Inventory Analysis

Haritha Saranga

Statistics on US inventories in
2009
Inventory related costs accounted for
approximately 2.5% of US GDP
Average monthly inventory was about $1.37
trillion on annual sales of $12 trillion
Of this, inventory at manufacturer, wholesaler
and retailer levels was $522 billion, $403 billion
and $411 billion respectively.
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Haritha Saranga

Disadvantages of Inventory
Excess inventories can
choke the process
Reduce flexibility to introduce new products
Increase inventory holding costs
Hide the problems on the shop floor

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Haritha Saranga

So, Why does one keep Inventory?

1. To maintain independence of operations
2. To allow flexibility in production scheduling

Decoupling
Inventory

3. To meet variation in product demand

4. To provide a safeguard for variation in raw

material delivery time

5. To take advantage of economic

purchase-order size
6. To cover the supply lead times

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Haritha Saranga

Safety
Inventory

Cycle
Inventory
Pipeline
Inventory

Decoupling Inventory
Production System without any decoupling inventory

1
Stage 1

Stage 2

10

Stage 3

10

Decoupling Inventory
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Haritha Saranga

Inventory System
Inventory is the stock of any item or resource used
in an organization and typically includes
raw materials (component parts & supplies)
work-in-process
finished products

An inventory system is the set of policies and

controls that monitor levels of inventory and
determines
what levels should be maintained
when stock should be replenished and
how large orders should be

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Haritha Saranga

Supply-Chain Performance Measures

One of the most commonly used performance
measures in all of operations management is
Inventory Turnover

Cost of goods sold

Inventory turnover =
Average aggregate inventory value
In situations where distribution inventory is
dominant, Weeks of Supply is preferred and
measures how many weeks worth of inventory
is in the system at a particular time
Average aggregate inventory value
* 52 weeks
Weeks of supply =
Cost
of
goods
sold

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Haritha Saranga

Inventory Systems
Single-Period Inventory Model
One time purchasing decision (Example:
vendor selling T-shirts at Vista-2016)
Seeks to balance the costs of inventory
overstock and under stock
Multi-Period Inventory Models
Fixed-Order Quantity (Q) Models
Event triggered (Example: running out of
stock)
Fixed-Time Period (P) Models
Time triggered (Example: Monthly sales call
by sales representative)
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Haritha Saranga

Fixed-Order Quantity (Q) Model Assumptions

Demand for the product is constant and
uniform throughout the period
Lead time (time from ordering to receipt)
is constant
Price per unit of product is constant
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Haritha Saranga

More Assumptions
Inventory holding cost is based on
average inventory
Ordering or setup costs are constant
All demands for the product will be
satisfied (No back orders are
allowed)
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Haritha Saranga

10

Most Important Questions

How much to order?

When to order?

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Haritha Saranga

11

Basic Fixed-Order Quantity (Q) Model and

Reorder Point Behavior
4. The cycle then repeats.

1. You receive an order quantity Q.

Number
of units
on hand

ROP

2. You start using

them up over time.

L
Time

ROP = Reorder point

Q = Economic order quantity
L = Lead time
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Haritha Saranga

L
3. When you reach down to
a level of inventory of
ROP, you place your next
Q sized order.
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Inventory Costs
Holding (or carrying) costs
Opportunity costs, costs of storage,
handling, insurance, etc
Setup (or production change) costs
Costs of arranging for specific
equipment setups, etc
Ordering costs
Costs of placing an order, etc
Shortage costs
Costs of not meeting the customer
demand, etc
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Haritha Saranga

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Cost Minimization Goal

By adding the holding and ordering costs together, we
determine the total cost curve, which in turn is used to
find the Qopt inventory order point that minimizes total
costs
Total Cost

C
O
S
T

Holding
Costs

Ordering Costs
QOPT
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Order Quantity (Q)

Haritha Saranga

14

Basic Fixed-Order Quantity (EOQ)

Model Formula
Total
Annual =
Cost

Annual
Annual
Annual
Purchase + Ordering + Holding
Cost
Cost
Cost

TC=Total annual
cost
R =Annual Outflow
Rate or throughput
C =Cost per unit
Q =Order quantity
K =Cost of placing
an order or setup
cost
L =Lead time
h=Annual holding
and storage cost
per unit of inventory

How much to order?

Using calculus, we take the first derivative of the total
cost function with respect to Q, and set the
derivative (slope) equal to zero, solving for the
optimized (cost minimized) value of Q*
2KR
2(Order or Setup Cost)(Annual Outflow)
Q =
=
h
Annual Holding Cost
*

Minimum Annual Cost TC* = 2KRh + C * R

Note that EOQ exactly balances annual order

and holding cos ts
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R Q*
\ K *=
h
Q
2

Haritha Saranga

16

When to Order?
We also need a
reorder point to tell
us when to place an
order

Reorder point, (ROP) = L * r

r = average demand per unit time

L = Lead time

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Haritha Saranga

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EOQ Example (1) Problem Data

Given the information below, what are the EOQ and
reorder point?

Annual Demand = 1,000 units

Days per year considered in average
daily demand = 365
Cost to place an order = $10
Holding cost per unit per year = $2.50
Lead time = 7 days
Cost per unit = $15
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Haritha Saranga

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EOQ Example (1) Solution

QOPT =

2KR
2(10)(1,000 )
=
= 89.443 units or 90 units
h
2.50

1,000 units/year
r=
= 2.74 units/day
365 days/year

Reorder point, ROP = L * r = 2.74units/ day (7days) = 19.18 or 20 units

In summary, you place an optimal order of 90 units. In
the course of using the units to meet demand, when
you only have 20 units left, place the next order of 90
units.
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Haritha Saranga

19

EOQ Example (2) Problem Data

Determine the economic order quantity
and the reorder point given the following

Annual Demand = 10,000 units

Days per year considered in average daily
demand = 365
Cost to place an order = $10
Holding cost per unit per year = 10% of cost
per unit
Lead time = 10 days
Cost per unit = $15
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Haritha Saranga

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EOQ Example (2) Solution

QOPT =

2KR
2(10)(10,000 )
=
= 365.148 units, or 366 units
h
1.50
10,000 units/year
r=
= 27.397 units/day
365 days/year

ROP = r * L = 27.397 units/day * (10 days) = 273.97 or 274 units

Place an order for 366 units. When in the course of

using the inventory you are left with only 274 units,
place the next order of 366 units.
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Haritha Saranga

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Insights from EOQ

Q* =

2KR
2(Order or Setup Cost)(Annual Demand)
=
h
Annual Holding Cost

Q is directly proportional to Order cost

Q is inversely proportional to Inventory Holding cost
If the demand R doubles, the optimum inventory Q*
will increase by only 2 times
Similarly, in order to reduce the batch size by half,
one needs to reduce the setup cost/ordering cost by
4 times
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Haritha Saranga

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CumulativePercentile
1.92%
3.83%
5.75%
7.67%
9.58%
11.50%
13.41%
15.33%
17.25%
19.16%
21.08%
23.00%
24.91%
26.83%
28.75%
30.66%
32.58%
34.49%
36.41%
38.33%
40.24%
42.16%
44.08%
45.99%
47.91%
49.83%
51.74%
53.66%
55.57%
57.49%
59.41%
61.32%
63.24%
65.16%
67.07%
68.99%
70.91%
72.82%
74.74%
76.66%
78.57%
80.49%
82.40%
84.32%
86.24%
88.15%
90.07%
91.99%
93.90%
95.82%
97.74%

Cost of raw material and its

cumulative usage

120.00%

100.00%

80.00%

60.00%
C

40.00%

20.00%

0.00%

Cumulative percentile of # of distinct raw materials

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Haritha Saranga
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