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Chapter 10 - Cycle Inventory Short

This document provides an overview of inventory management and cycle inventory in supply chains. It defines key concepts like lot size, cycle inventory, economic order quantity (EOQ) and discusses how to estimate costs associated with cycle inventory. The role of cycle inventory is to allow companies to purchase in larger lot sizes to benefit from economies of scale while meeting demand. EOQ models help determine the optimal lot size that minimizes total costs of ordering, holding and material costs. Examples are provided to illustrate inventory profiles and how costs are impacted by changing lot sizes and other parameters.

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Arnab Tripathy
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63 views

Chapter 10 - Cycle Inventory Short

This document provides an overview of inventory management and cycle inventory in supply chains. It defines key concepts like lot size, cycle inventory, economic order quantity (EOQ) and discusses how to estimate costs associated with cycle inventory. The role of cycle inventory is to allow companies to purchase in larger lot sizes to benefit from economies of scale while meeting demand. EOQ models help determine the optimal lot size that minimizes total costs of ordering, holding and material costs. Examples are provided to illustrate inventory profiles and how costs are impacted by changing lot sizes and other parameters.

Uploaded by

Arnab Tripathy
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Supply Chain

Management

Inventory
LECTURE 8
Management
Dr. Surya Prakash
Inventory Management

Chapter 10
Outline

• Know about inventory


• Role of Cycle Inventory in a Supply Chain
• Safety Inventory
• Managing Multi-Echelon Cycle Inventory
• Estimating Cycle Inventory Costs
• Inventory optimization
Role of Inventory in the Supply Chain
Role of Cycle Inventory in a Supply Chain

A lot or batch size is the quantity that a stage of a supply chain either produces or
purchases at a time.

Example, a computer store that sells an average of four printers a day.

The store manager, however, orders 80 printers each time he places an order.

The lot or batch size = 80 printers.

An average of 20 days before the store sells the entire lot and purchases a
replenishment lot.

The computer store holds an inventory of printers because the manager purchases
a lot size larger than the store’s daily sales.

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.
Q: Quantity in a lot or batch size

D: Demand per unit time

Here, it is assumed that the impact of demand variability and assume that demand
is stable.
Let us consider the cycle inventory of jeans at Jean-Mart, a department store. The
demand for jeans D =100 pairs per day.
The store manager purchases in lots of Q 1,000 pairs. It takes 10 days for an entire lot
to be sold.
The inventory profile of jeans at Jean-Mart is a plot depicting the level of inventory over
time, as shown in Figure 11-1.

Over these 10 days, the inventory of jeans at Jean-Mart declines steadily from 1,000
units (when the lot arrives) to 0 (when the last pair is sold).
Role of Cycle Inventory in a Supply Chain

• Lot Size/Batch Size: Quantity that a supply chain stage either


produces or orders at a given time.

• Cycle inventory: Average inventory that builds up in the


supply chain because a supply chain stage either produces or
purchases in lots that are larger than those demanded by the
customer

Q = lot/batch size of an order


D = demand per unit time

Cycle inventory = Q/2


Cycle inventory = Q/2

• Cycle inventory depends directly on lot size

• Avg. flow time is the time that elapses b/w the point at
which material enters the supply chain to the point at
which it exits.

• Average flow time = Avg inventory / Avg flow rate


(Taking avg flow rate = demand)

• Average flow time from cycle inventory = Q/(2D)


• For jeans at Jean-Mart, a department store. The
demand for jeans is relatively stable at D = 100
pairs of jeans per day. The store manager at Jean-
Mart currently purchases in lots of Q = 1,000 pairs.

• Find Cycle inventory Answer-


• Average flow time 500
5 days

Cycle inventory at the Jean-Mart store thus adds five days to the average
amount of time that jeans spend in the supply chain.
Inferences
• It means-

Cycle inventory adds 5 days to the time a unit spends in the supply chain

• Larger the cycle inventory, larger is the time b/w when the product is
produced and when it is sold.

• Lower cycle inventory is better because:

• Average flow time is lower


• Working capital requirements are lower
• Lower inventory holding costs
Cycle Inventory and Costs
• Cycle inventory is held primarily to take advantage of economies of
scale in the supply chain
• Supply chain costs influenced by lot size:
• Material cost/price paid per unit purchase = C
• Fixed ordering cost = S
• Holding cost = H = hC (h = cost of holding a unit in inventory for
one year)
• Primary role of cycle inventory is to allow different stages to purchase
product in lot sizes that minimize the sum of material, ordering, and
holding costs.

• Ideally, cycle inventory decisions should consider costs across the


entire supply chain, but in practice, each stage generally makes its
own supply chain decisions – increases total cycle inventory and total
costs in the supply chain
Economies of Scale – How?

• How do you decide whether to go shopping at a Kirana store or at Big


Bazaar? (Amount of purchase)

• Lot sizing for a single product

• Aggregating multiple products in a single order

• Lot sizing with multiple products or customers

• Lots are ordered and delivered independently for each product


• Lots are ordered and delivered jointly for all products
• Lots are ordered and delivered jointly for a subset of products
Thus,

• Any stage of the supply chain exploits economies of scale in its replenishment
decisions in the following three typical situations:

• 1. A fixed cost is incurred each time an order is placed or produced.


• 2. The supplier offers price discounts based on the quantity purchased per lot.
• 3. The supplier offers short-term price discounts or holds trade promotions.
Lot Sizing- EOQ

Let us consider-

Annual demand = D
Annual material cost = CD
Annual order cost = (D/Q)S
Annual holding cost = (Q/2)H = (Q/2)hC
Total annual cost = TC = CD + (D/Q)S + (Q/2)hC
Figure in next slide shows variation in different costs for different
lot sizes

Number of orders per year = D/Q


Effect of Lot Size on Costs

Cost

Total Cost

Holding Cost

Ordering Cost

Material Cost

Lot size
EOQ- Q*

H = hC
2 DS
Q* =
H
DH
n* =
2S
Obtained by first derivative of the total cost with respect
to Q and setting it equal to 0
Example
Example of Best Buy Computers
Demand, d = 1000 computers/month

Or D = 12,000 computers per year


Unit cost, C = $500
Holding cost fraction, h = 0.2
Fixed cost, S = $4,000/order
Q* = Sqrt[(2)(12000)(4000)/(0.2)(500)] = 980 computers

Avg. Cycle inventory = Q*/2 = 490

For a lot size of Q* = 980, the store manager evaluates


•You can investigate few more things to
understand costs…………………………..
Using a lot size of 1,100 (instead of 980) increases annual costs to $98,636
(from $97,980). Even though the order size is more than 10 percent larger
than the optimal order size Q*, total cost increases by only 0.67 percent.
Example 2
If desired lot size = Q* = 200 units, what would S have to
be?

D = 12000 units
C = $500
h = 0.2
Use EOQ equation and solve for S:
S = [hC(Q*)2]/2D = [(0.2)(500)(200)2]/(2)(12000) =
$166.67
Key Points from EOQ Model
• In deciding the optimal lot size, the tradeoff is between
setup (order) cost and holding cost.

• If demand increases by a factor of 4, it is optimal to increase


batch size by a factor of 2 and produce (order) twice as
often.

• If lot size is to be reduced, one has to reduce fixed order


cost. To reduce lot size by a factor of 2, order cost has to be
reduced by a factor of 4.

If demand at Best Buy increases to 4,000 computers a month (demand has increased by a
factor of 4), the EOQ formula shows that the optimal lot size doubles and the number of
orders placed per year also doubles. In contrast, average flow time decreases by a factor of
2.
Estimating Cycle Inventory-Related Costs in
Practice

• Inventory holding cost


• Cost of capital
• Obsolescence cost
• Handling cost
• Occupancy cost
• Miscellaneous costs
• Order cost
• Buyer time
• Transportation costs
• Receiving costs
• Other costs
Inventory Control/Monitor Methods

• ABC Analysis
• FSN Analysis
• VED Analysis
• LIFO/FIFO

• Why inventory control ??????? Balance between OVER STCOK------ OUT of Stock
ABC Analysis (Based On Annual Cost)

• Rule is 80-20 is
used
• Significant few

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