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Chapter 10—Inventory Management
Inventory Inventory ManagementManagement
2Chapter 14—Inventory Management
Learning ObjectivesLearning Objectives
Be Able To Apply Concepts Listed In Learning Goals
Be Able To Use Formulas Listed In The Equation Summary of Chapter
Chapter 10—Inventory Management
Inventory CostsInventory Costs
Interest or Opportunity Costs
Storage and Handling Costs
Taxes, Insurance, and Shrinkage Costs
Ordering and Setup Costs Transportation Costs
Chapter 10—Inventory Management
Types of InventoryTypes of InventoryCycle InventoryCycle Inventory
Average cycle inventory = Q + 0
2
Chapter 10—Inventory Management
Types of InventoryTypes of InventoryCycle InventoryCycle Inventory
Safety Stock InventorySafety Stock Inventory
Average cycle inventory = Q2
Chapter 10—Inventory Management
Types of InventoryTypes of InventoryCycle InventoryCycle Inventory
Safety Stock InventorySafety Stock InventoryAnticipation InventoryAnticipation Inventory
Average cycle inventory = Q2
Chapter 10—Inventory Management
Types of InventoryTypes of InventoryCycle InventoryCycle Inventory
Safety Stock InventorySafety Stock InventoryAnticipation InventoryAnticipation InventoryPipeline InventoryPipeline Inventory
Average cycle inventory =
Pipeline inventory = DL = dL
Q2
8Chapter 14—Inventory Management
ABC ClassificationABC Classification
Start With Inventoried Items Ranked by Dollar Value in Inventory in Descending Order
Plot Cumulative Dollar Value in Inventory Versus Cumulative Items in Inventory
. . . more
9Chapter 14—Inventory Management
ABC ClassificationABC Classification
Typical Observations A Small Percentage of Items (Class A) Make up
a Large Percentage of Inventory Value A Large Percentage of Items (Class C) Make up
a Small Percentage of Inventory Value
These Classifications Determine How Much Attention Should Be Given to Controlling Inventory of Different Items
Chapter 10—Inventory Management
ABC AnalysisABC Analysis
10 20 30 40 50 60 70 80 90 100
Percentage of items
Per
cen
tag
e o
f d
oll
ar v
alu
e
100 —
90 —
80 —
70 —
60 —
50 —
40 —
30 —
20 —
10 —
0 —
Chapter 10—Inventory Management
ABC AnalysisABC Analysis
10 20 30 40 50 60 70 80 90 100
Percentage of items
Per
cen
tag
e o
f d
oll
ar v
alu
e
100 —
90 —
80 —
70 —
60 —
50 —
40 —
30 —
20 —
10 —
0 —
Class C
Class A
Class B
Chapter 10—Inventory Management
ABC AnalysisABC Analysis
10 20 30 40 50 60 70 80 90 100
Percentage of items
Per
cen
tag
e o
f d
oll
ar v
alu
e
100 —
90 —
80 —
70 —
60 —
50 —
40 —
30 —
20 —
10 —
0 —
Class C
Class A
Class B
Chapter 10—Inventory Management
How How Much?Much? When!When!
Chapter 10—Inventory Management
Economic Economic Order Order QuantityQuantity
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order Quantity
1. Demand rate is constant2. No constraints on lot size3. Only relevant costs are holding and
ordering/setup4. Decisions for items are independent
from other items5. No uncertainty in lead time or
supply
Assumptions
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order QuantityO
n-h
and
in
ven
tory
(u
nit
s)
Time
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order QuantityO
n-h
and
in
ven
tory
(u
nit
s)
Time
Receive order
Q
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order QuantityO
n-h
and
in
ven
tory
(u
nit
s)
Time
Receive order
Q
1 cycle
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order QuantityO
n-h
and
in
ven
tory
(u
nit
s)
Time
Receive order
Q
1 cycle
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order QuantityO
n-h
and
in
ven
tory
(u
nit
s)
Time
Receive order
Inventory depletion (demand rate)
Q
1 cycle
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order QuantityO
n-h
and
in
ven
tory
(u
nit
s)
Time
Receive order
Inventory depletion (demand rate)
Q
1 cycle
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order QuantityO
n-h
and
in
ven
tory
(u
nit
s)
Time
Averagecycleinventory
Q
Q—2
1 cycle
Receive order
Inventory depletion (demand rate)
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order QuantityA
nn
ual
co
st
(do
llars
)
Lot Size (Q)
Holding cost (HC)
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order QuantityA
nn
ual
co
st
(do
llars
)
Lot Size (Q)
Holding cost (HC)
Ordering cost (OC)
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order QuantityA
nn
ual
co
st
(do
llars
)
Lot Size (Q)
Ordering cost (OC)
Holding cost (HC)
Total cost = HC + OC
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order Quantity
| | | | | | | |50 100 150 200 250 300 350 400
Lot Size (Q)
3000 —
2000 —
1000 —
0 —
Currentcost
CurrentQ
Total cost = (H) + (S)DQ
Q2
Holding cost = (H)Q2
Ordering cost = (S)DQ
An
nu
al c
ost
(d
oll
ars)
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order Quantity
| | | | | | | |50 100 150 200 250 300 350 400
Lot Size (Q)
3000 —
2000 —
1000 —
0 —
Currentcost
CurrentQ
Total cost = (H) + (S)DQ
Q2
Holding cost = (H)Q2
Ordering cost = (S)DQ
Bird feeder costs
D = (18 /week)(52 weeks) = 936 unitsH = 0.25 ($60/unit) = $15S = $45 Q = EOQ
C = (H) + (S)Q2
DQEOQ =
2DSH
An
nu
al c
ost
(d
oll
ars)
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order Quantity
| | | | | | | |50 100 150 200 250 300 350 400
Lot Size (Q)
3000 —
2000 —
1000 —
0 —
Currentcost
CurrentQ
Total cost = (H) + (S)DQ
Q2
Holding cost = (H)Q2
Ordering cost = (S)DQ
Bird feeder costs
D = (18 /week)(52 weeks) = 936 unitsH = 0.25 ($60/unit) = $15S = $45 Q = 75 units
C = (H) + (S)Q2
DQEOQ =
2DSH
An
nu
al c
ost
(d
oll
ars)
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order Quantity
| | | | | | | |50 100 150 200 250 300 350 400
Lot Size (Q)
3000 —
2000 —
1000 —
0 —
Currentcost
CurrentQ
Total cost = (H) + (S)DQ
Q2
Holding cost = (H)Q2
Ordering cost = (S)DQ
Bird feeder costs
D = (18 /week)(52 weeks) = 936 unitsH = 0.25 ($60/unit) = $15S = $45 Q = 75 units
C = $562 + $562 = $1124
C = (H) + (S)Q2
DQEOQ =
2DSH
An
nu
al c
ost
(d
oll
ars)
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order Quantity
| | | | | | | |50 100 150 200 250 300 350 400
Lot Size (Q)
3000 —
2000 —
1000 —
0 —
Currentcost
CurrentQ
Total cost = (H) + (S)DQ
Q2
Holding cost = (H)Q2
Ordering cost = (S)DQ
Bird feeder costs
D = (18 /week)(52 weeks) = 936 unitsH = 0.25 ($60/unit) = $15S = $45 Q = 75 units
C = $562 + $562 = $1124
C = (H) + (S)Q2
DQEOQ =
2DSH
An
nu
al c
ost
(d
oll
ars)
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order Quantity
| | | | | | | |50 100 150 200 250 300 350 400
Lot Size (Q)
3000 —
2000 —
1000 —
0 —
Currentcost
CurrentQ
Total cost = (H) + (S)DQ
Q2
Holding cost = (H)Q2
Ordering cost = (S)DQ
Bird feeder costs
D = (18 /week)(52 weeks) = 936 unitsH = 0.25 ($60/unit) = $15S = $45 Q = 75 units
C = $562 + $562 = $1124
C = (H) + (S)Q2
DQEOQ =
2DSH
Lowestcost
Best Q(EOQ)
An
nu
al c
ost
(d
oll
ars)
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order Quantity
| | | | | | | |50 100 150 200 250 300 350 400
Lot Size (Q)
3000 —
2000 —
1000 —
0 —
Currentcost
CurrentQ
Total cost = (H) + (S)DQ
Q2
Lowestcost
Best Q(EOQ)
An
nu
al c
ost
(d
oll
ars)
Bird feeder costs
D = (18 /week)(52 weeks) = 936 unitsH = 0.25 ($60/unit) = $15S = $45 Q = 75 units
C = $562 + $562 = $1124
C = (H) + (S)DQ
Q2EOQ =
2DSH
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order Quantity
| | | | | | | |50 100 150 200 250 300 350 400
Lot Size (Q)
3000 —
2000 —
1000 —
0 —
Currentcost
CurrentQ
Total cost = (H) + (S)DQ
Q2
Birdfeeder costs
D = (18 /week)(52 weeks) = 936 unitsH = 0.25 ($60/unit) = $15S = $45 Q = 75 units
C = $562 + $562 = $1124
C = (H) + (S)DQ
Q2EOQ =
2DSH
Lowestcost
Best Q(EOQ)
DQ
Time between orders
TBOEOQ = = 75/936 = 0.080 yearEOQ
D
An
nu
al c
ost
(d
oll
ars)
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order Quantity
| | | | | | | |50 100 150 200 250 300 350 400
Lot Size (Q)
3000 —
2000 —
1000 —
0 —
Currentcost
CurrentQ
Total cost = (H) + (S)DQ
Q2
Birdfeeder costs
D = (18 /week)(52 weeks) = 936 unitsH = 0.25 ($60/unit) = $15S = $45 Q = 75 units
Lowestcost
Best Q(EOQ)
Time between orders
TBOEOQ = = 75/936 = 0.080 year
TBOEOQ = (75/936)(12) = 0.96 months
TBOEOQ = (75/936)(52) = 4.17 weeks
TBOEOQ = (75/936)(365) = 29.25 days
EOQD
An
nu
al c
ost
(d
oll
ars)
Chapter 10—Inventory Management
Economic Order QuantityEconomic Order Quantity
| | | | | | | |50 100 150 200 250 300 350 400
Lot Size (Q)
3000 —
2000 —
1000 —
0 —
Currentcost
Lowestcost
Best Q(EOQ)
CurrentQ
Total cost = (H) + (S)DQ
Q2
Holding cost = (H)Q2
Ordering cost = (S)DQ
An
nu
al c
ost
(d
oll
ars)
Chapter 10—Inventory Management
How How Much?Much? When!When!
Chapter 10—Inventory Management
Continuous ReviewContinuous Review So
up S
oup
So
up
Time
R
Orderreceived
Q
OH
On
-han
d i
nve
nto
ry
Chapter 10—Inventory Management
Continuous ReviewContinuous Review So
up S
oup
So
up
Orderreceived
Q
OH
Orderplaced
IP
TBO
L
ROn
-han
d i
nve
nto
ry
Chapter 10—Inventory Management
Continuous ReviewContinuous Review So
up Sou
pS
ou
p
Time
Orderreceived
Orderreceived
Q Q
OH OH
Orderplaced
Orderplaced
IP IP
TBO
L
TBO
L
TBO
L
R
Orderreceived
Q
OH
Orderplaced
IP
Orderreceived
On
-han
d i
nve
nto
ry
Chapter 10—Inventory Management
Uncertain DemandUncertain Demand
Time
R
On
-han
d i
nve
nto
ry
Chapter 10—Inventory Management
Uncertain DemandUncertain Demand
Time
On
-han
d i
nve
nto
ry
Orderreceived
Q
OH
Orderplaced
Orderplaced
Orderreceived
IPIP
R
TBO1 TBO2 TBO3
L1 L2 L3
Q
Orderplaced
Q
Orderreceived
Orderreceived
Chapter 10—Inventory Management
Reorder Point / Safety StockReorder Point / Safety Stock
Average demand
during lead time
Chapter 10—Inventory Management
Reorder Point / Safety StockReorder Point / Safety Stock
Probability of stockout(1.0 – 0.99 = 0.01)
Cycle-service level = 99%
Average demand
during lead time
zL
R
Chapter 10—Inventory Management
Probability of stockout(1.0 – 0.99 = 0.015)
Cycle-service level = 99%
Average demand
during lead time
zL
R
Reorder Point / Safety StockReorder Point / Safety Stock
Safety Stock/R
dL = 250L = 22SL = 99%z = 2.33
Chapter 10—Inventory Management
Probability of stockout(1.0 – 0.99 = 0.01)
Cycle-service level = 99%
Average demand
during lead time
zL
R
Reorder Point / Safety StockReorder Point / Safety Stock
Safety Stock/R
Safety stock = zL
= 2.33(22) = 51.3= 51 boxes
Chapter 10—Inventory Management
Probability of stockout(1.0 – 0.99 = 0.01)
Cycle-service level = 99%
Average demand
during lead time
zL
R
Reorder Point / Safety StockReorder Point / Safety Stock
Safety Stock/R
Safety stock = zL
= 2.33(22) = 51.3= 51 boxes
Reorder point = dL + SS= 250 + 51= 301 boxes
Chapter 10—Inventory Management
Lead Time DistributionsLead Time Distributionst = 15
+75
Demand for week 1
Chapter 10—Inventory Management
Lead Time DistributionsLead Time Distributionst = 15
+
+75
Demand for week 1
75Demand for week 2
t = 15
Chapter 10—Inventory Management
Lead Time DistributionsLead Time Distributionst = 15
=
+
+75
Demand for week 1
75Demand for week 2
75Demand for week 3
t = 15
t = 15
Chapter 10—Inventory Management
Lead Time DistributionsLead Time Distributionst = 15
=
+
+75
Demand for week 1
75Demand for week 2
75Demand for week 3
L = 26
225Demand for
three-week lead time
t = 15
t = 15
15 3
26
L t
L
L
L
Chapter 10—Inventory Management
Lead Time DistributionsLead Time Distributionst = 15
=
+
+75
Demand for week 1
75Demand for week 2
75Demand for week 3
t = 26
225Demand for
three-week lead time
t = 15
t = 15
Bird feeder Lead Time Distribution
t = 1 week d = 18 L = 2t = 5 SL = 90%
Chapter 10—Inventory Management
Lead Time DistributionsLead Time Distributionst = 15
=
+
+75
Demand for week 1
75Demand for week 2
75Demand for week 3
t = 26
225Demand for
three-week lead time
t = 15
t = 15
Bird feeder Lead Time Distribution
t = 1 week d = 18 L = 2
L = t L = 5 2 = 7.1
t = 1 week d = 18 L = 2t = 5 SL = 90%
Chapter 10—Inventory Management
Lead Time DistributionsLead Time Distributionst = 15
=
+
+75
Demand for week 1
75Demand for week 2
75Demand for week 3
t = 26
225Demand for
three-week lead time
t = 15
t = 15
Bird feeder Lead Time Distribution
t = 1 week d = 18 L = 2
L = t L = 5 2 = 7.1
Safety stock = zL = 1.28(7.1) = 9.1 or 9 units
Reorder point = dL + SS= 2(18) + 9 = 45 units
t = 1 week d = 18 L = 2t = 5 SL = 90%
Chapter 10—Inventory Management
Lead Time DistributionsLead Time Distributionst = 15
=
+
+75
Demand for week 1
75Demand for week 2
75Demand for week 3
t = 26
225Demand for
three-week lead time
t = 15
t = 15
Bird feeder Lead Time Distribution
t = 1 week d = 18 L = 2Reorder point = 2(18) + 9 = 45 units
Chapter 10—Inventory Management
Lead Time DistributionsLead Time Distributionst = 15
=
+
+75
Demand for week 1
75Demand for week 2
75Demand for week 3
t = 26
225Demand for
three-week lead time
t = 15
t = 15
Bird feeder Lead Time Distribution
t = 1 week d = 18 L = 2Reorder point = 2(18) + 9 = 45 unitsWhen stock drops to 45, order 75
C = ($15) + ($45) + 9($15)75
2
936
75
C = $562.50 + $561.60 + $135 = $1259.10
Chapter 10—Inventory Management
Periodic Review SystemsPeriodic Review Systems
TimeP P
T
On
-han
d i
nve
nto
ry
Chapter 10—Inventory Management
Periodic Review SystemsPeriodic Review Systems
Time
On
-han
d i
nve
nto
ry
P P
T
Q1
Orderplaced
Chapter 10—Inventory Management
Periodic Review SystemsPeriodic Review Systems
Time
On
-han
d i
nve
nto
ry
P P
T
Q1
L
Orderplaced
Chapter 10—Inventory Management
Periodic Review SystemsPeriodic Review Systems
Time
On
-han
d i
nve
nto
ry
P P
T
Q1
L
Orderplaced
Orderreceived
Chapter 10—Inventory Management
Periodic Review SystemsPeriodic Review Systems
Time
On
-han
d i
nve
nto
ry
Orderreceived
Orderreceived
Orderplaced
Orderplaced
Q1Q2
Q3
L L LP P
T
Orderreceived
Chapter 10—Inventory Management
Periodic Review SystemsPeriodic Review Systems
Time
On
-han
d i
nve
nto
ry
IP1
IP3
IP2
Orderreceived
Orderreceived
IP IP
OH OH
Orderplaced
Orderplaced
Q1Q2
Q3
L L LP P
Protection interval
T
Orderreceived
IP
Chapter 10—Inventory Management
Time
On
-han
d i
nve
nto
ry
IP1
IP3
IP2
Orderreceived
Orderreceived
IP IP
OH OH
Orderplaced
Orderplaced
Q1Q2
Q3
L L LP P
Protection interval
T
Orderreceived
IP
Periodic Review SystemsPeriodic Review Systems
Bird feeder— Calculating P and T
Chapter 10—Inventory Management
Time
On
-han
d i
nve
nto
ry
IP1
IP3
IP2
Orderreceived
Orderreceived
IP IP
OH OH
Orderplaced
Orderplaced
Q1Q2
Q3
L L LP P
Protection interval
T
Orderreceived
IP
Periodic Review SystemsPeriodic Review Systems
EOQ = 75 units D = (18 units/week)(52 weeks) = 936 units
t = 5 units d = 18 L = 2 weeks cycle/service level = 90%
Bird feeder—Calculating P and T
Chapter 10—Inventory Management
Time
On
-han
d i
nve
nto
ry
IP1
IP3
IP2
Orderreceived
Orderreceived
IP IP
OH OH
Orderplaced
Orderplaced
Q1Q2
Q3
L L LP P
Protection interval
T
Orderreceived
IP
Periodic Review SystemsPeriodic Review Systems
EOQ = 75 units D = (18 units/week)(52 weeks) = 936 units
t = 5 units d = 18 L = 2 weeks cycle/service level = 90%
Bird feeder—Calculating P and T
P = (52) = (52) = 4.2 or 4 weeksEOQ
D75
936
P+L = P + L = 5 6 = 12 units
Chapter 10—Inventory Management
Time
On
-han
d i
nve
nto
ry
IP1
IP3
IP2
Orderreceived
Orderreceived
IP IP
OH OH
Orderplaced
Orderplaced
Q1Q2
Q3
L L LP P
Protection interval
T
Orderreceived
IP
Periodic Review SystemsPeriodic Review Systems
T = Average demand during the protection interval + Safety stock
= d (P + L) + zP + L
= (18 units/week)(6 weeks) + 1.28(12 units) = 123 units
EOQ = 75 units D = (18 units/week)(52 weeks) = 936 units
t = 5 units d = 18 L = 2 weeks cycle/service level = 90%
Bird feeder—Calculating P and T
P = (52) = (52) = 4.2 or 4 weeksEOQ
D75
936
P+L = P + L = 5 6 = 12 units
Chapter 10—Inventory Management
Time
On
-han
d i
nve
nto
ry
IP1
IP3
IP2
Orderreceived
Orderreceived
IP IP
OH OH
Orderplaced
Orderplaced
Q1Q2
Q3
L L LP P
Protection interval
T
Orderreceived
IP
Periodic Review SystemsPeriodic Review Systems
EOQ = 75 units D = (18 units/week)(52 weeks) = 936 units
t = 5 units d = 18 L = 2 weeks cycle/service level = 90%
Bird feeder—Calculating P and T
P = 4 weeks T = 123 units
Chapter 10—Inventory Management
Time
On
-han
d i
nve
nto
ry
IP1
IP3
IP2
Orderreceived
Orderreceived
IP IP
OH OH
Orderplaced
Orderplaced
Q1Q2
Q3
L L LP P
Protection interval
T
Orderreceived
IP
Periodic Review SystemsPeriodic Review Systems
EOQ = 75 units D = (18 units/week)(52 weeks) = 936 units
t = 5 units d = 18 L = 2 weeks cycle/service level = 90%
Bird feeder—Calculating P and T
C = ($15) + ($45) + 15($15)4(18)
2936
4(18)
C = $540 + $585 + $225 = $1350
P = 4 weeks T = 123 units
Chapter 10—Inventory Management
Comparison of Comparison of QQ and and PP Systems Systems
P Systems
Q Systems
Convenient to administer Orders may be combined IP only required at review
Individual review frequencies Possible quantity discounts Lower, less-expensive safety stocks
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