Inventory Management (Part 2)

Jurusan Teknik Industri

Fakultas Teknologi Industri
Universitas Katolik Parahyangan
2023
References
1. Tersine, Richard J., Principles of Inventory and Materials Management, 4th
ed., Prentice-Hall Inc., 1994 (Part 1 / Outline 1,2,3)
2. Fogarty, F.W., J.H. Blackstone, Jr, and T.R. Hoffmann, Production and
Inventory Management, 2nd Ed., South-Western Publishing Co., 1991. (Part
2/ Outline 4, 5)
Outline
1 • Introduction

2 • Deterministic Inventory Models

3 • Quantity Discount

4 • Order Release Decisions

5 • Joint Replenishment
Order Release Decisions

Objective of individual item management:

1. Deciding when to release an order for purchase or production
2. Deciding the quantity to order or produce (EOQ, EPQ)

Basic methods of deciding when to order independent inventory items:

1. Statistical order point
2. Periodic review
3. Hybrid methods
Statistical Order Point - 1
q Effectively used for independent demand items with relatively stable
demand.

q The statistical OP system place an order for a lot whenever the quantity on
hand is reduced to a predetermined level (known as order point) à demand
rate and replenishment lead time are constant.

q In more realistic case, OP used to cover variations in demand or in lead time à

safety stock is needed.
Statistical Order Point - 2
Statistical Order Point - 3
q If the demand rate and the replenishment lead time are constant, it is not
difficult to determine exactly how low the stock level of an item can drop
before an order must be placed

q Example: if an automobile parts distribution warehouse experiences a

constant demand for 250 ball joint sets every two weeks and the lead time
is two weeks, then the order point should be set at 250 sets (two weeks of
stock).

q OP = Demand during lead time

Statistical Order Point - 4
q More typically, the demand and lead time would vary

q An order point without safety stock will result in stockouts

q In more realistic case, the order point is established to cover average usage
during average lead time plus some of the expected high side variations in
demand or in lead time

q The amount of variation covered depends on the level of customer service

desired
Statistical Order Point - 5
Statistical Order Point - 6
OP = DLT + SS

q Safety stock can be determined using:

§ statistical measure of forecast error
§ service level (percentage of order cycle in which inventory is sufficient to cover
demands)
§ ratio of maximum covered demand to normal demand during lead time

q Calculating the safety stock:

§ Standar deviation(s) of demand, or
§ Mean Absolute Deviation (MAD)
 Safety Stock: Standard Deviation(s) - 1
O P = DLT + S S
SS = s . Za

𝐷𝐿𝑇 = demand during lead time

SS = safety stock
s = σ = demand standard deviation
1-α = service level

To use this model, the lead time must equal the forecast period.
Safety Stock: Standard Deviation(s) - 2

The safety factor corresponding to a 92 percent customer service level is 1.41. The
Z value of 1.41 corresponds to an area of 0.4207, or approximately 0.42 of the
right half of the curve
Mean Absolute Deviation (MAD) - 1

• If (Fi - Di) normal distributed: MAD = 0,8 x s

O P = D LT + S S
SS = M AD × SF
S F = 1, 2 5 × Z a

SF: safety factor

Common Safety Factors
Mean Absolute Deviation (MAD) - 2
A demand of 250 ball joint sets (D = 25 per day, LT = 10 days) was forecast for
each of 10 two-week periods. Lead time equals the forecast period, two weeks.
Mean Absolute Deviation (MAD) - 3
MAD = 150/10 = 15

If it is desired a customer service level of 95 percent, the safety factor is 2,06

(= 1,25 x 1,65)

SS = 15 x 2,06 = 30,9
OP = 250 + 30.9 = 280.9 ≈ 281 (rounded up)

How if OP is calculated using standard deviation if the desired service level is

95 percent? (the estimated standard deviation is 18,87)
Unequal LT and Forecast Period
If demand variation measured on period smaller than the lead time
LT
SS = s × Z a ×
FP

Where FP= the forecast period

Example:
Let lead time be four weeks (two periods) in the previous example with all
other factor remaining the same, then
OP
Implementation of OP System

1. Perpetual Inventory System

A record is kept of each transaction.

2. Two-Bin System
The inventory is physically separated into the OP quantity and remaining
units. Material may be placed in different bins.
Periodic Review - 1

q Time between reviews of quantity on hand is fixed.

q Used in following conditions:

1. For independent demand.
2. Continous review is difficult and expensive.
3. Groups of items are purchased from a commonn suppliers.
4. Item have limited shelf life (perishable).
5. There is an economic advantage in generating full carload shipments.
Periodic Review - 2
Periodic Review - 3
Maximum Inventory Level/target level:
M = D(R + LT )+ SS
Q = M - I

M = maximum inventory level

D = demand
R = review period duration
LT = lead time
SS = safety stock
Q = order quantity
I = inventory on hand
Example
A company normal usage of zinc-based primer is 3 galon per day, the review
period is every two weeks (ten working days), lead time is three days, safety
stocks is 4 galons. Inventory is reviewed at the appropriate time, and there are
15 galons in stock.
Thus, the max inventory level and the order quantity can be calculated as
follows.
M = D(LT + R) + SS
= 3(3 +10 )+ 4 = 43
Q =M -I
= 43 -15 = 28
Hybrid System - 1
1. The OP-Periodic Review Combination System
q If the inventory level drops bellow OP prior to the review date, an order is
placed.

q If not, the order quantity is determined at the end of the period in the basic
periodic review manner.

q Is appropriate when relatively large variations in demand are common or the cost
of safety stock is excessive.

q Implemented using perpetual records or two-bin system.

The OP-periodic Review Combination System
Hybrid System - 2
2. The Periodic Review-OP Combination System

q Also called s,S model or Optional Replenishment System.

§ s = order point (OP)
§ S = maximum inventory level (M)

q An order is placed only when at the review period, the quantity on hand is bellow
OP.

q Avoids placing orders for relatively small quantities.

q Increases the probability of stock out.
The Periodic Review-OP Combination System
Outline

1 • Introduction

2 • Deterministic Inventory Models

3 • Quantity Discount

4 • Order Release Decisions

5 • Joint Replenishment
Joint Replenishment - 1
q It is generally cheaper to ship one large lot than ship several small ones.

q Vendors often give discounts based on total value of an order.

q Joint replenishment or Joint order à an order which several items are

combined.

q The objectives is to achieve lower cost due to ordering, setup, shipping, and
quantity discount economic.
à The marginal cost adding one item to an existing order is much less than the
marginal cost of later ordering the item individually.
Joint Replenishment - 2
q Joint Replenishment requires decisions concerning:
1. The aggregate value of the order
2. The order quantity of each item
3. The order intervals for individual item within a group
4. The timing of order releases

q These decisions are used in management of:

1. Purchased item
2. Production parts manufactured on equipment dedicated to one or more
groups
Joint Purchase Order Quantity - 1
Assumptions:
1. The demand rate and lead time of each item is constant and known.
2. Replenishment or lead time is common to all items.
3. The carrying cost rate, individual item costs, and preparation cost are known
and there are no quantity discounts.
4. Each item is ordered every cycle.

à has similiar assumptions with EOQ.

Joint Purchase Order Quantity - 2

ai = demand for item i in dollars

Joint Purchase Order Quantity - 3
Example - 1
Example - 2
Optimal lot size is $8400.
How much quantity for each item?
Joint Purchase Order Quantity - 4
Practical aspects in implementing the order quantity results:
1. Order quantity must be an integer.
2. Order quantity is usually rounded to a multiple of 5 or 10.
3. Container and package size can affect the order quantity.

Optimum order interval:

Varying Item Cycle - 1

q Sometimes it is not economical to order item every cycle.

q For the minimum cost aggregate lot size:

§ Aggregate preparation costs = Aggregate carrying costs.
§ Any lack of balance à multiple cycles.
Varying Item Cycle - 2

Techniques of varying item cycles:

1. Brown’s Approach
2. Silver’s Approach
Silver’s Approach
Step1:
Determine the item that has the smallest ratio of minor setup cost to
annual dollar demand, and set its cycle interval to 1.

Step2:
Determine interval multiple (ni).

si
where j = the item with the lowest ratio
ai
 si
where j = the item with the lowest ratio
ai
ni rounded to the nearest integer greater than zero.
Joint Order Quantity Discounts - 1

q Used when price discounts are given based on the total dollar value
of an order.

q The number or different items on the order is not restricted.

Joint Order Quantity Discounts - 2
If Q1* ≤ order value required to obtain the discount,

then the Q should be increased, but only if:

the increasing carrying costs < the decreasing purchase and preparation costs.
Joint Order Quantity Discounts - 3
A good rule to increase order quantity to the discount quantity:
1. If the net savings are positive.
2. If neither constraint nor practical considerations override the decision.
3. If the rate of return of the increased investment is satisfactory.

Net Savings = benefits – costs

= (purchase price discount + preparation cost savings –
increased carrying costs)
Joint Order Quantity Discounts - 4
Example:
Use data in U1-8, Tabel 8-1, p-276, and grant a 2% discount on all orders
equal to or greater than $15,000.
Joint Order Quantity Discounts - 5
Benefits:
Purchase price discounts = $88,200 x 2% = $ 1,764.

Setup cost saving = decrease no. of setups x cost/setup

Costs:
Increased carrying cost = increased avg. inventory x k.

Net Saving = $1,764 + $554.40 - $990=$1,328.4

Q$*=$15,000 (if no constraints are violated)
Joint Order Quantity Discounts - 6
Question?