Inventory Management

Sanjay Choudhari
Indian Institute of Management Indore

Objective of Inventory Control

To maximize the level of customer service by avoiding understocking To promote efficiency in production or purchasing by minimizing the cost of providing an adequate level of customer service

How much to order or produce ? When to order or manufacture new lots ?

Economic Order Quantity

The lot size, Q, that minimizes total annual inventory holding and ordering costs EOQ/Q*
Assumptions

1. The company knows the demand rate for the item and it is constant over time. 2. The company produces the item in lots or purchase it in orders. 3. Each lot or order arrives in a single delivery. 4. The company knows the lead time (time between ordering to receipt) and it is constant. 5. The company bases its inventory holding cost on average inventory. 6. Ordering or setup cost are constant. 7. The company satisfies all demands for the product (no backorder) 8. No quantity discounts is available

Calculating EOQ
Receive order On-hand inventory (units) Inventory depletion (demand rate)

Q 2

Average cycle inventory

1 cycle, LT

Time

Calculating EOQ
Annual item cost = (Annual demand) * (Unit item cost)

Annual ordering cost = (Number of orders/Year) * (Ordering or Setup costs) Annual holding/carrying cost = (Average cycle inventory) * (Unit holding cost)

Total annual inventory costs

= Annual item cost + Annual holding/carrying cost + Annual ordering or setup cost

Calculating EOQ

Annual cost (dollars)

Total cost

Holding cost

Ordering cost

Lot Size (Q)

Calculating EOQ
Total annual inventory holding and ordering cost Q D TC = (CH) + (Co) 2 Q
where TC = Total annual inventory holding and ordering cost Q = lot size CH = holding cost per unit per year D = annual demand Co = ordering or setup costs per lot

Calculating EOQ
The EOQ formula: Q*= Time between orders TBOQ* = Number of orders n= D Q* 2 D Co CH

Q* D

(12 months/year)

Managerial Insights
SENSITIVITY ANALYSIS OF THE EOQ Parameter EOQ Parameter Change EOQ Change Comments Increase in lot size is in proportion to the square root of D. Weeks of supply decreases and inventory turnover increases because the lot size decreases.

Demand

2DCo CH

Order/Setu p Costs

2DCo CH

Holding Costs

2DCo CH

Larger lots are justified when holding costs decrease.

Managerial Insights : Few Issue

EOQ suggests fractional value for situation which

Supplier are unwilling to split standard package sizes (Q* of 227 kg cement as each bag is of 50 Kg) Deliveries are made by vehicles with fixed capacity
It is sometime make it convenient to make order
sixe to some suitable number

can be procured in discrete units (Q* of 2.3 lorries make no sense)

(Q* of 13 ton when each vehicle is of 12 ton capacity)

Managerial Insights : Few Issue

TC 1 TC* = 2

Q Q* + Q* Q

The total cost curve is flat near EOQ So, the total cost does not change much with a slight change in the order quantity

Managerial Insights : Few Issue

Q*=

2 D(1+E)Co CH