possible, unreliable
suppliers should be rehabilitated through
discussions or replaced.
• Quantity discounts: Often bulk discounts are
available if you buy in large rather than in
small quantities.
• Lower ordering costs: If you buy a larger
quantity of an item less frequently, the
ordering costs are less than buying smaller
quantities over and over again. (The costs of
holding the item for a longer period of time,
however, will be greater.)
• The acronym “SKU” stock keeping unit is a
common term in the inventory world. It
generally stands for a specific numeric or
alpha-numeric identifier for a specific item.
Functions of Inventory
Firms maintain inventory because of
economic reasons. Carrying inventory makes
it more economical to produce their products
than by not carrying it (Harding and
Harding 2001).
Also, inventory carried by firms have some
purpose (or function), of
which following are some important ones
(see Mahadevan 2015; Hill and Hill
2012):
• Decoupling
• Cycle (or Cyclical)
• Pipeline
• Buffer
• TYPES OF STOCK
• Inventory is basically divided into raw
materials, finished goods,and work-in-process.
• Raw materials: Used to produce partial
products or completed goods.
• Finished product: This is product ready for
current customer sales. It can also be used to
buffer manufacturing from predictable or
unpredictable market demand. In other
words, a manufacturing company can make up
a supply of toys during the year for predictably
higher sales during the holiday season.
• Work-in-process (WIP): Items are considered
to be WIP during the time raw material is
being converted into partial product,
subassemblies, and finished product. WIP
should be kept to a minimum. WIP occurs
because of such things as work delays, long
movement times between operations, and
queuing bottlenecks.
 Other categories of inventory should be considered
from a
functional standpoint
• Consumables: Light bulbs, hand towels, computer and
photocopying paper, brochures, tape, envelopes,
cleaning materials, lubricants, fertilizer, paint, dunnage
(packing materials), and so on are used in many
operations. These are often treated like raw materials.
• Service, repair, replacement, and spare items (S&R
items): These are after-market items used to “keep
things going.”As long as a machine or device of some
type is being used(in the market) and will need service
and repair in the future, it will never be obsolete.
• Quantity levels of S&R items will be based on such
considerations as preventive maintenance schedules,
predicted failure rates, and dates of various items of
equipment.
• Buffer/safety inventory: This type of inventory can
serve various purposes, such as:
• Compensating for demand and supply uncertainties.
• “Decoupling” and separating different parts of your
operation so that they can function independently
from one another.
• Anticipation Stock: This is inventory produced in
anticipation of an upcoming season, such as fancy
chocolates for Mother’s Day or Valentine’s Day.
• Transit inventory: This is inventory en route from
one place to another. It could be argued that
product moving within a facility is transit inventory,
but the common meaning refers to items moving
within the distribution channel toward you, items
outside of your facility, or items en route from your
facility to the customer.
Decoupling Inventory
Decoupling inventory is one that detaches a manufacturing process
from another.
Manufacturing a product typically requires several workstations,
usually in a
sequence. Raw material is fed to the first workstation, and after
processing it is
sent to the second workstation, and so on, until the last workstation in
the sequencefinishes the product. Workstations have different
processing capacities – some may finish processing faster while others
may take more time. A workstation in the
production line may also encounter a failure. If this happens, all
upstream workstations have to wait until the failed workstation is back
up online. Decoupling inventory is an intermediary inventory
maintained between two workstations. The function of this inventory is
to help smoothen the workflow between workstations and minimize
the impact of fluctuations.
Cycle Inventory
An organization does not procure all input materials at one go. In
most cases, they
also do not order one unit at a time. They order in batches, usually in
lot sizes that
are larger than those demanded by customers (see Chopra and
Meindl 2010,
pp. 246). For example, a manufacturing firm requiring 50,000 tons
annually may
order 4000 tons of steel to start with. The next order would be placed
when the
on-hand inventory is nearly depleted.
Mathematically,
if Q is the size of the order, then CI, the average cycle inventory, is given by
CI = Q/2
Pipeline Inventory
Manufacturing organizations procure input materials from their
suppliers. The
ordered materials are not received instantaneously. There is a delay
between
placement of orders and receipt of materials due to geographical
distance between
the supplier and the manufacturer. Inventory that is in transit (in
trucks, ships, etc.)
is referred to as pipeline inventory.
Mathematically,
PI = DL
where PI is the pipeline inventory, D is the demand, and L is the lead time.
Solved Problem
At the beginning of every month, a bicycle manufacturer, based in
Monterrey,
Mexico, places an order to procure lightweight steel tubes from their
suppliers
based in Leon, Mexico. Their average requirement is 1000 tons per
week, and the
procurement lead time is 14 days. Determine cycle and pipeline
inventory. Assume
4 weeks in a month.

Solution
Average weekly demand for steel tubes is 1000 tons. The monthly
demand (assuming 4 weeks in a month) is 4000 tons. The cycle
inventory from Eq. 1.1 is
CI = Q/2
= 4000/2
=2000 units
Since the procurement lead time is 14 days (or 2 weeks), using Eq. 1.2,
we get
pipeline inventory. Substituting the values, we get
PI = DL
= 1000 X 2
= 2000 tons
Inventory Management: Key Issues
• (a) How frequently should the inventory status
for an item be reviewed?
• (b) When should a replenishment order be
placed?
• (c) What should be the order size?
 characteristics of inventory items
• Demand: This is a key characteristic of an item in
any inventory system . Demand is generated by
people outside the firm, and therefore is mostly
uncontrollable.
• Replenishment Lead Time: Lead time is the time
between placement of a replenishment order and
the actual receipt of stock. Just like in the case of
demand, lead times for an item may be constant,
varying, or may be known with a probability
distribution.
• Inventory Level and Review Times: The
inventory level of an item may be known at all
times. In some cases, it may not be possible
(or may not be cost-effective)to monitor the
level of an item at all times. Instead, the level
of items is reviewed at certain predetermined
times.
• Lifetime & Reparability: An item may not
always have an indefinite lifetime. Its utility
value may drop to zero at some point after
which it may not have any takers (Nahmias
2005). Also, an item may fail but may be
repairable.
End of Session 1 & 2
BULL WHIP EFFECT
BULL WHIP EFFECT
Average Inventory turns
Average Inventory turns
End of session 3 & 4
 Inventory control systems
• Single Period systems
---Newsvendor model
• Multiple Period systems
---Economic order quantity
 Newsvendor model
• A simple way to think about this is to consider
how much risk we are willing to take for
running out of inventory.
• Let’s consider that the newsperson selling
papers in the sales stand had collected data
over a few months and had found that, on
average, each Monday 90 papers were sold
with a standard deviation of 10 papers.
 Inventory control systems
• Determine service rate say 80%
• To be 80 percent sure of not stocking out, we need to carry a few
more papers. From the cumulative standard normal distribution
table, we see that we need approximately 0.85 standard deviation
of extra papers to be 80 percent sure of not stocking out.
• A quick way to find the exact number of standard deviations
needed for a given probability of stocking out is with the
NORMSINV(probability) function in Microsoft Excel
(NORMSINV(0.8) = 0.84162). Given our result from Excel, which is
more accurate than what we can get from the tables, the number
of extra papers would be 0.84162 × 10 = 8.416, or 9 papers
• (There is no way to stock 0.4 paper!).
 Inventory control systems
• To make this more useful, it would be good to actually
consider the potential profit and loss associated with
stocking either too many or too few papers on the stand.
• Let’s say that our newspaper person pays $0.20 for each
paper and sells the papers for $0.50. In this case,the
marginal cost associated with underestimating demand is
$0.30, the lost profit. Similarly,the marginal cost of
overestimating demand is $0.20, the cost of buying too many
papers.
• The optimal stocking level, using marginal analysis, occurs at
the point where the expected benefits derived from carrying
the next unit are less than the expected costs for that unit.
Inventory control systems
 Inventory control systems
• our cost of overestimating demand (Co) is $0.20 per paper
and the cost of underestimating demand (Cu) is $0.30.
The probability therefore is 0.3/(0.2 + 0.3) = 0.6.
• Now we need to find the point on our demand
distribution that corresponds to the cumulative
probability of 0.6. Using the NORMSINV function to get
the number of standard deviations (commonly referred to
as the Z-score) of extra newspapers to carry, we get 0.253,
• which means we should stock 0.253(10) = 2.53 or 3 extra
papers.The total number of papers for the stand each
Monday morning, therefore, should be 93 papers.
Single-period inventory models are useful for a wide variety of service and
manufacturing
applications. Consider the following:
1. Overbooking of airline flights. It is common for customers to cancel
flight reservations
for a variety of reasons. Here, the cost of underestimating the number of
cancellations
is the revenue lost due to an empty seat on a flight. The cost of
overestimating
cancellations is the awards, such as free flights or cash payments, that are
given to
customers unable to board the flight.
2. Ordering of fashion items. A problem for a retailer selling fashion
items is that
often only a single order can be placed for the entire season. This is often
caused by
long lead times and the limited life of the merchandise. The cost of
underestimating
demand is the lost profit due to sales not made. The cost of overestimating
demand is
End of session 5
Leon Cardiology Centre in Mexico buys 25,000 stents each year from
its suppliers in Germany. Each stent costs $1500, and carrying cost is
26% of the value of the
average inventory of stents per year. If the ordering cost is $270 per
order,
determine the economic order quantity for stents. Also, determine the
number of
orders and the TICs.
Leon Cardiology Centre in Mexico buys 25,000 stents each year from
its suppliers in Germany. Each stent costs $1500, and carrying cost is
26% of the value of the
average inventory of stents per year. If the ordering cost is $270 per
order,
determine the economic order quantity for stents. Also, determine the
number of
orders and the TICs.

In this problem, the demand and carrying cost units are the same. Other information
we have are as follows:
• D is 25,000 per year.
• C is $1500 per stent.
• i is 26% per year, or 0.26.
• Co is $270 per order.
Substituting the values in the EOQ formula (Eq. 3.8), we get
The cardiology center needs to place an order for 186 stents each time
they place an order.
The number of orders can be determined using Eq. 3.2. Substituting
the values in Eq. 3.2, we get

The number of orders that need to be placed is 134 per year.

The TICs can be determined using Eq. 3.10. Substituting the values in Eq. 3.10,
we get

The TICs (ignoring the cost of investment) is $72,560

SleepWell Mattresses manufactures high-quality spring-based cotton
mattresses. A set of eight identical stainless steel springs are used to
produce a mattress. Theinventory holding cost for springs is $2.15 per
spring per year. SleepWell has
estimated an annual demand for 20,000 mattresses. Determine the
quantity of
springs SleepWell should procure to minimize the TICs for springs if the
ordering
cost per order is $50? Also, compute the average inventory level.
SleepWell Mattresses manufactures high-quality spring-based cotton
mattresses. A set of eight identical stainless steel springs are used to
produce a mattress. Theinventory holding cost for springs is $2.15 per
spring per year. SleepWell has
estimated an annual demand for 20,000 mattresses. Determine the
quantity of
springs SleepWell should procure to minimize the TICs for springs if the
ordering
cost per order is $50? Also, compute the average inventory level.
Inventory control systems
When to order-incorporating Lead time
Consumption of a bought-out item in a manufacturing organization is 100 per day.The
supplier supplies this item to the manufacturer at the rate of 300 per day. If the
carrying cost is $0.1 per item per day and the ordering cost is $250 per order,
compute the EOQ for this item.
Consumption of a bought-out item in a manufacturing organization
is 100 per day.The supplier supplies this item to the manufacturer at
the rate of 300 per day. If the carrying cost is $0.1 per item per day and the
ordering cost is $250 per order, compute the EOQ for this item.
Solved Problem 3.9
You have developed the following estimates for procuring an
item for your manufacturing operations:
• Item demand: 3600 units yearly (10 units per day)
• Purchase price: $25 per item
• Ordering cost: $35 per order
• Inventory holding rate: 25% annually
The following two options are available to you:
• Option 1: The supplier can supply all items at once.
• Option 2: The supplier can supply 15 items per day.
Compare the following for each of the options – total ordering
cost, total holding cost, cycle time, number of orders, and the
TICs.
Based on the information you have, which of the above options
would you prefer?
EOQ Model with Planned Shortages

EQ. 3.20

EQ. 3.18

EQ. 3.19
HOME WORK
Periodic Review Model: Deterministic Demand

Eq. 3.24
End of session 6 & 7
Step 1: Compute Order Size for All Values of Purchase Price
The first step is to compute the EOQ for each of the price-break values of $20 , $18,
and $16. We will use the following data that have been used in Chap. 3:
• Annual demand for vegetable oil is 7200 liters.
• Ordering cost Co is $80 per order.
• Unit cost C is $20 per liter (market price), $18 per liter if the order size is more
than 450 liters, $16 per liter if the order size is more than 500 liters.
• Inventory holding rate i is 30%.
 Service Levels and Safety Stock
Two types of service levels commonly used in
inventory management are
• (1) a measure based on the proportion of order
cycles in which no stockouts occur, called the
cycle service level and
• (2) a measure based on the proportion of
customer demands that are satisfied from the
inventory on hand, also referred to as the fill rate
(Nahmias 2005).
Determining Safety Stock Level
We can also use the graph to estimate the demand for a service level of, say
85%,
which corresponds to the 85th percentile value of the cumulative distribution
As can
be seen from the graph, this is 720. This means that there is an 85% chance
that the
demand for eggs in a given week may be up to 720. Alternatively, there is a
15%
chance that the demand for eggs in a given week may exceed 720. We can
now use
this information to compute the level of safety stock. The safety stock (SS sl) i
the
Since we know
difference that the
between the maximum
maximum demand
demand established
for eggs for for
a service
a givenlevel
service
of 85%
level (Dis
sl)

720 the
and and average
the average demand is 500, using Eq. 6.1, we have
demand

Thus, the safety stock required to maintain a service level of 85% is

220 eggs.
Solved Problem 6.1
Historical data presented in Table 6.4 shows a manufacturer’s weekly
demand for
an item that has a constant lead time of 1 week. The item costs $50 per unit.
The
manufacturer uses an inventory carrying rate of 20% per year. Determine the
safety
stock and the carrying costs if the manufacturer desires service levels of (a)
85%
and (b) 95%.
End of session 8 15.10.23
Reorder Level – Variable Demand, Constant
Lead Time
Reorder Level – Variable Demand, Constant
Lead Time
 Demand period is the time period for which demand is specified.

Case 1: If demand period is less than lead time

Consider the following example where the standard deviation of daily demand
is 4 units and the lead time is 3 days. Assuming the demand for each day is
independent, the standard deviation of lead time demand is equal to the square
root of the sum of the variances of daily demand (Jacobs and Chase 2011). In other
words
Solved Problem 6.3
The daily demand for an item is normally distributed with a mean of 100 units and a
standard deviation of 3 units. If the procurement lead time is 6 days, compute the
standard deviation of lead time demand.
Solved Problem 6.3
The daily demand for an item is normally distributed with a mean of 100 units and a
standard deviation of 3 units. If the procurement lead time is 6 days, compute the
standard deviation of lead time demand.
Solution
In this problem, demand period is 1 day (daily) and lead time is 6 days. Since demand
period is smaller than lead time, we use Eq. 6.6 to obtain the standard deviation of
lead time demand. The standard deviation of the daily demand is 3. The standard
deviation of lead time demand, assuming demand for each day is independent, is
Case 2: Demand period is greater than lead time

Consider a problem where the demand period is greater than lead time (e.g. demand
is annual and lead time is specified in days). If the standard deviation of demand
period is given and we need to determine the standard deviation of lead time
demand, we can use the following:

where n is the number of lead time periods that make up the demand period. For
example, if demand period is in months and lead time is in weeks, then n=4 (i.e.,
4 weeks make up a month). General rules to be followed are shown in Table 6.8
Solved Problem 6.4
The demand for an item in a month is normally distributed with a mean of 100 units
and a standard deviation of 3 units. If the lead time is 1 week, compute the standard
deviation of the lead time demand.
Solution
In this problem, the demand period is 1 month and lead time is 1 week. Since
demand period is greater than the lead time, we use Eq. 6.7 to obtain the standard
deviation of lead time demand. We assume there are 4 weeks in a month, so n=4.
Using Eq. 6.7, and substituting the values, we get

The standard deviation of lead time demand is 1.5 units.

Order Quantity – Variable Demand and Constant Lead Time
Let us consider the case when demand is variable and the lead time is constant. We
make the following assumptions:

• The inventory system is reviewed periodically with a review period of T days.

• The inventory system involves a single item.
• Demand for the item is random, but the distribution governing the demand is
known or can be estimated. We assume the demand is normally distributed with
a known mean and standard deviation.
• Lead time, L, is known and constant.
• An order of size Q is placed on completion of the review. The size of the order is
such that it brings the inventory on hand, I, up to a maximum level, S, specified
by the management. Q will, therefore, vary from period to period.
The first step in solving the variable demand, constant lead time review period
problem is to determine the optimal review period T. This can be computed using
Eq. 3.24 from Chap. 3, which is reproduced as follows:
Periodic Review Model: Deterministic Demand

Eq. 3.24
Solved Problem 6.13
A retail shop uses a periodic review inventory system. The annual demand for a
consumer product sold by the shop is 5500 units, the ordering cost is $43 per order,
and the inventory carrying rate is 35% per year. The product costs $100 per unit.
The daily demand for the product is normally distributed with a mean of 15 units
and a standard deviation of 3 units. If the procurement lead time is a constant 5 day
and the retail shop desires a 90% probability of no stock out during lead
time,
compute:
(a) Optimal review period
(b) Safety stock, SS
(c) Maximum inventory, S
(d) Order quantity, if the on-hand inventory is 24 units.
(e) New safety stock if the shop intends to use a new service level
criterion – that is to limit stock out to 1 order cycle per year (instead of
90% service level)
Factors affecting classification of Inventory
models
Inventory Management: Key Issues
• (a) How frequently should the inventory status
for an item be reviewed?
• (b) When should a replenishment order be
placed?
• (c) What should be the order size?
 Inventory control systems
• Review frequency
• Timing of replenishment order
• Size of replenishment order

• An inventory control system is one that

integrates these three factors into one whole.
Frequency, timing, and order size are the key
design factors of any inventory control system.
 Inventory control systems
• • Continuous Review, Fixed Order Quantity
(s,Q) System.
• • Continuous Review, Order-Up-to-Level (s, S)
System.
• • Periodic Review, Order-Up-to-Level (T, S)
System.
Inventory control systems
 Inventory control systems
How much should we order?

Every time we place an order, there are associated costs for

administration, delivery, and so on.

If we place large, infrequent orders,

the costs of ordering and delivery are kept low, but stock levels and
average inventory value are high.

If we place small frequent orders, costs of ordering and delivery are high,
but average stock level is low.

In general, we will look

for a compromise between these two extremes that minimizes overall
cost.
Inventory classification
Inventory classification techniques
Inventory classification
Inventory classification
Inventory classification
End of session 9 23.10.23
Independent demand methods assume that the demand for an item is
independent
of the demand for any other item. Then the aggregate demand for an item is
made up of many independent demands from separate customers – in the
way that the overall demand for milk in a supermarket is made up of many
small demands from separate customers.
customer order decoupling point, which is a point
where inventory is positioned to allow processes or
entities in the supply chain to operate independently.
For example,
if a product is stocked at a retailer, the customer pulls
the item from the shelf and the manufacturer never
sees a customer order.
Frameworks for Inventory Management and
Production Planning and
Scheduling