Logistics Purchasing

LOGISTICS III
CHAPTER 9
Inventory Policy Decisions
Department of Transport and Supply Chain Management

OVERVIEW
• Reasons For Holding Inventories

• Types Of Inventories
• Pull-inventory Philosophy
• Push-inventory Philosophy
• Service Level (Fill Rate)
• Costs Of Holding Inventory
– Procurement Costs
– Carrying Costs
– Out-of-stock Costs
• Economic Ordering Quantity (EOQ)
– Economic Ordering Quantity With Quantity Discount
• Push Inventory Control Calculation
• Pull Inventory Control Calculation
LOGISTICS 3 CHAPTER 9 2
Definition: Inventories are stockpiles of raw materials,
supplies, components, etc., found in warehouses,
yards, transport carriers, retail outlets, etc.
Having inventories available can cost between 20% to 40% of their value
LOGISTICS 3 CHAPTER 9 per year (Inventory Carrying Cost). 3
APPRAISAL OF INVENTORIES
Reasons for holding inventories:
• Improve Customer Service

• The availability of these inventories to customers can not only maintain
sales, but they can also increase them.
• Reduce Costs
• Encourage economies of production by allowing larger, longer
production runs.
• Fosters economies in purchasing and transportation.
• Forward buying involves purchasing additional product quantities at
lower current prices rather than at higher anticipated future prices.
• Buffer: Inventories are frequently used at many points in the SC to buffer
the effects of variability and, thereby, help to smooth operations.
• Production stops: Labor strikes, natural disasters, surges in demand,
and delays in supplies are the types of contingencies against which
inventories can afford some protection.
TYPES OF INVENTORIES
• Pipeline inventory.
• These are inventories in transit between echelons of the supply channel.
• Similarly, work-in-process inventories between manufacturing operations can be considered
as puipeline inventories.
• Speculative inventory
• Raw materials such as copper, gold, and silver are purchased as much for price speculation
as they are to meet operating requirements.
• Regular or cycle stock
• These are the inventories necessary to meet the average demand during the time between
successive replenishments. The amount of cycle stock is dependent on production lot sizes,
shipment quantities, storage space limitations, etc.
• Safety stock
• Inventory may be created as a buffer against the variability in demand for the inventory and in
replenishment lead time.
• Safety stock, is in addition to the regular stock that is needed to meet average demand.
• Obsolete, Dead, or Shrinkage stock
• Some of the inventory deteriorates, becomes out of date, or is lost or stolen when held for a
time. Such inventory is referred to as obsolete, dead, or shrinkage stock.
Pull-inventory philosophy
•This philosophy views each stocking

point (warehouse), as independent of all
others in the channel.
•Forecasting demand and determining
replenishment quantities are done by
taking into account only local conditions,
for a specific demand point.
•No direct consideration is given to the
effect that the replenishment quantities,
each with their different levels and timing,
will have on the economics of the
sourcing plant.
•This approach does give precise control
over inventory levels at each location.
•Pull methods are popular at the retail
level in the supply channel.
Push-inventory philosophy
• Many firms allocate replenishment quantities

to inventories based on projected needs for
inventories at each location or available
space.
• Inventory levels are set collectively across
the entire warehousing system.
• Is used when purchasing or production
economies of scale outweigh the benefits
of minimum collective inventory levels as
achieved by the pull method.
• Inventories can be managed centrally for
better overall control, production and
purchase economies can be used to dictate
inventory levels for lower costs, and
forecasting can be made on aggregate
demand and then apportioned to each
stocking point for improved accuracy.
Product Availability
Service Level (Fill Rate) for One Item
• A primary objective of inventory management is to ensure that

product is available at the time and in the quantities desired.
• This is commonly judged based on the probability of fulfillment
capability from current stock.
• This probability, or item fill rate, is referred to as the service
level, and, for a single item, can be defined as :
Service level = 1 - Expected number of units out of stock annually

Total annual demand
Example
1 - 10
100 = SL of 0.9 or 90%
Service Level (Fill Rate)
For many items
• Customers frequently order more than one item at a time.

• The probability of filling the customer order completely can be of
greater concern than single-item service levels.
• For example, suppose that five items are requested on an order
where each item has a fill rate of 0.95, that is, only a 5 percent
chance of not being in stock.
• Filling the entire order without any item being out of stock would
be:
0.95 x 0.95 x 0.95 x 0.95 x 0.95 = 0.77 or 77%
Relevant Costs of Inventory
•Three general classes of costs are

important to determining inventory policy:
– Procurement costs (ordering
costs)
– Carrying costs
– Stockout costs.
•These costs are in conflict, or in trade-

off, with each other.
•For determining the most Economic

Order Quantity (EOQ) to replenish an
item in inventory, these relevant costs
trade-off are shown in diagram.
Procurement Costs
•When a stock replenishment order

is placed, a number of costs are
incurred that are related to the
processing, setup, transmitting,
handling, and purchase of the
order.
•Procurement costs are fixed per
order.
•The per item procurement cost line
thus decreases as the number of
units ordered increases
Carrying Costs
• Inventory carrying costs result from storing,

or holding, goods for a period and are
roughly proportional to the average quantity
of goods on hand. – Carry cost increase as
inventory increases.
• Space Costs. Space costs are charges
made for the use of the volume inside the
storage building.
• Capital Costs. Capital costs refer to the cost
of the money tied up in inventory.
• This cost may represent over 80 % of total
inventory costThere are two reasons for this.
• Service Costs. Insurance and taxes are
part of inventory carrying costs because their
level roughly depends on the amount of
inventory on hand.
• Inventory Risk Costs. Costs associated
with deterioration, shrinkage (theft), damage,
or obsolescence make up the final category
of carrying costs.
Out-of-Stock Costs
•Out-of-stock costs are incurred when an order

is placed but cannot be filled from the
inventory.
•There are two kinds of out-ofstock costs: lost

sales costs and back order costs.
•A lost sales cost occurs when the customer,
faced :with an out-of-stock situation, chooses to
withdraw his or her request for the product.
•Products for which the customer is very willing

to substitute competing brands, such as bread,
are those that are most likely to incur lost sales.
•A back order cost occurs when a customer
will wait for his or her order to be filled.
•Back orders can create additional clerical

and sales costs for order processing, and
additional transportation.
•Products (automobiles and major appliances)

that can be differentiated in the consumer's
mind are more likely to be back ordered than
substituted.
Economic Ordering Quantity (EOQ)
•The basic EOQ formula is
developed from a total cost equation
involving procurement cost and
inventory carrying cost. It is
expressed as:
Where:
Order cost/Machine Setup cost = S
Demand per annum = D
Carrying cost of inventory per unit = I
Average unit Cost /Value per unit = C
EXAMPLE:
An industrial machine tool manufacturer supplies parts from its inventory. For a particular part, the
annual demand is expected to be 750 units. Machine setup costs are R50, carrying costs are 25%
of unit value per year, and the part is valued at R35 each.
ECONOMIC ORDER QUANTITY (Q): Where:

_________ Order cost/Machine Setup cost = S
Q = (2 x D x S) Demand per annum = D
√ (I x C) Carrying cost of inventory per unit = I
_______________ ________
Q = (2 x 750 x 50) = 75 000
√ (0.25 x 35) √ 8.75
_________
Q = √ 8 571,43 = 92.58 or 93 units
NOTE: The answer is in units and must thus be rounded off to a whole number !!!
ORDERS PLACED PER YEAR: N = D
Q
750
= 93 = 8.06 or 8 orders
TIME WHEN ORDER IS TO BE PLACED:

T= Q = 93
D 750 = 0.124 years
Where 0.124 years = 0.124 x 52 weeks per year = 6.45 weeks
Reorder Point quantity (units) ROP = d x LT

Where: d = demand rate, in time units
LT = average lead time, in time units
(Note: The demand rate (d) and the average lead time (LT) must be expressed in the
same time dimension, e.g. weeks)
Suppose that it takes 1.5 weeks to set up production and make the parts = LT.
d = 750 units per year / 52 weeks = 14.42 units per week.
ROP = 14.42 x 1.5 = 21.63 or 22 units
ANNUAL ORDER COST OC: = SxD = 50 x 750
Q 93
= R 403.23
ANNUAL INVENTORY CARRYING COST: ICC = ( I x C x Q)

2
= (0.25 x 35 x 93) 813.75
2 = 2
= R 406.88
TOTAL ANNUAL COST: TC = CAPITAL COST + ORDER COST + INV. CARRYING COST
= CD + S x D + (IxCxQ)
Q 2
= (R35x 750) + R 403.23 + R 406.8827060.1

= R 26 250 + R 403.23 + R 406.88
= R 27060.11
19
EXAMPLE
The annual demand for an item is 28500 and the value of each item
is R750. The lead time from the manufacturers is 1.3 weeks. The
inventory carrying cost is 26% of unit value, while the ordering cost
is R600.
Determine:
• EOQ
• Orders placed per year
• Time between orders
• Reorder point
• Annual ordering cost
• Annual inventory carrying cost
• Total cost
DATA ANNUAL DEMAND D 28500
CARRY COST P UNIT I 26%
ANSWER COST/VALUE P UNIT delivered
ORDER COST
C
S
R
R
750.00
600.00
LEAD TIME LT 1.3 WEEKS
CALCULTIONS:
Q √(2 x D x S)
(I x C)
Q = 419 UNITS
ORDER PLACED PER YEAR (N) = D/Q
N= 68 TIMES
TIME BETWEEN ORDERS (T) = Q/D

(Answer in weeks)
T= 0.8 WEEKS
REORDER POINT QUANTITY

WHERE d = D/52 548 UNITS PER WEEK
ROP = d x LT 713 UNITS
ANNUAL ORDER COST (OC) = S x (D/Q)
OC = R 40 832
ANNUAL INVENTORY CARRY COST (ICC) = (I x C x Q) / 2

ICC = R 40 832
TOTAL COST (TC) = CD + OC + ICC

TC = R 21 456 663.95
ECONOMIC ORDERING QUANTITY WITH QUANTITY DISCOUNT
A supplier is offering quantity discount rates to the company you work for. In your capacity as
purchasing manager, decide on the most economic quantity to buy from the supplier, given the
following information:
Annual Demand = 5 500 units

Ordering cost = R 11.00
Inventory carrying cost = 21 % ORDER UNIT
Discounted Selling prices: = UNITS PRICE
< 500 R 6.50
> = 500 R 5.30
________________________
Q1 = √ (2 x 5500 x 11) / (0.21 x 6.50)
= 298 units
• This quantity is Feasible (Within < 500 unit criteria at R6.50)
________________________
Q2 = √ (2 x 5500 x 11) / (0.21x 5.30)
= 330 units
This quantity is Rejected (Not within > 500 unit criteria at R5.30)
NOW DECIDE IF Q 1 (298 UNITS) OR THE MAXIMUM
ORDER (500 UNITS) SHOULD BE PLACED.
Formula: Where:
DS ICQ Order cost/Machine Setup cost = S
Demand per annum = D
Total Cost (TC) = CD + Q + 2 Carrying cost of inventory per unit = I
5500 x 11 0.21x 6.50 x 298

TC 1 = 6.50 x 5500 + 298 + 2
= R 36 156.41
5500 x 11 0.21x 5.30 x 500

TC (500) = 5.30 x 5500 + 500 + 2
= R 29 549.25
It is thus more cost beneficial to order 500 units.
PUSH INVENTORY CONTROL
A method for pushing quantities into stocking points involves the following
steps:
• Determine through forecasting or other means the requirements for the
period between now and the next expected production run or vendor
purchase.
• Find the current on-hand quantities at each stocking point.
• Establish the stock availability level at each stocking point.
• Calculate total requirements from the forecast plus additional quantities
needed to cover uncertainty in the demand forecast.
• Determine net requirements as the difference between total requirements
and the quantities on hand.
• Apportion the excess over total net requirements to the stocking points
on the basis of the average demand rate, that is, the forecasted demand.
• Sum the net requirements and prorate the excess quantities to find the
amount to be allocated to each stocking point.
PUSH INVENTORY CONTROL
Example
Current production is 125 000 tons.

Determine the total requirements for each warehouse and
allocate any excess of available stock to the respective stock
points on a pro-rata basis in line with the sales forecast
STOCK CURRENT FORCAST STANDARD STOCK
POINT STOCK DEMAND DEVIATION AVAILABILITY
LEVEL (tons) (tons) (tons) LEVEL %
1 5 000 10 000 2 000 90 %

2 15 000 50 000 1 500 95 %
3 30 000 70 000 20 000 90 %
Areas under the Standardised Normal Distribution Curve (Z value)
Forecast demand + (Z x Forecast deviation) = Total requirements

From normalised distribution table:
Z1 = 1.28 for 90 %
Z is the number of standard deviations on

the Standardised Normal Distribution
Curve beyond the forecast to the point
where 90% of the curve is represented
with a “z” value of 1.28
Z2 = 1.65 for 95%

(use the highest Z value if two Z answers
are the same)
Z3 = 1.28 for 90 %
For Z1 = 90 % = 90/100 = 0.9 Look for the closest value to 0.9000 = 0.8997 = Z of 1.28
Forecast demand + (Z x Forecast deviation) = Total Req.
1 10 000 + ( 1,28 x 2 000 ) = 12 560
2 50 000 + ( 1,65 x 1 500 ) = 52 475
3 70 000 + ( 1,28 x 20 000 ) = 95 600
TOTAL 160 635
DEPOT Total Stock Net Proration of Allocation
Requirements On Hand Requirements Excess (3) + (4)
(1) (2) (1) - (2) = (3) (4)
1 12 560 5 000
2 52 475 15 000
3 95 600 30 000
TOTAL 160 635
Total requirements - Stock on Hand = Net Req.
12 560 - 5 000 = 7 560
52 475 - 15 000 = 37 475
95 600 - 30 000 = 65 600
110 635
(1) (2) (1) - (2) = (3) (4)
1 12 560 5 000 7 560
2 52 475 15 000 37 475
3 95 600 30 000 65 600
TOTAL 160 635 110 635
PRORATION OF EXCESS STOCK:
Total current production = 125 000 tons
Total Net requirements = -110 635 tons
Excess to be prorated = 14 365 tons
FORMULA:
Stock point Forecast / Total Forecast) x 100 = % prorated to stock point
(Where total forecast = 10 000 + 50 000 + 70 000 = 130 000)
1 (10 000 / 130 000) x 100 = 8 % or 0.08
2 2 (50 000 / 130 000) x 100 = 38 % or 0.38
3 (70 000 / 130 000) x 100 = 54 % or 0.54
(it is OK to approximate)
Apply percentages to Total excess stock to be prorated:
1 0.08 x 14 365 = 1 149
2 0.38 x 14 365 = 5 459
3 0.54 x 14 365 = 7 757
14 365

(1) (2) (1) - (2) = (3) (4)
1 12 560 5 000 7 560 1 149 8 709

2 52 475 15 000 37 475 5 459 42 934
3 95 600 30 000 65 600 7 757 73 392
TOTAL 160 635 110 635 14 365 125 000
BASIC PULL INVENTORY CONTROL
Single-Order Quantity Demand
• Pull inventory control gives low inventory levels at stocking points because of
its response to the demand particular to each stocking point.
• Problems exist where the products involved are perishable or the demand for
them is a one-time event.
• Products such as fresh fruits and vegetables, cut flowers, newspapers have a
short shelf life.
• Hotdog buns for a baseball game, and posters for a political campaign, have a
one-time demand level that usually cannot be estimated with certainty.
• Only one order can be placed for these products to meet such demand. We
wish to determine how large the single order should be.
• To find the most economic order size (Q*), we can make use of marginal
economic analysis.
• That is, Q* is found at the point where the marginal profit on the next unit
sold equals the marginal loss of not selling the next unit.
THE MARGINAL PROFIT PER UNIT OBTAINED BY SELLING A UNIT IS:

PROFIT = PRICE PER UNIT – COST PER UNIT
THE PER UNIT LOSS BY NOT SELLING THE UNIT IS:

LOSS = COST PER UNIT – SALVAGE VALUE PER UNIT
Considering the probability of a given number of units being sold, the

expected profits and losses are balanced at this point.
That is: CPn (Loss) – (1 – Cpn)(Profit)
where CPn represents the cumulative frequency of selling at least
n units of product. Solving the above expression for CPn, we
have:
CPn = Profit
Profit + Loss
This says that we should continue to increase the order quantity

until the cumulative probability of selling additional units just
equals the ratio of Profit -:- (Profit + Loss).
Example: Pull Inventory Control
A grocery store estimates that it will sell 100 pounds of its specially prepared potato
salad in the next week. The demand distribution is normally distributed with a standard
deviation of 20 pounds. The supermarket can sell the salad for $5.99 per pound. It pays
$2.50 per pound for the ingredients. Since no preservatives are used, any unsold salad
is given to charity at no cost. Finding the quantity to prepare that will maximise profit
requires that we first compute CPn. That is,
CPn = Profit
Profit + Loss
(5.99 - 2.50)
(5.99 - 2.50) + (2.50 – 0) = 0.583
From the normal distribution curve, the optimum Q* is at

the point of 58.3 percent (0.583) of the area under the curve.
This is a point where z = 0.21.
The salad preparation quantity should be:
Q* = Forecast + Z(Standard deviation)
LOGISTICS 3 CHAPTER 9 Q* = 100 Ib + 0.21(20 Ib) = 104.2 Ib 36
Areas under the Standardized Normal
Distribution
Z
.00 .01 .02 .03 .04 .05 .06 .07 .08 .09
0.0 0.5000 0.5040 0.5080 0.5120 0.5160 0.5199 0.5239 0.5279 0.5319 0.5359
0.1 0.5398 0.5438 0.5478 0.5517 0.5557 0.5596 0.5636 0.5675 0.5714 0.5753
0.2 0.5793 0.5832 0.5871 0.5910 0.5948 0.5987 0.6026 0.6064 0.6103 0.6141
0.3 0.6179 0.6217 0.6255 0.6293 0.6331 0.6368 0.6406 0.6443 0.6480 0.6517
0.4 0.6554 0.6591 0.6628 0.6664 0.6700 0.6736 0.6772 0.6808 0.6844 0.6879
0.5 0.6915 0.6950 0.6985 0.7019 0.7054 0.7088 0.7123 0.7157 0.7190 0.7224
0.6 0.7257 0.7291 0.7324 0.7357 0.7389 0.7422 0.7454 0.7486 0.7517 0.7549
0.7 0.7580 0.7611 0.7642 0.7673 0.7704 0.7734 0.7764 0.7794 0.7823 0.7852
0.8 0.7881 0.7910 0.7939 0.7967 0.7995 0.8023 0.8051 0.8078 0.8106 0.8133
0.9 0.8159 0.8186 0.8212 0.8238 0.8264 0.8289 0.8315 0.8340 0.8365 0.8389
1.0 0.8413 0.8438 0.8461 0.8485 0.8508 0.8531 0.8554 0.8577 0.8599 0.8621
1.1 0.8643 0.8665 0.8686 0.8708 0.8729 0.8749 0.8770 0.8790 0.8810 0.8830
1.2 0.8849 0.8869 0.8888 0.8907 0.8925 0.8944 0.8962 0.8980 0.8997 0.9015
Example
A high fashion clothing store estimates that it will sell 250 dresses in the next
month. The demand distribution is normally distributed with a standard
deviation of 25 dresses. The store can sell the dresses for R155 per dress. It
pays R55 per dress for the material used. Any unsold dresses are converted
into T-shirts which are then disposed of at a reduced price of R30 each. Find
the quantity of dresses that will maximise profit.
.00 .01 .02 .03 .04 .05 .06 .07 .08 .09
Z
0.0 0.5000 0.5040 0.5080 0.5120 0.5160 0.5199 0.5239 0.5279 0.5319 0.5359
0.1 0.5398 0.5438 0.5478 0.5517 0.5557 0.5596 0.5636 0.5675 0.5714 0.5753
0.2 0.5793 0.5832 0.5871 0.5910 0.5948 0.5987 0.6026 0.6064 0.6103 0.6141
0.3 0.6179 0.6217 0.6255 0.6293 0.6331 0.6368 0.6406 0.6443 0.6480 0.6517
0.4 0.6554 0.6591 0.6628 0.6664 0.6700 0.6736 0.6772 0.6808 0.6844 0.6879
0.5 0.6915 0.6950 0.6985 0.7019 0.7054 0.7088 0.7123 0.7157 0.7190 0.7224
0.6 0.7257 0.7291 0.7324 0.7357 0.7389 0.7422 0.7454 0.7486 0.7517 0.7549
0.7 0.7580 0.7611 0.7642 0.7673 0.7704 0.7734 0.7764 0.7794 0.7823 0.7852
0.8 0.7881 0.7910 0.7939 0.7967 0.7995 0.8023 0.8051 0.8078 0.8106 0.8133
0.9 0.8159 0.8186 0.8212 0.8238 0.8264 0.8289 0.8315 0.8340 0.8365 0.8389
.00 .01 .02 .03 .04 .05 .06 .07 .08 .09
Z
0.0 0.5000 0.5040 0.5080 0.5120 0.5160 0.5199 0.5239 0.5279 0.5319 0.5359
0.1 0.5398 0.5438 0.5478 0.5517 0.5557 0.5596 0.5636 0.5675 0.5714 0.5753
0.2 0.5793 0.5832 0.5871 0.5910 0.5948 0.5987 0.6026 0.6064 0.6103 0.6141
0.3 0.6179 0.6217 0.6255 0.6293 0.6331 0.6368 0.6406 0.6443 0.6480 0.6517
0.4 0.6554 0.6591 0.6628 0.6664 0.6700 0.6736 0.6772 0.6808 0.6844 0.6879
0.5 0.6915 0.6950 0.6985 0.7019 0.7054 0.7088 0.7123 0.7157 0.7190 0.7224
0.6 0.7257 0.7291 0.7324 0.7357 0.7389 0.7422 0.7454 0.7486 0.7517 0.7549
0.7 0.7580 0.7611 0.7642 0.7673 0.7704 0.7734 0.7764 0.7794 0.7823 0.7852
0.8 0.7881 0.7910 0.7939 0.7967 0.7995 0.8023 0.8051 0.8078 0.8106 0.8133
0.9 0.8159 0.8186 0.8212 0.8238 0.8264 0.8289 0.8315 0.8340 0.8365 0.8389
1.0 0.8413 0.8438 0.8461 0.8485 0.8508 0.8531 0.8554 0.8577 0.8599 0.8621
1.1 0.8643 0.8665 0.8686 0.8708 0.8729 0.8749 0.8770 0.8790 0.8810 0.8830
1.2 0.8849 0.8869 0.8888 0.8907 0.8925 0.8944 0.8962 0.8980 0.8997 0.9015
CPn = Profit
Profit + Loss
(155 - 55)
(155 - 55) + (55 – 30) = 0.8
From the normal distribution curve, the optimum Q* is at

the point of 80% (0.8) of the area under the curve.
This is a point where z = 0.84.
The salad preparation quantity should be:
Q* = Forecast + Z(Standard deviation)
Q* = 250 + 0.84(25) = 271 dresses
Z
.00 .01 .02 .03 .04 .05 .06 .07 .08 .09
0.0 0.5000 0.5040 0.5080 0.5120 0.5160 0.5199 0.5239 0.5279 0.5319 0.5359
0.1 0.5398 0.5438 0.5478 0.5517 0.5557 0.5596 0.5636 0.5675 0.5714 0.5753
0.2 0.5793 0.5832 0.5871 0.5910 0.5948 0.5987 0.6026 0.6064 0.6103 0.6141
0.3 0.6179 0.6217 0.6255 0.6293 0.6331 0.6368 0.6406 0.6443 0.6480 0.6517
0.4 0.6554 0.6591 0.6628 0.6664 0.6700 0.6736 0.6772 0.6808 0.6844 0.6879
0.5 0.6915 0.6950 0.6985 0.7019 0.7054 0.7088 0.7123 0.7157 0.7190 0.7224
0.6 0.7257 0.7291 0.7324 0.7357 0.7389 0.7422 0.7454 0.7486 0.7517 0.7549
0.7 0.7580 0.7611 0.7642 0.7673 0.7704 0.7734 0.7764 0.7794 0.7823 0.7852
0.8 0.7881 0.7910 0.7939 0.7967 0.7995 0.8023 0.8051 0.8078 0.8106 0.8133
0.9 0.8159 0.8186 0.8212 0.8238 0.8264 0.8289 0.8315 0.8340 0.8365 0.8389
1.0 0.8413 0.8438 0.8461 0.8485 0.8508 0.8531 0.8554 0.8577 0.8599 0.8621
1.1 0.8643 0.8665 0.8686 0.8708 0.8729 0.8749 0.8770 0.8790 0.8810 0.8830
1.2 0.8849 0.8869 0.8888 0.8907 0.8925 0.8944 0.8962 0.8980 0.8997 0.9015
LOGISTICS III
CHAPTER 9
END
Department of Transport and Supply Chain Management

Logistics Purchasing

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LOGISTICS III

Department of Transport and Supply Chain Management

• Reasons For Holding Inventories

• Improve Customer Service

•This philosophy views each stocking

• Many firms allocate replenishment quantities

• A primary objective of inventory management is to ensure that

Service level = 1 - Expected number of units out of stock annually

• Customers frequently order more than one item at a time.

•Three general classes of costs are

•These costs are in conflict, or in trade-

•For determining the most Economic

•When a stock replenishment order

• Inventory carrying costs result from storing,

•Out-of-stock costs are incurred when an order

•There are two kinds of out-ofstock costs: lost

•Products for which the customer is very willing

•Back orders can create additional clerical

•Products (automobiles and major appliances)

ECONOMIC ORDER QUANTITY (Q): Where:

TIME WHEN ORDER IS TO BE PLACED:

Reorder Point quantity (units) ROP = d x LT

ROP = 14.42 x 1.5 = 21.63 or 22 units

ANNUAL INVENTORY CARRYING COST: ICC = ( I x C x Q)

= (R35x 750) + R 403.23 + R 406.8827060.1

ORDER PLACED PER YEAR (N) = D/Q

TIME BETWEEN ORDERS (T) = Q/D

REORDER POINT QUANTITY

ANNUAL ORDER COST (OC) = S x (D/Q)

ANNUAL INVENTORY CARRY COST (ICC) = (I x C x Q) / 2

TOTAL COST (TC) = CD + OC + ICC

Annual Demand = 5 500 units

5500 x 11 0.21x 6.50 x 298

5500 x 11 0.21x 5.30 x 500

Current production is 125 000 tons.

1 5 000 10 000 2 000 90 %

Forecast demand + (Z x Forecast deviation) = Total requirements

Z is the number of standard deviations on

Z2 = 1.65 for 95%

TOTAL 160 635

1 12 560 5 000 7 560

2 52 475 15 000 37 475

3 95 600 30 000 65 600

TOTAL 160 635 110 635

DEPOT Total Stock Net Proration of Allocation

1 12 560 5 000 7 560 1 149 8 709

THE MARGINAL PROFIT PER UNIT OBTAINED BY SELLING A UNIT IS:

THE PER UNIT LOSS BY NOT SELLING THE UNIT IS:

Considering the probability of a given number of units being sold, the

This says that we should continue to increase the order quantity

From the normal distribution curve, the optimum Q* is at

From the normal distribution curve, the optimum Q* is at

Department of Transport and Supply Chain Management

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