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Reid & Sanders, Operations Management© Wiley 2002
Independent Demand InventoryManagement 12
C H A P T E R
Page 2Reid & Sanders, Operations Management© Wiley 2002
Learning Objectives
• Describe different types & uses of inventory
• Understand relevant inventory costs
• Calculate order quantities
• Evaluate different inventory policies
• Calculate appropriate safety stock policies
• Understand ABC inventory policies
• Compare cycle & periodic counting
Page 3Reid & Sanders, Operations Management© Wiley 2002
Types of Inventory
Page 4Reid & Sanders, Operations Management© Wiley 2002
Uses of Inventory
• Anticipation or seasonal inventory• Safety stock: buffer demand fluctuations• Lot-size or cycle stock: take advantage of
quantity discounts or purchasing efficiencies• Pipeline or transportation inventory• Speculative or hedge inventory• Maintenance, repair, and operating (MRO)
inventories
Page 5Reid & Sanders, Operations Management© Wiley 2002
Objectives & Measures
• Provide desired customer service level:– Percentage of orders shipped on schedule– Percentage of lines shipped on schedule– Percentage of dollar volume shipped on schedule
• Provide for cost-efficient operations:– Total inventory-related costs
• Minimize inventory related investments:– Inventory turnover– Weeks (or days) of supply
Page 6Reid & Sanders, Operations Management© Wiley 2002
Relevant Costs
• Item price• Holding costs
– Variable costs dependent upon the amount of inventory held (e.g.: capital & opportunity costs, storage & insurance, risk of obsolescence)
• Ordering & setup costs:– Fixed cost of placing an order (e.g.: clerical accounting &
physical handling) or setting up production (e.g.: lost production to change tools & clean equipment)
• Shortage costs:– Lost profit, expediting & back ordering expenses
Page 7Reid & Sanders, Operations Management© Wiley 2002
Order Quantity Approaches
• Lot-for-lot: – Order exactly what is needed
• Fixed order quantity:– Order a predetermined amount each time
• Min-max system:– When inventory falls to a set minimum level, order up to
the predetermined maximum level
• Order enough for n periods• Periodic review:
– At specified intervals, order up to a predetermined target level
Page 8Reid & Sanders, Operations Management© Wiley 2002
Periodic Review System
• Target inventory calculation:
• Order quantity calculation:
SSLRPdTI
OHTIQ
Page 9Reid & Sanders, Operations Management© Wiley 2002
Fixed-Order Quantity Models
• Economic Order Quantity (EOQ)
• Economic Production Quantity (EPQ)
• Quantity Discount Model
Page 10Reid & Sanders, Operations Management© Wiley 2002
EOQ Assumptions
• Demand is known & constant - no safety stock is required
• Lead time is known & constant• No quantity discounts are available• Ordering (or setup) costs are constant• All demand is satisfied (no shortages)• The order quantity arrives in a single
shipment
Page 11Reid & Sanders, Operations Management© Wiley 2002
Inventory Profile
Page 12Reid & Sanders, Operations Management© Wiley 2002
EOQ Total Costs
Total annual costs + annual ordering costs + annual holding costs
Page 13Reid & Sanders, Operations Management© Wiley 2002
EOQ: Total Cost Equation
• Minimize the TC by ordering the EOQ:
H
QS
Q
DTCEOQ 2
H
DSEOQ
2
Page 14Reid & Sanders, Operations Management© Wiley 2002
Simple Reorder Point
R = dL
Page 15Reid & Sanders, Operations Management© Wiley 2002
EOQ Example
Page 16Reid & Sanders, Operations Management© Wiley 2002
Solution
Page 17Reid & Sanders, Operations Management© Wiley 2002
EPQ Assumptions
• Same as the EOQ except: inventory arrives in increments & is drawn down as it arrives
Page 18Reid & Sanders, Operations Management© Wiley 2002
EPQ Equations
• Adjusted total cost:
• Maximum inventory:
• Adjusted order quantity:
H
IS
Q
DTC MAX
EPQ 2
p
dQIMAX 1
pd
H
DSEPQ
1
2
Page 19Reid & Sanders, Operations Management© Wiley 2002
Quantity Discount Model Assumptions
• Same as the EOQ, except:– Unit price depends upon the quantity
ordered
• Adjusted total cost equation:
PDHQ
SQ
DTCQD
2
Page 20Reid & Sanders, Operations Management© Wiley 2002
Quantity Discount Procedure
• Calculate the EOQ at the lowest price• Determine whether the EOQ is feasible at
that price – Will the vendor sell that quantity at that price
• If yes, stop – if no, continue• Check the feasibility of EOQ at the next
higher price• Continue to the next slide ...
Page 21Reid & Sanders, Operations Management© Wiley 2002
QD Procedure
• Continue until you identify a feasible EOQ• Calculate the total costs (including purchase
price) for the feasible EOQ model• Calculate the total costs of buying at the
minimum quantity allowed for each of the cheaper unit prices
• Compare the total cost of each option & choose the lowest cost alternative
Page 22Reid & Sanders, Operations Management© Wiley 2002
What if Demand is Uncertain?
Page 23Reid & Sanders, Operations Management© Wiley 2002
Adding Safety Stock
• Order-cycle service level:– From a managerial standpoint, determine
the acceptable probability that demand during lead time won’t exceed on-hand inventory
– Risk of a stockout: 1 – (service level)
Page 24Reid & Sanders, Operations Management© Wiley 2002
Adjusted ReorderPoint Equation
R = reorder point
d = average daily demand
L = lead time in days
z = number of standard deviations associated with desired service level
sigma = standard deviation of demand during lead time
dLzdLR
Page 25Reid & Sanders, Operations Management© Wiley 2002
ABC Classification
• Pareto’s law:– Roughly 20% of inventories will account for 80% of
inventory value
• Divide inventories into A, B, and C categories based on value, risk, & other considerations– Use tight controls & frequent reviews for A items– Use normal methods to manage B items– Use simple, inexpensive systems with large safety
stocks to manage C items (just don’t run out)
Page 26Reid & Sanders, Operations Management© Wiley 2002
Periodic versus Cycle Counting
• Periodic counting:– Take a periodic (often annual) physical
inventory to verify & update records
• Cycle counting:– Count specified items each day (mini
physical inventories)– Frequency with which each item is counted
depends upon its ABC classification
Page 27Reid & Sanders, Operations Management© Wiley 2002
The End
Copyright © 2002 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United State Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.
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