1. CHAPTER 11 INVENTORY THEORY

2. Basic Functions Revenue Costs
To protect the production process from changes in the environment RM
Stock FG
Stock
Sales of FG
Manufacturing RM
Arrivals
WIP
Revenue
Costs

3. Why is it Important? Pervades the business world
Necessary for any company dealing with physical products
Manufacturing
Wholesalers
Retailers
Total value (in US) is more than $1000,000,000,000
25% associates with storing cost
Hence, reducing a little bit, can enhance company’s competitiveness

4. Basic Questions in Inventory Control
How much should we stock?
Two extreme answers to this question:
A lot
This ensures that we never run out
An easy way of managing Stock
Expensive in inventory costs, cheap in management costs
None/very Little
Known as JIT
A difficult way of managing stock
Cheap in inventory costs, expensive in management costs
When should we order?

5. Types of Inventory Policies
Depends on demand and lead time
the number of units that will need to be withdrawn from inventory
Deterministic Models
Stochastic Models

6. Types of Inventory Costs
Purchasing Costs
Holding costs
Ordering costs
Stock out costs
Not considered here
Annual Inventory Cost=Purchasing Costs+Holding Costs+Ordering Costs

7. Holding Costs Storage Costs Labor
Overheads (Heating, Lighting, Security)
Money Tied up (Loss of Interest, Opportunity Cost)
Obsolescence Costs
Stock Deterioration (Lose Money If Product Deteriorates)
Theft/insurance

8. Ordering Costs Clerical/labor Costs of Processing Orders
Inspection and Return of Poor Quality Products
Transport Costs
Handling Costs

9. Deterministic Assumptions
Demand is known and constant
Lead time is known and constant
Order quantity does not depend on price
Order quantity arrives all at once when needed
Planned shortages are not allowed

10. Basic Model Q
Inventory level
time

11. Inventory Control Notation
A=ordering cost
c=unit purchasing cost
H=IC=holding cost per unit per unit of time
Q=ordering quantity
A=annual demand
T=cycle time

12. Annual Holding Cost H(Q/2)
Annual holding cost = (holding cost per unit)(Average inventory
H(Q/2)
where Q/2 is the average (constant) inventory level
Annual
Holding
Cost
Holding Cost Curve
Order Quantity

13. Annual Order Cost Annual order cost = A(D/Q)
where (D/Q) is the number of orders per year
Total
Annual
Ordering
Cost
Annual Order Cost
Order Quantity

14. Total Annual Cost Curve
Annual holding cost
Annual ordering cost Q

15. Optimal Policy TC = IC(Q/2) + A(D/Q)
The function that we want to minimize by choosing an appropriate value of Q
Differentiating total cost with respect to Q and equating to zero :Q* = (2DA/IC)1/2
Total annual cost associated with the EOQ (2DAIC) 1/2