Inventory Control

What Is Inventory ?
Inventory is a stock of items kept to meet future demand.
Material that has been purchased from a supplier, may have been partially or
completely converted, but not yet sold to the customer (we “own” it - if it
gets stolen, it is our loss).
Inventory, in production context, is an idle resource. Resource is idle does
not mean it is serving no purpose. It is available when needed.
Types of Inventory
• Raw materials & purchased parts: Materials and components required
for making a product.
• Partially completed goods called work in progress product (WIP):
Materials and components that have begun their transformation to
finished goods.
• Finished-goods inventories: Goods ready for sale to customers i.e, Items
being transported and stored in ware houses.
• Tools and equipment.
1
Raw material WIP product

Finished
product

Tools 2
 Inventory Control
Why Hold Inventory ?

To balance against uncertainty (safety)

To smooth production requirements. Material buffers are used to
avoid uncertainty in material deliveries
To meet time varying demand or supply patterns. (To meet seasonal
demand)
To ensure a high level of customer service
Economies of scale in production or purchasing
To take advantage of quantity discounts
To hedge against price increases

3
 Inventory Costs
Holding or carrying costs (H): cost to carry an item
in inventory for a length of time.
Holding cost = Storage cost + Handling cost +
Depreciation cost + Insurance + Taxes
Holding cost increases as the order size increases
because larger orders mean higher inventory levels.

Ordering costs (O): costs of ordering and receiving

inventory. Primarily the staff costs associated with
processing the order.

Shortage costs: costs when demand exceeds

supply; temporary or permanent loss of sales when
demand cannot be met.
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 Inventory Control Systems

Continuous system (fixed-order-

quantity)
constant amount ordered when
inventory declines to predetermined
level

Periodic system (fixed-time-period)

order placed for variable amount
after fixed passage of time

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 ABC Classification System
Classifying inventory according
to some measure of importance and
allocating control efforts accordingly.
 Class A – Very important
◼ 5 – 15 % of units

◼ 70 – 80 % of value

 Class B – Mod. important

◼ 30 % of units

◼ 15 % of value

 Class C – least important

◼ 50 – 60 % of units

◼ 5 – 10 % of value

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ABC Classification: Example

Part Unit cost ($) Annual usage Total cost ($)

1 60 90 5400
2 350 40 14000
3 30 130 3900
4 80 60 4800
5 30 100 3000
6 20 180 3600
7 10 170 1700
8 320 50 16000
9 510 60 30600
10 20 120 2400
Total: 1000 85400

Sort parts in descending order of total cost

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ABC Classification: Example (cont.)

TOTAL % OF TOTAL % OF TOTAL

PART PART
VALUE ($) UNIT
VALUE COST ANNUAL%USAGE
QUANTITY CUMMULATIVE
9 1
30,600 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 11.0
2 14,000 16.4 4.0
A40 15.0
3 30 130
1 5,400 6.3 9.0 24.0
4 4
4,800 5.680 6.0 B60 30.0
3 5
3,900 4.630 10.0 100 40.0
6 6
3,600 4.220 18.0 180 58.0
5 3,000
7 3.510 13.0 170 71.0
10 2,400 2.8 12.0 C 83.0
8 320 50
7 1,700 2.0 17.0 100.0
9 510 60
85,400
10 20 120
Example 10.1
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ABC Classification: Example (cont.)

TOTAL % OF TOTAL % OF TOTAL

PART PART
VALUE ($) UNIT
VALUE COST ANNUAL%USAGE
QUANTITY CUMMULATIVE
9 1
30,600 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 11.0
2 14,000 16.4 4.0
A40 15.0
3 30 130
1 5,400 6.3 9.0 24.0
4 4
4,800 5.680 6.0 B60 30.0
3 5
3,900 4.630 10.0 100 40.0
6 6
3,600 4.220 % OF TOTAL
18.0 180%QUANTITY
OF TOTAL
58.0
CLASS ITEMS VALUE
5 3,000
7 3.510 13.0 170 71.0
10 2,400
A8 9, 8, 22.8 12.0
71.0 C 83.0
320 50 15.0
7 1,700
B 1, 4, 32.0 17.0
16.5 100.0
25.0
C
9 510
6, 5, 10, 7 12.5
60 60.0
85,400
10 20 120
Example 10.1
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 Inventory models
Inventory models quantify the relationship to identify the order size that
minimized total cost.
❑ Economic order quantity model (EOQ)
❑ Economic production quantity model (EPQ)

Assumptions of EOQ Model

▪ Only one product is involved
▪ Annual demand requirement is known
▪ Demand is even throughout the year
▪ Lead time does not vary
▪ Each order is received in a single delivery
▪ There are no quantity discounts
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 EOQ Model

Profile of Inventory Level Over Time

Q Usage
Quantity rate
on hand

Reorder
point

Time
Receive t1 t2 Place Receive
order Place Receive order order
order order

Lead time 11
 EOQ Model
Co - cost of placing order D - annual demand
Ch - annual per-unit carrying cost Q - order quantity

Annual holding cost (H) = (average number of inventory)×(holding

cost/unit/year)
• Average number of inventory = (Q+0)/2 = Q/2
Annual carrying cost (H) = (Q/2) Ch

• Annual ordering cost (O) = Cost per order × No. of order/year

O = Co × D/Q
Total Cost = Holding cost + Ordering cost
TC = (Q/2) ×Ch + Co × D/Q
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 EOQ Model

Total Cost
Slope = 0
ChQ
Holding Cost =
Minimum 2
total cost

CoD
Ordering Cost = Q

Optimal order
Qopt

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 EOQ Model
Example:
Deriving Qopt
A toy manufacturer uses approximately 32,000
Co D CQ silicon chips annually. The chips are used at a steady
TC = + h rate during the 240 days a year that the plant
Q 2
operates. Annual holding cost is $3 per chip, and
TC CD C ordering cost is $120. Determine
= - o2 + h
Q Q 2 • The optimal order quantity.
• Holding cost, ordering cost, and the total cost.
• The number of workdays in an order cycle.
2CoD
Qopt = D= 32, 000 Co = 120 Ch = 3
Ch
2×120×32000
Qopt = =1600
3
HC= ChQ/2= 3*800= 2400 OC= CoD/Q = 120*32000/1600 = 2400
Daily consumption rate= D/240 = 400/3
No. of Workdays = Q/Daily consumption rate=12 14
 Economic Production Quantity Model (EPQ)
• An inventory system in which an order is received gradually, as inventory
is simultaneously being depleted
• p - daily rate at which an order is received over time, or production rate
• d - daily rate at which inventory is demanded

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 EPQ Model
Q
Maximum inventory level = Q - d
p
d
= Q1-
p
Q
Average inventory level = 1- d
2 p

Co D CQ d
TC = + h 1- p
Q 2

2CoD
Qopt = d
Ch 1 -
p
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Quantity Discount Model
P: per unit price of item
D: annual demand

Cost
Adding Purchasing cost
doesn’t change EOQ TC with PD

TC without PD

PD

0 EOQ Quantity
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 Quantity Discount Model
Price per unit decreases as order quantity increases

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 Quantity Discount: Example
QUANTITY PRICE Co = $2,500
1 - 49 $ 1,400 Ch = $190 per computer per year
50 - 89 1,100 D = 200
90+ 900
Step 1: First determine
the optimal order size and
total cost with the basic
EOQ model.
For Q = 72.5 CoD ChQopt
TC = + + PD = $233,784
Qopt 2
Step 2: Compute Q using
the lowest unit price

For Q = 90 CcQ
CoD
TC = + + PD = $194,105 Optimum order
Q 2
quantity = 9020
 Inventory Control
Reorder Point: Level of inventory at which a new order is placed
ROP = d L where,
d = demand rate per period
L = lead time

Example: Demand is 20
items per day and lead time
is one week. What is the
reorder point (ROP)?
ROP = 20*7=140

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 Inventory Control
• Reorder Point - When the quantity on hand of an item drops to this
amount, the item is reordered.
• Safety Stock - Stock that is held in excess of expected demand due to
variable demand rate and/or lead time.
• Stockout – An inventory shortage
• Service Level - Probability that demand will not exceed supply
during lead time.

Variable Demand
with a Reorder Point

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Reorder Point with a Safety Stock

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 Reorder Point With Variable Demand

ROP = Expected demand during lead time + safety stocks

ROP for variable demand and

constant lead time
ROP for variable lead time and
constant demand
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 Reorder Point With Variable Demand
The carpet store wants a reorder point with a 95% service level and
a 5% stockout probability with a SD of 5 yards per day.
d = 30 yards per day
LT = 10 days
d = 5 yards per day
For a 95% service level, z = 1.65

ROP = d LT + z d LT
Safety stock = z d LT
= 30(10) + (1.65)(5)( 10)
= (1.65)(5)( 10)
= 326.1 yards
= 26.1 yards

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ROP for variable lead time and constant demand
The housekeeping department of a Hotel uses approximately 600 bars
of soap per day, and this tends to be fairly constant. Lead time for soap
delivery is normally distributed with a mean of six days and standard
deviation of two days. A service lead of 98% is desired. Find the ROP.

Given data:
d=600 bars/day
𝐿𝑇 =6 days
𝜎𝐿𝑇 = 2 𝑑𝑎𝑦𝑠
ROP=600*6+1.96*600*2 = 5952
Z=1.96

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ROP for variable demand and variable lead time
The Hotel replaces broken glasses at a rate of 25 per day. In the past,
this quantity has tend to vary normally and have a standard deviation
of 3 glasses per day. Glasses are ordered from a Cleveland supplier.
Lead time is normally distributed with an average of 10 days and a
standard deviation of 2 days. What ROP should be used to achieve a
service level of 95%?

ROP = d  LT + z LT + d  2
d
2 2
LT

Given data:
d=25 glasses/day ROP=25*10+ 1.65 10 ∗ 3 ∗ 3 + 25 ∗ 25 ∗ 2 ∗ 2
𝜎𝑑 = 3 𝑔𝑙𝑎𝑠𝑠𝑒𝑠 𝑑𝑎𝑦𝑠 =315.371
LT=10 days
𝜎𝐿𝑇 = 2 𝑑𝑎𝑦𝑠
Z=1.65
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