1. Inventory Control
Models

2. Chapter Learning Objectives
Students will be able to:
Use the economic order quantity (EOQ) to determine how much to order.
Compute the reorder point (ROP) in determining when to order more inventory.
Understand the importance of inventory control.
Perform sensitivity analysis on basic inventory quantities.

3. Chapter Learning Objectives continued
Students will be able to:
Understand the use of safety stock with known and unknown stockout costs.
Perform ABC analysis.

4. Inventory as an Important Asset
Inventory can be the most expensive and the most important asset for an organization
Inventory
40%
Other Assets
60%
Inventory as a
percentage of total assets

5. The Inventory Process Suppliers Customers Finished Goods Raw Materials
Work in
Process
Fabrication
and
Assembly
Inventory Storage
Inventory Processing

6. Importance of Inventory Control
Five Functions of Inventory
Decoupling
Storing resources
Adapting to irregular supply and demand
Enabling the company to take advantage of quantity discounts
Avoiding stockouts and shortages

7. wish to minimize total inventory cost
Inventory Decisions
How much to order
When to order
wish to minimize total inventory cost

8. Inventory Costs Cost of the items Cost of ordering
Cost of carrying, or holding inventory
Cost of safety stock
Cost of stockouts

9. Ordering Costs Developing and sending purchase orders
Processing and inspecting incoming inventory
Bill paying
Inventory inquiries
Utilities, phone bills, etc., - purchasing department.
Salaries/wages - purchasing department employees
Supplies (e.g., forms and paper) - purchasing department

10. Carrying Costs Cost of capital Taxes Insurance Spoilage Theft
Obsolescence
Salaries/wages - warehouse employees
Utilities/building costs - warehouse
Supplies (e.g., forms, paper) - warehouse

11. Inventory Usage Over Time

12. Costs as Functions of Order Quantity
Annual
Cost
Order Quantity Q*
Total Cost Curve
Carrying (holding)
Cost Curve
Ordering (set-up)
Minimum

13. Steps in Finding the Optimum Inventory
Develop an expression for the ordering cost.
Develop and expression for the carrying cost.
Set the ordering cost equal to the carrying cost.
Solve this equation for the optimum desired.

14. EOQ : Basic Assumptions
Demand is known and constant
Lead time is known and constant
Receipt of inventory is instantaneous
Quantity discounts are not possible
The only variable costs are the cost of setting up or placing an order, and the cost of holding or storing inventory over time
Stockouts can be completely avoided if orders are placed at the appropriate time

15. Developing the EOQ Annual ordering cost:
Annual holding or carrying cost:
Total inventory cost:

16. EOQ 2 DC IP Per Unit Carrying Cost: 2DC * Q = C h
Percentage Carrying Cost: IP DC 2

17. Inputs and Outputs of the EOQ Model
Models
Input Values
Output Values
Annual Demand
(D)
Ordering Cost
(Co)
Carrying Cost
(Ch)
Lead Time
(L)
Demand Per Day
(d)
Economic
Order
Quantity
(EOQ)
Reorder
Point
(ROP)

18. The Reorder Point (ROP) Curve
ROP = (Demand per day) x (Lead time for a new order, in days) = d x L
Inventory Level (Units) Q*
ROP
(Units)
Slope = Units/Day = d
Lead Time (Days) L

19. The Use of Safety Stock Inventory on Hand Time Stockout Safety Stock
is avoided
Safety Stock

20. The Use of Safety Stock Known stockout costs: Unknown stockout costs:
Given probability of demand, find total cost for each safety stock alternative
Unknown stockout costs:
Set service level; use normal distribution

21. Service Level versus Carrying Costs

22. Summary of ABC Analysis
Group A Items - Critical
Group B Items - Important
Group C Items - Not That Important
Inventory
Group
Dollar
Usage (%)
Items (%)
Are Complex
Quantitative Control
Techniques Used? A B C 70 20 10
Yes
In some cases No

23. ABC Inventory Analysis
100 90 80 70 60 50 40 30 20 10
Percent of Inventory Items
Percent of Annual
Dollar Usage A
Items
B Items
C Items

24. ABC Inventory Policies
Greater expenditure on supplier development for A items than for B items or C items
Tighter physical control on A items than on B items or on C items
Greater expenditure on forecasting A items than on B items or on C items