UNIVERSITY OF ECONOMIC AND LAW
Course
LOGISTICS
Instructor: Dr. Nguyễn Duy Quang
Email: quangnd@[Link]
2024
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CHAPTER 3 . INVENTORY MANAGEMENT
Contents
Definition, Types, Purposes
Inventory costs
Inventory models
Inventory issues
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DEFINITION AND TYPES OF INVENTORY
Inventory is supplies of goods and materials (incl. raw
materials, work in process, and finished goods) that are
held by an organization.
Types of inventory
o Cycle stock
o Safety stock
o In-transit stock
o Speculative stock
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PURPOSES OF INVENTORY
Be a buffer between different parts of the supply chain
Allow for demands that are larger than expected or unexpected
Allow for deliveries that are delayed
Take advantage of price discounts on large orders
Allow the purchase of items when the price is low
Allow the purchase of scarce items
Allow for seasonal operations
Make full loads and reduce transport costs
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Cover for emergencies
Be profitable when inflation is high
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INVENTORY COSTS
Carrying (holding) costs
o Obsolescence costs
o Inventory shrinkage
shortage
o Storage costs
o Handling costs
o Insurance, tax, interest
Ordering costs
Stock-out (shortage) costs
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INVENTORY MODELS
Single-period models: based on one-time purchasing
decision
Fixed-order quantity models (continuous system):
inventory is continuously tracked and an order is placed
when the inventory declines to a reorder point
Fixed-time period models (periodic system): inventory is
checked at regular periodic intervals and an order is
placed to raise the inventory level to a specified
threshold
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FIXED-ORDER QUANTITY MODEL – EOQ MODEL
Assumptions
Only one product involved
A continuous, constant, and known rate of demand
A constant and known lead time
A constant purchase price, independent of the order quantity
All demand is satisfied
Inventory holding cost is based on average inventory
A constant ordering cost
Determine order quantity that the total cost (incl. purchase cost,
ordering cost, holding cost) is minimized
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FIXED-ORDER QUANTITY MODEL – EOQ MODEL
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EOQ MODEL - EXAMPLE
Demand for a smartphone at a store is 75 units per month. The
store incurs a fixed order cost of $700 each time an order is
placed. Each smartphone costs the store $800 and the store has
an annual holding cost of 20 percent per unit. What is the optimal
order size in each replenishment?
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FIXED-ORDER QUANTITY MODEL – EOQ MODEL
Source: ASCM (2020)
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LOT SIZING WITH MULTIPLE PRODUCTS/CUSTOMERS
1. Lots are ordered and delivered independently for each
product
2. Lots are ordered and delivered jointly for all k models
3. Lots are ordered and delivered jointly for a selected
subset of the products
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LOTS ARE ORDERED AND DELIVERED INDEPENDENTLY
Annual demands for the three products are DL = 12,000
units, DM = 1,200 units, and DH = 120 units. Each model
costs $500. A fixed transportation cost of $4,000 is incurred
each time an order is delivered. For each model ordered
and delivered on the same truck, an additional fixed cost of
$1,000 per model is incurred for receiving and storage.
Holding cost: 20 percent. Calculate the annual cost.
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LOTS ARE ORDERED AND DELIVERED INDEPENDENTLY
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LOTS ARE ORDERED AND DELIVERED INDEPENDENTLY
Litepro Medpro Heavypro
Demand per year 12,000 1,200 120
Fixed cost/order $5,000 $5,000 $5,000
Optimal order size 1,095 346 110
Cycle inventory 548 173 55
Annual holding cost $54,772 $17,321 $5,477
Order frequency 11.0/year 3.5/year 1.1/year
Annual ordering cost $54,772 $17,321 $5,477
Average flow time 2.4 weeks 7.5 weeks 23.7 weeks
Annual cost $109,544 $34,642 $10,954
Total cost: $155,140
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LOTS ARE ORDERED AND DELIVERED JOINTLY
A decision to aggregate and order all three models each time an
order is placed. Calculate the optimal lot size for each model and
the annual cost.
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LOTS ARE ORDERED AND DELIVERED JOINTLY
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LOTS ARE ORDERED AND DELIVERED JOINTLY
Litepro Medpro Heavypro
Demand per year (D) 12,000 1,200 120
Order frequency (n ) 9.75/year 9.75/year 9.75/year
Optimal order size (D/n ) 1,230 123 12.3
Cycle inventory 615 61.5 6.15
Annual holding cost $61,512 $6,151 $615
Average flow time 2.67 weeks 2.67 weeks 2.67 weeks
Total cost: $136,558
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LOTS ARE ORDERED AND DELIVERED JOINTLY FOR A SELECTED
SUBSET OF THE PRODUCTS
A decision to order jointly, but to be selective about which models
they include in each order. Evaluate the ordering policy and
costs.
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LOTS ARE ORDERED AND DELIVERED JOINTLY FOR A
SELECTED SUBSET OF THE PRODUCTS
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LOTS ARE ORDERED AND DELIVERED JOINTLY FOR A SELECTED
SUBSET OF THE PRODUCTS
Litepro Medpro Heavypro
Demand per year (D) 12,000 1,200 120
Order frequency (n ) 11.47/year 5.74/year 2.29/year
Optimal order size (D/n ) 1,046 209 52
Cycle inventory 523 104.5 26
Annual holding cost $52,307 $10,461 $2,615
Average flow time 2.27 weeks 4.53 weeks 11.35 weeks
Total cost: $130,767
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EPQ MODEL
Assumptions
Only one product involved
Annual demand is known
The usage rate is constant
Usage occurs continually
Production occurs periodically
The production rate is constant
Lead time is known and constant
There are no quantity discounts
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EPQ MODEL
Slope =
Slope =
Production rate p Slope= - usage rate u
Production rate p
– usage rate u
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EPQ MODEL – ECONOMIC PRODUCTION QUANTITY
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EPQ MODEL - EXAMPLE
A toy manufacturer uses 48,000 rubber wheels per year for its
popular toy car series. The firm makes its own wheels, which it
can produce at a rate of 800 wheels per day. The toy cars are
assembled uniformly over entire year. Holding cost is $1 per
wheel a year. Setup costs for a production run of wheels is
$45. The firm operates 240 days per year.
What is the optimal run size?
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LITTLE’S LAW
The average amount of inventory in a system is proportional to
the time it takes for inventory to flow through the system
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REORDER POINT
1. Receive an order quantity Q. 4. The cycle then repeats.
Number
of units
on hand Q Q Q
R
2. Start using them L L
up over time. 3. When inventory reaches
Time down to a level of R, place
the next Q sized order.
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SAFETY STOCK
The amount of inventory carried in addition to the
expected demand to reduce risk of stock-out during lead
time
Quantity
Expected demand
during lead time
ROP
Safety stock
LT Time
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PRODUCT AVAILABILITY MEASUREMENT
Product fill rate: a fraction of product demand
satisfied from product in inventory
Order fill rate: a fraction of orders filled from available
inventory
Cycle service level: a fraction of replenishment
cycles ending with all the customer demand being
met
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CYCLE SERVICE LEVEL
The probability of not having a stock-out in a replenishment
cycle
Service level
Risk of
Probability of a stock-out
no stockout
Expected ROP Quantity
demand Safety
stock
0 z z-scale
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SAFETY STOCK
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STANDARD NORMAL DISTRIBUTION
Z 0.00 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09
0.0 0.5000 0.5040 0.5080 0.5120 0.5160 0.5199 0.5239 0.5279 0.5319 0.5359
0.1 0.5398 0.5438 0.5478 0.5517 0.5557 0.5596 0.5636 0.5675 0.5714 0.5753
0.2 0.5793 0.5832 0.5871 0.5910 0.5948 0.5987 0.6026 0.6064 0.6103 0.6141
0.3 0.6179 0.6217 0.6255 0.6293 0.6331 0.6368 0.6406 0.6443 0.6480 0.6517
0.4 0.6554 0.6591 0.6628 0.6664 0.6700 0.6736 0.6772 0.6808 0.6844 0.6879
0.5 0.6915 0.6950 0.6985 0.7019 0.7054 0.7088 0.7123 0.7157 0.7190 0.7224
0.6 0.7257 0.7291 0.7324 0.7357 0.7389 0.7422 0.7454 0.7486 0.7517 0.7549
0.7 0.7580 0.7611 0.7642 0.7673 0.7704 0.7734 0.7764 0.7794 0.7823 0.7852
0.8 0.7881 0.7910 0.7939 0.7967 0.7995 0.8023 0.8051 0.8078 0.8106 0.8133
0.9 0.8159 0.8186 0.8212 0.8238 0.8264 0.8289 0.8315 0.8340 0.8365 0.8389
1.0 0.8413 0.8438 0.8461 0.8485 0.8508 0.8531 0.8554 0.8577 0.8599 0.8621
1.1 0.8643 0.8665 0.8686 0.8708 0.8729 0.8749 0.8770 0.8790 0.8810 0.8830
1.2 0.8849 0.8869 0.8888 0.8907 0.8925 0.8944 0.8962 0.8980 0.8997 0.9015
1.3 0.9032 0.9049 0.9066 0.9082 0.9099 0.9115 0.9131 0.9147 0.9162 0.9177
1.4 0.9192 0.9207 0.9222 0.9236 0.9251 0.9265 0.9279 0.9292 0.9306 0.9319
1.5 0.9332 0.9345 0.9357 0.9370 0.9382 0.9394 0.9406 0.9418 0.9429 0.9441
1.6 0.9452 0.9463 0.9474 0.9484 0.9495 0.9505 0.9515 0.9525 0.9535 0.9545
1.7 0.9554 0.9564 0.9573 0.9582 0.9591 0.9599 0.9608 0.9616 0.9625 0.9633
1.8 0.9641 0.9649 0.9656 0.9664 0.9671 0.9678 0.9686 0.9693 0.9699 0.9706
1.9 0.9713 0.9719 0.9726 0.9732 0.9738 0.9744 0.9750 0.9756 0.9761 0.9767
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EXERCISE
Weekly demand for coke at a supermarket is normally distributed,
with a mean of 1,500 bottles and a standard deviation of 300. The
replenishment lead time is always two weeks. Assuming that a
continuous review policy is used, please calculate the safety stock
that the supermarket should carry to achieve a service level of 90
percent. What is the reorder point?
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EXERCISE
Daily demand for computers at a shop is normally distributed, with a
mean of 500 and a standard deviation of 30. The computer supplier
takes an average of seven days to replenish inventory at the shop.
The shop’s manager wants a cycle service level of 90 percent.
Determine the safety inventory of computers if the standard
deviation of the lead time is two days.
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FIXED-TIME PERIOD MODEL
Weekly demand for coke at a supermarket is normally distributed, with a mean
of 1,500 bottles and a standard deviation of 300. The replenishment lead time
is two weeks. Assuming that an inventory review of every three weeks is
conducted, please calculate the safety stock that the supermarket should carry
to achieve a service level of 90 percent. What is the order-up-to level?
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SINGLE-PERIOD MODEL
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EXERCISE
A school organize a tournament game this month. Based
on the past experience the tournament organizer sells on
average 1,500 T-shirts with a standard deviation of 200.
We make $10 on every shirt we sell at the game, but lose
$5 on every shirt not sold. How many shirts should we
make for the game?
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ABC ANALYSIS OF INVENTORY
ABC inventory classification is to classify items into groups to
establish the appropriate control over each item.
A items: 20% of items (making up 80% of annual dollar usage)
B items: 40% of items (making up 15% of annual dollar
usage)
C items: 40% of items (making up 5% of annual dollar usage)
High
A
Annual
$ value
of items
B
Low C
Low High
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ABC INVENTORY CLASSIFICATION
Annual Unit Cost Annual $ Usage
Part Number Annual $ Usage
Unit Usage ($) (%)
1 1,100 2 2,200 6%
2 600 40 24,000 63%
3 100 4 400 1%
4 1,300 1 1,300 3%
5 100 60 6,000 16%
6 10 25 250 1%
7 100 2 200 1%
8 1,500 2 3,000 8%
9 200 2 400 1%
10 500 1 500 1%
38,250
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ABC INVENTORY CLASSIFICATION
Part Annual $ Cummulative $ Cummulative % Cummulative %
Annual $ Usage
Number Usage (%) Usage $ Usage of Items
2 24,000 63% 24,000 63% 10%
5 6,000 16% 30,000 78% 20%
8 3,000 8% 33,000 86% 30%
1 2,200 6% 35,200 92% 40%
4 1,300 3% 36,500 95% 50%
10 500 1% 37,000 97% 60%
3 400 1% 37,400 98% 70%
9 400 1% 37,800 99% 80%
6 250 1% 38,050 99% 90%
7 200 1% 38,250 100% 100%
Percentage Percentage of Value per
Classification
of Items $ Usage Class
A 20% 78% 30,000
B 40% 18% 7,000
C 40% 3% 1,250
Total 100% 100%
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INVENTORY TURNOVER
The number of times that inventory is sold in a one-year period
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VENDOR-MANAGED INVENTORY (VMI)
An approach to inventory and order fulfilment whereby the
supplier, not the customer, is responsible for managing and
replenishing inventory
Benefits:
o Improve the forecast
o Minimize the impact of demand amplification
o Minimize inventory, but meeting the service level
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VENDOR-MANAGED INVENTORY (VMI)
Approach:
o Agree a contract
o Share information
o Monitor the process
o Replenish inventory
o Payment
Problems:
o Unwillingness to share data
o Investment and restructuring costs
o Retailer vulnerability
o Lack of standard procedures
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SAFETY STOCK IN CENTRALIZED VS DECENTRALIZED
SYSTEMS
DECENTRALIZED OPTION
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SAFETY STOCK IN CENTRALIZED VS DECENTRALIZED SYSTEMS
CENTRALIZED OPTION
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SAFETY STOCK IN CENTRALIZED VS DECENTRALIZED SYSTEMS
CENTRALIZED OPTION (a special case)
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EXERCISE
A car dealership has four outlets serving the entire and large province.
Weekly demand at each outlet is normally distributed, with a mean of
25 cars and a standard deviation of 5. The lead time for
replenishment from the manufacturer is 2 weeks. Each outlet covers a
separate geographic area, and the demand across any pair of areas is
independent. The dealership is considering the possibility of replacing
the four outlets with a single large outlet. Assume that the demand in
the central outlet is the sum of the demand across all four areas. The
dealership is targeting a service level of 0.90. Compare the level of
safety inventory needed in the two options.
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RISK POOLING
Centralized option (aggregation) reduces the required safety
inventory — as long as the demand being aggregated is not
perfectly positively correlated (ρ=1).
Risk pooling: Demand variability is reduced if demand is
aggregated across locations safety stock is reduced.
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