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INVENTORY

MANAGEMENT

Inventory

? Examples

Stock of anything

necessary

to do business

Stored capacity

Raw material

Inventory

Supplies

Inventory Management

Balancing the cost with the benefits of Inventories

Maintain wide assortment of stocks

Increase inventory turnover

Keep stock low

Keep adequate inventory

Obtain low prices

When to order? ?

MGT 3050 Md Asnyat Asmat 5

Cost of Inventories

or Carrying cost

Warehouse, Insurance, Interest,

Ch Holding Cost Obsolescence, Staffing, Damage,

or Cc

or Stockout cost Deterioration, Pilferage, etc

Stoppage of production

Co Ordering Cost Transport, Stationeries

C Item Cost Purchase of product

or P

MGT 3050 Md Asnyat Asmat 7

Inventory Control Models

Helpanswer

answerthethe

inventory

inventoryplanning

planning

Economic Order Quantity questions!

questions!

Production Order Quantity

Quantity Discount

Probabilistic models

Fixed order period models

Economic Order Quantity (EOQ)

Assumptions

Demand is known and constant

Lead time is known and constant

Receipt of inventory is instantaneous or at once

Quantity discount is not allowed

Only cost associated are holding and ordering

(or set up cost) [no shortages are allowed; so

there is no shortage cost (ie. no stockouts]

Inventory position is reviewed continuously

Economic Order Quantity (EOQ)

Assumptions

All values are known with certainty and constant

over time.

Inventory usage is uniform over time.

Carrying costs change proportionally with

changes in inventory levels.

All ordering costs are fixed.

These assumptions do not hold in the real

world, so safety stocks are held.

EOQ inventory model

When to Order

Inventory

Level

Demand

rate

Optimal

Order, Q*

Average

ReOrder

= Q*/2

Inventory

Point, R

(ROP)

0 Time

Order Lead

Order

Placed Time

Received

Deriving an EOQ equation

Four Steps:

Step 1: Develop an expression for the annual ordering

cost

Step 2: Develop an expression for the annual holding

cost

Step 3: Equate ordering cost expression with the

expression of holding cost

Step 4: Solve the above equation for Q

Notations:

D = Annual Demand

Q = Quantity to be ordered

Q* = Optimum value of Q

Co = Ordering cost/order

Ch = Holding cost/unit/year

I = Holding cost rate

C = Unit price

Ch = IC

MGT 3050 Md Asnyat Asmat 13

General equations related to

EOQ

Annual holding cost

= (Average inventory)(Annual holding

cost per unit)

= QCh

Annual ordering cost

= (Number of orders per year)(Cost per

order)

= (D/Q)Co

MGT 3050 Md Asnyat Asmat 14

Total annual cost

= (Annual holding cost) + (Annual

ordering cost)

TC = QCh + (D/Q)Co

Ch = IC

EOQ Inventory model

Cost

2DCo

Q* = Total Inventory Cost

Ch TC = CoD/Q + ChQ/2

Minimum

Cost

Order, Q*

= Q/2

EOQ model equation

2DCo

EOQ = Q* =

Ch

Reorder point

Reorder point

= (Demand per day)(Lead time for a

new order in days)

r = dm

r = reorder point

d = demand per day

m = lead time for a new order in days

Cycle time

Cycle time is the period between orders

Cycle time

= (Number of working days per

year)/(Number of orders per year)

= (Number of working Days)/(D/Q*)

Eg. Carpet Discount Store (BT)

D = 10,000 yds

Ch = $0.75 per yd Optimal Order Quantity

Q* = (2CoD/Ch) = 2,000 yds

Co = $150.00

Except Sundays, Thanksgiving = Total Ordering Cost + Total Holding Cost

& Christmas days (not Sunday) TC = CoD/Q* + ChQ*/2 = $1500

Thus: working days = 311 days

? Number of orders No of Orders per year

? Time between orders = D/Q* = 5 orders per year

(order cycle)

Order Cycle time

= Working days in the year/No of Orders per year

= 311/5 = 62.2 store days

EOQ Model Equations

Optimal Order Quantity 2 D Co

= Q* =

Ch

D

Expected Number of Orders = N =

Q*

Working Days / Year

Expected Time Between Orders = T =

N

D D = Demand per year

d =

Working Days / Year Co = Setup (order) cost per order

Ch = Holding (carrying) cost

ROP = d L

d = Demand per day

L = Lead time in days

MGT 3050 Md Asnyat Asmat 21

How would the following

factors affect an EOQ

analysis?

Just-in-time system: Eliminates the need

for using EOQ

Use of air freight for deliveries: Reduces

the need for safety stock

Computerized inventory control system:

Reduces safety stocks

Flexibility designed plants: Reduces

inventory holdings of final goods

MGT 3050 Md Asnyat Asmat 22

Production Lot size Model

Production Order Quantity Model

or Production Run Model

Answers how much to order and when to

order

Allows partial receipt of material

Other EOQ assumptions apply

Suited for production environment

Material produced, used immediately

Provides production lot size

MGT 3050 Md Asnyat Asmat 24

POQ inventory model

Total Carrying Cost

Inventory

Level = CcQ(1 d/p)/2

Inventory level

With no demand Total Annual Inventory Cost

Demand

Cycle with TC = CoD/Q + CcQ(1 d/p)/2

no supply

Maximum

Inventory = Q(1 - d/p)

Optimal Q* Average

= Q(1 - d/p)/2

Inventory

0 Time

Production

Supply Supply Cycle with

Begins Ends demand

General equations related to

POQ inventory model

Maximum inventory

= (p d)t

d = daily demand rate

p = daily production rate

t = number of days for a production run

Q = pt

Therefore, t = Q/p days

Maximum inventory

= (p d)t

= (p d)(Q/p)

= (1 d/p)Q

Annual holding cost

= (Average inventory)(Annual cost per

unit)

= (1 d/p)QCh

Annual set up cost

= (Number of production runs per

year)(Set up cost per unit)

= (D/Q)Co/s

MGT 3050 Md Asnyat Asmat 28

Total annual cost

TC = (1 d/p)QCh + (D/Q)Co/s

Or:

TC = (1 D/P)QCh + (D/Q)Co/s

POQ Model Equations

2*D*Co/s

Optimal Order Quantity = Qp * =

( )

C h* 1 -

d

p

1 -

d

p

D C D = Demand per year

Setup Cost = * o/s Co/s = Setup cost

Q

Ch = Holding cost

Holding Cost ( )

= 0.5 * Ch * Q 1 - d

p

d = Demand per day

p = Production per day

MGT 3050 Md Asnyat Asmat 30

Eg. Carpet Discount Store (BT)

Production of Super Shag carpet

D = 10,000 yds Optimal Order Quantity

Ch = $0.75 per yd Q* = (2CoD/(Ch(1 - d/p)) = 2,256.8 yds

Co = $150.00

Total Annual Total Cost

TC = CoD/Q* + ChQ*(1 d/p)/2 = $1329

p = 150 yds (per day)

Production run length

d = D/yearly working days = Q*/p = 15.05 days

= 10,000/311

= 32.2 yds per day No of production runs

= D/Q* = 4.43 runs

= Q*(1 - d/p) = 1,722 yds

Quantity Discount Model

Quantity Discount model

Cost 2DCo

EOQ Q* =

Ch Total Inventory Cost

TC = ChD/Q*+ CoQ/2+ CD

Note

Minimum

Ch = IC

Inventory

Cost

0 Inventory Level

Q1 Q2 Q3

Optimal

Order, Q*

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

Trade-off is between lower price &

increased holding cost

Quantity Discount with Constant Carrying Costs

Eg University Bookstore (inventory of personal computers:

Offered by Comptek computers) (BT)

Discount Discount Price Total Annual

category Quantity ($) Cost (TC) ($)

1 0 - 49 1,400

2 50 - 89 1,100 233,784

3 90 or more 900 194,105

Ch = $190 per unit

Decision ?

Co = $2500 Take advantage of the discount

? Whether should take

advantage of the discount

Order 90 units

EOQ=Q*= 72.5 units

MGT 3050 Md Asnyat Asmat 35

2DCo

Step 1: By using Q* = calculate

IC

Q* for each discount.

for discount.

and select the best Q*

Quantity Discount with Constant Carrying Costs

As a Percentage of Price

Discount Discount Price ($)

category Quantity Decision ?

Q* is 86.1, less than 90

1 0-49 1,400 to take advantage of discount

3 90 or more 900 is 90 units

category Cost (@15%) Quantity Cost (TC) ($)

1 210 69

2 165 77.8 232,845

3 135 86.1 191,630

MGT 3050 Md Asnyat Asmat 37

A Single Period Inventory Model

with Probabilistic Demand

(RI p76)

A Single Period Inventory Model

with Probabilistic Demand

Order is placed only at one time for a

specified period

Demand is uncertain but the probability

distribution is known

When demand is uncertain, two

possibilities:

Demand exceeds order quantity, or

Order quantity exceeds demand

Cu = cost of underestimation per unit

Co = cost of overestimation per unit

Method: marginal analysis or incremental

analysis

Expected Loss: optimal situation occurs

when:

EL(Q* + 1) = EL(Q*)

P(demandQ*)+P(Demand>Q*=1

EL(Q* + 1) = CoP(demand Q*)

EL(Q*) = CuP(demand > Q*)

= Cu[1 P(demand Q*)]

= Cu CuP(demand Q*)

Therefore:

P(demand Q*) = Cu/(Cu + Co)

Example: DCaf Restaurant (discrete

distribution) (RI p77)

DCafe produces a food item, which costs $6

per unit and sells at $15. DCafe knows that if

it cannot sell the food item within the day of

production, then it has to discard it, in which

case it will lose the production cost.

From the previous selling experience, DCafe

knows that the demand follows the following

probability distribution:

Daily Probability

Demand

14 0.05

15 0.15

16 0.15

17 0.20

18 0.25

19 0.10

20 0.10

Service level

Service level is the probability that there

will not be any stock out at any instant of

time

Cu/(Cu + Co) = 0.6

Stock Probability Service Level

14 0.05 0.05

15 0.15 0.05+0.15=0.20

16 0.15 0.20+0.15 = 0.35

17 0.20 0.35+0.20=0.55

18 0.25 0.55+0.25 = 0.80

Example: Fatimas shop (continuous

distribution) (RI p81)

Fatima orders a perishable product daily at a super

market. It costs her $1.20 and sells for $1.65/unit. Any

unit unsold at the end of the day can be returned for a

$1.00. Demand at her shop is normally distributed with

= 150 and = 30. How many units she should place

order every day?

If the disposal price is just 35 cents, then how many

units she should order?

Cu = 1.65 1.20 = 0.45

Co = 1.20 1.00 = 0.20

P(demand Q*) = Cu/(Cu + Co)

= 0.45/(0.45 + 0.20) = 0.6933

Z = (x )/ = (Q* - 150)/30

Q* = 165 units

P(demand Q*) = 0.3461

Z = -0.39

Q* = 138 units

An Order-Quantity Reorder

Point Model with

Probabilistic Demand

Probabilistic Models

Allow demand to vary

Follows normal distribution

Other EOQ assumptions apply

Service level = 1 - Probability of stockout

Higher service level means more safety stock

More safety stock means higher ROP

Service Level

Frequency

Service

Level

p(stockout)

SS X

ROP

Probabilistic Models

When to Order?

Freq Service

Inventory Level

Level P(Stockout)

Optimal

Order

Quantity X

SS

Reorder ROP

Point

(ROP)

Place Receive Time

order Lead Time order

MGT 3050 Md Asnyat Asmat 51

Example: Hospital Supplies at GH (RI p81)

Aminah is in-charge of maintaining hospital

supplies at General Hospital. During the past

year, she has observed that in the lead time the

demand for bandage AX-7 has been normally

distributed with mean = 75 units with standard

deviation = 12 units.

If Aminah intends to maintain 98% service

level, then what should be the reorder point?

Fixed Period Model

Answers how much to order

Orders placed at fixed intervals

Inventory brought up to target amount

Amount ordered varies

Possibility of stockout between intervals

Useful when vendors visit routinely

Example: P&G representative calls every 2

weeks

Fixed Period Model

When to Order?

Inventory Level Target maximum

Time

Period Period Period

MGT 3050 Md Asnyat Asmat 54

ABC Analysis

Profit

Inventories are divided into

three categories, A, B & C

depending on the

importance of the items

Category A make up

70% profit, 10% of

inventory

Category B make up

20% profit, 20% of

inventory

Category C make up

10% profit, 70% of A B C

inventory Inventory

MGT 3050 Md Asnyat Asmat 55

Wassalaam

z 0.00 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09

0.0 0.0000 0.0040 0.0080 0.0120 0.0160 0.0199 0.0239 0.0279 0.0319 0.0359

0.1 0.0398 0.0438 0.0478 0.0517 0.0557 0.0596 0.0636 0.0675 0.0714 0.0753

0.2 0.0793 0.0832 0.0871 0.0910 0.0948 0.0987 0.1026 0.1064 0.1103 0.1141

0.3 0.1179 0.1217 0.1255 0.1293 0.1331 0.1368 0.1406 0.1443 0.1480 0.1517

0.4 0.1554 0.1591 0.1628 0.1664 0.1700 0.1736 0.1772 0.1808 0.1844 0.1879

0.5 0.1915 0.1950 0.1985 0.2019 0.2054 0.2088 0.2123 0.2157 0.2190 0.2224

0.6 0.2257 0.2291 0.2324 0.2357 0.2389 0.2422 0.2454 0.2486 0.2518 0.2549

0.7 0.2580 0.2612 0.2642 0.2673 0.2704 0.2734 0.2764 0.2794 0.2823 0.2852

0.8 0.2881 0.2910 0.2939 0.2967 0.2995 0.3023 0.3051 0.3078 0.3106 0.3133

0.9 0.3159 0.3186 0.3212 0.3238 0.3264 0.3289 0.3315 0.3340 0.3365 0.3389

1.0 0.3413 0.3438 0.3461 0.3485 0.3508 0.3531 0.3554 0.3577 0.3599 0.3621

1.1 0.3643 0.3665 0.3686 0.3708 0.3729 0.3749 0.3770 0.3790 0.3810 0.3830

1.2 0.3849 0.3869 0.3888 0.3907 0.3925 0.3944 0.3962 0.3980 0.3997 0.4015

1.3 0.4032 0.4049 0.4066 0.4082 0.4099 0.4115 0.4131 0.4147 0.4162 0.4177

1.4 0.4192 0.4207 0.4222 0.4236 0.4251 0.4265 0.4279 0.4292 0.4306 0.4319

1.5 0.4332 0.4345 0.4357 0.4370 0.4382 0.4394 0.4406 0.4418 0.4429 0.4441

1.6 0.4452 0.4463 0.4474 0.4484 0.4495 0.4505 0.4515 0.4525 0.4535 0.4545

1.7 0.4554 0.4564 0.4573 0.4582 0.4591 0.4599 0.4608 0.4616 0.4625 0.4633

1.8 0.4641 0.4649 0.4656 0.4664 0.4671 0.4678 0.4686 0.4693 0.4699 0.4706

1.9 0.4713 0.4719 0.4726 0.4732 0.4738 0.4744 0.4750 0.4756 0.4761 0.4767

2.0 0.4772 0.4778 0.4783 0.4788 0.4793 0.4798 0.4803 0.4808 0.4812 0.4817

2.1 0.4821 0.4826 0.4830 0.4834 0.4838 0.4842 0.4846 0.4850 0.4854 0.4857

2.2 0.4861 0.4864 0.4868 0.4871 0.4875 0.4878 0.4881 0.4884 0.4887 0.4890

2.3 0.4893 0.4896 0.4898 0.4901 0.4904 0.4906 0.4909 0.4911 0.4913 0.4916

2.4 0.4918 0.4920 0.4922 0.4925 0.4927 0.4929 0.4931 0.4932 0.4934 0.4936

2.5 0.4938 0.4940 0.4941 0.4943 0.4945 0.4946 0.4948 0.4949 0.4951 0.4952

2.6 0.4953 0.4955 0.4956 0.4957 0.4959 0.4960 0.4961 0.4962 0.4963 0.4964

2.7 0.4965 0.4966 0.4967 0.4968 0.4969 0.4970 0.4971 0.4972 0.4973 0.4974

2.8 0.4974 0.4975 0.4976 0.4977 0.4977 0.4978 0.4979 0.4979 0.4980 0.4981

2.9 0.4981 0.4982 0.4982 0.4983 0.4984 0.4984 0.4985 0.4985 0.4986 0.4986

MGT 3050

3.0 0.4986 0.4987 0.4987 0.4988 0.4988 0.4989 0.4989 0.4989 0.4990 0.4990

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