4th Edition

N. D. Vohra

Quantitative
Techniques in
Management

© 2010
Chapter 9

Inventory
Management
Contents

1. Types of Inventory
2. Inventory Decisions and
Costs
3. Fixed Order Quantity
System
Classical EOQ Model
EOQ with Price Breaks
EOQ Model for
Production Runs
EOQ with Planned
Shortages
4. Determination of Safety
Stock
a)When Stock-out Costs
are Known
Contents
(…continued)
5. Periodic Review System
6. Ss System
7. One-period Model of
Inventory Management
8. Selective Approaches to
Inventory Control
ABC Analysis
VED Analysis
HML Analysis
SDE Analysis
S-OS Analysis
FSN Analysis
XYZ Analysis
In ven tory D ecision s
an d C osts
Basic Inventory Decisions


1. W h e n sh o u ld th e o rd e r b e
p la ce d ?
2. What is the quantity for
which the order be
placed?
3. What level of safety stock
be kept?


Inventory Costs


1. Purchase cost (Nominal

cost)
2. Ordering cost/ Setup cost
3. Carrying cost/Holding cost
4. Stock out cost (Back-
ordering cost)
In ven tory
M an ag em en t
SFiystem s
xe d O rd e r Q u a n tity S yste m
 ( Q - system )
 Order quantity is fixed and
order placed when the stock
level reaches a pre-determined
re-order point


Periodic Review System

 (P - system)
 Orders are placed
periodically at fixed
intervals while ordering
quantities can vary


Ss System
 Combines the features of P
and Q systems
Inventory Models:
Classical EOQ Model
 Assumptions:
1. The annual demand is fixed and
uniformly distributed
2. The lead time is fixed
3. The ordering cost per order if
same irrespective of the
order quantity The holding
cost per unit per year is
fixed
4. The holding cost per unit per
year is fixed
5. The unit cost of the item is same
irrespective of the order
quantity. No discounts for
large orders
6. The units ordered for each time
arrive in a single lot
7. Shortages are not permitted
For this model,

Relevant costs: Ordering and Holding

costs
At EOQ: Ordering cost = Holding cost
At EOQ, Total Cost is minimum
C lassicalEO Q M od el
(…continued)
EOQ, Q * = 2 AD
h

The holding cost, h, may be given. If

holding rate I is given, then h = ic,
where c is the unit cost of the item
Total Relevant Cost,
 T(Q*) = Ordering Cost + Holding
Cost
Also,
T(Q*) = 2 ADh
Optimal interval between successive
orders (Inventory cycle) T* = EOQ/D
Number of orders = D/EOQ or Rec. T*
For an order quantity (Q) other than EOQ,
 T(Q) = T(Q*)×0.5{k + 1/k},
 where k = Q/EOQ. Thus, for an
order quantity 25% higher than EOQ,
k = 1.25, and T(Q) = T(Q*) × 1.025
C lassicalEO Q M od el
(…continued)
Graphical Determination of the
EOQ
Ordering Cost
tsoC

Total Cost
Holding Cost

Order Size
EOQ
Inventory Profile:
Classical EOQ Model

Re-order Level = Demand Rate × Lead Time

Maximum Stock
Order Quantity
Q
Average Stock
Level

Time

Lead Time
Re-order Level Inventory
Cycle
Inventory Models: EOQ
with Price-breaks
Assumptions are the same as of
classical model, except No. 5

Lower prices are offered for large

orders. Hence the name price-breaks
or quantity discount model

Since unit cost varies with order

size, the relevant costs are:
Nominal, Ordering and Holding costs

Total Cost determined at feasible

EOQ and at each further price-break
to find optimal order quantity.
This is because the total cost
curve is not regular and smooth. It
is discontinuous at the points of
price-breaks. The cost curve is
evaluated at each price break after
the feasible EOQ so as to determine
the minimum point on the curve
Inventory Models:
Build-up Model/EOQ Model
for Production Runs
Used where source of supply is
internal
Based on same assumptions as
classical EOQ model except that
supplies are gradual here since
source of supply is internal
Relevant costs: Set-up and Holding
costs
At Economic Lot Size (ELS), TC is
minimum and Set-up cost =
Holding cost
If p be the rate of procurement
and d is the rate of demand, then

ELS = 2 AD
h
p
p −d

(
T (Q*) = 2 ADh 1 − dp )
Inventory Models:
Planned Shortages
Model
Used where back-ordering is
possible and planned
Based on same assumptions as
classical EOQ model except that
shortages are permitted
Back-ordering is possible and
shortages are in fact planned
EOQ determined where TC is minimum
and Ordering cost = Holding cost
+ Back-ordering cost

Q* = 2 AD
h
h +b
b

Maximum
T (QStock Q*×[
*) =, M 2=ADh b/(hbb++bh)]
Maximum Shortage Level, S = Q* - M
Safety Stock
Required when lead time and/or demand
rate are not fixed
When lead time and demand rate are
fixed, demand during lead time
(DDLT) can be determined . Deliveries
can be planned in such a manner
that there are no stock-outs
There is a risk of running out of
stock when lead time and demand
rate are variable, when provision
is made for only expected DDLT
The greater the variation in the two,
the greater the requirement of
safety stock
For a situation of never-out-of-
stock,
 Safety Stock = Maximum DDLT –
Expected DDLT
 where Max DDLT = Max Demand Rate ×
Max LT
For a smaller safety stock level,
there are chances of being out of
stock
Safety Stock
If the DDLT has a normal distribution,
with a given µ and σ then level of
service provided by a given safety
stock amount ss is equal to the area
under the curve to the left of X
(where X = µ + ss)
Re-order Level = Expected DDLT + Safety
Stock
leveL yrotnevnI

Re-order Level
Greater-than-average
Demand
Average Demand

SS

Re-order Level
leveL yrotnevnI

Demand

Lead Time
Extended Lead Time

SS to meet ( a ) high demand and ( b ) a delayed

delivery
Selective Approaches
to Inventory Control

Inventory Classification Basis

ABC Usage Value

VED Criticality of Item

HML Unit Cost

SDE Availability

S-OS Seasonality

FSN Speed of Movement

XYZ Closing Inventory Value

ABC Classification of
Items
eulaV fo egatnecreP

ABC Distribution Curve

Class Class B Class C

A

Percentage of Items
Multiple Choice
Questions
Φρ ο µ τ ηε
φ ο λ λ ο ω ι ν γ
σ τ α τ ε µ ε ν τ σ
ρ ε λ α τ ι ν γ τ ο
χ λ α σ σ ι χ αλ Ε ΟΘ
µ ο δ ε , µ αρ κ τ ηε
ι ν χ ο ρ ρ ε χ τ ο ν ε :
1.
2. Total Ordering Cost = Total
Holding Cost.
3.
4. Total Relevant Cost =
√2AOH.
5.
6. If annual demand doubles
with all other
parameters remaining
constant, the EOQ is
Multiple Choice
Questions
Mark the wrong statement:
1. Inventory cycle is the
time-period occurring
between successive
procurement actions.
2.
3. Shortage cost is the
penalty incurred for
being unable to meet a
demand as it occurs.
4.
5. Lead-time is the elapsed
time between the
initiation of an order
and the receipt of
replenishment stock.
6.
Multiple Choice
Questions
Mark the wrong statement:

1. In general, when back-

ordering cost is small,
orders are made less
often but of higher
quantity.
2. When back-ordering cost
becomes infinite, the
EOQ formula for the
planned shortages
model becomes the
same as that of the
classical model.
3. In planned shortages
model, it is possible for
re-order point to be a
negative value.
4. Like in classical EOQ
Multiple Choice
Questions
Mark the wrong statement:
1. If ordering cost/order and
holding cost/unit are both
doubled, it would double
the quantity under
classical EOQ model.
2.
3. If ordering cost/order and
holding cost/unit were
both doubled, it would
leave the order quantity
under classical EOQ model
unchanged.
4.
5. If the annual demand
increases by 20%,
ordering cost is reduced
by 20% and holding cost
increases by 50%, it would
reduce the order quantity
by 20%.
Multiple Choice
Questions
Which of the following is not
true?

1. In deterministic inventory
models, Re-order level
= Demand during lead
time (DDLT).
2.
3. In cases where demand is
probabilistic, ROL =
Expected DDLT +
Safety Stock.
4.
5. Greater the variation in
demand and/or lead-
time, greater the
amount of safety stock
needed.
Multiple Choice
Questions
If DDLT is known to be
distributed normally with a
variance of 6400, then a
safety stock of 160 units
will yield approximately
what level of service?
(Given: z = 2, Area = 0.4772)

1. 48%
2.
3. 98%
4.
5. 2%
6.
7. 52%
Multiple Choice
Questions
Fo r a 2 5 % in cre a se in o rd e r
q u a n tity ( u n d e r cla ssica l E O Q
m o d e l) th e to ta l re le va n t co st
w o u ld

1. Decrease by 2.5%
2.
3. Decrease by 0.25%
4.
5. Increase by 2.5%
6.
7. Increase by 1.025%
8.
Multiple Choice
Questions
M a rk th e w ro n g sta te m e n t:
1. The division of items into A,
B and C categories is
accomplished by
plotting the usage value
of items to obtain Pareto
curve.
2.
3. FNSD analysis represents
the speed classification
of items.
4.
5. XYZ analysis is based on
the classification of
items according to their
unit cost.
6.
7. SOS is the classification as