CHAPTER 6 Inventory Management

Purposes of Inventory
• Enables the firm to achieve economics of scale • Balances supply and demand • Enables specialization in manufacturing • Provides protection from uncertainties in demand and order cycle • Acts as a buffer between critical interfaces within the supply chain
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6-3 6-3 aa The Effect of Reorder Quantity on Average Inventory Investment with Constant Demand and Lead Time

A. Order quantity of 400 units Inventory 400 Order placed Order arrival Order placed Order arrival Average cycle inventory

200

0 Days 10 20 30 40 50 60

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The Effect of Reorder Quantity on Average Inventory Investment with Constant Demand and Lead Time

6-4 6-3 bb

Inventory 200 100 0 Days 10

B. Order quantity of 200 units Order placed Order arrival Average cycle inventory

20

30

40

50

60

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The Effect of Reorder Quantity on Average Inventory Investment with Constant Demand and Lead Time
Inventory 600 C. Order quantity of 600 units Order arrival

6-5 c 6-3 c

Order placed 300

Average cycle inventory

0 Days
McGraw-Hill/Irwin

10

20

30

40

50

60

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Average Inventory Investment Under Conditions of Uncertainty
A. With variable demand
Inve ntory 200 Average cycle inventory

6-6 6-4 aa

Ave ra ge inve nto ry (150)

{{
100 S afe ty s tock (50)

8

10

20 Days

30

40

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Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.

Average Inventory Investment Under Conditions of Uncertainty
B. With variable lead time
Inventory 200 Average cycle inventory

6-7 6-4 bb

Ave ra ge inve ntory (140)

{{
100 S afety s tock (40)

10

12

20 Days

30

40

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Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.

Average Inventory Investment Under Conditions of Uncertainty
C. With variable demand and lead time
Inve ntory 200 Average cycle inventory

6-8 6-4 cc

Ave ra ge inve nto ry (200)

{{
100 S afe ty s tock (10 0)

8

10

12

20 Days

30

40

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Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.

The EOQ Model
EOQ =
where: P = The ordering cost (dollars per order) D = Annual demand or usage of the product (number of units) C = Annual inventory carrying cost (as a percentage of product cost or value) V = Average cost or value of one unit of inventory

6-9 6-5

2PD CV

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Cost Trade-offs to Determine the Most Economic Order Quantity
Annual cost (dollars)
Lowest total cost (EOQ) Total cost

6-10 6-6

Inventory carrying cost

Ordering cost

Size of order
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Cost Trade-offs Required to Determine the Most Economic Order Quantity
Order Quantity Number of Orders (D/Q) Ordering Cost PX (D/Q) Inventory Carrying Cost 1/2 Q X C X V Total Cost

6-11 6-7

40 60 80 100 120 140 160 200 300 400
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120 80 60 48 40 35 30 24 18 12

$ 4,800 3,200 2,400 1,920 1,600 1,400 1,200 960 720 480

$ 500 750 1,000 1,250 1,500 1,750 2,000 2,500 3,750 5,000

$ 5,300 3,950 3,400 3,170 3,100 3,150 3,200 4,460 4,470 5,480

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Symptoms of Poor Inventory
• Increasing numbers of back orders • Increasing dollar investment in inventory with back orders remaining constant. • High customer turnover rate. • Increasing number of orders being canceled. • Periodic lack of sufficient storage space. • Wide variance in inventory turnover among distribution centers and major inventory items.
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6-12 6-8

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