TRƯỜNG ĐẠI HỌC TÔN ĐỨC THẮNG
KHOA QUẢN TRỊ KINH DOANH
CHAPTER 3
INVENTORY MANAGEMENT
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706118_ Chapter 3 Inventory Management
LEARNING OUTCOMES
1. Explain the concepts related to inventory management.
2. Explain and use the inventory models: EOQ, POQ, and quantity
discount model.
3. Explain and use the concepts of centralization in inventory
management
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706018– Chapter 2_Inventory management
CONTENT
3.1. Definition and types of inventories
3.1.1. Definition and aims of inventory
3.1.2. Types of stock
3.2. Inventory control models
3.2.1. Factors affecting inventory policy decision
3.2.2 Inventory control models
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3.1. Definition and types of inventories
Definition
• Stock of items kept to meet future demand;
• One of the most expensive assets of many companies
representing as much as 50% of total invested capital;
• Operations management must balance inventory investment
and customer service;
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706118_ Chapter 3 Inventory Management
3.1.1. Definition and aims of inventory
v The primary objective of inventory management is indeed to
strike a balance between inventory investment and customer
service. Customer
Cost
- Balancing Inventory Investment: Companies must demand
minimize the investment in inventory while ensuring that
enough stock is available to meet customer demand. Operations
- Customer Service: This means having the right products cost
available when customers need them. Customer satisfaction Customer
Inventory
and loyalty depend on the ability of a business to meet service
cost
demand promptly.
- Cost Considerations: To achieve this balance, inventory
management needs to take into account various cost factors:
§ Operation Costs: Setup cost; ordering cost
§ Inventory Holding Costs: - the costs of holding or “carrying”
inventory over time
§
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Discussion
cost?
What expenses are covered by the
operating costs and holding costs?
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3.1.1. Definition and aims of inventory
v Significance of Inventory as an Asset: Inventory is indeed one of the most expensive
assets for many companies.
ü Asset Value: For some businesses, the value of some kind of inventories can account
for a substantial portion of their total assets, sometimes up to 50% or more.
ü Capital Tied Up: When a company invests in inventory, it ties up capital that could be
used for other purposes.
v Balancing Act:
ü Lower Inventory Levels: Maintaining lower levels of inventory helps reduce costs
associated with warehousing, insurance, obsolescence, and holding financing.
However, it increases the risk of shortages.
ü Higher Inventory Levels: increasing inventory levels helps ensure a smoother flow of
production and goods to customers, reducing the likelihood of shortages but may lead
to higher holding costs.
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3.1.1. Definition and aims of inventory
Functions of Inventory
[Link] against Uncertainty; [Link] Planning;
[Link] Customer Demand; [Link];
[Link] of Scale; [Link] Against Price Fluctuations
[Link] Production;
[Link] Demand;
[Link] Supply;
[Link] Sales and Marketing;
[Link] Lead Times;
[Link] Mitigation
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3.1.1. Definition and aims of inventory
1. How much to order?
2. When to replenish, or order?
Purpose of Inventory determine the amount of
Management inventory to keep in stock
Minimized inventory cost
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3.1.2. Types of stock
• Raw material
• Purchased but not processed
• Work-in-process (WIP)
• Undergone some changes but not completed
• A function of flow time for a product
• Maintenance/repair/operating (MRO)
• Necessary to keep machinery and processes productive
• Finished goods
• Completed product awaiting shipment
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3.2. Inventory control models
Inventory control models are mathematical and analytical tools
used by businesses to optimize their inventory management
processes;
These models help organizations make informed decisions
about how much inventory to order, when to place orders, and how
to balance the trade-offs between holding costs and stockout
costs.
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3.2.1. Factors affecting inventory policy decision
Order quantity Q
Continuous Inventory
control systems • Tracks receipts and subtractions on a continuing basis;
• Fixed order quantity;
CONTINUOUS
INVENTORY SYSTEMS • Not predetermined ordering time;
• Costly tracking system;
• Low safety stock.
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3.2.1. Factors affecting inventory policy decision
ü Items are counted and records updated
on a periodic basis;
ü Q changes every period;
ü Fixed ordering time;
ü May result in stock-outs between periods;
ü May require increased safety stock.
Periodic Inventory
control systems Order quantity Q
PERIODIC INVENTORY
SYSTEMS (P-system)
T T T
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3.2.2 Inventory control models
Holding Cost
• the costs of holding or “carrying”
inventory over time
Inventory cost Ordering Cost/ Set-up cost
• the costs of placing an order and
receiving goods
• cost to prepare a machine or
process for manufacturing an order
Capital cost
Shortage cost/ Stockout cost
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3.2.2 Inventory control models
COST (AND RANGE) AS A
CATEGORY PERCENTAGE OF
INVENTORY VALUE
Housing costs (building rent or depreciation, operating costs, 6% (3 - 10%)
taxes, insurance)
Material handling costs (equipment lease or depreciation, power, 3% (1 - 3.5%)
operating cost)
Inventory Labor cost (receiving, warehousing, security) 3% (3 - 5%)
Holding Investment costs (borrowing costs, taxes, and insurance on 11% (6 - 24%)
inventory)
Costs
Pilferage, space, and obsolescence (much higher in industries 3% (2 - 5%)
Example undergoing rapid change like tablets and smart phones)
Overall carrying cost 26%
Holding costs vary considerably depending on the business, location, and interest rates.
Generally greater than 15%, some high tech and fashion items have holding costs greater
than 40%.
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3.2.2 Inventory control models
Independent & Dependent Demand
• Independent demand - the demand for item is independent of the
demand for any other item in inventory, i.e. laptop, …
à Inventory Models
• Dependent demand - the demand for item is dependent upon the demand
for some other item in the inventory, i.e. materials, parts,…
à MRP (material resource planning)
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3.2.2 Inventory control models
1. Basic economic order quantity
(EOQ) model
Inventory Models for
Independent demand 2. Production order quantity model
(POQ)
3. Quantity discount model
How much to order?
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3.2.2 Inventory control models
Important assumptions
1. Demand is known, constant, and
independent;
Basic Economic Order 2. Lead time is known and constant;
Quantity EOQ 3. Receipt of inventory is instantaneous and
complete;
4. Quantity discounts are not possible;
5. Only variable costs are setup (or
ordering) and holding;
6. Stockouts can be completely avoided;
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3.2.2 Inventory control models
Basic Economic Order Quantity EOQ
Inventory Usage Over Time
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3.2.2 Inventory control models
Basic Economic Order Quantity EOQ
Q= Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D= Annual demand in units for the inventory item
S= Setup or ordering cost for each order
H= Holding or carrying cost per unit per year
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3.2.2 Inventory control models
Basic Economic Order Quantity EOQ
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3.2.2 Inventory control models
Q* = Optimal number of pieces per order (E O
Q)
D= Annual demand in units for the inventory
EOQ model item
S= Setup or ordering cost for each order
H= Holding or carrying cost per unit per year
2SD
Q* = Total set-up or ordering cost = S x D/Q
H Total holding cost = H x Q/2
Total cost = S x D/Q + H x Q/2
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3.2.2 Inventory control models
• Reorder point (ROP) is the inventory
level (point) at which action is taken to
replenish the stocked item.
when to reorder
ROP = Demand per day (d) x Lead
time for a new order in days (L)
Re-order points Q*
ROP = d x L
Haøng toàn kho
R
0
L
T
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3.2.2 Inventory control models
A rice exporter buys rice from the only supplier. The demand of rice is certain
Exercise 1 throughout the year. Last year, the exporter exported 1,000 tons of rice.
Ordering cost is $150 per order. The annual holding cost is 10% of the
purchase cost. The exporter pays $500 per ton to the supplier. Leadtime is 2
days. There are 360 working days per year.
D = annual demand = 1000 tons; S = $150; H = 10% * $500= $50
a. What should the economic order quantity be?
b. What is the total annual holding cost?
c. What is the total annual ordering cost?
d. What is the reorder point?
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3.2.2 Inventory control models
D = annual demand = 1000 tons; S = $150; H = 10% x $500= $50, L = 2
Exercise 1 days,
d = D/number of working days = 1000/360
a. What should the economic order quantity be?
EOQ = Q* = 77.46 tons à 78 tons
b. What is the total annual holding cost?
HC = H x Q/2 = $1936.5
c. What is the total annual ordering cost?
OC = S x D/Q = $ 1923.1
d. Reorder point: R = L x d = 2 x 1000/360 = ?
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3.2.2 Inventory control models
Robust Model
• The EOQ model is robust
• It works even if all parameters and assumptions are not met
• The total cost curve is relatively flat in the area of the EOQ
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3.2.2 Inventory control models
Production 1. Used when inventory
builds up over a period of
Order time after an order is
Quantity placed
2. Used when units are
Model POQ produced and sold
simultaneously
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3.2.2 Inventory control models
Since Only consumption
production Slope = (– d) POQ MODEL
Both production and
and consumption
consumption Q* Slope = (p – d)
are at the
same time, Average
the inventory Imax
level never inventory
reaches Q*, ½*Imax
but just
reaches Imax
0
Tc Tp time
T
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3.2.2 Inventory control models
Production order quantity (POQ) Model
POQ model
2xSxD
Production Order Quantity = Q* =
( )
d
H 1-
p
Maximum inventory Imax = Q *
( 1 -
d
p ) D = Demand per year
DxS S = Setup cost
Setup Cost =
Q* H = Holding cost
d = Demand per day
Holding Cost = 1/2 x H x Q*
( )
1-
d
p
p = Production per day
Average inventory = ½ Imax
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3.2.2 Inventory control models
POQ MODEL
Consumption cycle time:
Tc = Imax /d
Time required to produce a batch (production
cycle time):
Tp = Q/p = Imax /(p-d)
Complete cycle time (time between 2 batches):
T=Tc + Tp = Q/d
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3.2.2 Inventory control models
Non-Slip Tile Company (NST) has been using production runs of 100,000
Exercise 2 tiles, 10 times per year to meet the demand of 1,000,000 tiles annually. The
set-up cost is $5,000 per run and holding cost is estimated at 10% of the
manufacturing cost of $1 per tile. The production capacity of the machine is
500,000 tiles per month. The factory is open 365 days per year.
Questions:
What is the production order quantity?
How many days are required to produce a batch?
Complete cycle time (time between 2 batches)?
What is the average inventory for this problem?
Set up cost? Holding cost?
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3.2.2 Inventory control models
Exercise 2
D = annual demand = 1,000,000 tiles à d = daily demand = D/365 = 2740 tiles
S = $5,000
H = 10% x $1 = $0.1 per tile per year
p = 500,000/30 = 16667 tiles per day
Production order quantity = Q*= 345 939 tiles
Days are required to produce a batch: Tp = Q/p = 345 939/16667
Complete cycle time (time between 2 batches): T= Q/d =345939/2740
Average inventory = Imax/2 = Q*/2 (1- d/p) = 345939/2 x (1 – 2740/16667) =
Set up cost = $14453
Holding cost = $14453
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3.2.2 Inventory control models
• Reduced prices are often available when larger
quantities are purchased
Quantity • Trade-off is between reduced product cost and
increased holding cost
Discount Models
Steps in analyzing a quantity discount
1. calculate Q* for each price range
2. Adjust the Q to meet price condition
3. Calculate the total annual cost for each
possible order quantity determined in
Step 2. Select the quantity that gives the
lowest total cost.
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3.2.2 Inventory control models
Total cost
Quantity Discount
= Ordering cost + Holding cost + Capital
cost
Models
= S x D/Q + H x Q/2 + Px D
D: Annual demand
P: Unit price
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3.2.2 Inventory control models
Quantity PRICE RANGE QUANTITY ORDERED PRICE PER UNIT
Discount Initial price 1 to 119 $100
Models
Example Discount price 1 120 to 1,499 $98
Discount price 2 1,500 and over $96
Furthermore, setup cost is $200 per order, annual demand is 5,200 units, and
annual inventory carrying charge as a percent of cost, I , is 28%. What order
quantity will minimize the total inventory cost?
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3.2.2 Inventory control models
SOLUTION:
S= $200; D= 5,200 units; H= 28%*P.
• Compute EOQ with price P = $100
EOQ = (2*200*5200/0.28*100)^1/2 = 273 units à not belong to [1, 119] à We choose Q =1 à
Total cost = S*D/Q + H*Q/2 + P*D = $1,040,114 (1)
• Compute EOQ with price P = $ 98
EOQ = 276 units à belong to [120, 1499] à We choose Q = 276 à Total cost = $517,155 (2)
• Compute EOQ with price P = $ 96
EOQ = 279 units à Not belong to [1,500 and over] à We choose Q = 1500 à Total cost =
$520,053 (3)
Compare (1), (2), (3) à We choose Q = 276 units because it gives the lowest cost.
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3.2.2 Inventory control models
Continuous Review Policy
• Daily demand is random and follows a normal distribution.
• Every time the distributor places an order from the manufacturer, the distributor
pays a fixed cost, K, plus an amount proportional to the quantity ordered.
• Inventory holding cost is charged per item per unit time.
• Inventory level is continuously reviewed, and if an order is placed, the order
arrives after the appropriate lead time.
• If a customer order arrives when there is no inventory on hand to fill the order
(i.e., when the distributor is stocked out), the order is lost.
• The distributor specifies a required service level.
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3.2.2 Inventory control models
Continuous Review Policy
• AVG = Average daily demand faced by the distributor
• STD = Standard deviation of daily demand faced by the distributor
• L = Replenishment lead time from the supplier to the
distributor in days
• h = Cost of holding one unit of the product for one day at the
distributor
• α = service level. This implies that the probability of stocking out is
1-α
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3.2.2 Inventory control models
Continuous Review Policy
• (Q,R) policy – whenever inventory level falls to a reorder level R, place
an order for Q units
• What is the value of R?
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3.2.2 Inventory control models
Continuous Review Policy
• Average demand during lead time: L x AVG
• Safety stock: z ´ STD ´ L
• Reorder Level, R: L ´ AVG + z ´ STD ´ L
2 K ´ AVG
• Order Quantity, Q: Q =
h
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3.2.2 Inventory control models
Service Level & Safety Factor, z
Service Level 90% 91% 92% 93% 94% 95% 96% 97% 98% 99% 99.9%
z 1.29 1.34 1.41 1.48 1.56 1.65 1.75 1.88 2.05 2.33 3.08
z is chosen from statistical tables to ensure
that the probability of stockouts during lead time is exactly 1 - α
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3.2.2 Inventory control models
Inventory level as a function of time in a (Q,R) policy
Continuous Review Policy
Inventory level before receiving an order = z ´ STD ´ L
Inventory level after receiving an order = Q + z ´ STD ´ L
Average Inventory = Q
2 + z ´ STD ´ L
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3.2.2 Inventory control models
Continuous Review Policy
Instructions:
K = $4,500
h = 18% x $250 / 52
L = 2 weeks
Expected service level = 97% à z = 1.88
AVG (monthly) = 191.17 à AVG (weekly) =
191.17 / 4.3 = 44.45 (Note: month/week = 30/7
=4.3)
STD (monthly) = 66.53 à STD (weekly) = 66.53 /
√4.3 = 32.08
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3.2.2 Inventory control models
Continuous Review Policy Example
The following table provides historical data of a typical product of ABC. The table includes weekly demand
information of the product for the last 4 weeks in each market area.
Table 1: Weekly demand in units
Week 1 2 3 4
Market A 13 11 20 19
Market B 15 10 20 14
The weekly demand follow normal distribution. It costs $1,200 whenever a warehouse places an order. The
annual holding costs is $65 per unit. It usually takes 3 weeks for the factory to fulfill an order. The service levels
of two market is now 96%. ABC has considered an alternative distribution strategy in which the two regional
warehouses are replaced with one single and central warehouse to fulfill all customer orders. The CEO insists
that the alternative strategy can increase the service level to 98% (which has the corresponding service factor of
2.05).
Calculate the average inventory of each system. Should ABC adopt the alternative system?
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3.2.2 Inventory control models
System 1: Two regional warehouses serve two markets
K=$1,200
Week 1 2 3 4
h (weekly) = $65/52
L = 3 weeks Market A 13 11 20 19
Z = 2.05 Market B 15 10 20 14
2 K ´ AVG
Q=
h
AVG (A) = 15.75 AVG (B) = 14.75 Average inventory (system 1) =
STD (A) = 4.43 STD (B) = 4.11 Average inventory (A) + Average
Q (A) = 173.9 Q (B) = 168.29 inventory (B)
Average inventory (A) = 102.68 Average inventory (B) = 98.74 = 201.42 (1)
System 2: One central warehouse serves two markets
Week 1 2 3 4
Market A+B 28 21 40 33
AVG (A+B) = 30.5
STD (A+B) = 8.02 Since (2)< (1) à ABC should
Q (A+B) = 241.99 adopt the alternative
Average inventory (system 2) = 149.47 (2) system (system 2)
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3.2.2 Inventory control models
Single Period Models
Short lifecycle products
• One ordering opportunity only
• Order quantity to be decided before demand occurs
• Order Quantity > Demand => Dispose excess inventory
• Order Quantity < Demand => Lose sales/profits
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3.2.2 Inventory control models
Single Period Models
• Using historical data
• determine the probability of all scenarios
• Given a specific inventory policy
• determine the profit associated with a particular scenario
• given a specific order quantity
• weight each scenario’s profit by its probability
• determine the expected profit for a particular ordering
quantity.
• Order the quantity that maximizes the average profit.
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3.2.2 Inventory control models
Single Period Model - Example
Demand 8000 10000 12000 14000 16000 18000
Probability 11% 11% 28% 22% 18% 10%
• Fixed production cost: $100,000
• Variable production cost per unit: $80.
• During the summer season, selling price: $125 per unit.
• Salvage value: Any swimsuit not sold during the summer season is sold to a discount store for $20.
The company should produce 9000 units or 16000 units if:
1. The manager is the risk-taker?
2. The manager is the risk-avoider?
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3.2.2 Inventory control models
• Fixed production cost: $100,000
Demand 8000 10000 12000 14000 16000 18000
• Variable production cost per unit: $80.
Prob 11% 11% 28% 22% 18% 10% • During the summer season, selling price: $125 per unit.
• Salvage value: Any swimsuit not sold during the summer season is
sold to a discount store for $20.
PRODUCE 9.000 UNITS
Demand 8000 10000 12000 14000 1600 18000
0
Profit = 8000*125 = 305000 = 305 000 = 305 = 305 000
+ 1000*20 – 9000*125 000
(100000 + – (100000
+ 80*9000) à Expected profit = 200000*11% + 305000*89%
80*9000)
= 200 000 = 305 000 = 293 450
PRODUCE 16.000 UNITS
Demand 8000 10000 12000 14000 16000 18000
à Expected profit = -220000*11% -10000*11%
Profit =8000*125+8 =10000*125 =12000*125 =14000*125 =16000*125 620 000
000*20 - +6000*20 - +4000*20 - +2000*20 - - (100000 + +200000*28%+410000*22%+620000*28%
(100000 + (100000 + (100000 + (100000 + 80*16000) =294 500
80*16000) 80*16000) 80*16000) 80*16000) = 620 000
= -220 000 = -10 000 = 200 000 = 410 000
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THE END