Inventory

Inventory
• Inventory: the physical stock of any items or resources
used in an organization
• The objective of an inventory system is to specify:
1. When items should be ordered.
2. What quantity of each item should be ordered.
• In manufacturing, types of inventory include raw
materials, work in process, finished goods, component
parts and supplies.
• In services, inventory refers to tangible goods that are
sold as part of the service and maintenance, repair, and
operating (MRO) supplies that are necessary.

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 Reasons to Carry Inventory
• Set-up and ordering
costs
• Customer service and
variation in demand
• Labor and equipment
utilization
• Transportation cost Source: © Image Source/Corbis

• Costs of
materials/quantity
discounts

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 Cycle Inventory
• Cycle inventory: a quantity of inventory that
varies in proportion to order quantity

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 Safety Stock Inventory
• Safety stock
inventory: excess
Inventory that a
company holds to
guard against
uncertainty in
demand, lead time,
and supply
Source: © Image Source/Corbis

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 Pipeline Inventory
• Pipeline inventory: inventory that is in the
process of moving from one location in the
supply chain to another

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 Work-in-process (WIP) Inventory
• Work-in-process inventory: inventory that is in
the process of being transformed from one state
to another
• It cannot be sold to a customer because it is not
yet finished.

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 Remanufactured/reconditioned
• Remanufactured/reconditioned inventory:
products that have been used by a customer
and then reacquired by a company and either
remanufactured or reconditioned for resale

What are some examples of

remanufactured inventory?

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 Independent versus
Dependent Demand
• Independent demand: demand for items that
are considered end items that go directly to a
customer, and for which demand is influenced
by market conditions and not related to inventory
decisions for any other item.
• Dependent demand: demand for items that are
used to make another item or are considered to
be component parts

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 Independent/Dependent Demand Items
Penfield Arrow Company makes arrows for the hunting industry.
There are three components that make up it’s arrow: the arrowhead,
shaft, and feathers.
Arrow

Feather Shaft Arrowhead

Is the arrow an independent item, or are the feathers, shaft, and

arrowhead independent?

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 Inventory Systems
• An inventory system provides the structure and
operating policies for maintaining and controlling
goods to be stocked in inventory.
• The system is responsible for ordering, tracking,
and receiving goods.
There are two essential policies:
1. How much or what quantity of an item to order?
2. When should an order for that item be placed?

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 Two Types of Systems
• Continuous review system: an inventory
system that always orders the same quantity of
items but has differing periods of time between
orders
• Periodic review system: an inventory system
that has a fixed time between orders but has
different order quantities from order to order

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 Continuous Review Systems
• Inventory position: on-hand inventory plus
outstanding orders, minus any backorder
quantities (items promised to a customer but not
yet delivered)

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 Setting the Order Quantity
• The goal for the inventory system is to minimize
total annual inventory cost:
• The total annual inventory cost is the
Q
sum of the cost of holding inventory H
2
and the cost of ordering inventory. D S
Q

D Q
IC  S H
Q 2

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 Figure 6.4: Annual Inventory Costs

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 Economic Order Quantity
• Economic order quantity: the order quantity
that minimizes the total annual cost of ordering
and holding inventory for a particular item

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 Setting the Reorder
Point with Certain Demand
• Reorder point: the predetermined level that an
inventory position must reach for an order to be
placed
• Lead time: is the time between when an order is
placed and when it is expected to arrive or be
finished

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 Special Cases of the
Economic Order Quantity
• Two relevant costs: ordering/setup (S) and holding (H)
• Constant demand
• Item independence
• Certainty in demand, lead time and supply
• Some version of the EOQ is used in almost every
company or organization dealing with inventory.
• The EOQ works despite the fact that the assumptions
are not strictly true for two reasons:
– It is relatively insensitive to errors because it involved a square
root.
– The EOQ works despite its slightly flawed assumptions that
adjustments for uncertainty are included in the overall inventory
system.
– Assumption 3 states that items are independent.
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 Technological Applications
• The biggest change in inventory management
over the past 20 years is the ability of companies
to use sophisticated software and hardware to
track and monitor inventory very closely.
• Enterprise Resource Planning (ERP): a large,
integrated information system that supports most
enterprise processes and data storage needs
across the entire organization
• Radio Frequency Identification (RFID): an
automatic identification method that relies on
storing and remotely retrieving data using
devices such as RFID tags or transponders
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