Inventory models

Nur Aini Masruroh

Outline

Introduction Deterministic model Probabilistic model

Introduction

What is inventory?

It is usable but idle resource Keeping of physical goods or commodities for the purpose of satisfying demand over a specified time horizon.

Over stocking

Higher invested capital per unit time Less frequent occurrence of placement of orders Less frequent occurrence of shortages Lower invested capital per unit time Increase the frequency of ordering Higher risk of running out of stock

Under stocking

The Functions of Inventory

To decouple or separate various parts of the production process To provide a stock of goods that will provide a selection for customers To take advantage of quantity discounts To hedge against inflation and upward price changes

Disadvantages of Inventory

Higher costs

Item cost (if purchased) Ordering (or setup) cost

Costs of forms, clerks wages etc. Building lease, insurance, taxes etc.

Holding (or carrying) cost

Difficult to control Hides production problems

Inventory Classifications

Inventory

1984-1994 T/Maker Co.

Process stage

Number & Value

Demand Type

Other

Raw Material WIP Finished Goods

A Items B Items C Items

Independent Dependent

Maintenance Operating

ABC Analysis

Divides on-hand inventory into 3 classes

A class, B class, C class

Basis is usually annual $ volume

$ volume = Annual demand x Unit cost

Develop class A suppliers more Give tighter physical control of A items Forecast A items more carefully

Policies based on ABC analysis

Classifying Items as ABC

% Annual $ Usage
100 80 60 40

Class A B C

% $ Vol 80 15 5

% Items 15 30 55

A B
0 50

20
0

C
100

% of Inventory Items

Independent versus Dependent Demand

Independent demand - demand for item is independent of demand for any other item Dependent demand - demand for item is dependent upon the demand for some other item

Inventory decision

How should it be ordered for stocking? When should it be ordered?

Basic characteristics of inventory systems

Economic parameters

Holding cost Ordering cost Setup cost Shortage cost Purchase price Selling price

Demand Ordering cycle Delivery lags or lead times

Economic parameters

Holding costs - associated with holding or carrying inventory over time Ordering (setup) costs - Involve the fixed charge associated with the placement of an order or with the initial preparation of a production system. Shortage costs - The penalty costs incurred as a result of running out of stock

Loss in customers goodwill Loss in sales, etc.

Purchase price - This parameter is of interest when quantity discounts or price breaks can be secured for orders above a certain quantity Selling price- This parameter is of interest when the demand on the commodity may be affected by the quantity stocked

Holding (Carrying) Costs

Obsolescence Insurance Extra staffing Interest Pilferage Damage Warehousing Etc.

Ordering Costs

Supplies Forms Order processing Clerical support Etc.

Symbols of inventory model

Q = Order quantity per order K = Setup cost per order d = Demand rate h = Holding cost per unit per unit time c = Purchase price or cost per unit s = Shortage cost per unit per unit time t = Inventory cycle

Basic EOQ model

EOQ assumptions: Known and constant demand Known and constant lead time Instantaneous receipt of material No quantity discounts Only order (setup) cost and holding cost No stockouts

Inventory Usage Over Time

Order quantity = Q (maximum inventory level)
Inventory Level Usage Rate

Average Inventory (Q*/2)

Minimum inventory0

Time

EOQ Model How Much to Order?

Annual Cost

Minimu m total cost

Order (Setup) Cost Curve Optimal Order Quantity (Q*)

Order quantity

Why Holding Costs Increase

More units must be stored if more are ordered

Purchase Order Description Qty. Microwave 1

Purchase Order Description Qty. Microwave 1000

Order quantity

Order quantity

Why Order Costs Decrease

Cost is spread over more units

Example: You need 1000 microwave ovens

1 Order (Postage $ 0.33)
Purchase Order Description Qty. Microwave 1000

1000 Orders (Postage $330)

Purchase Order Purchase Order Description Qty. Purchase Order Description Qty. Description Qty.1 Microwave Description Qty. Microwave 11 Microwave Microwave 1

Order quantity

EOQ Model When To Order

Inventory Level

Optimal Order Quantity (Q*) Reorder Point (ROP)

Average Inventory (Q*/2)

Time

Lead Time

Inventory holding cost per cycle: hQ2/(2d)

Deriving EOQ Model

Total cost per cycle TC(Q) = Acquisition costs + Holding cost = K + cQ + hQ2/(2d) Total cost per unit time TCU(Q) = TC(Q)/t = Kd/Q + cd + hQ/2 where t = Q/d. To minimize the total cost per unit time, we differentiate TCU(Q) with respect to Q and set it equal to zero

This gives
The order cycle length,

The Reorder Point (ROP) Curve

Q* Slope = units/day = d Inventory level (units)

ROP (Units)

Lead time = L

Time (days)

EOQ Model with Shortages Allowed

Assumptions: A continuous, constant and known rate of demand d Constant lead time L Constant unit price or cost c No interaction between items Infinite planning horizon Unfilled demands are backlogged at the cost of s per unit per unit time Split delivery not allowed No limit on capital availability

EOQ Model with Shortages Allowed

EOQ Model with Shortages Allowed

Single item economic production quantity (EPQ)

Assumptions: Continuous, constant and known rate of demand d Continuous, constant and known rate of production p P>d Constant lead time L Constant unit price or cost c No interaction between items Infinite planning horizon Shortages are not permitted Production and consumption can occur simultaneously No limit on production capacity

Single item economic production quantity (EPQ)

Single item economic production quantity (EPQ)

Quantity Discount Model

Answers how much to order & when to order Allows quantity discounts

Reduced price when item is purchased in larger quantities Other EOQ assumptions apply

Trade-off is between lower price & increased holding cost

Quantity Discount Schedule

Discount Discount Quantity Discount Number (%) 1 0 to 999 No discount 2 3 1,000 to 1,999 2,000 and over 4 5 Discount Price (P) $5.00 $4.80 $4.75

Quantity Discount How Much to Order

Probabilistic Models

Answer how much & when to order Allow demand to vary

Follows normal distribution Other EOQ assumptions apply Service level = 1 - Probability of stockout Higher service level means more safety stock

Consider service level & safety stock

More safety stock means higher ROP

Probabilistic Models When to Order?

Inventory Level Optimal Order Quantity Reorder Point (ROP) ROP
Frequenc y

Service Level

P(Stockout)

SS

Safety Stock (SS) Place order Lead Time Receive order Time

Fixed Period Model

Answers how much to order Orders placed at fixed intervals

Inventory brought up to target amount Amount ordered varies Possibility of stockout between intervals

No continuous inventory count

Useful when vendors visit routinely

Example: P&G representative calls every 2 weeks

Inventory Level in a Fixed Period System

Various amounts (Qi) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum

Q1

Q2 Q3

Target maximum Q4

On-Hand Inventory

Time

Fixed Period Model When to Order?

Inventory Level Target maximum

Time Period Period Period