• Theft
• Ties up money
• Depreciation
• Expiring Products

• Primarily involves establishing the amount of inventory to keep in stock
• The most important aspect of this process involves balancing the trade-offs between the losts of carrying inventory and the benefits of carrying inventory
• Essentially, this addresses the previous questions of how much to order and when to order

• Raw materials and Components (basic inputs)
• Work-In-Process (WIP)
• Finished goods

Classified by how it is created

• Cycle stock
• Safety stock
• anticipatory
• pipeline-most ignored by companies

Represents the accumulated supply of goods which have been obtained for future use or sale to satisfy demand

Reasons for Carrying:

• Economies of scale: price and quantity discounts, transportation rate discounts, production economies
• seasonal constraints

Represents an "extra" supply of goods held to protect against uncertainty and unforeseen events

Reasons for Carrying:

• uncertainty about customer demand
• Lead time delays
• Disruptions in supply

Represents a supply of good held to buffer against planned disruptions or anticipated demand

Reasons for carrying:

• stockpile during "off-seasons"
• scheduled shutdown
• seasonal weather disruptions
• smooth production
• contract negotiation-possible labor stoppages

Represents products moving from point to point in the materials flow system. This consists of orders that have been placed by not yet received

Reasons for Carrying

• time and distance
• work-in-process inventory

• Item cost
• ordeing/setup cost
• shortage cost
• inventory carrying (holding) cost

• Item cost refers to the price of an item (price breaks, diff. prices from vendors, quantity discounts)
• Ordering/ setup cost refers to the cost associated with replenishing inventory
• Shortage cost refers to the cost of being unable to meet demand (lost sales, backorders, customer goodwill)
• Inventory carrying cost refers to the cost of holding items in inventory

The explicit and implicit costs of maintaining inventory.

• varies with level of inventory and length of time item is held
• typically expressed as annual percentage of item's value
• ranges from 20%-40% of items value

The cost associated with a foregone alternative use of the capital

• referred to as opportunity cost
• often the largest component of inventory carrying cost
• usually set to the firm's hurdle rate (minimum rate of return expected on new investments

Includes:

• warehouse facilities (most firms include variable expenses-those that vary with the amount of inventory in the short run)
• material handling
• maintenance cost
• utility costs

Reflects the possibility that the inventory's dollar value may decline due to:

• obsolescence:equal to the original cost less salvage value
• deterioration
• damage
• depreciation
• shrinkage (theft)

A method of classifying inventory items into three groups in terms of importance.

Theis idea is to establish inventory policies that focus on the few critical items and not the many trivial ones.

• Paretos Law (80-20 rule)
• "Trivial many" versus "vital few"

Class A: about 20% of items but about 80% of dollar value

Class B: about 50% of items but about 15% of dollar value

Class C: about 30% of items but about 5% of dollar value

This model is a slight variation of the Economic Order Quantity (EOQ) model.

• underlying assumptions are the same as for the EOQ model except that replenishment occurs over time, rather than in a single shipment
• non-instantaneous replenishment or gradula delivery model
• Applies: when delivery orders over a period of time and with production orders

• Demand rate is continuous, known, and constant
• Lead time is known and constant
• Item cost is known and constant
• No shortages permitted
• Replenishment occurs gradually over time at a known and constant rate
• Relevant costs include inventory carrying cost and ordering cost
• Ordering decisions for an item are independent of orders for other itmes
• No constraints on order quantity (Q)

d- delivery (or production) rate (units per time)

r- demand depletion rate (units per time) d>r

t_d- time to deliver (or produce) Q units t_d= Q/d

l_max-maximum inventory level = Q(1-r/d)

Q- quantity

The objective is to minimize the total cost which is comprised of only inventory carrying cost and ordering cost.

Total annual cost= annual carrying cost + annual ordering cost

Annual carrying cost = (carrying cost per unit per year) (average inventory)

Annual Order Cost = (cost per order) (number of orders per year)

• Maximum inventory = shipment quantity
• Average inventory = (minimum + shipment)/2

EOQ- "all at once" for each replenishment period

EDQ- "over time" for each replenishment period

P (NRO)- probability of not running out of stock

P (RO)- probability of running out of stock (1-P(NRO))

Z = X-μ/σ

Two perspectives involving probabilistic conditions (i.e. uncertainty) will be considered to determine the reorder point for the basic EOQ model.

1. Reorder point based on minimizing costs
2. Reorder point based on customer service level

Notation:

R- forecasted mean period demand

X_LT- mean lead time (expected lead time)

X- forecasted mean demand during lead time X=(R)(X_LT)

ROP= X + safety stock

Safety Stock (SS)= Z * σ (standard deviation)

Z- number of standard deviations associated with normal distribution based on the service level

σ_LT- standard deviation of lead time

σ_R- standard deviation of the forecast error per period

σ- standard deviation of forecast error during lead time

P(NRO)= Customer service level

Reorder point system, fixed order quantity system

• determines if it is time to reorder whenever an item is taken from inventory
• a fixed quantity is ordered when the inventory is reduced to the reorder point

periodic reorder system, fixed interval reorder system

• after a fixed period of time, an order is placed to bring inventory position to a desired target level