Managing Facilitating Goods

Factory Wholesaler Distributor Retailer Customer

Replenishment
order
Replenishment
order
Replenishment
order
Customer
order
Production
Delay
Wholesaler
Inventory
Shipping
Delay
Shipping
Delay
Distributor
Inventory
Retailer
Inventory
Item Withdrawn

Learning Objectives
Discuss the role of information technology in managing inventories.
Describe the functions and costs of an inventory system.
Determine the order quantity.
Determine the reorder point and safety stock for inventory systems
with uncertain demand.
Design a continuous or periodic review inventory-control system.

Conduct an ABC analysis of inventory items.

Determine the order quantity for the single-period inventory case.

Describe the rationale behind the retail discounting model.

Role of Inventory in Services

Decoupling inventories

Seasonal inventories

Speculative inventories

Cyclical inventories

In-transit inventories

Safety stocks
Definitions of Inventory control:
The process of establishing the physical presence of all objects in a museum
for which that museum has custody and is legally responsible (including
objects in the collection, objects on loan to the museum, and objects in custody
of the museum).

the process of maintaining sufficient inventory measures to meet customer
needs, weighted against the cost of carrying inventory to determine an
appropriate inventory level.

Discovering and maintaining the optimum level of investment in inventories.
The main problem of inventory control is balancing ordering costs against
carrying costs in order to calculate the economic order quantify (EQQ) which
minimizes total costs. Ordering costs include clerical costs, stationery,
postage's, telephone, etc.; carrying costs include insurance, rent and internist
foregone.

The tasks and activities related to the maintenance of a company's inventory
levels. Inventory can include the companies products, assets, supplies, and
other physical items. One of the most important tasks involved with inventory
control is that of keeping detailed statistics on the quantity and value of a
company's inventory for tax purposes. In the case of manufacturing firms,
inventory control can become quite complex. ...

Applications where bar coding and other forms of AIDC are used to add or
delete items from inventory with 100% accuracy.

supervision of the supply and storage and accessibility of items in order to
insure an adequate supply without excessive oversupply

Considerations in Inventory
Systems

Type of customer demand

Planning time horizon

Replenishment lead time

Constraints and relevant costs

Relevant Inventory Costs

Ordering costs

Receiving and inspections costs

Holding or carrying costs

Shortage costs

Inventory Management
Questions

What should be the order quantity (Q)?

When should an order be placed, called a

reorder point (ROP)?

How much safety stock (SS) should be

maintained?

Inventory Models

Economic Order Quantity (EOQ)

Special Inventory Models

With Quantity Discounts
Planned Shortages

Demand Uncertainty - Safety Stocks

Inventory Control Systems

Continuous-Review (Q,r)
Periodic-Review (order-up-to)

Single Period Inventory Model

Inventory Levels For EOQ
Model
0
U
n
i
t
s

o
n

H
a
n
d
Q
Q
D
Time

Annual Costs For EOQ Model
0
100
200
300
400
500
600
700
800
900
0
2
0
4
0
6
0
8
0
1
0
0
1
2
0
1
4
0
Order Quantity, Q
A
n
n
u
a
l

C
o
s
t
,

$
Holding Cost
Ordering Cost
Total Cost

EOQ Formula

Notation
D = demand in units per year
H = holding cost in dollars/unit/year
S = cost of placing an order in dollars
Q = order quantity in units

Total Annual Cost for Purchase Lots

EOQ
TCp S D Q H Q + ( / ) ( / ) 2
EOQ
DS
H

2

Annual Costs for Quantity
Discount Model
0 100 200 300 400 500 600 700
22,000
21000
20000
2000
1000
C = $20.00 C = $19.50 C = $18.75
Order quantity, Q
A
n
n
u
a
l

C
o
s
t
,

$

Inventory Levels For Planned
Shortages Model
Q
Q-K
0
-K
T1 T2
TIME
T

Formulas for Special Models

Quantity Discount Total Cost Model

Model with Planned Shortages

TC CD S D Q I CQ
qd
+ + ( / ) ( / ) 2
TC S
D
Q
H
Q K
Q
B
K
Q
b
+

+
( )
2 2
2 2
Q
DS
H
H B
B
*

+
|
.

`
,

2
K Q
H
H B
* *

+
|
.

`
,

Values for Q* and K* as A
Function of Backorder Cost
B Q* K* Inventory Levels
B
0 < < B
B 0
2DS
H
2DS
H
H B
B
+
|
.

`
,

undefined
Q
H
H B
*
+

]
]
]
Q*
0
0
0
0

Demand During Lead Time
Example
+
+ + =
u=3
15 .
u=3 u=3
u=3
15 . 15 .

L
3
d
L

12 ROP
s s
Four Days Lead Time
Demand During Lead time
15 .

Safety Stock (SS)

Demand During Lead Time (LT) has

Normal Distribution with
-
-

SS with r% service level

Reorder Point
Mean d LT
L
( ) ( )
Std Dev LT
L
. .( )
SS z LT
r

ROP SS d
L
+

Continuous Review System
(Q,r)
Average lead time usage, d
L
Reorder point, ROP
Safety stock, SS
Inventory on hand
O
r
d
e
r

q
u
a
n
t
i
t
y
,

E
O
Q
EOQ
EOQ
d
1
d
2
d
3
Amount used during first lead time
First lead
time, LT
1
Order 1 placed
LT
2 LT
3
Order 2 placed Order 3 placed
Shipment 1 received
Shipment 2 received Shipment 3 received
Time

Periodic Review System
(order-up-to)
RP RP RP
Review period
First order quantity, Q1
d
1
Q
2
Q
3
d
2
d
3
Target inventory level, TIL
Amount used during
first lead time
Safety stock, SS
First lead time, LT
1
LT
2
LT
3
Order 1 placed Order 2 placed Order 3 placed
Shipment 1 received Shipment 2 received Shipment 3 received
Time
Inventory on Hand

Inventory Control Systems

Continuous Review System

Periodic Review System

EOQ
DS
H
ROP SS LT
SS z LT
r

RP EOQ
TIL SS RP LT
SS z RP LT
r

+ +
+
/
( )

ABC Classification of Inventory
Items
0
1 0
2 0
3 0
4 0
5 0
6 0
7 0
8 0
9 0
1 0 0
1 1 0
0
1
0
2
0
3
0
4
0
5
0
6
0
7
0
8
0
9
0
1
0
0
P e r c e n t a g e o f i n v e n t o r y i t e m s ( S KUs )
P
e
r
c
e
n
t
a
g
e

o
f

d
o
l
l
a
r

v
o
l
u
m
e
A B
C

Inventory Items Listed in
Descending Order of Dollar Volume
Monthly Percent of
Unit cost Sales Dollar Dollar Percent of
Inventory Item ($) (units) Volume ($) Volume SKUs Class
Computers 3000 50 150,000 74 20 A
Entertainment center 2500 30 75,000
Television sets 400 60 24,000
Refrigerators 1000 15 15,000 16 30 B
Monitors 200 50 10,000
Stereos 150 60 9,000
Cameras 200 40 8,000
Software 50 100 5,000 10 50 C
Computer disks 5 1000 5,000
CDs 20 200 4,000
Totals 305,000 100 100

Single Period Inventory Model
Newsvendor Problem Example
D = newspapers demanded
p(D) = probability of demand
Q = newspapers stocked
P = selling price of newspaper, $10
C = cost of newspaper, $4
S = salvage value of newspaper, $2
C
u
= unit contribution: P-C = $6
C
o
= unit loss: C-S = $2

Single Period Inventory Model
Expected Value Analysis
Stock Q
p(D) D 6 7 8 9 10
.028 2 4 2 0 -2 -4
.055 3 12 10 8 6 4
.083 4 20 18 16 14 12
.111 5 28 26 24 22 20
.139 6 36 34 32 30 28
.167 7 36 42 40 38 36
.139 8 36 42 48 46 44
.111 9 36 42 48 54 52
.083 10 36 42 48 54 60
.055 11 36 42 48 54 60
.028 12 36 42 48 54 60
Expected Profit $31.54 $34.43 $35.77 $35.99 $35.33

Single Period Inventory Model
Incremental Analysis
E (revenue on last sale) E (loss on last sale)
P ( revenue) (unit revenue) P (loss) (unit loss)

P D Q C P D Q C
u o
( ) ( ) <

[ ] 1 < < P D Q C P D Q C
u o
( ) ( )
P D Q
C
C C
u
u o
( ) <
+
(Critical Fractile)
where:
C
u
= unit contribution from newspaper sale ( opportunity cost of underestimating demand)
C
o
= unit loss from not selling newspaper (cost of overestimating demand)
D = demand
Q = newspaper stocked

Critical fractile for the
newsvendor problem
0 2 4 6 8 10 12 14
Ne w s pape r de m and, Q
P
r
o
b
a
b
i
l
i
t
y
P(D<Q)
(C
o
applies)
P(D>Q)
(C
u
applies)
0.722
Retail Discounting Model

S = current selling price

D = discount price

P = profit margin on cost (% markup as decimal)

Y = average number of years to sell entire stock of dogs at

current price (total years to clear stock divided by 2)

N = inventory turns (number of times stock turns in one year)

Loss per item = Gain from revenue
S D = D(PNY)
) 1 ( PNY
S
D
+

Topics for Discussion

Discuss the functions of inventory for different

organizations in the supply chain.

How would one find values for inventory costs?

How can information technology create a

competitive advantage through inventory
management?

How valid are the assumptions for the EOQ model?

How is a service level determined for inventory

items?

What inventory model would apply to service

capacity such as seats on an aircraft?
Interactive Exercise
The class engages in an estimation of the cost
of a 12-ounce serving of Coke in various
situations (e.g., supermarket, convenience
store, fast-food restaurant, sit-down restaurant,
and ballpark). What explains the differences?