Managing

Operations UNIT 8 INVENTORY PLANNING AND

CONTROL

Objectives
After studying this unit, you will be able to
• Define inventory planning and control.
• Understand the Inventory Concepts.
• Differentiate various types of Inventories.
• Get to know the features and scope of inventory planning and control.
• Understand the various inventory models.
• Know the Operations of the Inventory System.
STRUCTURE
8.1 Introduction
8.1.1 Inventory Concepts
8.1.2 Types of Inventories
8.1.3 What is Inventory Planning?
8.1.4 What are the advantages of Inventory Planning and Control?
8.2 Controlling the Inventory
8.2.1 Inventory Decisions
8.2.2 The Concept of EOQ
8.2.3 Continuous Inventory Systems
8.2.4 Periodic Inventory Systems
8.2.5 Inventory Challenges
8.3 Inventory Problems
8.3.1 Deterministic inventory problems with no shortages
8.3.2 The problem of EOQ with finite replacement (Production)
8.3.3 Deterministic inventory problems with shortages
8.3.4 Independent Demand System for Multiple Products
8.3.5 Models with Uncertain Demand
8.4 Inventory System Operation
8.5 Bulk discount model
8.6 Summary
8.7 Keywords
8.8 Self–Assessment Exercises
8.9 Further Readings

8.1 INTRODUCTION
The term "Inventory” pertains to the raw materials, work in process, and
finished products of the business. Inventory management is a critical function
that determines the health of the organization. Inventory is a stock of items an
organisation keeps meeting internal and external customer demand. Every
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organisation continually strives to maintain optimum inventory to meet its Inventory Planning
and Control
requirements. Inventory items are divided into two categories, i.e.,
Independent specified inventory items and Dependent demand inventory
items. The first is determined by the item's usage history and quantitative
changes in demand. In contrast, the latter is determined by the manufacturing
plans of the final products in which the item under consideration is a
component. As a result, the Independent specified inventory items are
founded on a replenishment philosophy, whereas the Dependent demand
inventory items are founded on a requirements philosophy.

8.1.1 Inventory Concepts

Ordering Cost: Costs related to ordering raw materials for production
purposes. Advertisements, consumption of stationery and postage, telephone
charges, inspection fees, rent for space used by the purchasing department,
travelling expenditure incurred, etc., are examples of ordering costs.

Carrying (Holding) Cost: The carrying cost is coupled with carrying or

holding inventory. This cost generally includes the costs such as rent for
space used for storage, interest on the money locked up, insurance of stored
equipment, production, taxes, depreciation of equipment, furniture used, etc.
Set-up Cost: Cost of setting up machinery before starting production. Set-up
cost is generally assumed to be independent of the quantity ordered for or
produced.
Shortage (Stock out) Cost: The penalty cost for running out of stock (i.e.,
when an item cannot be supplied on the customer’s demand) is known as
shortage cost. The cost includes the loss of potential profit through sales of
items and loss of goodwill in terms of permanent loss of customers and its
associated lost profit in future sales.
Backorder: An order not fulfilled due to a lack of readily accessible stock.
The product ordered may not be available in the firm's current stock but may
still be in creation, or the firm may require further production.

Lead time: The time interval between placing an order and receiving the
ordered goods. In another way, it is the elapsed time between placing the
order and having the goods in stock ready for use.

8.1.2 Types of Inventories

Based on their nature and purpose, inventories are broadly classified as
follows.

Pipeline inventory: Pipeline inventory is all the items in transit between the
different locations of a supply chain. The inventory may be on its way to a
factory from a large distributor, where it will turn into finished goods
inventory.

Buffer Inventory: Inventory maintained to meet the average demand during

the lead time and emergencies, transportation delays, or surges in demand.
Anticipation inventory: Additional finished products or raw materials 125
Managing bought by an organisation to meet anticipated demand.
Operations
Decoupling Inventory: The stock is maintained to reduce the
interdependence of various stages of the production system.

8.1.3 What is Inventory Planning?

Inventory is considered as critical business asset. Since most of the cash is
tied to inventory, this discourages the organization from investing in other
business areas. The adverse effects of excess inventory can disrupt cash flow
and hamper business growth. Companies do product planning to meet
demand while reducing expenses. It involves forecasting demand and making
the right decisions about how much stock and when to order. It assists the
organization in having the appropriate amount of inventory in the right
location at the right time. The benefits are as follows:
• Reduces the total cost of inventory.
• Optimizes inventory allocation routes.
• Always have the necessary products to meet customer needs to avoid ove
rstocked products.
• Increases customer satisfaction through sales protection.

8.1.4 What Are the Advantages of Inventory Planning and

Control?
Inventory Planning and Control are essential tasks of any organization.
Inventory planning insists on developing estimates to determine how much
inventory should be kept satisfying customers' needs. The main advantages of
inventory planning include increased transparency, smooth cashflows,
increased profit, enhanced customer satisfaction, etc. Inventory control also
has many benefits, including warehouse cost reduction, waste minimization,
boosting efficiency, increasing internal communication, and raising quality
standards.

Check your progress: Possible answers.

1. Inventory costs are generally classified as
(a) Sales expenditures.
(b) Ongoing work.
(c) In the annual physical inventory.
(d) The costs of ordering and holding.
2. EDI is the transmission of routine business transactions over standard
communication lines.
True (a) False (b)
3. Service and repair stock must only be kept for up to five years from the
date of purchase.
True (a) False (b)
4. Anticipation stock is inventory that goes from one location to another.

126 True (a) False (b)

Answers: 1. (d), 2. (a), 3. (b), 4. (b) Inventory Planning
and Control

8.2 CONTROLLING THE INVENTORY

Inventory is necessary to give operating flexibility to the system. The stock
can be divided into three categories: finished commodities, in-process
materials, and raw resources. The material inventories eliminate reliance
between factories and suppliers. Work-in-progress inventories eliminate
machine dependency in a product line. Stockpiling completed products
removes dependence between the factory and its customers or market.

8.2.1 Inventory Decisions

Inventory control decides what and how many items will be kept in stock. It
also determines the time and quantity of various items to be procured.
Inventory managers often make the following two fundamental decisions.

1. How much to order?

2. When should the order be placed?

8.2.2 The Concept of EOQ

The inventory problems in which demand is assumed to be fixed and wholly
predetermined are usually called Economic Order Quantity (EOQ) or lot size
problems. If the purchased quantity is less, the order cost will be higher. The
ordering cost decreases as the purchase amount increases, but the carrying
cost increases. The total cost curve in the figure below equals the sum of
ordering and carrying costs. The Economic Order Quantity (EOQ) or Q* is
the order size, which minimizes the total annual costs of carrying inventory
and the cost of Ordering.

Figure 8.1: Economic Order Quantity

It is evident from the above that the minimum total cost occurs when the
ordering costs and inventory carrying costs are equal.
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Managing
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8.2.3 Continuous Inventory Systems
A continuous Inventory System, also known as a Fixed-order-quantity
system,is a continual record of the inventory level for every item maintained.
Whenever the inventory on hand decreases to a predetermined level, referred
to as the reorder point, a new order is placed to replenish the inventory stock.
The order that is placed is for a fixed amount that minimizes the total
inventory costs. A positive feature of a Continuous Inventory System is that
the inventory level is continuously monitored, which enables the
management to know the inventory status always. This benefits critical items
such as replacement parts, raw materials, and supplies. However, maintaining
a continual record of the inventory on hand can also be costly.

8.2.4 Periodic Inventory Systems

The periodic inventory system is also known as a Fixed-time-period system.
In this system, the inventory on hand is counted at specific intervals, i.e.,
every week or at the end of each month. After the inventory in stock is
determined, an order is placed for an amount that will bring the inventory
back up to a desired level. The inventory level is not monitored at all during
the time interval between orders, so it has the advantage of lessrequired
record keeping. The disadvantage is less direct control, which typically
results in larger inventory levels than a Continuous Inventory System.

8.2.5 Inventory Challenges

Inconsistent Tracking:Using physical tracking of inventory techniques
spanning many applications and sheets is lengthy, unnecessary, and prone to
mistakes. Small businesses could profit from a centralized stock monitoring
system with financial functionality.
Warehouse Efficiency: Receipt and put away, selection, packaging, and
transportation are all labor-intensive procedures in the administration of
inventory systems at the storage place. The aim is to managealltheseactivities
as efficiently as feasible.
Inaccurate Data: One must precisely know what stock quantity is available
at any given time.
Changing Demand:Demand from consumers is constantly changing.
Maintaining excessively may result in obsolete stock that onecannot market,
whereas maintaining inadequate stock may result in an inability to meet
client demands. Order methods to store vital supplies and technologies for
creating and executing a stock plan can assist in compensating for demand
swings.
Limited Visibility:If goods at the storage facility are challenging to recognize
or identify, it results in insufficient, erroneous, or postponed deliveries.
Acquiring and locating the correct inventory is critical to effective storage
operations and pleasant client interactions.

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 Inventory Planning
8.3 INVENTORYPROBLEMS and Control

Inventory management models enhance the business by keeping up the

perfect measure of inventory while lessening costs.
• Deterministic inventory problems with no shortages
• The problem of EOQ with finite replacement (Production)
• Deterministic inventory problems with shortages
• Independent Demand System for Multiple Products
• Models with Uncertain Demand

8.3.1 Deterministic inventory problems with no shortages

Orders of the same quantity are placed regularly in this inventory approach.
The goods purchased are immediately replenished and steadily depleted. The
purchasing price per unit remains constant regardless of transaction size.

Let D denote the annual requirement in units.

The order/ordering cost is Co.
Cc denotes the carrying cost per unit per year.
P is the unit purchase price.
Q is the ordered quantity.
In the image below, the appropriate model is displayed.

Figure 8.2: Deterministic Inventory model

The number of orders/years=

Average inventory =

Ordering cost = Co

Carrying cost/year = Cc

Purchase cost/year = D× P

The total inventory cost (TC)/year=Ordering cost + Carrying cost

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Managing D Q
Operations ( C0 )+ ( Cc )
Q 2

At minimum total inventory cost,

Ordering cost = Carrying cost
D Q
× C0 × Cc
Q = 2

Q2 =

No. of orders=

Time between orders=

Total cost= Ordering cost + Carrying cost

D Q
× C0 × Cc
Total Cost = Q + 2

By substituting the Q value,

Total cost =

Example: 1
Abhi Industry expects to sell 14,000 pieces of merchandise in the coming
year. The purchase price is Rs. 120 per order, and the yearly holding cost is
equivalent to 25% of the purchase price. The purchase price is 60 rupees per
unit.

Determine

(a) EOQ
(b) The number of purchases made each year
(c) The interval between sales
(d) Total cost
Solution:
D=14,000 units/year
C0=Rs. 120/order
Cc= 60 0.25= Rs.15/unit/year
Therefore,

EOQ=Q* =
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 Inventory Planning
= and Control

= 473 units (Approx).

No. of orders/year =

=
=24.49

The time between successive orders= = = 0.03 year= 0.4803 month=

14.61 days.

Total cost = =

= Rs. 7,100 (approx.)

8.3.2 The problem of EOQ with finite replacement (Production)

When a company manufactures a component for its main product, its
stocking model is called a "manufacturing model." Throughout the year, the
rate of product usage remains consistent. The manufacturing cost per unit is
the same regardless of output lot size.
Let r denote the item's desired rate, and k is its production rate per unit of
time.

D denotes the number of units required per year.

C0 is the set-up cost per set-up.

Let Cc be the carrying cost per unit per time.

Economic Batch Quantity (EBQ):

The production process is shown in the image below. Duringperiod t1, the
object is produced at a rate of k units per period and consumed at a rate of r
units per period. As a result, the inventory is being created at a rate of (k-r)
units per session. The item is no longer produced during the time interval t2.
As a result, the inventory is depleting at a rate of r units per session.

The various formulae for this situation are listed below.

EBQ =

Figure 8.3: EOQ for Production Problem

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Managing Number of production runs per year = n= D/Q*
Operations

t1* = Q* k
* Q* [1 − r k ]
t =
2
r

Cycle time=
t1* +t2*
Total minimum production inventory cost =

Example: 2
The following information pertains to a product manufactured within the
company,

r= 28,000 units per year.

k= 52, 000 units per year
C0= Rs.240 for each set-up
Cc=Rs.24/unit/year
Find the rotation period and EBQ.
Since the r value is given per annum, D=r= 28,000

2C 0 D
C c (1 − r k )
EBQ=

EBQ =

EBQ= 1,102 units (approx.)

t1* = Q * k

t1= 1,102/52,000 =0.0211 year = 0.253 month= 7.7 days

Q*  r 
t 2* = 1 − 
r  k

1102  28,000 
= 1 − 
28,000  52,000 

=0.018 year=0.216 month= 6.5 days

Thus, the total cycle duration =0.253 + 0.216 = 0.469 months= 14.2 days

Total minimum production inventory cost =

= Rs. 12,201 (approx.)

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8.3.3 Deterministic inventory problems with shortages Inventory Planning
and Control

In this case, the purchased items will be delivered immediately and consumed
continuously. Regardless of purchase volume, the price per unit remains
constant. If no inventory is available when the request is made, it is assumed
to be supplied later for a fee. Backordering is what we call it. This model's
operation is depicted in the accompanying image.

The variables which are used in this model are given below.
D = Demand/period
Cc = Carrying/cost/period
C0 = Ordering cost/order
Cs = Shortage cost/unit/period

Figure 8.3: Deterministic EOQ for Shortages

In the above model,

Q*=EOQ=
2C 0 D (C s + Cc )
Cc Cs

 Cs  *
Q1* =   Q
C
 s + Cc 

 Cs  2C 0 D
Q1* =  
 Cs + Cc  Cc

* *
Q 2 =Q*-Q 1
*
t* = Q D

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Managing
Operations t2* = Q2* D

Example: 3
A bike manufacturer has an annual requirement of 20,000 units. The ordering
cost is Rs. 24 per order, the transportation cost is Rs. 0.80 per unit per year,
and the shortage cost is Rs. 14 per unit per year. Determine the maximum
supply, deficit amount, inventory period, shortage period, cycle time, and
total optimum inventory cost.

Solution:
D= 20,000 units/year
Cc= Rs.0.80/unit/year
C0= Rs. 24.00/order
Cs= Rs.14.00/unit/year
Q*= 2C 0 D (C s + C c )
Cc Cs

=1,127

=( )Q

= 1,066

Q2* = Q* - Q1*
Q2* = 1,127 – 1,066 = 61

= 0.050 years = 18 days

= 0.053 years= 19 days

= 0.00305years = 1 day

Total optimum inventory cost=

= Rs. 934 (approx.)

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8.3.4 Independent Demand System for Multiple Products Inventory Planning
and Control

When the inventories consist of several items under some limitations, such as
the availability of floor space of the warehouse, the total investment in
inventories, the total number of orders to be placed per year for all items, etc.,
then it is not possible to consider each item separately. Let us look at the
problem of EOQ with warehouse capacity for floor space constraints.

Example: 4
A company produces three products, 1, 2 and 3 in lots. The shop has a
warehouse whose total floor area is 4,000 sq. meters. The inventory carrying
costs for the shop is 20% of the average inventory valuation per annum for
each item. If stockouts are not allowed and at no time can the warehouse
capacity be exceeded. If the table below summarizes the relevant data,
determine the optimum lot size for each item.

Item 1 2 3
Annual demand (in units) 550 350 620
Cost per unit (Rs.) 25 40 60
Set-up cost per lot (Rs.) 700 500 1200
Floor area required per
5 4 10
item (sq. meters per unit)

Ignoring the restriction of total warehouse capacity, find out the EOQs for all
three items.

= 392 (approx.)

= 209 (approx.)

= 352 (approx.)

Using the above, calculate the floor area required.

Total floor area= 392 5 + 209 + 352 = 6320 (approx.)

Hence, it is more than 4000 sq. meters, applying Lagrange's multiplier

technique.

Assume ⅄=1,
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Managing
Operations = = 227 (approx.)

= = 148 (approx.)

= 216 (approx.)

Using the above, calculate the floor area required.

Total floor area= 227 5 + 148 + 216 = 3,881 (approx.), less than
4,000 sq. meters.

Assume ⅄=0.9, we get

=223.

Using the above, calculate the floor area required.

Total floor area= 235 5 + 152 + 223 = 4,007 (approx.), slightly
more than 4,000 sq. meters.

Assume ⅄=0.91, we get

=222.

Using the above, calculate the floor area required.

Total floor area= 234 5 + 151 + 222 = 3,994 (approx.), which is
almost equal to 4,000 sq. meters.

8.3.5 Models with Uncertain Demand

Uncertainty creates significant manufacturing control and planning
difficulties. It considers whether demand and supply are specific or
unpredictable. However, demand constantly fluctuates due to changes in
orders, the erratic capacity of suppliers, and unforeseeable factors like
weather, machine malfunctions, and human errors. When discussing
uncertainty, we need safety stock to address the chance of stockouts caused
by uncertain demand. Applying the computed EOQ on steady demand will
significantly influence stockout when demand is unknown. To overcome the
potential of stockout, increase the reorder point by storing excess stock as
safety stock.
The excess stock covering the possibility of stockouts resulting from supply
or demand variations is referred to as the logistician's statement in safety
stock terms. Safety stock is an additional on-hand inventory that protects
against stockouts. By looking at past demand data, one can assign weights to
different levels of demand data. Higher weights indicate a greater frequency
of occurrence or a greater likelihood of that event occurring (note: each level
of demand is an event). Because of such uncertainty in the demand pattern
(similar uncertainties with the lead time), we look for expected outcomes,
136
such as expected demand, revenue, profit, inventory, shortages, etc. Consider Inventory Planning
and Control
the following case faced with uncertainties because of the variations:

SinglePeriod Problem:
A vendor stocks perishable items, which, if not consumed, must be
eitherthrown or salvaged at the end of the stock period. Thus, if demand
remains within the quantity stocked, the cost of overstocking is incurred.
Some examples:

• A newsboy at the newsstand stocking newspapers for the day. These

papers become useless the following day. At best, they can be sold as
wastepaper.
• The local bakery stocks fresh bread for the day.
• Monthly magazines are stocked for a month.

There could be instances where demand still needs to be fulfilled. These

become lost opportunities which are considered as the costs of understocking.
These problems are solved with the help of single-period models. Note that a
period could be a day, week, month, or even a specific lead time. For each of
these periods, we must have the historical demand data. It is popularly known
as the newsboy model. A newspaper vendor must decide howmuchtostock to
maximize the expectedprofitsattheendoftheday. The following problem
illustrates the procedure to solve the newsboy problem.

Example:5
A newspaper boy buys a paper for Rs. 4 and sells them for Rs. 4.75 each. He
needs to return unsold newspapers. Daily demand has the following
distribution:

Daily 25 26 27 28 29 30 31 32 33 34
Demand

Probability 0.03 0.05 0.06 0.12 0.15 0.20 0.18 0.11 0.06 0.04

If each day's demand is independent of the previous days, how many papers
should he order each day?

Solution:

If D > Q He will face a penalty forIn our example,

understocking, which is his cost(C1). C1 =Saleprice- Costprice
Whichisthecost ofprofits foregone. =S - C
=4.75- 4.00=75p
IfD< Q He faces a penalty for overstocking. In our example,
This is his cost of overstocking (C2),C2=C=Rs4.00
which is the purchase cost of the
unsold units.

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Managing
Operations Critical Ratio= = = 0.158

Cumulative distribution of weekly demand

Daily 25 26 27 28 29 30 31 32 33 34
Demand
Probability 0.03 0.05 0.06 0.12 0.15 0.20 0.18 0.11 0.06 0.04
Cumulative 0.03 0.08 0.14 0.26 0.41 0.61 0.79 0.90 0.96 1.00
Probability

Since the critical ratio 0.158 lies between 0.14 and 0.26, the condition of
optimality suggests that Q* =28. Hence, he should order 28 papers every day.

MultiplePeriodModels
The Multiple Period Models problem is like the basic inventory model with
shortages. Uncertainties are faced in either variations in demand or variations
in lead time. The objective is to decide how much to order and when to order.
That is, thequantity to be ordered (Q) and the level at which the order is
placed (ROP) are to bedetermined while minimizing the total cost of
Ordering, holding, and shortages (or backorders). Under real-life situations,
companies are more vulnerable when stocksare low. Hence, as a hedge
against stockouts, a buffer stock (or safety stock) isfrequently added to the
expected demand during the lead time to absorb variations indemand and
lead time.
Note: If the safety stock is high, carrying costs will increase; if the safety
stock is low, stockout costs may increase. Because of this vulnerability,
determining the ROP is more critical.

The cost of shortages (Cs) is known:

We can quantify the cost of not meeting the customer demand. Also, we
know the average annual requirement, holding cost, and ordering (or
preparation) cost. Thus,

Annual requirement = D (in units per annum)

Holding cost = Cc (Rs/unit/year)
Orderingcost=Co (Rs/order)
Shortagecost=Cs (Rs/unit/order cycle)
We determine the optimal order quantity Q* using the EOQ formula for such
problems. Even though it is based on a deterministic model, it helps to
evaluate the cost of overstocking and understocking.

Cost of overstocking= C1 = Cc
Cost of understocking=C2 = C0 (D/Q*)
Then depending on historical data for demand during lead-time, try to fix the
ROP using the newsboy model concept. We find the largest ROP for which
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the following inequality holds: Inventory Planning
and Control

P (D ROP) >

or P (D ROP) >

Example: 6
D= 12,000

Cc = Rs 1 (unit/year)
Co = Rs. 10 per order
Cs = Rs. 10 per unit (per order cycle)
We also have the lead time historical demand data:

Demand During Lead Time P(DDLT) Cum. Probability

(DDLT)
50 0.10 0.10
40 0.20 0.30
30 0.30 0.60
20 0.20 0.80
10 0.10 0.90.
0 0.10 1.00

Now Q* = 490 (using the EOQ formula)

C1 = Cc = Rs. 1 per unit per year

C2 = Co (D/Q*) =10 (12000/490) = Rs 245 per unit per year

Note the relatively high cost of understocking. Intuitively, the ROP should be
high. One cannot afford to lose customers and would rather dump the items
in inventory. To determine ROP, calculate

= 0.0041

This means the chances of a stockout should be very low. So we find the
ROP by choosing the largest value for which the inequality is satisfied.
Prob (D 50) = 0.10 >0.0041

ROP=50.
Hence Q and ROP are equal to 490 and 50, respectively. According to this
policy, we order 490 units when the stock level during any stock cycle comes
down to 50.
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Managing
Operations 8.4 INVENTORY SYSTEM OPERATION
Let Q* represent the economic order size and t* represent the cycle duration.
DDLT means Demand during Lead Time. Stockouts will frequently occur if
left the system alone and do not make any changes to account for demand or
wait time changes.

Even ifassuming a model with constant requirements and lead times, orders
must be made well before the end of the cycle to ensure that the products are
delivered exactly at the end of the current cycle or the beginning of the next.

Allow DDLT to act as the lead time requirement.

DDLT is an abbreviation for demand rate delay time (d/day). (LT in days)

DDLT = Reorder Level (ROL)

Figure 8.4: Inventory system operation

Inventory management system with continuous demand and lead time.

The stock level at which one places a reorder decides when to receive the
items purchased at the start of the next cycle.
If the demand fluctuates, the ROL is as follows.

ROL=DDLT+SS

SS is the safety stock, which functions as a cushion to absorb demand

variation, and K is the standard normal statistic value for a particular service
level. The corresponding chart is shown in the image below.

Example: 7
A company has a demand distribution with a standard deviation of 350 units
over a constant lead time. The business aims to offer 98% service. What
quantity of safety stock should be transported? What is the reorder level if the
average demand during lead time is 1300 units?
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Solution: Inventory Planning
and Control
z=2.05 for a 98% service level using the stand-normal table.
Safety stock = 2.05 350 = 717.5 units
(b) ROL=DDLT+SS =1300+717.5 = 2017.5 units

8.5 BULK DISCOUNTS MODEL

Buyers frequently receive discounts on the purchase price of goods when
they buy in bulk. This discount could be a step function of the purchased
quantity specified.

Quantity Purchase price

0 ≤ Q 1 < b1 P1
b1 ≤ Q 2 < b 2 P2
b2 ≤ Q3 < b3 P3

bn−1 ≤ Q4 Pn

The procedure to compute the optimal order size for this situation is given in
the following steps.
Step 1. Find EOQ for the nth (last) price break.

2C 0 D
Q n* =
iPn

Inventory holding cost is expressed as a percentage of the unit cost.

*
If it is greater than or equal to bn-1, the optimal order size is Q*=Q n ;
otherwise, go to Step 2.
Step2. Find EOQ for the (n-1)th price break.

2C 0 D
Q n*−1 =
iPn −1

If it is greater than or equal to bn-2, compute the following and select the least
cost purchase quantity and the optimal order size; otherwise, go to Step 3.

(i) Total cost, TC Qn−1 ( )*

(ii) Total cost, TC (bn−1 )

Step 3: Find EOQ for the (n-2) th price break

2C 0 D
Q n*− 2 =
iPn − 2

If it is greater than or equal to bn-3, then compute the following and select the
least cost purchase quantity; otherwise, go to Step 4
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Managing
Operations (
(i) Total cost, TC Qn−2
*
)
(ii) Total cost, TC (bn−2 )

(iii) Total cost, TC (bn−1 )

*
Step 4: Continue in this manner until Qn−i ≥ bn−i−1 . Then compare the total
costs.

Example: 8
Annual demand for an item is 5000 units. The ordering cost is Rs.600 per
order. Inventory carrying cost is 25% of the purchase price per unit per year.
The price breaks are shown as;

Quantity Price (Rs.)

0 ≤ Q1 < 1500 20
1500 ≤ Q 2 < 3000 12
3000 ≤Q3 9

(a) Find the optimal order size.

(b) Find the optimal order size if the order cost is changed to Rs.400.00 per
order.

Solution:
D=5000, Co=600,i=0.25

Step 1,
P3=Rs.9.00

2C 0 D
Q 3* =
iP3

2 ∋ 600 ∋ 5000
0.25 ∋ 9

Hence Q3 < b2 (3000) , go to Step 2.

*

Step 2, P2=Rs.12.00

2C 0 D
Q 2* =
iP2

2 × 600× 5000
=
0.25×12

=1414
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Since Q2 < b1 (1500) finding the following and selecting the order size
* Inventory Planning
and Control
concerning the least cost as the optimal order size.
600 × 5000 0 .25 × 9 × 1414
( )
TC Q 2* = (12 × 5000 ) + (
1414
)+ (
2
)

=Rs. 63,712 (Approx)

600 5000 0.25 12 3000

TC (b2 ) = (9 5000) + ( )+ ( )
3000 2

=Rs. 50,500 (approx.)

*
The least cost is RS. 50.500. Hence, the optimal order size is Q3 which is
equal to 1581.

(a) C0= 400, D=5000, i=0.25

Step 1, P3=Rs.9.00

2C 0 D
Q 3* =
iP3

2 × 300 × 488
=
0.24 × 8

=1,333

Since Q3 < b2 (2000) going to Step 2.

*

Step 2. P2=Rs.12.00

2C 0 D
Q 3* =
iP2

2 × 400 × 5000
=
0.25 × 12

=1,155

Q2* < b1 (1200) Go to step 3.

Step 3. P1=Rs.20.00

2C 0 D
Q1* =
iPi

2 × 400 × 5000
=
0.25 × 20

= 894
143
Managing Find the following and select the order size concerning the least cost.
Operations
400 × 5000 0 .25 × 20 × 894
( )
TC Q1* = ( 20 × 5000 ) + (
894
)+ (
2
)

= Rs.1,04,472
400 × 5000 0 .25 × 12 × 1500
TC (b1 ) = (12 × 5000 ) + ( )+ ( )
1500 2

=Rs.63,583
400 × 5000 0 .25 × 9 × 3000
TC (b 2 ) = (9 × 5000 ) + ( )+ ( )
3000 2

=Rs.49, 042
Since TC(b2) is the minimum cost, the optimal order size is b2, which equals
3000.

8.6 SUMMARY
The fundamental aim of inventory management is to maintain optimal
inventory levels, that is, between too excessive and too little, to keep overall
costs to a minimum. The economic order quantity (EOQ) model aids in
determining this ideal stock level. Enough safety stock should be kept on
hand to prevent a stock out. Due to the high carrying cost of specific
products, stockouts may occasionally be purposefully caused. An
organization must keep inventories of a wide range of products,
andpracticing the same level of stringent inventory management on every
item is impossible.

8.7 KEYWORDS
Inventory The stock of idle resources in a firm for future use.
Safety/buffer Extra stock is maintained more than the anticipation
stock inventory to protect against demand fluctuations and
abrupt increases in the time taken by the suppliers to
supply the items.
Ordering cost Cost of placing a single order.
per order
Carrying/holding Cost of storing the inventory in the warehouse.
cost
Lead time The interval between placing an order and receiving the
ordered goods.
Economic order The optimal size of an order for which the total
quality (EOQ) inventory cost is minimum.
Quantity A specified quantity of items must be purchased for a
discount fixed percentage discount.
Safety stock Hedge (protection) against the possibility of a stock out
144
 Inventory Planning
Cost of shortages The cost is mainly due to a loss in goodwill on the and Control
customer’s part, which depends on how long they have
waited to receive the goods. It also includes potential
profit loss due to customers switching to competitors.

8.8 SELF – ASSESSMENT EXERCISES

1. What are the justifications for keeping products in inventory?
2. Describe and list the various sorts of charges in the stock system.
3. What are the various inventory system models? Explain them
thoroughly.
4. Create the EOQ equation for the Buying scenario that is devoid of
shortages.
5. Differentiate between the P and Q Inventory Systems?
6. Alpha Industry anticipates selling 20,000 units of its goods in the future
year. The ordering cost is Rs.250 for each order, and the annual carrying
cost is 30% of the cost of buying price per unit, or Rs.60. Find out
a. Economic order size
b. No. of orders per year
c. The time between successive orders
7. An automobile factory manufactures a particular type of gear within the
factory. This gear is used in the final assembly. The particulars of this
gear are presented below.
Demand rate, r= 24,000 units/year
Production rate, k= 13,000 units/year
Set-up cost, C0=Rs.600 per set-up
Carrying cost, Cc= Rs.25/unit/year
Find the EBQ and cycle time.
8. The annual demand for an automobile component is 25,000 units. The
carrying cost is Rs. 0.70/unit/year, the ordering cost is Rs.35.00 per
order, and the shortage cost is Rs.35.00/unit/year. Find the optimal
values of the following:
(i) Economic ordering quantity
(ii) Maximum Inventory
(iii) Maximum shortage quantity
(iv) Cycle time
(v) Inventory period (t1)
(vi) Shortage period (t2)
9. Annual demand for an item is 5000 units. The ordering cost is Rs.400
per order. Inventory carrying cost is 28% of the purchase price per unit
per year. The page breaks are as shown below.

145
Managing
Operations Quantity Price (Rs.)
0≤Q1<3000 30
3000 ≤ Q2<5000 35
5000 ≤ Q3 12
10. A small shop produces three machine parts, I, II, and III, in lots. The
shop only has 650 sq. ft. of storage space. The inventory carrying costs
for the shop is 15% of the average inventory valuation per annum for
each item. If stockouts are not allowed and at no time can the warehouse
capacity be exceeded. If the table below summarizes the relevant data,
determine the optimum lot size for each item.
Item I II III
Annual demand (in units) 5,000 2,000 10,000
Cost per unit (Rs.) 10 15 5
Ordering Cost (Rs.) 100 200 75
Floor area required per
0.70 0.80 0.40
item (sq. ft. per unit)
11. A newspaper boy buys a paper for Rs. 5 and sells them for Rs. 6.50 each.
He needs to return unsold newspapers. Daily demand has the following
distribution:

Daily 18 19 20 21 22 23 24 25
Demand

Probability 0.08 0.10 0.12 0.25 0.16 0.14 0.11 0.04

If each day's demand is independent of the previous day's, how many papers
should he order each day?

8.9 FURTHER READINGS

Aswathappa K. and Shridhara Bhat K., Production and Operations
Management, 1stEdn, Himalayan Publishing House, Mumbai, 2015.
Lee J. Krajewski and Larry Ritzman P. Operations Management – Strategy
and Analysis, 6thEdn, Pearson Education, New Delhi, 2001.
Muller, M. (2019). Essentials of inventory management. HarperCollins
Leadership.

Narasimhan, L., McLeavey, D.W., and Billinton, P.J. Production Planning

and Inventory Control, Prentice Hall of India, New Delhi,1994.

Operations Research, Kanti Swarup, Sulthanchand,2010

Operations Research: An Introduction to Research. Hamdy A. Taha, Pearson,
146
2019. Inventory Planning
and Control
Richard B. Chase, Nicholas J. Aquilano, F. Robert Jacob, F. Robert,
Production and Operations Management: Manufacturing and Services,
8thEdn, Jacobs Irwin Professional Publishing, 1998.
Roberta S. Russel and Bernard W. Taylor III, Operations Management
4thEdn, Pearson Education, New Delhi, 2010.
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147