Concept of Inventory and different

types of Inventory models

Ahmed Sayem
Department of Industrial & Production Engineering
ShahJalal University of Science & Technology

sayem-ipe@sust.edu

Production Lot-size model (1/2)
One of the earlier assumption was: the entire order
arrives at one time.
Here in the production lot-size model this assumption is
relaxed.
The essence is that: order is produced or supplied at
some uniform rate p (units per day).
Naturally, the production rate p must be greater than the
demand rate d.
So, inventory building rate is p-d. and, that will change
the concept of inventory by the cycle inventory.
Time that the process must run to produce Q units is
T=Q/p
Our objective is to find the best quantity of a product to
produce each time. And also to reduce the cost of setup.

Production Lot-size model (2/2)
Maximum cycle inventory = time to accumulate the
inventory inventory accumulation rate


so, total cost will be
Here S represents the cost of setup, production control, etc.
Then, Economic Production Lot or Quantity (EPL) can be
derived by (just like the ordinary EOQ derived from TC)


Here the Holding cost is multiplied by (1-d/p), as we hold
only that amount of inventory.

) 1 ( ) (
max
p
d
Q d p
p
Q
CI
S
Q
D
H
Q
TC
a
p
d

2
) 1 (
) 1 (
2
p
d
a
H
S D
EPL

Quantity Discount Consideration

(1/4)
Another assumption was that, cost of the item is not
affected by the order size.
But in reality Quantity Discount is very common and is
affects on the Economics of Scale.
Here our objective is to select the economic order size
(when discounts are available)
then Total cost equation
Total cost=Holding Cost+ Ordering Cost + Item cost
Holding cost H
i
is a function of purchasing cost (i.e. % of purchasing cost)


i a
a
i
C D S
Q
D
H
Q
TC
2
Quantity Discount Consideration
(2/4)


Quantity Discount Consideration
(3/4)
The procedure for finding best order quantity is as follows:
(a) consider the lowest price and solve the Basic EOQ. If
feasible, this is the best quantity, so stop, otherwise go to
step b
(b) Solve for the EOQ for the next higher price, if this EOQ is
feasible go to step d
(c) If the EOQ is not feasible, repeat step b, until a feasible
EOQ is found.
(d) Compute the TC for the feasible EOQ and also for all the
greater quantities where the price break occur. Select the
quantity with the lowest TC.
Quantity Discount Consideration
(4/4)
Possible total cost curve relationships, when price breaks are
available.







a) for lowest item cost, (b) the reduction in total cost due to purchasing at
the next higher price break is not sufficient to overcome the holding costs
(of extra inventory purchase), (c) purchasing more will achieve a quantity
discount that reduces the item cost more than the increase in the holding
cost.
Quantity Discount Consideration
(Example)

Reorder Level (RL)
RL= units required per time period Lead Time.
The reorder level is the number of units on hand
and on order (rather than to just the amount on
hand).
This is (quantity on order), important when one
or more orders are outstanding when the reorder
level is reached.

Safety Stock (SS)
If we could replenish inventory on a moments notice, there would be
no reason to be concerned about the demand uncertainty. i.e. whenever
inventory goes to zero, we could restock.
But, in some time, the demand during the delivery lead-time would be
higher than the expected; then we will incur a loss due to stockout.
Safety stock or Buffer stock is means of protecting against the
stockout risk.
Then, RL becomes, RL=(dLT) +SS


Factors affecting Safety Stock Level
The loss due to stock-out may be high- e.g. unavailability
of raw materials can cause production stoppage.
The cost of carrying safety stock may be low-
The variability of demand is high- in that case it is
economical to carry inventory instead of spending to
improve forecasting method. (better forecasting reduces
variability of demand)
The number of annual exposures to the risk of stockout
may increase- If a companys supply is purchased only
once a year, than in that case, stockout can occur only
once a year-Holding cost may be extremely high.
Vice-versa: frequent purchasing of small order leads to
frequent exposure to stock-out, & low holding cost.

Method of determining Safety
Stock Level
Service Level vs. Holding cost
Service level is a measure of how effective a
company is, at supplying demanded goods from its
stock on hand.
or, how well the company prevents lost sales and
back orders.
One measure of service level is: the probability of
covering the demand that occurs during the inventory
replenishment lead time.
So, service level is reciprocal to the probability of
stock-out.
And, the probability of stock-out is determined from the Lead-time
demand.