BUAD306

Chapter 13 - Inventory Management

Everyday Inventory

 Food
 Gasoline

 Clean clothes…

What else?
Inventory

 Stock or quantity of items kept to meet

demand
 Takes on different forms
 Final goods
 Raw materials
 Purchased/component parts
 Labor
 In-process materials
 Working capital
Inventory

 Static – only one opportunity to buy

and sell units
 Dynamic – ongoing need for units;
reordering must take place
Demand

 Dependent Demand
 Items are used internally to produce a
final product
 Independent Demand
 Items are final products demanded by
external customers
Reasons To Hold Inventory

 To meet anticipated demand

 To smooth production requirements
 To decouple components of the production-
distribution system
 To protect against stock-outs
 To take advantage of order cycles
 To hedge against price increases or to take
advantage of quantity discounts
 To permit operations
Inventory Costs
 Carrying Costs - Storage, warehousing,
insurance, security, taxes, opportunity
cost, depreciation, etc.
 Ordering Costs - Determining
quantities needed, preparing
documentation, shipping, inspection of
goods, etc.
 Stockout Costs – Temporary or
permanent loss of sales / goodwill
when demand cannot be met
Inventory Management

How much and when to order inventory?

 Objective: To keep enough inventory

to meet customer demand AND also
be cost-effective
 Goal: To determine the amount of
inventory to keep in stock - how much
to order AND when to order
Inventory Management
Requirements
 A system to keep track of the inventory
on hand and on order
 A reliable forecast of demand
 Knowledge of lead times
 Reasonable estimates of inventory
costs
 A classification system for inventory
items (ABC)
Inventory Control Systems

 Control the level of inventory by

determining how much to order and
when
 Continuous (Perpetual) Inventory
System - a continual record of the
inventory level for every item is
maintained
 Periodic Inventory System - inventory
on hand is counted at specific time
intervals
Other Control
Systems/Tools
 Universal Product Codes (UPC)
 RFID Tags

 Two-Bin System – two containers of

inventory; reorder when the first is
empty

0
214800
232087768
Considerations

 Lead Time
 Time interval between ordering and
receiving the order
 Cycle Counting
 Physical count of items in inventory
 Usage Rate
 Rate at which amount of inventory is
depleted
 Inventory Cycle
Profile of Inventory Level Over Time
Q Usage
rate

Quantity
on hand

Reorder
point

Time
Receive Place Receive Place Receive
order order order order order
Lead time
Economic Order Quantity

 The EOQ Model determines the

optimal order size that minimizes total
inventory costs
 Optimal Order Quantity

=
2DS = 2 (Annual Demand) (Order Cost)
Q
o H Annual Holding Cost per unit

Length of order cycle =

Qo
D

# Orders / Year =
D
Qo
 Basic EOQ Model

Annual Annual
Total cost = carrying + ordering
cost cost

Qo + DS
TC = H
2 Qo

Where: Qo = Economic order quantity in units

H = Holding (carrying) cost per unit
D = Demand, usually in units per year
S = Ordering cost
 Cost Minimization Goal

The Total-Cost Curve is U-Shaped

Qo D
TC  H S
Annual Cost

2 Qo

Carrying Costs

Ordering Costs

QO (optimal order quantity) Order Quantity

(Q)
 EOQ Example 1
A local office supply store expects to sell
2400 printers next year. Annual carrying
cost is $50 per printer, and ordering cost is
$30. The company operates 300 days a
year.
A) What is the EOQ?
B) How many times per year does the store reorder?
C) What is the length of an order cycle?
D) What is the total annual cost if the EOQ quantity is
ordered?
 EOQ Example 2
A local electronics store expects to sell 500
flat-screen TVs each month during next
year. Annual carrying cost is $60 per TV,
and ordering cost is $50. The company
operates 364 days a year.
A) What is the EOQ?
B) How many times per year does the store reorder?
C) What is the length of an order cycle?
D) What is the total annual cost if the EOQ quantity is
ordered?
 Quantity Discounts

A price discount on an item if

predetermined numbers of units
are ordered
TC =
Carrying cost + Ordering cost + Purchasing cost =
(Q / 2) H + (D / Q) S + PD

where P = Unit Price

 Quantity Discount Example
Campus Computers 2Go Inc. wants to reduce a large
stock of laptops it is discontinuing. It has offered the
University Bookstore a quantity discount pricing
schedule as shown below. Given the discount
schedule and its known costs, the bookstore wants to
determine if it should take advantage of this discount
or order the basic EOQ order size.
Quantity Price Carrying Cost: $200
1 – 49 $1,500 Ordering Cost $1,000
50 – 89 $1,000 Annual Demand 400 units
90 + $800
EPQ – Economic Production
Quantity (OQ with Incremental Replenishment)
 Used when company makes its own
product
 Considers a variety of costs/terms:
 Carrying Cost
 Setup Cost (analogous to ordering costs)
 Maximum and Average Inventory Levels
 Economic Run Quantity
 Cycle Time
 Run Time
EOQ with Incremental
Replenishment (EPQ)
 Definitions
 S = Setup Cost
 H = Holding Cost
 Imax = Maximum Inventory
 Iavg = Average Inventory
 D = Demand/Year
 p = Production or Delivery Rate
 u = Usage Rate
 EOQ with Incremental
Replenishment
Total Cost = Carrying (Imax/2) H + (D/Qo) S
Cost + Setup Cost
Economic run quantity Qo = 2DS/H * p/(p-u)
Cycle time (time between Qo /u
runs)
Run time (production Qo /p
phase)
Maximum Inventory Level Imax = (Qo /p)(p-u)
Average Inventory Level Iaverage = Imax /2
Assumptions

 Only one item is involved

 Annual demand is known
 Usage rate is constant
 Usage occurs continually, production
periodically
 Production rate is constant
 Lead time doesn’t vary
 No quantity discounts
 EOQ Replenishment Example
A toy manufacturer uses 48,000 rubber wheels per
year for its product. The firm makes its own
wheels, which it can produce at a rate of 800 per
day. The toy trucks are assembled uniformly over
the entire year. Carrying cost is $1 per wheel a
year. Setup cost for a production run of wheels is
$45. The firm operates 240 days per year.
Determine the:
Optimal run size
Minimum total annual cost for carrying and setup
Cycle time for the optimal run size
Run time
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

600 1200 1800 1600 1400 1200 1000 800 600 400 200 0 START ALL OVER
Other Considerations

 Safety Stock
 Reorder Point

 Seasonality
 HW #13

A mail-order house
# Boxes Unit Price
uses 18,000 boxes
a year. Carrying 1000-1999 $1.25
costs are $.60 per
box per year and 2000-4999 $1.20
ordering costs are
$96. The following 5000-9999 $1.15
price schedule is
offered. Determine 10000+ $1.10
the EOQ and the #
of orders per year.