4.

Inventory Management Case Study

2
Inventory Management – ABC and EOQ
Case Study
Introduction
The IM Company makes novelties for advertising/promotional campaigns. Typical products
are rosettes, mugs and badges for sporting events such as the Rugby World Cup and
Olympics, British royal events such as weddings and christenings as well as political election
campaigns.
The company makes these products from only 7 different purchased parts and each part is
purchased from a different supplier. The part numbers, purchase prices and annual
demands for these 7 items are given in the table below. Demand for these parts can be
assumed to be constant and independent. The low number of parts purchased by the
company has meant that inventory management has not been given much attention in the
past.

Part number Annual demand, D Purchase price per part, P Annual spend, D*P
A34 1,000 £10 £10,000
B7 10 £100 £1,000
B28 600 £130 £78,000
CD84 2,000 £80 £160,000
CD91 3,000 £1 £3,000
G4 100 £4 £400
G15 600 £1 £600
Total     £253,000
Table 1 - Annual demand, purchase prices and spend for the 7 part numbers

Increased competition has seriously reduced IM's profits and the current profit margin is
only 4%. In an effort to cut costs the company has turned its attention to inventory
management. Discussing the problem with colleagues in other industries they have heard
about various ways to improve including ABC analysis, the Economic Order Quantity formula
and the introduction of long-term purchase contracts with a supplier.
They have decided to employ a consultancy group to evaluate whether costs could be
reduced. You are part of the consultancy group chosen by IM and your team must assess
the inventory management policies employed by IM.

Page 1
4. Inventory Management Case Study

Tasks

1. Use Pareto analysis to complete Table 2 to group the 7 parts into 3 classifications based
on the following:
 Class A = 20% of parts and 80% of annual spend.
 Class B = 30% of parts and 15% of annual spend (80-95% cumulative spend)
 Class C = 50% of parts and 5% of annual spend (95-100% cumulative spend)

% Cum. no.
Part Annual Purchase Cum. % Cum. of part
numbe demand, price per Annual annual annual numbers ABC
r D part, P spend, D*P spend spend (1/7=14.3%) Class
CD84 2,000 £80 £160,000 £160,000 63.2% 14.3%  A
B28 600 £130 £78,000 £238,000 94.1%  28.57%  B
A34 1,000 £10 £10,000 £248,000 98%  42.86%   B
CD91 3,000 £1 £3,000 £251,000 99.22% 57.14%  C
B7 10 £100 £1,000 £252,000 99.6%   71.4%  C
G15 600 £1 £600 £252,600 99.8%   85.7% C 
G4 100 £4 £400 £253,000 100.0% 100.0% C 
Total     £253,000        
Table 2 - ABC classification

1. Complete Table 3, defining each item as either a runner, repeater or a stranger and
develop a policy for dealing with any stranger items.

Runner, repeater or stranger Which part numbers?

Runners CD91 ,CD84 , A34
Repeaters B28 G15 ,
Strangers B7, G4
Table 3 - Runner, repeater, stranger classification

2. The total inventory management costs of using reorder point control for the 7 parts are
given in Table 4. Orders have been placed for 6 months’ worth of each item using a
reorder point control technique. Placing an order in this manner costs £100, C, inventory
holding costs are estimated to be 30%, i = 0.3. The order cost of £100 represents the
cost of the administration time to conduct some online searches to review the market,
verify that the previous supplier is still offering the best deal and conduct some basic
credit checks on the supplier to ensure they remain financially viable. The £100 also
includes the cost of inspecting the parts on delivery by the stores person to check that

Page 2
4. Inventory Management Case Study

they are made to the correct quality standards and that the right quantity has been
delivered. The total inventory management costs are just over 8% of the annual spend.

Annual
inventory
Annual holding Total
Annual Order Purchase purchase cost, inventory
Part demand, quantity, Q = price per cost, Q/2*i*P management
number D D/2 part, P D/Q*C (i=0.3) cost
CD84 2,000 1,000 £80 £200 £12,000 £12,200
B28 600 300 £130 £200 £5,850 £6,050
A34 1,000 500 £10 £200 £750 £950
CD91 3,000 1,500 £1 £200 £225 £425
B7 10 5 £100 £200 £75 £275
G15 600 300 £1 £200 £45 £245
G4 100 50 £4 £200 £30 £230
Total       £1,400 £18,975 £20,375
Table 4 - Total inventory management costs for the 7 part numbers

Complete Table 5 to decide if using Economic Order Quantities combined with a Reorder
point Control System with a policy of zero safety stock will produce savings, and if so
how much.

2∗D∗C
Economic Order Quantity EOQ = √
i∗P

D∗C EOQ
Annual ordering costs = Annual inventory holding costs = ∗i∗P
EOQ 2

Annual
inventory
EOQ = Annual holding Total
Annual √(2*D*C)/(i*P Purchase purchase cost, inventory
Part demand, ) price per cost, Q/2*i*P management
number D C=£100, i=0.3 part, P D/Q*C i=0.3 cost
CD84 2,000 129 £80 £1,549 £1,549 £3,098
B28 600 56 £130 1081.1 1082.25 2163.
A34 1,000 259 £10 387.3 387.3
CD91 3,000 1415 £1 212.1 212.13
B7 10 8 £100 £122 £122 £244
G15 600 632 £1 £95 £95 £190
G4 100 129 £4 £77 £77 £154
EOQ       3523.4 3523.6
Original £1,400 £18,975 £20,375
Savings
Table 5 - EOQ and resulting total inventory management costs

Page 3
4. Inventory Management Case Study

3. Use the information from Table 4 and Table 5 to decide if a long-term purchase contract
offers better value for money for any of the 7 part numbers. To negotiate a long-term
contract a more in-depth search for potential suppliers is needed and a credit agency
will be used to conduct a more thorough financial audit. Extra time will be taken to
negotiate the contract with each supplier. The long-term agreement would result in the
supplier making weekly deliveries of parts direct to the production line on a Just-In-Time
basis. It is estimated that a long-term purchase contract for each part number will cost
£1,000 per year. The purchase order size will be reduced to 1 week and there would be
no inspection required on receipt of the delivery as the supplier will be trusted to deliver
the right quantity to the right quality standard. Assume that IM works for 50 weeks
during the year.

Hint – which part numbers have a total annual inventory management cost of more than
£1,000?

Annual
inventory
Purchas Annual holding Total
Annual EOQ or e price purchase cost, inventory
Part demand, weekly per part, cost, Q/2*i*P management
number D order P D/Q*C (i=0.3) cost
CD84 2,000 £80
B28 600 £130
A34 1,000 £10
CD91 3,000 £1
B7 10 £100
G15 600 £1
G4 100 £4
LT contract      
EOQ      
LT savings      
Table 6 - Introduction of a long-term purchase contract

4. If one or more long-term contracts were implemented this would reduce the workload
for the only stores person employed but a part-time role for a stores person would still
be required. Advise your client on what options IM could consider to make the best use
of the spare capacity created for the role of the stores person.

Hint – what could the stores person do in any spare time?

Page 4