Inventory Management

12 Inventory Management
For Operations Management, 9e by

PowerPoint Slides
Krajewski/Ritzman/Malhotra
by Jeff Heyl © 2010 Pearson Education
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 1
Inventory Management
 Inventories are important to all types of

organizations
 They have to be counted, paid for, used in
operations, used to satisfy customers, and
managed
 Too much inventory reduces profitability
 Too little inventory damages customer
confidence
 Inventory trade-offs

ABC Analysis
 Stock-keeping units (SKU)

 Identify the classes so management can
control inventory levels
 A Pareto chart
 Cycle counting

ABC Analysis
Class C
100 — Class B
90 —
Percentage of dollar value Class A
80 —
70 —
60 —
50 —
40 —
30 —
20 —
10 —
0—
10 20 30 40 50 60 70 80 90 100
Percentage of SKUs
Figure 12.1 – Typical Chart Using ABC Analysis
Economic Order Quantity
 The lot size, Q, that minimizes total annual

inventory holding and ordering costs
 Five assumptions
1. Demand rate is constant and known with certainty
2. No constraints are placed on the size of each lot
3. The only two relevant costs are the inventory holding
cost and the fixed cost per lot for ordering or setup
4. Decisions for one item can be made independently of
decisions for other items
5. The lead time is constant and known with certainty

Economic Order Quantity
 Don’t use the EOQ

 Make-to-order strategy
 Order size is constrained
 Modify the EOQ
 Quantity discounts
 Replenishment not instantaneous
 Use the EOQ
 Make-to-stock
 Carrying and setup costs are known and
relatively stable

Calculating EOQ
Receive Inventory depletion

order (demand rate)
On-hand inventory (units)
Average
Q cycle
2 inventory
1 cycle
Time
Figure 12.2 – Cycle-Inventory Levels

Calculating EOQ
 Annual holding cost

Annual holding cost = (Average cycle inventory)
 (Unit holding cost)

 Annual ordering cost
Annual ordering cost = (Number of orders/Year)
 (Ordering or setup costs)
 Total annual cycle-inventory cost

Total costs = Annual holding cost
+ Annual ordering or setup cost

Calculating EOQ
Annual cost (dollars)
Total cost
Holding cost
Ordering cost
Lot Size (Q)
Figure 12.3 – Graphs of Annual Holding, Ordering, and Total Costs

Calculating EOQ
 Total annual cycle-inventory and ordering cost
Q D
C= (H) + (S)
2 Q
where
C = total annual cycle-inventory cost
Q = lot size
H = holding cost per unit per year
D = annual demand
S = ordering or setup costs per lot

The Cost of a Lot-Sizing Policy
EXAMPLE 12.1
 A museum of natural history opened a gift shop which
operates 52 weeks per year.
 Managing inventories has become a problem.
 Top-selling SKU is a bird feeder.
 Sales are 18 units per week, the supplier charges $60 per
unit.
 Ordering cost is $45.
 Annual holding cost is 25 percent of a feeder’s value.
 Management chose a 390-unit lot size.
 What is the annual cycle-inventory cost of the current policy
of using a 390-unit lot size?
 Would a lot size of 468 be better?

SOLUTION
We begin by computing the annual demand and holding cost as
D= (18 units/week)(52 weeks/year) = 936 units
H= 0.25($60/unit) = $15
The total annual cycle-inventory cost for the current policy is

Q D 390 936
C= (H) + Q (S) = ($15) + ($45)
2 2 390
= $2,925 + $108 = $3,033
The total annual cycle-inventory cost for the alternative lot

size is
468 936
C= ($15) + ($45) = $3,510 + $90 = $3,600
2 468

Figure 12.4 – Total Annual Cycle-Inventory Cost
Function for the Bird Feeder
Current
cost
3000 –
Total Q D
Annual cost (dollars)
cost = (H) + (S)

2 Q
2000 –
Q
Holding cost = (H)
2
1000 –
D
Ordering cost = (S)
Lowest Q
cost 0 –
| | | | | | | |
50 100 150 200 250 300 350 400
Lot Size (Q)
Best Q Current
(EOQ) Q
Calculating EOQ
 The EOQ formula:
2DS
EOQ =
H
 Time between orders
EOQ
TBOEOQ = (12 months/year)
D

Finding the EOQ, Total Cost, TBO
EXAMPLE 12.2
For the bird feeders in Example 12.1, calculate the EOQ and its
total annual cycle-inventory cost. How frequently will orders be
placed if the EOQ is used?
SOLUTION
Using the formulas for EOQ and annual cost, we
get
2DS 2(936)(45)
EOQ = = = 74.94 or 75 units
H 15

Figure 12.5 shows that the total annual cost is much less than
the $3,033 cost of the current policy of placing 390-unit orders.
Figure 12.5 – Total Annual Cycle-Inventory Costs Based

on EOQ Using Tutor 12.2

When the EOQ is used, the TBO can be expressed in various
ways for the same time period.
EOQ 75
TBOEOQ = = = 0.080 year
D 936
EOQ 75
TBOEOQ = (12 months/year) = (12) = 0.96 month
D 936
EOQ 75
TBOEOQ = (52 weeks/year) = (52) = 4.17 weeks
D 936
EOQ 75
TBOEOQ = (365 days/year) = (365) = 29.25 days
D 936

Application 12.1
Suppose that you are reviewing the inventory policies on an
$80 item stocked at a hardware store. The current policy is to
replenish inventory by ordering in lots of 360 units. Additional
information is:
D = 60 units per week, or 3,120 units per year
S = $30 per order
H = 25% of selling price, or $20 per unit per year
What is the EOQ?
SOLUTION
2DS 2(3,120)(30)
EOQ = = = 97 units
H 20

Application 12.1
What is the total annual cost of the current policy (Q = 360), and
how does it compare with the cost with using the EOQ?
Current Policy EOQ Policy

Q = 360 units Q = 97 units
C = (360/2)(20) + (3,120/360)(30) C = (97/2)(20) + (3,120/97)(30)
C = 3,600 + 260 C = 970 + 965
C = $3,860 C = $1,935

Application 12.1
What is the time between orders (TBO) for the current policy
and the EOQ policy, expressed in weeks?
SOLUTION
360
TBO360 = (52 weeks per year) = 6 weeks
3,120
97
TBOEOQ = (52 weeks per year) = 1.6 weeks
3,120

Managerial Insights
TABLE 12.1 | SENSITIVITY ANALYSIS OF THE EOQ

Parameter EOQ Parameter EOQ Comments
Change Change
Increase in lot size is in proportion to the

Demand 2DS
H
↑ ↑ square root of D.
Weeks of supply decreases and inventory

Order/Setup
Costs
2DS
H
↓ ↓ turnover increases because the lot size
decreases.
Holding Larger lots are justified when holding

Costs
2DS
H
↓ ↑ costs decrease.

Inventory Control Systems
 Two important questions:

 How much?
 When?
 Nature of demand
 Independent demand
 Dependent demand

Inventory Control Systems
 Continuous review (Q) system

 Reorder point system (ROP) and fixed order
quantity system
 For independent demand items
 Tracks inventory position (IP)
 Includes scheduled receipts (SR), on-hand
inventory (OH), and back orders (BO)
osition = On-hand inventory + Scheduled receipts

– Backorders
IP = OH + SR – BO

Selecting the Reorder Point
IP IP IP
Order Order Order Order
received received received received
On-hand inventory
Q Q Q
OH OH OH
R
Order Order Order
placed placed placed
L L L Time
TBO TBO TBO
Figure 12.6 – Q System When Demand and Lead Time Are Constant and Certain

Application 12.2
The on-hand inventory is only 10 units, and the reorder point

R is 100. There are no backorders and one open order for
200 units. Should a new order be placed?
SOLUTION
IP = OH + SR – BO = 10 + 200 – 0 = 210
R = 100
Decision: Place no new order

Placing a New Order
EXAMPLE 12.3
Demand for chicken soup at a supermarket is always 25 cases
a day and the lead time is always 4 days. The shelves were just
restocked with chicken soup, leaving an on-hand inventory of
only 10 cases. No backorders currently exist, but there is one
open order in the pipeline for 200 cases. What is the inventory
position? Should a new order be placed?
SOLUTION
R = Total demand during lead time = (25)(4) = 100 cases
IP = OH + SR – BO
= 10 + 200 – 0 = 210 cases

Continuous Review Systems
 Selecting the reorder point with variable demand

and constant lead time
oint = Average demand during lead time

+ Safety stock
= dL + safety stock
where
d = average demand per week (or day or months)
L = constant lead time in weeks (or days or months)

IP IP IP
Order Order
Order
received
received received
Order
On-hand inventory
received
Q Q Q
R
Order Order Order
placed placed placed
0
L1 L2 L3 Time
TBO1 TBO2 TBO3
Figure 12.7 – Q System When Demand Is Uncertain

Reorder Point
1. Choose an appropriate service-level policy

 Select service level or cycle service level
 Protection interval
2. Determine the demand during lead time

probability distribution
3. Determine the safety stock and reorder

point levels

Demand During Lead Time
 Specify mean and standard deviation
 Standard deviation of demand during lead time
σdLT = σd2L = σd L
 Safety stock and reorder point
Safety stock = zσdLT

where
z = number of standard deviations needed to
achieve the cycle-service level
σdLT = stand deviation of demand during lead time
Reorder point = R = dL + safety stock

σt = 15 σt = 15 σt = 15
+ + =
75 75 75
Demand for week 1 Demand for week 2 Demand for week 3
σt = 25.98
Figure 12.8 – Development of Demand

Distribution for the Lead
Time
225
Demand for 3-week lead time
Cycle-service level = 85%
Probability of stockout
(1.0 – 0.85 = 0.15)
Average
demand
during
lead time R
zσdLT
Figure 12.9 – Finding Safety Stock with a Normal Probability Distribution for an
85 Percent Cycle-Service Level

Reorder Point for Variable Demand
EXAMPLE 12.4
Let us return to the bird feeder in Example

12.2. The EOQ is 75 units. Suppose that the
average demand is 18 units per week with
a standard deviation of 5 units. The lead
time is constant at two weeks. Determine
the safety stock and reorder point if
management wants a 90 percent cycle-
service level.

SOLUTION
In this case, σd = 5, d = 18 units, and L = 2 weeks, so
σdLT = σd L = 5 2 = 7.07. Consult the body of the table in the
Normal Distribution appendix for 0.9000, which corresponds to
a 90 percent cycle-service level. The closest number is 0.8997,
which corresponds to 1.2 in the row heading and 0.08 in the
column heading. Adding these values gives a z value of 1.28.
With this information, we calculate the safety stock and reorder
point as follows:
Safety stock = zσdLT = 1.28(7.07) = 9.05 or 9 units
rder point = dL + Safety stock = 2(18) + 9 = 45 units

Application 12.3
Suppose that the demand during lead time is normally
distributed with an average of 85 and σdLT = 40. Find the safety
stock, and reorder point R, for a 95 percent cycle-service level.
SOLUTION
Safety stock = zσdLT = 1.645(40) = 65.8 or 66 units
R = Average demand during lead time + Safety stock
R = 85 + 66 = 151 units
Find the safety stock, and reorder point R, for an 85 percent

cycle-service level.
Safety stock = zσdLT = 1.04(40) = 41.6 or 42 units
R = 85 + 42 = 127 units

and Lead Time
 Often the case that both are variable
 The equations are more complicated
Safety stock = zσdLT

R = (Average weekly demand  Average lead time)
+ Safety stock
= dL + Safety stock
re
d = Average weekly (or daily or monthly) demand
L = Average lead time
σd = Standard deviation of weekly (or daily or monthly) demand
σLT = Standard deviation of the lead time
σdLT = Lσd2 + d2σLT2

Reorder Point
EXAMPLE 12.5
The Office Supply Shop estimates that the average demand for
a popular ball-point pen is 12,000 pens per week with a
standard deviation of 3,000 pens. The current inventory policy
calls for replenishment orders of 156,000 pens. The average
lead time from the distributor is 5 weeks, with a standard
deviation of 2 weeks. If management wants a 95 percent cycle-
service level, what should the reorder point be?

Reorder Point
SOLUTION
We have d = 12,000 pens, σd = 3,000 pens, L = 5 weeks,
and σLT = 2 weeks
σdLT = Lσd2 + d2σLT2 = (5)(3,000)2 + (12,000)2(2)2

= 24,919.87 pens
From the Normal Distribution appendix for 0.9500, the
appropriate z value = 1.65. We calculate the safety stock and
reorder point as follows:
y stock = zσdLT = (1.65)(24,919.87)

= 41,117.79 or 41,118 pens
fety stock = (12,000)(5) + 41.118

= 101,118 pens

Application 12.4
Grey Wolf lodge is a popular 500-room hotel in the

North Woods. Managers need to keep close tabs on
all of the room service items, including a special
pint-scented bar soap. The daily demand for the
soap is 275 bars, with a standard deviation of 30
bars. Ordering cost is $10 and the inventory holding
cost is $0.30/bar/year. The lead time from the
supplier is 5 days, with a standard deviation of 1 day.
The lodge is open 365 days a year.
What should the reorder point be for the bar of soap
if management wants to have a 99 percent cycle-
service?

Application 12.4
SOLUTION
d = 275 bars
L = 5 days
σd = 30 bars
σLT = 1 day
σdLT = Lσd2 + d2σLT2 283.06
= bars
From the Normal Distribution appendix for 0.9900, z = 2.33.

We calculate the safety stock and reorder point as follows;
= (2.33)(283.06) = 659.53 or 660 bars

fety stock = dL + safety stock
= (275)(5) + 660 = 2,035 bars

 Two-Bin system
 Visual system
 An empty first bin signals the need to place an order
 Calculating total systems costs
Total cost = Annual cycle inventory holding cost

+ Annual ordering cost
+ Annual safety stock holding cost
Q D
C= (H) + (S) + (H) (Safety stock)
2 Q

Application 12.5
The Discount Appliance Store uses a continuous

review system (Q system). One of the company’s
items has the following characteristics:
Demand = 10 units/wk (assume 52 weeks per

year)
Ordering and setup cost (S) = $45/order
Holding cost (H) = $12/unit/year
Lead time (L) = 3 weeks (constant)
Standard deviation in weekly demand = 8 units
Cycle-service level = 70%

Application 12.5
SOLUTION
What is the EOQ for this item?
D = 10/wk  52 wks/yr = 520 units
2DS 2(520)(45)
EOQ = = = 62 units
H 12
What is the desired safety stock?
σdLT = σd L = 8 3 = 14 units
Safety stock = zσdLT = 0.525(14) = 8 units

Application 12.5
What is the desired reorder point R?

R= 3(10) + 8 = 38 units
What is the total annual cost?
62 520
C= ($12) + ($45) + 8($12) = $845.42
2 62

Application 12.5
Suppose that the current policy is Q = 80 and R = 150. What will
be the changes in average cycle inventory and safety stock if
your EOQ and R values are implemented?
Reducing Q from 80 to 62
Cycle inventory reduction = 40 – 31 = 9 units
Safety stock reduction = 120 – 8 = 112 units
Reducing R from 150 to 38

Periodic Review System (P)
 Fixed interval reorder system or periodic reorder

system
 Four of the original EOQ assumptions maintained

 No constraints are placed on lot size
 Holding and ordering costs only
 Independent demand
 Lead times are certain
 Order is placed to bring the inventory position up

to the target inventory level, T, when the
predetermined time, P, has elapsed

Periodic Review System (P)
T
IP IP IP
Order Order Order
received received received
On-hand inventory
Q1 Q3
OH Q2 OH
IP1
IP3
Order Order
placed placed
IP2
L L L Time
P P
Protection interval
Figure 12.10 – P System When Demand Is Uncertain

How Much to Order in a P System
EXAMPLE 12.6
A distribution center has a backorder for five 36-inch color TV
sets. No inventory is currently on hand, and now is the time to
review. How many should be reordered if T = 400 and no
receipts are scheduled?
SOLUTION
IP = OH + SR – BO
= 0 + 0 – 5 = –5 sets
T – IP = 400 – (–5) = 405 sets
That is, 405 sets must be ordered to bring the inventory

position up to T sets.

Application 12.6
The on-hand inventory is 10 units, and T is 400. There are no
back orders, but one scheduled receipt of 200 units. Now is the
time to review. How much should be reordered?
SOLUTION
IP = OH + SR – BO
= 10 + 200 – 0 = 210
T – IP = 400 – 210 = 190
The decision is to order 190 units

Periodic Review System
 Selecting the time between reviews,

choosing P and T
 Selecting T when demand is variable and
lead time is constant
 IP covers demand over a protection interval of
P+L
 The average demand during the protection
interval is d(P + L), or
T = d(P + L) + safety stock for protection interval
Safety stock = zσP + L , where σP + L =  d P  L

Calculating P and T
EXAMPLE 12.7
Again, let us return to the bird feeder example.

Recall that demand for the bird feeder is normally
distributed with a mean of 18 units per week and a
standard deviation in weekly demand of 5 units. The
lead time is 2 weeks, and the business operates 52
weeks per year. The Q system developed in Example
12.4 called for an EOQ of 75 units and a safety stock
of 9 units for a cycle-service level of 90 percent.
What is the equivalent P system? Answers are to be
rounded to the nearest integer.

Calculating P and T
SOLUTION
We first define D and then P. Here, P is the time between
reviews, expressed in weeks because the data are expressed
as demand per week:
D = (18 units/week)(52 weeks/year) = 936 units
EOQ 75
P= (52) = (52) = 4.2 or 4 weeks
D 936
With d = 18 units per week, an alternative approach is to

calculate P by dividing the EOQ by d to get 75/18 = 4.2 or 4
weeks. Either way, we would review the bird feeder inventory
every 4 weeks.

Calculating P and T
We now find the standard deviation of demand over the
protection interval (P + L) = 6:
 P  L   d P  L  5 6  12.25 units
Before calculating T, we also need a z value. For a 90 percent

cycle-service level z = 1.28. The safety stock becomes
Safety stock = zσP + L = 1.28(12.25) = 15.68 or 16 units
We now solve for T:
T = Average demand during the protection interval + Safety stock

= d(P + L) + safety stock
= (18 units/week)(6 weeks) + 16 units = 124 units

Periodic Review System
 Use simulation when both demand and lead time

are variable
 Suitable to single-bin systems
 Total costs for the P system are the sum of the
same three cost elements as in the Q system
 Order quantity and safety stock are calculated
differently
dP D
C= (H) + (S) + HzσP + L
2 dP

Application 12.7
Return to Discount Appliance Store (Application 12.4), but now
use the P system for the item.
Previous information
Demand = 10 units/wk (assume 52 weeks per year) = 520
EOQ = 62 units (with reorder point system)
Lead time (L) = 3 weeks
Standard deviation in weekly demand = 8 units
z = 0.525 (for cycle-service level of 70%)
Reorder interval P, if you make the average lot size using the
Periodic Review System approximate the EOQ.

Application 12.7
SOLUTION
Reorder interval P, if you make the average lot size using the
Periodic Review System approximate the EOQ.
P = (EOQ/D)(52) = (62/529)(52) = 6.2 or 6 weeks
Safety stock
Safety stock =  d P  L
  0.525  8  6  3  12.6 or 13 units
Target inventory
T = d(P + L) + safety stock for protection interval
T = 10(6 + 3) + 13 = 103 units

Application 12.7
Total cost
dP D
C = 2 (H) + (S) + HzσP + L
dP
10(6) 520
= ($12) + ($45) + (13)($12) = $906.00
2 10(6)

Comparative Advantages
 Primary advantages of P systems

 Convenient
 Orders can be combined
 Only need to know IP when review is made
 Primary advantages of Q systems

 Review frequency may be individualized
 Fixed lot sizes can result in quantity discounts
 Lower safety stocks

Hybrid systems
 Optional replenishment systems

 Optimal review, min-max, or (s,S) system, like the P
system
 Reviews IP at fixed time intervals and places a variable-
sized order to cover expected needs
 Ensures that a reasonable large order is placed
 Base-stock system
 Replenishment order is issued each time a withdrawal is
made
 Order quantities vary to keep the inventory position at R
 Minimizes cycle inventory, but increases ordering costs
 Appropriate for expensive items

Solved Problem 1
Booker’s Book Bindery divides SKUs into three classes,
according to their dollar usage. Calculate the usage values of
the following SKUs and determine which is most likely to be
classified as class A.
SKU Number Description Quantity Used Unit Value

per Year ($)
1 Boxes 500 3.00
2 Cardboard 18,000 0.02
(square feet)
3 Cover stock 10,000 0.75
4 Glue (gallons) 75 40.00
5 Inside covers 20,000 0.05
6 Reinforcing tape 3,000 0.15
(meters)
7 Signatures 150,000 0.45

Solved Problem 1
SOLUTION
The annual dollar usage for each item is determined by
multiplying the annual usage quantity by the value per unit. As
shown in Figure 12.11, the SKUs are then sorted by annual
dollar usage, in declining order. Finally, A–B and B–C class
lines are drawn roughly, according to the guidelines presented
in the text. Here, class A includes only one SKU (signatures),
which represents only 1/7, or 14 percent, of the SKUs but
accounts for 83 percent of annual dollar usage. Class B
includes the next two SKUs, which taken together represent 28
percent of the SKUs and account for 13 percent of annual dollar
usage. The final four SKUs, class C, represent over half the
number of SKUs but only 4 percent of total annual dollar usage.

Solved Problem 1
Quantity
SKU Unit Value Annual Dollar
Description Used per
Number ($) Usage ($)
Year
1 Boxes 500  3.00 = 1,500
2 Cardboard 18,000  0.02 = 360
(square feet)
3 Cover stock 10,000  0.75 = 7,500
4 Glue (gallons) 75  40.00 = 3,000
5 Inside covers 20,000  0.05 = 1,000
6 Reinforcing tape 3,000  0.15 = 450
(meters)
7 Signatures 150,000  0.45 = 67,500
Total 81,310

Solved Problem 1
Class C
100 – Class B
Class
90 – A
Percentage of Dollar Value
80 –
70 –
60 –
50 –
40 –
30 – Figure 12.11 – Annual Dollar Usage for
Class A, B, and C SKUs
20 –
Using Tutor 12.2
10 –
0–
10 20 30 40 50 60 70 80 90 100
Percentage of SKUs

Solved Problem 2
Nelson’s Hardware Store stocks a 19.2 volt cordless drill that is
a popular seller. Annual demand is 5,000 units, the ordering
cost is $15, and the inventory holding cost is $4/unit/year.
a. What is the economic order quantity?
b. What is the total annual cost for this inventory item?
SOLUTION
a. The order quantity is
2DS 2(5,000)($15)
EOQ = =
H $4
= 37,500 = 193.65 or 194 drills
b. The total annual cost is
Q D 194 5,000
C= (H) + (S) = ($4) + ($15) = $774.60
2 Q 2 194
Solved Problem 3
A regional distributor purchases discontinued appliances from
various suppliers and then sells them on demand to retailers in
the region. The distributor operates 5 days per week, 52 weeks
per year. Only when it is open for business can orders be
received. Management wants to reevaluate its current inventory
policy, which calls for order quantities of 440 counter-top
mixers. The following data are estimated for the mixer:
Average daily demand (d) = 100 mixers
Standard deviation of daily demand (σd) = 30 mixers
Lead time (L) = 3 days
Holding cost (H) = $9.40/unit/year
Ordering cost (S) = $35/order
Cycle-service level = 92 percent
The distributor uses a continuous review (Q) system

Solved Problem 3
a. What order quantity Q, and reorder point, R, should be used?

b. What is the total annual cost of the system?
c. If on-hand inventory is 40 units, one open order for 440
mixers is pending, and no backorders exist, should a new
order be placed?

Solved Problem 3
SOLUTION
a. Annual demand is
D = (5 days/week)(52 weeks/year)(100 mixers/day)
= 26,000 mixers/year
The order quantity is
2DS 2(26,000)($35)
EOQ = =
H $9.40
= 193,167 = 440.02 or 440 mixers

Solved Problem 3
The standard deviation of the demand during lead time

distribution is
σdLT = σd L = 30 3 = 51.96
A 92 percent cycle-service level corresponds to z = 1.41
Safety stock = zσdLT = 1.41(51.96 mixers) = 73.26 or 73 mixers
Average demand during lead time = dL = 100(3) = 300 mixers
Reorder point (R) = Average demand during lead time + Safety stock
= 300 mixers + 73 mixers = 373 mixers
With a continuous review system, Q = 440 and R = 373

Solved Problem 3
b. The total annual cost for the Q systems is
Q D
C= (H) + Q (S) + (H)(Safety stock)
2
440 26,000
C= ($9.40) + ($35) + ($9.40)(73) = $4,822.38
2 440
c. Inventory position = On-hand

inventory + Scheduled receipts –
Backorders
IP = OH + SR – BO = 40 + 440 – 0 = 480 mixers
Because IP (480) exceeds R (373), do not place a new order

Solved Problem 4
Suppose that a periodic review (P) system is used at the
distributor in Solved Problem 3, but otherwise the data are the
same.
a. Calculate the P (in workdays, rounded to the nearest day)
that gives approximately the same number of orders per
year as the EOQ.
b. What is the target inventory level, T? Compare the P system
to the Q system in Solved Problem 3.
c. What is the total annual cost of the P system?
d. It is time to review the item. On-hand inventory is 40 mixers;
receipt of 440 mixers is scheduled, and no backorders exist.
How much should be reordered?

Solved Problem 4
SOLUTION
a. The time between orders is
EOQ 440
P= (260 days/year) = (260) = 4.4 or 4 days
D 26,000
b. Figure 12.12 shows that T = 812 and safety stock

= (1.41)(79.37) = 111.91 or about 112 mixers. The
corresponding Q system for the counter-top mixer requires
less safety stock.
Figure 12.12 –
OM Explorer Solver
for Inventory
Systems

Solved Problem 4
c. The total annual cost of the P system is
dP D
C = 2 (H) + (S) + (H)(Safety stock)
dP
100(4) 26,000
C= ($9.40) + ($35) + ($9.40)(1.41)(79.37)
2 100(4)
= $5,207.80
d. Inventory position is the amount on hand plus scheduled
receipts minus backorders, or
IP = OH + SR – BO = 40 + 440 – 0 = 480 mixers
The order quantity is the target inventory level minus the
inventory position, or
Q = T – IP = 812 mixers – 480 mixers = 332 mixers
An order for 332 mixers should be placed.
Solved Problem 5
Grey Wolf Lodge is a popular 500-room hotel in the North
Woods. Managers need to keep close tabs on all room service
items, including a special pine-scented bar soap. The daily
demand for the soap is 275 bars, with a standard deviation of
30 bars. Ordering cost is $10 and the inventory holding cost is
$0.30/bar/year. The lead time from the supplier is 5 days, with a
standard deviation of 1 day. The lodge is open 365 days a year.
a. What is the economic order quantity for the bar of soap?
b. What should the reorder point be for the bar of soap if
management wants to have a 99 percent cycle-service level?
c. What is the total annual cost for the bar of soap, assuming a
Q system will be used?

Solved Problem 5
SOLUTION
a. We have D = (275)(365) = 100,375 bars of soap; S = $10; and
H = $0.30. The EOQ for the bar of soap is
2DS 2(100,375)($10)
EOQ = =
H $0.30
= 6,691,666.7 = 2,586.83 or 2,587 bars

Solved Problem 5
b. We have d = 275 bars/day, σd = 30 bars, L = 5 days,
and σLT = 1 day.
σdLT = Lσd2 + d2σLT2 = (5)(30)2 + (275)2(1)2 = 283.06 bars
Consult the body of the Normal Distribution appendix for

0.9900. The closest value is 0.9901, which corresponds to
a z value of 2.33. We calculate the safety stock and
reorder point as follows:
Safety stock = zσdLT = (2.33)(283.06) = 659.53 or 660 bars
y stock = (275)(5) + 660 = 2,035 bars

Solved Problem 5
c. The total annual cost for the Q system is
Q D
C= (H) + Q (S) + (H)(Safety stock)
2
2,587 100,375
C= ($0.30) + ($10) + ($0.30)(660) = $974.05
2 2,587

Solved Problem 6
Zeke’s Hardware Store sells furnace filters. The cost to place an
order to the distributor is $25 and the annual cost to hold a
filter in stock is $2. The average demand per week for the filters
is 32 units, and the store operates 50 weeks per year. The
weekly demand for filters has the probability distribution
shown on the left below.
The delivery lead time from the distributor is uncertain and has
the probability distribution shown on the right below.
Suppose Zeke wants to use a P system with P = 6 weeks and a
cycle-service level of 90 percent. What is the appropriate value
for T and the associated annual cost of the system?

Solved Problem 6
Demand Probability Lead Time (wks) Probability
24 0.15 1 0.05
28 0.20 2 0.25
32 0.30 3 0.40
36 0.20 4 0.25
40 0.15 5 0.05

Solved Problem 6
SOLUTION
Figure 12.13 contains output from the Demand During the
Protection Interval Simulator from OM Explorer.
Figure 12.13 – OM Explorer Solver for Demand during the Protection

Interval

Solved Problem 6
Given the desired cycle-service level of 90 percent, the
appropriate T value is 322 units. The simulation estimated the
average demand during the protection interval to be 289 units,
consequently the safety stock is 322 – 289 = 33 units.
The annual cost of this P system is
6(32) 50(32)
C= ($2) + ($25) + (33)($2)
2 6(32)
= $192.00 + $208.33 + $66.00 = $466.33

Solved Problem 7
Consider Zeke’s inventory in Solved Problem 6. Suppose that
he wants to use a continuous review (Q) system for the filters,
with an order quantity of 200 and a reorder point of 140. Initial
inventory is 170 units. If the stockout cost is $5 per unit, and all
of the other data in Solved Problem 6 are the same, what is the
expected cost per week of using the Q system?
SOLUTION
Figure 12.14 shows output from the Q System Simulator in OM
Explorer. Only weeks 1 through 13 and weeks 41 through 50
are shown in the figure. The average total cost per week is
$305.62. Notice that no stockouts occurred in this simulation.
These results are dependent on Zeke’s choices for the reorder
point and lot size. It is possible that stockouts would occur if
the simulation were run for more than 50 weeks.

Solved Problem 7
Figure 12.14 – OM Explorer Q System Simulator


Inventory Management

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12 Inventory Management

For Operations Management, 9e by

 Inventories are important to all types of

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 2

 Stock-keeping units (SKU)

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 3

 The lot size, Q, that minimizes total annual

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 5

 Don’t use the EOQ

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 6

Receive Inventory depletion

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 Annual holding cost

 (Unit holding cost)

 Total annual cycle-inventory cost

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 8

Annual cost (dollars)

Lot Size (Q)

Figure 12.3 – Graphs of Annual Holding, Ordering, and Total Costs

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 9

 Total annual cycle-inventory and ordering cost

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 10

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 11

The total annual cycle-inventory cost for the current policy is

The total annual cycle-inventory cost for the alternative lot

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 12

cost = (H) + (S)

 The EOQ formula:

 Time between orders

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 14

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 15

Figure 12.5 – Total Annual Cycle-Inventory Costs Based

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 16

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 17

What is the EOQ?

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Current Policy EOQ Policy

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Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 20

TABLE 12.1 | SENSITIVITY ANALYSIS OF THE EOQ

Increase in lot size is in proportion to the

Weeks of supply decreases and inventory

Holding Larger lots are justified when holding

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 21

 Two important questions:

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 22

 Continuous review (Q) system

osition = On-hand inventory + Scheduled receipts

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 23

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 24

The on-hand inventory is only 10 units, and the reorder point

Decision: Place no new order

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 25

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 26

 Selecting the reorder point with variable demand

oint = Average demand during lead time

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 27

Figure 12.7 – Q System When Demand Is Uncertain

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 28

1. Choose an appropriate service-level policy

2. Determine the demand during lead time

3. Determine the safety stock and reorder

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12 – 29