INVENTORY

MANAGEMENT
Facts on Inventory Management
 INVENTORY MANAGEMENT:
A SHORT STORY
The senior executives of “Alpha
Numerics” were having their annual
retreat to review accomplishments of
the past year and to discuss major
policy issues for the coming year. As
was the norm, the retreat was held at a
small hotel in the mountains of
Pennsylvania, well removed from the
company’s actual manufacturing facility.
INVENTORY MANAGEMENT :
A SHORT STORY

The first day’s meeting had gone well, but in

the early evening, after dinner, the
subject of inventory control and the
number of shortages that had occurred
over the past year came up for discussion.

The Vice-President of engineering

suggested that, as a solution to the
shortage problem, purchasing should order
all of the projected material requirements
a the beginning of the year.
 INVENTORY MANAGEMENT: A
SHORT STORY

The Vice-President was so taken aback by this

suggestion that, to the amazement of the others in
the room, he leaped onto the conference table and
shouted out, “Inventory is evil!” He turned to the
President and said,

“If we were to follow this suggestion, Mr. President,

do you have an extra 25,000 square feet of
warehouses space where we can store the material?”
INVENTORY MANAGEMENT: A SHORT
STORY

The President shook his head.

“and do you, Mr. Vice-President of Finance, have
an extra $5 million dollars to buy all this
material?” The Vic-President of Finance similarly
shook his head.
“And are you, Mr. Vice-President of Marketing,
going to provide me with a perfect forecast of he
products we expect to sell for he next year?”

The Vice-President of Marketing said, ”No, of

course . That would be impossible.”
 INVENTORY MANAGEMENT: A SHORT STORY

And turning to the VP of Engineering who made the

initial proposal, he said, “and you’ll keep the same
designs in he coming year without many any changes,
won’t you?” The VP of Engineering said, ”that would
be very unrealistic. ”All of the individuals in the room
then looked up to the VP of Manufacturing still
standing on the conference table and said, “we see
what you mean. Inventory is indeed evil!”
 Inventory Management: (Continued)
Learning Objectives: After this chapter, you should be
able to;
• Define the term inventory and list the major reasons for holding
inventories;
• Contrast independent and dependent demand;
• List the main requirements for effective inventory management;
• Discuss the objectives of inventory management;
• Describe the basic EOQ model and its assumptions and solve
typical problems;
• Describe the economic run size model and solve typical
problems;
• Describe the quantity discount model and solve typical problems.
Inventory Management: (Continued)

Good Inventory Management is essential to the

successful operation of most organization for a
number reasons;
The amount of money inventory represents;
The impact that inventories have on the daily
operations of an organization

Q- trigger!
What is lacking is an understanding of
* What needs to be done and
* How to do it!
Inventory Management: (Continued)
INTRODUCTION
An Inventory is a stock or sore of goods;
* Firms typically stock hundreds or thousands
of items in inventory; ranging from small things such
as pencil, paper clips, screw, nuts, and bolts to large
items such as machines, trucks, construction
equipment and airplanes.
Dependent Demand
* Items in inventory that are subassemblies
or components parts to be used in the production of
finished goods
Independent Demand
* Items are the finished goods of other end
items.
Inventory Management: (Continued)

Inventories are vital part of business. Not

only are they necessary for operations, but also they
contribute to customer satisfaction.
Q-Trigger
* A typical firm probably has about 30% of is
current assets and perhaps as much as 90% of is
working capital invested in inventory.
* A typical manufacturing firm carries
different types of inventories, including the
following;
Raw materials and purchased parts;
Partially completed goods, called work-
in-process (WIP);
Inventory Management: (Continued)
Finished goods inventories (manufacturing
firms) or merchandise (retail stores);
Replacement parts, tools and
supplies;
Goods-in-transition warehouse or
customers.
Service firms do not carry these
types of inventories, although hay do carry
inventories of supplies and equipment.
Inventory Management: (Continued)

FUNCTIONS OF INVENTORY:

To meet anticipated demand;

To smooth production requirements;
To decouple components of he production-
distribution system;
To protect against stock-outs;
To take advantage of order cycles;
To hedge against price increases or to take
advantage of quantity discounts;
To permit operations.
Inventory Management: (Continued)

Requirements for effective inventory management;

* A system to keep track of the inventory on
hand and on hand and on order;
* A reliable forecast of demand that includes
an indication of possible forecast error;
* Knowledge of lead times and lead time
variability;
* Reasonable estimates of inventory holding
costs, ordering costs, and shortage costs;
* A classification system for inventory items.
Inventory Management: (Continued)

INVENTORY COUNTING SYSTEMS

* Perpetual Inventory System – a system that
keeps track of removals from inventory
continuously, thus monitoring current levels of
each item;
* Two- bin System – two containers of inventory;
reorder when the first is empty;
* Universal Product Code – bar code printed on a
label that has information about the item to
which it is attached.
Inventory Management: (Continued)

DEMAND FORECAST AND LEAD TIME INFORMATION

Inventories are used to satisfy demand requirements,
so it is essential to have reliable estimates of the amount
and timing of demand.
COST INFORMATION
Holding or Carrying Costs – relate to physically having
items in storage. Costs include interest, insurance, taxes,
depreciation, obsolescence, deterioration, spoilage,
pilferage, breakage, and warehousing costs.
Ordering Costs – are the costs of ordering and
receiving inventory. These include determining how much is
needed, preparing invoices, inspecting goods upon arrival for
quality and quantity, and moving the goods to temporary
storage
Inventory Management: (Continued)

Q-TRIGGER
What levels should be
maintained?
When stock should be
replenished, and;
How large orders should be?
 Inventory Management: (Continued)
Assumptions of the basic EOQ model
2. Only one product is involved;
3. Annual demand requirements are known;
4. Demand is spread evenly throughout the year so
that the demand rate is reasonable constant;
5. Lead time does not vary;
6. Each order is received in a single delivery;
7. There are no quantity discounts.
 IE 1
1. 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 costs are $16 per tire, and
ordering costs are $75. The distributor operates
288 days a year.
b. What is the EOQ?
c. How many times per year does the store reorder?
d. What is the length of an order cycle?
 IE 2
2. Piddling Manufacturing assembles television
sets. It purchases 3,600 black-and-white
picture tubes a year at $65 each. Ordering
costs are $31, and annual carrying costs are
20 percent of the purchase price. Compute
the optimal quantity and the total annual cost
ordering and carrying the inventory.
EOQ with Non-instantaneous
Replenishment
The basic EOQ model assumes that
each order is delivered at a single
point in time. In some instances,
however, such as when a firm is both a
producer and user or when deliveries
are spread over time, inventories tend
to build gradually instead of
instantaneously.
IE 3
3. A toy manufacturer uses a 48,000 rubber wheels per year
for its popular dump truck series. The firm makes its own
wheels, which it can produce at a rate of 800 per day.
The toy trucks are assembled uniformly over the entire
year. Carrying cost is &1 per wheel. Setup cost for a
production run of wheels is $45. The firm operates 240
days per year. Determine each of the following:
b. Optimal run size
c. Minimum total annual cost for carrying and setup
d. Cycle time for the optimal run size
e. Run time
Quantity Discounts are price reductions for large orders offered
to customers to induce them to buy in large quantities.
• If quantity discounts are offered, the customer must weigh the
potential benefits of reduced purchase price and fewer orders that will
result from buying in large quantities against the increase in carrying
costs caused by higher average inventories.
• The buyer’s goal with quantity discounts is to select the order quantity
that will minimize total cost, where total cost is the sum of carrying
cost, ordering cost, and purchasing cost.
IE 4
4. The maintenance department of a large hospital
uses about 816 cases of liquid cleanser annually.
Ordering costs are $12, carrying costs are $4 per case
a year, and the new price schedule indicates that
orders of less than 50 cases will cost $20 per case, 50
to 79 cases will cost $18 per case, 80 to 99 cases will
cost $17 per case, and larger orders will costs $16 per
case. Determine the optimal order quantity and the total
cost.
 Inventory Management: Illustrative
Examples
When carrying costs are expressed as a percentage of price,
determine the best purchase quantity with the following
procedure;
• Beginning with the lowest price, compute the EOQs for each
price range until a feasible EOQ is found;
• If the EOQ for the lowest price is feasible, it is the optimal
order quantity. If the EOQ is not the lowest price range,
compare the total cost at the price break for all lower prices
with the total cost of the largest feasible EOQ. The quantity
that yields the lowest total cost is the optimum.
IE 5
• Surge Electric uses 4,000 toggle
switches a year. Switches are priced
as follows: 1 to 499, 90 cents each;
500 to 999, 85 cents each; and 1,000
or more, 82 cents of purchase prices
per unit on an annual basis.
Determine the optimal order quantity
and the total annual cost.
When to Reorder with EOQ Ordering
EOQ models answer the question of how much
to order, but not the question of when to
order. The latter is the function of models
that identify the reorder point (ROP) in
terms of quantity: the reorder point occurs
when the quantity on hand drops to a
predetermined amount. The amount that
generally includes expected demand during
lead time and perhaps an extra cushion of
stock, which serves to reduce the
probability of experiencing a stock-out
during lead time.
The basic concern of the manager is to place an
order when the amount of inventory on hand is
sufficient to satisfy demand during the time it
takes to receive that order. There are four
determinants of the reorder point quantity;
2. The rate of demand;
3. The length of lead time;
4. The extent of demand and/or lead time
variability;
5. The degree of stock-out risk acceptable to
management.
 IE 6

6. Tingly takes Two-a-Day vitamins, which are delivered

to his home by a route man seven days after an
order is called in. At what point should Tingly
telephone his order in?

Safety Stock – a stock that is held in excess of

expected demand rate due to variable
demand rate and/or lead time.
Service Level – Probability that demand will not exceed
supply during lead time.
The amount of safety stock that is
appropriately for a given situation
depends on the following factors;
2. The average demand rate and
average lead time.
3. Demand and lead time variability.
4. The desired service level.
 IE 7
7. Suppose that the manager of a construction supply
house determined from the historical records that
the lead time demand for sand averages 50 tons. In
addition, suppose the manager determined that
demand during lead time could be described by a
normal distribution that has a mean of 50 tons and
a standard deviation of 5 tons. Answer these
questions, assuming that the manager is willing to
accept a stock-out risk of no more than 3 percent.
b. What value of z is appropriate?
c. How much safety stock should be held?
d. What reorder point should be used?
 IE 8
8. A restaurant uses an average of 50 jars of a special
sauce each week. Weekly usage of sauce has a
standard deviation of 3 jars. The manager is willing
to accept no more than a 10 percent risk of a stock-
out during lead time, which is two weeks. Assume
the distribution of usage is normal.
b. Which formula is appropriate to this situation?
c. Determine the value of z.
d. Determine the ROP.
 IE 9

1. The housekeeping department of a motel uses

approximately 400 washcloths per day. The actual
amount tends to vary with the number of guests on
any given night. Usage can be approximated by a
normal distribution that has a mean of 400 and a
standard deviation of 9 washcloths per day. A linen
supply company delivers towels and washcloths with a
lead time of three days. If the motel policy is to
maintain a stock-out risk of 2 percent, what is the
minimum number of washcloths that must be on hand
at reorder time, and how much of that amount can be
considered safety stock?
IE 10

2. The motel in the preceding example uses

approximately 600 bars of soap each day, and
this tends not to vary by more than a few bars
either way. Lead time for soap delivery is
normally distributed with a mean of six days
and standard deviation of two days. A service
level of 90 percent is desired. Find the ROP.
IE 10

3. The motel replaces broken glasses at a

rate of 25 per day. In the past, this
quantity has tended to vary normally and
have a standard deviation of 3 glasses per
day. Glasses are ordered from a Cleveland
supplier. Lead time is normally distributed
with an average of 10 days and a standard
deviation of 2 days. What ROP should be
used to achieve a service level of 95
percent?
 IE 11

4. The manager of a store that sells office supplies has decided

to set an annual service level of 96 percent for a certain
model of telephone answering equipment. The store sells
approximately 300 of this model a year. Holding cost is $5
per unit annually, ordering cost is $25, σdLT= 7.
stock of the chemical?

a. What average number of units short per year will be

consistent with the specified annual service level?
b. What average number of units short per cycle will
provide the desired annual service level?
c. What lead time service level is necessary for the 96
percent annual service level?
IE 13

5. A lab orders a number of chemicals from the same supplier

every 30 days. Lead time is 5 days. The assistant manager
of the lab must determine how much of one of these
chemicals to order. A check of stock revealed that eleven
25-ml jars are on hand. Daily usage of the chemical is
approximately normal with a mean of 15.2 ml per day and
standard deviation of 1.6 ml per day. The desired service
level for this chemical is 95 percent.
How many bottles of the chemical should be ordered?
What is the average amount of safety
IE #14: Shortages & SL
The manager of a store that sells
office supplies has decided to set an
annual service level of 96 percent for
a certain model of telephone
answering equipment. The store sells
approximately 300 of this model a
year. Holding cost is $5 per unit
annually, ordering cost is $25, and
σdLT = 7.
a. What average number of units short
per year will be consistent with the
specified annual service level?
b. What average number of units short
cycle will provide the desired annual
service level?
c. What lead time service level is
necessary for the 96 percent annual
service level?
 IE #15
A lab orders a number of chemicals
from the same supplier every 30
days. Lead time is 5 days. The
assistant manager of the lab must
determine how much of one of these
chemicals to order. A check of stock
revealed that eleven 25-ml jars are
on hand. Daily usage of the chemical
is approximately normal with a mean
Of 15.2 ml per day and a standard
deviation of 1.6 ml per day. The
desired service level for this
chemical is 95 percent.
b.How many bottles of the chemical
should be ordered?
c.What is the average amount of
safety stock of the chemical?
 IE #16
Sweet cider is delivered weekly to Pappy’s
Produce Stand. Demand varies uniformly
between 300 liters and 500 liters per
week. Pappy pays 20 percent per liter for
the cider and charges 80 cents per liter
for it. Unsold cider has no salvage value
and cannot be carried over into the next
week due to spoilage. Find the optimal
stocking level and its stock-out risk for
that quantity.
 IE #17
Pappy’s Stand also sells a blend of
cherry juice and apple cider. Demand
for the blend is approximately normal
with a mean of 200 liters per week
and a standard deviation of 10 liters
per week. Cs = 60 cents per liter, and
Ce = 20 cents per liter. Find the
optimal stocking level for the apple-
cherry blend.
Materials Requirements
Planning
 A Short Story
FMC Corporation is a $3.75 billion
global producer of food machinery,
chemicals, and defense equipment.
Already skilled at producing high-
quality, low-cost products, the
company now wants to take advantage
of emerging worldwide markets while
being its customers’ best supplier.
 A Short Story (cont’d)
To do that, FMC plans to supply the
sales force with up-to-date
information about the markets, the
company’s product lines, and product
availability across their plants. This
will allow the sales force to access
current information from 112 plants
in 20 countries.
 A Short Story (cont’d)
In addition, sales representatives will
be given tools to analyze available
inventory, capacity, cost, and
currency considerations in order to
achieve the most favorable
economics in delivering products to
customers. But first, FMC needs to
get the right information from the
company’s multiple ManMan MRP II
 A Short Story (cont’d)
Systems from the The Ask Cos.
Currently, FMC is working with Ask
to develop the capabilities to support
its goals.
Customer service is the primary focus
at Dow Corning Corporation. The
company has launched 30 cross-
functional teams across five of its
eight divisions. These teams are
 A Short Story (cont’d)
Working to change Dow’s operational
processes, work flows, and the way
people perform to increase customer
satisfaction and reduce consumption.
Of utmost importance is shortening
the time-to-market of new products
and placing operational activities,
such as order entry, into the hands
of customers. Key to these plans is
 A Short Story (cont’d)
An EDI system for the entire supply
chain. Dow also plans to replace its
20-year old, in-house-developed MRP
II system with an advanced system
that can balance its production
resources across all of its divisions.
Today, MRP systems, in part or in
whole, are used in manufacturing
firms both large and small. The
reason is that MRP is a logical and
readily understandable approach.
 Learning Objectives
• Describe the conditions under which
MRP is most appropriate;
• Describe the inputs, outputs, and
nature of MRP processing;
• Discuss the benefits and
requirements of MRP.
 Chapter Outline
• MRP Inputs
• MRP Processing
• Other Considerations
• Capacity Requirements Planning
• Solved Problems
• Problems
 Overview
Materials Requirements Planning (MRP)
is a computer-based information
system designed to handle ordering
and scheduling of dependent demand
inventories.
Historically, ordering and scheduling of
assembled products suffered from
two difficulties.
 Overview (Cont’d)

One was the enormous task of setting

up schedules, keeping track of large
numbers of parts and components,
and coping with schedule and order
changes.
 MRP Inputs
1. The Master Schedule
One of three primary inputs; states
which end items are to be produced,
when these are needed, and in what
quantities.
2. Bill-of-Materials
A listing of all of the raw materials,
parts, subassemblies, and assemblies
needed to produce one unit of a
product.
 MRP Inputs
3. The Inventory Records File
Includes information on the status of
each item by time period.
 Example #1
Use the information presented;
b.Determine the quantities of B, C, D,
E, and F needed to assemble one X.
c.Determine the quantities of these
components that will be required to
assemble 200 Xs.
 Example #1: Solution
a.
Component Qty
B 2 Bs per X 2
D 3 Ds per B x 2 Bs per X 6
E 4 Es per D x 3 Ds per B 24
x 2 Bs per X
E 1 E per B x 2 Bs per X 2
C 1 C per X 1
E 2 Es per C x 1 C per X 2
F 2 Fs per C x 1 C per X 2
 Example #1: Solution

b. In order to assemble 200 units of

X., the quantities of each component
must be multiplied by 200. Hence,
there must be 200(2) = 400 Bs,
200(6) = 1,200 Ds, 200(28) = 5,600
Es and so on…
 MRP Processing
• Gross Requirements
Total expected demand for an item or
raw material in a time period.
• Scheduled Receipts
Open orders scheduled to arrive from
vendors or elsewhere in the pipeline.
• Projected on hand
Expected amount of inventory that will
be on hand at the beginning of each
time period.
 MRP Processing
• Net requirements
The actual amount needed in each time
period.
• Planned-order receipts
Quantity expected to be received by the
beginning of the period in which it is
shown.
• Planned-order releases
Planned amount to order in each time period;
planned-order receipts offset by lead time
 Example #2
A firm that produces wood shutters and bookcases has
received two orders for shutters: one for 100 shutters and
one for 150 shutters. The 100-unit order is due for delivery
at the start of week 4 of the current schedule, and the
150-unit order is due for delivery at the start of week 4 of
the current schedule, and the 150-unit order is due for
delivery at the start of week 8. Each shutter consists of
four slatted wood sections and two frames. The wood
sections are made by the firm, and fabrication takes one
week. The frames are ordered, and lead time is two weeks.
Assembly of the shutters requires one week. There is a
scheduled receipt of 70 wood sections in week.
2. Determine the size and timing of planned-order releases necessary
to meet delivery requirements under each of these conditions.
• Lot-for-lot ordering
• Lot-size ordering with a lot size of 320 units for frames and 70
units for wood sections.
 MRP Outputs
MRP systems have the ability to
provide management with a fairly
broad range of outputs. These are
often classified as primary reports,
which are the main reports, and
secondary reports, which are optional
outputs.
MRP Outputs (Cont’d) Primary
Reports
• Planned orders
Schedule indicating the amount and
timing of future orders.
• Order releases
Authorization for the execution of
planned orders.
• Changes
Revisions of due dates or order
quantities, or cancellations or orders.
 MRP Outputs (Cont’d)
Secondary Reports
• Performance –control reports
Evaluation of system operation,
including deviations from plans and
cost information.
• Planning reports
Data useful for assessing future
material requirements.
• Exception reports
Data on any major discrepancies
encountered.
 Other Considerations
• Safety Stock
• Lot Sizing
• Lot-for-lot Ordering
• Economic Order Quantity Model
• Fixed-Period Ordering
• Part-Period Model
 Example #3
Use the part-period method to determine
order sizes for this demand schedule:
Setup cost is $80 per run for this item, and
unit holding cost is $.95 per period.

Period
1 2 3 4 5 6 7 8
Demand 60 40 20 2 30 - 70 50
Cum. 60 100 120 122 152 152 222 272
Dem.
 Example #2: Solution
1. First compute the EPP:
EPP=$80/$.95=84.21
Period Lot Extra Periods Part Cum.
Size Invty Carried Periods Part
carried Periods
1 60 0 0 0 0
100 40 1 40 40
120 20 2 40 80
122 2 3 6 86
5 30 0 0 0 0
100 70 2 140 140
50 0 0 0 0
 Capacity Requirements
Planning
The process of determining short-
range capacity requirements.
• Load reports
Department or work center reports
that compare known and expected
future capacity requirements with
projected capacity availability.
 Benefits and
Requirements of MRP
• Low levels of in-process inventories;
• The ability to keep track of material
requirements;
• The ability to evaluate capacity
requirements generated by a given
master schedule;
• A means of allocating production
time.
 Example #3
The following product structure tree
indicates the components needed to
assemble one unit of product W.
Redraw the tree so that it conforms
to low-level coding. Then determine
the quantities of each component
needed to assemble 100 units of W.
 Example #4
The following product structure tree
indicates the components needed to
assemble one unit of product W.
Redraw the tree so that it conforms
to low-level coding. Then determine
the quantities of each component to
assemble 100 units of W.
 Example #4
W

A B (2) C(4)

D(2) E E(2) F D(3) G(2)

D
 Example #4
Level Item (1 W) (100 W)
Qty Qty
0 W 1

1 A 1

B 2

C 4

2 E 5

F 2

G 8

3 D 22
 Example #5
The product structure tree for end item E
follows. The manager wants to know the
material requirements for ordered part R
that will be needed to complete 120 units
of E by the start of week 5. Lead times
for items are one week for level 0 items,
one week for level 1 items, and two for
level 2 items. There is a scheduled receipt
of 60 units of M at the end of week 1 and
100 units of R at the start of week 1. lot-
for-lot ordering is used. (Solution in Excel)
 Example #6
Given the following production schedule
in units and the production standards
for labor and machine time for this
products, determine the labor and
machine capacity requirements for
each week. Then compute the
percent utilization of labor and
machines in each week if labor
capacity is 200 hours per week and
machine capacity is 250 hours per
week
 Example #6
Production schedule:

Week 1 2 3 4

Quantity 200 300 100 150

Standarda
time:
Labor .5 hours/unit

Machine 1.0 hours/unit

 Example #6 (solution)
Week 1 2 3 4

Quantity 200 300 100 150

Labor hours 100 150 50 75

Machine 200 300 100 150

hours
Week 1 2 3 4

Labor 50% 75% 25% 37.5%

Machine 80% 120% 40% 60%