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Inventory Management
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Inventory ManagementInventory Management
Sanjay Choudhari
Indian Institute of Management Indore
Objective of Inventory ControlObjective 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 QuantityEconomic Order QuantityThe 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 EOQCalculating EOQ
Inventory depletion (demand rate)
Receive order
1 cycle, LT
On
-han
d i
nve
nto
ry (
un
its)
Time
Q
Averagecycleinventory
Q
2
Calculating EOQCalculating EOQ
Annual item cost = (Annual demand) * (Unit item cost)
Annual ordering cost = (Number of orders/Year) * (Ordering or Setup costs)
Total annual inventory costs
= Annual item cost + Annual
holding/carrying cost + Annual ordering or setup cost
Annual holding/carrying cost = (Average cycle inventory) * (Unit holding cost)
An
nu
al c
ost
(d
olla
rs)
Lot Size (Q)
Holding cost
Ordering cost
Total cost
Calculating EOQCalculating EOQ
Calculating EOQCalculating EOQ
Total annual inventory holding and ordering cost
whereTC = Total annual inventory holding and ordering
costQ = lot sizeCH = holding cost per unit per yearD = annual demandCo = ordering or setup costs per lot
TC = (CH) + (Co)Q2
DQ
Calculating EOQCalculating EOQ
The EOQ formula:
Q*= 2 D CoCH
Time between orders
TBOQ* = (12 months/year)Q*D
Number of orders
n =DQ*
Managerial InsightsManagerial Insights
SENSITIVITY ANALYSIS OF THE EOQ
Parameter EOQ Parameter Change
EOQ Change
Comments
Demand ↑ ↑ Increase in lot size is in proportion to the square root of D.
Order/Setup Costs
↓ ↓Weeks of supply decreases and inventory turnover increases because the lot size decreases.
Holding Costs ↓ ↑ Larger lots are justified when
holding costs decrease.
2DCoCH
2DCoCH
2DCoCH
Managerial Insights : Few Managerial Insights : Few IssueIssue
• EOQ suggests fractional value for situation which can be procured in discrete units (Q* of 2.3 lorries make no sense)
• 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 (Q* of 13 ton when each vehicle is of 12 ton capacity)
• It is sometime make it convenient to make order sixe to some suitable number
Managerial Insights : Few Managerial Insights : Few IssueIssue
The total cost curve is flat near EOQ– So, the total cost does not change much with a slight
change in the order quantity
=TCTC*
12
QQ*
Q*Q
+
Managerial Insights : Few Managerial Insights : Few IssueIssue
Q*= 2 D(1+E)CoCH
