INVENT

ORY
APPROA
CHES
Managing Inventory
MGL204

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 LECTURE OUTLINE
1. The relationship between inventory and
customer service
2. Different approaches to managing
inventory.
3. The logic behind the Economic Order
Quantity (EOQ) approach to inventory
decision making,
4. Alternative approaches to managing
inventory --- JIT, MRP, and DRP.

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 •By the end of the lecture, learners
should be able to:
•Understand the relationship between
inventory and customer service

LEARNI •Understand the fundamental

differences among approaches to

NG managing inventory.
•Appreciate the logic behind the
OBJECTI Economic Order Quantity (EOQ)
approach to inventory decision
VES making,
•Understand alternative approaches
to managing inventory --- JIT, MRP,
and DRP.

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 INTRODUCTION
•Basic issues are simple…how much to order and
when to order.
•Additional issues are…where to store inventory
and what items to order.
•Traditionally, conflicts were usually present…as
customer service levels increased, investment
in inventory also increased.
•Recent emphasis is on increasing customer
service and reducing inventory investment.

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 INTRODUCTION
•Four factors might permit this apparent paradox,
that is, the firm can achieve higher levels of
customer service without increasing inventory:
 More responsive order processing

 Ability to strategically manage logistics data

 More capable and reliable transportation

 Improvements in the location of inventory

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INVENTORY AND
CUSTOMER SERVICE
LEVEL
•Inventory costs money because it ties up working
capital, eats up labor and real estate, and depreciates
quickly.
•Many supply chain professionals consider inventory as
an enemy.
•Companies make money by selling products to their
customers, and if they have no product to sell, they
earn no revenue.
•Customers value is achieved when customers are
willing to pay for — the product itself.
• You have to consider, for example, whether customers would be
willing to pay the same amount for your product if they had to pick
it up 100 miles away or if they had to wait for it for a year.
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INVENTORY AND
CUSTOMER SERVICE
LEVEL
•The placement and availability of a product actually have a
big impact on its value to your customers and on company
revenues.
• Inventory acts as a buffer against uncertainty about who's
going to buy the product, how much they're going to buy,
when they're going to buy it, and where they're going to
want it.
•Whether customers buy the product in a store or through a
website, your ability to provide them with all of the
products they want when they order them is called
your service level.
•Customers tend to buy from suppliers that meet their
needs quickly, so high service levels can increase revenue
and grow market share.
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INVENTORY AND
CUSTOMER SERVICE
LEVEL
•Achieving a high service level typically requires you to have
inventory on hand.
•To maintain a 100 percent service level, you'd actually need
to have an infinite amount of inventory, which is unrealistic,
so you need to find ways to manage the tension between
reducing inventories to lower costs and increasing
inventories to maintain acceptable service levels.
•Companies balance inventory levels and service levels by
optimizing their inventory.
•Inventory optimization is a process of reducing inventories
to the minimum level necessary to maintain the desired
service level.

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THE RELATIONSHIP BETWEEN
INVENTORY AND CUSTOMER
SERVICE LEVEL

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KEY DIFFERENCES AMONG
APPROACHES TO
MANAGING INVENTORY
•Inventory items can be divided into two main types:
Independent demand and dependent demand items.
•The systems for managing these two types if inventory
differ significantly.
•The categories are based on demand pattern and
therefore, trying to establish the distinction between
the two is necessary because the inventory
management systems and process are different for both
categories.

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DEPENDENT VERSUS
INDEPENDENT DEMAND
•Independent demand inventory control
procedures rely upon unbiased forecasts of
uncertain demand.
•Demand and lead times may be treated as
random variables.
•Forecasts are used to develop production and
purchase schedules for end items.
•Dependent demand inventory control
procedures rely upon the certain demand
relationship in order to determine production
and purchase schedules.
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DEPENDENT VERSUS
INDEPENDENT DEMAND

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KEY DIFFERENCES AMONG
APPROACHES TO MANAGING
INVENTORY
 Of the inventory management processes Just-In-
Time (JIT), Materials Resource Planning (MRP)
and Manufacturing Resource Planning (MRPII)
are generally associated with items having
dependent demand.
 Alternatively, Distribution Resource Planning
(DRP) and the Economic Order Quantity (EOQ )
models are generally associated with items
exhibiting independent demand.

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PUSH VERSUS PULL
APPROACHES
 Push systems use an orderly and disciplined
master plan for inventory management and
apply more to dependent demand situations.
 Push approach is a “proactive” system and uses
inventory replenishment to anticipate future
demand. Catering businesses are examples of
push systems.

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PUSH VERSUS PULL
APPROACHES
•With a push-based system, products are pushed through
the channel, from the production side up to the retailer.
•The manufacturer sets production at a level in accord
with historical ordering patterns from retailers.
•It takes longer for a push-based supply chain to respond
to changes in demand, which can result in overstocking or
bottlenecks and delays (the bullwhip effect), unacceptable
service levels and product obsolescence.

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ADVANTAGES

•Enough products are produced

•Customer satisfaction.
•Save money in purchase price ……buy
in bulk ……transport cost

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DISADVANTAGES

•Forecast are often inaccurate.

•Increase in cost of storing goods
•Product deterioration

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 PUSH VERSUS PULL
APPROACHES
 Pull systems respond quickly to sudden or abrupt
changes in demand, involve one-way
communications, and apply more to independent
demand situations.
 Pull approach is a “reactive” system, relying on
customer demand to “pull” product through a
logistics system. MacDonald’s is an example.
 The pull inventory control system begins with a
customer's order. With this strategy, companies only
make enough
02/03/2025 12:55 PM product to fulfill customer'sDRorders.
J KANYEPE (CMILT) 18
ADVANTAGES
•Improves product quality
•Reduced storing/ holding cost.
• Production mistakes can be spotted more quickly
and corrected.
•The company is investing far less cash in its
inventory, since less inventory is needed

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DISADVANTAGES
•A company may not be able to immediately
meet the requirements of a massive and
unexpected order, since it has few or no
stocks of finished goods
•A supplier that does not deliver goods to the
company exactly on time and in the correct
amounts could seriously impact the
production process.
•A natural disaster could interfere with the
flow of goods to the company from suppliers,
which could halt production almost at once.
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TASK

Distinguish between System-wide and Single-

facility solutions

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INVENTORY SYSTEMS
•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:-
1.The fixed order quantity system
2.The
02/03/2025 fixed order periodic system
12:55 PM DR J KANYEPE (CMILT) 22
FIXED ORDER QUANTITY
SYSTEM
•The Fixed Order Quantity is the inventory
control system, wherein the maximum and
minimum inventory levels are fixed, and
maximum and fixed amount of inventory can be
replenished at a time when the inventory level
reaches the auto set reorder point or the
minimum stock level.
•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.
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FIXED ORDER QUANTITY
SYSTEM
•Whenever a new consignment arrives, the
total stock is maintained within the maximum
and the minimum limits.
•The fixed order quantity method is a method
that facilitates for a predetermined amount of
a given material to be ordered at a particular
period of time.
•This method helps to limit reorder mistakes,
conserve space for the storage of the finished
goods, and block those unnecessary
expenditures that would tie up funds that
could be better utilized elsewhere. DR J KANYEPE (CMILT)
02/03/2025 12:55 PM 24
FIXED ORDER QUANTITY
SYSTEM
•The fixed order quantity may be bridged to an
automatic reorder point where a particular quantity of
a good is ordered when stock at hand reaches a level
which is already determined.
•The Fixed Order Quantity method assumes that all the
variables are known with certainty and remains
constant.
•Such variables could be the sales, unit cost, holding
cost, Lead time, stock out cost, etc.
•But, however, this assumption could not be true in the
real life situations and despite this, the method is
frequently applied by the firms and yields excellent
results
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FIXED ORDER QUANTITY
SYSTEM

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ADVANTAGES
•Each material can be procured in the most
economical quantity.
•Purchasing and inventory control people
automatically gives their attention to those
items which are required only when are
needed.
•Positive control can easily be handled to
maintain the inventory investment at the
desired level only by calculating the
predetermined maximum and minimum
values.
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 DISADVANTAGES
•Sometimes, the orders are placed at the irregular time
periods which may not be convenient to the producers or the
suppliers of the materials.
•The items cannot be grouped and ordered at a time since the
reorder points occur irregularly.
•If there is a case when the order placement time is very high,
there would be two to three orders pending with the supplier
each time and there is likelihood that he may supply all
orders at a time.
•EOQ may give an order quantity which is much lower than
the supplier minimum and there is always a probability that
the order placement level for a material has been reached
but not noticed in which case a stock out may occur.
•The system assumes stable usage and definite lead time.
When
02/03/2025these
12:55 PM change significantly, a new order
DRquantity
J KANYEPE (CMILT)and
28 a
 FIXED ORDER QUANTITY APPROACH
(CONDITION OF CERTAINTY): INVENTORY
CYCLES

•In this example, each cycle

starts with 4,000 units:
• Demand is constant at the rate
of 800 units per day.
• When inventory falls below
1,500 units, an order is placed
for an additional 4,000 units.
• After 5 days the inventory is
completely used.
• Just as the 4,000th unit is sold,
the next order of 4,000 units
arrives and a new cycle begins.

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FIXED ORDER QUANTITY
APPROACH (CONDITION OF
CERTAINTY): SIMPLE EOQ MODEL
Simple EOQ Model Assumptions
 Continuous, constant, known and infinite
rate of demand on one item of inventory.
 A constant and known replenishment
time.
 Satisfaction of all demand.
 Constant cost, independent of order
quantity or time.
 No inventory in transit costs.
 No limits on capital availability.
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FIXED ORDER QUANTITY
APPROACH (CONDITION OF
CERTAINTY): SIMPLE EOQ MODEL
Simple EOQ Model Variables
 R = annual rate of demand
 Q = quantity ordered (lot size in units)
 A = order or setup cost
 V = value or cost of one unit in dollars
 W = carrying cost per dollar value in percent
 S = VW = annual storage cost in $/unit per
year
 t = time in days
 TAC = total annual costs in dollars per year

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INVENTORY CARRYING COST

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ORDER OR SETUP COST

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INVENTORY COSTS

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 FIXED ORDER QUANTITY APPROACH
(CONDITION OF UNCERTAINTY)

Uncertainty is a more normal

condition.
 Demand is often affected
by exogenous factors---
weather, forgetfulness,
etc.
 Lead times often vary
regardless of carrier
intentions.
 Note the variability in lead
times and demand.
Reorder Point – A Special Note
 With uncertainty of demand, the reorder point becomes the average daily demand
during lead time plus the safety stock.

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 FIXED ORDER QUANTITY
APPROACH (CONDITION
OF UNCERTAINTY)
Uncertainty of Demand Affects Simple EOQ Model
Assumptions:
 a constant and known replenishment time.
 constant cost/price, independent of order
quantity or time.
 no inventory in transit costs.
 one item and no interaction among
the inventory items.
 infinite planning horizon.
 no limit on capital availability.

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FIXED ORDER PERIOD
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.
•Every order quantity in their method is obtained by the
following formula.
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ADVANTAGES
•The ordering and inventory costs are low. The ordering
cost is considerably reduced though follow up work for
each delivery may be necessary.
•The suppliers will also offer attractive discounts as
sales are guaranteed.
•The system works well for those products which exhibit
an irregular or seasonal usage and whose purchases
must be planned in advance on the basis of sales
estimates.

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DISADVANTAGES
•The periodic testing system tends to peak the
purchasing work around the review dates.
•The system demands the establishment of rather
inflexible order quantities in the interest of
administrative efficiency.
•It compels a periodic review of all items; this itself
makes the system somewhat inefficient

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FIXED ORDER PERIOD MODEL
(WITH SAFETY STOCK)

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ADDITIONAL
APPROACHES TO
INVENTORY
MANAGEMENT
Three approaches to inventory management that have
special relevance to supply chain management:
 JIT (Just in Time)
 MRP (Materials Requirements into Planning)
 DRP (Distribution Resource Planning)

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TIME-BASED
APPROACHES TO
REPLENISHMENT
LOGISTICS: JIT of JIT Systems -
Definition and Components
designed to manage lead times and eliminate
waste.
 Kanban - refers to the informative signboards on
carts in a Toyota system of delivering parts to the
production line. Each signboard details the exact
quantities and necessary time of replenishment.
 JIT operations - Kanban cards and light warning
system communicate possible production
interruptions.
 Fundamental concepts - JIT can substantially
reduce inventory and related costs.
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TIME-BASED
APPROACHES TO
REPLENISHMENT
LOGISTICS: JIT
Definition and Components of JIT
Systems - designed to manage lead
times and eliminate waste.
 Goal is zero inventory, and zero defects.
 Similarity to the two-bin system - one bin
fills demand for part, the other is used when
the first is empty.
 Reduces lead times through requiring small
and frequent replenishment.

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TIME-BASED
APPROACHES TO
REPLENISHMENT
LOGISTICS: JIT
JIT is a widely used and effective
strategy for managing the movement of
parts, materials, semi-finished products
from points of supply to production
facilities.
Product should arrive exactly when a
firm needs it, with no tolerance for early
or late deliveries.
JIT systems place a high priority on
short, consistent lead times.
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JIT VERSUS EOQ
APPROACHES TO
INVENTORY
MANAGEMENT
Six major differences:
First, JIT attempts to eliminate excess
inventories for both buyer and seller.
Second, JIT systems involve short
production runs with frequent
changeovers.
Third, JIT minimizes waiting lines by
delivering goods when and where
needed.

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JIT VERSUS EOQ
APPROACHES TO
INVENTORY
MANAGEMENT
 Fourth, JIT uses short, consistent lead
times to satisfy inventory needs in a
timely manner.
 Fifth, JIT relies on high-quality incoming
products and on exceptionally high-
quality inbound logistics operations.
 Sixth, JIT requires a strong, mutual
commitment between buyer and
seller, emphasizing quality and win-win
outcomes for both partners.
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TABLE 7-6 EOQ VERSUS JIT
ATTITUDES AND BEHAVIORS

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TIME-BASED
APPROACHES TO
REPLENISHMENT
LOGISTICS:
JIT JIT Management
versus Traditional Inventory
 Reduces excess inventories
 Shorter, more frequent production runs
 Minimize waiting lines by delivering materials
when and where needed
 Short, consistent lead times through proximate
location
 Quality stressed throughout supply chain
 Win-win relationships necessary to a healthy
supply chain

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TIME-BASED
APPROACHES TO
REPLENISHMENT
LOGISTICS: MRP
•A Materials Requirements Planning
(MRP) system consists of a set of
logically related procedures, decision
rules, and records designed to translate
a master production schedule into
time-phased net inventory
requirements for each component item
needed to implement this schedule.
•MRPs re-plan net requirements based
on changes in schedule, demand, etc.
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TIME-BASED
APPROACHES TO
REPLENISHMENT
LOGISTICS: MRP
Goals of an MRP:
 Ensure the availability of
materials, components,
and products for
planned production.
 Maintain lowest possible
inventory level.
 Plan manufacturing
activities, delivery
schedules, and
purchasing activities.
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TIME-BASED
APPROACHES TO
REPLENISHMENT
LOGISTICS: MRP
Key elements of an MRP:
Master production schedule
Bill of materials file
Inventory status file
MRP program
Outputs and reports

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 FIGURE 7-13
AN MRP SYSTEM

Customer Orders Demand Forecasts

Bill of Material File Inventory Status File

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TIME-BASED
APPROACHES TO
REPLENISHMENT
LOGISTICS: MRP
Principal advantages of MRP:
 Maintain reasonable safety stock.
 Minimize or eliminate inventories.
 Identification of process problems.
 Production schedules based on actual
demand.
 Coordination of materials ordering.
 Most suitable for batch or intermittent
production schedules.

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TIME-BASED
APPROACHES TO
REPLENISHMENT
LOGISTICS: MRP
Principal shortcomings of MRP:
 Computer intensive.
 Difficult to make changes once operating.
 Ordering and transportation costs may rise.
 Not usually as sensitive to short-term
fluctuations in demand.
 Frequently become quite complex.
 May not work exactly as intended.

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 TIME-BASED APPROACHES TO
REPLENISHMENT LOGISTICS:
DISTRIBUTION RESOURCE
PLANNING
•MRP sets a master production schedule and
“explodes” into gross and net requirements.
•DRP starts with customer demand and works
backwards toward establishing a realistic
system-wide plan for ordering the necessary
finished products.
•Then DRP works to develop a time-phased plan
for distributing product from plants and
warehouses to the consumer.

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TIME-BASED APPROACHES TO
REPLENISHMENT LOGISTICS:
DISTRIBUTION RESOURCE
PLANNING
DRP develops a projection for each SKU
and requires:
 Forecast of demand for each SKU.
 Current inventory level for each SKU.
 Target safety stock.
 Recommended replenishment quantity.
 Lead time for replenishment.

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CONCLUSION
•Basic issues are simple…how much to order, when
to order, where to store inventory and what items
to order.
•Traditionally, conflicts were usually present…as
customer service levels increased, investment in
inventory also increased.
•An inventory system facilitates the organizational
structure and the operating policies for
maintaining and controlling materials to be
inventoried.

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