Page 194 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 12: Inventory Management

In the “classic” inventory models, which include both the simpler deterministic models and the Notes
more complex probabilistic models, it is assumed that demand is either uniform or dispersed
and independent over time. In other words, demand is assumed either to be constant or to
fluctuate overtime due to random elements. These types of demand situations are common in
retailing and some services operations.
The simper deterministic inventory control models, such as the Economic Order Quantity (EOQ)
model, assume that both demand and lead times are constant and known with certainty. The
more complex probabilistic inventory control models assume that demand, lead time, or both
are random variables with known probability distributions.

Caselet Dell’s Working Capital

ell Computer Corporation was founded in 1984 by then nineteen-year-old Michael
Dell. The company designed, manufactured, sold and serviced high performance
Dpersonal computers. Its Core Strategy was to Sell Directly to customers. It had a
low cost sales distribution model with production cycle that began after the company
received a customer’s order. The Built-to-order manufacturing process yielded low finished
goods inventory balances. By mid 90’s finished goods inventory was as low as 10% to 20%.
It had low number of suppliers which helped Dell to focus on sourcing quality components.
The ware houses were located close to dell’s plants which helped them maintain low level
of inventory. This saved both space and capital. Supply of inventory lower than its
competitors, provided Dell a competitive advantage.
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Basic EOQ Model

Inventories serve a number of important functions such as meeting anticipated demand,
smoothing production requirements, taking advantage of quantity discounts, minimizing the
effects of production and delivery disruptions, and hedging against price increases. However,
inventories cost money to obtain and keep around. Therefore, two simultaneous pursuits of
inventory control are to provide the right material at the right time and to minimize the cost of
providing that service.
The Economic Order Quantity (EOQ) is the number of units that a company should add to
inventory with each order to minimize the total costs of inventory – such as holding costs, order
costs, and shortage costs. The EOQ is used as part of a continuous review inventory system, in
which the level of inventory is monitored at all times, and a fixed quantity is ordered each time
the inventory level reaches a specific reorder point. The EOQ provides a model for calculating
the appropriate reorder point and the optimal reorder quantity to ensure the instantaneous
replenishment of inventory with no shortages. It can be a valuable tool for small business
owners who need to make decisions about how much inventory to keep on hand, how many
items to order each time, and how often to reorder to incur the lowest possible costs.
There are several assumptions used in the derivation of the economic order quantity:
1. Knowing the ordering cost and the cost of holding inventory

2. Instant replenishment of inventory (entire shipment comes in at one time)
3. The item is not allowed to experience shortages (at least in the simple EOQ relationship)

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