Dr.

Atif Shahzad
_____________________
BE, MECHANICAL ENGINEERING
UNIVERSITY OF ENGINEERING & TECHNOLOGY, TAXILA, PAKISTAN, 2000

MCS, SOFTWARE ENGINEERING

SZABIST,, ISLAMABAD, PAKISTAN, 2003

MS, AUTOMATION & PRODUCTION SYSTEMS

ECOLE CENTRALE DE NANTES, NANTES, FRANCE, 2007

PhD, AUTOMATION & APPLIED INFORMATICS

UNIVERSITE DE NANTES, NANTES, FRANCE, 2011

EMAIL: atifshahzad@Gmail.com

TEL: +92-333-5219846, +92-51-5179755

LINKEDIN: pk.linkedin.com/in/dratifshahzad
 ENGINEERING
MANAGEMENT
TODAY’S LECTURE
Inventory Models
 Review

Reasons for Keeping Inventories Inventory Management

Inventory Control Techniques of Inventory Control

• what to order, • ABC analysis
• when to order, • HML analysis
• how much to order and • VED analysis
• how much to stock • FSN analysis
• SDE analysis
• GOLF analysis
• SOS analysis
Dr. Atif Shahzad
 Deciding on the inventory model
17–4

Assume an analyst applies an

inventory model that does not
allow for spoilage to a grocery
A little thought will show that this
chain’s ordering policy for lettuce
is obliviously foolish.
and formulates the strategy of
ordering lettuce in large amounts
every 14 days.

However it is not a failure of

This strategy implies that lettuce
inventory, it is a failure to apply the
will be spoiled.
correct model.
Dr. Atif Shahzad
 EOQ & Re-order point

EOQ – gives answer to question

“How much to Order”

Re-order point – gives answer to

question “when to order”
Dr. Atif Shahzad
 optimum inventory level
17–6
Dr. Atif Shahzad
 optimum inventory level
17–7

Ordering cost
• Quotation or tendering Requisitioning
• Order placing
• Transportation
• Receiving, inspecting and storing
Stock-out cost
• Quality control
• Clerical and staff

Carrying costs
Dr. Atif Shahzad
 optimum inventory level
17–8

Stock-out cost
• Loss of sale
Ordering cost • Failure to meet
delivery commitments

Carrying costs
Dr. Atif Shahzad
 optimum inventory level
17–9

Ordering cost Stock-out cost

Carrying costs
• Warehousing or storage Handling
• Clerical and staff Insurance
• Interest Deterioration,shrinkage,
• evaporation and obsolescence
• Taxes
Dr. Atif Shahzad

• Cost of capital
 Walmart
 WALMART making sure that the shelves
are stocked with tens of thousands of
products is no simple matter for inventory
managers at Walmart, which has
¤ 10,700 Walmart stores and
Sam’s Club locations in 27
countries,
¤ employs more than 2.2 million
associates,
¤ serves245 million customers
per week worldwide,
¤ and uses 100,000 suppliers.
Dr. Atif Shahzad
 Approaches
17–11

Certainty approach Uncertainty

• Uncertain variables and approach
risk are addressed • Uncertain variables and
separately risk are
addressedsimultaneously

Deterministic Probabilistic
approach approach
Dr. Atif Shahzad
 Basic EOQ Model: Assumptions
17–12
Seasonal fluctuation in demand are ruled out
ECONOMIC ORDER QUANTITY

Zero lead time – Time lapsed between purchase order and

inventory usage

Cost of placing an order and receiving are same and

independent of the units ordered

Annual cost of carrying the inventory is constant

Dr. Atif Shahzad

Total inventory cost = Ordering cost + carrying cost

 EOQ – Three Approaches

Trial and Error method

Order-formula approach

Graphical approach
Dr. Atif Shahzad
 Trial and Error method
Trial and Error Order-formula approach
method Graphical approach

Assumptions:-
Annual requirement (C)=1200 units Carrying cost
(I) = Rs.1
Ordering cost (O) =Rs.37.5
Order size Q 1200 600 400 300 240 200 150 120 100

Average inventory Q/2 600 300 200 150 120 100 75 60 50

No. of orders C/Q 1 2 3 4 5 6 8 10 12

Annual carrying cost 600 300 200 150 120 100 75 60 50

I* Q/2
Annual ordering cost 37.5 75 112.5 150 187.5 225 300 375 450
O*C/Q
Dr. Atif Shahzad

Total annual cost 637.5 375 312.5 300 307.5 325 375 435 500
 Trial and Error method
Order-formula Order-formula approach
approach Graphical approach

Assumptions:-
Annual requirement (C)=1200 units Carrying cost
(I) = Rs.1
Ordering cost (O) =Rs.37.5

EOQ
I = Carrying
cost per unit =(2CO/I)

O = Ordering C = Annual
cost per order demand

EOQ =(2*1200*37.5/1) =
Dr. Atif Shahzad

300 units
 Trial and Error method
Graphical Order-formula approach
approach Graphical approach

Assumptions:-
Annual requirement (C)=1200 units Carrying cost
(I) = Rs.1
Ordering cost (O) =Rs.37.5
Cost in RS.
Dr. Atif Shahzad

0 EOQ
Order quantity
 Trial and Error method
Graphical Order-formula approach
approach Graphical approach
Dr. Atif Shahzad
 Intellectuals solve problems; geniuses prevent them.

QUIZ
 A plant makes monthly shipments of electric drills
to a wholesaler in average lot sizes of 280 drills.
 The wholesaler’s average demand is 70 drills a
week, and the lead time from the plant is 3
weeks.
 The wholesaler must pay for the inventory from
the moment the plant makes a shipment.
 If the wholesaler is willing to increase its purchase
quantity to 350 units, the plant will give priority
to the wholesaler and guarantee a lead time of
only2 weeks.
 What is the effect on the
wholesaler’s cycle and pipeline
Dr. Atif Shahzad

inventories?
  What is the annual cycle-inventory cost of the
current policy of using a 390-unit lot size?
QUIZ  Would a lot size of 468 be better?

 A museum of natural history opened a gift shop two years

ago. Managing inventories has become a problem. Low
inventory turnover is squeezing profit margins and causing
cash-flow problems.
 One of the top-selling SKUs in the container group at the
museum’s gift shop is a bird feeder.
 Sales are 18 units per week, and the supplier charges $60
per unit.
 The cost of placing an order with the supplier is $45.
 Annual holding cost is 25 percent of a feeder’s value, and the
museum operates 52 weeks per year.
Dr. Atif Shahzad

 Management chose a 390-unit lot size so that new orders

could be placed less frequently.
  What is the annual cycle-inventory cost of the
current policy of using a 390-unit lot size?
QUIZ  Would a lot size of 468 be better?
Dr. Atif Shahzad
  What is the annual cycle-inventory cost of the
current policy of using a 390-unit lot size?
QUIZ  Would a lot size of 468 be better?
Dr. Atif Shahzad
 EOQ

 We use calculus to obtain the EOQ formula from the total annual cycle-
inventory cost function.
 We take the first derivative of the total annual cycle-inventory cost function
with respect to Q, set it equal to 0, and solve for Q.
Dr. Atif Shahzad
Dr. Atif Shahzad

EOQ
  A distribution center experiences an average weekly demand of
50 units for one of its items.
Activity  The product is valued at $650 per unit.
 Inbound shipments from the factory warehouse average 350
units.
 Average lead time (including ordering delays and transit time) is
2 weeks.
 The distribution center operates 52 weeks per year; it carries a
1-week supply of inventory as safety stock and no anticipation
inventory.
 What is the value of the average aggregate inventory being
held by the distribution center?
Dr. Atif Shahzad
  A distribution center experiences an average weekly demand of
50 units for one of its items.
Activity  The product is valued at $650 per unit.
 Inbound shipments from the factory warehouse average 350
units.
 Average lead time (including ordering delays and transit time) is
2 weeks.
 The distribution center operates 52 weeks per year; it carries a
1-week supply of inventory as safety stock and no anticipation
inventory.
 What is the value of the average aggregate inventory being
held by the distribution center?
Dr. Atif Shahzad
 Certainty case of the inventory
cycle
Q
Inventory level
order quantity

Average inventory = Q/2

0 T1 T2 T3 T4

T1, T2, T3, T4

represents the
replenishment points
Dr. Atif Shahzad
 Extension of basic EOQ model

quantity discounts

T he whole of science is nothing more

than a refinement of everyday thinking. 27

–Albert Einstein
Dr. Atif Shahzad
 Non-zero lead time

Extension of basic EOQ model

If the lead time is ‘n’ then procurement must be done prior to ‘n’ days, i.e. T-n

Reorder point

0 T1 - n T1 T2 - n T2 T3 - n T3 T4 - n T4

Time
Dr. Atif Shahzad

Placement of a order
 Quantity discounts

Extension of basic EOQ model

Quantity discounts are price incentives to purchase large quantities

For any per-unit price level, P, the total cost is

 For example, a supplier may offer a price of $4.00 per unit for orders
between 1 and 99 units, a price of $3.50 per unit for orders between 100 and
199 units, and a price of $3.00 per unit for orders of 200 or more units.
 The item’s price is no longer fixed, as assumed in the EOQ derivation;
instead, if the order quantity is increased enough, the price is discounted.
Dr. Atif Shahzad
 Non- instantaneous
Replenishment
Extension of basic EOQ model
 If an item is being produced internally rather than
purchased, finished units may be used or sold as soon as
they are completed, without waiting until a full lot is
completed.
 For example, a restaurant that bakes its own dinner rolls

begins to use some of the rolls from the first pan even
before the baker finishes a five-pan batch.
 The inventory of rolls never reaches the full five-pan
Dr. Atif Shahzad

level, the way it would if the rolls all arrived at once on a

truck sent by a supplier.
 Non- instantaneous
Replenishment
Extension of basic EOQ model
 Figure depicts the usual case, in which the production rate, p, exceeds the
demand rate, d. If demand and production were equal, manufacturing
would be continuous with no buildup of cycle inventory.
 If the production rate is lower than the demand rate, sales opportunities are
being missed on an ongoing basis. We assume that p > d here.

Economic production lot size

(ELS)
Dr. Atif Shahzad
 Some terminology

 cycle inventory: The portion of total inventory that varies directly with lot
size.
 lot sizing: The determination of how frequently and in what quantity to
order inventory.
 safety stock inventory: Surplus inventory that a company holds to protect
against uncertainties in demand, lead time, and supply changes
 anticipation inventory: Inventory used to absorb uneven rates of demand
or supply.
 Pipeline Inventory: Inventory that is created when an order for an item is
issued but not yet received is called
Dr. Atif Shahzad
 Objectives of Inventory Control
17–33

To ensure adequate supply of products to customer and avoid shortages as far as possible.

To make sure that the financial investment in inventories is minimum (i.e., to see that the working capital is blocked to
the minimum possible extent).

Efficient purchasing, storing, consumption and accounting for materials is an important objective.

To maintain timely record of inventories of all the items and to maintain the stock within the desired limits.

To ensure timely action for replenishment.

To provide a reserve stock for variations in lead times of delivery of materials.

Dr. Atif Shahzad

To provide a scientific base for both short-term and long-term planning of materials.
 Benefits of Inventory Control
17–34

Improvement in customer’s relationship because of the timely delivery of goods and

service.

Smooth and uninterrupted production and, hence, no stock out.

Efficient utilisation of working capital. Helps in minimising loss due to deterioration,

obsolescence damage and pilferage.

Economy in purchasing.

Eliminates the possibility of duplicate ordering.

Dr. Atif Shahzad
QUESTIONS
THANK YOU FOR YOUR INTEREST