Chapter 11

11-1
Inventory Management
11-2
CHAPTER
Operations Management
11
Inventory
Management
William J. Stevenson
8th edition
Operations Management, Eighth Edition, by William J. Stevenson
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
11-3
11-4
Inventory: a stock or store of goods
Independent Demand
Dependent Demand
Types of Inventories
Raw materials & purchased parts

Partially completed goods called
work in progress
C(2)
B(4)
D(2)
E(1)
D(3)
Finished-goods inventories
F(2)
Independent demand is uncertain.

Dependent demand is certain.
(manufacturing firms)
or merchandise
(retail stores)
11-5
11-7
Types of Inventories (Cont

(Contd)
11-6
Functions of Inventory
Replacement parts, tools, & supplies
To meet anticipated demand
Goods-in-transit to warehouses or customers
To smooth production requirements
To decouple operations
To protect against stock-outs
Functions of Inventory (Cont

(Contd)
To take advantage of order cycles
To help hedge against price increases
To permit operations
To take advantage of quantity discounts
11-8
Objective of Inventory Control
To achieve satisfactory levels of customer

service while keeping inventory costs within
reasonable bounds
Level of customer service
Costs of ordering and carrying inventory
11-9
Effective Inventory Management
A system to keep track of inventory
A reliable forecast of demand
Knowledge of lead times
Reasonable estimates of
Holding costs
Ordering costs
Shortage costs
11-10 Inventory Management
Inventory Counting Systems
Periodic System
Physical count of items made at periodic
intervals
Perpetual Inventory System

System that keeps track
of removals from inventory
continuously, thus
monitoring
current levels of
each item
A classification system
Inventory Counting Systems (Cont

(Contd)
Two-Bin System - Two containers of
inventory; reorder when the first is empty
Universal Bar Code - Bar code
printed on a label that has
information about the item
to which it is attached
214800 232087768
Key Inventory Terms
Lead time: time interval between ordering

and receiving the order
Holding (carrying) costs: cost to carry an
item in inventory for a length of time,
usually a year
Ordering costs: costs of ordering and
receiving inventory
Shortage costs: costs when demand exceeds
supply
ABC Classification System
Cycle Counting
Figure 11.1
Classifying inventory according to some

measure of importance and allocating control
efforts accordingly.
A - very important
B - mod. important
C - least important
High
A physical count of items in inventory
Cycle counting management
Annual
$ value
of items
How much accuracy is needed?
When should cycle counting be performed?
Who should do it?
B
C
Low
Few
Many
Number of Items
Economic Order Quantity Models
Assumptions of EOQ Model
Economic order quantity model
Only one product is involved
Economic production model
Annual demand requirements known
Quantity discount model
Demand is even throughout the year
Lead time does not vary
Each order is received in a single delivery
There are no quantity discounts
The Inventory Cycle
Total Cost
Figure 11.2
Profile of Inventory Level Over Time
Usage
rate
Quantity
on hand
Annual
Annual
Total cost = carrying + ordering
cost
cost
TC =
Reorder
point
Receive
order
Place Receive
order order
Q
H
2
DS
Q
Time
Place Receive
order order
Lead time
Cost Minimization Goal
Deriving the EOQ
Figure 11.4C
Annual Cost
The Total-Cost Curve is U-Shaped

TC =
D
Q
H+ S
2
Q
Using calculus, we take the derivative of the

total cost function and set the derivative
(slope) equal to zero and solve for Q.
Q OPT =
Ordering Costs
QO (optimal order quantity)
Order Quantity
(Q)
2DS
=
H
2( Annual Demand )(Order or Setup Cost )

Annual Holding Cost
Minimum Total Cost
The total cost curve reaches its minimum

where the carrying and ordering costs are
equal.
Q OPT =
2DS
=
H
2( Annual Demand )(Order or Setup Cost )

Annual Holding Cost
Economic Production Quantity Assumptions

Only one item is involved
Annual demand is known
Usage rate is constant
Usage occurs continually
Production rate is constant
Lead time does not vary
No quantity discounts
Economic Production Quantity (EPQ)

Production done in batches or lots
Capacity to produce a part exceeds the parts
usage or demand rate
Assumptions of EPQ are similar to EOQ
except orders are received incrementally
during production
Economic Run Size
Q0 =
p
2DS
H p u
Total Costs with Purchasing Cost
Total Costs with PD
Cost
Figure 11.7
Annual
Annual
TC = carrying + ordering + Purchasing
cost
cost
cost
TC =
Q
H
2
DS
Q
Adding Purchasing cost

doesnt change EOQ
TC with PD
TC without PD
PD
PD
Total Cost with Constant Carrying Costs
EOQ
Quantity
When to Reorder with EOQ Ordering
Figure 11.9
Reorder Point - When the quantity on hand

of an item drops to this amount, the item is
reordered
Safety Stock - Stock that is held in excess of

expected demand due to variable demand
rate and/or lead time.
Service Level - Probability that demand will

not exceed supply during lead time.
Total Cost
TCa
TCb
Decreasing
Price
TCc
CC a,b,c
OC
EOQ
Quantity
Determinants of the Reorder Point
Safety Stock
Figure 11.12
The rate of demand

The lead time
Demand and/or lead time variability
Stockout risk (safety stock)
Quantity
Maximum probable demand

during lead time
Expected demand
during lead time
ROP
Safety stock reduces risk of
stockout during lead time
Safety stock
LT
Time
Reorder Point
FixedFixed-OrderOrder-Interval Model
Figure 11.13
The ROP based on a normal
Distribution of lead time demand
Service level
Risk of
a stockout
Probability of
no stockout
Expected
demand
0
ROP
Quantity
Safety
stock
z
z-scale
Orders are placed at fixed time intervals

Order quantity for next interval?
Suppliers might encourage fixed intervals
May require only periodic checks of
inventory levels
Risk of stockout
FixedFixed-Interval Benefits
Tight control of inventory items

Items from same supplier may yield savings
in:
Ordering
Packing
Shipping costs
FixedFixed-Interval Disadvantages
Requires a larger safety stock

Increases carrying cost
Costs of periodic reviews
May be practical when inventories cannot be

closely monitored
Single Period Model
Single period model: model for ordering of

perishables and other items with limited
useful lives
Shortage cost: generally the unrealized

profits per unit
Excess cost: difference between purchase

cost and salvage value of items left over at
the end of a period
Single Period Model
Continuous stocking levels
Identifies optimal stocking levels
Optimal stocking level balances unit shortage

and excess cost
Discrete stocking levels
Service levels are discrete rather than

continuous
Desired service level is equaled or exceeded
Operations Strategy
CHAPTER
Too much inventory

Tends to hide problems
Easier to live with problems than to eliminate
them
Costly to maintain
Wise strategy
11
Additional PowerPoint slides

contributed by
Geoff Willis,
University of Central Oklahoma.
Reduce lot sizes

Reduce safety stock
Usage
Production
& Usage
Production
& Usage
Economic Production Quantity
Gortrac Manufacturing
Usage
In
v
en
t
or
yL
ev
el
GTS3
Inventory/Assessment/Reduction
Materials
PS7
Washburn Guitars

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11-1

Inventory: a stock or store of goods

Raw materials & purchased parts

Independent demand is uncertain.

Types of Inventories (Cont

Replacement parts, tools, & supplies

To meet anticipated demand

Goods-in-transit to warehouses or customers

To smooth production requirements

To protect against stock-outs

Functions of Inventory (Cont

To take advantage of order cycles

To help hedge against price increases

To take advantage of quantity discounts

Objective of Inventory Control

To achieve satisfactory levels of customer

Level of customer service

Costs of ordering and carrying inventory

Effective Inventory Management

A system to keep track of inventory

A reliable forecast of demand

Knowledge of lead times

11-10 Inventory Management

Inventory Counting Systems

Perpetual Inventory System

11-11 Inventory Management

Inventory Counting Systems (Cont

11-12 Inventory Management

Key Inventory Terms

Lead time: time interval between ordering

11-13 Inventory Management

11-14 Inventory Management

ABC Classification System

Classifying inventory according to some

A physical count of items in inventory

Cycle counting management

How much accuracy is needed?

When should cycle counting be performed?

Who should do it?

11-15 Inventory Management

Economic Order Quantity Models

11-16 Inventory Management

Assumptions of EOQ Model

Economic order quantity model

Only one product is involved

Economic production model

Annual demand requirements known

Quantity discount model

Demand is even throughout the year

Lead time does not vary

Each order is received in a single delivery

There are no quantity discounts

11-17 Inventory Management

11-18 Inventory Management

The Inventory Cycle

11-19 Inventory Management

Cost Minimization Goal

11-20 Inventory Management

Deriving the EOQ

The Total-Cost Curve is U-Shaped

Using calculus, we take the derivative of the

2( Annual Demand )(Order or Setup Cost )

11-21 Inventory Management