MSc.

Do Thi Phuong Nam

Learning outcomes

 Know how to classify inventory types

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 Have a thorough understanding of
how to manage inventory by different
methods

Inventory management
MSc. Do Thi Phuong Nam

MSc. Do Thi Phuong Nam

Contents What is inventory?
Definitions Stock of items kept to meet future demand.

Inventory costs Inventory types:

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 Purchased parts from suppliers: raw

ROP
materials, processed materials,
EOQ model components,…

ABC analysis  Work-in-progress (WIP)

 Finished goods
Inventory turnover
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MSc. Do Thi Phuong Nam

 Maintenance, repair and operating

JIT approach
supplies (MRO)
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Inventory classifications Inventory management Why do we

need
You eat 1 egg a day and buy eggs by the dozen. inventory?
 Buy a new container of eggs every 12 days
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Cycle stock (base stock) Timing Quantity

Safety stock (buffer stock) Inventory costs Inventory purposes

 Smooth-out variations in operation
Pipeline stock (in-transit stock) performances
1. Ordering cost
 Avoid stock out or shortage
2. Carrying cost (or Holding cost)
Speculative stock  Safeguard against price changes and inflation
3. Stock-out cost (or shortage cost)
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 Take advantage of quantity discounts
Psychic stock

Ordering cost Ordering cost per order

 Cost to prepare a purchase requisition
Chi phí chuẩn bị yêu cầu mua hàng British Gas is the largest UK energy and home services company. They supply gas and
 Cost to prepare a purchase order electricity, boilers and boiler cover as well as other home services. The company expands its
Chi phí chuẩn bị đơn đặt hàng
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 Cost of the labor required to inspect goods pipelines every now and then. Installation of pipelines involves the use of specialized high-
when they are received quality pipes, customized valves and other spares and loose tools.
Chi phí nhân công cần thiết để kiểm tra hàng hóa khi chúng được nhận
 Cost to put away goods once they have been Case study British Gas has only a few suppliers who produce these customized tools. The UK
received You are a grocery store owner. At the end of government regulations require the company to advertise in three national and two
Chi phí chuyển hàng vào kho khi chúng đã được nhận
the day, you realize that the shelf of shampoo international newspapers before placing a purchase order, this will cost £200,000. The
 Cost to process the supplier invoice related suppliers have to modify their own production plans and they charge an amount of £2 million
has been almost out of stock and you need to
to an order regardless of the size of order. The opportunity cost of staff time spent on drafting the tender
Chi phí xử lý hóa đơn nhà cung cấp liên quan đến đơn đặt hàng make a new order for this product to fill up
 Cost to prepare and issue a payment to the your store’s shelf. How do you know about documents is estimated at £250,000. Related legal costs are £50,000. In each procurement,
supplier the number of shampoo that you need to British Gas hires a firm for inspection at a flat fee of £100,000. Bank charges an amount of
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MSc. Do Thi Phuong Nam

Chi phí chuẩn bị và thanh toán cho nhà cung cấp £3,000 as documentation charges.
order, about the way to order and about the
Note: Ordering cost is independent of the order right time to make that order? How much does an order of British Gas costs?
size
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Trade-off between Carrying and Ordering costs

Carrying cost or Holding cost
 Cost of holding an item in inventory for a period of time Ordering cost for a year CO = no. of orders per
year × ordering cost per order
 Approximate percentage of the value of an item: 25% – 26%.

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Carrying cost
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 Vary from product to product = sum of expenses related to

components
servicing an order

Costs
Obsolescence Inventory Storage Handling Insurance Interest
Taxes
costs shrinkage costs costs costs costs Carrying cost for 1 order Ch= average inventory ×
carrying costs per unit

Opportunity cost average inventory = ½ order size

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MSc. Do Thi Phuong Nam

Specialized storage Costs for keeping

requirements result in “products” alive Order quantity
Note: Assume that as many orders as inventories
higher costs

Ordering cost and Carrying cost Stock out (or Shortage cost)
Suppose weekly demand is 100 units, order cost per order is £80, the value Customer agrees to wait for the item
of an item is £50 and carrying cost is 20% of the value of an item.
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a) If we place one order per year for the product, how much are the
ordering cost per year and carrying cost per order? Customer chooses other products with the same
objectives
b) If we place one order per week, how much are those costs?
Possible
consequences
Co for a year = number of orders per year × Co per order
Customer bakes orders the items
Ch for 1 order = ½ order size × Ch per unit
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a) Ordering cost = £80 b) Ordering cost = £4160 Customer cancels the order, buy products from a
Carrying cost = £26000 Carrying cost = £500 competitor and maybe is no longer a customer
MSc. Do Thi Phuong Nam

Lead time Company XYZ makes and sells widgets. It has a customer, ABC
Trade-off between (Or replenishment cycle)
Company, that wants to buy 10,000 widgets to put in its retail
stores in October for the Christmas season. It takes two weeks to
Carrying and Stockout costs get the widget parts and a week to assemble 10,000 units, so
Company XYZ has a lead time of about a month. That means that
You walk into a restaurant to have lunch. You
leave your order at 11:00 am and the waiter tells it must get the order from ABC company no later than
you that the chef will take 15 minutes to cook September 1 in order to make the delivery on time.
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for you. However, until 11:20 am, you receive
your meal together with the apology from the
staff because of being late. The lead time of
Carrying Stockout your meal is 20 minutes. What is lead time?
cost cost Work Work
Jake made an order through Amazon and when he starts ends
was about to the final step of confirmation, the
payment step, he chose the option of 3 days
delivery (because this was the cheapest option for
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MSc. Do Thi Phuong Nam

delivery service) and then made the payment.
Fortunately, after 2 days, he received his package at
the doorstep. So the real lead time is just 2 days. Lead time

ROP = (DD x RC) + SS

When to order? When to order?
DD: average daily demand (units)
ROP practice RC: length of the replenishment cycle (days)
SS: safety stock
Fixed order quantity system Fixed time period system
 The average daily demand is 40 units = DD
(Continuous system) (Fixed order interval/ Periodic system)
 The replenishment cycle is 4 days = RC
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 Orders placed with a constant size in  Orders placed for variable amount at specific
different time period time intervals  The company want to hold 40 units of safety stock = SS
When will they reorder?
+ Inventory level continuously monitored. + Proactive occasion.
– Costly. – Less direct control. ROP = (DD x RC) + SS = (40 x 4) + 40 = 200 units

Check Place When the inventory level reach 200 units, the company
Reorder point – ROP ROP = (DD x RC) + SS inventory order have to reorder or place a new order
The level of inventory at which a
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MSc. Do Thi Phuong Nam

200 200
replenishment is placed DD: average daily demand (units) units units
RC: length of the replenishment cycle (days)
160 120 80 40
SS: safety stock units units units units
New order
arrives
MSc. Do Thi Phuong Nam

ROP = (DD x RC) + SS

ROP – Reorder point DD: average daily demand
RC: length of the replenishment cycle (days)
How much to order?
Economic Order Quantity EOQ

Annual costs
SS: safety stock

Demand for chicken soup at a supermarket is always

900 packs a month. The shelves are restocked with EOQ model determines:

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chicken soup after 4 days calculating from the moment

 The point at which the sum of
an order is sent. The manager always leaves an on-hand
inventory of at least 10 packs. carrying cost and ordering cost are

What is the reorder point? minimized

TC
What is the meaning of the result?  The point at which carrying cost
Note: Assuming a month has 30 days equal ordering cost

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MSc. Do Thi Phuong Nam

Q* Order quantity
= EOQ

Basic EOQ assumptions EOQ cost model

If Q units are ordered:
TC (Q ) = annual ordering cost + annual holding cost + annual
1. A continuous, constant, and known rate of demand purchasing cost
2. A constant and known replenishment or lead time Annual ordering cost = ordering cost per order × orders per year = Co × D/Q
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3. A constant purchase price that is independent of the order Annual holding cost = holding cost per unit × average inventory = Ch × Q/2
quantity
Annual purchasing cost = P × D
4. All demand is satisfied  D: the number of units demanded per year
𝑪𝟎 𝑫 𝑪𝒉 𝑸  Q: the quantity ordered each time the
5. No inventory in transit ⇒ 𝑻𝑪 = + + 𝑷𝑫
𝑸 𝟐 inventory level = 0
6. Only one item in inventory or no interaction between inventory
𝐶 𝐷 𝐶 𝑄 2𝐶 𝐷  Co: cost of placing 1 order
items Then: = ⇒ 𝑄 =
𝑄 2 𝐶  Ch: annual holding cost/unit
7. An infinite planning horizon
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 P: purchase cost/unit
8. Unlimited capital availability 𝟐𝑪𝟎 𝑫
⇒ 𝑬𝑶𝑸 = 𝑸∗ = Problem is to find Q* that minimizes the annual
𝑪𝒉
inventory total cost.
MSc. Do Thi Phuong Nam

𝑪𝟎 𝑫 𝑪𝒉 𝑸
EOQ cost model ⇒ 𝑻𝑪 = + + 𝑷𝑫 EOQ model - Practice
Annual costs 𝑸 𝟐
ABC International company uses 100,000 pounds of aluminum ingots
∗
𝟐𝑪𝟎 𝑫 per year, and the cost to place each order is $15. The carrying cost for
⇒ 𝑬𝑶𝑸 = 𝑸 =
one pound of aluminum ingots is $5 per year.
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𝑪𝒉
 Calculate the EOQ reorder point.
Total cost
Slope = 0  D: the number of units demanded
𝐂𝐡 𝐐 per year.
𝟐𝑪𝟎 𝑫
Carrying cost = ⇒ 𝑸∗ =
Minimum 𝟐 𝑪𝒉
total cost  Q: the quantity ordered each time
the inventory level = 0.
𝐂𝟎 𝐃  Co: cost of placing 1 order. 𝟐 × 𝟏𝟓 × 𝟏𝟎𝟎, 𝟎𝟎𝟎
Ordering cost = ⇒ 𝑸∗ =
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MSc. Do Thi Phuong Nam

= 𝟕𝟕𝟓 𝒖𝒏𝒊𝒕𝒔
𝐐 𝟓
EOQ (or Q*) Order quantity  Ch: annual holding cost/unit.
Optimal order  P: purchase cost/unit

EOQ model - Practice

A building materials supplier obtains its bagged cement from a single supplier. Demand is reasonably
ABC analysis
constant throughout the year and last year the company sold 2000 tons of this product. It estimates the
The ABC analysis states that a
costs of placing an order at around £25 each time an order is placed and the annual cost of holding inventory company should rate items
is 20% of the purchase cost. The company purchases the cement at £60 per ton. from A to C, based on:
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a) How much should the company order at a time?
Standards of evaluation
• Sales volume in money
b) How many orders should be placed each year?
c) How much time will elapse between the placements of orders (what is the cycle length)? • Sales volume in units
• Fastest-selling items
 D: the number of units demanded per year. 𝑪𝟎 𝑫 𝑪𝒉 𝑸
 Q: the quantity ordered each time the ⇒ 𝑸∗ =
𝟐𝑪𝟎 𝑫 ⇒ 𝑻𝑪 =
𝑸
+
𝟐
+ 𝑷𝑫 • Item profitability
inventory level = 0. 𝑪𝒉
• Item importance
 Co: cost of placing 1 order.
• Fragileness level
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MSc. Do Thi Phuong Nam

No. of orders per year = D/Q*

 Ch: annual holding cost/unit.
Time between orders (Cycle) = Q*/D
 P: purchase cost/unit
MSc. Do Thi Phuong Nam

ABC analysis Flowers

50 $0.50
Sally who owns a grocery store is fairly profitable, but would like to focus Inventory turnover
on the items that create more revenue.
 A ratio showing how many times a company's inventory is sold and replaced over
Apples a period of time
Squashes
150  Inventory turnover measures how fast a company is selling inventory and is
30
$0.10 generally compared against industry averages
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$0.25
 Beginning inventory: The value of goods, inputs or materials available for use or
Toothbrushes
sale at the beginning of an inventory accounting period
100 $4.00
 Ending inventory: The value of goods available for sale at the end of the
accounting period.
Magazines
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
200 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
$1.00
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MSc. Do Thi Phuong Nam

Balloons
Stools 𝑏𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 + 𝑒𝑛𝑑𝑖𝑛𝑔 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Paper towels 400 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 =
100 2
$15.00 200 $1.50 $1.00

Inventory turnover – Example “ The more inventory a company

The Hegemony Toy Company is reviewing its inventory levels. The related
information is $8,150,000 of cost of goods sold in the past year, and the has, the less likely they will
average inventory of $1,630,000.
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have what they need

 Calculate the inventory turnover and determine the days number that
the inventory of Hegemoney is on hand.
Taiichi Ohno
”
Thank you for your effort.
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MSc. Do Thi Phuong Nam