Inventory
Management
Chapter 10 in Book 1
Lecturer: Nguyen Thi Hong An
School of Business
INTERNATIONAL UNIVERSITY
Updated in 2025
Contents
1. Inventory System
2. Inventory Models
3. Replenishment Policies
4. Vendor Managed Inventory (VMI)
Lecturer: Nguyen Thi Hong An
Inventory System
01
Lecturer: Nguyen Thi Hong An
Stock vs. Inventory
01 02
Stock consists of all the Inventory is a list of
goods and materials items held in stock.
held by an organization.
03 04
The main purpose of Recently, Inventory is used
stocks is to act as a for both the list of items
buffer between supply and and the stock itself, and
demand Allow the two terms then
operations to continue become interchangeable.
smoothly and avoid
disruptions
INVENTORY SYSTEM
5
TYPES OF INVENTORY
7
INVENTORY PROFILE
Inventory (Stock)
Usage Avg.
Order invento
quantity = rate
ry on
Q hand
(max.
inventory Q
level, lot 2
size)
level
Min.
invento
ry
0 Tim
Stock
Cycle e
8
PURPOSE OF
INVENTORY
Lea
d
tim
e
Why
Economi
es of holding Uncertainty
scales inventor
y?
Short
product
life cycle
9
ABC INVENTORY
CONTROL SYSTEM
• Auseful tool to determine which inventories should be counted
more frequently and managed more closely and which others
should not.
• ABC analysis is often combined with the 80/20 rule or Pareto analysis.
– This rule suggests that 80 percent of the objective can be achieved by doing
20 percent of the tasks,
– but the remaining 20 percent of the objective will take up 80 percent of
the tasks.
• This system classifies inventory items into groups A, B, and C.
1
0
ABC INVENTORY
• The
CLASSIFICATION
A items are given the highest priority, while C items have the
lowest priority and the B items fall somewhere in between.
• The priority is most often determined by annual dollar usage.
However, priority may also be determined by product shelf life,
sales volume, whether the materials are critical components, or some
other criteria.
• A summary of the classification is provided
1
1
INVENTORY
CLASSIFICATION-
Unit Cost
ANNUAL
Annual Annual DOLLAR
Percentage of
USAGE Item
($)
Usage
(Units
Usage
($)
Total Annual
Dollar Usage
) (%)
1 1.5 5,000 7,500 2.9
0
2 8.00 1,500 12,00 4.7
0
3 10.50 10,000 105,00 41.2
0
4 2.00 6,000 12,00 4.7
0
5 0.50 7,500 3,750 1.5
6 13.60 6,000 81,60 32.0
0 1
7 0.75 5,000 3,750 1.5 2
PARETO
CHART
45.0 120.0
% %
40.0
% 100.0
Cumulative % Usage
35.0 %
%
Percent Usage
30.0 80.0
% %
25.0
% 60.0
20.0 %
%
15.0 40.0
% %
10.0
% 20.0
5.0 %
%
0.0 0.0
% 3 9 2 4 1 8 5 7 %
6 1 0
Item No.
Percentage of Total Dollar Cumulative 15
Usage Percentage
EXAMPLE
A small store has ten categories of product with the following
costs and annual demands:
Question: Do an ABC analysis of these items.If resourcesfor
inventory control are limited, which items should be given least
attention?
16
Inventory Models
02
Economic Order Quantity (EOQ) Model
Holding Cost Assumptions of the Optimal Order Size Optimal Order Size
and Ordering EOQ Model (1/2) (2/2)
Direct variable Further calculations
Cost costs with Demand is known and Total inventory
placing an order. constant. cost (TIC) and detailed
Order costs include Order lead time is known and formula. solution.
managerial and clerical constant. Derivation and
costs. Replenishment is calculation of
Holding costs for storing instantaneous. EOQ.
inventory. Price is constant. Example with
Calculations include various Holding and order costs are data for order
expenses. known and constant. size
2.1. ECONOMIC ORDER QUANTITY
(EOQ)
•
MODEL
The model is a classic independent demand inventory system that
provides many useful ordering decisions.
• The basic order decision is to determine the optimal order size
that
minimizes total annual inventory costs (the sum of the annual order
cost
and the annual inventory holding cost).
• In EOQ computations, the term carrying cost is often
used in place of
holding cost and setup cost is used in place of order cost.
19
HOLDING COST AND
ORDERING COST
Ordering cost/ Setup cost Holding cost/ Carrying
cost
• Direct variable
with placing costs with
an order associated•
the The costs
inventory incurred for
in storage
holding
supplier • Holding costs include
• Order costs include handling charges, warehousing
managerial
and clerical costs for preparing expenses, insurance, pilferag
the purchase, as well as shrinkage, taxes, and the
e, cost
other
incidental expenses traced of
capital. obsolescence (or
directly to the purchase Also
spoilage) value the
• Ex: time, placing stored productdrops
cost: of because
buyer
Transportationorder,
costs, its market value or quality
receiving costs, … falls.
20
ASSUMPTIONS OF THE
EOQ
• The demand is known and constant.
MODEL
• Order lead time is known and constant.
• Replenishment is instantaneous. The entire order is delivered at one
time and partial shipments are not allowed.
• Price is constant. Quantity or price discounts are not allowed.
• The holding cost is known and constant.
• The order cost is known and constant.
• Stockouts are not allowed. Inventory must be available at all times.
21
OPTIMAL ORDER
SIZE
The EOQ can be (1/2)
derived from the total cost formula as follows:
Total Cost = Purchase cost + Holding/Carrying cost + Ordering/Setup cost
𝑻𝑪 = 𝑫∗𝑪 + (𝑸/𝟐) ∗ 𝑯 + (𝑫/𝑸) ∗ 𝑺
Total inventory cost (𝑻𝑰𝑪) = (𝑸/𝟐) ∗ 𝑯 + (𝑫/𝑸) ∗ 𝑺
The optimum Q (the EOQ) can be obtained by taking the first derivative of
TC with respect to Q and then setting it equal to zero.
𝟐𝑫𝑺 𝟐𝑫
=𝟎
Q: Quantity in a lot or batch size/Order size
𝒅𝑻𝑪
𝑺𝒉
(units)
D: Demand per unit time
𝒅
→ 𝑬𝑶𝑸 = 𝑸∗ =�
C: Unit cost = average price/unit purchased
𝑸 𝑪
�
=
S: Cost per order placed or setup cost,
($/unit)
($/order)
H: Holding/Carrying = hC
h: cost
($/unit/year)
fraction of the unit cost of the
product
2
N: Number of orders per time 0
OPTIMAL ORDER SIZE
(2/2)
23
EXAMPLE 1
• The store S has observed a stable monthly demand for its
line of mobile phone iPhone of 100 pcs per month. The
store incurs a setup cost of $2,000 every time it places an
order for additional iPhones. The store pays $200 per iPhone.
The store’s out-of-pocket costs of storing an iPhone for a
year are about 10% and the opportunity cost of capital is 15%.
Question: What order size do you recommend for the S store?
24
EXAMPL
• John Pritchard E stationery
buys 2 for Pen Motors. The
demand for printed forms is constant at 20 boxes a month.
Each box of forms costs £50, the cost of processing an
order and arranging delivery is £60, and holding cost is £18 a
box a year.
Question: What are the economicorder quantity, cycle
length and inventory costs?
25
INSIGHTS FROM EOQ
FORMULA
• Fixed Cost Reduction:
– Leads to smaller orders/batches
• Sales growth:
– Suppose sales quadruple
– Average inventory only doubles
• Centralization of inventory:
– Suppose four equal sizes hospitals “pool” their
inventories
– Total inventory cut in half
26
2.2. QUANTITY
DISCOUNT MODEL
• The quantity discount model is one variation of the EOQ model.
• It relaxes the constant unit price assumption by allowing purchase
quantity discounts the unit price of an item is allowed to vary with the
order size.
• Discounts offerings with quantity constitute motives for
ordering higher
quantities and hence, holding larger inventories.
• Therefore, it becomes crucial to find the trade-off between price
discount and
cost increase due to keeping larger inventory. 27
TOTAL COST CURVE FOR
THE QUANTITY
DISCOUNT MODEL (1/2)
28
TOTAL COST CURVE FOR
THE QUANTITY
DISCOUNT MODEL (2/2)
29
QUANTITY DISCOUNT
STEPS
1. For each discount price level (P), compute
𝟐𝑫𝑺
EOQ:
𝑬𝑶𝑸 = 𝟐𝑫𝑺
=
𝑸 ∗
𝑯
= discount, then 𝒉𝑷
𝑄 = 𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑓𝑜𝑟 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡
2. If EOQ < Minimum for adjust the quantity to
𝑪 = 𝑫 ∗ 𝑷 + (𝑸/𝟐) ∗ 𝑯 + (𝑫/𝑸) ∗ 𝑺
3. For each EOQ, compute the total cost:
4. Compare total cost and choose the lowest cost quantity from
all levels.
30
EXAMP
LEis negotiating the air-conditioning units’
• The retailer of Heat International
respective purchase cost along with the quantity ordered. Heat
International offers the discounts summarized in the table provided below:
• The total demand for air-conditioning units is 6,500 units/year. Ordering cost
is €50
and the annual inventory holding cost is estimated 25% of the unit’s price.
Question: How many air-conditioning units should the retailer order to minimize
its total annual cost?
31
Quantity Discount Model
Total Cost Curve for the Quantity Discount Model
Steps for quantity 01.
discount calculation.
02. Example with
detailed steps and
Calculation of the solution.
minimum total annual 03.
cost and optimal
ordering quantity.
03
Replenishment
Policies
Continuous and Periodic Review
Continuous Review
Continuous Review Periodic Review Policy (s, Q)
Orders fixed quantity Q Inventory checked at Orders same quantity Q
when inventory hits regular intervals. when inventory hits
Reorder Point (ROP). Order placed to raise reorder point s.
inventory to Order up to
Level (OUL).
Continuous Review Periodic Review Periodic Review
Policy (s, S) Policy (nQ, s, R) Policy (s, S, R)
Orders inventory up to Orders nQ to bring Orders to predetermined level S if
predetermined level S inventory between s and inventory below s.
when below reorder point (s+Q). Addresses deficiency of (S, R)
policy.
s. Example given with
Comparison to periodic review
specific values.
CONTINUOUS AND
PERIODIC REVIEW
• Continuous Review: Inventory is continuously monitored
and an order fixed quantity Q is placed
when the inventory reaches the Reorder Point (ROP).
• Periodic Review: Inventory is checked at regular/periodic intervals
T and an
order is placed to raise total inventory to the Order up to Level (OUL).
35
CONTINUOUS REVIEW
• (s, Q)
SYSTEM
continuous review policy: This policy orders the same
quantity Q when the inventory reaches the reorder point s. The
quantity Q can be determined by one of the fixed order
quantity methods (such as the EOQ).
• (s, S) continuous review policy: When current inventory reaches or
falls below the reorder point s sufficient units are ordered to bring
the inventory up to a predetermined level S.
• For instance, suppose 𝑠 = 10, 𝑆 = 120, and current inventory is 11
units. If the next demand is 3 units, then on-hand inventory will
be reduced to 8 units. Consequently, an order size of 112 units
would be released.
36
PERIODIC REVIEW
• (nQ, SYSTEM (1/3)
s, R) periodic review policy: If at the time of inventory
review, the inventory is equal to or less than the reorder
point s, the quantity nQ is ordered to bring the inventory up to
the level between s and (s + Q).
• Recall that n= 1, 2, 3, …, and the order size is then some multiple
of Q. No
order is placed if the current inventory is higher than the reorder
point.
• For example, let 𝑠 = 100 and 𝑄 = 50. If the current inventory is
20 units at the time of the review, then 2Q quantities (2 x 50 =
37
PERIODIC REVIEW
SYSTEM (3/3)
• (s, S, R) periodic review policy: If at the time of inventory
review, the physical inventory is equal to or less than the
reorder point s, a sufficient quantity is ordered to bring the
inventory level up to the maximum inventory level S.
• However, if the physical inventory is higher than the reorder point
s, no order is placed. This policy addresses the major deficiency of
the (S, R) policy.
38
PERIODIC REVIEW
SYSTEM (3/3)
• (S, R) periodic review policy: At each review time, a sufficient
quantity is ordered to bring the inventory up to a
predetermined maximum inventory level S.
• This policy places a variable-sized order as long as the inventory is less
than the maximum inventory level S.
• If order cost is high, this is obviously not a preferred
system. However, it may work well if a large variety of items
are ordered from the same supplier
39
04
Vendor Managed
Inventory (VMI)
Vendor Managed Inventory
01 02 03
Third- party managementSupplier Benefits include
of inventory control. manages stocks, coordinated stocks,
sends more efficient transport, supply
when needed.
chain integration, and
consistent customer
service.
VENDOR MANAGED
INVENTORY
• If an organisation is trying to reduce the amount of effort it
puts into inventory control, one option is to leave the whole
problem to a third party.
• Have another organization look after the stock control The
most common arrangement of this kind is vendor managed
inventory.
• With vendor managed inventory, the wholesaler controls the
stocks, and sends more along when they are needed.
• The benefits: the supplier can co-ordinate stocks over 42a
Thanks
Lecturer: Nguyen Thi Hong An
School of Business
INTERNATIONAL UNIVERSITY
Updated in 2025
