LCS3052 Inventory Models

and Waiting Lines (Queues)

Section 02
Trabajo en curso
(

Class No. 2 January 17th, 2023

Make-up time
Tuesday and Thursday 4:00pm – 5:15pm
(75 minutes)

Change to:
Tuesday and Thursday 4:00pm – 5:20pm
(from January 19th to March 16th, 15 days)
Agenda
 What are inventories?
 Types of existing inventories
 Why do we want to hold inventories?
 Why we do not want to hold
inventories?
 Definition Los inventarios son las piezas o recursos existentes
utilizados en una organización

 “Inventories are the existing parts or

resources used in an organization.”

for for external

production clients
producción
clientes externos

Richard B. Chase and F. Robert Jacobs

 Types of inventories
Raw materials
Materia prima

Work-in-process (WIP)
Trabajo en curso

Incoming
materials
Finished goods
(“inventario en Productos terminados

tránsito”) Richard B. Chase and F. Robert Jacobs

 Who is the client and who is
the supplier for….?
Raw materials

Work-in-process (WIP)

Finished goods
Richard B. Chase and F. Robert Jacobs
 Who is the client and who is
the supplier for….?
Raw materials

Work-in-process (WIP)
Trabajo en curso
(tra

Finished goods
Richard B. Chase and F. Robert Jacobs
 Who is the client and who is
the supplier for….?
Raw materials

Work-in-process (WIP)

Finished goods
Richard B. Chase and F. Robert Jacobs
Why do we want to hold raw
material inventories? ¿Para que queremos tener existencias
de materia prima?

Raw materials
1.Requirement for production. Requerimiento para la producción

2.Suppliers produce and ship some raw

materials in batches. el proveedor produce y envía algunas
materias primas por lotes

3.Larger purchases result in more

inventory, but quantity discounts and
reduced freight and materials-handling
las compras de mayor volumen suponen más existencias,

costs may result. pero pueden conllevar descuentos por cantidad y menores
costes de transporte y manipulación de materiales
(Norman Gaither and Greg Frazier)
Why do we want to hold
¿Por qué queremos mantener
inventarios de trabajo en curso?

work-in-process inventories?
Work-in-process (WIP)
Trabajo en curso (WIP)

1.A requirement for production,

increases flexibility. Un requisito para la producción,
aumenta la flexibilidad Producir y transportar
grandes lotes de

2.Producing and transporting larger productos genera más

existencias, pero puede
reducir los costes de

batches of products creates more manipulación de

materiales
y de producción.

inventory but may reduce materials-

handling and production costs.
(Norman Gaither and Greg Frazier)
Why do we want to hold ¿Por qué queremos tener
existencias de productos
terminados?

finished goods inventories?

Finished goods
Productos terminados

1.Shipping to customers. Encío a los clientes

2.Essential for positioning strategies,

of strategic importance.
Esencial para las estrategias de
posicionamiento, de importancia
estratégica.

3.Products can be displayed to

customers. Los productos pueden mostrarse a los clientes.

(Norman Gaither and Greg Frazier)

 Why we do not want to hold
inventories? (in general) ¿Por qué no queremos tener
iinventarios? (en general)

1. Cost of customer responsiveness. The

time required to produce and deliver
customer orders is increased. Costo de la capacidad de respuesta al cliente.
Se incrementa el tiempo necesario para
producir y entregar los pedidos de los clientes.

2. Cost of coordinating production. More

people are needed to solve congestion-
related production problems.
Costo de coordinación de la producción.
Se necesita más personal para resolver
los problemas de producción relacionados
con la congestión.

3. Inventory represents a form of waste.

El inventario representa una forma de desperdicio
(Norman Gaither and Greg Frazier)
 Why we do not want to hold
inventories?
4. Large-lot quality cost. If something goes
wrong in a large production lot, the lot
might be a defective lot.
Costo de calidad de los grandes lotes.
Si algo va mal en un lote de producción grande,
el lote podría ser un lote defectuoso.

5. Cost of production problems. Higher in-

process inventories camouflage problems
Trabajo en curso

like machine breakdowns, poor product

quality, and material shortages. Costo de los problemas de producción.
Unas mayores existencias en proceso
camuflan problemas como averías de
la maquinaria, mala calidad del producto
y escasez de material.

(Norman Gaither and Greg Frazier)

 Why we do not want to hold
inventories?
6. Carrying cost (holding cost). Costo de mantenimiento

Interest on debt, warehouse rent, cooling,

heating, lighting, cleaning, repairing,
protecting, shipping, receiving, materials
handling, taxes, insurance, and management
are some of the costs incurred to insure,
finance, store, handle and manage larger
Los intereses de la deuda, el alquiler del almacén, la refrigeración, la calefacción,

inventories.
la iluminación, la limpieza, la reparación, la protección, el envío, la recepción,
la manipulación de materiales, los impuestos, los seguros y la gestión son algunos de los
costes en que se incurre para asegurar, financiar, almacenar, manipular y
gestionar los grandes inventarios. (Norman Gaither and Greg Frazier)
 Estimate of Carrying Costs as a
Author Publication
Percentage of Inventory Value

L.P Alford and John R. Bangs (eds.) Production Handbook 25%

George W. Aljian Purchasing Handbook 12% - 34%

Dean S. Ammer Materials Management 20% -25%
Donald J. Bowersox and David J.
Logistical Management 19.25%
Closs
Purchasing and Materials
Joseph L. Cavinato 25%
Management
John J. Coyle, Edward J. Bardi, and The Management of Business
25%
C. John Langley Jr. Logistics
Inventory Management Takes
Gordon T. Crook 25%
Teamwork
Inventory Carrying Costs: A Case
Thomas W. Hall 20.40%
Study
J.L Heskett, N. A. Glaskowsky Jr.,
Business Logistics 28.70%
and R.M. Ivie
James C. Johnson, Donald F.
Wood, Daniel L. Wardlow, and Contemporary Logistics 25%
Paul R. Murphy Jr.
John F. Magee The Logistics of Distribution 20% - 35%
Management of Industrial
Benjamin Melnitsky 25%
Inventory
Thomson M. Whitlin Princeton University 25%
James R. Stock & Doublas M. Lambert, Strategic Logistics Management
How to determine the Carrying
Cost or Holding Cost?
¿cómo determinar el costo contable
o de mantenimiento?

Cost of keeping the items in costo de mantener los artículos

en buen estado

good condition.
 Inventory investment
Capital and
costs Opportunity cost
inversión en inventario y costo de oportunidad
Costos de capital

Insurance seguro
Inventory
service costs Taxes impuestos

Costo de servicio
del inventario

Inventory
carrrying costs Rented warehouses
Storage renta de almcén
Costos de mantenimiento
space costs Company-owned warehouses
costo del espacio almacén propio de la empresa
de almacenamiento

Obsolescence
obsolencia

Inventory
risk costs Damage
daños
Costos de riesgo
de inventario
Stock, J. R. y Lambert, D. M. (2001) Strategic Shrinkage
contratación
Logistics Management. Fourth Edition. Mc Graw-
Hill, pages 193 – 207. Relocation costs
costos de reubicación
Opportunity Cost Costos de oportunidad

“Holding inventory ties up money that could

be used for other types of investments.”
mantener existencias inmoviliza dinero
que podría destinarse a otro tipo de
inversiones

(James R. Sotck and Douglas M. Lambert)

Service costs Costos de servicio

“Taxes, fire and theft insurance paid as

a result of holding the inventory.”
impuestos, seguros de incendio y robo pagados
como consecuencia de la tenencia del inventario

(James R. Sotck and Douglas M. Lambert)

 Inventory investment
Capital and
costs Opportunity cost

Insurance
Inventory
service costs Taxes

Inventory
carrrying costs Rented warehouses
Storage
space costs Company-owned warehouses

Obsolescence

Inventory
risk costs Damage

Shrinkage
Stock, J. R. y Lambert, D. M. (2001) Strategic
Logistics Management. Fourth Edition. Mc Graw- Relocation costs
Hill, pages 193 – 207.
 Inventory investment
Capital and
costs Opportunity cost

Insurance
Inventory
service costs Taxes

Inventory
carrrying costs Rented warehouses
Storage
space costs Company-owned warehouses

Obsolescence

Inventory
risk costs Damage

Shrinkage
Stock, J. R. y Lambert, D. M. (2001) Strategic
Logistics Management. Fourth Edition. Mc Graw- Relocation costs
Hill, pages 193 – 207.
Obsolescence cost Costos obsolentes

Obsolescence: “cost of each unit that must be disposed

of at a loss because it can no longer be sold at regular
price.” Obsolescencia: "Coste de cada unidad que debe eliminarse con pérdidas porque ya no puede
venderse al precio habitual".

Obs. cost = original production cost – salvage value

= coste de producción original - valor de recuperación

Or
= precio de venta al público original - precio de venta al público reducido

Obs. cost = original retail price – reduced retail price

(James R. Sotck and Douglas M. Lambert)
 Inventory investment
Capital and
costs Opportunity cost

Insurance
Inventory
service costs Taxes

Inventory
carrrying costs Rented warehouses
Storage
space costs Company-owned warehouses

Obsolescence

Inventory
risk costs Damage

Shrinkage
Stock, J. R. y Lambert, D. M. (2001) Strategic
Logistics Management. Fourth Edition. Mc Graw- Relocation costs
Hill, pages 193 – 207.
 Inventory investment
Capital and
costs Opportunity cost

Insurance
Inventory
service costs Taxes

Inventory
carrrying costs Rented warehouses
Storage
space costs Company-owned warehouses

Obsolescence

Inventory
risk costs Damage

Shrinkage
Stock, J. R. y Lambert, D. M. (2001) Strategic
Logistics Management. Fourth Edition. Mc Graw- Relocation costs
Hill, pages 193 – 207.
 Inventory investment
Capital and
costs Opportunity cost

Insurance
Inventory
service costs Taxes

Inventory
carrrying costs Rented warehouses
Storage
space costs Company-owned warehouses

Obsolescence

Inventory
risk costs Damage

Shrinkage
Stock, J. R. y Lambert, D. M. (2001) Strategic
Logistics Management. Fourth Edition. Mc Graw- Relocation costs
Hill, pages 193 – 207.
Procedure
Step 1. Determine the opportunity cost, %, (“cost of money”)
Step 2. Determine the total inventory cost (includes:
production cost, and any transportation needed to take the
product closer to the client); this represents the 100%
Step 3. Determine the service costs (taxes and insurance)
Step 4. Determine the storage space costs
Step 5. Determine the risk costs (obsolescence, damage,
shrikage, relocation)
Step 6. Determine the corresponding % for each of the costs
mentioned on steps 3, 4 and 5 (% with respect to the total
inventory cost)
Step 7. Add the %s that result from step 6, to the one of step
1. The total is kwon as the carrying cost %.
Example
Consider the data on the following
slide and determine the
corresponding carrying cost %.
 Category Quantity
Annual opportunity cost 30%
Annual taxes $90,948
Annual insurance $4,524
Rented warehouse (annual) $226,654
Owned warehouse (annual) Not apply

Obsolescence (annual) $62,400

Shrinkage (annual) $100,308

Annual cost for relocating
Not apply
inventory
Annual inventory value $7,800,000

(James R. Stock and Douglas M. Lambert)

Step Category Quantity
1 Annual opportunity cost 30%
2 Annual inventory value $7,800,000
Annual taxes $90,948
3
Annual insurance $4,524
Rented warehouse (annual) $226,654
4
Owned warehouse (annual) Not apply
Obsolescence (annual) $62,400

5 Shrinkage (annual) $100,308

Annual cost for relocating Not apply
inventory
(James R. Stock and Douglas M. Lambert)
Step Category Quantity Step 6
1 Annual opportunity cost 30% 30%
2 Annual inventory value $7,800,000 100%
Annual taxes $90,948 1.166%
3
Annual insurance $4,524 0.058%
Rented warehouse (annual) $226,654 2.9058%
4
Owned warehouse (annual) Not apply Not apply
Obsolescence (annual) $62,400 0.8%

5 Shrinkage (annual) $100,308 1.286%

Annual cost for relocating
inventory Not apply Not apply
Step Category Quantity Step 6
1 Annual opportunity cost 30% 30%
Annual taxes $90,948 1.166%
3
Annual insurance $4,524 0.058%
Rented warehouse (annual) $226,654 2.9058%
4
Owned warehouse (annual) Not apply Not apply
Obsolescence (annual) $62,400 0.8%

5 Shrinkage (annual) $100,308 1.286%

Annual cost for relocating Not apply Not apply
inventory
Total (step 7: 36.2158
“%, anual or 36.22%
carrying
cost”)
 Activity No. 1 (You can work with a partner)
Due date and time: January 19th, 5:20pm. Please upload your work on
Blackboard. Each member must turn in the activity.

Problem: Determine the inventory carrying cost percentage given the

following annual information:
•Finished goods inventory is $35 million valued at full manufactured cost.
•The variable transportation cost incurred to move the inventory from plants
to warehouse locations close to customers is $2 million.
•Personal property taxes paid on inventory is approximately $210,000.
•Insurance coverage to protect against loss of inventory is $140,000.
•Storage charges at public warehouses totaled $800,000.
•Variable private storage in plant warehouses is considered to be negligible.
•Obsolescence is $80,000.
•Shrinkage (merma) is $100,000.
•Damage related to inventory storage is $30,000.
•Transportation cost associated to the relocation of field inventory to avoid
obsolescence is considered to be negligible.
•The opportunity cost is considered to be 30%.