Chapter 12

Inventory Management

Reasons to Hold Inventory

Meet unexpected demand Smooth seasonal or cyclical demand Meet variations in customer demand Take advantage of price discounts Hedge against price increases Quantity discounts

Inventory Costs
Carrying Cost
Cost of holding an item in inventory, May include cost of obsolescence

Ordering Cost
Cost of replenishing inventory

Shortage Cost
Temporary or permanent loss of sales when demand cannot be met

Inventory Control Systems

Continuous system (fixed-order(fixed-orderquantity)
Constant amount ordered when inventory declines to predetermined level

Periodic system (fixed-time-period) (fixed-timeOrder placed for variable amount after fixed passage of time

Assumptions of Basic Economic Order Quantity Model

 Demand is known with certainty and is constant over time  No shortages are allowed  Lead time for the receipt of orders is constant  The order quantity is received all at once

The Inventory Order Cycle

Order quantity, Q Inventory Level

Demand rate

Reorder point, R

Lead time Order Order placed receipt

Lead time Order Order placed receipt

Time

When to Order
Reorder Point is the level of inventory at which a new order is placed R = dL where d = demand rate per period L = lead time

Reorder Point Example

Demand = 10,000 yards/year Store open 311 days/year Daily demand = 10,000 / 311 = 32.154 yards/day Lead time = L = 10 days R = dL = (32.154)(10) = 321.54 yards

Safety Stocks
 Safety stock
 buffer added to on hand inventory during lead time

 Stockout
 an inventory shortage

 Service level
 probability that the inventory available during lead time will meet demand

Variable Demand with a Reorder Point

Q Inventory level

Reorder point, R

LT Time

LT

Reorder Point with a Safety Stock

Inventory level Q
Reorder point, R

Safety Stock

LT Time

LT

EOQ Cost Model

Co - cost of placing order Cc - annual per-unit carrying cost perD - annual demand Q - order quantity CoD Annual ordering cost = Q C cQ Annual carrying cost = 2 C cQ CoD Total cost = + 2 Q

EOQ Cost Model

CDeriving Q D - annual demand o - cost of placing order Proving equality of opt Cc - annual per-unit carrying cost costsorder quantity perQ - at optimal point C cQ C oD TC = + 2 Q CoD C cQ Annual ordering cost = = Q 2 C oD Cc xTC =- 2 + Q 2 xQ C cQ 2CoD 2 = Annual carrying cost = Q 2 C0D Cc Cc 0 =- 2 + Q 2 C cQ CoD 2CoD Total cost = + 2 Qopt = Q 2CoD Cc Qopt = Cc

EOQ Cost Model

Annual cost ($) Slope = 0 Minimum total cost CcQ Carrying Cost = 2 Total Cost

CoD Ordering Cost = Q Optimal order Qopt Order Quantity, Q

EOQ Example
Cc = $0.75 per yard Qopt = Qopt = 2CoD Cc
2(150)(10,000) (0.75)

Co = $150

D = 10,000 yards

CoD CcQ TCmin = + Q 2 TCmin

(150)(10,000) (0.75)(2,000) = + 2 2,000

Qopt = 2,000 yards

TCmin = $750 + $750 = $1,500

Order cycle time = 311 days/(D/Qopt) days/(D Orders per year = D/Qopt = 311/5 = 10,000/2,000 = 62.2 store days = 5 orders/year

EOQ with Noninstantaneous Receipt

Inventory level Maximum inventory level Average inventory level Q(1-d/p) (1-d/p)

Q (1-d/p) (1-d/p) 2

0 Order receipt period Begin End order order receipt receipt Time

EOQ with Noninstantaneous Receipt

p = production rate Maximum inventory level = Q - Q d p =Q1- d p Q d Average inventory level = 12 p CoD CcQ d TC = Q + 2 1 - p d = demand rate

2CoD Qopt = d Cc 1 p

Quantity Discounts
 Price per unit decreases as order quantity increases
CcQ CoD TC = + + PD 2 Q where P = per unit price of the item D = annual demand

Quantity Discounts
 Price per unit decreases as order quantity increases
CcQ CoD TC = + + PD 2 Q where ORDER SIZE P = per unit price- of the item 1 99 D = annual demand 100 - 199 200+ PRICE $10 8 6

Quantity Discount Model

TC = ($10 ) TC (d1 = $8 ) Inventory cost ($) TC (d2 = $6 )

Carrying cost

Ordering cost Q(d1 ) = 100 Qopt Q(d2 ) = 200

Quantity Discount Model

TC = ($10 ) TC (d1 = $8 ) Inventory cost ($) TC (d2 = $6 )

Carrying cost

Ordering cost Q(d1 ) = 100 Qopt Q(d2 ) = 200