IES 303

Chapter 15: Inventory Management

Supplement E

Week 13
February 2, 2006
Learning Objectives:
Understand the practical aspects of various inventory systems
Identify the major factors affecting inventory system performance
Understand how to calculate the optimal order quantity in various
circumstance
1
Inventory Management

Inventory : Stock of items held to meet future demand

Determine the amount of inventory to keep in stock

Inventory management answers two questions:

_________________________
________________ or
________________ (EOQ)
_________________________

2
Physical Types of Reasons to Hold
Inventory Inventory

Raw materials Meet unexpected demand

Purchased parts and supplies Smooth seasonal or cyclical
demand
Labor
Meet variations in customer
In-process (partially demand
completed) products
Take advantage of
Component parts price discounts
Tools, machinery, and Quantity discounts
equipment

3
 Pressures for Low Inventories
When keeping inventory, there are
always some cost incurred ________
___________________________
The variable cost of keeping items on
hand
$/ unit-period
Inventory holding cost generally
includes:
_________________________
_________________________
_________________________
4
Pressures for High Inventories
Customer service
Ordering cost ($ / order)
Setup cost
Transportation cost
Payment to suppliers
Labor and equipment
utilization

5
Types of Inventory
Cycle Inventory

Safety stock inventory

Anticipation inventory

Pipeline inventory

6
Inventory Reduction Approach
Cycle Inventory

Safety stock inventory

Anticipation inventory

Pipeline inventory

7
 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

8
ABC Analysis
100 Class C
Class B
90
Class A
Percentage of dollar value

80

70

60

50

40

30

20

10

0
10 20 30 40 50 60 70 80 90 100 9
Figure 15.2
Percentage of items
 Economic Order Quantity (EOQ)
EOQ: the lot size or order size that minimizes total annual
inventory holding and ordering cost
Total inventory cost = Holding cost (HC) + ordering cost (OC)
Assumptions for Basic EOQ Model
____________________________________________

____________________________________________

____________________________________________

____________________________________________

____________________________________________

10
Basic EOQ Model
Cycle Inventory Levels
Order quantity, Q
Inventory Level

0 Lead Time
time
Order Order Order Order
placed receipt placed receipt
11
Basic EOQ Model
Graphs of Annual Holding, Ordering, and Total
Costs

Total cost = HC + OC
Annual cost (dollars)

Holding cost (HC)

Ordering cost (OC)

Figure 15.4 Lot Size (Q) 12

Basic EOQ Model
Derivation of total annual inventory cost and economic order quantity order
quantity functions

Q D Q = order size (units)

C ( H ) (S ) D = annual demand (units/year)
2 Q S = ordering cost per order ($/order)
H = annual per unit carrying cost ($/unit)

2 DS
EOQ
H

EOQ
TBOEOQ (12 months/year)
D
13
 Basic EOQ Model
Ex 1:Carpet Sell
The I-75 Carpet store stocks carpet in its warehouse and sells it
through a showroom. The store keeps several brands and
styles of carpet in stock; however, its bigger seller is the BIG
C carpet. The store wants to determine the optimal order
size and total inventory cost for this brand of carpet given an
estimated annual demand of 10,000 yards of carpet, an
annual carrying cost of $0.75 per yard, and an ordering cost
of $150.

The store would like to know the number of orders that will be
made annually and the time between orders given that the
store is open every except Sunday, Thanksgiving Day and
Christmas Day. 14
EOQ Sensitivity Analysis
Use estimates of relevant costs
Ignore uncertainty in demand
What happen if the holding / ordering cost is off by 20%,
30%?
Consider 4 cases of variations of the model parameters.
1. Both ordering and carrying costs are 10% less than the original
estimates
2. Both are 10% higher
3. Ordering cost is 10% higher and carrying cost is10% lower
4. Ordering cost is 10% lower and carrying cost is 10% higher

Determine EOQ in each case. Remark on the sensitivity of Q on the

estimated total cost. 15
Basic Types of Inventory Control System
Continuous review system
________________________
________________________
The ordering interval may not be consistent
Manager has direct control

Periodic review System (P)

________________________
________________________
No direct control
Tend to have higher inventory to prevent stockout

16
Continuous review system

IP IP IP

Order Order Order Order

received received received received
On-hand inventory

Q Q Q

OH OH OH

R
Order Order Order
placed placed placed

L L L Time
17

TBO TBO TBO

 Continuous review system
Selecting Reorder Point
When demand is certain
Reorder point (R) = demand during lead time

When demand is uncertain

Reorder point (R) = Avg demand during lead time + Safety stock

18
Variable Demand
Safety Stocks
Safety stock

________________

Inventory level

Q
________________

Stockout
an inventory shortage
Reorder
point, R
Service level
________________
________________ 0
LT LT
Time
Variable Demand with Reorder Point
19
 Variable Demand
Safety Stocks
Prevent stockout under uncertain demand
Inventory level

Q
Reorder
point, R

Safety Stock
0
LT LT 20

Time
Reorder Point for a Service Level
Probability of
meeting demand during
lead time = service level

Average demand
during lead time Probability of
a stockout

Safety stock
zt L

Demand R
21
Reorder Point with Variable Demand
Reorder point with safety stock
Service level = probability of NO stockout

R dL z t L
d average demand
L lead time
t standard deviation of demand
z number of standard deviations corresponding to
the service level probabilit y
z t L safety stock 22
Variable Demand
Ex 2: PM computer
PM Computers assembles microcomputers from generic
components. It purchases its color monitors from a
manufacturer in Taiwan. There is a long lead time of 25
days. Daily demand is normally distributed with a mean of
2.5 monitors and a standard deviation of 1.2 monitors.
Determine the safety stock and reorder point corresponding
to a 90% service level

23
Periodic Review System (P system)
T
IP IP IP
Order Order Order
received received received
On-hand inventory

Q3
Q1
OH Q2 OH
IP1

IP3
Order Order
placed placed
IP2

L L L Time
P P
24
Protection interval
Figure 15.12
 Special Inventory Model
Noninstantaneous
Replenishment

Production quantity
Q
On-hand inventory

Demand during
production interval
Imax
Maximum inventory

pd

Time
Production Demand
and demand only 25

TBO
Figure E.1
Special Inventory Model
Noninstantaneous Replenishment

pd
Imax =
Q
p
(
(p d) = Q p )
Imax D Q pd
C = 2 (H) +
Q
(S) (
C =2 p ) +
D
Q
(S)

2DS p
ELS = H pd
26
 Noninstantaneous Replenishment
Ex 3: Cheese Maker
The Wood Valley Dairy makes cheese to supply to stores in its
area. The dairy can make 250 lbs of cheese per day, and
the demand at area stores is 180 lbs per day. Each time the
dairy makes cheeses, it costs $125 to set up the production
process. The annual cost of carrying a pound of cheese is
$12.

Determine the followings:

- The optimal order size and the minimum total annual
inventory cost
- Length of time to receive an order, production run
- Number of orders per year
- Maximum inventory level 27
 Special Inventory Model
Quantity Discount
Price discount for higher quantity orders
Q D
Include the purchase price in EOQ model C H S PD
2 Q
P = Unit price of item
TC = ($10 )
TC (P1 = $8 )
Inventory cost ($)

TC (P2 = $6 )

Carrying cost

Ordering cost
28
Q(P1 ) = 100 Qopt Q(P2 ) = 200
Quantity Discount
Ex 4: Sweatshirt in bookstore

The UW bookstore purchases sweatshirts with school logo from a

vendor. The vendor sells the sweatshirts to the store for $38 a
piece. The cost to bookstore for placing an order is $120, and the
annual carrying cost is 25% of the cost of sweatshirt. 1700
sweatshirts are estimated to be sold during the year. The vendor
has offered the bookstore the following volume discount:
Order Size Discount
1-299 0%
300-499 2%
500-799 4%
800 and up 5%

29
What is an optimal order quantity?