The objective of inventory management is to strike a balance between inventory investment and

customer service.
Necessary for operations
Contribute to customer satisfaction
Inventories are a vital part of the business
Inventory - stock/store of goods
Raw Material -purchased but not processed
Work-in-process - undergone some change but not completed ; function of cycle time for a
product

Maintenance/ repair/ operating - necessary to keep machinery and processes productive

Finished - completed product awaiting shipment
Types of Inventory
To meet anticipated customer demand - anticipated stock 1.
To smooth production requirement - seasonal inventories 2.
To decouple operation - decoupling stock 3.
To protect against stock outs - safety stock 4.
To take advantage of order cycles - cycle stock 5.
To hedge against price increases 6.
To permit operations 7.
To take advantage of quantity discounts 8.
Inventory turnover - ratio of average cost of goods sold to average
inventory investment

Establish a system for tracking items in inventory

when to order
how much to order
Make decisions about
Management has two basic functions concerning inventory
Functions of Inventory
A system to keep track of inventory on hand order 1.
A reliable forecast of demand that includes an indication of possible forecast error 2.
Knowledge of lead times and lead time variability 3.
Reasonable estimates of inventory holding costs, ordering costs, and shortage costs. 4.
A classification systemfor inventory items. 5.
Requirements for Effective Inventory Management
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Physical count of items in inventory made at periodic intervals
Periodic System
one-bin system - order enough to refill bin
two -system - order one bin of inventory
Bin System
an order is placed when inventory drops to a predetermined minimum level
system that keeps track of removals from inventory continuously, thus monitoring current levels
of each item

Perpetual Inventory System

Bar code printed on a label that has information about the item to which it Is attached -
Universal Product Code
Increase in speed and accuracy, continuous information on inventories, reduce the need for
periodic inventories and order size determinations, improve the level of customer service by
indicating the price and quantity of each item on the customer receipt
Advantages for retail business
Simplified production and inventory control, bar codes attached to parts, subassemblies,
and finish goods greatly facilitate counting and monitoring activities, automatic routing,
scheduling, sorting and packaging can also be done by bar code
Advantages of manufacturing
Help reduce drug dispensing errors
Advantages in health care
Used to keep track of inventory in certain applications, provides real-time information that
increases the ability to track and process shipping containers, parts in warehouses, items on
supermarket shelves, and a whole lot more.
Can carry more information than bar codes
Don't require line-of-sight to be scanned
Advantages of RFID
RFID - Radio Frequency Identification Tags
Inventory Counting Systems - Keeping track of Inventory
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Reliable estimates of the account and timing of demand
Lead time - the time between submitting an order and receiving it
Know how long it will take for orders to be delivered
Point-of-sale systems (POS) - record items at the time of sale
Inventory Costs
Interest, insurance, depreciation, obsolescence, deterioration, spoilage, pilferage, breakage,
warehouse cost ( heat, light, rent, security )

Typical annual holding cost range from 20% - 40% of the value of an item.
Cost to carry an item in inventory for a length of time, usually a year
Holding or Carrying Costs
Shipping costs, determine how much is needed preparing invoice, inspection of goods upon
arrival for quality and quantity, moving the goods to temporary storage

Fixed amount regardless of order size

Costs of placing an order and receiving inventory
Ordering Costs
Fixed change per production run regardless of the size of the run
Set up time - the time required to prepare a machine or process for production
Costs to prepare a machine or process for manufacturing an order
Set up Costs
Cost of not making a sale, loss of customer goodwill, late charges, shortage of items for
internal use ( to supply an assembly line ), lost production or downtime

Such cost can easily run into hundreds or thousands pesos a minute or more
Difficult to measure and may be subjectively estimated
Costs resulting when demand exceeds the supply of inventory
Shortage Costs
Classification System
Classify inventory items according to some measure of importance, and allocating control efforts
accordingly

ABC Approach
Class % of Units % of Annual Value
A 10-20 60-70
B 30 20-40
C 50-60 10-15
physical counting of inventory
Cycle Counting
BRING
CALCULATOR!
Demanding Forecasts and Lead Time Information
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physical counting of inventory
purpose of cycle counting is to reduce discrepancies between the amounts indicated by
inventory records and actual quantities on hand

the counts are conducted more frequently than once a year

often used ABC approach to determine cycle
"A" Items are counted most frequently , "C" items least frequently
Eliminates shutdowns and interruptions 1.
Eliminates annual inventory adjustment 2.
Trained annual inventory adjustment 3.
Trained personnel audit inventory accuracy 4.
Allows causes of errors to be identified and corrected 5.
Maintains accurate inventory records 6.
Advantages
can be a critical component of profitability
Shrinkage - retail inventory that is unaccounted for between receipt and sale
Pilferage - a small amount of theft
losses may come from shrinkage or pilferage
Good personnel selection, training and discipline
Tight control on incoming shipments
Effective control on all goods leaving facility
Applicable techniques include
Control of Service Inventory
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*Dependent demand - items are used internally to produce a final product
*Independent demand - items are final products demanded by external customers
Identify the optional order quantity by minimizing the sum of certain annual costs that vary with the order
size
3 order size models
The basic economic order model i.
The economic production quantity model ii.
The quantity discount model iii.
Economic Order Quantity ( EOQ) models
How much to order
It is used to identify a fixed order size that will minimize the sum of the annual costs of holding inventory and
ordering inventory
Only one product is involved a.
Annual demand requirements are known b.
Demand requirements are known c.
Demand is spread evenly throughout the year so that the demand rate is spread evenly throughout the year
so that the demand rate is reasonably constant
d.
Lead time does not vary e.
Each order is received in a single delivery f.
There are no quantity discounts g.
Important Assumptions
Basic EOQ Model
Independent Vs. Dependent Demand
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The EOQ Model
Q = number of pieces per order
D = annual demand in units for inventory item
S = setupor ordering cost for each order
Annual Set up costs
= (number of orders placed per year) X ( set up or order costs per order)
Q= number of pieces per order
H= holding or carrying cost per unit per year
Annual Holding Cost
= (average inventory level) X (holding cost per unit per year)
Optimal Order Quantity
Total Cost
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In an inventory system in which an order is received gradually, as inventory is depleted
Used when inventory builds up over a period of time after an order is placed
Used when units are produced and sold simultaneously
EOQ model order received in a single delivery, EPQ units received incrementally during production
Only one item is involved 1.
Annual demand is known 2.
The usage rate is constant 3.
Usage occurs continually, but production occurs periodically 4.
The production rate is constant 5.
Lead time does not vary 6.
There are no quantity discounts 7.
Important Assumptions
Formulas :
d= daily demand
p= daily production rate
H = holding cost ; maximum inventory/2

d= annual demand/ working days
Maximum Inventory = Q

Economic Production Quantity

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Example :
A toy manufacturer uses 48000 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. Set up cost for a production run of wheels is $45. the firm operates 240 days per
year.
Optimal Run size a.
Minimum Total cost b.
Maximum Inventory c.
Number of production run in a year d.
Cycle time e.
Run time f.
Pure consumption portion of the cycle g.
12-3 =9

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Trade-off is between reduced product cost and increased holding cost
price reduction for large orders offered to customers to induce them to buy in large quantities -
Quantity Discount Model
Total Cost = set up cost + holding cost + product cost
Carrying costs are constant -
Carrying costs are states as percentage of purchase price -
2 General Cases of Quantity Discount Model
Carrying Costs are constant
Compute the common minimum point 1.
If the feasible minimum point is on the lowest price range, that is the optimal order quantity a.
If the feasible minimum point is in any other range, compute the total cost for the minimum point and for
the price breaks of all lower unit cost. Compare the total costs : the quantity ( minimum point or price
break ) that yields the lowest total costs : the quantity ( minimum point or price break ) that yields the
lowest total cost is the optimal order quantity.
b.
Only one of the unit price will have the minimum point in its feasible range since the ranges do not overlap.
Identify that range.
2.
STEPS
*Note = Use the minimum quantity of the ranges whenever computing for their TC
E.G = 90 of 90-100
IF they're not the EOQ.
Carrying Costs are stated as percentage of purchase price
Each curve has a different minimum point. Lower prices will mean lower carrying costs and larger minimum point. As
price decreases, each curve's minimum point will lead to the right of the next higher curve's minimum point.
Beginning with the lowest unit price, compute the minimum points for each price range until you find a feasible
minimum point.
1.
If the minimum point for the lowest unit price is feasible, it is the optimal order quantity. If the minimum point is
not feasible in the lowest price range, compare the total cost at the price break for all lower price with total cost
of the feasible minimum point. The quantity that yields the lowest cost is the optimum.
2.
Steps to determine the best purchase quantity:
P = unit price
Q= EOQ
Quantity Discount Model
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Example : Meralco uses 4000 toggle switches a year. Switches are priced as follows : 1-499, 90 cents each; 500 to 999, 85
cents each, and 1000 or more,80 cents each. It costs approx.$30 to prepare an order and receive it, and carrying costs
are 40% of purchase price per unit on an annual basis.
1. Determine the optimal order quantity
2. Total annual cost
Each curve has a different minimum point. Later prices will mean lower carrying costs and larger minimum point. As
price decreases, each minimum point will lead to the right of the next higher curve's minimum point.
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Is the level of inventory at which a new order should be placed
the reorder point tells " when " to order
When the quantity on hand of an item drops to this amount, the item is reordered
The rate of demand
The lead time
The extent of demand and/or lead time variability
The degree of stock out risk acceptable to management
Determinants of the Reorder Point
Inventory level ( units )
ROP = (demand rate per day) ( lead time for a new order in days)
= d X LT
d=

Reorder Point : Under Uncertainty

Demand / lead time uncertainty creates the possibility that demand will be greater than available supply -
Safety stock - stock that is held in excess of executed demand due to variable demand and/or lead time
Stock out - an inventory management
To reduce the likelihood of a stock out, it becomes necessary to carry a safety stock -
ROP = d X LT + SS
Lead Time = L
Resupply takes place as order arrives
Slop = units/days = d
Q* --------------------------
------------------------------------------------- ROP ( units )
Time ( days )
Reorder Points
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When data on demand during the lead time is not available, there are other models available
When demand is variable and lead time is constant 1.
When lead time is variable and demand is constant 2.
When both demand and lead time are variable 3.
ROP = (d) x LT + (Z)(
d
)(LT)
Demand is Variable and Lead Time is Constant
d= average daily demand

d
= standard deviation
LT = lead time
The average daily demand for Apple iPods at Compex Store is 15, with a standard deviation of 5 units.
The lead time is constant at 2 days. The management wants a 90% service level.
Determine the value of z a.
Determine the ROP b.
Determine the safety stock c.
z=1.28
ROP = 39.05 or 40
SS = z
d
LT = 9.05
ROP = d x LT + (z)(d)(
LT
)
d= daily demand

d
= standard deviation of lead time in days
LT = average lead time
Lead Time is Variable and Demand is Constant
Compex Store sells about 10 digital cameras a day (almost a constant quantity). Lead time for camera
delivery is normally distrubted with a mean time of 6 days and a standard deviation of 3 days. A 98%
service level is set.
Value of z = 2.05 a.
ROP = 10 x 6 +(2.05)(10)(3) = 60 + 61.5 = 121.5 b.
Safety stock = (2.05)(10)(3) = 61.5 c.
Both demand and lead time are variable
Other Probabilistic Models
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Difference
FOI EOQ/ROP
Demand Varies Fixed.
Determines "how much to order" -
Orders are placed at fixed time intervals -
Supplier's policy may encourage its use -
Grouping orders from the same supplier can produce savings in -
-
P costs -
Some circumstances do not lend themselves to continuously monitoring inventory position -
Reasons for using the FOI Model
Fixed Quantity - safety stock during lead time
Fixed Interval - safety stock from order interval until lead time because the demand varies
Fixed Quantity Fixed Interval
Orders are triggered by quantity Orders are triggered by time
You only need protection during lead
time
You need protection during lead time and order
interval
When To Order How Much to Order
Difference between Fixed Quantity and Fixed Interval
Advantages & Disadvantages of FOI
Advantages Disadvantages
Fixed interval system result tight control Fixed interval system necessitates a larger
amount of safety stock
Grouping orders can yield savings in ordering, packing
and shipping costs
Increases carrying cost
May be the only practical approach if inventory
withdrawals cannot be closely monitored
Cost of periodic reviews
Amount to Order = expected demand during protection interval + safety stock - amount on hand
at reorder time
FOI Model
OI = order interval
A = amount on hand at reorder time
Fixed Order Interval
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*this is our cycle time and lead time, this will reflect the amount of
inventory that will protect against the entire time until the next order
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Model for ordering of perishables and other items with limited useful lives
Unsold or unused goods are not carried over from one period to the next
May even have some cost associated with the disposal of left over goods
The goal of single - period model is to identify the order quantity or stocking level that will
minimize the long-run excess and shortage costs

Shortage cost
Excess cost
Analysis of single-period situations focuses on two costs
" newsboy / news stand " model
The unrealized profit per unit -
May also include a charge for loss of customer goodwill as well as the opportunity cost of lost
sales
-
Shortage Cost
If shortage or stockout relates to an item used in production or to a spare part for a machine,
then shortage cost refers to the actual cost of the loss of production

C
shortage
= C
s
= Revenue per unit - cost per unit
Pertains to items left over at the end of the period -
Excess Cost
If there is cost associated with the disposing of excess items, the salvage will be negative and
will therefore increase the excess cost per unit

C
excess =
C
e
= Original cost per unit - salvage unit per unit
Service Level
What is the service level a.
Find the appropriate value of z b.
What is the optimal stocking level? c.
What is the stock out risk for that quantity? d.
Fiber's news stand usually sells 120 copies of Philippine Daily Inquirer each day. Fiber believes
the sale of PDI is normally distributed with a standard deviation of 15 papers. He pays $15 for
each paper, which he sells for $18. PDI gives him a $13 credit for each unsold paper.
Determine the following :
Example :
Sales price = 18
Cost/unit = 15
Salvage value/unit = 13
d= 120
= 15
C
s
= 18 -1 5 = 3
C
e
= 15 - 13 = 2
Single - Period Model
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Service Level = 3/(3+2) = 0.6
Value of z = 0.25
= 123.75
Optimal Stocking Level = S
o
= 120 +(15)(0.25)
= 1 - 0.6 = 0.4
Stocking Level = 1 - service level
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Record keeping = accurate information
Variation reduction = realistic estimates
Lean operation = demand driven system
Supply chain management = relationship with supplier
Inventory Strategy
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