Inventory Planning and Control

Inventory Planning
• Finished goods and spare parts typically belong to independent
demand items in manufacturing organisations
• Two attributes characterise and distinguish independent
demand items:
– Timing of demand: Independent demand items have a continuous
demand
– Uncertainty of demand: There is considerable element of uncertainty
in the demand in the case of independent demand items
• Inventory planning of independent demand items must address
the following two key questions:
– How much?
– When?
 Types of Inventory
• Seasonal Inventory: Seasonality in demand is
absorbed using inventory
• Decoupling Inventory: Complexity of production control
is reduced by splitting manufacturing into stages and
maintaining inventory between these stages
• Cyclic Inventory: Periodic replenishment causes cyclic
inventory
• Pipeline Inventory: Exists due to lead time
• Safety Stock: Used to absorb fluctuations in demand
due to uncertainty
Cyclic, Pipeline and Safety Stocks
A graphical illustration

Cyclic
Stock
Quantity

Pipeline inventory

Safety stock
L

Time
Cyclic inventory, pipeline inventory and safety stocks are critically linked to
“how much” and “when” decisions in inventory planning
 Costs in Inventory Planning
Carrying Cost
• Interest for short-term borrowings for working
capital
• Cost of stores and warehousing
• Administrative costs related to maintaining and
accounting for inventory
• Insurance costs, cost of obsolescence, pilferage,
damages and wastage
• All these costs are directly related to the level of
inventory
 Costs in Inventory Planning
Ordering Cost
• Search and identification of appropriate sources
of supply
• Price negotiation, contracting and purchase
order generation
• Follow-up and receipt of material
• Eventual stocking in the stores after necessary
accounting and verification
• A larger order quantity will require less number
of orders to meet a known demand and vice
versa
Cost of carrying and cost of ordering are fundamentally two
opposing cost structures in inventory planning
 Costs in Inventory Planning
Shortage Cost
• Costs arising out of pushing the order back and
rescheduling the production system to
accommodate these changes
• Rush purchases, uneven utilisation of available
resources and lower capacity utilisation
• Missed delivery schedules leading to customer
dissatisfaction and loss of good will
• The effects of shortage are vastly intangible, it is
indeed difficult to accurately estimate
Inventory Control for deterministic
demand: EOQ Model
Demand during the planning period =D
Order quantity =Q
The cost of ordering per order =Co
Inventory carrying cost per unit per unit time = C c
Q
The average inventory carried by an organisation=
2
Q 
The cost associated with carrying inventory =  * C c 
2 
D 
The total ordering cost is given by  * C o 
Q 
Total cost of the plan =
Total cost of carrying inventory + Total cost of ordering
Q  D 
TC(Q) =  * C 
c +  * C o 

2  Q 
 Inventory Control for deterministic
demand: EOQ Model…
When the total cost is minimum, we obtain the most economic
order quantity (EOQ). By taking the first derivative f with
respect to Q and equating it to zero we can obtain the EOQ
Differentiating total cost equation with respect to Q we obtain,
dTC (Q) C c C o D
  2
dQ 2 Q
The second derivative is positive and hence we obtain the
minimum cost by equating the first derivative to zero.
* 2C o D
Denoting EOQ by Q , we obtain the expression of Q as: Q
* *

Cc
D
The optimal number of orders =
Q*
Q*
Time between orders =
D
 EOQ Model
A graphical representation
Sum of the two costs
Cost of Inventory

Total cost of carrying

Minimum Cost

Total cost of ordering

Economic Level of Inventory

Order Qty.
 Issues in using EOQ Model
Model assumptions
1. The demand is known with certainty
2. Demand is continuous over time
3. There is an instantaneous replenishment of items
4. The items are sourced from an outside supplier
5. Assumptions about order quantity
a) There are no restrictions in the quantity that we can order
b) There are no preferred order quantities for the items
c) No price discount is offered when the order size is large

• Despite this, the EOQ model could be applied with suitable modifications
because it is robust
• Assumptions 3, 4 and 5 can be addressed with required modifications
• Relaxing assumption 1 will result in shortages due to difficulty in
estimating demand
 Inventory Planning Models
Example EOQ
Mean of weekly demand : 2500
Unit cost of the raw material : Rs. 400/-
Ordering cost : Rs. 1000/- per order
Carrying cost percentage : 5% of cost of product
Lead time for procurement : 2 weeks

EOQ Model
Weekly demand = 2500
Number of weeks per year = 52
Annual demand, D =Q *52 = 1,30,000
Carrying cost, Cc = Rs. 20.00 per unit per year
2Co D 2 *1000 *130000
Economic Order Quantity =   3605
Cc 20
130000
Time between orders =  36orders ,365  36  10days
3605
Selective Control of Inventories
Alternative Classification Schemes
• ABC Classification (on the basis of consumption value)
• XYZ Classification (on the basis of unit cost of the item)
– High Unit cost (X Class item)
– Medium Unit cost (Y Class item)
– Low unit cost (Z Class item)
• FSN Classification (on the basis of movement of inventory)
– Fast Moving
– Slow Moving
– Non-moving
• VED Classification (on the basis of criticality of items)
– Vital
– Essential
– Desirable
• On the basis of sources of supply
– Imported
– Indigenous (National Suppliers)
– Indigenous (Local Suppliers)
 ABC Classification
A graphical illustration
100%

90%
Class C
80%
Class B
Consummption value (%)

70%

60%
Class A
50%

40%

30%

20%

10%

0%
0%

0%
10

20

30

60
40

50

70

80

90

10
No. of items (% )