Chapter 8

Inventory Management
Introduction
Chapter 8 - Inventory Management 3
Radio Frequency Identification
(RFID)
Conventional bar codes are replaced
with computer chips or smart tags.
Use wireless technology to track
inventory.
Chapter 8 - Inventory Management 4
Wal-Mart RFID
Early adopter of RFID is Wal-Mart.
By January 2005, 53 of its top 100
suppliers were sending RFID-tagged
goods to its three distribution centers in
the Dallas, Texas area.
Wal-Marts goal is to have all top 100
suppliers shipping RFID-tagged goods
by the end of February 2005 in addition
to 37 other suppliers.
Chapter 8 - Inventory Management 5
Wal-Mart RFID continued
The impetus for Wal-Marts investment in
RFID was the lack of visibility it had into
its backroom storage areas.
The major drawback to RFID is its cost.
In 2005, the cost of smart tags was
$0.25 each if purchased in volume, and
$0.75 if purchased in smaller quantities.
The stated goal in the industry is to get
the price of smart tags down to $.05
Chapter 8 - Inventory Management 6
Vendor-Managed Inventory (VMI)
With VMI, suppliers are given
responsibility for managing the inventory
carried by their retail or wholesale
customers.
Rich Products, a $2 billion family-owned
food company headquartered in Buffalo,
NY, has a partnership with IBM to
provide VMI services to the grocery
industry for its frozen food items.
General Considerations
Chapter 8 - Inventory Management 8
Functions of Inventories
Transit Inventories
Buffer Inventories (safety stocks)
Anticipation Inventories
Decoupling Inventories
Cycle Inventories
Chapter 8 - Inventory Management 9
Forms of Inventories
Raw materials
Maintenance, repair, and operating
supplies
Work-in-process (WIP)
Finished goods
Chapter 8 - Inventory Management 10
Inventory-Related Costs
Ordering or setup costs
Inventory carrying or holding costs
Stockout costs
Opportunity costs
Cost of goods
Chapter 8 - Inventory Management 11
Decisions in Inventory Management
When to order?

How much to order?
Chapter 8 - Inventory Management 12
Types of Inventory Management
Systems
Reorder point systems
time between orders varies
constant order quantity
Periodic review systems
time between orders fixed
order quantity varies
Material requirements planning (MRP)
dependent demand items
Chapter 8 - Inventory Management 13
Fluctuations in Inventory
Chapter 8 - Inventory Management 14
Reorder Point Systems
Reorder point
Lead time
Two-bin system
Perpetual inventory system
Chapter 8 - Inventory Management 15
A Reorder Point System
Chapter 8 - Inventory Management 16
Periodic Review System
maximum inventory level
- on-hand inventory
- on-order quantity
+ demand over lead time
reorder quantity
Chapter 8 - Inventory Management 17
Periodic Review System Without
Considering On-Order Quantity
Chapter 8 - Inventory Management 18
Periodic Review System (Assumes
None On Order at Time of Reorder)
Chapter 8 - Inventory Management 19
Priorities for Inventory Management:
The ABC Concept
A items
15-20% of items that account for 75-80% of
annual inventory value
B items
30-40% of items that account for 15% of
annual inventory value
C items
40-50% of items that account for 10-15% of
annual inventory value
Chapter 8 - Inventory Management 20
ABC Inventory Categories

The Economic Order Quantity
(EOQ)
Chapter 8 - Inventory Management 22
Assumptions
Constant rate of demand
Shortages not allowed
Stock replenishment can be scheduled to
arrive exactly when inventory drops to zero
Purchase price, ordering cost, and per unit
holding cost are independent of quantity
ordered
Items are ordered independently of each other
Chapter 8 - Inventory Management 23
Notation
Q = order quantity

U = annual usage

CO = order cost per order

CH = annual holding cost per unit
Chapter 8 - Inventory Management 24
Water Distributors Inventory Pattern
Chapter 8 - Inventory Management 25
Water Distributors Inventory Graph
Chapter 8 - Inventory Management 26
Annual Order Cost
$
Q

U
Q
C
O

Chapter 8 - Inventory Management 27

Annual Holding Cost
$
Q
H
C
2
Q

Chapter 8 - Inventory Management 28

Graph of Annual Inventory Costs
Chapter 8 - Inventory Management 29
Finding an Optimal Policy
Q
2
C
U
Q
C
H O
|
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=
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Q
UC
C
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O
H
=
2
EOQ =
2UC
C
O
H
Chapter 8 - Inventory Management 30
Alternative Way of Deriving EOQ
TAC =
Q
2
C
U
Q
C
TAC
Q
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2
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Q
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c
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H
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Chapter 8 - Inventory Management 31
Alternative Way of Deriving EOQ
continued
U
Q
C
C
2
UC
Q C
2
UC
C
Q
UC
C
Q
2
O
H
O
2
H
O
H
2
H
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=
=
=
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2
2
O
Chapter 8 - Inventory Management 32
EOQ Example
Given:
25,000 annual demand
$3 per unit per year holding cost
$100 ordering costs
EOQ =
2(25,000)(100)
3
= 1291
Chapter 8 - Inventory Management 33
Cautions Regarding EOQ
GIGO
Exclude sunk costs
Very small EOQ values my not be valid
Chapter 8 - Inventory
Management
34