By Subhrajyoti Parida PGDIE 40,Sec.B, Roll No.124.

Def. - A physical resource which a firm stocks with the intent of selling it or meeting unexpected rise in demand or transforming it into a more valuable state. Classification of Inventory Raw Materials Works-in-Process Finished Goods Maintenance, Repair and Overhaul (MRO) , eg. spare parts, extra accessories etc.

Continuous Review System.

Also called as Fixed Quantity /Order Point Model. The inventory status is reviewed almost on daily basis. The order is placed when the inventory level comes down to a re-order level and is the same is expected to arrive when inventory level is equal to safety stock level. Stock qty. to be ordered remains fixed. This is applicable to markets where demand and lead time is highly dynamic and fluctuating.

Q Inventory level R

Re-order point

Safety Stock L
lead time to get a new order in

Time

Periodic Review System.

Also called as Fixed Order Interval/Period Model. Stock qty. ordered is not fixed , but the ordering period/interval remains fixed. Optimum Ordering period is decided based on the customer s demand. Ordering qty. is determined such that certain optimum level of stock is achieved called as Base Stock Level.

Inventory level

Time

The model is suitable when the demand is quite predictive and stable. the suppliers are few/known Lead time variability is minimum Base stock level = (Avg. Demand during r+L days) + (Safety Stock Level) , = [(r + L) x AVGD] + [z x STD x (r + L)] L= supply lead time r = review period Total stock level after receipt of the order = (r x AVGD) + z x STD x (r + L) Avg. inventory level = [r x AVGD]/2 + [z x STD x (r + L)] after order receipt

B) Calculation of Buffer/Safety Stock

Buffer/Safety Stock refers to the minimum qty. of stock which should be maintained to absorb deviations in demand. Optimum safety stock prevents stock out cases and hence improves service level of a warehouse. It also economizes the inventory carrying cost of the stocks.  Safety Stock =z x [STL2 x mean. D 2 + STD2 x mean. L] -- 1

z= value corresponding to req. Service Level Eqn. 1 applicable to both demand and lead time variability.
Only lead time variability , Safety Stock =z x STD x (mean. L) --2

C) Service Level Concept

Service Level : In inventory management, this refers to the probability of success in making the stock available to meet the customer s demand , as against the case of stock out. Service level = Probability of NOT stocking out. It is expressed in percentage .

95% chance of order fulfillment

95% service level means 95 times out of 100 no.s of orders , the order is fulfilled, and 5 times stock out took place. Service level gives the value of z (safety factor) which is used to determine Safety Stock
5% chance of stock out

Safety Stock =z x [STL2 x mean. D 2 + STD2 x mean. L].

D) Price Break and Discounts

Reduction in per-unit price if an order exceeds a specified quantity set by the supplier. Supplier enjoys economy of scale is terms of quantity /truck loads. A temporary reduction/discount in the price of a product during certain period when the demand is expected to increase , i.e during weekends, festive seasons etc.

This leads to expected higher sales for a certain period.

Application of Price Break/Discounts in EOQ Model

Ideal EOQ model doesn t consider price reduction due to quantity or freight discounts

Revised EOQ model with price break consideration :

Q (rev.) = 2(rD/C0 ) + (1-r)Q0 where r = red. In price in %, D= annual avg. demand in units, Co = Inventory carrying cost in %, Q0 = EOQ under ideal condition.

Consider:  D = Total demand for the year  S = Cost to place a single order  H = Cost to hold one unit in inventory for a year  Q = Order quantity Then: Total Cost = Annual Holding Cost + Annual Ordering Cost = [(Q/2) H] + [(D/Q) S]

$
(Q/2)H

Holding cost increases as Q increases . . .

$ Ordering costs per year decrease as Q increases

(Q/2)H

(D/Q)S

Holding Cos 2000 Inventory Cost ($) 1500 1000 500 0

O de ing Cos

o al Cos

17 0

21 0

13 0

Order Qua

EOQ at m nimum total cost

41 0

29 0

33 0

37 0

25 0

10

50

90

E) Economic Order Quantity (EOQ)

EOQ: This refers to the minimum quantity which should be ordered such that ordering cost and inventory carrying cost is minimized. EOQ (without shortage) : [(2SD)/H],

S Ordering cost per unit order D-Annual demand H-Inventory carrying cost

Assumptions in traditional EOQ model:  No shortage in any of the echelons, i.e demand is always met.  Constant purchase and transportation price with respect to time or quantity  No fluctuation in demand or lead time  No inventory in transit  Only one type of product ordered.  No limitation to capital investments.

EOQ (with shortage) :

M/2 -Avg. inventory in units (q-M)/2 Avg. shortage h( M/2)(M/q) - Annual inventory carrying cost s* ( q-M)/2 * (q-M)/q : Annual Shortage cost P Ordering cost per unit order D-Annual demand C-Cost of the item

Total cost (with shortage) = Inv. Carrying cost + Shortage cost + Cost of the stock + Ordering cost

=PD/q + CD+ M 2 h/2q + s( q-M) 2/2q

From above equation,

The optimal qty. to order ,q = [(2PD)/h] x [(h+s)/s](1/2) = EOQ x[(h+s)/s](1/2) The actual order obtained , M = [(2PD)/h] x [(s)/(h+s](1/2) = EOQ x [(s)/(h+s](1/2)

References
Fundamentals of Logistics Management by Lambert & Stock EOQ Model with Backlogging Allowed by Siqian Shen, Dept. of Industrial And Systems Engg.,University of Florida