2. What is inventory?
Inventory is the raw materials, component
parts, work-in-process, or finished products
that are held at a location in the supply chain.
3. Costs of Inventory
• Physical holding costs:
– out of pocket expenses for storing inventory
(insurance, security, warehouse rental, cooling)
– All costs that may be entailed before you sell it
(obsolescence, spoilage, rework...)
• Opportunity cost of inventory: foregone return on
the funds invested.
• Operational costs:
– Delay in detection of quality problems.
– Delay the introduction of new products.
– Increase throughput times.
4. Benefits of Inventory
• Hedge against uncertain demand
• Hedge against uncertain supply
• Economize on ordering costs
• Smoothing
To summarize, we build and keep inventory in
order to match supply and demand in the
most cost effective way.
5. 12-5
Types of Inventories
• Raw materials & purchased parts
• Partially completed goods called
work in progress
• Finished-goods inventories
– (manufacturing firms)
or merchandise
(retail stores)
6. 12-6
Types of Inventories (Cont’d)
• Replacement parts, tools, & supplies
• Goods-in-transit to warehouses or customers
7. 12-7
Functions of Inventory
• To meet anticipated demand
• To smooth production requirements
• To decouple operations
• To protect against stock-outs
8. 12-8
Functions of Inventory (Cont’d)
• To take advantage of order cycles
• To help hedge against price increases
• To permit operations
• To take advantage of quantity discounts
9. 12-9
Objective of Inventory Control
• To achieve satisfactory levels of customer
service while keeping inventory costs
within reasonable bounds
– Level of customer service
– Costs of ordering and carrying inventory
Inventory turnover is the ratio of
average cost of goods sold to
average inventory investment.
10. 12-10
Effective Inventory Management
• A system to keep track of inventory
• A reliable forecast of demand
• Knowledge of lead times
• Reasonable estimates of
– Holding costs
– Ordering costs
– Shortage costs
• A classification system
11. 12-11
Operations Strategy
• Too much inventory
– Tends to hide problems
– Easier to live with problems than to eliminate
them
– Costly to maintain
• Wise strategy
– Reduce lot sizes
– Reduce safety stock
12. Inventory Control Systems
Continuous system (fixed-order-quantity)
constant amount ordered when
inventory declines to
predetermined level
Periodic system (fixed-time-period)
order placed for variable amount
after fixed passage of time
13. Economic Order Quantity (EOQ)
Models
• EOQ
– optimal order quantity that will
minimize total inventory costs
• Basic EOQ model
• Production quantity model
14. Assumptions of Basic EOQ
Model
Demand is known with certainty and is constant over time
No shortages are allowed
Lead time for the receipt of orders is constant
Order quantity is received all at once
15. Inventory Order Cycle
Demand
rate
Lead Lead
Time
time
time
Order
placed
Order
placed
Order
receipt
Order
receipt
Order quantity, Q
Inventory Level
Reorder point, R
0
16. EOQ Cost Model
Co - cost of placing order D - annual demand
Cc - annual per-unit carrying cost Q - order quantity
Annual ordering cost =
CoD
Q
Annual carrying cost =
CcQ
2
CoD
Q
Total cost = +
CcQ
2
17. EOQ Cost Model (cont.)
Annual
cost ($) Total Cost
Carrying Cost =
CcQ
2
Order Quantity, Q
Slope = 0
Minimum
total cost
Optimal order
Qopt
Ordering Cost =
CoD
Q
