1. McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

2. *** Important note ***
Since the text contains advanced materials on inventory management, which will confuse you, do not refer to the text.
Notations and method should be used consistently as this slides do.

3. Types of Inventory Inventory: supply of items held to meet demand
Suppliers
Suppliers
MRO
MRO
Raw Material
Raw Material
Components
Components
Maintenance, repair &
Maintenance, repair &
operating supplies
operating supplies
Work in
Work in
Process (WIP)
Process (WIP)
Finished
Finished
Goods (FGI)
Goods (FGI)
Transportation
Distribution
Distribution
Customers
Customers
7–3

4. Inventory Control Objectives
We need to answer the following questions in order to balance supply and demand, and balance costs and service levels.
When do I order?
How much do I order?
Where do I deploy the inventory?
How much?
Where?
When?
14–4

5. Functions of Inventory
To meet anticipated demand
To smooth production requirements
To decouple operations
To protect against stock-outs

6. Functions of Inventory (Cont’d)
To help hedge against price increases
To permit operations through WIP
To take advantage of quantity discounts

7. Disadvantages of Inventories
Difficult to Control
Determining optimal amounts
Storage and maintenance
Handling inventory is a non-value added
activity

8. Inventory Management
Independent Demand: demand is beyond control of the organization
Dependent Demand: demand is driven by demand of another item
14–8

9. Inventory Counting Systems
Periodic inventory System
Physical count of items made at periodic intervals
Perpetual Inventory System System that keeps track of inventory continuously, thus monitoring current levels of each item

10. Bullwhip Effect
Inventory oscillations become progressively larger looking backward through the supply chain

11. Managing Inventory Across the Supply Chain
Collaborative planning, forecasting and replenishment (CPFR): supply chain partners sharing information
Vendor-managed Inventory (VMI): the vendor is responsible for managing inventory for the customer
Vendor monitors and replenishes inventory balances
Customer saves holding costs
Vendor has higher visibility of inventory usage

12. Inventory Management in the supply chain : Example (Wal-Mart)
P&G:
Cross-docking:

13. Managing Inventory – ABC Analysis
ABC analysis: ranking inventory by importance
Pareto’s Law: small percentage of items have a large impact profit
100 95 80 50 C
Items B
Items A
Items
Cumulative
Percentage
of Revenue
Cumulative Percentage of Items
7–13

14. Financial Impact of Inventory
Set-up (Ordering)Cost
Purchased items: placing and receiving orders
Holding (Carrying ) Costs
Opportunity cost (including cost of capital)
Storage and warehouse management
Taxes and insurance
Obsolescence, spoilage, & shrinkage
Material handling, tracking and management
Ordering cost
Carrying cost
7–14 14

15. Total Inventory Costs
Total Inventory Costs: sum of all relevant annual inventory costs. i.e. total set-up cost + total holding cost.
14–15

16. TIC = annual ordering cost + annual carrying cost
Total Inventory Costs
TIC = annual ordering cost + annual carrying cost
= (D/Q)(S) + (Q/2)(IC)
N = D/Q
A = Q/2
Where:
N = orders per year A = average inventory level
D = annual demand S = order cost per order
Q = order quantity C = unit cost
I = % carrying cost per year
14–16

17. Total Inventory Costs
Note that frequently holding cost is given as a single number meaning H = IC
Example: H =$2/item/year
14–17

18. N = D/Q = 3000 / 500 = 6 order per year
Total Inventory Costs
If we need 3,000 units per year at a unit price of $20 and we order 500 each time, at a cost of $50 per order with a carrying cost of 20%, what is the TIC?
N = D/Q = 3000 / 500 = 6 order per year
A = Q/2 = 500 / 2 = 250 average inventory
TIC = ordering cost + carrying cost
= S (D/Q) + (IC)(Q/2)
= $50 (3000/500) + ($20*0.20)*(500/2) = $1,300
Where:
N = D/Q Q = A = Q/ C = $20
D = 3, S = $ I= 0.20
14–18

19. N = D/Q = 3000 / 200 = 15 order per year
Total Inventory Costs
If we need 3,000 units per year at a units price of $20 and we order 200 each time, at a cost of $50 per order with a carrying cost of 20%, what is the TIC?
N = D/Q = 3000 / 200 = 15 order per year
A = Q/2 = 200 / 2 = 100 average inventory
TIC = ordering cost + carrying cost
= S (D/Q) + ( IC )(Q/2)
= 50 (3000/200) + ($20*0.20)*(200/2) = $1,150
Where:
N = D/Q Q = A = Q/ C = $20
D = 3, S = $ I = 0.20
Example 14-2
14–19

20. Economic Order Quantity (EOQ)
Economic Order Quantity (EOQ): minimizes total acquisition costs; point at which holding and orders costs are equal
How much to order
D = Annual Demand
S= Ordering cost
I= Percent of unit cost
C = Unit cost
H= IC= holding cost of item
per year
14–20

21. EOQ Model

22. Economic Order Quantity (EOQ)
Carrying + Order
Carrying Cost
Cost
Order Cost
EOQ
Order Quantity (Q)
14–22

23. Economic Order Quantity (EOQ)
If we need 3,000 units per year at a unit price of $20, at a cost of $50 per order with a carrying cost of 20%, what is lowest TIC order quantity?
D = 3,000
S= $50
C = $20
I = 20%
Example 14-3
14–23

24. EOQ Example What is the optimal order quantity?
Example : D=48,000 units/year
S= $20/order
I= 18%, c=$100

25. EOQ theorem Example : D=12,000 units/year
S= $60/order, H= $10/unit/year
Q= order quantity,
Q*=optimal order quantity
What is the optimal order quantity?

26. Production Order Quantity Model
= POQ Model
It is also called Economic Production Quantity Model
= EPQ Model

27. POQ Model ■ Suited for Production Environment
■ Provides Production lot size

28. POQ Model Equations D= Demand per year S= Setup cost H=Holding cost
Let,
D= Demand per year
S= Setup cost
H=Holding cost
d=demand per day
p=production per day

29. POQ Model Equations ■ Optimal order quantity or production lot size
■ Max. Inventory level
■ Setup cost
■ Holding cost

30. Production Order Quantity
S= $2,000
I= 25%
C = $10
d = 2,000
p = 5,000
Example 14-6
14–30

31. POQ Example
■ The Watkins Chemical Company produces a chemical compound that is used as a lawn fertilizer. The compound can be produced at a rate of 10,000 pounds per day. Demand for the compound is 0.6 million pounds per year. The fixed cost of setting up for a production run of the chemical is $1,500, and the variable cost of production is $3.50 per pound. The company uses an annual interest rate of 22% to account for the cost of capital, and the annual costs of storage and handling of the chemical amount to 12% of the value. Assume that there are 250 working days in a year. What is the optimal lot size, maximum inventory level, and total cost?

32. Quantity discounts

33. Quantity Discount Models
Material cost:
Total material cost is affected by the Discount (%)
Unit cost if first $5.00, then $4.80,
and finally $4.75
6-33

34. Quantity Discount Models
Total Cost Curves for each of the 3 discount plans
6-34

35. All-Units quantity discounts
1. Consider the all-units quantity discount schedule below.
Units Ordered Price Per Unit EOQ at that Price $ $ $ $ $
≥ $
What are the possible optimal order quantities? 

36. Steps for Solving Quantity Discount
Compute EOQ for each discount price:
If EOQ < discount minimum level, let Q = minimum.
For each EOQ or minimum Q, compute total cost:
TC = DC + (D/Q)(S) + (Q/2)(H)
Choose the lowest cost quantity from all levels. Q * = IC
2DS
6-36

37. All-Units quantity discounts
A supplier for Lower Florida Keys Health System
has introduced all-units quantity discounts
to encourage larger order quantities
of a special catheter. The price schedule is:
Order Quantity Price per Unit
$60.00
$58.80
500 or more $  

38. All-Units quantity discounts
The firm estimates that its annual demand
for this item is 936 units, its setup cost is $45 per order, and its annual holding cost is 25% of the catheter’s unit price.
What’s the best order size?

39. All-Units quantity discounts
Calculate EOQ

40. All-Units quantity discounts
Total cost for the quantity discount case:

41. Homework problems for ch 14
Problem 1. The I-75 Carpet Discount store in Washington stocks carpet in its warehouse and sells it through an adjoining showroom. The store keeps several brands and styles of carpet in stock; however, its biggest selling item is Super Shag carpet. The store wants to determine the optimal order size and total inventory cost for this brand of carpet given an estimated annual demand of 10,000 yards of carpet, annual carrying cost of $0.765 per yard, and an ordering cost of $150.
a) Decide the optimal order quantity
b) Calculate the minimum total annual inventory cost

42. Homework problems for ch 14
Problem 2. Ashlee’s Beach Chairs company produces upscale beach chairs. Annual demand for the chairs is estimated at 18,000 units. The frames are made in batches before the final assembly process. Ashlee’s frame department can produce 2,500 frames per month. The setup cost is $800 per order, and the annual holding cost is $18 per unit. The company operates 20 days per month.
a) Determine the optimal lot size
b) Calculate the total holding cost
c) Calculate maximum inventory level

43. Homework problems for ch 14
Problem 3. Sharp inc, a company that markets painless hypodermic needles to hospitals, would like to reduce its inventory cost by determining the optimal number of hypodermic needles to obtain per order. The annual demand is 1,000 units; the holding cost per unit per year is $0.5. The inventory manager of Sharp inc, calculated the optimal order quantity of 200 units.
a) What is the ordering cost per order in the company
b) What is the total ordering cost? 

44. Homework problems for ch 14
Problem 4 . A produce distributor uses 800 packing crates a month, which it purchases at a cost of $10 each. The manager has assigned an annual carrying cost of 35 percent of the purchase price per crate. Ordering costs are $28 each time. Currently the manager orders once a month. How much could the firm save annually in ordering and carrying costs by using the EOQ?

45. Homework problems for ch 14
Problem 5. Ross White’s machine shop uses 2,500 brackets during the course of a year, and this usage is relatively constant throughout the year. These brackets are purchased for $15 each. The holding cost per bracket per year is 10% of the unit cost and the ordering cost per order is $ There are 250 working days per year.
a) What is EOQ?
b) In minimizing cost, how many orders would be made each year?
c) What would be the total annual inventory cost?(i.e. addition of total ordering and holding cost)

46. Homework problems for ch 14
Problem 6. A hospital buys disposable surgical packages from Pfishier, Inc. Pfisher’s price schedule is $50.25 per package on order of 1 to 199 packages, and $49.00 per packages on orders of 200 or more packages. Ordering cost is $64 per order, and annual holding cost is 20 percent of the per-unit purchase price. Annual demand is 490 packages. What is the best purchase quantity?