Inventory Management 1

Inventory Management
Inventory
Inventory is stock or store of goods
Types of Inventory
 Raw material
 Work-in-process
 Finished goods
 Maintenance and repairs (MRO) inventory: Maintenance, repair, spare parts
Functions of Inventory
• To meet anticipated demand

• To smooth production requirements – seasonal
• To protect against stockouts
• To take advantages of quantity discounts
• To permit operations – about WIP
Inventory Management-Purpose
 Order Quantity (How many units to order)

 When to order
Two Forms of Demand
Dependent Demand: for items used to produce final

products
Independent Demand: for items used by external

customers
COPYRIGHT 2006 JOHN WILEY & SONS, INC. 12-5

Inventory Cost
• Ordering cost
• Requisition and purchase orders, transportation and shipping, receiving, inspection
• Holding/Carrying cost:
• Facility storage (rent, depreciation, power, lighting, security, refrigeration, taxes, insurance)
• Labor
• Record keeping
• Borrowing to purchase inventory (interest on loans, taxes, insurance)
• Product deterioration, spoilage, breakage, obsolescence etc.
• Shortage cost-Reputation cost
ABC Analysis:
How inventory items can be classified
A-B-C approach classifies inventory items according to measure of importance, and then
allocates control efforts according to their relative importance
80% volume contributes to 20% value
20% volume contributes to 80% value
Class A: Very Important

10-15% volume contributes to 60-70% value
A
Value/ Cost
B Class B: 20-30% volume contributes to 20-30% value
C Class C: 60-70% volume contributes to 5-10% value
Quantity
Inventory Models for Independent demand
Economic Order Quantity (EOQ) model
EOQ is the order quantity that minimizes total cost.
Assumptions:
 Only one product is involved

 Annual demand requirements are known
 Demand is spread evenly
 Lead time does not vary
 No quantity discount
EOQ is the order quantity that minimizes total cost
Inventory ordering & usage cycles:

- Begin with receipt of an order of Q units
- Withdrawn at constant rate over time (Usage rate constant)
- When quantity is just sufficient to meet demand for lead time, order Q units
- Order will be received at the precise instant that the inventory on hand falls to zero
Quantity
Re-order
ROP
Point
Order LT Order Order LT Order Time

placed receipt placed receipt
Lead Time, LT
Economic Order Quantity (EOQ) model: Cost Characteristics
Total cost
Annual Cost Holding cost
Material cost
Ordering cost
EOQ-Optimum Order Order Quantity
Quantity
Order Cycle: Time between receipt of orders in an inventory cycle.
Q
Annual holding cost = H
2
Annual ordering cost = D S
Q
Developing EOQ model
Q
Annual holding cost = H
2
D
Annual ordering cost = S
Q
Q D
Total cost = TC  H  S
2 Q
Q D
Total cost (including material) = TC  H  S  D * P
2 Q
2 DS
For minimum cost, Q
H
Sharp, Inc., a company that markets painless hypodermic needles to hospitals, would like to reduce its
inventory cost by determining the optimal number of hypodermic needles to obtain per order. The annual
demand is 1,000 units; the setup or ordering cost is $10 per order; and the holding cost per unit per year is
$.50.
Sharp, Inc., a company that markets painless hypodermic needles to hospitals, would like to reduce its
inventory cost by determining the optimal number of hypodermic needles to obtain per order. The annual
demand is 1,000 units; the setup or ordering cost is $10 per order; and the holding cost per unit per year is
$.50.
Sharp, Inc. has a 250-day working year and wants to find the number of orders ( N ) and
the expected time between orders ( T )
The Warren W. Fisher Computer Corporation
purchases 8,000 transistors each year as components
in minicomputers. The unit cost of each transistor is
$10, and the cost of carrying one transistor in
inventory for a year is $3. Ordering cost is $30 per
order. What are
(a) the optimal order quantity,
(b) the expected number of orders placed each year,
and
(c) the expected time between orders? Assume that
Fisher operates on a 200-day working year.
Determining when to order: Reorder Point:
The level of inventory at which a new order should be
placed
1. The ePaint Internet Store is open 311 days per year. If annual demand is 10,000 gallons of Iron coat paint and the lead
time to receive an order is 10 days, determine the reorder point for paint.
2. Whole Nature Foods sells a gluten-free product for which the annual demand is 5,000 boxes. At the moment, it is paying
$6.40 for each box; carrying cost is 25% of the unit cost; ordering costs are $25. A new supplier has offered to sell the same
item for $6.00 if Whole Nature Foods buys at least 3,000 boxes per order. Should the firm stick with the old supplier, or take
advantage of the new quantity discount?
Economic Production Quantity (EPQ) Model
Production quantity that minimizes total cost
Assumptions
• Only one product is involved

• Annual demand requirements are known
• Production as well as usage rate is constant
• Usage occur continuously but Production occur periodically
• Lead time does not vary
• No quantity discount
Here, Production and Usage occur simultaneously

Production & Usage cycle
Quantity
Production Production
& Usage Usage only & Usage Usage only Q0 = Run Size, No. of Units
Run (Lot) size Q0 H = Holding cost per unit per year

Cumulative
production S= Set up Cost
Imax
p = Daily production rate
Inventory
u = Daily demand rate, or usage rate
Time
t = Length of the production run in days
 u
I max  Q0 1   Imax= Maximum inventory level
 p
EPQ
Cost Calculations
I max  u
Annual holding cost = H I max  Q0 1  
2  p
D
Annual Order cost = S
Q0
I max D Q  u D
Total cost = TC  H S  0 1   H  S
2 Q0 2  p Q0
2 DS p
For minimum cost, Q0 
H p u
Nathan Manufacturing, Inc., makes and sells specialty hubcaps for the retail automobile aftermarket. Nathan’s forecast for
its wire-wheel hubcap is 1,000 units next year, with an average daily demand of 4 units. However, the production process is
most efficient at 8 units per day. So the company produces 8 per day but uses only 4 per day. The company wants to solve
for the optimum run size. ( Note: This plant schedules production of this hubcap only as needed, during the 250 days per
year the shop operates.)
A toy manufacturer uses 48,000 rubber wheels per year for its popular dump truck series. The firm makes its own wheels, which
it can produce at a rate of 800 per day. The toy trucks are assembled uniformly over the entire year. Carrying cost is $1 per
wheel a year. Setup cost for a production run of wheels is $45. The firm operates 240 days per year. Determine the following:
a. Optimal run size
b. Maximum Inventory level
c. Minimum total annual cost
d. Run time
e. Number of run in a year

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Inventory Management

• To meet anticipated demand

 Order Quantity (How many units to order)

Dependent Demand: for items used to produce final

Independent Demand: for items used by external

COPYRIGHT 2006 JOHN WILEY & SONS, INC. 12-5

80% volume contributes to 20% value

20% volume contributes to 80% value

Class A: Very Important

B Class B: 20-30% volume contributes to 20-30% value

C Class C: 60-70% volume contributes to 5-10% value

 Only one product is involved

Inventory ordering & usage cycles:

Order LT Order Order LT Order Time

Annual Cost Holding cost

• Only one product is involved

Here, Production and Usage occur simultaneously

Run (Lot) size Q0 H = Holding cost per unit per year

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