INVENTORY MANAGEMENT

Dr. Tanu Manocha

 Outline
 Inventory Management
 Functions of Inventory
 Types of Inventory
 Inventory Management
 ABC Analysis
 Record Accuracy
 Cycle Counting
 Control of Service
Inventories
© 2008 Prentice Hall, Inc. 12 – 2
 Inventory

In order to meet the demand for raw materials,

components or other inputs from internal processes of a
firm and demand for finished products from customers,
there is need to maintain stock at each stage of production
and delivery.

This stock is called inventory – labelled as raw materials

inventory, work in progress inventory and finished goods
inventory.
 Outline – Continued
 Inventory Models
 Independent vs. Dependent Demand
 Holding, Ordering, and Setup Costs

© 2008 Prentice Hall, Inc. 12 – 4

 To provide the buffer
between successive
To satisfy the expected operations ( decoupling To satisfy periods of
customer demand inventory or WIP seasonal high demand
(Anticipation Demand ) inventory) (seasonal Inventory)

To act as a buffer
To protect against price between various
increases and take Inventory elements of the
advantage of quantity supply chain ,
discount suppliers
producers-
distributors-
wholesalers –
retailers-
To minimize the total cost customers
To avoid Stock outs
by ordering the economic (pipeline or transit
(safety stock or Buffer
order quantity stock
stock)
(cycle stock )
 Inventory Management System

Independent demand IMS Dependent demand IMS

For MRP JIT

For Retailers
Manufacturers

Hybrid MRP-JIT
ABC classification of EOQ model for
system
items manufacturers

Category A Category B Category C

Basic EOQ Periodic Review

EOQ model with EOQ model EOQ model with

EOQ model with
differential with safety Intentional
quantity Discount
discounting stock shortages
An inventory system facilitates the
organizational structure and the operating
policies for maintaining and controlling
materials to be inventoried. This system is
responsible for ordering and receipt of
materials, timing the order placement and
keeping record of what has been ordered,
how much ordered and from whom the
order placement has been done.

There are two models of inventory system:-

•The fixed order quantity system (Q SYSTEM)

•The fixed order periodic system (P system)

The fixed order quantity system is also known as
the Q system. In this system, whenever the stock
on hand reaches the reorder point, a fixed
quantity of materials is ordered. The fixed
quantity of material ordered each time is actually
the economic order quantity.
FIXED ORDER PERIOD SYSTEM (P SYSTEM)
In this system, the stock position of each material of a product is
checked at regular intervals of time period. When the stock level
of a given product is not sufficient to sustain the operation of
production until the next scheduled tested, an order is placed
destroying the supply. The frequency of reviews varies from
organization to organization. It also varies among products within
the same organization, depending upon the importance of the
product, predetermined production schedules, market conditions
and so forth. The order quantities vary for different materials.
 Distinction Between Q System and P System

Point of difference Q system P system

Stock on hand reaches to Based on fixed review

Initiation of order
reorder point period and not stock level

Any time when stock level Only after the

Period of order
reaches to reorder point predetermined period

Continuously each time a

Record keeping withdrawal or addition is Only at the review period
made

Constant the same

Quantity of order varies
Order quantity quantity ordered each
each time order is placed
time

Size of inventory less than the P system Larger than the Q system

Higher due to perpetual Less than due to only at

Time to maintain
record keeping the review period
 Functions of Inventory
1. To decouple or separate various
parts of the production process
2. To decouple (isolate) the firm
from fluctuations in demand and
provide a stock of goods that will
provide a selection for
customers
3. To take advantage of quantity
discounts
4. To hedge against inflation
© 2008 Prentice Hall, Inc. 12 – 13
 Types of Inventory
 Raw material
 Purchased but not processed
 Work-in-process
 Undergone some change but not completed
 A function of cycle time for a product
 Maintenance/repair/operating (MRO)
 Necessary to keep machinery and processes
productive
 Finished goods
 Completed product awaiting shipment
© 2008 Prentice Hall, Inc. 12 – 14
Objectives of Inventory
Management
1. Ensure a continuous Supply of Raw Material and Supplies to
facilitate uninterrupted production.
2. Maintain Sufficient –finished goods for smooth sales
operation and efficient customer service.
3. Inventories permit the procurement of raw materials in
economic lot sizes as well as processing these raw materials
into finished goods is the most economical quantity known
as “Economic Lot Size”
4. Reduce dependencies of one another and enable the
organisations to schedule its operations independently of
another.
5. Inventory Management helps to reduce Material Handling
Costs.
6. It helps to utilize people and equipment reasonably
7. It facilitates product display and service in customers.
Factors Influencing Inventory
Management and Control
1. Type of Product
2. Type of Manufacture
3. Volume of Production

Process Of Inventory Management and Control

Step 1: Determination of Optimum Inventory Levels and procedure

of their review and adjustment.
Step 2 : Determination of the Degree of control that is required for
the best results.
Step 3 : Planning and Design of the inventory control system.
Step 4 : Planning of the inventory control Organisation
 The Material Flow Cycle

Cycle time

95% 5%

Input Wait for Wait to Move Wait in queue Setup Run Output
inspection be moved time for operator time time

Figure 12.1

© 2008 Prentice Hall, Inc. 12 – 18

 Inventory Management

 How inventory items can be

classified
 How accurate inventory records
can be maintained

© 2008 Prentice Hall, Inc. 12 – 19

Inventory Control Techniques
1. ABC Analysis ( Always Better Control) also called as SIM
( selective Inventory Control Method).

2. HML ( High , Medium and Low)

3. VED ( Vital, Essential and Desirable)
4. SDE ( Scarce, Difficult and easy to obtain)
5. FSN ( Fast moving, Slow moving and non – moving )
6. EOQ ( Economic Order Quantity )
7. Maximum and minimum system
8. Two bin System
 ABC Analysis
 Divides inventory into three classes
based on annual dollar volume
 Class A - high annual dollar volume
 Class B - medium annual dollar
volume
 Class C - low annual dollar
volume
 Used to establish policies that focus
on the few critical parts and not the
many trivial ones
© 2008 Prentice Hall, Inc. 12 – 21
 ABC ANALYSIS

ABC ANALYSIS IS BASED ON THE PRINCIPLE THAT FOR AN ITEM, THE

LEVEL OF CONTROL SHOULD BE ACCORDING TO THE POTENTIAL OF
SAVINGS FOR THAT ITEM WHICH WOULD IN TURN DEPEND UPON THE
VALUE OF ANNUAL CONSUMPTION OF THAT ITEM
CATEGORIES OF ITEMS IN ABC ANALYSIS
In the list of items based on their annual consumption value
Category A: Top 10%
Category B: 10 to 30 %
Category C: 30-100%

STEPS INVOLVED IN ABC ANALYSIS

1. Prepare a list of all SKUs and assign a code number to each
2. Determine annual consumption value for each item
3. List items in descending order of annual consumption value
4. Classify items in A,B and C categories as follows
Category A: Few high annual consumption value items
Category B: Some medium annual consumption value items Category
C: Large number of low annual consumption value items
INVENTORY CONTROL BASED ON ABC ANALYSIS

Level of control
Safety stock
Frequency of ordering
Frequency of deliveries
Follow up and expediting
Value analysis
Number of sources
Forecasting
Periodicity of review
 ABC Analysis
Percent of Percent of
Item Number Annual Annual Annual
Stock of Items Unit Dollar Dollar
Number Stocked (units)
Volume x Cost = Volume Volume Class

#10286 20% 1,000 $ 90.00 $ 90,000 38.8% A

72%
#11526 500 154.00 77,000 33.2% A

#12760 1,550 17.00 26,350 11.3% B

#10867 30% 350 42.86 15,001 6.4% 23% B

#10500 1,000 12.50 12,500 5.4% B

© 2008 Prentice Hall, Inc. 12 – 25

 ABC Analysis
Percent of Percent of
Item Number Annual Annual Annual
Stock of Items Unit Dollar Dollar
Number Stocked (units)
Volume x Cost = Volume Volume Class

#12572 600 $ 14.17 $ 8,502 3.7% C

#14075 2,000 .60 1,200 .5% C

#01036 50% 100 8.50 850 .4% 5% C

#01307 1,200 .42 504 .2% C

#10572 250 .60 150 .1% C

8,550 $232,057 100.0%

© 2008 Prentice Hall, Inc. 12 – 26

 Percent of annual dollar usage ABC Analysis
A Items
80 –
70 –
60 –
50 –
40 –
30 –
20 – B Items
10 – C Items
0 – | | | | | | | | | |

10 20 30 40 50 60 70 80 90
100
Percent of inventory items Figure 12.2

© 2008 Prentice Hall, Inc. 12 – 27

 ABC Analysis
 Other criteria than annual dollar
volume may be used
 Anticipated engineering
changes
 Delivery problems
 Quality problems
 High unit cost

© 2008 Prentice Hall, Inc. 12 – 28

 ABC Analysis
 Policies employed may include
 More emphasis on supplier
development for A items
 Tighter physical inventory control for
A items
 More care in forecasting A items

© 2008 Prentice Hall, Inc. 12 – 29

Example

Nike, Inc is an American manufacturer of shoes. In their ABC

analysis, leather forms class A, sole forms class B while shoe
lace forms class C. ABC analysis is a vital method for
management of inventory.
 Record Accuracy
 Accurate records are a critical
ingredient in production and inventory
systems
 Allows organization to focus on what
is needed
 Necessary to make precise decisions
about ordering, scheduling, and
shipping
 Incoming and outgoing record
keeping must be accurate
 Stockrooms should be secure
© 2008 Prentice Hall, Inc. 12 – 31
 Cycle Counting
 Items are counted and records updated
on a periodic basis
 Often used with ABC analysis
to determine cycle
 Has several advantages
 Eliminates shutdowns and
interruptions
 Eliminates annual inventory
adjustment
 Trained personnel audit
inventory accuracy
 Allows causes of errors to be identified and
© 2008 Prentice Hall, Inc. 12 – 32
 Cycle Counting Example
5,000 items in inventory, 500 A items, 1,750 B items, 2,750 C
items
Policy is to count A items every month (20 working days), B
items every quarter (60 days), and C items every six months
(120 days)

Item Number of Items

Class Quantity Cycle Counting Policy Counted per Day
A 500 Each month 500/20 = 25/day
B 1,750 Each quarter 1,750/60 = 29/day
C 2,750 Every 6 months 2,750/120 = 23/day
77/day

© 2008 Prentice Hall, Inc. 12 – 33

 Control of Service
Inventories
 Can be a critical component
of profitability
 Losses may come from
shrinkage or pilferage
 Applicable techniques
include
1. Good personnel selection, training, and
discipline
2. Tight control on incoming shipments
3. Effective control on all goods leaving
© 2008 Prentice Hall, Inc. facility 12 – 34
 Independent Versus
Dependent
Demand
 Independent demand - the
demand for item is independent
of the demand for any other
item in inventory
 Dependent demand - the
demand for item is dependent
upon the demand for some
other item in the inventory

© 2008 Prentice Hall, Inc. 12 – 35

 Holding, Ordering, and
Setup Costs
 Holding costs - the costs of holding
or “carrying” inventory over time
 Ordering costs - the costs of
placing an order and receiving
goods
 Setup costs - cost to prepare a
machine or process for
manufacturing an order
© 2008 Prentice Hall, Inc. 12 – 36
 Holding Costs
Cost (and range)
as a Percent of
Category Inventory Value
Housing costs (building rent or 6% (3 - 10%)
depreciation, operating costs, taxes,
insurance)
Material handling costs (equipment lease or 3% (1 - 3.5%)
depreciation, power, operating cost)
Labor cost 3% (3 - 5%)
Investment costs (borrowing costs, taxes, 11% (6 - 24%)
and insurance on inventory)
Pilferage, space, and obsolescence 3% (2 - 5%)
Overall carrying cost 26%

Table 12.1
© 2008 Prentice Hall, Inc. 12 – 37
 Inventory Models for
Independent
Demand
Need to determine when and how
much to order

 Basic economic order

quantity
 Production order quantity
 Quantity discount model
© 2008 Prentice Hall, Inc. 12 – 38
 Basic EOQ Model
Important assumptions
1. Demand is known, constant, and
independent
2. Lead time is known and
constant
3. Receipt of inventory is instantaneous and
complete
4. Quantity discounts are not possible
5. Only variable costs are setup and holding
6. Stockouts can be completely avoided
© 2008 Prentice Hall, Inc. 12 – 39
TERMS USED IN INVENTORY
Annual demand ...
MODELS
… … … … A
Daily demand ... … … … … d
Quantity to be ordered … … … … Q
Economic order quantity … … … … Q*
Buying cost per order ... … … … … B
Cost of one unit of purchased item … … … C
Inventory carrying cost per year … … … I
Inventory carrying cost per unit per year … … CI
Lead time … … … … … LT
Quantity delivered per day for multiple delivery order p
Back order cost per unit per year (in case of a stockout) … b
Reorder level ... … … … … R
Inventory cycle time … … … … T
Inventory cycle time associated with EOQ … … T*
No. of orders per year … … … … N
No. of orders per year associated with EOQ … N*
Annual variable cost … … … … AVC
Annual total cost ... … … … … ATC
.

Q SYSTEM - CLASSICAL MODEL

Assumptions
i) Demand is uniform during an inventory cycle and also cycle to cycle
ii) Lead time is uniform for each cycle
QUANTITY IN STOCK (Q)

Q*

Q*/2
R

P LT P LT P LT
T* T* T*
TIME (T)
Q SYSTEM, CLASSICAL MODEL

EOQ (Q*)=√(2A.B)/(C.I);
AVC (for order quantity Q) = (A.B)/Q+1/2(Q.C.I) [(Buying cost+Carrying cost)]
AVC (for order quantity Q*) = (A.B)/Q*+1/2(Q*.C.I)=√(2A.B)(C.I)

ATC (for order quantity Q) = AVC+(A.C)=(A.B)/Q+1/2(Q.C.I)+(A.C)[(Buying cost+Carrying cost

` `+Product cost)]
ATC (for order quantity Q*) = (A.B)/Q*+1/2(Q*.C.I)+(A.C)=AVC+
(A.C)=√(2A.B)(C.I) + (A.C)
Inventory cycle time, T*= Q*/A year; No. of orders per year, N*= A/Q*;
Reorder Level R= d.LT; Average Inventory = Q*/2;
Main bin quantity = Q*- R; Auxiliary bin quantity =R
 Q SYSTEM, CLASSICAL MODEL
EXAMPLE
A fan manufacturer produces 40,000 fans per year. Each fan has one aluminum body which
costs Rs 100 each. The firm has estimated that its annual inventory carrying costs are 20 %
of the value of average inventory carried. The cost of buying has been determined as Rs
1000 per order. For the
40,000 aluminum bodies that the manufacturer buys per year, find the economic order
quantity (Q*), annual variable cost (AVC), annual total cost (ATC), number of orders per
year (N*), inventory cycle time (T*), reorder level (R), average inventory, quantities in the
main bin and auxiliary bin for two bin inventory control system. You may assume that the
firm has 300 working days in a year and lead time is 6 working days.
ANSWER
Given A = 40000; B = 1000; C = 100; I = 20% = 0.2; d = 40000/300 = 400/3 =133.33
EOQ (Q*)=√(2A.B)/(C.I) = √ 2x40000x1000)/(100x0.2) = 2,000
AVC=√(2A.B)(C.I) = √ 2x40000x1000x100x0.2 = 40,000
ATC=AVC+(A.C) = 40,000 + 40000x100 = 40,40,000
N*=A/Q* = 40000/2000 = 20
T*=Q*/A = 2000/40000 = 0.05 year = 0.05x300 = 15 working days
R=d.LT = (400/3).6 = 800
Average Inventory = Q*/2 = 2000/2 =1000
Main bin quantity=Q*- R = 2000 – 800 = 1200
Auxiliary bin quantity=R = 800
Q SYSTEM - QUANTITY DISCOUNT MODEL
ATC =Ordering cost + Carrying cost + Product cost
=(A.B)/Q +1/2(Q.C.I) + A.C
[Accept discount option if ATCdiscount < ATCEOQ]

EXAMPLE
For the fan manufacturer example discussed earlier, the vendor has offered a price discount of Rs 2
per fan body, provided the order quantity is 20000 units. Should the fan manufacturer accept the
offer?
ANSWER
For order quantity Q, ATCQ =(A.B)/Q+1/2(Q.C.I)+(A.C)
ATCEOQ = 2000 =(40,000x1000)/2,000+1/2(2,000x100x0.2)+(40,000x100) = 40,40,000
For order quantity, 20,000 and cost per unit Rs 98,
ATCQ=20000 =(40,000x1000)/20,000+1/2(20,000x98x0.2)+(40,000x98) = 41,18,000
ATCQ=20000 > ATCEOQ Therefore, manufacturer should reject vendor’s offer.
.
Q SYSTEM - MULTIPLE DELIVERY MODEL

EOQ (Q*)=√[(2A.B)/(C.I)].[p/(p-d)] p is quantity delivered per day, p>d

AVC=√[(2A.B)(C.I)].[(p-d)/(p)
EXAMPLE
For the fan manufacturer example discussed earlier, if the vendor agrees to deliver
150 fan bodies per day at no extra cost, what should be the order quantity?
Also determine the annual variable cost?
ANSWER
Given p = 150 per day d = 133.33 per day (as calculated earlier)
EOQ (Q*)= √[(2A.B)/(C.I)].[p/(p-d)] Or
EOQ (Q*)=√[2x40000x1000)/(100x0.2)].[150/(150-133.33)] = √(4000000).(8.9982) = 6000
AVC=√[(2A.B)(C.I)].[(p-d)/(p)]
AVC= √[2x40000x1000)(100x0.2)].[(150-133.33)/150] = √(1600000000).(8.9982) = 13335
Note that for EOQ classical model, AVC = 40,000
So multiple delivery model brings down annual variable cost to almost 1/3 of
annual variable cost for classical model .
Q SYSTEM - PLANNED STOCKOUT MODEL
EOQ (Q*)=√[(2A.B)/(C.I)].[(C.I+b)/(b)];
AVC=√[(2A.B)(C.I)].[(b)/(C.I+b)
EXAMPLE
Where b is stock out cost per unit per
For the fan manufacturer example discussed earlier, the firm is prepared to work with shortages,
year
since the item can be procured from an alternate source at slightly higher price off the shelf. The
cost of shortage has been determined as half the inventory carrying cost per unit per year. Find EOQ
and the annual variable cost (AVC)
ANSWER
Inventory carrying cost per unit per year (C.I) = 100x0.2 = 20 Given b = ½ C.I = 10
EOQ (Q*)= √[(2A.B)/(C.I)].[(C.I+b)/(b)] Or
EOQ (Q*)=√[2x40000x1000)/(100x0.2)].[(20+10/10)] = √(4000000).(3) = 3464
AVC=√[(2A.B)(C.I)].[b/(C.I+b)]
AVC= √[2x40000x1000)(100x0.2)].[(10/(20+10)] = √(1600000000).(0.33) = 23094
Note that for EOQ classical model, AVC = 40,000
So planned stock out model brings down annual variable cost to little
over half the annual variable cost for classical model
.
Q SYSTEM - ECONOMIC BATCH QUANTITY (EBQ)
EBQ = √(2A.B')/(C.I)
A is annual demand or annual production; B' is batch set up cost;
C is cost of production per unit; I is the inventory carrying cost per year
AVC (for order quantity Q) = (A.B')/Q+1/2(Q.C.I) [(Set up cost+Carrying cost)]
EXAMPLE
An automobile manufacturer has found that the annual demand for a particular model of car is
1,00,000 units. The cost of production per car is Rs 1.5 lakhs. Set up time is 6 days. The assembly
line can produce 1000 cars per day. Each car contributes gross profit of Rs 50,000. Set up cost is
determined as the loss of profit during the set up time when there is no production. Inventory
carrying cost is 20 percent per annum. Determine the economic batch quantity (EBQ). Also
determine EBQ if the set up time is reduced to i) 3 days ii)1 day iii) ½
day.

A=1,00,000 B'=Rs 5,00,00,000/day C= 1,50,000 I = 0.2

Set up time (days) 6 3 1 0.5
EBQ =√(2A.B')/(C.I)
(2A.B')/(C.I) 2000000000 1000000000 333333333 166666667
EBQ =√(2A.B')/(C.I) 44721 31623 18257 12910
AVC = (A.B')/Q+1/2(Q.C.I) Rs Crores 134.16 94.87 54.77 38.73
Note that for 6 days’ set up time AVC is Rs 134 Cr, for ½ day set up time, AVC is Rs 39 Cr
P SYSTEM
Tp* = √(2B)/(A.C.I) where
Tp is
EXAMPLE optimal review period
An engineering and fabrication company has collected following data with respect to some C
category items that it determined that it uses regularly. Assuming that buying cost per order is Rs
400 and inventory carrying cost is 20 percent per annum, determine optimal review period for all the
items. Also suggest what should be the frequency of review for each item. Assume 365 days in a
year.

ANSWER
GIVEN A as per table, B = Rs200 per order C as per table, I = 20% Tp = (2B)/(A.C.I) Tp = √(2B)/(A.C.I)
2
Year Days Review
Item Unit B A C I= 0.2 T p2 Tp Yearx365 Period
Lubricating oil litre 200 1600 175 0.2 0.0071 0.0845 31 1 month
Grease kg 200 600 300 0.2 0.0111 0.1054 38 1 month
Welding electrodes Nos 200 10000 10 0.2 0.02 0.1414 52 1.5 months
Grinding wheels Nos 200 300 214 0.2 0.0312 0.1765 64 2 months
Polishing wheels Nos 200 400 108 0.2 0.0463 0.2152 79 2.5 months
A4 paper 500 sheets/pkt Pkt 200 300 245 0.2 0.0272 0.1650 60 1.5 months

.
 Inventory Usage Over Time

Usage rate Average

Order inventory
quantity = Q
Inventory level

on hand
(maximum
inventory Q
level) 2

Minimum

inventory

0 Time

Figure 12.3
© 2008 Prentice Hall, Inc. 12 – 49
 Minimizing Costs
Objective is to minimize total costs
Curve for total
cost of holding
and setup

Minimum
total
cost
Annual cost

Holding cost
curve

Setup (or order)

cost curve
Optimal order Order quantity
Table 11.5 quantity (Q*)
© 2008 Prentice Hall, Inc. 12 – 50
 The EOQ Mode Annual setup cost = D
Q
S

Q = Number of pieces per order

ode l l
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory
item S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year

Annual setup cost = (Number of orders

placed per year)
x (Setup or order cost per
order)
Annual demand Setup or order
=
Number of units in cost per
each order order
D
= (S)
Q
© 2008 Prentice Hall, Inc. 12 – 51
 The EOQ Mode Annual setup cost = D
Q
S

Q = Number of pieces per order

ode l l
Annual
H
holding cost = Q

2
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory
item S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year

Annual holding cost = (Average inventory level)

x (Holding cost per unit per
year)
Order quantity
= (Holding cost per unit per year)
2

Q
= (H)
2

© 2008 Prentice Hall, Inc. 12 – 52

 The EOQ Mode Annual setup cost = D
Q
S

Q = Number of pieces per order

ode l l
Annual
H
holding cost = Q

2
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory
item S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year

Optimal order quantity is found when annual setup cost

equals annual holding cost

D QH
QS 2
Solving for Q* =
2DS = Q2H
Q2 = 2DS/H
Q* =
© 2008 Prentice Hall, Inc. 2DS/H 12 – 53
 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units
S = $10 per order
H = $.50 per unit per year

2DS
Q* =
H

Q* = 2(1,000)(10) 40,000 = 200 units

0.50 =

© 2008 Prentice Hall, Inc. 12 – 54

 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year

Expected Demand D
=
number of
orders =N=
Order quantity
Q*
1,000
N= 200 = 5 orders per year

© 2008 Prentice Hall, Inc. 12 – 55

 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per
H = $.50 per unit per year year

Number of working
Expected days per year
time between = T =
orders N

250
T= 5 = 50 days between orders

© 2008 Prentice Hall, Inc. 12 – 56

 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days

Total annual cost = Setup cost + Holding cost

D Q
TC = Q S + 2 H
TC = 1,000 ($10) + 200 ($.50)
200 2

TC = (5)($10) + (100)($.50) = $50 + $50 =

$100
© 2008 Prentice Hall, Inc. 12 – 57
 Robust Model

 The EOQ model is robust

 It works even if all parameters
and assumptions are not met
 The total cost curve is relatively
flat in the area of the EOQ

© 2008 Prentice Hall, Inc. 12 – 58

 An EOQ Example
Management underestimated demand by 50%
D = 1,000 units1,500 units Q* = 200 units
S = $10 per order N = 5 orders per
H = $.50 per unit per year year T = 50
days
D Q H
TC = Q S + 2
TC = 1,500 ($10) + 200 ($.50) = $75 + $50 = $125
200 2

Total annual cost increases by only 25%

© 2008 Prentice Hall, Inc. 12 – 59

 An EOQ Example
Actual EOQ for new demand is 244.9 units
D = 1,000 units 1,500 units Q* = 244.9 units
S = $10 per order N = 5 orders per
H = $.50 per unit per year year T = 50
days
D Q H
TC = Q S + 2
Only 2% less
TC = 1,500 ($10) + 244.9 ($.50) than the total
244.9 2 cost of $125
when the
TC = $61.24 + $61.24 = $122.48 order quantity
was 200

© 2008 Prentice Hall, Inc. 12 – 60

 Reorder Points
 EOQ answers the “how much” question
 The reorder point (ROP) tells when to
order
Demand Lead time for a
ROP = per new order in days
day
=dxL
D Number of
d=
working days in a year

© 2008 Prentice Hall, Inc. 12 – 61

 Reorder Point Curve
Q*
Inventory level (units)

Slope = units/day = d

ROP
(units)

Time (days)
Figure 12.5 Lead time = L
© 2008 Prentice Hall, Inc. 12 – 62
 Reorder Point Example
Demand = 8,000 iPods per year
250 working day year
Lead time for orders is 3 working days

d=
D Number of
working days in a year
= 8,000/250 = 32 units

ROP = d x L
= 32 units per day x 3 days = 96 units

© 2008 Prentice Hall, Inc. 12 – 63

Thank You