Chapter 1

Introduction

1.1 Importance and Objectives of Inventory Control

For more or less all organizations in any sector of the economy, Supply Chain Man-
agement, i.e., the control of the material flow from suppliers of raw material to final
customers is a crucial problem. Today the strategic importance of this area is fully
recognized by top management. The total investment in inventories is enormous, and
the control of capital tied up in raw material, work-in-progress, and finished goods
offers a very important potential for improvement. Scientific methods for inventory
control can give a significant competitive advantage. This book deals with a wide
range of different inventory models that can be used when developing inventory
control systems.
Inventories cannot be decoupled from other functions, for example purchasing,
production, and marketing. As a matter of fact, the objective of inventory control
is often to balance conflicting goals. One goal is, of course, to keep stock levels
down to make cash available for other purposes. The purchasing manager may wish
to order large batches to get volume discounts. The production manager similarly
wants long production runs to avoid time-consuming setups. He also prefers to have
a large raw material inventory to avoid stops in production due to missing materials.
The marketing manager would like to have a high stock of finished goods to be able
to provide customers a high service level.
One way to understand which roles inventories can play is to use a func-
tional classification. Silver et al. (1998), for example, consider six broad decision
categories:
In practice it is common to produce in batches due to ordering and/or setup costs.
The resulting stock increase is usually denoted cycle inventories or cycle stock. (We
can also see this as an example of economies of scale.)
Uncertainties in supply and demand together with lead-times in production and
transportation inevitably create a need for safety stocks. Safety stock is the amount
of inventory kept on hand, on the average, to allow for variations in demand and
supply.
Anticipation inventory is accumulated stock that you plan to use for an expected
future peak in sales.

© Springer International Publishing Switzerland 2015 1

S. Axsäter, Inventory Control, International Series in Operations
Research & Management Science 225, DOI 10.1007/978-3-319-15729-0_1
2 1 Introduction

Pipeline inventory is stock that has been ordered but has still not been delivered.
Such inventories include work-in-process.
Decoupling stock is used to permit a decentralization of the inventory control by
separation of the decision-making at different stock points.
Although a functional classification like this may be very helpful, it is also im-
portant to understand that the different types of inventories interact with each other.
Assume that we decide to use a larger batch quantity for some item. This means
larger cycle stock. But larger batches also mean that we need less safety stock to
keep the same customer service. So both a larger safety stock and a larger cycle stock
will increase the service level.
Most organizations can reduce their inventories without increasing other costs by
using more efficient inventory control tools. Furthermore, advances in information
technology have drastically changed the possibilities to apply efficient inventory
control techniques. The recent progress in research has resulted in new and more
general methods that can reduce the supply chain costs substantially. The field of
inventory control has indeed changed during the last decades. It used to mean ap-
plication of simple decision rules, which essentially could be carried out manually.
Modern inventory control is based on quite advanced and complex decision models,
which may require considerable computational efforts.
There are important inventory control problems in all supply chains. For those
who are working with logistics and supply chains, it is difficult to think of any
qualification that is more essential than a thorough understanding of basic inventory
models.

1.2 Overview and Purpose of the Book

The main purpose of this book is that it should be useful as a course textbook.
However, it has also turned out to be very useful for many practitioners working
with logistics. The structure of the book is illustrated in Fig. 1.1.
After this introduction we consider different forecasting techniques in Chap. 2.
We focus on methods like exponential smoothing and moving average procedures for
estimating the future demand from historical demand data, because such methods are
most common in practical applications. We also provide techniques for evaluating
the size of forecast errors.
Chapters 3–6 deal with basic inventory problems for a single installation and
items that can be handled independently. More precisely, Chap. 3 presents various
basic concepts. Chapter 4 deals with deterministic lot sizing and Chap. 5 with safety
stocks and reorder points. In Chap. 6 we discuss integration and optimality.
The contents in Chaps. 2–6 provide the foundation for an efficient standard
inventory control system, which can include:
• A forecasting module, which periodically updates demand forecasts and evaluates
forecast errors.
1.2 Overview and Purpose of the Book 3

Fig. 1.1 Structure of the book

Forecasting
Chapter 2

Single-echelon
independent items
Chapters 3 - 6

Coordinated ordering Multi-echelon

Chapter 7 Chapters 8 - 10

Implementation
Chapter 11

• A module for determination of reorder points and order quantities.

• Continuous or periodic monitoring of inventory levels and outstanding orders.
Triggering of suggested orders when reaching the reorder points.
A reader who already has a reasonably good background in forecasting can skip
Chap. 2 and go directly to Chap. 3.
In Chap. 7 we leave the assumption of independent items and consider co-
ordinated replenishments. Both production smoothing models and so-called joint
replenishment problems are analyzed.
Chapters 8–10 focus on multi-echelon inventory systems, i.e., on several installa-
tions which are coupled to each other. The installations can represent, for example,
stocks of raw materials, components, work-in-process, and final products in a pro-
duction system, or a central warehouse and a number of retailers in a distribution
system. In Chap. 8 we consider structures and ordering policies. Chapter 9 deals
with lot sizing and Chap. 10 with safety stocks and reorder points.
Finally, in Chap. 11 we discuss various practical problems in connection with
implementation of inventory control systems.
Over the years a substantial number of excellent books and overview papers deal-
ing with various inventory control topics have been published. A selection of these
publications is listed at the end of this chapter. A natural question then is why this
book is needed. To explain this, note first that this book is different from most other
books because it also covers very recent advances in inventory theory, for example
new techniques for multi-echelon inventory systems and Roundy’s 98 % approxi-
mation. Furthermore, this book is also different from most other books because it
4 1 Introduction

assumes a reader with a good basic knowledge of mathematics and probability the-
ory. This makes it possible to present different inventory models in a compact and
hopefully more efficient way. The book attempts to explain fundamental ideas in
inventory modeling in a simple but still rigorous way. However, to simplify, several
models are less general than they could have been.
Because the book assumes a good basic knowledge of mathematics and prob-
ability theory, it is most suitable for industrial engineering and management
science/operations research students. It can be used in a basic undergraduate course,
and/or in a more advanced graduate course.
Chapter 2 may be omitted in a course which is strictly focused on inventory
control. If it is included, it should probably be the first part of the course. Chapters 3–
6 should precede Chaps. 7–10. Chapter 7 can either precede or succeed Chaps. 8–10.
Chapter 11 should come at the end of the course.
An undergraduate course can, for example, be based on the following parts of
the book: Sects. 2.1–2.6, 2.10–2.12, Chaps. 3–4, Sects. 5.1.1, 5.2.1, 5.3–5.8, 5.13,
6.3, 7.2.1, 8.1, 8.2.1–8.2.2, 8.2.4–8.2.5, 9.1, 9.2.1, Chap. 11.
For students that have taken the suggested undergraduate course, or a correspond-
ing course, a graduate course can build on a selection of the remaining parts of the
book, e.g., Sects. 5.1.2–5.1.5, 5.2.2, 5.9–5.12, 5.14–5.15, 6.1–6.2, 7.1, 7.3, 8.2.3,
9.2–9.3, Chap. 10.
A graduate course for students that have no prior knowledge of inventory control
but a good mathematical background should include most of the material suggested
for the undergraduate course, but can exclude some of the sections suggested for the
graduate course.
Another purpose of this book is to describe and explain efficient inventory control
techniques for practitioners and in that way simplify and promote implementation
in practice. The book can, e.g., be used as a handbook when implementing and
adjusting inventory control systems.

1.3 Framework

Models and methods in this book are based on the cost structure that is most common
in industrial applications. We consider holding costs including opportunity costs of
alternative investments, ordering or setup costs, and shortage costs or service level
constraints. An important first question is whether a certain considered item should
be stocked or not. We will not deal with, for example, inventory problems related to
financial speculation, i.e., when the value of an item can be expected to increase, or
with aggregate planning models for smoothing production in case of seasonal demand
variations. The interaction with production is recognized through setup costs but also
in some models by explicit capacity constraints. The book does not cover production
planning settings that are not directly related to inventory control.
See Sect. 3.1 for more details.
1.3 Framework 5

The models considered in the book assume that the basic conditions for inventory
control are given, for example in the form of demand distributions, lead-times,
service requirements, and holding and ordering costs. In practice, most of these
conditions can be changed at least in the long run. There are, consequently, there are
many important questions concerning inventories that are related to the structure and
organization of the inventory control system. Such questions may concern evaluation
of investments to reduce setup costs, or whether the customers should be served
through a single-stage or a multi-stage inventory system. Although we do not treat
such questions directly, it is important to note that a correct evaluation must always
be based on inventory models of the type considered in this book. The question is
always whether the savings in inventory-related costs are larger than the costs for
changing the structure of the system.