1. Independent Demand Inventory Management
C H A P T E R 12
Independent Demand Inventory Management

2. Learning Objectives Describe different types & uses of inventory
Understand relevant inventory costs
Calculate order quantities
Evaluate different inventory policies
Calculate appropriate safety stock policies
Understand ABC inventory policies
Compare cycle & periodic counting

3. Types of Inventory

4. Uses of Inventory Anticipation or seasonal inventory
Safety stock: buffer demand fluctuations
Lot-size or cycle stock: take advantage of quantity discounts or purchasing efficiencies
Pipeline or transportation inventory
Speculative or hedge inventory
Maintenance, repair, and operating (MRO) inventories

5. Objectives & Measures Provide desired customer service level:
Percentage of orders shipped on schedule
Percentage of lines shipped on schedule
Percentage of dollar volume shipped on schedule
Provide for cost-efficient operations:
Total inventory-related costs
Minimize inventory related investments:
Inventory turnover
Weeks (or days) of supply

6. Relevant Costs Item price Holding costs Ordering & setup costs:
Variable costs dependent upon the amount of inventory held (e.g.: capital & opportunity costs, storage & insurance, risk of obsolescence)
Ordering & setup costs:
Fixed cost of placing an order (e.g.: clerical accounting & physical handling) or setting up production (e.g.: lost production to change tools & clean equipment)
Shortage costs:
Lost profit, expediting & back ordering expenses

7. Order Quantity Approaches
Lot-for-lot:
Order exactly what is needed
Fixed order quantity:
Order a predetermined amount each time
Min-max system:
When inventory falls to a set minimum level, order up to the predetermined maximum level
Order enough for n periods
Periodic review:
At specified intervals, order up to a predetermined target level

8. Periodic Review System
Target inventory calculation:
Order quantity calculation:

9. Fixed-Order Quantity Models
Economic Order Quantity (EOQ)
Economic Production Quantity (EPQ)
Quantity Discount Model

10. EOQ Assumptions
Demand is known & constant - no safety stock is required
Lead time is known & constant
No quantity discounts are available
Ordering (or setup) costs are constant
All demand is satisfied (no shortages)
The order quantity arrives in a single shipment

11. Inventory Profile

12. EOQ Total Costs
Total annual costs + annual ordering costs + annual holding costs

13. EOQ: Total Cost Equation
Minimize the TC by ordering the EOQ:

14. Simple Reorder Point
R = dL

15. EOQ Example

16. Solution

17. EPQ Assumptions
Same as the EOQ except: inventory arrives in increments & is drawn down as it arrives

18. EPQ Equations Adjusted total cost: Maximum inventory:
Adjusted order quantity:

19. Quantity Discount Model Assumptions
Same as the EOQ, except:
Unit price depends upon the quantity ordered
Adjusted total cost equation:

20. Quantity Discount Procedure
Calculate the EOQ at the lowest price
Determine whether the EOQ is feasible at that price
Will the vendor sell that quantity at that price
If yes, stop – if no, continue
Check the feasibility of EOQ at the next higher price
Continue to the next slide ...

21. QD Procedure Continue until you identify a feasible EOQ
Calculate the total costs (including purchase price) for the feasible EOQ model
Calculate the total costs of buying at the minimum quantity allowed for each of the cheaper unit prices
Compare the total cost of each option & choose the lowest cost alternative

22. What if Demand is Uncertain?

23. Adding Safety Stock Order-cycle service level:
From a managerial standpoint, determine the acceptable probability that demand during lead time won’t exceed on-hand inventory
Risk of a stockout: 1 – (service level)

24. Adjusted Reorder Point Equation
R = reorder point
d = average daily demand
L = lead time in days
z = number of standard deviations associated with desired service level
sigma = standard deviation of demand during lead time

25. ABC Classification Pareto’s law:
Roughly 20% of inventories will account for 80% of inventory value
Divide inventories into A, B, and C categories based on value, risk, & other considerations
Use tight controls & frequent reviews for A items
Use normal methods to manage B items
Use simple, inexpensive systems with large safety stocks to manage C items (just don’t run out)

26. Periodic versus Cycle Counting
Periodic counting:
Take a periodic (often annual) physical inventory to verify & update records
Cycle counting:
Count specified items each day (mini physical inventories)
Frequency with which each item is counted depends upon its ABC classification

27. The End
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