Chapter 17 Inventory Control

Learning Objectives Explain the different purposes for keeping inventory. Understand that the type of inventory system logic that is appropriate for an item depends on the type of demand for that item. Calculate the appropriate order size when a one-time purchase must be made. Describe what the economic order quantity is and how to calculate it. Summarize fixed–order quantity and fixed–time period models, including ways to determine safety stock when there is variability in demand. Discuss why inventory turn is directly related to order quantity and safety stock.

To maintain independence of operations Purposes of Inventory To maintain independence of operations To meet variation in product demand To allow flexibility in production scheduling To provide a safeguard for variation in raw material delivery time To take advantage of economic purchase-order size LO 2 4

Holding (or carrying) costs Inventory Costs Holding (or carrying) costs Costs for storage, handling, insurance, and so on Setup (or production change) costs Costs for arranging specific equipment setups, and so on Ordering costs Costs of placing an order Shortage costs Costs of running out LO 3 5

Single-period inventory model Inventory Systems Single-period inventory model One time purchasing decision (Example: vendor selling t-shirts at a football game) Seeks to balance the costs of inventory overstock and under stock Multi-period inventory models Fixed-order quantity models Event triggered (Example: running out of stock) Fixed-time period models Time triggered (Example: Monthly sales call by sales representative) LO 2 7

A Single-Period Inventory Model Consider the problem of deciding how many newspapers to put in a hotel lobby Too few papers and some customers will not be able to purchase a paper and they will lose the profit associated with these sales Too many papers and will have paid for papers that were not sold during the day, lowering profit LO 3

Single-Period Inventory Model Formulas We should increase the size of the inventory so long as the probability of selling the last unit added is equal to or greater than the ratio of Cu/Co+Cu LO 3 8

There are two general types of multi-period inventory systems Multi-Period Models There are two general types of multi-period inventory systems Fixed–order quantity models Also called the economic order quantity, EOQ, and Q-model Event triggered Fixed–time period models Also called the periodic system, periodic review system, fixed-order interval system, and P-model Time triggered LO 5

The fixed–time period model Key Differences To use the fixed–order quantity model, the inventory remaining must be continually monitored In a fixed–time period model, counting takes place only at the review period The fixed–time period model Has a larger average inventory Favors more expensive items Is more appropriate for important items Requires more time to maintain LO 5

Fixed-Order Quantity Model Models Demand for the product is constant and uniform throughout the period Lead time (time from ordering to receipt) is constant Price per unit of product is constant Inventory holding cost is based on average inventory Ordering or setup costs are constant All demands for the product will be satisfied LO 4

Basic Fixed-Order Quantity (EOQ) Model Formula LO 4 12

Establishing Safety Stock Levels Safety stock: amount of inventory carried in addition to expected demand Safety stock can be determined based on many different criteria A common approach is to simply keep a certain number of weeks of supply A better approach is to use probability Assume demand is normally distributed Assume we know mean and standard deviation To determine probability, we plot a normal distribution for expected demand and note where the amount we have lies on the curve LO 4

Fixed–Order Quantity Model with Safety Stock LO 5

Fixed-Time Period Models LO 5 18

Price Break Models Price varies with the order size To find the lowest-cost, need to calculate the order quantity for each price and see if the quantity is feasible Sort prices from lowest to highest and calculate the order quantity for each price until a feasible order quantity is found If the first feasible order quantity is the lowest price, this is best, otherwise, calculate the total cost for the first feasible quantity and calculate total cost at each price lower than the first feasible order quantity LO 4