,B :rn:1i ~Tl 6

~~~~~~--------------
Inventory Control

6.1 INTRODUCTION
Inventory is a stock of items kept on hand to meet the fluctuating demand. A certain level of
inventory is maintained that will help meet the anticipa ted demand. If demand is not known
with certainty, safety stocks are kept on hand. Additional stocks are sometimes used to meet
seasonal or cyclical' demand. So1netimes, large amounts of items are purchased and stored to take
advantage of discounts.
In an organization, normally, four types of inventory are used as discussed below:

I. Raw materials and parts: These include all raw materials, components and assemblies
used in the manufacture of a product.
2. Consumables and spares: These may include materials required for maintenance and
day-to-day operations.
3. Work-in-progress inventory: These are items under various stages of production not yet
converted as finished goods. ·
4. Finished products: These are finished goods not yet sold or put into use.

6.1.1 Objectives of Inventory Control

The following are the objectives of inventory control:
I. To keep the investment in inventory to the minimum.
2. T0 . . .
mm_irrnze idle time by avoiding stock-outs and shortages.
3. To avoid carrying cost.
4
· To imp_rove customer satisfaction level with lesser inventory.
5. To avoid obsolescence of inventory.

6.1.2 Functions of Inventory

The following th f.'. •
are e iunct1ons of inventory:
I. !1
0
meet anticipated demand: The demand cannot be estimated with full accuracy~ Thi.:rc
s .always· cha nee O f mcreasmg
· . or decreasing the demand due to vano · us factors.1
.
o ll"\I.) \:·t
· d
this uncertai 11 t 111 . d d mand, inventory
_ .
1cqu1rcd.
Y emand variation or to meet the anticipate e I ).-;
l
i

Ir
'
I
2. To smooth production requirement . Th
Inventory Control
109

ll
. l d. s. ere may be a sudd b
mvo ve m production. In this situation . . en reakdown of the ma h'
· h , an mventory is • d c me
contmue t e production without any disruption require at each workstation to
3. To decouple operations: In case of product . · .
I·
postpone the product differentiation tow· d nuthx or multi-product production, we try to
r:
'•
h d d ar s e end of the prod f
t e em~n of a customized product can be fulfilled ver _uc ion_ ~rocess, so that
product 1s produced and at the end of d t· · h Y easily. Imtially, a generic
d fi pro uc 10n· t ese products a t d .
1orman nallycustomizedasperdemand Th '. f . _res ore m generic
is known as decoupling point. · e pomt O cu stomization or differentiation
4. To protect against stock-outs· A safety or reserve stock. .
or delay in the replenishmen~ of inventory. In case of :equ1red todme~t t~e s~ortages
d d f th . . r ages, pro uct10n 1s disrupted
or eman o e customer remams unfulfilled which lead tO · ·
1 1 Th · . . · s poor customer satisfaction
eve . us, mventory 1s reqmred to protect against stock-out.
5. To help he~ge agai~st price increases: The price of a product may increase in near
future. In this case, mvento~y is _required to help hedge against price increases.
6. To take advantage of quantity discounts: Inventory provides economies of scale. If we
p~oduce or purchase the items in bulk or batch, there may be provision of quantity
discount.

6.1.3 Understocking and Overstocking

Understocking of inventory results in cost incurred when an item is out of stock. It includes the
cost oflost production during the period of stock-out and the extra cost per unit which might have
lo be paid for an emergency purchase. Also, sometimes the company may incur an intangible cost
like opportunity cost and poor reputation in the market due to undcrstocking.
Overstocking results in the cost incurred due to obsolescence and pilferage, and the
opportunity cost in the form of capital invested in inventory that could be invested for some
olhcr purposes.

6.2 CLASSIFICATIONS OF INVENTORY

l hc methods used to analyse the items in inventory are discussed in the following subsections.
Always Better Control Analysis
As is evident from the above heading, 'ABC' connotes 'Always Better Control.' The basis of
umdysing the annual consumption cost of the inventory items is the principle 'Vital Few - Trivial
M11 11y,' and the criterion used he.re is the money spent, not the quantity consumed, Figure 6.1
r.lHiws the value and corresponding units in inventory. A-class items are very impo~ant and
liitvc value up to 70 per cent, but their inventory used is up to 10 per ~e~t. B-class item~ are
L1J' 111odcrate importance and have a value up to 20 per cent and also the1r mventory used ts up
h .• ,W per cent. C-class items are of lower importance and have a value up to 10 per cent, but
1l11\·111o ry up to 70 per cent.
r 110
Industrial En ineering and Management

Class c
100
90
(IJ
::I 80
ti, •
> 70
en
a:
-0
(IJ
50
60

g' 40
.....
ai 30
....(IJ 20
(..)

a..
10
0
10 20 30 40 50 60 70 80 90 100
Percentage of SKUs

Figure 6-1: ABC analysis

Vital, Essential and Desirable Analysis

The inventory items, when subjected to analysis based on their criticality, can be classified into
vital, essential and desirable (YEO) items. This analysis is termed as VED analysis.
1. Vital: Items without which production or a system comes to a standstill. The non-
availability of these items cannot be tolerated.
2. Essential: Items whose non-availability can be tolerated for 2-3 days because similar or
alternative items are available. ·
3. Desirable: Items whose non-availability can be tolerated for a long period.
Although. the proportion of vital ' essential and desirable items varies ·tfrom company
l 1·terns to company
are 10 per cent,
depending
: . on the type and quantity of workload,. on an average f vihat0tal inventory
. ava1-1.able.
essential items are 40 per cent and desirable items are 50 per cent o t e

Fast, Slow-Moving and Non-moving Analysis . . h rate of consumpt'ion of

Fast, slow-moving and non-moving (FSN) analysis is based on t
. . l . k ·ng proper eves
t
dnon-moving items.
inventory items. The items can be classified as fast-moving, slow-movling of their inventory by
..
An 'd'
un derstandmg of the movement of items he ps m eept .
. . . l 1·1cy is concerne
d with decisions about
d th
dec1 mg a .rational policy or reordering. Here,. rat10na po .
f h 1·t ms This me
thod is base on e fact
reorder pomt and order size as per consumpt10n o t e e ·th
that some stock items have a much higher annual usage than ers. °
Scarce, Difficult, or Easy Analysis . ould be scare~, difficult
. . · , ·1abihty that c 51·5 of difficulty
Th- c cl ass1ficat10n of inventory items is based on thetr avat .d don the ba or
· are dec1 e
01 easy (SOE). The importance anq. storage of an item

ease of its availability.

a
 I
I
Inventory Control
111

I.
S refers to scarce items, especially im orted
short supply. p ones a nd those which are very much in
2. D refers to difficult items which are proc bl .
· • ura e In the market b t ·
example, items which have to come firom f: ff . . , u not easily available. For
• ar o c1t1es or th ·
for them m the market or their.good quality . ere ts not much competition
1
3. E refers to easy items. These a.re mostly lo P tes ar~ difficult to get or procure.
ca I ems which are easily available.

6.3 INVENTORY COSTS

The following costs are involved in keeping inventory:

l. Inventory carrying costs: Costs of holding items in storage. Important features of these
costs are as follows:
(a). These costs vary with the level of inventory and sometimes with the length oftim
the inventory is held. e
(b) These include facility operating costs, record-keeping, interest, etc.
( c) These are assigned on per unit basis per time period, or as percentage of average
; ,,I inventory value (usually estimated as 10 to 40 per cent).
2. Ordering costs: Costs ofreplenishing the stock ofinventory. Important features of these
i costs are as follows:
1 (a) These costs are expressed as rupees per order, independent of the order size.
i
(b) These costs vary with the number of orders made.
(c) These costs include purchase orders, shipping, handling, in~pection, etc.
3. Shortage (stock-out) costs: Costs associated with insufficient inventory. Important
features of these costs are as follows: .
(a) These costs result in permanent loss of sales and profits for items not on hand.
(b) Sometimes, penalties are involved; if the customer is internal, work delays could
result, i.e., if the consumer is ready to bear the small delay the supplier may be
imposed with penalty due to shortages to minimize the loss.
The relationship between the ordering cost, inventory carrying cost and total cost is shown in
hgure 6.2.

Total cost

Lot size (Q)

Figure 6-2: Opti mization of inventory costs

r 112 Industrial Engineering and Management

6.4 CONTINUOUS AND PERIODIC INVENTORY Review SY

The inventory review system is concerned with the volume of items in t k . STE Ms
There are two types of review systems: continuous review and periosd?c a~d Its replenishment
.
review . placed for the same constant amount whe1c review
system, an order Is . · In a continuous.
·fi d 1 1 I · ct· ·
a spec1 e eve . n a peno IC review system, an order is placed for a n inventory
.b decreases to
specified period of time. · vana le amount over a
In the continuous review system, the following process is followed.
1.
The inventory level is reviewed continuously.
2.
Whenever inventory decreases to a predetermined level the reoY<,J .
'
is placed for a.fixed amount to replenish the stock. The fixed uer isP0temt' an
amount d order
economic oruer quantity
• ,,1 • (EOQ) , w ose magmtu e 1s set at a level that m·rme
h . d . · . as the
h
.
total mventory . ordenng
carrymg, . and sh(!rtage costs. zmmzzes t e

Because afconUnua/ reviewing, the management is always aware of the status of the inventory
level and critical parts, but this system is relatively expensive to maintain.
In the periodic review system, the following process is followed:

1. Inventory on ha_nd is counted at specific time intervals and an order placed that brings
inventory up to a specified level. Inventory is not monitored between counts; therefore,
the system is less costly to track and keep account of inventory. The system results in
less direct control of the management and thus generally higher levels of inventory to
guard against stock-outs.
2. A new order quantity each time an order is placed. It is used in smallerretail stores, drug
stores, grocery stores and offices.

6.5 ECONOMIC ORDER QUANTITY

.
The EOQ and formula were originally presented by Ford Whitman H · (1913)
. ams . . thein his
quantity
paper
' Factory, The Magazine of Management'. The EOQ, or the economic lot ~ized, is . g the EOQ
ordered when inventory decreases to the reorder pomt.
. The amoun t is
. deternune
. h tusm ill minimize
model. The purpose of the EOQ model is to determine the optimal order size I a w
the total inventory costs.

Assumptions of the EOQ Model

The following are the assumptions of the EOQ model :
1. The demand rate is constant and is known with certainty.
2.
3. No constraints are placed on the size of each lot. h fixed cost per lot for
The only two relevant costs are the mventory
· h o !ding cost and t e .

4. ordering or set-up. f d .. ns for other items.

. .
Dec1s1ons .
for one item can be ma d e m
· d epen dently. o ec1s10 ·
5.
The lead time is constant and is known with certamty.
 ltW!!l}\UtYCot1lrol 11j

. we will discuss the following four EOQ inventory ll lOde lK:

. secuon,
IntlllS ic EOQ model .
1. sas del without instantaneous receipt
EOQmO
2. EOQ model with short~ges .
!: EOQ model with quantity discount

sasic eoa Model

6Th•
.. 1
5 following are the assumptions of the basic EOQ model:
Demand is known with certainty and is relatively constant over time.
1._ No shortages are allowed.
23. Lead time for the receipt of orders is constant.
4. The entire order quantity is received at once and instantaneously.
In Figure 6.3, Q is maximum inventory level. At the beginning of the cycle, the inventory level
is Q and at the end of the cycle it becomes zero. Therefore, the average inventory level is Q/2.
The reorder point depends on the consumption rate and 1ead time. At reorder point, the inventory
should be able to meet the need during the lead time of replenishment/supply, i.e . reorder point
is equal to lead time multiplied by consumption rate. Lead time is the time interval between the
point of order placement and order receipt. In the basic model ofEOQ, the supply is instantaneous
demand is constant throughout the year.
The inventory carrying cost is usually expressed on a per unit basis of time, traditionally one
year. The inventory carrying cost is calculated by multiplying inventory cost per unit per year
to average inventory size. Ordering cost per year can be calculated by multiplying the ordering
cost _per order to the number of orders per year. The derivation of expression for EOQ (Q") can

be given below as:

Demand
Order rate

I
quantity, Q
t ai
>
c'.:'
.....C
0
Q/2 - - - - -. - - - - - - - ----- ------ ------
" Q)
> Reorder r----~.,....------l------~------l- --
E I
point, R I
I
I
Lead 1 Time
0
1 1 Order
1 time
Order
Order Order
placed receipt
placed receipt

Figure 6-3: The basic EOQ model

?'tpU:VF~·
Industrial Engineering and .Mana ement
114

Inventory carrying cost per unit per year= Cc

. Q
Average mventory =
2
. . CCQ
Annual mventory carrymg cost = - -
2

Total annual ordering cost equals

.
cost per order (Co) times -number of Orders per y N
number of orders per year with known and constant demand is given by D!Q h ear.. ow
annual demand and Q is the order size. Also, we have ' w ere D 1s the

Annual ordering cost = C x D

0 Q

Therefore, total inventory cost, TIC = C x Q

D + C' x Q
0 2 C

Differentiating TIC w.r.t. Q, we get minimum TC as:

dTIC =O
dQ

Q
•=pc,D
-
cc
Annual
cost Total cost

Minimum
total cost

D
Ordering coSt = Goa

Order quantity, Q
Optimal order,
Oopl

. · basic E OQ model
Figure 6-4: Optimization of total inventory coS tS 10 unit of
fated per
• . . ince it is cal~U ecause of less
Inventory carrying cost increases as the order size mcreases s . order size b dering cost
1·t em pet. u111t
· · · ease tn d or ·
time. But the ordering cost decreases due to mer • g costs an O and tot·tl
' . f rryin zer '
number of orders. The total variable cost is the summatwn ca
as sh · · . I
°
0 f tota1 co
st becomes
. own Figure 6.4. At an optimum order size, the s ope
10
vanable costs become minimum.
-------------~ _ _ _ __Jl~nv~en~to~ry~C_2!:on~tro~I_ .J11155

r: ample 6.1: A manufacturer deals exclusively .h

i-X . . d 'd wit the prod t'
the Company 1s trymg to ec1 e on an inventory · and reorder ol'uc ion of brake shoes · Current1y
shoe costs the company Rs 75 each, and demand 1-s about 5000 P icy for the brake shoes A hr k'
b k . ae
fairly evenly throughout the year. Reordering costs are Rs 800 ra e shoes per year c!istributed
red at 20 per cent of the cost of the item The per order and carrying costs are
figu . . company is 300
week and closed two weeks m August). The lead tim . 4 op~n days a year (6 days a
. h b f d e is O workmg da F' d h
reorder pomt, t e num er o or ers per year and total vana . bl e costs. ys. m t e EOQ, the

Solution:
We have C. = Rs 75, D = 5000 units, C = Rs 800 C = o2 x c _0•2 x 75 =Rs 15, L =40 days.
Now the EOQ is o , c • ;-

• lC,D
EOQis

Q ·= T =
2 x 800 x 5000
1
5
= 73 0.29 = 731 unit of brake shoes

Now, L =40 days and daily demand d =5000/300 = 16.67; therefore, the reorder point is
r = (16.67)( 40) = 666.66"" 667 units ·11
The company should reorder 731 brake shoes when his inventory position reaches 667. Number
of reorder times per year is
(5000/731) = 6.83
',/

-~.,~,.
or after n·t
u
1"

(300/6.83) = 43.92"" 44 working days

So
Total ·c osts= (Carying cost)+ (Ordering cost)
TC= [Cc(Q/2)]+ [Co(DIQ)]
= [0.2(75)(Q/2)] + [800(5000/Q)]
= I 5Q-+ (40, 00, 000/Q)
Therefore,
TC= 15(731) + ( 40, 00, 000/731) = Rs 16,436.95.

6.5.2 EOQ Model without Instantaneous Receipt ' .

.. . elo ed the production lot s_1ze
I hu ::;ccond major paper was presented by Taft ( 1918) who dev . P t' g the production
. I EOQ odel mcorpora m d
liHldcl. This model is an extension of th~ s1mp e m . the production or er
1t\\t;.. Camp
.
( 1922) was the first to present a general fonnula to detennme 1·nvestrnent would
. . · t est on stores • t:
1 10
111 u11 1L1ty, such that the total cost per umt for settmg up P us er 1 'th instantaneous receip
lw II minimum. The following are the assumptions of the EOQ mode wi
116 Industrial Engineering and Mana ement

6.5.3 Demand Occurs at a Constant Rate of D Item P

1. The production rate is P items per year (and P > D). s erYear
2. Set-up cost: Rs C per run.
0

3. Carrying costs: Rs Cc per item in inventory per year.

4. Purchase cost per unit is constant (no quar1tity discount).
5. Set-up time (lead time) is constant.
6. Planned shortages are not permitted.

In this model, the inventory replenishment is not instantaneous. Generally, this type f.
model 1s· used m· pro duction
· of an item.
· Inventory rep1ems· hment 1s
. a continual
' process·o inventory
si .
. 1 . . 1 . l B h h
the inventory dep ebon IS a_ so a conbnua process. ot t_ e processes occur simultaneously, ' nu1arbut
1Y,
the rate of mventory replemshment (1.e. p) 1s greater than mventory depletion (i.e. d) as shown in
Figure 6.5. The fraction of total production stored in stock is (p-cf)lp or (I -dip). The maximum
level of inventory stored in stock is Q(l - dip) and average inventory level is Q(I -dlp)/2. Ifp
is the daily rate at which the order is received over time and dis the daily rate at which inventory
is demanded, then

Inventory Inventory
replenished depleted
Maximum
c inventory level
.8
~9(1-~)p
E 2 Average
inventory level

Begin End nme

order order
rec~ipt receipt receipt
period

Figure 6-5: Graphical representation of the EOQ mo deI without instantaneo

us receipt

Maximum inventory level Q ( 1- ; )

Aver,ge inventory level~ ;1(1- ;J

Total ordering cost== C D
"Q
Total carrying cost== c . Q
( 2
(1- d) p

Total Inventory cost, TIC== CQD+ C . Q2 (1 - pd)

0 C

...
 Differentiating TIC w.r.t. Q, we get minimum TC as:

~- _ D C (
dQ -0--C"Q'+t I<)
Q*= 2COD
or,
c,(1-~)
Therefore,
.
0 ptimal order size Q * =

Example 6.2_: A cement manufacturing company has been using production runs of l,OO,OOO
packets, 10 times per year to me~t the de~an~ of l 0,00,000 packets annually. The set-up cost
is Rs 5000 per run and the carrym~ cost 1s ~stimated at 10 per cent of the manufacturing cost
t : of Rs 100 per packet. The production capacity of the machine is 5,00,000 packets per month.
I,
!- The factory is open 365 days per year. Calculate the optimal production lot size; the number
f of production runs per year; the total annual variable cost; and the difference between existing
total annual variable cost and optimal annual variable costs; the order time between production
rf ...
f runs; the maximum inventory; and machine utilization.
, ..
I'
I~
Solution:

~.·_i We have D -- 1,000 ,OOO·, Co = Rs 5, 000·, Cc = Rs 10; d = 1,000,000 per year, p = 12 x 5,00,000
:::: 6,000,000 per year
p::_: The optimal production lot size is given by
.--------:--:--=:--:-
t<.F
!' Q* = .J2DC)[(l-dlp)CJ
..
1 = .[2(1, 000, 000)(5, 000)/[(10)(1-1/ 6)]
= 34, 641 packets
l i,~ uumber of production runs per year is
DIQ* = 28.86 times per year

i\l flo, . 34641 (1 10,00,000 Rs 288,675.13 I=

Oplitnal TC= 5000(10,00,000/3464 1)+ t0xzx - 60,00,000)
l, 00, 00~(1- l 0, 00, 000 I=
Rs 466,666.66
1·llrrc nt TC = 5000(1 o, 00, 000/1, 00, 000) + 10 x- 2 60, 00, 000 )

l l,1!11:li>rn, the difference is 53

991
466,666.66-288,67 5-13 ::::Rsl?7, .
 118 Industrial Engineering and Management

There are 28.86 cycles per year. Thus, each cycle lasts
(365/28.86) = 12.64 days
The time to produce 34,641 packets per run is
(34, 641/6, 000, 000)365 = 2.10 days
Thus, the machine is idle for
(12.64 - 2.10) = I 0.54 days between each run

6.5.4 EOQ Model with Shortages

The assumptions of the EOQ model with shortages are as follows:
I. Demand occurs at a constant rate of D items/year.
2. Ordering cost: Rs C0 per order.
3. Holding cost: Rs C" per item in inventory per year.
4. Backorder cost: Rs Cb per item backordered per year.
5. Purchase cost per unit is constant (no quantity discount).
6. Set-up time (lead time) is constant.
7. Planned shortages are permitted (backordered demand units are withdrawn from a
replenishment order when it is delivered).
In this model, Q is the maximum size of inventory; Sis the inventory required or to be c?ns~ed
during the shortages period t2 ; · Q - Sis the inventory available for the period tr Her~, t2 m<licates
the shortage period. Total cycle time is t as shown in Figure 6.6. Inventory exi sts only for
t 1 period and for rest t2 period, there· is a shortage of items.

. . . Total units over time period

Time penod m days=-------_.;;..--
Demand in units per day

. 'th shortages
Figure 6-6: Graphical representation of the EOQ model W1
a

-------------
1~

{(Average mventory
• 1
Average inventory level -- + (Average inventory
. evel over t,)xt1
1evel
t
overt1 ) X t1 }

(Q-S)
= 2 t, +O· t1
t
(Q-S) . (Q-S)
2 D +O ·t1
= Q
D
= (Q-S)2
2Q

{(Average shortage level over tI ) x tI

Average shortage level = + ( Average shortage level over t2 ) X t2 }
t
O·t+(S)_t
I 2 2
=
t
0+-·-
s s
2 D
=
Q
D
(S)2
=-
2Q

·rota I shortage cost s2

= Cs -2Q

Tolal carrying cost =C. (Q 2Q

C
- s)2

Total ordering cost = COD

Q
·1·nta l inventory cost= Ordering cost +Carrying cost +Shortage co st
S2 (Q-S)2 D
:::C -+C - -+C -
s ZQ C 2Q O Q
 120 Industrial Engineering and Management

Differentiating the total inventory cost w.r.t. Q, we get

.
Optimal order quantity, Q =
*
T2C D(C, C,.+Cc)
0

Shortage level, s• = Q •( C,:C, )

-
en
0
0
Slope= 0 Total cost

Minimum
Carrying cost
cost

----:;,.-:::...___ Order cost

0
-----P------- Shortage -::-Q
cost
L___ _ _ _----1..._ _ _ _ _ _ _ _ _ _

Oopt

Figure 6-7: Optimization of the total inventory costs in the EOQ model with shortages

.
In Figure . cost and shortages
6.7, there are three variable costs: carrying cost, ordenng . . cost.
,·n
with mcrease
These costs vary with order size, Q. Ordering cost and shortages cost decre~se ation of
t th
order size, but carrying cost increases with increase in order size. Total coS is e sununfttal cost
these three costs and becomes minimum when its slope equals to zero. A t zero slopeo
O '

the inventory size is known as optimal or EOQ.

R 8 50 000. There
~xamp/e 6.3: A car retailer has a monthly demand of 12 cars. Each car costs T~e ~et~iler has an
,s also a Rs I0,000 order cost (independent of the number of cars ordered). btain cars after
.
annual carrying cost at the rate of 5 per cent on each car. It takes two we eks too Rs 4000 profit.
1 t
t iey are ordered. For each week if one car is out of the market, there ai ·1er loses
. . an order does
.
(a) Find the EOQ and the optimal' order policy. (b) How many day~ after receiY!ng
. t f'V per eye Ie?·
the reta1·1 er run with
. inventory'?
. . wit. hou t any mven 0,1
(c) How long is the retailer

Solution:
We have

D =12xl2 =144 cars,· C = Rs 10,000;

/}

Cc = 0.05(8, 50,000) = Rs 42,500;

ch = 4000 x 52 = Rs 2, 08, 000
t :
•
_ _ _ _ _ _ _ _ _ _ _ _ _ _ __ _ _ __ _ _ _ _ _ _ _l~nv~e~nt~ory~
C~on!!!lr~ol~ _!1~21

Now,
(a) Q* =.J2DC)Cc x-J(Cc +Cb)/Cb
= .j2(144)(10,000)/42,500 x.J~c4~2-;:,5;-;:;-0:::-0+-=-2,-=-08=-,-oo-o-)/-2,-08- , -0 0-o = 9.03
S* = Q *[Cc/(Cc +Cb)]
=9.03(42,500/(42,500 + 2,08,000))
=1.53
Demand is 12 cars per month or 3 cars per week. Since lead time is 2 weeks lead time
d1/mand is 6. Since the optimal policy is to order 9 cars and one car is out of~arket each
week. The order should be placed when there are 5 cars remaining in inventory.

(b) Inventory exists for Cbl(Cc +Cb)= 2,08,000/(42,500+ 2,08,000)

= 0.83 of the order cycle
Note (Q * -S*)IQ* = 0.83 also, before Q * and S * are rounded. An order cycle is

Q • t D = 0.0627 years= 22.88 days

l-
Thus, the retailer has inventory (0.83)(22.88) = 19 days after receiving an order.

(c) Service is out of stock for approximately 22.88-19 = 3.88 days.

6.5.5 EOQ Model with Quantity Discount

The EOQ model with quantity discount is applicable when a supplier offers a lower purchase cost
for an item ordered in large quantities. In this model, variable costs are annual carrying, ordering
a11d purchase costs. For the optimal order quantity, the annual carrying and ordering costs are not
11ccessarily equal.
The following are the assumptions of the EOQ model with discount:
'I
I. Demand occurs at a constant rate of D items/year.
2. Ordering cost is Rs C per order.
\ 0
3. Holding or carrying cost is Rs C" = Rs C/ per item in inventory per year. (Note that the
holding cost is based on the cost of the item, Cr)
4. The purchase cost is Rs C per item if the quantity ordered is between Oandx , Rs C if
1 1 2
the ordered quantity is between x 1 and x2, and so on.
5. Delivery time (lead time) is constant.
(,_
Planned shortages arc not permitted.

Total annual cost= Carrying+ Ordering+ Purchase

= [(1/2)Q * Cc]+[DC)Q*]+ DC

- ---
122 Industrial Engineering and Management

Example 6.4: An electronic shop carries film for the cam

. . era. The f']1
er umt and 1s sold for Rs 85. The shop has the film shelf ...,
11teofI8 m costs the h
P . . sopR
are 21 films per week, and its annual mventory carrying cost . months. The sh s 80
. rate 1s 20 op sal
shop Rs 20 to place an order. The film manufacturing compan ffi per cent. It c es
. . Y o ers a 7 °sts the
orders of 400 f Ilms or more, a 10 per cent discount for 900 film per cent discount
. . s or more a d on
discount for 2000 films or more. Determme the shop's optimal quantity. n a 15 per cent

Solution:
We have D = 21 (52) = 1092; Cc= 0.20 (C); C = 20. 0

(a) For C4 = 0.85(80) = Rs 68

To receive a 15 per cent discount, the shop must order at least 2000 films. Unfortun 1 1
the batteries' shelf life is 18 months. The demand in 18 months is a e y,
78x21=1638films
If he orders 2000 films, he would have to scrap 372 of them. This would cost more than
the 15 per cent discount would save.
(b) For C3 = 0.90(80) = Rs 72

Q; = ICC
= I [ 0.20(72)]
= 55 films (not feasible) .
t
The most economical feasible quantity for C is 900 films. Since the ca~ing coS ts
. , J • • 900 f iJms.
function of material cost and equals to Rs 72 only when order SlZe 18
(c) For C2 = 0.93(80) = Rs 74.4

Q; = ICC
= ( 1092) ( 20) I [ 0.20 ( 74.4)]
= 54.18 films (not feasible) •ng cost is a
Tl1 . . S. ce the carrYI
e mo st economical, feasible quantity for C2 is 400 films. tn . e is 400 filJTlS.
function of material cost and equals to Rs 74.4 only when rd er °
812

(d) For cl = 1.00(80) = Rs 80

Q; = .J2DC)C,.
= ( 1092) ( 20) I 0.2 ( 80)
= 52.24 films (feasible)
We know that
 ----------~
Therefore, we have
lnvento~ Control
-
123

rc3 =(l/2)(900)(72) + ((l092)(20)1

TC2 =(l/2)(400)(74.4) + ((1092)(20(~0;))+(1092)(14.4) = Rs 48,149.06
rel =(1/2)(53)(80) + ((1092)(20)/53))( 00)) + (1092)(14.88) = Rs 31 183 5
+(1092)(16)- Rs ' .6
Comparing the total costs for 53 400 a - 20,004.07
9
d
Rs 20,004.07. The shop should or er 53 films
~d 00at films,
a time. the lowest total annual cost is

6.6 REORDER POINT

The·1reorder ·point is the inventory level t which a new ord · l
w i ethere is enough stock in place to caover demand dunng
. er islead
P aced. 1
time The order must be p ace d
h
R=dL
where d is the demand rate per time period d L . h
depleted at a slower or faster rate during /and t· is tWhelead time. The inventory level might be
1 ime. en demand is rt ·
added as a hedge against stock-out. unce am, safety stock is
The
d service
d level is the probability that the amount of mventory
.· on hand is suffi . t t
meet em~n- durin~ l~ad :ime (i.e., the probability of a stock-out will not occur Th;i~n h:r
..
the probability of existmg mventory results in more likelihood of meet·mg the customer
). demandg
A s~rvice level ~f- 95 per cent means there is a 0.95 probability that demand wi.H be met and
0.5 1s the probability of a stock-out.

6.6.1 Reorder Point for Variable Demand

There are three situations for determining the reorder point: reorder point with variable demand,
reorder point for variable leadtime, and reorder point for both variable demand and lead time.
If the daily demand is a variable and lead time of supply is a constant, _!!le following
expression is used to find the reorder point. The first term of the reorder point, i.e. dL represents
the average inventory required for the lead-time period and the second tenn, i.e. Z<J JL
represents the safety stock.
R=

·I · t· f d ·1 d
th sta
where R is the reorder point d is the average daily demand, L is the lead time,.<J, is e
d, z' ·s the number of standard deviations correspondmg to service eve
•t~
t cv1a 10n o a1 y eman 1
probability, and ZCJ d _i~ the safety _stock. d d robabilit of a stock-out are shown on
In Figure 6.8, probab1hty of meetmg demanl. a~ Ph l ft "dy of reorder point Rshows the
. "b · ve The area 1es mt e e s1 e , . 0f
l 1e slandard normal d1stn ution cur · f h d • t R shows the µrob abihty
I .. . h d d nd right side o t e reor er µom ' . the
•','
probability of meeting t e eman a i e dL and R shows the µrobability ofrnceting
11 :-;lock-out. The area between the mean value, · ·

dt:1na nd from the safety stock.

 Industrial Engineering and Mana ement
124

Probability of meer
during lead time _ ing ~emand
- service level
/

Probability of
Safety stock a stock-out

dL R
Demand

Figure 6-8: Probability distribution for stock-out

I
Example 6.5: A furniture house wants a reorder point with a 95 per cent service level and
a 5 per cent stock-out probability. The av~rage demand per day is 75 chairs with a lead time
of 5 days. The standard deviation is 6 chairs per day. Find the reorder point.

Solution:

For a 95 per cent service level, z = 1.65. So, the reorder point is

= 75(5)+(1.65)(6)./(5)
= 397.13 :=:; 398 chairs

662
· · Reorder Point for Variable Lead Time . is used to
ression
When lead t" · . following exp
tlet . ime is vanable and daily demand is constant,
ennine the reorder point:

R = d L + Zda L dard deviation

where d is the . . - . (1 is the stafl is the safety
of lead t· con stant daily demand, L is the average lead time, . L and ZdCh
1me, do- · h . 1 d urne,
stock. 1. is t e standard deviation of demand dunng ea

1ead time
erage
Example 6 . d y The av . 95 per cent
· ·6· A cloth · k ts per a · with
is 8 days and th . merchant has a fixed demand of 45 JaC e d r point
serv1ce
· level, e dev1at·1011 In
· lead time is 2 days. Calcu1ate the reor e
-
Solution:
We
. have demand
2d rate, d = 45 J·ackets per da ·
nme, <J= ays, Z corresponding to 95 per cent
Y, average
se . lead t·tme, L- = 8 da .
- rv1ce level is 1.65 then ys, deviation in lead
R = dL+Zda '
= 45 X 8 + 1.65 X 45 X 2
= 508.5
= 509 jackets

6.6.3 Reorder Point for Variabl.e 0 emand and Vari bl

When daily demand and lead time b0 th . a e Lead Time
• . are vanables th
o owmg expression: ' e reorder point can be detennmed
. by the
fi 11

R=

where d is the average demand and l is. th e vanable

. lead time (<i )2[ +( )2 -d2 .
. ·. . r------ ' d <J L is the
standard deviation dunng the lead time z'\J/(a d )2 [ + ( a L )2 -d 2 is
• the safety stock.

Example 6.7: A cloth merchant has an average demand f 4 .

l' . deviation of 6 jackets per day. The average lead time is da5 Jackets per day _with a standard
(
ts 2 days. Calculate the reorder point with 95 per cent servic~sl eve
and!. the deviat10n m lead time

; .: '
...
~""'
~;;-:,
Solution:
R=
t*·
! -
. = (45)(8) +
2 2
6) (8) + (2) ( 45)
2

= 51 1. 11 "" 512 jackets

.. ,~.'
!4,... -
, .
~;,t ·~ ' 6.7 ORDER QUANTITY FOR VARIABLE DEMAND
'._ • '"~

In this chapter, we have studied to determine the order size, i.e. EOQ only when demand is
constant. Here, we will discuss the determination order size when demand is variable. Due to
va riability in demand, we use safety stock in detennination of order size as shown in following
expression:
Q = d(th + L) + Z<Jd ftb + L - I
where d is the average demand rate, t1, is the fixed time between orders, L is the lead time, ", is
st
lho' "'ndard deviation of demand, zer, ft, + L is the safety stock, and I is the inventory in ock.
-
_ __!!!ln~du~s~tr~ia~IE~n~g~in~ee~ri~n~g~an~d~M~a~n~a~ge_m_e_n_t_ _ _ _ _ _ _ _ _ __
126

Example 6.8:
A small shop has an average demand b 45 jacketsdper day
. of . and the standard dev1ation
. . .
1
demand is 6 jackets. The fi xe d time etween or ers 1s 16 days and th 1 d . _naverage
· · k F 95 f · e ea time 1s 8 d
Inventory in stock 1s 40 Jac ets. or per cent o service level what shou1d be the ays.
~~cy? m~

Solution:
Q = d(tb + L)+ ZCJd.Jtb + L -I
= 45(i6+8)+ 1.65x6x.Jl6+8-40
= 1088.49 jackets

SUMMARY
In this chapter, we have discussed about the importance of inventory and classification of
-items in inventory based on their value, availability and consumption rate. In addition to
these discussions, various inventory models have been explained with numerical illustrations.
Also, reorder point has been explained with variable demand, variable lead time and variable
demand and lead time both. Finally, the order size for variable demand has been illustrated in
this text.

MULTIPLE-CHOICE QUESTIONS
I. Which of the following DOES NOT belong to the assumption of economic batch quantity (EBQ)?
(a) Only two or more items are involved
(b) Annual demand is known
(c) Usage rate is constant
(d) Usage occurs continually
2· Inventory carrying costs are influenced by
(a) only ordering (b) only holding carrying cost per unit.
(c) both ordering and holding (d) only production cost
3· Which of the following statements concerning the basic EOQ model is true?
(a) a decrease in demand will increase the EOQ value ·ty compared
(b) the Ih · 11 order quantt
annua oldmg cost is less than the annual ordering cost for a sma er-
to EOQ
(c) an increase ·m I10 Id'mg cost will increase the EOQ value
(d) as annual ord enng
· costs mcrease,
. . costs
so do annual carrymg
4. ABC analysis deals with
(a) ordering cost (b) flow of materials . Is
(c) ordering sched I O f . (d) the cost involved wi th th e materta
ue the matenals
 5. Which of the following are difference b ·
:e . . s etween Period· .
s. (a) Continuous inventory systems are t· 1c inventory and c . .
. . . ime-phased h"l1 . ontinuous inv
er (b) Penod1c inventory systems have re ul e Penoctic invento s entory systems?
irregular order times g ar 0rder times While conr ry . YSlerns are not
(c) Periodic inventory systems have regul inuous invento ry systems have
irregular order quantities ar order qu ti •
an ties while continuous .
(d) none of the above s ave
I inventory system h
!,
6. A fixed time between orders and a variable d .
(a) continuous inventory system or
(b) er quantity
. are charactenstics
. of a
. . . .
(c) penodtc inventory system two-bin
(d) ""np system
7. The function of inventory is nm_ system

-
of
to
I
.'
(a)
(b)
(c)
(d)
to meet the fluctuating demand of the market
to make smooth production systems
to kelp hedge against price increase
all of the above
ilS.
)le 8. VED analysis of inventory deals with
1n (a) utility of the materials
(c) availability of the material (b) cost of the materials
9. FSN analysis of inventory deals with (d) consumption of the material
(a) utility of the materials
(c) availability of the material (b) cost of the materials
10. SOE analysis of inventory deals with (d) consumption of the material

(a) utility of the materials

(b) cost of the materials
(c) availability of the material
(d) consumption of the material
11. Which of the following is NOT the part of assumptions of basic EOQ model?
(a) Demand is known with certainty and is relatively constant over time.
(b) Shortages are allowed.
(c) Lead time for the receipt of orders is constant.
(d) The entire order quantity is received at once and instantaneously.

ared 12. Which of the following EOQ model assumes that material cost is the variable cost?
(a) Basic EOQ model with instantaneous receipt.
(b) EOQ model without instantaneous receipt.
(c) EOQ model with shortages.
(d) EOQ model with quantity discount.
1
3. To determine the reorder point, which of the following information is required?
(a) Demand rate (b) Lead time
(c) Safety stock (d) All the above
128 Industrial Engineering and Management

14 A firm has consumption rate of the material is 20 units per week d .

· material is two weeks. Wh.ic h of the "io 11owmg
· will· be the reorderan .lead t1m e of supply of th
pomt? e raw
(a) 20 units (b) 40 units
(c) 60 units (d) 80 units

1s. In the basic model of EOQ with instantaneous supply

(a) Ordering cost will be less than the holding cost.
(b) Ordering cost will be equal to the holding cost.
(c) Ordering cost will be more than the holding cost.
(d) There is no relationship between ordering cost and holding cost.

Answers
I. (a) 2. (c) 3. (b) 4. (d) 5. (b) 6. (c) 7. (d) 8. (a) 9. (d)
I 0. (c) I I. (b) 12. (d) 13. (d) 14. (b) 15. (b)

REVIEW QUESTIONS
I. What are the various types of inventory maintained in a manufacturing organization?
2. What are the objectives of inventory?
3. Discuss the functions of inventory.
4. Write short notes on the following
(a) ABC analysis
(b) YEO analysis
(c) FSN analysis
(d) SOE analysis d
. . . . ly no shortage, an
S. Denve an express10n for economic order quantity subject to mstantaneous SUPP '
without any discount.
6. Discuss the reorder point for variable demand and variable lead time.

EXERCISES
ed the following
I · A company ABC 1s • to stock a product A. The company has deve Iop
· planning
information:
Annual usage = 6000 units
Cost of the product= Rs 350 /unit
Ordering cost = Rs 50 per order
Carrying cost = 25 per cent of the materials cost per unit per year.
(a) Determine the optimal number of units per order
(b) Fi nd th e optimal number of orders/year
(c) Fi nd the annual total inventory cost
 ~-_
lnve
....::nlo Control
129
2. A furniture house decides to use th EOQ.
Th ·
carpenter. e inventory manager obe model tO deterrnine the d .
last two years and expected to be samserves
. hthat the. annual demand oforther i;._
size. of fillrniture
. from a
d h . . e in
order an ot er vanabie costs associated Witht e coming y e •uin1ture
ea,,_He has estimated that is 500 . fo,
_umt,
20 per cent per year to hold items in sto k H· each order are about Rs 250 d . preparat'. on of an
(a) How many furniture should be ordered c . ishcost
. for the furniture
. an It costs him about ·
is Rs '1000.
(b) How many orders would there be? eac tune?·
(c) Determine the approximate length of cycle time.
(d) Calculate the minimum total inventory t
cos.
3. An auto component manufacturer supplies head!" ht
approximately 6000 headlight assemblies The ig /ssembly to car dealers. The annual demand is
and estimates that the annual holding cos~ is 15 spupp iertpafyshRs 2000 for each headlight assembly
approximate
· 1y Rs 500 to place an order The supplieer cen °t e headlight assembries , va Iue. It costs
. the total inventory
(a) Determine . costs .for the current d Iy orders
r current · 500 headlights per month ·
.
(b) Determine the economic order quantity (EOQ). O r er quantity.

(c) How many orders will be placed per year using the EOQ?
(d) Determine the total inventory costs for the EOQ.

4. _In Exercise 3: upon closer inspection, the supplier detennines that the demand for headlight assembly
1s nonnally dIStnbuted with mean 4 headlight assemblies per day and standaro deviation 3 headlight
assemblies per day.
receive an order from(The
the supplier
factory. plant is open 300 days per year.) It usually takes abouI 4 days Io
(a) What is the standard deviation of usage during the lead time?
(b) Determine the reorder point needed to achieve a service level of 95 per cent.
(c) What is the safety stock? What is the holding cost associated with this safety stock?
(d) How would your analysis change if the service level changed to 98 per cent?

REFERENCES AND FURTHER READINGS

I. Camp,
17-18. W E. (1922), 'Determining the Production Order Quantity', Management Engineering, 2:

2. Hariga, M. and Ben Daya, M. (1999), 'Some Stochastic Inventory Models with Deterministic Variable
Lead Time', European Journal of Operational Research, 113 : 42-51.
3. Harris, F. W (1913 ). 'How Many Parts to Make at 0. nee. Fac tory ,, Th e Magazine of Management,
10(2): 135-136. [Reprinted in 1990, Management Science, 38, 947-950.]
4. Kh OUJa.
. M. an d Sungiune
. P.. (2003) , 'Optimal Lot Sizing Under Continuous Price Decrease', Omega,
December 2003.
S. Lan, S. P., Chu, P., Chung, K. J., and Wan, W J. ( 1999!, •A Simple Method
Solution of Inventory Model with Vanable Lead Time , Computer and Op
::u::L t the Optimal
; esean:h, 26
599-605.