Managing Inventories

in Supply Chains
 Inventory Management
• Involves planning, coordinating, and controlling
– Acquisition, storage, handling, movement, distribution,
and possible sale of raw materials
– Component parts and subassemblies
– Supplies and tools
– Replacement parts
– Other assets that are needed to meet customer wants and
needs
 Types of Inventory
• Raw materials, component • Finished-goods inventory
parts, subassemblies, and – Completed products ready for
supplies distribution or sale to customers
– Inputs to manufacturing and • Safety stock inventory
service-delivery processes – Additional amount of inventory
• Work-in-process (WIP) kept over and above the average
inventory amount required to meet
demand
– Partially finished products in
various stages of completion
that are awaiting further
processing
Role of Inventory in the Value Chain
Categories of Inventory Costs
 Inventory Characteristics
• Each item is assigned a unique – Dynamic demand varies over
identifier, called a stock-keeping unit time
(SKU) • Storage planning approaches
– Stock-keeping unit (SKU): Single
item or asset stored at a particular – Analyzing inventory for single
location or multiple periods
• Nature of demand • Lead time
– Time between placement of an order
– Independent demand and its receipt
• Demand for an SKU that is unrelated
• Stockouts
to the demand for other SKUs and
needs to be forecasted – Inability to satisfy the demand for an
item
– Dependent demand
• Backorder: Occurs when a customer is
• Directly related to the demand of willing to wait for an item
other SKUs and can be calculated • Lost sale: Occurs when the customer is
without needing to be forecasted unwilling to wait and purchases the
item elsewhere
– Static demand is stable in nature
 ABC Inventory Analysis Fixed-Quantity System
(FQS)
• Categorizes SKUs into groups • Deals with a fixed order quantity
according to their total annual dollar or lot size
usage – Same quantity is ordered every
– Total dollar usage = Item usage time, and it does not have to be
(volume) x Item's dollar value (unit economically determined
cost) • Managed using:
– A items - Account for a large dollar – Inventory position (IP)
value but a relatively small • On-hand quantity (OH) plus any
percentage of total items orders placed that have not
– C items - Account for a small dollar arrived (scheduled receipts, SR),
value but a large percentage of total minus any backorders (BO)
items Eq. 12.1 IP = OH + SR − BO
– B items - Items between A and C
Managing Fixed-Quantity Summary of Fixed-
Inventory Systems Quantity System (FQS)

– When IP falls at or below Exhibit 12.5 Summary of FQS

Managerial Order Quantity (Q) and Reorder Point (r)
a certain value (reorder Decisions
point), a new order is Ordering decision A new order is triggered whenever the
rule inventory position for the item drops to or
placed past the reorder point. The size of each

• Reorder point (r): Value of order is Q units.

the inventory position that Key characteristics The order quantity Q is always fixed.
The time between orders (TBO) is constant
triggers a new order when the demand rate is stable.
The TBO can vary when demand is variable.
Fixed-Quantity System (FQS) under Stable Demand
Fixed-Quantity System (FQS) with Highly Variable
Demand
 Economic Order Quantity (EOQ) Model, Part 1
• Classic economic model that • Cycle inventory (order or lot size
minimizes the total cost inventory)
– Total cost is the sum of the – Results from purchasing or producing
in larger lots than are needed for
inventory-holding cost and the
immediate consumption or sale
ordering cost
– Assumptions Eq. 12.2:
• Only a single item (SKU) is
considered
• Entire order quantity (Q) arrives in
the inventory at one time
• Deals with only order/setup and
inventory-holding costs
• No stockouts are allowed
• Demand for an item is constant and
continuous over time
• Lead time is constant
Cycle Inventory Pattern for the EOQ Model
 Economic Order Quantity (EOQ) Model, Part 2
• Annual holding cost per unit (Ch) • Total Annual Cost:
• Ch = (I)(C) [Eq. 12.3] [Eq. 12.6]
Where:
• I - Annual inventory-holding charge
• Economic order quantity (Q*)
expressed as a percent of unit cost
• C - Unit cost of the inventory item or SKU – Minimizes the total annual cost
• Annual Inventory-holding Cost: [Eq. 12.7]
=(Ave. Inv.) x (Annual holding cost per unit)
1
= QCh [Eq. 12.4]
2
• Reorder point (r)
• Annual Ordering Cost:
= (Number or Orders per Year) x (Cost per Order)
𝐷 [Eq. 12.8]
= C [Eq. 12.5]
𝑄 0
• Where
– D - Annual demand for the product
– Q - Number of items ordered
– C0 - Cost of placing one order
 Quantity Discount Model
• Discounts offered for large quantities ordered • 3-Step Procedure (contd…):
• To incorporate quantity discounts in the EOQ 3. For each of the order quantities resulting
model, purchase cost of the item in the total from steps 1 and 2, compute the total annual cost
cost equation is included using the unit price from the appropriate discount
• 3-Step Procedure: category. The total annual cost can be found by
adding the purchase cost (annual demand, D,
1. Compute EOQ (Q) using EOQ formula for the
times the unit cost, C) to the holding and order
unit cost associated with each discount
costs
category
2. For Q*s that are too small to qualify for the • [Eq. 12.9]
assumed discount price, adjust the order
quantity upward to the nearest order
quantity that will allow the product to be
purchased at the assumed price. If a
calculated Q* for a given price is larger than
the highest order quantity that provides the
particular discount price, that discount price
need not be considered further, since it
cannot lead to an optimal solution.
Avoiding Stockouts in a Fixed-Order-Quantity System
• Reorder point (r) is determined
r = μL + zσL [Eq. 12.10]
– Where
• μL - Average demand during the lead
time
• 𝜎L - Standard deviation of demand
during the lead time
• z - Number of standard deviations
necessary to achieve the acceptable
service level
• z𝜎L - Amount of safety stock
• Suppose that μ𝑡 and 𝜎t are the
mean and standard deviation of
demand for some time interval (t),
then [Eq. 12.11]

[Eq. 12.12]
 Fixed-Period System (FPS)
• Inventory position is checked only at • Optimal replenishment level without safety
stock
fixed intervals of time, T, rather than
on a continuous basis [Eq. 12.14]

• Known as periodic review system

– Principal decisions • Where
- d - Average demand per time period
• Time interval between reviews (T) - L - Lead time in the same time units
• Replenishment level (M) - M - Demand during the lead time plus
• Optimal policy is established using review period
the EOQ model that provides the • To add safety stock in an FPS
best economic time interval under [Eq. 12.15]
model assumptions
[Eq. 12.13]
[Eq. 12.16]
• Where
- Q* - Economic order quantity [Eq. 12.17]
Operation of a Fixed-Period System (FPS)
 Summary of Fixed-Period Inventory Systems

Managerial Review Period (T) and Replenishment Level (M)

Decisions
Ordering Decision Place a new order every T periods, where the order quantity at time
Rule t is Qt= M - IPt , and IPt is the inventory position at the time of
review, t.
Key Characteristics The review period, T, is constant, and placing an order is time-
triggered. The order quantity, Qf varies at each review period.
M is chosen to include the demand during the review period and
lead time, plus any safety stock.
Stockouts can occur when demand is stochastic and can be
addressed by adding safety stock to the expected demand during
time T+ L.
 Single-Period Inventory Model
• Used in situations involving seasonal • Costs are defined as
or perishable items that cannot be – cs - Cost per item of
carried in inventory and sold in the overestimating demand
future – cu - Cost per item of
• Known as newsvendor problem underestimating demand
• Solved using marginal economic • Optimal order quantity is the
analysis quantity of Q* that satisfies
– Compares the cost or loss of
ordering one additional item with [Eq. 12.18]
the cost or loss of not ordering one
additional item
 SUMMARY
• Inventory is an asset held for future use or sale
• Economic order quantity (EOQ) model minimizes the
total cost
• In a fixed-period system (FPS), inventory position is
checked only at fixed intervals of time, T
• Single-period models are used in situations involving
items that cannot be carried in inventory and sold in
future periods