Inventory Planning and

Control
Inventory

• Inventory is a stock or store of goods.

• The term inventory denotes any idle resource that could be put to
some future use.
• Inventory examples
• Raw materials
• Partially completed goods (WIP Inventory)
• Finished goods Inventories
• Tools and supplies
• Maintenance and repair inventory
• Goods in transit (pipeline inventory)
Functions of Inventory

• To meet anticipated customer demand.

• To smooth production requirements. (seasonal inventories)
• To decouple operations. (buffer stock)
• To reduce risk of stock outs.
• To take advantage of order cycles.
• To hedge against price increases.
• To take advantage of quantity discounts.
Types of Inventory

Seasonal Inventory
• Organizations carry inventory to meet fluctuations in demand arising out of
seasonality
Decoupling Inventory
• Manufacturing systems typically involve a series of production and assembly
workstations. Raw material passes through these stages before it is converted
into finished goods.
• One way to simplify the production planning and control problem is to decouple
successive stages using inventory at some intermediate points. Each stage will
have an input buffer and an output buffer. The output buffer of the preceding
stage becomes the input buffer of the succeeding stage.
Types of Inventory

Cyclic Inventory
• It is customary for organizations to order inventory in repeated cycles and
consume them over time.
• For example, a hospital may order disposable syringes in quantities of 10,000. If
the average consumption rate is 500 per day, then it takes 20 days to deplete one
order. On the twenty-first day, another order of 10,000 will arrive and it will be
consumed over the next 20 days, and so on.
Types of Inventory

• Cyclic inventory goes through a saw-toothed pattern

as shown in Figure.
• Each cycle begins with replenishment and ends with
complete depletion of the inventory.

If Q is the order quantity per cycle,

The average cyclic inventory = =

Types of Inventory

Pipeline Inventory
• Pipeline inventory pertains to the level of inventory that organizations carry in
the long run due to non-zero lead time for order, transport, and receipt of
material from the suppliers.
• Because of the geographical distances between the buyers and the suppliers and
the host of business processes involved in ordering and receiving material, there
is a time delay between order placement and order receipt.
• The inventory carried to take care of these delays is known as pipeline inventory.
• if the lead time for supply is L, and the mean demand per unit time is µ, then the
pipeline inventory is L × µ.
Types of Inventory
• Pipeline Inventory
Types of Inventory

Safety Stock
• Organizations also have additional investment in inventory to buffer against
uncertainties in demand and supply of raw material and components.
• In order to improve the availability to meet uncertain demand, an additional quantity
known as safety stock is kept.
• Greater investment in safety stock leads to a lower probability of inventory going out of
stock. Similarly, the higher the uncertainty, the greater is the need for safety stock.
• Safety stock only serves to prevent shortages in the short run. However, in the long run,
the demand will tend toward an average value and the safety stock will not be
consumed.
Types of Inventory

• Cyclic inventory, pipeline inventory, and safety stock are critically linked to both
the “how much” and “when” questions in inventory planning. Lead time
influences the “when” decision directly and determines the level of pipeline
inventory in the system.

• Similarly, cyclic inventory is the outcome of the “how much” decision that an
inventory planner makes. Safety stock influences both “how much” and “when”
in an indirect sense.
Inventory Costs

There are several costs associated with inventory planning and control.
These costs could be classified under three broad categories:
• The cost of carrying inventory. All costs related to maintaining
inventory in organizations will be classified under this.
• The cost associated with ordering material and replenishing it in cyclic
intervals.
• The cost arising out of shortages.
Inventory-carrying Cost

• Organizations need to spend a considerable amount of money to

carry inventory.

• The most significant component is the interest for the short-term

borrowals for the working capital required for inventory investment.

• The second significant cost relates to the cost of stores and

warehousing and the administrative costs related to maintaining
inventory and accounting for it.
Inventory-carrying Cost

• The elements of storing and warehousing costs include the following.

• Investments in store space and retrieval systems.
• Software for maintaining inventory status.
• Managerial and other administrative manpower to discharge various
activities related to stores.
• Insurance costs.
• Cost of obsolescence, pilferage, damages, and wastage.
Inventory-carrying Cost

• Let denote the inventory-carrying cost per unit per unit time.
• Thus, if is the unit cost of the item,
• Since the interest component is the predominant part of , the usual
practice is to represent as a percentage of the unit cost of the item.
• = , where i is in percentage.
Inventory-carrying Cost

• For example, if the unit cost of an item is ₹5,000, the annual interest charges are
12 per cent, and the other annual costs related to carrying inventory are 3 per
cent, then the inventory-carrying cost is 15 per cent of the unit cost, that is, ₹750
per unit per year.

• For an order quantity of Q, the average inventory carried by an organization is

Q/2. Therefore, Cost associated with carrying inventory = ()
Cost of Ordering

• Replenishment of cyclic inventory is achieved by ordering material with the

suppliers. Organizations perform a series of tasks related to ordering material.
• All these tasks involve manpower, resources, and time that can be classified
under cost of ordering.
• Since several of these costs are fixed in nature, ordering a larger quantity could
reduce the total costs of ordering. A larger order quantity Q will require fewer
orders to meet a known demand D, and vice versa.
• The number of orders to be placed to satisfy a demand of D is equal to D/Q.
• If denotes the cost of ordering per order, then:
• Total ordering cost =
• The cost of carrying and the cost of ordering
are fundamentally two opposing cost
structures in inventory planning.
• For instance, when the order quantity
becomes smaller, the total cost of carrying
inventory decreases. On the other hand,
since a large number of orders are to be
placed to satisfy the demand, the total
ordering costs will go up.
• Conversely, when the order quantity is
increased, while the total cost of ordering
will come down owing to fewer orders being
placed, the total cost of carrying inventory
will increase due to an increase in the
average cyclic inventory in the system.
Cost of Shortages

• Despite careful planning, organizations are likely to run out of stock for several
reasons. There could be a sudden surge in demand.
• Alternatively, the suppliers might not have delivered the material as per schedule,
or a lot could have been rejected because of defective components.
• Such events disrupt production and have a cascading effect down the supply
chain. Delivery schedules are missed, leading to customer dissatisfaction and loss
of goodwill.
• It also introduces additional costs arising out of pushing the order back and
rescheduling the production system to accommodate these changes.
Inventory Control for Deterministic Demand Items

• Let us consider a situation in which the demand for an item is continuous and is
known with certainty. Since the demand is known, we exclude the possibility of
having shortages.
• Better inventory control requires that we answer the “how much” and “when”
questions by balancing the total costs of carrying inventory and ordering. For an
order quantity of Q, we can compute the total cost of carrying and ordering.
• Total cost of the plan = Total cost of carrying inventory + Total cost of ordering
• TC(Q)= () + )
• When the total cost is minimum, we obtain the most economic order quantity
(EOQ).
Economic order quantity (EOQ)

• When the total cost is minimum, we obtain the most economic order quantity (EOQ).

• Economic order quantity (EOQ) is the ideal quantity of units a company should purchase
to meet demand while minimizing inventory costs such as holding costs, shortage costs,
and order costs.
• The economic order quantity (EOQ) is a company's optimal order quantity that meets
demand while minimizing its total costs related to ordering, receiving, and holding
inventory.
• The EOQ formula is best applied in situations where demand, ordering, and holding costs
remain constant over time.
• One of the important limitations of the economic order quantity is that it assumes the
demand for the company’s products is constant over time.
Economic Order Quantity (EOQ)

• Denoting EOQ by Q* , we obtain the expression of Q* as:

• Optimal number of orders =

• Time between orders =

Inventory Control Systems
The Periodic Review (P)

• A periodic review system is a simple and common method of inventory control,

where you check the stock levels at fixed intervals, such as weekly, monthly, or
quarterly. Based on the demand forecast and the reorder point, you decide how
much to order to replenish the inventory.
• The main advantage of this system is that it is easy to implement and requires
less monitoring and record-keeping.
• However, the main disadvantage is that it can lead to stockouts or excess
inventory, as the demand and lead time may vary between the review periods.
The Continuous Review (Q) System

• A continuous review system is a more sophisticated and dynamic

method of inventory control, where you monitor the stock levels
continuously and place an order whenever the inventory reaches a
predetermined level, called the reorder point.
• The reorder point depends on the demand rate, the lead time, and
the safety stock.
• The main advantage of this system is that it can reduce the risk of
stockouts and optimize the inventory costs.
• However, the main disadvantage is that it requires more resources
and technology to track and update the inventory data.
The Continuous Review (Q) System

• Organizations widely use a continuous review system called a two-bin

system. In operation, the available inventory is stocked in two bins, first in a
smaller bin and the balance in a larger bin.

• As the material is consumed, the larger bin is emptied first. As soon as the
larger bin is empty, an order is placed with a supplier for a predetermined
quantity, Q, and until the material arrives in the stores, the smaller bin is
consumed.

• During replenishment, the smaller bin is filled in first and the cycle
continues.
Problem
Answer
Answer
Answer

= 200