A

Presentation
on
Inventory Management
By

Sunit Mhasade (105)

PGDIE 40
 Index

• Introduction to Inventory

• Types of Inventory

• Inventory Management Techniques

• Service level consideration

• Review Systems

• Price break up / Discounts

• References
 Inventory Definition

• Inventory - A physical resource that a firm holds in

stock with the intent of selling it or transforming it
into a more valuable state.
• Inventory System - A set of policies and controls
that monitors levels of inventory and determines
what levels should be maintained, when stock
should be replenished, and how large orders should
3
be placed
 Objective of Inventory

• MEET CUSTOMER DEMAND

• KEEP OPERATIONS RUNNING

• LEAD TIME

• PRICE / QUANTITY DISCOUNT

• SMOOTHING REQUIREMENTS

• ACHIEVING EFFICIENT PRODUCTION RUNS

4
 Nature/Forms of Inventory

Work in
process

Vendors Raw Work in Finished Customer

Materials process goods

Work in
process

Raw Material Work in process Finished Goods

Inventory Inventory Inventory

Semi-manufactured
Goodsinputs
Basic for resale
thatproducts
are
- returned
converted
need
goods
some
intothat
components,
more
are works
saleablebefore
subassemblies,
they become
or finished
finished
products
goodsthrough
Completely for salethe manufacturing
manufactured process
products ready for sale 5
Spare parts
 Types of Inventory

• Transit inventory
• Buffer Inventory (safety stock)
• Anticipation Inventory
• Decoupling Inventory
• Cycle Inventory
• MRO Goods Inventory
Transit
Everyinventories
machine in result from the produces
the process need to transport
at exactly items
the or
same
material
Thesecycle
rate.
goods
Used itfrom
areone
inventory location
results
"decouples"
to protect
usually or to
against another,
from
disengages
consumed a and
theordering from
thein the
ofbatches
plant's
asuncertainties
result the fact orthat
supply lotand
of dependence
there firms
sizesis somewill than
rather purchase and material
transportation
ordering hold
time inventory
involved
strictly that
in is in from
getting
as needed. excess oneof
upon
production
demand, the sequential
process wellareasrequirements
as but notunpredictable of events
directly a part the
of thesystem
such (i.e.,
finished 6one
as poor
their
location current
to another need in anticipation of a possible future event
machine
product.delivery feeds partsortopoor
reliability the quality
next machine)
of a supplier's products
 An optimum inventory level
involves three types of costs
1. Ordering costs • Quotation or tendering

2. Carrying costs • Requisitioning

• Order placing
3. Stock-out cost
• Transportation

• Receiving, inspecting and storing

• Quality control

• Clerical and staff

7
 An optimum inventory level
involves three types of costs
1. Ordering costs

2. Carrying costs • Loss of sale

3. Stock-out cost • Failure to meet delivery

commitments

8
 An optimum inventory level
involves three types of costs
1. Ordering costs • Warehousing or storage

• Handling
2. Carrying costs
• Clerical and staff
3. Stock-out or shortage • Insurance
cost
• Interest

• Deterioration, shrinkage,
evaporation and obsolescence
• Taxes
9
 An optimum inventory level
involves three types of costs
1. Ordering costs
• Associated with the nature of the
2. Carrying costs control systems selected

• However, there is no substantial

3. Stock-out or shortage
cost increase in costs because of the
proposed control system Hence,
4. Systems Costs
this cost can be overlooked

10
Inventory Management
Techniques

 Level Setting
 EOQ Analysis
 Production Quantity Model
 VED Analysis
 ABC Analysis
 Just In Time System
11
 Level Setting

DANGER Average consumption*Maximum reorder period for

LEVEL emergency purchase
Reordering level – ( Normal consumption * Normal
MINIMUM LEVEL reorder period)

REORDERING LEVEL
Maximum consumption*maximum reorder period

AVG. LEVEL Minimum stock level + ½ of reorder

quantity

MAX.LEVEL
Reordering level+ Reordering quantity-
(minimum consumption*minimum reorder
period) 12
 EOQ Analysis
• Basic EOQ Model
– The lot size, Q, that minimizes total annual inventory holding and
ordering costs

– Assumptions for EOQ model –

1. Demand rate is constant and known with certainty
2. No constraints are placed on the size of each lot
3. The only two relevant costs are the inventory holding cost
and the fixed cost per lot for ordering or setup
4. Decisions for one item can be made independently of
decisions for other items
5. The lead time is constant and known with certainty

13
 Basic EOQ Model

Receive Inventory depletion

order (demand rate)

Q
level order
Inventory

quantity

Average inventory =
Q/2

0 T T T T
1 2 Time 3 4
Certainty case of the inventory cycle

1. Here the negative slope from Q to T1 represents the

inventory being used up
2. T1, T2, T3, T4 represents the replenishment points
3. The inventory varies between 0 and Q 14
 Calculating EOQ

(Holding cost) + (Ordering or

setup cost)

Total cost
Annual cost (dollars)

Holding cost
(Average cycle
inventory) ×
(Unit holding
cost)

Ordering cost
(Number of orders/Year) ×
Lowest (Ordering or setup costs)
cost

Best Q Lot Size (Q)

(EOQ)
15
Graphs of Annual Holding, Ordering, and Total Costs
 Calculating EOQ

• The EOQ formula

2DS
EOQ =
H

 Time between orders

EOQ
TBOEOQ = (12 months/year)
D
where
C = total annual cycle-inventory cost
Q = lot size
H = holding cost per unit per year
D = annual demand
S = ordering or setup costs per lot 16
 Reorder Point
• Quantity to which inventory is allowed to drop
before replenishment order is made

• Need to order EOQ at the Reorder Point:

ROP = D X LT
Where,
D = Demand rate per period
LT = lead time in periods
17
 Factors affecting Reorder Point

1. Variable demand

2. Safety or buffer stock

3. Service level

18
 Variable Demand with a Reorder
Point

Q
Inventory level

Reorder
point, R

0
LT LT
Time
19
 Safety / Buffer Stocks

Safety stock
• Buffer added to on hand inventory during lead
time

Stockout
• an inventory shortage

Service level
• probability that the inventory available during
lead time will meet demand 20
 Reorder Point with a Safety Stock
Inventory level

Q
Reorder
point, R

Safety Stock
0
LT LT
Time 21
 Service level consideration
• Increasing service level
Optimized service
– inventory will increase, level
– cost will also increase
Cost of
better and

Cost Incurred
better
• Reduced service level service
– out of stock
– Part order
– Loss of customer goodwill
– External buying from non
regular sources

70 80 90 100 %

Service level 22
Reorder Point for a Service Level

Probability of meeting
Average demand demand during lead time =
during lead time service level
Cycle-service level = 85%

Probability of stock out

(1.0 – 0.85 = 0.15)

Safety stock
zσ d L

dL R
Demand
23
 Reorder Point for a Service Level

R = dL + zσ d L
where

d = average daily demand

L = lead time
σ d = the standard deviation of daily demand
z = number of standard deviations
corresponding to the service level
probability
zσ d L = safety stock 24
 Review Systems

1. Periodic review System

2. Continuous review System

3. Top-up with regular review System-

25
 Periodic Review System (P)

 Fixed interval reorder system or periodic reorder system

Four of the original EOQ assumptions maintained
 No constraints are placed on lot size
 Holding and ordering costs
 Independent demand
 Lead times are certain

 Order is placed to bring the inventory position up to

the target inventory level, T, when the predetermined
time, P, has elapsed

26
 Periodic Review System (P)
T
IP IP IP
Order Order Order
received received received
Q3
On-hand inventory

Q1
OH Q2 OH
IP1

IP3
Order Order
placed placed
IP2

L L L Time
P P
Protection interval

P System When Demand Is Uncertain

27
each stock item reordered at different times
 Periodic Review System (P)

• Thus,

Target level inventory is given by

T = d (P+L) + Safety stock

Where,

T = Target inventory level

d = demand / unit time

L = lead time

P = review period
 Periodic Review System (P)

• Advantages of Periodic Review System (P)

– inventory levels for multiple stock items reviewed at
same time
– Convenient

– Orders can be combined

– Only need to know IP when review is made

29
 Continuous Review Systems

• Advantages of Continuous review systems (Q)

• each stock item reordered at different times
• Complex
• no economies of scope or common prod./transport runs
• Review frequency may be individualized
• Fixed lot sizes can result in quantity discounts
• Lower safety stocks

• Advantages of Top-up with regular review

– Stock not to exceed upper limit (perishables, corrosives, limited
capacity)
– use with – regular review (continuous or periodic) 30
 Price break ups and Quantity
Discount Models
 Reduced prices are often available when larger
quantities are purchased
 Trade-off is between reduced product cost and
increased holding cost

Total cost = Setup cost + Holding cost + Product cost

31
 Price break ups and Quantity
Discount Models
Steps in analyzing a quantity discount

1. For each discount, calculate Q*

2. If Q* for a discount doesn’t qualify, choose the
smallest possible order size to get the discount
3. Compute the total cost for each Q* or adjusted
value from Step 2
4. Select the Q* that gives the lowest total cost

32
 Price break ups and Quantity
Discount Models

A typical quantity discount schedule

Discount Discount Quantity Discount (%) Discount

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

33
Price break ups and Quantity
Discount Models
Total cost curve for discount 2
Total cost
curve for
discount 1
Total cost $

Total cost curve for discount 3

b
a Q* for discount 2 is below the allowable range at point a and
must be adjusted upward to 1,000 units at point b

1st price 2nd price

break break

0 1,000 2,000
Order quantity 34
 Price break up and Quantity
Discount Models
Calculate Q* for every discount 2DS
Q* =
IP

2(5,000)(49)
Q1* = = 700 cars order
(.2)(5.00)

2(5,000)(49)
Q2* = = 714 cars order
(.2)(4.80)

2(5,000)(49)
Q3* = = 718 cars order
(.2)(4.75)
35
 Price break up and Quantity
Discount Models
Discount Unit Order Annual Annual Annual Total
Number Price Quantity Product Ordering Holding
Cost Cost Cost
1 $5.00 700 $25,000 $350 $350 $25,700

2 $4.80 1,000 $24,000 $245 $480 $24,725

3 $4.75 2,000 $23.750 $122.50 $950 $24,822.50

Choose the price and quantity that gives the lowest

total cost
Buy 1,000 units at $4.80 per unit
36
 Ways to minimize Inventory cost
• Control Order • Pre-planning
Transaction Costs • Use of special tools or equipment

• Lower Inventory Holding • Improve space utilization in leased

Costs • Minimize or delay expansion
• Postponement • Removal of inappropriate product
• Rationalize SKUs • Develop activity-based costs

• Get Demand Plans from • Information on upcoming needs

Downstream from customers thus reducing the
safety stock for service level
• Take Advantage of
• Two things are shipped from
Price/Quantity Breaks different locations and then
• Merge-In-Transit married in transit so that they
reach the customer as a single
shipment
 References
• Financial Management, 9th edition by I.M. Pandey.
• Introduction to Materials Management by JR Tony Arnold, Stephen
and Lloyd M Clive
• Collaborative Materials Management by Farzad Boukani and
soundous Boufaim, Jonkoping International School, January 2009
• http://en.wikipedia.org/wiki/Inventory_control_system
• http://en.wikipedia.org/wiki/Inventory
• http://rapidlibrary.com
• Pearson Education for Operations Management, 9e by Krajewski /
Ritzman / Malhotra
• Amazon.com