INVENTORY MANAGEMENT

Chapter 7 Logistics Management Vinod V Sople Chapter S!ppl" Chain Logistics Management #onald $ %o&erso'( #a)id $ Closs( M %i'*" Cooper

Contents
Definition, role, importance Inventory Functionality Purpose of inventory holding / Reasons for carrying inventory Types of inventories * Inventory & profitability Impact of inventory on total logistical cost ** Inventory management ob!ectives / importance "ymptoms of poor inventory management Improving effectiveness of inventory management * Improvise the slides of Inventory & profitability for Impact or effect of Carrying costs on financial records ** Improvise the slides of Inventory management objectives for inventory management importance 2

+++ Contents

Inventory turnover Inventory Policy "ervice levels Planning Inventory

Reorder level #R$%& 'conomic $rder (uantity #'$(&

) *ssumptions & limitations of '$(

'conomic +atch (uantity #'+(& "afety stoc,

3

-umericals

In)entor"
#E,INITION

"toc, of items ,ept on hand by a organi.ation to be used to meet customer demand The ra/ materials, /or,0in0process goods and finished goods that are considered to be the portion of a business1s assets that are ready or /ill be ready for sale

+++ In)entor"

2irtually every type of organi.ation maintains some type of inventory

3hatever form of inventory an organi.ation carries & /hatever the purpose of carrying the inventory, it often represents a significant cost to an organi.ation For many different organi.ations, inventory maybe the largest current asset If a firm carries e4cessive inventory, it is estimated that the average inventory carrying costs could be 567 of the inventory costs

Role o- In)entor"

To match the supply and demand situation some inventory al/ays e4ists in the supply chain process Inventory is spread throughout the supply chain from ra/ materials to /or, in process to finished goods held by suppliers, manufacturers, distributors and retailers The roles played by inventory in the supply chain

Maximize Product Demand Minimize Costs

+++ Role o- In)entor"

Maximize Product Demand Inventory ma,es it possible to increase the amount of demand that can be satisfied by having product ready and available /hen the customer /ants it e8g8 In a retail store, inventory is intentionally ,ept for meeting the future demand Minimize Costs 9inimi.e the cost through 'ffective inventory management %ean manufacturing *chieving economies of scale during the process of production and distribution 7

Importance o- In)entor"

Inventories allo/ for smooth flo/ of production processes by ensuring that ade:uate flo/ of ra/ materials, components are available Inventories of manufactured goods reduce stoc,0out situations /hich could result in loss of customers & revenue

In)entor" ,!nctionalit"

Inventory functionality are the functions served by managing inventory Ideally there should be a .ero0inventory based supply chain Practically a .ero0inventory based supply chain is not possible 9ost firms carry an average inventory that e4ceeds their basic re:uirements In the supply chain, inventories are usually located /ith manufacturers, /holesalers & retailers Irrespective of /here the inventory is located in the supply chain, inventory serves the follo/ing functions The four functions served by inventory are

eographical !pecialization Decoupling

!upply " Demand #alancing #uffering $ncertainties

9

+++ In)entor" ,!nctionalit"

eographical !pecialization

Inventory allo/s firms /ith subsidiaries to speciali.e The need for geographical speciali.ation arises because various factors of production vi.8 po/er, materials, /ater, labour, are located at a considerable distance from the ma!or mar,ets and from each other ;ence for economical gains, manufacturing operations are usually located close to the sources of these factors of production The manufactured goods / ra/ materials from various locations are collected at a simple /arehouse / plant to assemble into the final product

10

+++ In)entor" ,!nctionalit"

eographical !pecialization

'conomies gained through geographical speciali.ation invariably offset increased inventory & transportation cost e8g8 P&< uses distribution centres to combine products from its laundry, personal care, health care and feminine care divisions to offer the customer a single integrated shipment

11

+++ In)entor" ,!nctionalit"

Decoupling

Provides for increasing operating efficiency /ithin a single manufacturing facility by stoc%piling &or%'in'process inventory bet/een production operations Decoupling increases the operating efficiency at a single location /hile geographical speciali.ation includes multiple locations ;o/ever, =IT, DRP etc have reduced the economic benefits of decoupling considerably
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+++ In)entor" ,!nctionalit"

!upply " Demand #alancing

Production & consumption cycles never match +alancing is concerned /ith elapsed time bet/een consumption and manufacturing as balancing inventory reconciles supply availability /ith demand The finished goods inventory helps meet demand /hen material is no longer available e8g8 $ranges are available in plenty from December to February8 ;o/ever demand for orange !uices is ma4imum from 9arch to 9ay
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+++ In)entor" ,!nctionalit"

((( !upply " Demand #alancing

Firms dealing /ith seasonal products, must accumulate inventory in advance of seasonal demand e8g8 an apparels manufacture sees some demand year0round but >67 sales happen during the festive season of Di/ali +y manufacturing to stoc,, production can be ,ept at a constant level throughout the year This helps reduce idle plant capacity & maintain constant labor force ,eeping costs lo/
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+++ In)entor" ,!nctionalit"

((( !upply " Demand #alancing

$rgani.ations try to anticipate demand & accordingly manufactured products In case of short selling seasons, manufacturers, /holesalers and retailers are forced to ta,e an inventory position far in advance of pea, selling season e8g8 umbrellas From retailers? perspective, an inventory position is planned > months prior to the pea, selling period The main function of balancing supply & demand is to ensure that investment in stoc,s is li:uidated completely /ithin the season

15

+++ In)entor" ,!nctionalit"

#uffering $ncertainties

;olding inventory as safety stoc, protects against t/o types of uncertainties

Demand in e4cess of forecast during the performance cycle vi. customers? re:uest more or less units than planned Delays in the performance0cycle length itself vi. delay in order receipt, order processing, or transportation

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+++ In)entor" ,!nctionalit"

((( #uffering $ncertainties

Inventory can buffer the follo/ing interfaces, creating time & place utility

"upplier & purchasing Production & mar,eting

9ar,eting & distribution Intermediary & customer

Purchasing & production Distribution & intermediary

Inventory at the above interfaces helps ensure demand is met & stoc,0outs are minimi.ed

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Reasons ,or Carr"ing In)entor"

Inventory is re:uired for producing goods & providing services to customers In case of +0@0+, a firm1s goods are re:uired to ,eep the customer1s manufacturing operation running ;ence inventory plays a crucial role in the supply chain of a firm Inventory helps ,eep a smooth flo/ of products across a supply chain ;o/ever holding e4cess inventory in the supply chain results in additional costs
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+++ Reasons ,or Carr"ing In)entor"

The benefits & losses of carrying inventory should be evaluated in light of the follo/ing reasons

Meeting Production )e*uirements !upporting +perational )e*uirements Customer !ervice Considerations ,edge -gainst .uture /xpectations /conomies of !cale
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+++ Reasons ,or Carr"ing In)entor"

Meeting Production )e*uirements

Ra/ materials, component parts are re:uired for manufacturing finished goods 9anufacturing organi.ations ,eep stoc,s of ra/ material to meet continuous re:uirements of production & honor order commitments Increasingly organi.ations have started adopting =IT principle, nonetheless some stoc, of ra/ material have to be ,ept on hand to meet contingencies 3or,0in0progress inventory constitutes ma!or portion of production0related inventory Reduction in /or,0in0progress inventory results in reduction in inventory0related investments 20
20

+++ Reasons ,or Carr"ing In)entor"

!upporting +perational )e*uirements

To support production operations, spare parts of production machineries, consumables such as lubricating oils, chemicals, /elding rods etc are also re:uired 9any a times firms ,eep si.able stoc, of consumables & spare parts of machineries to prevent stoppage of production

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+++ Reasons ,or Carr"ing In)entor"

Customer !ervice Considerations

Firms must maintain sufficient spare parts to honor guarantees / /arranties & service contracts Timely availability of spare parts is crucial to providing timely service to customers /hich results in customer satisfaction Aan be a source of competitive advantage %evel of service spare parts maintained is related to level of customer service offered by the firm 9aintaining a significant level of service spare parts & ,eeping it replenished re:uires si.able investments
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+++ Reasons ,or Carr"ing In)entor"

,edge -gainst .uture /xpectations

To ta,e care of shortages in material availability or anticipated increase in the price of ra/ materials, firms buy e4cess inventory Firms also tend to stoc, up critical material to ensure running of operations /ithout interruptions This approach tends to increase inventory levels for short periods of time ;o/ever, benefits derived from ,eeping e4cess inventory out/eigh its carrying cost
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+++ Reasons ,or Carr"ing In)entor"

/conomies of !cale

+y holding inventory a firm can reali.e economies of scale in purchasing, manufacturing, and transportation If purchasing buys large :uantities 0 the firm can get :uantity discounts 9anufacturing can have longer production runs, causing reduction in per unit cost of production Transportation can move larger volumes and get economies of scale through better asset utili.ation / transportation rates
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T"pes o- In)entories
The industry different types of inventories held at different points in the supply chain / integrated logistics channel )a& materials Procured materials and components scheduled for use in production 0or% in process 10IP2 9aterials and components that have begun their transformation to finished goods .inished goods <oods ready for sale to customers at source or at distribution center

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+++ T"pes o- In)entories

-verage Inventory Aonsists of the materials, components, /or,0in0progress, & finished goods typically stoc,ed in logistical facilities The appropriate level of inventory must be determined for each facility Includes cycle stoc,, safety stoc, and in0transit inventory Cycle !toc% " 3ot size stoc% *B* +ase "toc, The portion of average inventory that results through replenishment *t the beginning of a order cycle, stoc, is at a ma4imum level Does not include safety stoc, 26

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+++ T"pes o- In)entories

Cycle !toc% Daily customer demands 4dra& off4 inventory until stoc, level reaches .ero

+efore this a replenishment order Cne/ stoc,D must be initiated so that stoc, arrives before stoc,0out occurs The replenishment inventory is called order *uantity The average inventory held in possession as a result of the ordering process is called base stoc% Aonsidering only the order :uantity, average inventory is e:ual to one0half of ordered :uantity
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+++ T"pes o- In)entories

!afety " #uffer !toc% Inventory /hich protects the firm against stoc,0outs due to some unforeseen circumstances or uncertainty in supply or demand situation

Aonsidering safety stoc,, average inventory is e:ual to one0half of ordered :uantity E safety stoc,

In'transit Inventory *B* Pipeline Inventory / Transit Inventory

"toc, /hich is in transit vi. in the process of distribution Inventory /hich has left the firm1s plant but has not yet been delivered
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+++ T"pes o- In)entories

((( In'transit Inventory

"toc, is either moving in a transport vehicle or is a/aiting movement at a transport terminal -ot in possession of the o/ner i8e8 the organi.ation, hence it cannot be put to any use ;o/ever it is an asset and has been paid for Previously it /as difficult to identify the e4act location of this inventory, in modern times due to <P" trac,ing of vehicles, e4act location of transit inventory can be ,no/n
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+++ T"pes o- In)entories

((( In'transit Inventory

3hether transit inventory is treated as a part of average inventory depends on condition regarding transfer of o/nership

If o/nership of inventory is transferred at the origin Cstart of !ourneyD then it should be treated as part of average inventory If o/nership of inventory is transferred at the destination Cend of !ourneyD then it should not be treated as part of average inventory
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In)entor" . /ro-ita*ilit"

%ogistics cost elements such as transportation or /arehousing are e4plicitly mentioned in firm1s financial statements ;ence these logistics costs are apparent in the firm1s financial statements ;o/ever inventory related costs are not as apparent In a firm1s financial statement

Inventory is stated as a current asset There usually no corresponding entry for inventory carrying costs
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+++ In)entor" . /ro-ita*ilit"

"ince inventories are current assets, these are paid for from /or,ing capital Fsually /or,ing capital is borro/ed from ban,s for /hich interest must be paid The longer the firm holds the inventory, the longer the firm /ill ta,e to recover monies invested in inventories In the process, the interest payouts /hich is the inventory carrying cost, /ill reduce the profitability of the firm Thus although inventory carrying cost is not e4plicitly mentioned in a firm1s financial statement, it is still very significant & real
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Improvise the slides of Inventory & profitability for Impact or effect of Carrying costs on financial records

In)entor" Related Costs

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+++ In)entor" Related Costs

* ma!or portion of /or,ing capital is bloc,ed in inventory The funds tied up in inventory cannot be used for other productive purposes, resulting in loss of opportunity This also results in a loss of profitability Aosts associated /ith inventory are Inventory Aost +rdering Aost

Carrying Aost /4change Rate Differentials

0arehousing Aost $bsolescence, Damage, 3oss, Pilferage Aost

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+++ In)entor" Related Costs

Inventory Costs

These are the unit purchase price, if purchased from an e4ternal source Fnit production cost, if produced internally

Fnit production cost includes direct labour, direct material and factory overhead

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+++ In)entor" Related Costs

Carrying Costs

Aost associated /ith investing in inventory Funds invested in inventory are from /or,ing capital borro/ed from ban,s /hich attract interest Aarrying costs is the second major contributor to inventory costs 2aries /ith the volume of inventory held & time period for /hich it is held vi. greater the level of inventory over time, higher the carrying costs '4pressed as Rs8 per unit of item held per time period vi. month or year
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+++ In)entor" Related Costs

/xchange )ate Differentials

In case of imported inventories, valuation is done based on the current foreign e4change rates *ny fluctuation in the e4change rates may increase or decrease the inventory value Due to e4change rate fluctuations, there is a ris, of selling the materials at prices lo/er than landed costs

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+++ In)entor" Related Costs

+rdering Cost

'4pense of issuing a purchase order to an outside supplier or from internal production setup costs 2ary directly /ith no8 of orders or setups $rder cost includes cost for re:uisition, selecting suppliers, chec,ing stoc,, /riting purchase orders, preparing payments, revie/ing inventory levels, receiving materials, inspecting materials, transportation cost, follo/ing up orders & performing the tas,s necessary to complete the transaction
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+++ In)entor" Related Costs

+bsolescence5 Damage5 3oss5 Pilferage Cost

9aterials stored carries the ris, of

Damage, shrin,age & loss of /eight Pilferage $bsolescence due to change in technology

Percentage varies from 68G7 to @7 depending on the product

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+++ In)entor" Related Costs

0arehousing Cost

These are costs of holding inventories in /arehouses Depending on the type of /arehouse Cself o/ned, public or privateD there /ill be a cost related to space occupancy Aost varies from H8G7 to I7

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In)entor" Management
#E,INITION

9anagement of inventories, /ith the primary ob!ective of determining & controlling stoc, levels to balance the need for product availability against the need for minimi.ing stoc, holding and handling costs Policies, procedures, and techni:ues employed in maintaining the optimum number or amount of each inventory item
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O*0ecti)es o- In)entor" Management

6o /nsure -de*uate !toc%

'very department must get the ra/ materials or other necessary item as and /hen re:uired 'ffective inventory management puts in place a system of purchasing, storage and maintenance so that enough stoc, is available on hand Inventory 9anagement must ensure that e4cessive stoc, is not ,ept and unnecessary capital is not loc,ed up +ut there must be ade:uate stoc,, so that production is not disrupted
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6o Minimize Inventories on ,and

+++ O*0ecti)es o- In)entor" Management

6o Maintain Continuity in Production

Inventory 9anagement and control system should ensure that production is completed as per schedule The supplies of materials spare parts, consumable stores etc8 must be stoc,ed to the optimum level, so that continuity of operations is maintained Inventory 9anagement must ensure there is economy in cost of purchasing, cost of receiving and inspection, storage and issue of materials etc The e4penses to be reduced to minimum are interest on capital loc,ed, insurance, maintenance, inspection & transportation costs

Minimize the Cost of Purchasing and !torage

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+++ O*0ecti)es o- In)entor" Management

6o Minimize 0astage and 3oss

In every manufacturing organi.ation, there is a ris, of /astage and theft of stores, /astage and losses are li,ely to occur during movements and during the production processes Inventory management & control must ensure that the ris, of theft, /astage and losses are minimi.ed If a considerable time elapses in the storage of goods, there arise t/o types of ris,s

6o )educe the )is% of Deterioration

The deterioration of goods stored The goods becoming obsolete and out dated

Inventory management & control ensures that such ris,s are minimi.ed 44

+++ O*0ecti)es o- In)entor" Management

/ffective $se of -vailable Capital 2arious levels li,e ma4imum level, minimum level, reordering level etc8 are fi4ed in a system of inventory control, /hich ensures that unnecessary capital is not loc,ed up in inventory $rder is placed at right time and in right :uantity, ta,ing into account the re0ordering level 6o ive Maximum !atisfaction to Customers Austomer satisfaction is a sign of a progressive enterprise Inventory management & control assists in supplying goods at proper price and at right time Inventory control leads to economical purchase, ma,es possible continuity of production and maintaining enough stoc, *ll these leads to consumer satisfaction 45

+++ O*0ecti)es o- In)entor" Management

6o Minimize 3oss Due to Price Decline

3hen considerable investment is made in inventory, the price decrease on a large scale may lead to a considerable loss to the firm This is reduced to a great e4tent by proper inventory management & control $ne of the ob!ectives of inventory control is to ma,e ma4imum use of storage capacity available This /ill reduce storage costs
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Maximum $se of !torage Capacity

+++ O*0ecti)es o- In)entor" Management

Proper !torage of Materials

Inventory management & control function includes supervision and control of storage of materials, tools etc8 3here thousands of items are stored, it is necessary that material of a particular type re:uired is immediately available 'fficient storage is made possible due to inventory management & control

Improvise the slides of Inventory management objectives for inventory management importance
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S"mptoms o- /oor In)entor" Management

*n increase in the number of bac,orders, indicating too many stoc, outs Rising inventory investment ;igh customer turnover *n increasing number of canceled orders Insufficient storage space 0 too much inventory on hand *n increase in the volume and value of obsolete products %o/ Inventory Turn $ver Ratio #about G6 is a good ratio & 3or,ing capital problems
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Impro)ing E--ecti)eness o- In)entor" Management

"ome firms use some of the follo/ing initiatives to improve effectiveness of inventory management

Policy'definition and refinement Information Integration /xpert !ystem -pplications

Inventory management involves a number of policies & procedures that guide inventory0related decisions Inventory policy decisions include factors such as
J 3hat to purchase or manufacture J 3hen to ta,e action J In /hat :uantity
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+++ Impro)ing E--ecti)eness o- In)entor" Management

((( Policy'definition and refinement

Includes decisions related to

J The locations /here the inventory is to be ,ept J ;o/ much inventory is to be ,ept at each location J 3hen to order replenishment, to allo/ the firm to

maintain the target service level /hile minimi.ing inventory related costs

J ;o/ much inventory to be ordered each time

Inventory planners must monitor inventory performance & in case of problems, refine the inventory policy

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+++ Impro)ing E--ecti)eness o- In)entor" Management

((( Policy'definition and refinement

The policy decisions also involve performance measures & training

Performance Measures
) Alear & consistent performance measures are ) Reflect trade0off bet/een customer service

the ,eys to the inventory management process levels & inventory levels

) 9ust clearly reflect the trade0off desired by the

firm & re/ard structure for employees /ho maintain inventory

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+++ Impro)ing E--ecti)eness o- In)entor" Management

((( Policy'definition and refinement

6raining

+ecause inventory management is comple4 & critical, many organi.ations impart training to employees /hich helps in inventory decision ma,ing Training in t/o areas is appropriate
) Fnderstanding ho/ revie/ periods, order

:uantities, safety stoc, can be traded0off to meet service ob!ectives

) Fnderstanding ho/ their inventory related

decisions affect other members in the supply chain

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+++ Impro)ing E--ecti)eness o- In)entor" Management

Information Integration

Inventory management effectiveness can be increased & uncertainty decreased by proper information flo/ across the organi.ation & its channel partners Aurrent technology facilitates information e4change over global net/or,s, electronic data e4change & satellite communication

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+++ Impro)ing E--ecti)eness o- In)entor" Management

/xpert !ystems

To determine appropriate reorder :uantity, inventory managers must ma,e decisions that involve a no8 of interrelated factors /hich include sales volumes, transportation rates, inventory carrying costs, discounts etc8 "ince these interrelations are comple4, inventory management soft/ares based on e4pert system technology are deployed e8g8 Inventory 9anagement *ssistant #I9*&, an e4pert system based inventory management application /as designed for F8 "8 *ir Force %ogistics Aommand

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In)entor" T!rno)er
Is a relationship bet/een the cost of goods sold during a particular period of time and the cost of average inventory during a particular period

Is e4pressed as a ratio vi. Inventory Turnover Ratio *B* "toc, Turnover Ratio, Inventory Turns, "toc,turn, "toc, turns, Turns '4pressed in number of times Indicates the number of times the stoc, has been turned over during the period and evaluates the efficiency /ith /hich a firm is able to manage its inventory Indicates /hether investment in stoc, is /ithin proper limit or not
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+++ In)entor" T!rno)er

Inventory Turnover Ratio K Aost of <oods "old *verage Inventory Aost of goods sold K "ales 0 Profit

Aosts include all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition Inventory turnover ratio measures the velocity of conversion of stoc, into sales
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+++ In)entor" T!rno)er

* high inventory turnover ratio

Fsually indicates efficient management of inventory because more fre:uently the stoc,s are sold, the lesser amount of money is re:uired to finance the inventory Fsually indicates an inefficient management of inventory Implies over0investment in inventories, dull business, poor :uality of goods, stoc, accumulation, accumulation of obsolete and slo/ moving goods and lo/ profits as compared to total investment

* lo/ inventory turnover ratio

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In)entor" /olic"

Aonsists of guidelines regarding

0hat to purchase or manufacture 0hen to ta%e action In &hat *uantity The locations /here the inventory is to be ,ept ;o/ much inventory is to be ,ept at each location 3hen to order replenishment, to allo/ the firm to maintain the target service level /hile minimi.ing inventory related costs ;o/ much inventory to be ordered each time

Includes decisions related to

Formulating a sound inventory policy is the most difficult issue /ithin overall inventory management 58

Ser)ice le)els

"ervice %evel is a target specified by management Defines the performance ob!ectives that the inventory must be capable of achieving "ervice levels are indicators of :uality of logistics performed in a company Aan be defined in term of any one of the follo/ing or any combination of the follo/ing

+rder Cycle 6ime +rder .ill )ate Case .ill )ate 3ine .ill )ate
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+++ Ser)ice le)els

#asic .unda -n order is a re*uest for cases or units of different product lines

+nly for your understanding( 7ot re*uired for exam

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+++ Ser)ice le)els

+rder Cycle 6ime

Is the time elapsed bet/een the receipt of purchase order from a customer & dispatch of the shipment to the customer Perceived from the supplier?s perspective as a measure of performance Perceived from the customer1s perspective as the time bet/een placement of order & replenishment of stoc, This concept from customer?s vie/ point is called 3ead' time Is the percentage of customer orders that could be filled completely

+rder .ill )ate

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+++ Ser)ice le)els

Case .ill )ate

*re the percentage of cases or units ordered, that can be shipped e8g8 a case fill rate of LG7 KM on an average LG cases out of H66 could be filled from available stoc,8 The remaining G cases /ould be bac,0ordered or deleted

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+++ Ser)ice le)els

3ine .ill )ate

*re the percentage of lines ordered, that could be filled completely e8g8 Austomer orderN O6 cases / units of Product %ine * @6 cases / units of Product %ine + This order contains @ lines & H66 cases / units If there are only PG units of product * available & all @6 units of product + available Aase fill rate K PG E @6 K LG7 "ince only H product line of the @ product lines ordered is completely filled %ine fill rate K Q K G67 $rder Fill Rate K 89

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/lanning In)entor"
* firm faces t/o main decisions concerning the management of inventoryN

0hen should ne/ stoc, be ordered Determined by Reorder %evel #R$%& 0hat :uantities of ne/ stoc, should be ordered Determined by 'conomic $rder (uantity #'$(&
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+++ /lanning In)entor"

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+++ /lanning In)entor"

-verage Inventory

Is e:ual to one0half the order :uantity It is also calculated as the average bet/een t/o inventory values
*verage inventory K CInitial Inventory E Final InventoryD @

*lso calculated as the average bet/een order :uantity & safety stoc,
*verage inventory K C$rder :uantity E safety stoc,D @
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+++ /lanning In)entor"

)eorder 3evel 1)+32

*B* Reorder Point Determines /hen a replenishment order is initiated In the e4ample, /henever :uantity on hand falls to H66nos8, an additional order for @66 nos8 is initiated Aan be specified in term of units or days1 supply Reorder %evel K Caverage demand R lead timeD RKdRT 3here R K Reorder level in units d K *verage daily demand in units T K %ead time

;erein it is assumed that replenishment shipment /ill arrive on schedule

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+++ /lanning In)entor"

((( )eorder 3evel 1)+32

3hen uncertainty e4ists, in either delivery schedule or performance, safety stoc, is re:uired In that case, R$% formula is
Reorder %evel K Caverage demand R lead timeD E "afety "toc,

R K Cd R TD E ""
3here R K Reorder level in units d K *verage daily demand in units T K %ead time "" K "afety stoc, in units
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+++ /lanning In)entor"

/conomic +rder :uantity 1/+:2

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+++ /lanning In)entor"

((( /conomic +rder :uantity 1/+:2

%ot si.ing balances inventory costs /ith cost of ordering +alancing the cost of maintaining inventories against the cost of ordering is re:uired %arger the :uantity ordered

%arger the average inventory <reater the inventory carrying costs Fe/er orders re:uired per planning period %o/er ordering costs

The point at /hich the sum of ordering costs & inventory maintenance costs is minimi.ed represents the lo/est total cost 70

+++ /lanning In)entor"

((( /conomic +rder :uantity 1/+:2 '$( is the replenishment order :uantity that minimi.es the combined cost of inventory maintenance & ordering
'$( K @ Ao D Ai F

/here '$( K 'conomic $rder (uantity Ao K $rdering Aost per order D K *nnual sales volume or *nnual demand of an item or Total demand per year, units Ai K 7 of inventory cost vis0a0vis unit cost F K Aost per unit or unit cost of the item
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+++ /lanning In)entor"

((( /conomic +rder :uantity 1/+:2
'$( K @ Ao D "

/here '$( K 'conomic $rder (uantity Ao K $rdering Aost per order D K *nnual sales volume or *nnual demand of an item or Total demand per year, units " K *nnual inventory carrying cost F K Aost per unit or unit cost of the item

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+++ /lanning In)entor"

((( /conomic +rder :uantity 1/+:2 -ssumptions

"atisfaction of all demand C-o stoc,0outsD Aontinuous, constant & ,no/n rate of demand Aonstant & ,no/n lead0time Aonstant price, independent of order :uantity Cvi. no discounts on order :uantity or transportation are availableD Aonstant transportation cost -o inventory in transit -o interaction bet/een multiple items of inventory
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+++ /lanning In)entor"

((( /conomic +rder :uantity 1/+:2

3imitations The '$( model ma,es assumptions that are not realistic 9a!or limitations of the '$( model are

The demand or usage is predictable The demand or usage is evenly distributed / constant The price of the items purchased remain the same throughout the year 9aterial is available as and /hen re:uired 3hen :uantity discounts are available, it /ould be economical to buy in bul,, by ignoring the '$( model

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+++ /lanning In)entor"

Total $rdering Aost K D R Ao ( /here ( K 'conomic $rder (uantity Ao K $rdering Aost per order D K *nnual sales volume or *nnual demand of an item or Total demand per year, units Inventory Aarrying Aost K Ai R F R ( @ /here ( K 'conomic $rder (uantity Ai K 7 of inventory cost vis0a0vis unit cost F K Aost per unit or unit cost of the item
75

+++ /lanning In)entor"

Inventory Aarrying Aost K " R F R ( @ /here ( K 'conomic $rder (uantity " K *nnual inventory carrying cost F K Aost per unit or unit cost of the item

76

+++ /lanning In)entor"

/conomic #atch :uantity

77

+++ /lanning In)entor"

((( /conomic #atch :uantity

*B* 'conomic Production (uantity #'P(& Is the :uantity of units that can be economically produced in a given batch or production run ;erein the optimal lot0si.e to manufacture is determined "et0up costs & inventory carrying costs play a ,ey role in determining '+( "et0up costs are the costs of setting up the machinery & production systems for producing a batch of products 78

+++ /lanning In)entor"

((( /conomic #atch :uantity

"maller the batch si.e

;igher the set0up costs %o/er the inventory holding cost %o/er the set0up costs ;igher the inventory holding cost

%arger the batch si.e

'+( is the point at /hich the total cost is minimum

79

+++ /lanning In)entor"

((( /conomic #atch :uantity '+( K K @ R *nnual Demand R "et0up Aost Inventory carrying cost per unit @RDR" A

/here D K *nnual demand for product " K "et0up Aost per batch A K Inventory carrying cost per unit 3ith advancements in technology, it is possible to have very small set0up times & fre:uent deliveries $n account of this the concept of '+( is losing relevance
80

+++ /lanning In)entor"

!afety !toc%

81

+++ /lanning In)entor"

!afety !toc% *B* +uffer "toc, In practical situations, there is uncertainty in the customer demand level and lead0time for supply of inventory To buffer against this uncertainty, firms maintain a level of e4tra stoc, ,no/n as safety stoc, "afety stoc, is employed /hen the lead time of manufacturing is too long to satisfy the customer demand at the right cost / :uality / /aiting time "afety stoc,s absorb the variability of the customer demand improving the customer service level "afety stoc, is used as a buffer to protect organi.ations from stoc,0outs caused by inaccurate planning or poor schedule adherence by suppliers 82

+++ /lanning In)entor"

((( !afety !toc%

;o/ much safety stoc, to maintain is a inventory policy decision & finding the right balance bet/een too much and too little safety stoc, is essential The amount of safety stoc, a firm chooses to ,eep on hand can dramatically affect a firm1s business

Too much safety stoc, can result in high holding costs of inventory Products /hich are stored for too long a time can get spoilt or damaged Too little safety stoc, can result in lost sales and, thus, a higher rate of customer turnover
83

+++ /lanning In)entor"

((( !afety !toc% Methods adopted to reduce safety stoc%

Increased collaboration /ith suppliers *dopting statistical & mathematical techni:ues /hich help managers to plan the levels of safety stoc,

.actors that influence the level of safety stoc% Category of Item

1*1 category items "ince better inventory control is e4ercised, a lo/ level of buffer stoc, /ould be sufficient $ther category items may re:uire a relatively higher safety stoc,
84

+++ /lanning In)entor"

((( !afety !toc% ((( .actors that influence the level of safety stoc% 3ead'time %onger the lead0time, more the safety stoc, 7o( of suppliers %esser the no8 of suppliers for a particular item, higher the safety stoc, Criticality of item 9ore critical a particular item, higher the safety stoc, -vailability of !ubstitutes If substitutes for a particular item are available, a lo/ safety stoc, maybe maintained 85

+++ /lanning In)entor"

((( !afety !toc% ((( .actors that influence the level of safety stoc% Possibility of ma%ing the item in'house If it is possible to ma,e the item in0house, a lo/er safety stoc, /ould suffice )is% of obsolescence or deterioration If there is ris, of obsolescence or deterioration over time, it is better to maintain a lo/ safety stoc, !pace restrictions If the available storage space is small, it is better to maintain a lo/ safety stoc,

9a4imum Inventory K "afety "toc, E '$(

86

N!mericals
H8 Demand for a particular item is H@ units per day8 The performance cycle length is @@ days8 Find the re0 order point8 RKdRT K H@ R @@ K @>I units

87

+++ N!mericals
@8 From the follo/ing data, determine '$(, no8 of orders, total ordering cost, average inventory & inventory carrying cost *nnual demand K 5,>66 units Fnit value at cost K Rs8 I *nnual inventory carrying cost 7 K HO7 $rder Aost K Rs8 @6 per order

88

+++ N!mericals
"olutionN '$( K K K K C@ R Ao R DD Ai R F @ R @6 R 5,>66 68HO R I H,II,666 68P@ @,66,666

K IIP units
89

+++ N!mericals
D '$( K 5>66 IIP K O orders Total ordering cost K D R Ao '$( K 5>66 R @6 IIP K Rs8 H>H Inventory carrying cost K Ai R F R '$( @ K 68HO R I R IIP @ K Rs8 H>68L@ -o8 of orders K

90

+++ N!mericals
58 *nup %td8 Pays Rs8 O6 each for an electrical s/itch, for /hich annual demand is I666 units8 The ordering cost is Rs8 @6 per order8 Aarrying charges @678 3hat is the '$( for this itemJ "olutionN '$( K K K K C@ R Ao R DD CAi R FD C@ R @6 R I,666D C68@6 R O6D CH,>6,666D CH>D H6,666

K H66 units
91

+++ N!mericals
I8 *utomated 9achines %td8 Fses @G,666 gear bo4es each year and purchases them at Rs8 G66 each8 It costs Rs8 G6 to process & receive an order8 Inventory is carried at Rs8 PO per unit per year8 a8 ;o/ many gears should be ordered at a timeJ b8 ;o/ many orders should be placed every yearJ "olutionN '$( K K K C@ R Ao R DD C"D C@ R G6 R @G,666D C68POD

-o8 of orders K

D '$( K @G,666 HPL6 K HI orders / year

C@G,66,666D C68POD K 5@,6G,H@O K HPL6 gear bo4es

92

+++ N!mericals
G8 +elo/ is the data for $rgani.ation R & $rgani.ation S8 Find the average inventory & inventory turnover ratio

93

+++ N!mericals

94

Re-erences
Presentation Image httpN/////8retalon8com/imagesThome/retalonTinventoryTmanagement8!pg Production 9anagement & 9aterials 9anagement 0 B8 "hridhara +hat %ogistics 9anagement 0 "atish A8 *ila/adi, Ra,esh "ingh %ogistical 9anagement Donald = +o/erso4, David = Aloss Role of Inventory httpN//inventory0managment8blogspot8com/@66L/65/role0of0inventory0in0supply0chain8html Inventory Functionality httpN//boo,s8google8com/boo,sJ idKaU,p@*:I>'SA&pgKP*PG>&lpgKP*PG>&d:KgeographicalEspeciali.ationEofEinventory&sourceKbl&otsKFgoA$ SO6rI&sigKfFU0u*dP-y<nbBT"4RS0 TgSITp(&hlKen&eiKfuS@TuP>9Iiyr*fHHURaA/&saKR&oiKboo,Tresult&ctKresult&resnumKH&vedK6A+S(>*'/* DgBVvKonepage&:Kgeographical7@6speciali.ation7@6of7@6inventory&fKfalse httpN/////8slideshare8net/chronicles@>/logistics0note0bms0presentation "ymptoms of Poor Inventory 9anagement httpN/////8docstoc8com/docs/H>>L6PHH/50I-2'-T$RS09*-*<'9'-T Inventory Turnover httpN/////8accountingformanagement8com/stoc,TturnToverTratio8htm httpN//en8/i,ipedia8org//i,i/InventoryTturnover httpN//en8/i,ipedia8org//i,i/AostTofTgoodsTsold $b!ectives of inventory management httpN/////8listedall8com/@66L/H@/ob!ectives0of0inventory0management8html Improving effectiveness of inventory management %ogistical 9anagement Donald = +o/erso4, David = Aloss Pg 565 %ogistics & "upply Ahain 9anagement 2inay Pandit 95

+++ Re-erences
Inventory Policy

httpN/////8marcbo/les8com/courses/advTdip/moduleI/moduleI/mIthree8htm httpN/////8docstoc8com/docs/H>>L6PHH/50I-2'-T$RS09*-*<'9'-T *verage Inventory httpN/////8free0logistics8com/inde48php/"pec0"heets/Forecasts0"upply0and0Inventory/Inventory0concepts0 and0Aalculation8htmlV"ervice7@6factor '$( & '$P httpN/////8marcbo/les8com/courses/advTdip/moduleI/moduleI/mIthreeH8htm "upply Ahain %ogistics 9anagement Donald = +o/erso4, David = Aloss, 9 +i4by Aooper httpN/////8thefreedictionary8com/replenishment httpN//@H>8GI8HL8HHH/Wmountaintop/logH6@/modH6/elo@/eloH6H@T6L68html %imitations of '$( httpN/////8docstoc8com/docs/H>>L6PHH/50I-2'-T$RS09*-*<'9'-T %ogistics & "upply Ahain 9anagement 2ishal 9ehta & 9ihir 9ehta '+( httpN//boo,s8google8com/boo,sJ idK(g6%BP>eI6IA&pgKP*HP6&lpgKP*HP6&d:KeconomicEbatchE:uantity&sourceKbl&otsKPOAA6APoa6& sigKbHiB-APmoO@l%ueT'm-cHFRIsUS&hlKen&eiKcS*yToRrF-;Br*e=:$5'A/&saKR&oiKboo,Tresult&c tKresult&resnumKH&vedK6A+S(>*'/*DgFVvKonepage&:Keconomic7@6batch7@6:uantity&fKfalse httpN/////8svtuition8org/@6H6/HH/economic0batch0:uantity8html httpN//en8/i,ipedia8org//i,i/'conomicTbatchT:uantity "afety stoc, httpN//en8/i,ipedia8org//i,i/"afetyTstoc, Factors that influence safety stoc, %ogistics & "upply Ahain 9anagement 2inay Pandit 96