Chapter 13
Inventory Management
Operations Management
Roberta Russell & Bernard W. Taylor, III
Copyright 2006 John Wiley & Sons, Inc.
Beni Asllani
University of Tennessee at Chattanooga
Two Forms of Demand
 Dependent


Demand for items used to produce
final products
Tires stored at a Goodyear plant are
an example of a dependent demand
item
 Independent


Demand for items used by external
customers
Cars, appliances, computers, and
houses are examples of independent
demand inventory
Copyright 2006 John Wiley & Sons, Inc.
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Independent vs. Dependent
Demand
Independent Demand (Demand not related to other
items or the final end-product)
E(1
)
Copyright 2006 John Wiley & Sons, Inc.
Dependent
Demand
(Derived demand
items for
component parts,
subassemblies,
raw materials,
etc.)
Types of Inventory
 Raw materials
 Purchased parts and supplies
 Work-in-process (partially completed)
products (WIP)
 Items being transported
 Tools and equipment
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13-4
Inventory and Quality
Management
 Customers usually perceive quality
service as availability of goods they want
when they want them
 Inventory must be sufficient to provide
high-quality customer service in TQM
Copyright 2006 John Wiley & Sons, Inc.
13-5
Inventory Costs
 Carrying cost
 cost of holding an item in inventory
 Ordering cost
 cost of replenishing inventory
 Shortage cost
 temporary or permanent loss of sales
when demand cannot be met
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NEGATIVE ASPECTS OF
INVENTORY







Overuse can prohibit quality feedback
Large inventories hide operational problems
Financial costs to carrying excess inventory
Risk of damage
Tracking and accounting costs
Risk of obsolescence and depreciation
Impact on value adding system flexibility
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13-7
Inventory Control Systems
 Continuous system (fixedorder-quantity)

constant amount ordered
when inventory declines to
predetermined level
 Periodic system (fixed-timeperiod)

order placed for variable
amount after fixed passage of
time
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13-8
Economic Order Quantity
(EOQ) Models
 EOQ

optimal order quantity that will
minimize total inventory costs
 Basic EOQ model
 Production quantity model
Copyright 2006 John Wiley & Sons, Inc.
13-9
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
Copyright 2006 John Wiley & Sons, Inc.
13-10
Inventory Order Cycle
Order quantity, Q
Inventory Level
Demand
rate
Reorder point, R
0
Lead
time
Order Order
placed receipt
Copyright 2006 John Wiley & Sons, Inc.
Lead
time
Order Order
placed receipt
Time
13-11
EOQ Cost Model (cont.)
Annual
cost ($)
Total Cost
Slope = 0
CcQ
Carrying Cost =
2
Minimum
total cost
CoD
Ordering Cost = Q
Optimal order
Qopt
Copyright 2006 John Wiley & Sons, Inc.
Order Quantity, Q
13-12
Production Quantity
Model
 An inventory system in which an order is
received gradually, as inventory is
simultaneously being depleted
 AKA non-instantaneous receipt model

assumption that Q is received all at once is relaxed
 p - daily rate at which an order is received over
time, a.k.a. production rate
 d - daily rate at which inventory is demanded
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13-13
Production Quantity Model
(cont.)
Inventory
level
Q(1-d/p)
Maximum
inventory
level
Q
(1-d/p)
2
Average
inventory
level
0
Order
receipt period
Begin
End
order order
receipt receipt
Copyright 2006 John Wiley & Sons, Inc.
Time
13-14
Quantity Discounts
Price per unit decreases as order
quantity increases
CoD
CcQ
TC =
+
+ PD
Q
2
where
P = per unit price of the item
D = annual demand
Copyright 2006 John Wiley & Sons, Inc.
13-15
Fixed-Period (P) Systems
 Orders placed at the end of a fixed period
 Inventory counted only at end of period
 Order brings inventory up to target level
 Only relevant costs are ordering and holding
 Lead times are known and constant
 Items are independent from one another
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Fixed-Period (P) Systems
On-hand inventory
Target maximum (T)
Q4
Q2
P
Q1
Q3
P
P
Time
Figure 13.9