MANAGEMENT OF INVENTORY SYSTEMS

Introduction to Inventory and Materials Management

PROF PRADIP KUMAR RAY

DEPARTMENT OF INDUSTRIAL AND SYSTEMS ENGINEERING
IIT KHARAGPUR

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Introduction to Inventory and Materials Management

 Classes of Inventory Problems

 Inventory Costs

PROF PRADIP KUMAR RAY

DEPARTMENT OF INDUSTRIAL AND SYSTEMS ENGINEERING
2
IIT KHARAGPUR
 Classification of Inventory Problems
• Each class of inventory problem is represented by a route as depicted in the
Figure.
• In simplest form, the inventory problems can be classified as per the
following:

Type of Demand
problem
(Supply) Certainty Risk Uncertainty

Static *  
Dynamic   
PROF PRADIP KUMAR RAY
DEPARTMENT OF INDUSTRIAL AND SYSTEMS ENGINEERING
IIT KHARAGPUR 3
 Classification of Inventory Problems

• There are six classes of problems.

• However, static inventory problem under certainty does not come under
inventory problem as two decisions (when to order and how much to order)
can be made without even formulating the problem. The decisions are
already known. Only when a number of items are considered under this
class, the problem may refer to a typical scheduling problem.

PROF PRADIP KUMAR RAY

DEPARTMENT OF INDUSTRIAL AND SYSTEMS ENGINEERING
IIT KHARAGPUR 4
 Inventory Costs

• While formulating any class of problem, we need to know the working of the
inventory control system, its parameters, the constraints, if any, and
assumptions for modelling.
• Usually the values of these parameters are determined such that the cost of
the inventory control system under consideration is held at a minimum level.

• In this context, the types of inventory-related costs are to be identified.

PROF PRADIP KUMAR RAY

DEPARTMENT OF INDUSTRIAL AND SYSTEMS ENGINEERING
IIT KHARAGPUR 5
 Inventory Costs
• There are a number of inventory-related costs that need to be considered.
These costs are as follows:

i. Purchase Cost: This is also known as procurement cost. While an item is

purchased from an outside source (supplier), unit purchase price for the
item determines the purchase cost.
ii. Setup Cost: This cost is relevant when the item is supplied from within
(self-supply). The cost associated with setting up of the process or the
machinery as per production run and lot size is the setup cost. It is usually
measured per setup basis.

PROF PRADIP KUMAR RAY

DEPARTMENT OF INDUSTRIAL AND SYSTEMS ENGINEERING
IIT KHARAGPUR 6
 Inventory Costs
iii. Production Cost: This is incurred when the item in required quantity is
produced by the production department (self-supply). The production cost
per unit is its measure.
iv. Order Cost: This cost is relevant when the item is supplied from outside
(supplier). An authorization note in the form of purchase order, is to be
placed to the supplier. The cost of preparing and placing the order for the
item in required quantity and quality under agreed terms and conditions is
referred to as the order cost. Usually, it is measured per order basis.

PROF PRADIP KUMAR RAY

DEPARTMENT OF INDUSTRIAL AND SYSTEMS ENGINEERING
IIT KHARAGPUR 7
 Inventory Costs
v. Inventory Carrying or Holding Cost: This is essentially the cost of money
tied up in inventory. There is a time lag between the arrival/production of
inventory and its use. While it is stored for the time period, it is essential
that it is kept in good condition. The costs associated with the lost earning
power (due to cost of the money tied up in inventory without getting the
return if this tied up money were invested elsewhere), storage,
deterioration, insurance, and other prevention measures taken to maintain
inventory of the item in acceptable/usable condition. This cost is measured
either as a proportion/percent of the cost of average inventory or as a cost
per unit price of the item (in absolute term).

PROF PRADIP KUMAR RAY

DEPARTMENT OF INDUSTRIAL AND SYSTEMS ENGINEERING
IIT KHARAGPUR 8
 Inventory Costs
vi. Overstock Cost: This cost is incurred when supply is more than demand,
and at the end of the selling season, an extra amount of inventory beyond
demand is kept. Elimination or at least, minimization of overstock amount
is one of the main objectives of any inventory control system.
vii. Understock Cost: Also referred to as ‘out-of-stock’ or ‘stockout’ cost, this is
incurred when supply is less than demand during a period of time.
Depending on the response of the customer to unfulfilled demand, there
may be two types of understock cost: Backordering Cost (in case unfulfilled
demand remains and can be met later or next time period) and Lost Sales
Cost (in case unfulfilled demand is lost forever and cannot be met later or
next time period).
PROF PRADIP KUMAR RAY
DEPARTMENT OF INDUSTRIAL AND SYSTEMS ENGINEERING
IIT KHARAGPUR 9
 Inventory Costs
• Among these costs, the Purchase Cost is considered a fixed cost as it
remains same irrespective of order quantity, number of orders, and
ordering cycles or ordering period.

• Other types of costs as stated are considered a variable cost as these costs
are dependent on inventory control system or policy.

• While formulating a problem, Understock Cost may be assumed to be a

constant (irrespective of amount of shortages) or a variable (per unit of
shortage).

PROF PRADIP KUMAR RAY

DEPARTMENT OF INDUSTRIAL AND SYSTEMS ENGINEERING
IIT KHARAGPUR 10
 Inventory Costs

• While formulating an inventory control problem, we need to identify, and

consider those costs found relevant in a given problem.

• An important type of cost, called Systemic or Implementation Cost (cost

incurred for making changes in the system) needs to be considered when a
new or better inventory control system is introduced for an item.

• In this context, as an example from a typical production system, the

inventory cost accumulation profile is presented in the following Figure:

PROF PRADIP KUMAR RAY

DEPARTMENT OF INDUSTRIAL AND SYSTEMS ENGINEERING
IIT KHARAGPUR 11
 Inventory Costs
Storage
C

B In a repetitive manufacturing
system, (batch production),
Storage
the cost profile consists of
Storage Material cost (OA), Labour
Storage
cost (AB), Overhead cost (BC),
A and Total Product cost (OC)
R/M F/G
O

Manufacturing Cycle time

Throughput time
Material Product
Acquisition Shipment

PROF PRADIP KUMAR RAY

DEPARTMENT OF INDUSTRIAL AND SYSTEMS ENGINEERING
IIT KHARAGPUR 12
List of Reference Textbooks

• Starr, M K and Miller, D W, Inventory Control: Theory and Practice,

Prentice Hall.

• Tersine, R J, Principles of Inventory and Materials Management, PTR

Prentice Hall.

• Silver, E A, Pyke, D F and Peterson, R, Inventory Management and

Production Planning and Scheduling, John Wiley.

Prof Pradip Kumar Ray

Department of Industrial and Systems Engineering 13
Thank You!!

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