What is Inventory?

Integrated Production System I
Material and Inventory Management Chapter 12

Ø Inventory any idle goods or materials that are held for future use.
ØStock of materials ØStored capacity

Ø Examples


Types of Inventory
ØRaw material ØComponents ØWork-in-process ØFinished goods ØMaintenance/repair/operating supply

Why an organization carries inventories:
Ø It is rarely possible to forecast sales levels and production time accurately. Thus fluctuation inventories, most often called safety stock, are maintained in order to minimize the effect of such variation. Ø Many items have high seasonal demand; it might be impossible to produce enough quantity during a short selling season because of limit production capacity Ø To take advantage of economies of scales in production and purchasing such as quantity discounts, truck load discounts. Ø to maintain constant operation of manufacturing phase raw material and parts are required. Ø smooth running of machines spare parts for ٤ machines are needed.


Inventory Costs

Disadvantages of Inventory
• Higher costs
– Item cost (if purchased) – Ordering (or setup) cost
• Costs of forms, clerks’ wages etc.

ØOrdering costs - associated with costs of placing order and receiving goods e.g.
Supplies; Forms; support; Etc. Order processing; Clerical

ØSetup costs - cost to prepare a machine or process for manufacturing an order e.g.
Clean-up costs; Re-tooling costs; Adjustment costs; Etc.

– Holding (or carrying) cost
• Capital, Building lease, insurance, taxes etc.

• Difficult to control • Hides production problems

ØHolding costs - associated with holding or “carrying” inventory over time e.g.
Obsolescence; Insurance; Extra-staffing; Interest; Pilferage; Damage; Warehousing; Etc.

ØItem cost ØShortage costs



Classifying of Inventory Problems

The Material Flow Cycle
Number of items Nature of demand

One or many

Number of periods Lead time Stock-outs

Independent pr dependant; deterministic or stochastic; static or dynamic time One or many Deterministic or stochastic Backorders or lost sales
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The Material Flow Cycle
Input Other Wait Time Move Time Queue Time Setup Time Run Time Output

Three Primary Decisions That Must Be Made Regard To Inventory:
ØHow to monitor Inventory? ØHow Much Should Be Ordered? ØWhen Should Orders be Placed?

Cycle Time

1 Run time: Job is at machine and being worked on 2 Setup time: Job is at the work station, and the work station is being "setup." 3 Queue time: Job is where it should be, but is not being processed because other work precedes it. 4 Move time: The time a job spends in transit 5 Wait time: When one process is finished, but the job is waiting to be moved to the next work area. 6 Other: "Just-in-case" inventory.


ABC Analysis
• Divides on-hand inventory into 3 classes
– A class, B class, C class

Classifying Items as ABC
% Annual $ Usage
100 80 60 40 20 0 0

• Basis is usually annual $ volume
– $ volume = Annual demand x Unit cost

Class A B C

% $ Vol 80 15 5

% Items 15 30 55

• Policies based on ABC analysis
– Develop class A suppliers more – Give tighter physical control of A items – Forecast A items more carefully



% of Inventory Items


Cycle Counting
• Physically counting a sample of total inventory on a regular basis • Used often with ABC classification
– A items counted most often (e.g., daily)

Advantages of Cycle Counting
• Eliminates shutdown and interruption of production necessary for annual physical inventories • Eliminates annual inventory adjustments • Provides trained personnel to audit the accuracy of inventory • Allows the cause of errors to be identified and remedial action to be taken • Maintains accurate inventory records
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Techniques for Controlling Service Inventory Include:
• Good personnel selection, training, and discipline • Tight control of incoming shipments • Effective control of all goods leaving the facility

Inventory Models
• Fixed order-quantity models – Economic order quantity – Production order quantity – Quantity discount • Probabilistic models • Fixed order-period models
© 1984-1994 T/Maker Co.

Help answer the Help answer the inventory planning inventory planning questions! questions!



EOQ Assumptions
• • • • • • Known and constant demand Known and constant lead time Instantaneous receipt of material No quantity discounts Only order (setup) cost and holding cost No stockouts

Inventory Usage Over Time
Order quantity = Q (maximum inventory level)

Usage Rate

Minimum inventory 0

Inventory Level

Average Inventory (Q*/2)




EOQ Model How Much to Order?
Annual Cost
rve t Cu l Cos rve Tota t Cu Cos in g Hold

Why Holding Costs Increase
• More units must be stored if more are ordered

Minimum total cost

Order (Setup) Cost Curve Optimal Order Quantity (Q*)

Purchase Order Description Qty. Microwave 1

Purchase Order Description Qty. Microwave 1000

Order quantity

Order quantity

Order quantity

Why Order Costs Decrease
Cost is spread over more units
Example: You need 1000 microwave ovens
1 Order (Postage $ 0.33)
Purchase Order Description Qty. Microwave 1000

Deriving an EOQ
1. Develop an expression for setup or ordering costs 2. Develop an expression for holding cost 3. Set setup cost equal to holding cost 4. Solve the resulting equation for the best order quantity

1000 Orders (Postage $330)

Purchase Purchase Order Purchase Order DescriptionOrder Qty. Purchase OrderQty. Description Qty. Description Qty. 1 Microwave Description Microwave 1 Microwave Microwave 11

Order quantity
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EOQ Model When To Order
Inventory Level
Optimal Order Quantity (Q*) Reorder Point (ROP) Lead Time Average Inventory (Q*/2)

EOQ Model Equations
Optimal Order Quantity Expected Number of Orders Expected Time Between Orders

= Q* =

2 ×D ×S H D =N = Q* =T =
Working Days / Year


d =

Working Days / Year


ROP = d × L

D = Demand per year S = Setup (order) cost per order H = Holding (carrying) cost d = Demand per day L = Lead time in days


The Reorder Point (ROP) Curve
Q* Slope = units/day = d Inventory level (units)

Production Order Quantity Model
• Answers how much to order and when to order • Allows partial receipt of material
– Other EOQ assumptions apply

ROP (Units)

• Suited for production environment
– Material produced, used immediately – Provides production lot size
Time (days)
Lead time = L
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• Lower holding cost than EOQ model

EOQ POQ Model When To Order
Maximum inventory level

EOQ POQ Model When To Order
Inventory Level
Optimal Order Quantity (Q*) Reorder Point (ROP) Average Inventory

Both production and usage take place

Usage only takes place

Inventory Level


Lead Time


Reasons for Variability in Production
Most variability is caused by waste or by poor management. Specific causes include:
qemployees, machines, and suppliers produce units that do not conform to standards, are late or are not the proper quantity qinaccurate engineering drawings or specifications qproduction personnel try to produce before drawings or specifications are complete qcustomer demands are unknown

POQ Model Inventory Levels
Inventory Level Level
Production portion of cycle

Demand portion of cycle with no supply

Supply Begins

Supply Ends




POQ Model Inventory Levels
Inventory Level Inventory level with no demand Max. Inventory Q·(1- d/p) Q·(1-

POQ Model Equations
Optimal Order Quantity = Q* = p H* d p


Production Portion of Cycle

2*D*S d 1p

( )
D = Demand per year S = Setup cost H = Holding cost d = Demand per day p = Production per day

Maximum inventory level Setup Cost Supply Begins Supply Ends Demand portion of cycle with no supply Time Holding Cost

= Q*


1 -




* S

= 0.5 * H * Q

( )
1d p

Quantity Discount Model
• Answers how much to order & when to order • Allows quantity discounts
– Reduced price when item is purchased in larger quantities – Other EOQ assumptions apply

Quantity Discount Schedule
Discou nt Numb er 1 2 3

Discount Quantity

Discount (%)

Discount Price (P)

0 to 999 1,000 to 1,999 2,000 and over

• Trade-off is between lower price & increased holding cost

No discount 4 5

$5.00 $4.80 $4.75

Quantity Discount – How Much to Order

Probabilistic Models
• Answer how much & when to order • Allow demand to vary
– Follows normal distribution – Other EOQ assumptions apply

• Consider service level & safety stock
– Service level = 1 - Probability of stockout – Higher service level means more safety stock
• More safety stock means higher ROP
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Probabilistic Models When to Order?
Inventory Level Optimal Order Quantity Reorder Point (ROP) ROP

Fixed Period Model

Service Level

• Answers how much to order • Orders placed at fixed intervals
– Inventory brought up to target amount – Amount ordered varies



• No continuous inventory count
Safety Stock (SS)

– Possibility of stockout between intervals

Place order

Lead Time

Receive order


• Useful when vendors visit routinely
– Example: P&G representative calls every 2 weeks

Inventory Level in a Fixed Period System
Various amounts (Qi) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum
Target maximum

Fixed Period Model When to Order?
Inventory Level Target maximum

OnOn -Hand Inventory


Q2 Q3 p p p