INVENTORY CONTROL

Prof. Kaushik Paul

Associate Professor
Operations Area
E-Mail: [email protected]
Phone: 43559308
 OBJECTIVES
 Inventory System Defined

 Inventory Costs

 Independent vs. Dependent Demand

 Single-Period Inventory Model

 Multi-Period Inventory Models: Basic Fixed-Order

Quantity Models

 Multi-Period Inventory Models: Basic Fixed-Time

Period Model

 Miscellaneous Systems and Issues 2

 INVENTORY SYSTEM

 Inventory is the stock of any item or resource used in

an organization and can include: raw materials,
finished products, component parts, supplies, and
work-in-process

 An inventory system is the set of policies and controls

that monitor levels of inventory and determines what
levels should be maintained, when stock should be
replenished, and how large orders should be
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 PURPOSES OF INVENTORY
1. To maintain independence of operations

3. To meet variation in product demand

5. To allow flexibility in production scheduling

7. To provide a safeguard for variation in raw material

delivery time

9. To take advantage of economic purchase-order size

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 INVENTORY COSTS
 Holding (or carrying) costs

 Costs for storage, handling, insurance, etc

 Setup (or production change) costs

 Costs for arranging specific equipment setups, etc

 Ordering costs

 Costs of someone placing an order, etc

 Shortage costs

 Costs of canceling an order, etc

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 INDEPENDENT VS. DEPENDENT
DEMAND

Independent Demand (Demand for the final end-

product or demand not related to other items)

Finished
product

Dependent
Demand
(Derived
demand items
E
for component
(1) parts,
subassemblies,
raw materials,
Component parts etc)
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 INVENTORY SYSTEMS
 Single-Period Inventory Model

 One time purchasing decision (Example: vendor

selling t-shirts at a football game)

 Seeks to balance the costs of inventory overstock

and under stock

 Multi-Period Inventory Models

 Fixed-Order Quantity Models

 Event triggered (Example: running out of stock)

 Fixed-Time Period Models

 Time triggered (Example: Monthly sales call by

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sales representative)
 MULTI-PERIOD MODELS:
FIXED-ORDER QUANTITY MODEL

 Demand for the product is constant and uniform

throughout the period

 Lead time (time from ordering to receipt) is constant

 Price per unit of product is constant

 Inventory holding cost is based on average inventory

 Ordering or setup costs are constant

 All demands for the product will be satisfied (No back

orders are allowed)

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 BASIC FIXED-ORDER QUANTITY MODEL
AND REORDER POINT BEHAVIOR
1. You receive an order quantity Q. 4. The cycle then repeats.

Number
of units
on hand Q Q Q

R
2. Your start L L
using them up 3. When you reach
over time. Time down to a level of
R = Reorder point inventory of R, you
Q = Economic order quantity
place your next Q sized
L = Lead time
order.
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 COST MINIMIZATION GOAL
By adding the item, holding, and ordering costs
together, we determine the total cost curve, which
in turn is used to find the Qopt inventory order point
that minimizes total costs

Total Cost
C
O
S
T Holding
Costs
Annual Cost of
Items (DC)

Ordering Costs

QOPT
Order Quantity (Q) 10
 BASIC FIXED-ORDER
QUANTITY (EOQ) MODEL TC=Total annual
cost
FORMULA
D =Demand
Total Annual Annual Annual C =Cost per unit
Annual = Purchase + Ordering + Holding Q =Order quantity
Cost Cost Cost Cost S =Cost of placing
an order or setup
cost
R =Reorder point
L =Lead time
H=Annual holding
D Q and storage cost
TC = DC + S + H per unit of inventory
Q 2

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Deriving the EOQ
Using calculus, we take the first derivative of the
total cost function with respect to Q, and set
the derivative (slope) equal to zero, solving for
the optimized (cost minimized) value of Qopt

2DS 2(Annual Demand)(Order or Setup Cost)

Q OPT = =
H Annual Holding Cost
_
We also need a Reorder point, R = d L
reorder point to _
tell us when to d = average daily demand (constant)
place an order
L = Lead time (constant)
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 EOQ EXAMPLE (1) PROBLEM DATA

Given the information below, what are the EOQ and

reorder point?
Annual Demand = 1,000 units

Days per year considered in average daily demand =

365

Cost to place an order = $10

Holding cost per unit per year = $2.50

Lead time = 7 days

Cost per unit = $15

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 EOQ EXAMPLE (1) SOLUTION
2DS 2(1,000 )(10)
Q OPT = = = 89.443 units or 90 units
H 2.50

1,000 units / year

d = = 2.74 units / day
365 days / year

_
Reorder point, R = d L = 2.74units / day (7days) = 19.18 or 20 units

In summary, you place an optimal order of 90

units. In the course of using the units to meet
demand, when you only have 20 units left, place
the next order of 90 units.

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 EOQ Example (2) Problem Data
Determine the economic order quantity and the reorder
point given the following…

Annual Demand = 10,000 units

Days per year considered in average daily demand =

365

Cost to place an order = $10

Holding cost per unit per year = 10% of cost per unit

Lead time = 10 days

Cost per unit = $15

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 EOQ EXAMPLE (2) SOLUTION
2DS 2(10,000 )(10)
Q OPT = = = 365.148 units, or 366 units
H 1.50

10,000 units / year

d= = 27.397 units / day
365 days / year

_
R = d L = 27.397 units / day (10 days) = 273.97 or 274 units

Place an order for 366 units. When in the course of

using the inventory you are left with only 274 units,
place the next order of 366 units.

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FIXED-TIME PERIOD MODEL WITH
SAFETY STOCK FORMULA
q = Average demand + Safety stock – Inventory currently on hand

q = d(T + L) + Z σ T + L - I

Where :
q = quantitiy to be ordered
T = the number of days between reviews
L = lead time in days
d = forecast average daily demand
z = the number of standard deviations for a specified service probability
σ T + L = standard deviation of demand over the review and lead time
I = current inventory level (includes items on order)
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 MULTI-PERIOD MODELS: FIXED-TIME
PERIOD MODEL, DETERMINING THE
VALUE OF ST+L

∑(σ )
T+ L 2
σ T+ L = di
i =1

Since each day is independent and σ d is constant,

σ T+ L = (T + L)σ d 2

 The standard deviation of a sequence of random events

equals the square root of the sum of the variances

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 EXAMPLE OF THE FIXED-TIME PERIOD
MODEL
Given the information below, how many units should be
ordered?

Average daily demand for a product is 20 units. The

review period is 30 days, and lead time is 10 days.
Management has set a policy of satisfying 96 percent
of demand from items in stock. At the beginning of
the review period there are 200 units in inventory.
The daily demand standard deviation is 4 units.

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EXAMPLE OF THE FIXED-TIME PERIOD
MODEL: SOLUTION (PART 1)
σ T+ L = (T + L)σ d = 2
( 30 + 10) ( 4) = 25.298
2

The value for “z” is found by using the Excel NORMSINV function, or
as we will do here, using Appendix D. By adding 0.5 to all the values in
Appendix D and finding the value in the table that comes closest to the
service probability, the “z” value can be read by adding the column
heading label to the row label.

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
MODEL: SOLUTION (PART 2)

q = d(T + L) + Z σ T + L - I

q = 20(30 + 10) + (1.75)(25.298) - 200

q = 800 + 44.272 - 200 = 644.272, or 645 units

So, to satisfy 96 percent of the demand, you

should place an order of 645 units at this review
period

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 PRICE-BREAK MODEL FORMULA
Based on the same assumptions as the EOQ model,
the price-break model has a similar Qopt formula:

2DS 2(Annual Demand)(Order or Setup Cost)

Q OPT = =
iC Annual Holding Cost

i = percentage of unit cost attributed to carrying

inventory
C = cost per unit

Since “C” changes for each price-break, the formula

above will have to be used with each price-break cost
value

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 PRICE-BREAK EXAMPLE PROBLEM
DATA (PART 1)
A company has a chance to reduce their inventory
ordering costs by placing larger quantity orders using
the price-break order quantity schedule below. What
should their optimal order quantity be if this company
purchases this single inventory item with an e-mail
ordering cost of $4, a carrying cost rate of 2% of the
inventory cost of the item, and an annual demand of
10,000 units?
Order Quantity(units) Price/unit($)
0 to 2,499 $1.20
2,500 to 3,999 1.00
4,000 or more .98

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 PRICE-BREAK EXAMPLE SOLUTION (PART
2)
First, plug data into formula for each price-break value
of “C”
Annual Demand (D)= 10,000 unitsCarrying cost % of total cost
Cost to place an order (S)= $4 (i)= 2%
Cost per unit (C) = $1.20,
Next, determine if the computed
$1.00,Q$0.98
opt values are feasible
or not
Interval from 0 to 2499, the 2DS 2(10,000)(4)
Qopt value is feasible Q OPT = = = 1,826 units
iC 0.02(1.20)
Interval from 2500-3999, the 2DS 2(10,000)(4)
Qopt value is not feasible Q OPT = = = 2,000 units
iC 0.02(1.00)
Interval from 4000 & more, 2DS 2(10,000)(4)
the Qopt value is not feasible Q OPT = = = 2,020 units
iC 0.02(0.98)
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Price-Break Example Solution (Part
3)
Since the feasible solution occurred in the first price-
break, it means that all the other true Qopt values occur
at the beginnings of each price-break interval. Why?

Because the total annual cost function is a

Total “u” shaped function
annual
costs So the candidates
for the price-
breaks are 1826,
2500, and 4000
units

0 1826 2500 4000 Order Quantity

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PRICE-BREAK EXAMPLE SOLUTION (PART
4)

Next, we plug the true Qopt values into the total cost
annual cost function to determine the total cost under
each price-break
D Q
TC = DC + S+ iC
Q 2

TC(0-
2499)=(10000*1.20)+(10000/1826)*4+(1826/2)(0.02*1.20
)
= $12,043.82
TC(2500-3999)= $10,041
TC(4000&more)= $9,949.20
Finally, we select the least costly Qopt, which is this
problem occurs in the 4000 & more interval. In
summary, our optimal order quantity is 4000 units
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 MISCELLANEOUS SYSTEMS: OPTIONAL
REPLENISHMENT SYSTEM
Maximum Inventory Level, M

q=M-I

Actual Inventory Level, I

M

Q = minimum acceptable order quantity

If q > Q, order q, otherwise do not order any.

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MISCELLANEOUS SYSTEMS: BIN
SYSTEMS

Two-Bin System

Order One Bin of

Inventory
Full Empty

One-Bin System

Order Enough to
Refill Bin
Periodic Check

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 ABC CLASSIFICATION SYSTEM
 Items kept in inventory are not of equal
importance in terms of:
 dollars invested 60
% of
 profit potential $ Value 30 A
 sales or usage volume 0 B
% of 30 C
 stock-out penalties
Use 60

So, identify inventory items based on percentage of total

dollar value, where “A” items are roughly top 15 %, “B”
items as next 35 %, and the lower 65% are the “C” items

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 INVENTORY ACCURACY AND CYCLE
COUNTING

 Inventory accuracy refers to how well the

inventory records agree with physical count

 Cycle Counting is a physical inventory-taking

technique in which inventory is counted on a
frequent basis rather than once or twice a year

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Reference: Operations Management for
Competitive Advantage
By Chase, Jacobs & Aquilano, 10e

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