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You are on page 1of 26

MOTIVATION FOR STUDYING

INVENTORY MANAGEMENT

• Economics involved in producing or

purchasing in batches

• Uncertainty in both demand and supply

• Seasonality in demand pattern

• Availability of different Transportation and

Distribution modes

TYPES OF INVENTORY

Manufacturing or purchasing an item at a rate higher than its

consumption rate, to reduce set-up/ordering costs. Involves

trade-off between Inventory and set-up/ordering costs.

Maintaining extra stock over the average requirement to guard

against uncertainty. Involves trade-off between Inventory

Investment and Customer Service level.

TYPES OF INVENTORY

• ANTICIPATION STOCK

Maintaining extra stock to meet peak season demand.

Involves trade-off between Inventory carrying costs and

costs related to changing production levels.

• TRANSPORTATION STOCK

Goods-in–transit arises because of the necessity of

moving material from one place to another. Movement rate

depends on Inventory carrying and Transportation costs.

SELECTIVE CONTROL OF

MATERIALS

ABC ANALYSIS

Classification of all consumption items, based on

the “Consumption Value”.

If Annual Demand = D units

Cost per unit =Rs.C

Then, Consumption value = Rs.(DxC). Based on

this, Inventory of a number of items can be

separated into A, B and C classes.

ABC CLASSIFICATION

account for high consumption value (CV),

say,15% of the items accounting for 70%

of the consumption value.

• B items: say,25% of the items, accounting

for 20% of the consumption value.

• C items: Bulk of the items, say,60%, that

account for 10% of the consumption value.

ABC CLASSIFICATION

EXAMPLE:

Annual Usage/ CV(Rs) Cum.Usage

1. 39400 39400 (39.4%) A

2. 30500 69900 (69.9%) A

3. 10900 80800 (80.8%) B

4. 9800 90600 (90.6%) B

5. 3800 94400 (94.4%) B

6. 2000 96400 (96.4%) C

7. 1800 98200 (98.2%) C

8. 800 99000 (99.0%) C

9. 600 99600 (99.6%) C

10. 400 100000 (100%) C

INVENTORY CONTROL MODELS

DEMAND

PROBLEM P1 PROBLEM P2 PROBLEM P4

PROBLEM P3

PROBLEM P1: INVENTORY CONTROL

FOR STATIC DETERMINISTIC DEMAND

• Consider the following problem: Demand for a

particular item is uniform and 12,000 units per

year. There is a fixed order placement and

receiving cost of Rs. 120 each time an order is

placed. Each item costs Rs. 10 and the retailer

has a holding cost of 20%. Find the quantity that

the store manager should order in each

replenishment lot.

inv. carrying cost

Annual ordering cost = DA/Q

Annual inv. carrying cost = ½ QIC

PROBLEM P1: DETERMINING THE EOQ/

BATCH/CYCLE STOCK

Total annual cost = DA/Q + ½ QIC

On differentiating total cost with respect to Q, we

obtain the Economic Order Quantity (EOQ) as:

________

EOQ = √2DA / IC

D = Annual Demand (Units) = 12,000

A = Cost per Order = Rs. 120

I = Inv. carrying factor (Rs/Rs/ yr)= 0.2

C = Cost per unit = Rs 10

Thus, required Order Quantity = 1200 units

PROBLEM P1: INVENTORY CONTROL

FOR STATIC DETERMINISTIC DEMAND

• P1 allows us to determine the Batch/

Cycle stock.

• It brings out the economics that may exist

in purchasing/producing items in batches.

• The typical tradeoff is between inventory

carrying cost and ordering/setup cost.

• At optimum, the annual inventory carrying

cost is equal to the annual ordering cost.

PROBLEM P1: AN EXTENSION

change that now, the supplier has offered

a discount based on the batch size that is

ordered, say if the order size is between 0

and 799 units, the cost per unit will be

Rs.13 for all units, if the size is between

800 to 1499 units the cost will be Rs.12

and finally cost per unit will be Rs.10 if the

order size is ≥ 1500 units.

PROBLEM P1: AN EXTENSION,

EOQ WITH DISCOUNTS

Here, purchasing cost is also a relevant cost.

Algorithm:

Step 1: Determine EOQ using the lowest cost per unit

(Rs.10). Check whether this EOQ is feasible i.e.whether

it is above 1500. If feasible : Stop, optimal has been

found. If not feasible go to next step.

1500 units. For example, at Q= 1500 units, total cost =

12000 x 10 (purchase cost) + 8 x 120 (ordering cost) +

½ x 1500 x 0.2 x 10 (inventory carrying cost)

PROBLEM P1: AN EXTENSION

Step 3: Determine EOQ using the next higher

cost/unit (Rs.12). Check whether this EOQ is

feasible i.e., whether it is between 800 and 1499. If

feasible, find the minimum of total cost at EOQ,

and total cost at Break Point i.e., TC(EOQ) and

TC(1500). Stop,Q corresponding to the min.cost is

optimal. If not feasible go to step 2. Continue till

end.

PROBLEM P2: INVENTORY CONTROL

FOR STATIC PROBABILISTIC DEMAND

respect to time.

• With uncertainty coming in, besides the ordering

and inventory carrying costs, one more type of

cost becomes relevant, i.e. the cost of shortage.

• Surrogate for the cost of shortage : service level

(SL); 100% SL implies no stock out, 90% SL

implies probability of stock out = 10%.

PROBLEM P2: INVENTORY CONTROL

FOR STATIC PROBABILISTIC DEMAND

For P2, Inventory Control implies answering the

following questions:

• How frequently to check the stock status.

• How much to order

• When to place an order.

The policies for answering the first question

can be broadly divided into two categories:

• Continuous Review Policy, also known as

Transaction Reporting System, as the stock

status needs to be checked only if a transaction

occurs.

• Periodic Review Policy: checking the stock status

every T period.

PROBLEM P2: INVENTORY CONTROL

FOR STATIC PROBABILISTIC DEMAND

• A typical Continuous Review policy may read as

follows: “Go on checking the stock status

continuously, order Q units when the inventory

position drops down to s or below.” Q and s are

respectively the order qty and the reorder level,

the answers to the two major decision variables.

• A typical Periodic Review Policy on the other

hand may read as “ check the stock status every

T months and order so as to bring the inventory

position to S units.” The decision variables in this

case are the review period T and the order up-to

level S.

PROBLEM P2 : AN EXAMPLE

Say, the daily demand of an item is uncertain, and

it can be 1,2 or 3 kg. with all the values being

equally probable. The average demand is not

changing with time. The lead time for procurement

is 2 days. Assume, that (s,Q) policy is used for

Inventory Control, where Q has been found from

Inventory holding and Ordering cost trade-off. The

Manager is interested in finding, when to place the

order so that (a) there is no stock out, (b) Service

Level achieved is 80%.

DETERMINING REORDER LEVEL

(CONT.REVIEW POLICIES)

• Step 1 Find the Probability Distribution of

Demand during the Lead time (L.T),

Demand during LT Prob. Cum.Prob.

2 1/9 1/9

3 2/9 3/9

4 3/9 6/9

5 2/9 8/9

6 1/9 9/9

DETERMINING REORDER LEVEL

(CONT.REVIEW POLICIES)

Interpretation of Cumulative probability : Say,

for demand of 4 during lead time, the cum.prob. is

6/9, i.e, 67%. It implies that during the lead time

there is 67% chance that demand will be ≤ 4 kg.

Thus, if an order is placed with 4Kg. in hand, the

demand will be satisfied for 67% of the time (SL).

Thus, 80% SL implies a Reorder Level of 5Kg.

PROBLEM P2: INVENTORY CONTROL

FOR STATIC PROBABALISTIC DEMAND

• P2 allows us to determine the Buffer/

Safety stock.

• It brings out the economics that may exist

in not allowing shortages.

• The typical tradeoff is between inventory

carrying cost and the shortage cost/

service level.

PROBLEM P3: INVENTORY CONTROL

FOR DYNAMIC DETERMINISTIC DEMAND

AN EXAMPLE: The forecasted monthly requirement

of a consumption item for the next one year is given below.

(Jan to Dec) 25, 55, 65, 85, 75, 63, 51, 57, 115, 87, 52, 91.

The cost per order is Rs.500 and the inventory carrying

cost calculated based on the quantity left at the end of

every month is given as Rs.10 per unit per month. The

manager has to decide how much to order, and when.

PROBLEM P3: CONCEPT OF DOMINANT

SEQUENCE

PROBLEM STATEMENT: the requirement of an item

in the upcoming two months are 100 and 50 units. The

problem is to find the minimum cost purchase plan. The

relevant costs are, ordering cost, and inventory carrying

cost (ICC). Cost per order is Rs. A and ICC is Rs. H per

unit per month levied on the end inventory.

ANALYSIS: As there is no shortage allowed, the

alternative purchase plans can be written as:

9. Procure 100 in first month and 50 in the second

10. Procure 101 in first month and 49 in the second

11. Procure 102 in first month and 48 in the second

PROBLEM P3: CONCEPT OF DOMINANT

SEQUENCE cont.,

The costs of the alternative purchasing plans can

be seen as 2A, 2A + H, 2A +2H……A + 50H. As H

is positive, it is sufficient to consider only the first

and the last alternative. Thus, if the requirement

for the two months are D1 and D2 respectively, it is

sufficient to consider the following two sequences/

plans for optimality: 1. D1 + D2 , 0

2. D1 , D2

These are called the dominant sequences.

PROBLEM P3: CONCEPT OF DOMINANT

SEQUENCE cont.,

The number of dominant sequences for a T period

problem = 2 T-1, thus for a 3 period problem with

requirements D1 ,D2 , D3 , The minimum cost plan

will be one among the following four plans:

• D1 + D2 + D3 , 0,0

• D1 + D2 , 0, D3

• D1 , D2 + D3 , 0

• D1 , D2 , D3

CONCLUDING REMARKS

Approaches to Inventory Management

b) Decisions on Inventory taken without

consideration of Production issues.

c) Simultaneous decisions on Inventory and

Production

Approach (a) has been examined in this

session. Approach (b) will be taken up under

Operations Planning in the next session.

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