2017 09 11 Quantitative Methods Fall 2017 HAUT Chapter 6 PPT FINAL STUDENT

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Textbook: pp. 203-254
Chapter 6: Inventory Control Models

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Learning Objectives
After completing this chapter, students will be able to:

• Understand the importance of inventory control.
• Understand the various types of inventory related
decisions.
• Use the economic order quantity (EOQ) to determine how
much to order.
• Compute the reorder point (ROP) in determining when to
order more inventory.
• Handle inventory problems that allow non-instantaneous
receipt.
• Handle inventory problems that allow quantity discounts.
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Learning Objectives
After completing this chapter, students will be able to:

• Understand the use of safety stock.
• Compute single period inventory quantities using marginal
analysis.
• Understand the importance of ABC analysis.
• Describe the use of material requirements planning in solving
dependent-demand inventory problems.
• Discuss just-in-time inventory concepts to reduce
inventory levels and costs.
• Discuss enterprise resource planning systems.
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Introduction (1 of 3)
• Inventory is an expensive and important asset
• Any stored resource used to satisfy a current or

future need
o Raw materials
o Work-in-process
o Finished goods
• Balance high and low inventory levels to minimise

costs
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• Lower inventory levels

• Can reduce costs
• May result in stockouts (frequent inventory outages)
and dissatisfied customers
• All organisations (banks, hospitals, universities …)

have some type of inventory planning and control
system
• We want to study “how organisations achieve their

objectives by supplying goods/services to their
customers”!
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Components of Inventory Planning and Control System

Planning Phase
manufactured or purchase
from third party
Feedback Loop
7
Importance of Inventory Control (1 of 3)
Five uses of inventory:

1. The decoupling function
2. Storing resources
3. Irregular supply and demand
4. Quantity discounts
5. Avoiding stockouts and shortages
• Decoupling Function
o Reduces delays and improves efficiency
o A buffer between stages
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• Storing resources
o Seasonal products stored to satisfy off-season
demand
o Materials stored as raw materials, work-in-process,
or finished goods
o Labour can be stored as a component of partially
completed subassemblies
• Irregular supply and demand

o Not constant over time
o Inventory used to buffer the variability
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• Quantity discounts
o Lower prices may be available for larger orders
o Higher storage and holding costs (spoilage,
damaged stock, theft, insurance…)
o By investing in more inventory, you will have less
cash to invest elsewhere!
• Avoiding stockouts and shortages
o Stockouts may result in lost sales
o Dissatisfied customers may choose to buy from
another supplier
o Loss of goodwill
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Inventory Decisions
Economic Order Quantity (EOQ)
Reorder Point (ROP)
Two fundamental decisions:

1. How much to order
2. When to order
Major objective is to minimise total inventory costs:

1. Cost of the items (purchase cost or material cost)
2. Cost of ordering (often involves personnel time)
3. Cost of carrying, or holding, inventory (taxes, insurance,
cost of capital…)
4. Cost of stockouts (lost sales and goodwill that result from
not having the items available for the customers)
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Inventory Cost Factors (1 of 2)

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Inventory Cost Factors (2 of 2)
• Ordering costs are generally independent of order

quantity
o Many involve personnel time
o The amount of work is the same no matter the size
of the order
• Holding costs generally vary with the amount of
inventory or order size
o Labour, space, and other costs increase with order
size
o Cost of items purchased can vary with quantity
discounts
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Economic Order Quantity (EOQ) (1 of 2)
• Economic order quantity (EOQ) model

o One of the oldest and most commonly known
inventory control techniques
o Easy to use
o Several important assumptions  limits the
applicability of this model!
• Objective is to minimise total cost of inventory

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*Lead time = the time between the placement of the order and
the receipt of the order!
Economic Order Quantity (EOQ) (2 of 2)
Assumptions:
1. Demand is known and constant over time
2. Lead time* is known and constant
3. Receipt of inventory is instantaneous (arrives in one batch, at one
point in time!)
4. Purchase cost (= cost of the inventory!) per unit is constant
throughout the year (Quantity discounts are not possible!)
5. The only variable costs are ordering cost and holding or
carrying cost, and these are constant throughout the year
6. Orders are placed so that stockouts or shortages are avoided
completely
 When these assumptions are not met – adjustments to the EOQ
must be made!
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If this amount is 1,000 bananas, all 1,000 bananas arrive at one time when
an order is received. The inventory level jumps from 0 to 1,000 bananas (Q).
Inventory Usage Over Time
Demand is constant over time 

inventory drops at a uniform rate! e.g. 1,000 bananas
A new order is placed so that when the inventory level reaches 0, the new order
is received and the inventory level again jumps to Q units (vertical line)!
16
𝑄
Average Inventory Level =
2
Inventory Costs in the EOQ Situation

Based on our assumptions - if we minimise the sum of the
ordering and carrying costs we are minimising the total costs!
• Annual ordering cost is number of orders per year times cost of
placing each order
• Annual carrying cost is the average inventory times carrying cost
per unit per year
Computing Average Inventory:
Blank Blank INVENTORY LEVEL Blank
DAY BEGINNING ENDING AVERAGE

April 1 (order received) 10 8 9
April 2 8 6 7
April 3 6 4 5
April 4 4 2 3
April 5 2 0 1
Maximum level April 1 = 10 units Total of daily averages = 9 + 7 + 5 + 3 + 1 = 25

Number of days = 5 Average inventory level = 25÷5 = 5 units
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Inventory Costs in the EOQ Situation (1 of 3)
Q = number of pieces to order

EOQ = Q* = optimal number of pieces to order
D = annual demand in units for the inventory item
Co = ordering cost of each order
Ch = holding or carrying cost per unit per year
Annual  Number of 
   Ordering cost 
Ordering   orders placed    
 per year   per order 
cost  
 
 Annual demand   Ordering cost  D
    Co
 Number of units   per order  Q
 in each order 
 
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Q = number of pieces to order

EOQ = Q* = optimal number of pieces to order
Annual  Carrying cost 
 Average   
holding      per unit 
 inventory   
cost  per year 
Order quantity
  (Carrying cost per unit per year)
2
Q
 Ch
2
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Total Cost as a Function of Order Quantity:

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Finding the EOQ (1 of 2)
• When the EOQ assumptions are met, total cost is

minimised when:
Annual ordering cost = Annual holding cost
D Q
Co  Ch
Q 2
Solving for Q: Q 2Ch  2DCo
2DCo
Q2 
Ch
2DCo
Q
Ch
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Finding the EOQ (2 of 2)
Equation summary:
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Q = number of pieces to order; D = annual demand in units for the
inventory item; Co = ordering cost of each order; Ch = holding or carrying
cost per unit per year
Sumco Pump Company (1 of 5)
• Sells pump housings to other companies

• Reduce inventory costs by finding optimal order quantity
Annual demand = 1,000 units

Ordering cost = $10 per order
Average carrying cost per unit per year = $0.50
2DCo 2(1,000)(10)
Q *
  40,000  200 units
Ch 0.50 optimal number of
units per order
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Q = number of pieces to order; D = annual demand in units for the
inventory item; Co = ordering cost of each order; Ch = holding or carrying
cost per unit per year
The total annual inventory cost is the sum of the

ordering costs and the carrying costs:
D Q
TC  Co  Ch
Q 2
1,000 200
 (10)  (0.5)
200 2
 $50 + $50  $100
Number of orders per year = (D÷Q) = 5

Average inventory (Q÷2) = 100
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Purchase Cost of Inventory Items (1 of 2)
• The total inventory cost can be written to include the

cost of purchased items
o Annual purchase cost is constant at D × C no matter
the order policy, where
C is the purchase cost per unit
D is the annual demand in units
• The average dollar level of inventory
(CQ )
Average dollar level 
2
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C = unit price or cost of an inventory item
Purchase Cost of Inventory Items (2 of 2)
• Inventory carrying cost is often expressed as an

annual percentage of the unit cost or price of the
inventory
• When this is the case, a new variable is introduced:
I = (Annual inventory holding charge as a percentage of

unit price or cost)
Cost of storing inventory for one year = Ch = IC
Thus
2DCo
Q *
IC
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Sensitivity Analysis with the EOQ Model (1 of 2)
• The EOQ model assumes all input values are know

with certainty and fixed over time!
• Values are estimated or may change
• Sensitivity analysis determines the effects of these
changes
2DCo
EOQ  Q *
Ch
• Because the EOQ is a square root, changes in the
inputs (D; Co; Ch) result in relatively minor changes
in the order quantity
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Sensitivity Analysis with the EOQ Model (2 of 2)

2DCo
EOQ  Q 
*
Sumco Pump example: Ch
2(1,000)(10)
EOQ   200 units
0.50
If we increase Co from $10 to $40
2(1,000)(40)
EOQ   400 units
0.50
In general, the EOQ changes by the square root of the

change to any of the inputs!
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Reorder Point: Determining When To Order
• Next decision is “When to order”

• The time between placing an order and its receipt is
called the lead time (L) or delivery time
• “On hand” and “on order” inventory must be
available to meet demand during lead  the total of
these is called “inventory position”
• Generally the “when to order” decision is usually
expressed in terms of a reorder point (ROP; inventory
position at which an order should be placed)
ROP  (Demand per day)  (Lead time for a new order in days)
 d L
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d = Demand per day
L = Lead time for a new order in days
Procomp’s Computer Chips (1 of 2)
D = Annual demand = 8,000

d = Daily demand = 40 units
L = Delivery in 3 working days
ROP  d  L  40 units per day  3 days

 120 units
 An order for the EOQ (400) is placed when the inventory

reaches 120 units
 The order arrives 3 days later just as the inventory is
depleted to 0!
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Time between placing an order and its receipt is called lead time (L)
Q = 400
Reorder Point Graphs d = 40 units
ROP = d * L = 120
ROP < Q 120 < 400
120 = 120 + 0
400  New order placed
when inventory = 120
120
3 days
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Annual demand = 8,000

Daily demand = 40 units
Delivery in three twelve working days
Suppose the lead time for Procomp Computer Chips was

12 days instead of 3 days. How would this affect the
“reorder point”?
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Annual demand = 8,000

Daily demand = 40 units
Delivery in three twelve working days
 New order placed when inventory = 80 and one order is

in transit!
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Q = 400
Reorder Point Graphs d = 40 units
ROP = d * L = 480
ROP > Q 480 > 400
480 = 80 + 400
400  New order placed
when inventory = 80
and one order is in
transit!
80
12 days
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Reorder Point Graphs
400 Q = 400
d = 40 units
ROP = d * L = 120
ROP < Q 120 < 400
3 days
400 Q = 400
d = 40 units
ROP = d * L = 480
ROP < Q 480 < 400
12 days
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EOQ Without Instantaneous Receipt
• When a firm receives its inventory over a period of

time, a new model is needed that does not require the
“instantaneous inventory receipt assumption”!
• This new model is applicable when inventory

continuously flows or builds up over a period of
time after an order has been placed or when units
are produced and sold simultaneously.
 Under these circumstances, the daily demand rate (d)

must be taken into account.
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EOQ Without Instantaneous Receipt
• Production run model: This graph shows inventory

levels as a function of time. Model especially suited to
the production environment!
Inventory Control and the Production Process:
Units are produced and sold simultaneously!

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Annual Carrying Cost for Production Run

Model (1 of 3)
• In the production process, instead of having an
ordering cost, there will be a setup cost
 Cost of setting up the production facility to manufacture
the desired product!
• Salaries and wages of employees responsible for

setting up the equipment
• Engineering and design costs of making the setup
• Paperwork, supplies, utilities …
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Model (1 of 3)
• So how can we derive the optimal production quantity?
• We need to set our “setup costs” equal to “carrying

costs” and then solve for the “order quantity”.
• Let’s start by developing the expression for carrying

cost!
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Model (1 of 3)
• As with the EOQ model, the carrying costs of the
production run model are based on the average
inventory, and the average inventory is one-half the
maximum inventory level.
Model variables:
Q = number of pieces per order (production run)
Cs = setup cost
p = daily production rate
d = daily demand rate
t = length of production run in days
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p = daily production rate
d = daily demand rate
t = length of production run in days

Model (2 of 3)
• Maximum inventory level =
(Total produced during the production run)
− (Total used during production run) =
= (Daily production rate)(Number of days production)
− (Daily demand)(Number of days production) =
= (pt) − (dt)
Q
Since Total produced = Q = pt and t =
p
Q Q  d
Maximum inventory level = pt – dt  p – d  Q  1– 
p p  p
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Model (3 of 3)
Average inventory is one-half the maximum:
Q d
Average inventory   1– 
2 p
and
Q d
Annual holding cost   1–  Ch
2 p
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Q = number of orders or production run; Cs = setup cost;
D = annual demand rate
Annual Setup Cost for Production Run Model
When a product is produced over time, setup cost

replaces ordering cost:
and
Both of these are independent of the size of the order

and the size of the production run! This cost is simply
the number of orders (or production runs) times the
ordering cost (setup cost).
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Determining the Optimal Production Quantity
• Set setup costs equal to holding costs and solve for

the optimal order quantity
o Annual holding cost = Annual setup cost
Solving for Q, we get the optimal production quantity Q*

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Production Run Model
Equation summary:
Q d
Annual holding cost  1 –  Ch
2 p
D
Annual setup cost  Cs
Q
2DCs
Optimal production quantity Q 
*
 d
Ch  1 – 
 p
Q d
Annual holding cost   1 –  Ch 46
2 p
D
Q
2DCs
Brown Manufacturing
Optimal production
(1 of 4) quantity Q  *
 d
Ch  1 – 
 p
Brown Manufacturing produces commercial refrigeration units in
batches. The firm’s estimated demand for the year is 10,000
units. It costs about $100 to set up the manufacturing process,
and the carrying cost is about 50 cents per unit per year. When
the production process has been set up, 80 refrigeration units
can be manufactured daily. The demand during the production
period has traditionally been 60 units each day. Brown operates
its refrigeration unit production area 167 days per year.
How many units should Brown produce in each batch?

How long should the production part of the cycle last?
Q d
Annual holding cost   1 –  Ch 47
2 p
D
Q
2DCs
Brown Manufacturing
Optimal production
(1 of 4) quantity Q  *
 d
Ch  1 – 
 p
Produces commercial refrigeration units in batches:
Annual demand = D = 10,000 units
Setup cost = Cs = $100
Carrying cost = Ch = $0.50 per unit per year
Daily production rate = p = 80 units daily
Daily demand rate = d = 60 units daily
1. How many units should Brown produce in each batch?
2. How long should the production part of the cycle last?

48
Brown Manufacturing (2 of 4)
1.
2DCs
Q* 
 d
Ch  1 – 
 p
2  10,000  100
Q* 
 60 
0.5  1 –
 80 
2,000,000
  16,000,000
 
0.5 1
4
 4,000 units
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Annual demand = D = 10,000 units
Setup cost = Cs = $100
Carrying cost = Ch = $0.50 per unit per year
Daily production rate = p = 80 units daily
Daily demand rate = d = 60 units daily
1. 2. Quantity produced
in each batch
2DCs
Q* 
 d Daily production
Ch  1 –  rate
 p
2  10,000  100
Q* 
 60 
0.5  1 –
 80 
2,000,000
  16,000,000
0.5 1
4  
 4,000 units
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If Q* = 4,000 units and we know that 80 units can be produced

daily, the length of each production cycle will be days. When
Brown decides to produce refrigeration units, the equipment will
be set up to manufacture the units for a 50-day time span.
The number of production runs per year will be

D/Q = 10,000/4,000 = 2.5.
 The average number of production runs per year is 2.5.

 There will be 3 production runs in one year with some inventory
carried to the next year
 Therefore only 2 production runs are needed in the second year.
51
Quantity Discount Models (1 of 7)
In developing the EOQ model, we assumed that quantity

discounts were not available.
 However, many companies do offer quantity discounts.

 If such a discount is possible, but all of the other EOQ
assumptions are met, it is possible to find the quantity
that minimises the total inventory cost by using the EOQ
model and making some adjustments!
52
Q = number of orders or production run
• When quantity discounts are available the basic EOQ

model is adjusted by adding in the “purchase or
materials cost” (Logic  they change based on order
quantity!):
Total cost = Material cost + Ordering cost + Holding cost

D Q
Total cost  DC + Co + Ch
Q 2
Where D = annual demand in units
C = cost per unit
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Holding cost per unit is based on cost per unit (C), so

Ch = IC
Where I = holding cost as a percentage of the unit cost (C)
54
You are now offered following discounts by your supplier:
Will buying at the lowest unit cost

result in lowest total cost?
Overall our objective is to minimise the total cost!

55
• Overall our objective is to minimise the total cost.

• Because the unit cost (4.75) for the third discount is
lowest, we might be tempted to order 2,000 units or more
to take advantage of the lower material cost.
• Placing an order for that quantity with the greatest discount

cost might not minimise the total inventory cost.
• As the discount quantity goes up, the material cost goes
down, but the carrying cost increases because the orders
are large.
• Key trade-off when considering quantity discounts is
between the reduced material cost and the increased
carrying cost!
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Total Cost (TC) Curve for the Quantity Discount Model

57
Steps in the process:

2DCo
1. For each discount price (C), compute EOQ 
IC
2. If EOQ < Minimum for discount, adjust the quantity to Q

= Minimum for discount
3. For each EOQ or adjusted Q, compute

D Q
Total cost  DC + Co + Ch
Q 2
4. Choose the lowest-cost quantity
58
Brass Department Store (1 of 6)
Brass Department Store stocks toy race cars. Recently,

the store was given a quantity discount schedule for the
cars. The ordering cost is $49 per order, the annual
demand is 5,000 race cars, and the inventory carrying
charge as a percentage of cost, I, is 20%.
Discount schedule:
What order quantity will minimise the total inventory cost?

59
Toy race cars:

Quantity discounts available
Step 1 – Compute EOQs for each discount

60
Total Cost (TC) Curve for the Quantity Discount Model

61
Step 2 – If EOQ < Minimum for discount, adjust the

quantity to Q = Minimum for discount
2DCo
EOQ 
IC
62
Step 2 – If EOQ < Minimum for discount, adjust the

quantity to Q = Minimum for discount
• The EOQ for discount 1 is allowable

• The EOQs for discounts 2 and 3 are outside the
allowable range, adjust to the possible quantity closest
to the EOQ
Q1 = 700
Q2 = 1,000
Q3 = 2,000
63
Step 3 – Compute total cost for each quantity
Total Cost Computations for Brass Department Store:
Step 4 – Choose the alternative with the lowest total cost

64
Step 3 – Compute total cost for each quantity
Total Cost Computations for Brass Department Store:
Step 4 – Choose the alternative with the lowest total cost

65
Reorder Point Graphs

• When the EOQ assumptions
are met, it is possible to
400
schedule orders to arrive so
that stockouts are completely
avoided!
• If the demand or the lead
time is uncertain, the exact
3 days
demand during the lead time
(ROP in the EOQ situation)
400 will not be known with
certainty!
• Therefore, to prevent
stockouts, it is necessary to
carry additional inventory
called safety stock.
12 days
66
Use of Safety Stock (1 of 4)
• If demand or the lead time are uncertain, the exact

ROP will not be known with certainty!
• To prevent stockouts, it is necessary to carry additional
inventory called safety stock.
• Can be implemented by adjusting the Reorder Point
(ROP)
ROP = (Average demand during lead time) + Safety stock

ROP = (Average demand during lead time) + SS
where SS = safety stock

67
• When demand is
unusually high during
the lead time, you dip into
the safety stock instead of
encountering a stockout!
• The main purpose of

safety stock is to avoid
stockouts when the
demand is higher than
expected.
68
• Objective is to choose a safety stock amount the

minimises total holding and stockout costs
• If variation in demand and holding and stockout costs

are known, payoff/cost tables could be used to
determine safety stock
• More general approach is to choose a desired service

level based on satisfying customer demand
69
• Set safety stock to achieve a desired service level
Service level = 1 − Probability of a stockout

or
Probability of a stockout = 1 − Service level
70
Safety Stock with the Normal Distribution
ROP = (Average demand during lead time) + ZσdLT
where
Z = number of standard deviations for a given service level

σdLT = standard deviation of demand during the lead time
Thus Safety stock = ZσdLT

71
Hinsdale Company (1 of 8) --- Safety Stock and

the Normal Distribution
• Item A3378 has normally distributed demand during
lead time
Mean = 350 units, standard deviation = 10
• Stockouts should occur only 5% of the time
μ = Mean demand = 350
σdLT = Standard deviation = 10
X= Mean demand + Safety stock
SS= Safety stock = X − μ = Zσ
X 
Z

72
Hinsdale Company (2 of 8)
X  SS
From Appendix A we find Z = 1.65  
 
ROP = (Average demand during lead time) + ZsdLT
= 350 + 1.65(10)
= 350 + 16.5 = 366.5 units (or about 367 units)
73
Calculating Lead Time Demand and Standard

Deviation (1 of 4)
Three situations to consider:
o Demand is variable but lead time is constant
o Demand is constant but lead time is variable
o Both demand and lead time are variable
74

Deviation (2 of 4)
1. Demand is variable but lead time is constant

ROP  dL  Z  d L 
where d  average daily demand
 d  standard deviation of daily demand
L  lead time in days
75

Deviation (3 of 4)
2. Demand is constant but lead time is variable
ROP  dL  Z  d L 
where L  average lead time

 L  standard deviation of lead time
d  daily demand
76

Deviation (4 of 4)
3. Both demand and lead time are variable
ROP  dL  Z L d2  d 2 L2
• The most general case

• Can be simplified to the earlier equations
77
• Determine safety stock for three other items

• For SKU F5402, d = 15,  d = 3, L = 4
• Desired service level = 97%
o For a 97% service level, Z = 1.88

ROP  dL  Z  d L 
 15(4) + 1.88(3 4 )  15(4) + 1.88(6)
 60 + 11.28  71.28
78
• For SKU B7319, d = 25, L = 6,  L = 3

ROP  dL  Z  d L 
 25(6) + 2.05(25)(3)  150 + 2.05(75)
 150 + 153.75  303.75
79
• For SKU F9004, d = 20,  d = 4, L = 5,  L = 2

ROP  dL  Z L d2  d 2 L2
 (20)(5) + 1.55 5(4)2 + (20)2 (2)2
 100 + 1.55 1680
 100 + 1.55(40.99)  100 + 63.53  163.53
80
Service Levels, Safety Stock, and Holding

Costs
• As service levels increase
o Safety stock increases at an increasing rate
• As safety stock increases

o Annual holding costs increase
81
Safety Stock for SKU A3378 at Different Service Levels:

82
Calculating Annual Holding Cost with Safety

Stock
Under standard assumptions of EOQ
o Average inventory = Q÷2
o Annual holding cost = (Q÷2)Ch
With safety stock
 Holding cost of 
 Total annual     Holding cost of 
  regular   
 holding cost     safety stock 
 inventory 
Q
THC  Ch  (SS)Ch where THC = total annual holding cost
2
Q = order quantity
Ch = holding cost per unit per year
SS = safety stock
83
Service Level Versus Annual Carrying Costs:

84
A prudent manager should spend more time managing those items
representing the greatest dollar inventory cost because this is where
the greatest potential savings are.
ABC Analysis (1 of 5)
• The purpose is to divide the inventory into three

groups (A, B, and C) based on the overall inventory
value of the items
• Group A items account for the major portion of
inventory costs (high price!)
o Typically 70% of the dollar value but only 10% of the
quantity of items
o Great care should be taken in forecasting the demand
and developing good inventory management policies for
this group!
o Mistakes can be expensive!
85
• Group B items are more moderately priced

o Items represent about 20% of the company’s
business in dollars, and about 20% of the items in
inventory
o Not appropriate to spend as much time developing
optimal inventory policies for this group as with the A
group since inventory costs are much lower!
o Moderate levels of control!
86
• Group C items are very low cost but high volume

o These items may constitute only 10% of the company’s
business in dollars, but they may consist of 70% of the
items in inventory.
o It is not cost effective to spend a lot of time managing
these items!
o For the group C items, the company should develop a
very simple inventory policy, and this may include a
relatively large safety stock.
o Since the items cost very little, the holding cost
associated with a large safety stock will also be very
low.
87
• More care should be taken in determining the safety

stock with the higher priced group B items.
• For the very expensive group A items, the cost of
carrying the inventory is so high, it is beneficial to
carefully analyse the demand for these so that safety
stock is at an appropriate level!
• Otherwise, the company may have exceedingly high
holding costs for the group A items.
88
Summary of ABC Analysis:

89
Homework --- Chapter 6
• End of chapter self-test 1-14

(pp. 243-244)
Compile all answers into one
document and submit at the
beginning of the next lecture!
On the top of the document,
write your Pinyin-Name and
Student ID.
• Please read Chapter 11!

2017 09 11 Quantitative Methods Fall 2017 HAUT Chapter 6 PPT FINAL STUDENT

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1

Textbook: pp. 203-254

Chapter 6: Inventory Control Models

After completing this chapter, students will be able to:

After completing this chapter, students will be able to:

• Inventory is an expensive and important asset

• Any stored resource used to satisfy a current or

• Balance high and low inventory levels to minimise

• Lower inventory levels

• All organisations (banks, hospitals, universities …)

• We want to study “how organisations achieve their

Components of Inventory Planning and Control System

Importance of Inventory Control (1 of 3)

Five uses of inventory:

Importance of Inventory Control (2 of 3)

• Irregular supply and demand

Importance of Inventory Control (3 of 3)

Two fundamental decisions:

Major objective is to minimise total inventory costs:

Inventory Cost Factors (1 of 2)

Inventory Cost Factors (2 of 2)

• Ordering costs are generally independent of order

Economic Order Quantity (EOQ) (1 of 2)

• Economic order quantity (EOQ) model

• Objective is to minimise total cost of inventory

Economic Order Quantity (EOQ) (2 of 2)

Inventory Usage Over Time

Demand is constant over time 

Inventory Costs in the EOQ Situation

DAY BEGINNING ENDING AVERAGE

Maximum level April 1 = 10 units Total of daily averages = 9 + 7 + 5 + 3 + 1 = 25

Inventory Costs in the EOQ Situation (1 of 3)

Q = number of pieces to order

Inventory Costs in the EOQ Situation (2 of 3)

Q = number of pieces to order

Inventory Costs in the EOQ Situation (3 of 3)

Total Cost as a Function of Order Quantity:

Finding the EOQ (1 of 2)

• When the EOQ assumptions are met, total cost is

Finding the EOQ (2 of 2)

Sumco Pump Company (1 of 5)

• Sells pump housings to other companies

Annual demand = 1,000 units

Sumco Pump Company (2 of 5)

The total annual inventory cost is the sum of the

Number of orders per year = (D÷Q) = 5

Sumco Pump Company (3 of 5)

Purchase Cost of Inventory Items (1 of 2)

• The total inventory cost can be written to include the

Purchase Cost of Inventory Items (2 of 2)

• Inventory carrying cost is often expressed as an

I = (Annual inventory holding charge as a percentage of

Sensitivity Analysis with the EOQ Model (1 of 2)

• The EOQ model assumes all input values are know

Sensitivity Analysis with the EOQ Model (2 of 2)

Sumco Pump example: Ch

If we increase Co from $10 to $40

In general, the EOQ changes by the square root of the

Reorder Point: Determining When To Order

• Next decision is “When to order”

Procomp’s Computer Chips (1 of 2)

D = Annual demand = 8,000

ROP  d  L  40 units per day  3 days

 An order for the EOQ (400) is placed when the inventory