SCRC Articles Library: SCM Inventory Management Models : A Tutorial
SCM Inventory Management Models : A Tutorial Articles

Introduction: Inventory Management Models : A Tutorial
INTRODUCTION Learning Objectives Tutorial Outline Learning Objectives By then end of this module, you will be able to: Describe the functions and drivers of inventory. Distinguish between independent demand and dependent demand inventory items. Discuss the basic workings of two classic independent demand inventory models: Period review Perpetual review systems Calculate the economic order quantity (EOQ) and reorder point (ROP) for a perpetual review system. Tutorial Outline Functions & drivers of inventory Independent vs. dependent demand inventory systems Two classic independent demand systems Period review Perpetual review systems EOQ, reorder point, and safety stock analysis

SUMMARY: Inventory Management Models : A Tutorial
SUMMARY Inventory serves a useful purpose in the supply chain. That said, firms can help minimize the need for inventory by carefully managing those factors that drive inventory levels up. Inventory items can be divided into two main types: Independent demand and dependent demand items. The systems for managing these two types if inventory differ significantly. The two classic systems for managing independent demand inventory are periodic review and perpetual review systems. The economic order quantity (EOQ) is the order quantity that minimizes total holding and ordering costs for the year. Even if all the assumptions don’t hold exactly,

REFERENCES: Inventory Management Models : A Tutorial
REFERENCES Most introductory textbooks in Operations and Supply Chain Management offer a good discussion of inventory systems. Inventory functions and drivers, independent demand models, and safety stock calculations are routinely covered in these books. One possible source: Cecil Bozarth and Robert Handfield, “Introduction to Operations and Supply Chain Management,” PrenticeHall, 2006. ISBN 0139446206 In addition, there are many books that deal exclusively with inventory management, some of which are decidedly more academic in nature than others.

REORDER POINT FORMULA: Inventory Management Models : A Tutorial
REORDER POINT FORMULA The reorder point formula allows us to determine the safety stock (SS) needed to achieve a certain cycle service level. In general, the longer the lead times are, and the greater the variability of demand and lead times, the more SS we will need. Revisiting the Reorder Point Formula Fill Rate vs. Cycle Service Level h2. Revisiting the Reorder Point Formula Where the formula came from is not important, but notice the implications for safety stock: What happens if lead time is constant? What happens if the demand rate is constant? What happens if both are constant?

SAFETY STOCK ANALYSIS: Inventory Management Models : A Tutorial
SAFETY STOCK ANALYSIS EOQ tells us HOW MUCH to order…but WHEN should we order? p. Safety StockWhat Happens when either Demand or Lead Time Varies?What is the Chance of a Stockout?EXAMPLEFinding Z h2. Safety Stock When both lead time & demand are constant, you know exactly what the reorder point is … Under these assumptions: Reorder point = demand during lead time Where = demand per time period = lead time What Happens when either Demand or Lead Time Varies? Variances are caused by changes in demand rates and lead times. Additional inventory beyond amount needed to meet “average” demand

PERPETUAL SYSTEM: Inventory Management Models : A Tutorial
PERPETUAL SYSTEM p. The two classic systems for managing independent demand inventory are periodic review and perpetual review systems. This section focuses on the Perpetual System. What is a Perpetual System? Q and Average Inventory Level What is the “Best” Order Size Q? h2. What is a Perpetual System? Inventory level is constantly monitored and a new order place when a preestablished reorder point R is met h2. Q and Average Inventory Level As the order quantity doubles so does average inventory (= Q/2) h2. What is the “Best” Order Size Q? Inventory related costs Order preparation costs / setup costs Inventory

ECONOMIC ORDER QUANTITY (EOQ) MODEL: Inventory Management Models : A Tutorial
ECONOMIC ORDER QUANTITY (EOQ) MODEL The economic order quantity (EOQ) is the order quantity that minimizes total holding and ordering costs for the year. Even if all the assumptions don’t hold exactly, the EOQ gives us a good indication of whether or not current order quantities are reasonable. What is the EOQ Model? What Would Holding and Ordering Costs Look Like for the Years? Total Relevant* Cost (TRC) Economic Order Quantity (EOQ) EOQ Formula Same Problem What is the EOQ Model? Cost Minimizing “Q” Assumptions: Relatively uniform & known demand rate Fixed item cost Fixed ordering and holding cost Constant

FUNCTIONS AND DRIVERS OF INVENTORY: Inventory Management Models : A Tutorial
FUNCTIONS AND DRIVERS OF INVENTORY p. Inventory serves a useful purpose in the supply chain. That said, firms can help minimize the need for inventory by carefully managing those factors that drive inventory levels up. Functions of Inventory Four Inventory Drivers h2. Functions of Inventory Transit stock / pipeline inventory Cycle stock Safety stock (buffer inventory) Anticipation inventory Others Smoothing inventories Hedge inventories h2. Four Inventory Drivers Demand / Capacity Mismatches Smoothing inventories Demand / Process Volume Mismatches Cycle stocks Demand / Supply Uncertainty Safety stocks Demand / Supply chain lead time mismatches Anticipation inventories

PERIODIC REVIEW SYSTEM: Inventory Management Models : A Tutorial
PERIODIC REVIEW SYSTEM The two classic systems for managing independent demand inventory are periodic review and perpetual review systems. This section focuses on the Periodic Review System. What is a Periodic Review System? EXAMPLE 1 EXAMPLE 2 h2. What is a Periodic Review System? Classic independent inventory system Inventory levels start at some restocking level, R At regular time intervals (ex. – 3 days, two weeks, etc.), the inventory level is reviewed. This new inventory level is called I. Some amount, Q, is added to bring the inventory level back up to R: Q = R – I EXAMPLE 1 A retailer reviews the inventory for a

INDEPENDENT VS DEPENDENT DEMAND INVENTORY SYSTEMS  An EXAMPLE: Inventory Management Models : A Tutorial
*h2. INDEPENDENT VS DEPENDENT DEMAND INVENTORY SYSTEMS – An EXAMPLE Inventory items can be divided into two main types: Independent demand and dependent demand items. The systems for managing these two types if inventory differ significantly. EXAMPLE What is an Independent Demand Item? What is a Dependent Demand Item? Continuing with the EXAMPLE... Summary h2. EXAMPLE A pharmaceutical firm offers a new drug: The firm can try to predict demand for the drug, or even try to manipulate demand through pricing incentives and other marketing efforts, BUT... …ultimately, demand is determined by the marketplace. h2. What is a Dependent Demand