2

Inventory
` Inventory is the stock of any item or resource
used in an organization and can include:
` raw materials
t i l
` finished products
` component parts
` supplies
Chapter 15 ` work-in-process
Inventory Control

December 10, 2008

Ref: Parts/inventory at Wahburn Guitar: PS10.avi

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Inventory System Purposes of Inventory

` An inventory system is the set of policies and 1. To maintain independence of operations
controls that
` monitor
it levels
l l off inventory
i t 2
2. To meet variation in product demand
` determines what levels should be maintained
3. To allow flexibility in production scheduling
` when stock should be replenished
` how large orders should be 4. To provide a safeguard for variation in raw
material delivery time
5
5. To take advantage of economic purchase-order
purchase order
size

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Inventory Costs Independent vs. Dependent Demand

` Holding (or carrying) costs Independent Demand (Demand for the final
` Costs for storage, handling, insurance, etc end-product or demand not related to other items)

` Setup (or production change) costs Finished

` Costs for arranging specific equipment setups, etc product
Dependent Demand
` Ordering costs (Derived demand
` Costs of someone placing an order, etc items for component
parts, subassemblies,
p
` Sh t
Shortage costs
t E(1 raw materials, etc)
` Costs of canceling an order, etc )

Component parts
Ref: Inventory Cost: MI1.avi
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Inventory Systems Single-Period Inventory Model

` Single-Period Inventory Model This model states that we
` One time purchasing decision should continue to increase
Cu
P
` E
Example:
l vendor
d selling
lli t-shirts
hi at a ffootball
b ll game the size of the inventory so
` Seeks to balance the costs of inventory overstock and long as the probability of
under stock Co + Cu selling the last unit added is
equal to or greater than the
` Multi-Period Inventory Models
ratio of: Cu/Co+Cu
` Fixed-Order Quantity Models
Where :
` Event triggered (Example: running out of stock)
` Fixed-Time Period Models Co = Cost per unit of demand over estimated
` Time triggered (Example: Monthly sales call by sales representative)
Cu = Cost per unit of demand under estimated
P = Probability that the unit will be sold
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Multi-Period Models:
Single Period Model Example Fixed-Order Quantity Model Model Assumptions

` Our college basketball team is playing in a tournament game ` Demand for the product is constant and uniform throughout
this weekend. Based on our past experience, we sell on the period
average 2,400
2 400 shirts with a standard deviation of 350
350. We
make $10 on every shirt we sell at the game, but lose $5 on ` Lead time (time from ordering to receipt) is constant
every shirt not sold. How many shirts should we make for
the game? ` Price per unit of product is constant
Cu = $10 and Co = $5;
P $10 / ($10 + $5) = .667 ` Inventory holding cost is based on average inventory
Now, we need
N d to find
f d the
h point on our demand
d d distribution
d b that
h
corresponds to the cumulative probability of 0.667:
` Ordering or setup costs are constant

Z.667 = .432 (use NORMSINV(.667) or Appendix E) ` All demands for the product will be satisfied (No back orders
are allowed)
therefore we need 2,400 + .432(350) = 2,551 shirts

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Basic Fixed-Order Quantity Model and

Reorder Point Behavior Cost Minimization Goal
By adding the item, holding, and ordering costs together, we
1. You receive an order quantity Q. 4. The cycle then repeats. determine the total cost curve, which in turn is used to find
the Qopt inventory order point that minimizes total costs

Number Total Cost

of units C
on hand Q Q Q O
S
T Holding
R Costs
L L Annual Cost of
2. Your start using Items (DC)
them up over time. 3. When you reach down to
Time a level of inventory of R, Ordering Costs
R = Reorder point
Q = Economic order quantity you place your next Q
L = Lead time sized order. QOPT
11 12 Order Quantity (Q)
 13 14

Basic Fixed-Order Quantity (EOQ) Model

Formula Deriving the EOQ
TC=Total annual cost Using calculus, we take the first derivative of the total cost
Total Annual Annual Annual D =Demand function with respect to Q, and set the derivative (slope)
Annual = Purchase + Ordering + Holding C =Cost pper unit equal to zero
zero, solving for the optimized (cost minimized)
Q =Order quantity
Cost Cost Cost Cost value of Qopt
S =Cost of placing an
order or setup cost
R =Reorder point 2DS 2(Annual Demand)(Order or Setup Cost)
L =Lead time
QOPT = =
H Annual Holding Cost
H=Annual holding and
D Q storage cost per
W also
We l need da
_
R eo rd er p o in t, R = d L
TC = DC + S + H unit of inventory reorder point to tell
us when to place an _
Q 2 order d = average daily demand (constant)
L = Lead time (constant)
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EOQ Example (1) Problem Data EOQ Example (1) Solution

2D S 2(1,000 )(10)
Given the information below, what are the EOQ and Q O PT = = = 89.443 units or 90 units
H 2.50
reorder
d point?
i t?
1,000 units / year
d = = 2.74 units / day
Annual Demand = 1,000 units 365 days / year
Days per year considered in average
_
daily demand = 365 R eorder point, R = d L = 2.74units / day (7days) = 19.18 or 20 un its
Cost to place an order = $10
Holding cost per unit per year = $2.50 In summary, you place an optimal order of 90 units. In
Lead time = 7 days the course of using the units to meet demand, when
Cost per unit = $15 you only have 20 units left, place the next order of 90
units.

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EOQ Example (2) Problem Data EOQ Example (2) Solution

Determine the economic order quantity 2D S 2(10,00 0 )(10)
Q O PT = = = 365 .148 un its, or 366 u n its
and the reorder point given the following H 1.50

10,000 units / year

Annual Demand = 10,000 units d= = 27.397 units / day
365 days / year
Days per year considered in average daily
demand = 365 _

Cost to place an order = $10 R = d L = 27.397 units / day (10 days) = 273.97 or 274 u n its
H ldi costt per unit
Holding it per year = 10% off costt
per unit Place an order for 366 units. When in the course of
Lead time = 10 days using the inventory you are left with only 274 units,
place the next order of 366 units.
Cost per unit = $15
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Fixed-Time Period Model with Safety Multi-Period Models: Fixed-Time Period Model:
Stock Formula Determining the Value of T+L

q = Average demand + Safety stock Inventory currently on hand

( )
T+ L 2

q = d (T + L) + Z T + L - I
T+ L = di
i =1

Where :
q = quantitiy to be ordered
Since each day is independent and d is constant,
T = the number of days between reviews T+ L = (T + L) d 2
L = lead time in days
d = forecast average daily demand
z = the number of standard deviations for a specified service probabilit y
` The standard deviation of a sequence of random events
T + L = standard deviation of demand over the review and lead time
equals the square root of the sum of the variances
I = current inventory level (includes items on order)

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Example of the Fixed-Time Period Example of the Fixed-Time Period
Model Model: Solution (Part 1)

T+ L = (T + L) d 2 = ( 30 + 10 )( 4 ) 2 = 25.298
Given the information below, how many units
should
h ld bbe ordered?
d d?
The value for z is found by using the Excel NORMSINV
function, or as we will do here, using Appendix D. By adding
Average daily demand for a product is 20 units. The review 0.5 to all the values in Appendix D and finding the value in the
period is 30 days, and lead time is 10 days. Management has table that comes closest to the service probability, the z value
set a policy of satisfying 96 percent of demand from items in can be read by adding the column heading label to the row label.
stock. At the beginning of the review period there are 200
units in inventory. The daily demand standard deviation is 4
units. So, by adding 0.5 to the value from Appendix D of 0.4599,
we have a probability of 0.9599, which is given by a z = 1.75

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Example of the Fixed-Time Period Miscellaneous Systems:
Model: Solution (Part 2) Optional Replenishment System
Maximum Inventory Level, M
q = d(T + L) + Z T + L - I

q=M-I
q = 20(30 + 10) + (1.75)(25.298) - 200
Actual Inventory Level, I
M
q = 800 + 44.272 - 200 = 644.272, or 645 units
I
So, to satisfy 96 percent of the demand, you
should place an order of 645 units at this Q = minimum acceptable order quantity
review period
If q > Q, order q, otherwise do not order any.
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Miscellaneous Systems:
Bin Systems ABC Classification System
Two-Bin System ` Items kept in inventory are not of equal importance
in terms of:
Order
O d One
O Bin
Bi off ` dollars invested
60
Inventory ` profit potential
% of
$ Value 30 A
Full Empty
` sales or usage volume 0 B
One-Bin System % of 30 C
` stock-out penalties Use 60

Order Enough to
Refill Bin So, identify inventory items based on percentage of total
Periodic Check dollar value, where A items are roughly top 15 %, B
Ref: Inventory Control with Kanban: http://tw.youtube.com/watch?v=VaOUWsZl6So
items as next 35 %, and the lower 65% are the C items
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Inventory Accuracy and
Cycle Counting Real Practice
` Case Study-Microsoft Retail Management System:
` Inventory accuracy refers to how well the inventory
http://tw.youtube.com/watch?v=84-P7opRxwk
records agree with physical count
` Cycle Counting is a physical inventory-taking technique
in which inventory is counted on a frequent basis rather ` ERP Systems: DVD
than once or twice a year

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Question Bowl Question Bowl

The average cost of inventory in the United States
is which of the following?
a. 10 to 15 percent of its cost
b. 15 to 20 percent of its cost
c. 20 to 25 percent of its cost
d. 25 to 30 percent of its cost
e. 30 to 35 percent of its cost
Which of the following is a reason why firms keep a
supply of inventory?
a
a. To maintain independence of operations
b. To meet variation in product demand
c. To allow flexibility in production scheduling
d. To take advantage of economic purchase order size
e. All of the above

Answer: e. All of the above (Also can include to provide

Answer: e. 30 to 35 percent of its cost a safeguard for variation in raw material delivery
time.)

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Question Bowl Question Bowl

An Inventory System should include policies that Which of the following is an Inventory Cost item
are related to which of the following? that is related to the managerial and clerical
a
a. How large inventory purchase orders should be costs
t to
t prepare a purchase
h or production
d ti
b. Monitoring levels of inventory
order?
c. Stating when stock should be replenished
a. Holding costs
d. All of the above
e. None of the above b. Setup costs
c. Carrying costs
d. Shortage costs
Answer: e. None of the
e. None of the above above (Correct answer
is Ordering Costs.)

Answer: d. All of the above

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Question Bowl Question Bowl

Which of the following is considered a If you are marketing a more expensive
Independent Demand inventory item? independent demand inventory item, which
a. Bolts
B lt tto a automobile
t bil manufacturer
f t i
inventory
t model
d l should
h ld you use??
b. Timber to a home builder a. Fixed-time period model
c. Windows to a home builder b. Fixed-order quantity model
d. Containers of milk to a grocery store c. Periodic system
e. None of the above d. Periodic review system
e. P-model

Answer: d. Containers of milk to a grocery store

Answer: b. Fixed-order quantity model
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Question Bowl Question Bowl

The basic logic behind the ABC Classification A physical inventory-taking technique in which
system for inventory management is which of inventory is counted frequently rather than
the following? once or twice a year is which of the following?
a. Cycle counting
a. Two-bin logic
b. Mathematical programming
b. One-bin logic
c. Pareto principle
c. Pareto principle d. ABC classification
d. All of the above e. Stockkeeping unit (SKU)
e. None of the above

Answer: c. Pareto principle

Answer: a. Cycle counting
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