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Inventory Models – Costs, EOQ model

Organizations spend lot of money in materials. Material cost represent 20 to 60 percent of the cost of production, even a small saving in material will reflect in profit.


Need for inventory:

Inventory is required for taking care of uncertainty in business,

Ex raw material inventory required because of uncertainty of supply .i.e. .supplier is not prompt in supplying goods, Supply is also lesser than expected. Therefore to take care of these raw material supply uncertainty, you need raw material inventory.

 Types of inventory:

  1. Raw material inventory
  2. Work in process inventory
  3. Finished goods inventory
  4. Supplies
  5. Pipeline inventory
  6. Buffer stock or Safety stock
  7. Decoupling inventory

1,2,3,4 are the basic types of inventory where as others are named based on usage.


Materials which are used other than those used for production of finished goods.

Ex: lubricants, pencil, pen, paper, spare parts.

Pipeline inventory:

It can be raw material, work in progress or finished goods inventory

Ex: Assume supplier is far away. Consumption per day is 20 units, 5 days for transportation

20X5= 100 units are required for the period of transportation.

So if you keep 100 units in your stock it becomes your pipeline inventory.

Decoupling inventory:

Inventory “decouples” in different stages. It might be raw material, WIP, finished goods inventory.

Ex: customer has inventory for 10 days for consumption. For 10 days customer is decoupled from producer.

So, decoupling inventory is the one which decouples customer and producer.

Safety stock:

This stock may be raw material, WIP or finished goods which are extra stock required to      take care of fluctuation or uncertainties in demand or lead time.

Usually in a business organization two things are uncertain,

–         Demand

–         Lead time

Inventory models adopted by organizations depend upon the level of uncertainty with   lead-time or demand.

The following table portrays the type of inventory model organizations has to be adopted against the lead-time and demand situations.

Table  – Demand and lead time in different types of Model to be adopted

Situations Demand Lead time Type of Model to be adopted
1 Constant Constant Deterministic Model
2 Constant Variable Probabilistic Model
3 Variable Constant Probabilistic Model
4 Variable Variable Probabilistic Model

Lead time:

There are two types of leadtime

  • manufacturing lead time
  • supply lead time

Supply lead time:

This time refers to time lapse between placing of order with supplier and receiving it by customer.

Manufacturing Lead time:

The average time consumed by the product in the plant.


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