Chapter 7 Inventory Models

Inventory refers to idle goods or materials that are held by an organization for use sometime in the future. Items carried in inventory include raw materials, purchased parts, components, subassemblies, work-in-process, finished goods, and supplies. One reason organizations maintain inventory is that it is rarely possible to predict sales levels, production times, demand, and usage needs exactly. Thus, inventory serves as a buffer against uncertain and fluctuating usage and keeps a supply of items available in case the items are needed by the organization or its customers. While inventory serves an important and essential role, the expense associated with financing and maintaining inventories is a substantial part of the cost of doing business. In large organizations, the cost associated with inventory can run into the millions of dollars. Two important questions that must be answered in order to effectively manage inventories are as follows: 1. How much should be ordered when the inventory for an item is replenished? 2. When should the inventory be replenished? The purpose of this chapter is to show how quantitative models can assist in making these decisions. We will first consider deterministic inventory models in which we assume that the rate of demand for the item is constant or nearly constant. Later we will consider probabilistic inventory models in which the demand for the item fluctuates and can be described only in probabilistic terms. In addition, we will describe an inventory management procedure referred to as material requirements planning (MRP); this approach is suited for managing inventories of raw materials, subassemblies, and components whose demand is directly dependent on the demand for the final products in the inventory system. Finally, in the last section of the chapter, we discuss a philosophy