Material Management - Inventory Control Models - Presentation, Study notes of Managerial Economics

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Inventory Control Models

Inventory

• (^) Any stored resource used to satisfy a current or future need (raw materials, work-in-process, finished goods, etc.)
• (^) Represents as much as 50% of invested capitol at some companies
• (^) Excessive inventory levels are costly
• (^) Insufficient inventory levels lead to stockouts

Main Uses of Inventory

1. The decoupling function
2. Storing resources
3. Irregular supply and demand
4. Quantity discounts
5. Avoiding stockouts and shortages

Inventory Control Decisions

Objective: Minimize total inventory cost Decisions:

• (^) How much to order?
• (^) When to order?

Economic Order Quantity (EOQ):

Determining How Much to Order

• (^) One of the oldest and most well known inventory control techniques
• (^) Easy to use
• (^) Based on a number of assumptions

Assumptions of the EOQ Model

1. Demand is known and constant
2. Lead time is known and constant
3. Receipt of inventory is instantaneous
4. Quantity discounts are not available
5. Variable costs are limited to: ordering cost and carrying (or holding) cost
6. If orders are placed at the right time, stockouts can be avoided

Minimizing EOQ Model Costs

• (^) Only ordering and carrying costs need to be minimized (all other costs are assumed constant)
• (^) As Q (order quantity) increases:
  • (^) Carry cost increases
  • (^) Ordering cost decreases (since the number of orders per year decreases)

EOQ Model Total Cost

At optimal order quantity (Q*): Carrying cost = Ordering cost

Two Methods for Carrying Cost

Carry cost (Ch) can be expressed either:

1. As a fixed cost, such as Ch = $0.50 per unit per year
2. As a percentage of the item’s purchase cost (P) Ch = I x P I = a percentage of the purchase cost

EOQ Total Cost

Total ordering cost = (D/Q) x Co Total carrying cost = (Q/2) x Ch Total purchase cost = P x D = Total cost Note:

• (^) (Q/2) is the average inventory level
• (^) Purchase cost does not depend on Q

EOQ Example: Sumco Pump Co.

Buys pump housing from a manufacturer and sells to retailers D = 1000 pumps annually Co = $10 per order Ch = $0.50 per pump per year P = $ Q* =?

Using ExcelModules for Inventory

• (^) Worksheet for inventory models in ExcelModules are color coded - (^) Input cells are yellow - (^) Output cells are green
• (^) Select “Inventory Models” from the ExcelModules menu, then select “EOQ” Go to file 12-2.xls

Calculating Ordering and

Carrying Costs for a Given Q

• (^) Sometimes Co and Ch are difficult to estimate
• (^) We can use the EOQ formula to calculate the value of Co or Ch that would make a given Q optimal: Co = Q 2 x Ch/(2D) Ch = 2DCo/Q^2

Sensitivity of the EOQ Formula

• (^) The EOQ formula assumes all inputs are know with certainty
• (^) In reality these values are often estimates
• (^) Determining the effect of input value changes on Q* is called sensitivity analysis