Managing inventory in
a supply chain
• Managing inventory in a supply chain:
Introduction, Classification of inventories, Economic
order quantity, Inventory control models – EOQ
determination with instantaneous delivery and
without shortages, Effect of quantity discount, Safety
stock, Reorder level, lead time [06]
LEARNING OBJECTIVES
After reading this chapter, you will be able to
• Balance the appropriate costs to choose the optimal lot
size and cycle inventory in a supply chain.
• Understand the impact of quantity discounts on lot size
and cycle inventory.
• Appropriate discounting schemes for a supply chain.
Inventory
Inventory is a stock or store of goods or services, kept for use or sale
in the future.
There are four types of inventory
• Raw materials & purchased parts
• Partially completed goods called work in progress (WIP)
• Finished-goods inventories
• Goods-in-transit to warehouses or customers (GIT)
Inventory Management
Inventory appears in the supply chain in several forms
Inventory Management
Every participant in a supply chain, whether retailer, wholesaler,
manufacturer or vendor, prefers to reduce inventories and yet
maintain customer service so as not to lose customers because of
non-availability of goods.
Huge inventories are a drain on resources, as it blocks money and
increases cost of operations.
Zero inventory is a very popular term in business literature, but as we
shall see zero inventory translates into zero business
Objectives of Inventory Management System
• Material Availability
• Better Level of Customer Service
• Keeping Wastage and Losses to a Minimum
• Maintaining Sufficient Stock
• Cost-Effective Storage
• Optimizing Product Sales
Managing Economies of Scale in a Supply Chain:
Cycle Inventory
Classification of Inventory
Cycle stock
Safety stock
Cycle inventory is the average inventory in a supply chain due to
either production or purchases in lot sizes that are larger than those
demanded by the customer.
Lot Sizing for a Single Product (Economic
Order Quantity)
Problem 1
• Demand for the Desk-pro computer at Best Buy is 1,000 units
per month. Best Buy incurs a fixed order placement,
transportation, and receiving cost of $4,000 each time an
order is placed. Each computer costs Best Buy $500 and the
retailer has a holding cost of 20 percent. Evaluate the number
of computers that the store manager should order in each
replenishment lot.
Example 2:
ABC Ltd. uses EOQ logic to determine the order quantity
for its various components and is planning its orders. The
Annual consumption is 80,000 units, Cost to place one order
is Rs. 1,200, Cost per unit is Rs. 50 and carrying cost is 6%
of Unit cost.
Find EOQ, No. of order per year, Ordering Cost and
Carrying Cost and Total Cost of Inventory
Multiple Products with Lots Ordered and Delivered
Independently
Best Buy sells three models of computers, the Litepro, the Medpro,
and the Heavypro. Annual demands for the three products are DL =
12,000 for the Litepro, DM = 1,200 units for the Medpro, and DH =
120 units for the Heavypro. Each model costs Best Buy $500. A fixed
transportation cost of $4,000 is incurred each time an order is
delivered. For each model ordered and delivered on the same truck, an
additional fixed cost of $1,000 is incurred for receiving and storage.
Best Buy incurs a holding cost of 20 percent.
(A) Evaluate the lot sizes that the Best Buy manager should order if
lots for each product are ordered and delivered independently. Also
evaluate the annual cost of such a policy
(B) Evaluate the lot sizes that the Best Buy manager should order if
lots for each product are ordered and delivered Jointly
Demand, DL = 12,000/year, DM = 1,200/year, DH = 120/year
Common order cost, S = $4,000
Product-specific order cost, sL = $1,000, sM = $1,000, sH =
$1,000
Holding cost, h = 0.2
Unit cost, CL = $500, CM = $500, CH = $500
Lot sizes and Cost for Independent Order
Litepro Medpro Heavypro
Demand per year 12,000 1,200 120
Fixed cost/order $5,000 $5,000 $5,000
Optimal order size 1,095 346 110
Cycle inventory 548 173 55
Annual holding cost $54800 $17,321 $5,477
Order frequency 11.0/year 3.5/year 1.1/year
Annual ordering cost(O) $55,000 $17,321 $5,477
Average flow time 2.4 weeks 7.5 weeks 23.7 weeks
Annual cost(H+O) $109800 $34,642 $10,954
The annual ordering and holding cost Best Buy incurs if the three
models are ordered independently turns out to be $155,140
LOTS ARE ORDERED AND DELIVERED JOINTLY
FOR ALL THREE MODELS
LOTS ARE ORDERED AND DELIVERED JOINTLY
FOR ALL THREE MODELS
Litepro Medpro Heavypro
Demand per year 12,000 1,200 120
Fixed cost/order $7,000(4000+1000+1000+1000)
Optimal order size 1230 123 12.3
Cycle inventory 615 61.5 6.15
Annual holding cost $61512 $6151 $615
Order frequency 9.75/year 9.75/year 9.75/year
Annual ordering
cost(O)
$68250
Average flow time 2.67weeks 2.67weeks 2.67weeks
Annual cost(H+O)
The annual ordering and holding cost Best Buy incurs if the three
models are ordered jointly turns out to be $136,528
Example 4:
An auto parts supplier sells Hardy-brand batteries to car dealers and
auto mechanics. The annual demand is approximately 1,200
batteries. The supplier pays $28 for each battery and estimates that
the annual holding cost is 30 percent of the battery’s value. It
costs approximately $20 to place an order (managerial and clerical
costs). The supplier currently orders 100 batteries per month.
a. Determine the ordering, holding, and total inventory costs for the
current order quantity.
b. Determine the economic order quantity
c. How many orders will be placed per year using the EOQ
d. Determine the ordering, holding, and total inventory costs for the
EOQ, How has ordering cost changed? Holding cost? Total inventory
cost
Example 5:
QUANTITY DISCOUNTS
A quantity discount is an incentive offered to a buyer that
results in a decreased cost per unit of goods or materials
when purchased in greater numbers
Problems on Quantity Discounts
• Drugs Online (DO) is an online retailer of prescription drugs
and health supplements. Vitamins represent a significant
percentage of its sales. Demand for vitamins is 10,000 bottles
per month. DO incurs a fixed order placement, transportation,
and receiving cost of $100 each time an order for vitamins is
placed with the manufacturer. DO incurs a holding cost of 20
percent. The manufacturer uses the following all unit discount
pricing schedule. Evaluate the number of bottles that the DO
manager should order in each lot.
Example 6:
Safety Inventory
• Safety inventory is inventory carried to satisfy demand that
exceeds the amount forecasted for a given period.
•Safety stock is the extra stock maintained to avoid the risk of losing
customers because of having insufficient inventory due to
unforeseen circumstances.
Replenishment Policies
Safety Inventory
Measuring Product Availability
Problem-1
Assume that weekly demand for phones at B & M office supplies is
normally distributed with a mean of 2500 and a standard deviation
of 500. The manufacturer takes two weeks to fill an order placed by
the B&M manager. The store manager currently orders 10,000
phones when the inventory on hand drops to 6000. Evaluate the
safety inventory and the average inventory carried by B &M. Also
evaluate the average time a phone spends at B&M.
• SS= 1.28 X 707 =905
