Inventory Management

Inventory Management
•An inventory is a stock or store of goods.
•Manufacturing firms carry supplies of raw materials, purchased parts, partially finished
items, and finished goods, as well as spare parts for machines, tools, and other supplies.
•Department stores carry clothing, furniture, carpeting, stationery, cosmetics, gifts, cards,
and toys. Some also stock sporting goods, paints, and tools.
•Hospitals stock drugs, surgical supplies, life-monitoring equipment, sheets and pillow
cases, and more.
•Supermarkets stock fresh and canned foods, packaged and frozen foods, household
supplies, magazines, baked goods, dairy products, produce, and other items.
What do we understand by Inventory?
 Necessary Evil!

 Necessary:  Evil:
• Decoupling • Capital tied up unused – no value
• Disruption control addition at present
• Reduction of no. of orders / machine • Obsolescence, depreciation
setups • Risky for perishable products
• Hedging against inflation • Resistance to NPD / use of substitute
• Availing quantity discounts materials
• Facing uncertainty
Inventory Classification Problem
• In several ways we can define an inventory problem.
•What are the factors actually determined the inventory problem?
 Repetitiveness
• Single Order
• Repeat Order
 Supply Source
• Outside Supply
• Inside Supply
 Knowledge of Demand
•Constant demand or Variable demand
•Independent demand or Dependent demand
Inventory Classification Problem
Knowledge of Lead Time
• Constant Lead Time
• Variable Lead Time
 Kinds of Inventory System
• Q-System or Continuous Review
• P-System or Periodic Review.
• MRP
• Single order quantity
Types of Inventory
Cyclic inventory – regular production or purchase in batches
Safety stock – safeguard against uncertainty of demand & supply
Decoupling stocks – manage mismatch or independent operations among depts,
decision making units
Anticipation inventory – seasonal stock.
Pipeline inventory – in-transit inventory, work-in-process inventory
Inventory planning for independent Item
Inventory planning of independent demand items must address the following two key
questions:
• How Much?
- The replenishment could be of a fixed quantity or variable.
- It could be based on the cost associated.
- It could also satisfy certain practical considerations such as truck capacity, quantity
discount, minimum order quantity restriction posed by the suppliers.
•When?
- The other issue is related to timing of the replenishment.
- Since demand is continuous and uncertain, the timing of replenishment is equally
important.
Inventory Related Costs
There are several costs associated with inventory planning and control. These costs could
be classified under three broad categories:
• The cost of carrying an inventory.
• The cost associated with ordering material and replenishing it in cyclic intervals.
• The cost arising out of shortages.
Inventory control models should take these into consideration and aim at minimizing the
sum of all these costs.
•Sometimes, the unit cost of the item for which inventory planning is done is also a relevant
cost for decision making.
•This is because when large quantities are ordered, there could be some discount in the unit
cost of the item.
Inventory Carrying Cost
The most significant component is the interest for the short-term borrowals for the
working capital required for inventory investment.
The second significant cost relates to the cost of stores and warehousing and the
administrative costs related to maintaining inventory and accounting for it.
The elements of storing and warehousing costs include the following:
• Investment in store space and storage and retrieval systems.
• Software for maintaining the inventory status.
• Managerial and other administrative manpower to discharge various activities
related to stores.
• Insurance costs.
• Cost of obsolescence, pilferage, damages, and wastage.
All the costs related to carrying inventory are directly related to the level of inventory
Inventory Ordering Cost
Replenishment of cyclic inventory is achieved by ordering material with the suppliers.
Organizations perform a series of tasks related to ordering material.
• Search and identification of appropriate sources of supply.
• Price negotiation.
• contracting and purchase-order generation.
• Follow-up and receipt of material.
Ordering cost is independent of size of replenishment i.e. fixed in nature.
Ordering a larger quantity could reduce the total costs of ordering.
As the order size increased the number order will decrease.
Trade off between total ordering cost and
total inventory carrying cost
•The total cost of carrying and the cost of ordering are fundamentally two opposing cost
structures in inventory planning.
•When the order quantity becomes smaller, the total cost of carrying inventory decreases.
•On the other hand, since a large number of orders are to be placed to satisfy the demand,
the total ordering costs will go up.
•Balancing these two opposing costs will be central to inventory planning and control in
any organization
Shortage cost
Shortage costs result when demand exceeds the supply of inventory on hand.
 Shortage costs includes
 cost of the adverse effect due to non-availability of materials (includes intangibles like
loss of image to customers, loyalty etc.),
lost sales / backorder etc.
•When the demand is not met and the order is canceled, this is referred to as a stock out.
•A backorder is when the order is held and filled at a later date when the inventory for the
item is replenished.
How much to order: Economic Order
Quantity (EOQ)
EOQ models identify the optimal order quantity by minimizing the total inventory cost
that vary with order size and order frequency.
It is used to identify a fixed order size that will minimize the sum of the annual costs of
holding inventory and ordering inventory.
The unit purchase price of items in inventory is not generally included in the total cost
because the unit cost is unaffected by the order size unless quantity discounts are a factor
This basics model involves some basic assumptions
•Only product is involved.
•Annual demand requirements are known
•Demand rate is reasonably constant
•Instantaneous replenishment.
•No quantity discount.
How much to order: Economic Order
Quantity (EOQ)

• Inventory ordering and usage occur in cycles.

• A cycle begins with receipt of an order of Q units,
which are withdrawn at a constant rate over time.
• The optimal order quantity reflects a balance
between carrying costs and ordering costs.
How much to order: Economic Order
Quantity (EOQ)
Total cost of plan = total cost of inventory carrying + total cost of ordering
Let, D – Annual demand
Cc – inventory carrying cost per unit per annum
Co – ordering cost per order
Q – quantity of order, then
Total cost: TC(Q) = (Q/2 * Cc) + (D/Q * Co)
From the above equation, we get
Optimal number of orders and time between orders
Problem
A two-wheeler component manufacturing unit uses large quantities of a component
made of steel. Although these are production items, the demand is continuous and
inventory planning could be done independent of the production plan. The annual
demand for the component is 2,500 boxes. The company procures the item from a
supplier at the rate of 750 per box. The company estimates the cost of carrying inventory
to be 18 percent per unit per annum and the cost of ordering as 1,080 per order. The
company works for 250 days in a year. How should the company design an inventory
control system for this item? What is the overall cost of the plan?
 Solution
Annual Demand (D) =2500 boxes.
Number of working days = 250
Average daily demand =
Unit cost of the item = Rs. 750 per box
The company estimates the cost of carrying inventory to be 18 per cent per unit per
annum
Inventory carrying cost =
Cost of ordering
Economic Order Quantity
Solution
Number of order
Time between the orders .
Total cost of the plan

Hence, the manufacturer will place an order for 200 boxes of the component once in
every 20 days and will incur a total cost of 27,000 for the plan. Any quantity above or
below will increase the cost of the plan.
Problem -EOQ
Demand for the computer at XYZ retail store is 1,000 units per month. XYZ incurs a
fixed order placement, transportation, and receiving cost of $4,000 each time an order is
placed. Each computer costs XYZ $500 and the retailer has a holding cost of 20 percent.
Evaluate the number of computers that the store manager should order in each
replenishment lot. How much time each computer spends on average before it is sold?
Solution
Annual Demand (D) =
Cost of ordering
Unit cost of computer = C =$500
Holding cost per year as a fraction of unit cost , i =0.2
Economic Order Quantity
Number of orders per year =
Total inventory cost at EOQ =
Average flow time =
Practice
A local distributor for a national tire company expects to sell approximately 9,600
steel-belted radial tires of a certain size and tread design next year. Annual carrying cost
is $16 per tire, and ordering cost is $75. The distributor operates 288 days a year.
a. What is the EOQ?
b. How many times per year does the store reorder?
c. What is the length of an order cycle?
d. What will the total annual cost be if the EOQ quantity is ordered?
 Re-order point with constant Lead time
If the lead time is L, then by placing an order L periods ahead of depletion of inventory,
one can ensure availability of material.
We assume the demand remains constant during lead time (L).
The reorder point
Production Order Quantity Model
1. Used when inventory builds up over a period of time after an order is placed
2. Used when units are produced and sold simultaneously
Change in Inventory Levels over Time for the Production Model
Production Order Quantity Model
Q = Number of units per order
H = Holding cost per unit per year
t = Length of the production run in days
p = Daily production
d = Daily demand/usage rate

 Maximum
inventory level

 Total produced during
the production run
 
 Total used during
the production run

 pt  dt
Price Discount – Order size calculation
•Large order sizes result in price discounts.
•There are other reasons for placing a larger order than what the EOQ suggests.
•Sometimes, it will be economical to transport a truckload of items and save on
transportation cost.
•In other cases, the supplier may impose a minimum order quantity.
•In all these cases, the relevant cost for analysis includes cost elements other than
carrying and ordering.
Price Discount – Order size calculation
The pricing schedule contains specified break points where .
If an order placed is at least as large as but smaller than , each unit is obtained at a cost
of .
In general, the unit cost decreases as the quantity ordered increases.
Price Discount – Order size calculation
Step 1: Evaluate the economic order quantity for each price .

Step 2: We next select the order quantity for each price . There are three possible cases
for

Case 3 can be ignored for because it is considered for . Thus, we need to consider only
the first two cases.
Price Discount – Order size calculation
If then set .
If , then a lot size of order does not result in a discount. In this case, set to qualify for
the discounted price of per unit.
Step 3: For each i, calculate the total annual cost of ordering units (this includes order
cost, holding cost, and material cost) as follows:

Step 4: Over all i select order quantity with the lowest total cost
Price Discount – Order size calculation
Drugs Online (DO) is an online retailer of prescription drugs and health supplements.
Vitamins represent a significant percentage of sales. Demand for vitamins is 10,000
bottles per month. DO incurs a fixed order placement, transportation and receiving cost
of $100 each time an order for vitamins is placed with the manufacturer. DO incurs a
holding cost of 20 percent. The manufacturer uses the following all unit discount pricing
schedule. Evaluate the number of bottles that DO manager should order in each lot.
Order Quantity Unit Price
0-4999 $3.00
5,000-9,999 $2.96
10,000 or more $2.92
Price Discount – Order size calculation
Solution:
In this case

Based on Step 1, we get

In step 2, we ignore i=0 because For i=1, 2 we obtain
Price Discount – Order size calculation
In step 3, We calculate the total cost as follows:

Thus, it is optimal for DO to order 10,000 bottles

Price Discount-Problem
Let, D = 2500 boxes; Price of each box = Rs 750
Inventory carrying cost = 18%; So, Cc = 0.18 *750 = Rs 135; Co = Rs 1080:
EOQ = 200 boxes
If discounts available like:
for 400 – 799 boxes, discount = 2%
for 800 – 1000 boxes, discount = 3%
Selective Control of Inventory
Managing inventory invariably amounts to handling a large number and variety of
items.
For instance, an automobile manufacturer such as Ashok Leyland may have an
inventory of about 50,000 items in their stores.
A vast majority of them will be consumed and will require a mechanism for monitoring
inventory on-hand, establishing reorder points, order quantity, and the type of inventory
control system that needs to be adopted.
Establishing the same level of monitoring and control for all the items may not be
practically feasible.
Therefore, organizations devise suitable ways of categorizing the items and adopt
mechanisms that have variable levels of control on the different categories of items.
Selective control of inventories

ABC analysis:
Pareto principle / 80-20 rule / Vital Few and Trivial Many
On the basis of value or cost of annual consumption.
A: 5-10% of items contributing to 70-80% of value
B: 20-30% of items contributing to 10-25% of value
C: 60-70% of items contributing to 5-10% of value
 Example of ABC Analysis

Item no. Unit Value (Rs) Annual Consumption Cum number of Cum Value (%)
Consumption Value (Rs) items (%)
1 30000 80 2400000 5.00 62.96
2 450 1200 540000 10.00 77.12
3 590 400 236000 15.00 83.32
…… …… …… …… ...... …….
18 80 100 8000 90.00 99.90
19 25 100 2500 95.00 99.96
20 1 1500 1500 100.00 100.00
 Percentage of
Item Stock Annual Consumption Annual Dollar Percentage of Annual Dollar Cummulati
number of Item Unit Value ($) Class
Number (units) Volume Volume ve percent
stocked
#10286 1000 90 90,000 0.387835747 38.8
20% A
#11526 500 154 77,000 0.331815028 72
#12760 1550 17 26,350 0.113549688 83.3
#10867 30% 350 42.86 15001 0.0646436 89.7 B
#10500 1000 12.5 12500 0.053866076 95.1
#12572 600 14.17 8502 0.03663755 98.8
#14075 2000 0.6 1200 0.005171143 99.3
#01036 50% 100 8.5 850 0.003662893 99.7 C
#01307 1200 0.42 504 0.00217188 99.9
#10572 250 0.6 150 0.000646393 1
8550 2,32,057
VED analysis:
On the basis of criticality of items in operations.
V: Vital or highly critical items
E: Essential or moderately critical items
D: Desirable or non-critical items
FSN analysis:
On the basis of movement of inventory or period of stocking.
F: Fast moving items
S: Slow moving items
N: Non - moving items