Operations Notes – Inventory Management

Cycle stock – up and down inventory cycles that arise from reorder quantity choices
4 basic costs to balance:

1. Variable costs
2. Ordering costs
3. Holding costs
4. Backorder costs

SL = Service Level

• Optimal Q balances the cost of holding cycle stock inventory (holding cost, h) against the fixed costs of placing an order (ordering costs) and the cost benefit of volume discounts (variable cost)
• Optimal R balances the cost of holding safety stock (holding cost) against the risk of being out of stock (backorder cost)

If there are no volume discounts (and demand is steady), can use the EOQ (Economic Order Quantity) formula:

h – depends on storage costs, opportunity cost of capital, risk of obsolescence, shrinkage. Increase in variability ⇒ increase in safety stock