Inventory Mgmt & EOQ: Stock Control & Cost Optimization

TAKEAWAYS:

• Inventory management balances holding costs (storage, obsolescence) and ordering costs (setup, transportation) to optimize stock levels.
• The EOQ formula $Q^{\ast }=\sqrt{\frac{2DS}{H}}$ finds the ideal order quantity that minimizes total inventory costs.
• ABC classification prioritizes items by value (A: 20% items, 80% cost) to focus control on high-value stock.
• Safety stock prevents stockouts during demand uncertainty (e.g., NTC’s phone chargers during peak season).
• Just-in-Time (JIT) eliminates excess inventory but risks stockouts (used by Pathao for spare bike parts).
• Lead time (time from order to delivery) directly affects reorder points and inventory turnover.

1. What is Inventory Management?

Inventory management is the strategic control of stock—raw materials, work-in-progress, and finished goods—to ensure availability while minimizing costs. It balances:

• Stockout risk (running out of items)
• Excess inventory (dead stock, storage costs)
• Cash flow (tied-up capital in unsold goods)

Real-world example:

• Daraz’s warehouse uses inventory management to balance stock levels for 10,000+ products. If a popular item (e.g., a smartphone) is ordered in bulk (high EOQ), Daraz avoids stockouts but must store it (holding cost). For seasonal items (e.g., winter coats), Daraz uses safety stock to cover unexpected demand spikes.

2. Types of Inventory

Inventory is classified based on purpose and location in the supply chain:

Visual:

flowchart TD
    A["Raw Materials"] -->|"Processed"| B["Work-in-Progress"]
    B -->|"Finished"| C["Finished Goods"]
    C -->|"Sold"| D["Customer"]
    E["Supplier"] -->|"Ships"| A
    F["Warehouse"] -->|"Distributes"| C
    G["Safety Stock"] -->|"Backup"| C

3. Costs in Inventory Management

Three primary costs drive inventory decisions:

1. Holding (Carrying) Costs

   • Cost of storing inventory (rent, insurance, depreciation, obsolescence).
   • Typically 20–30% of item value per year.
   • Example: Storing Rs. 10,000 worth of iPhones in a warehouse costs Rs. 2,000–3,000/year.

2. Ordering (Setup) Costs

   • Fixed costs per order (admin, transportation, placement fees).
   • Example: Ordering 100 units of a product may cost Rs. 500 (fixed), regardless of quantity.

3. Stockout Costs

   • Lost sales, emergency orders, or customer dissatisfaction.
   • Example: NTC losing Rs. 500,000/day if a popular phone model is out of stock.

Trade-off:

• Low inventory → Lower holding costs but higher stockout risk.
• High inventory → Higher holding costs but lower stockout risk.

4. Economic Order Quantity (EOQ) Model

The EOQ model calculates the optimal order quantity that minimizes total inventory costs (holding + ordering).

Key Assumptions:

• Demand is constant and known.
• Lead time is fixed.
• Ordering costs and holding costs are constant.
• No quantity discounts.

EOQ Formula:

$$Q^{\ast }=\sqrt{\frac{2DS}{H}}$$ Where:

• $Q^{\ast }$ = Optimal order quantity
• $D$ = Annual demand (units)
• $S$ = Ordering cost per order (Rs.)
• $H$ = Holding cost per unit per year (Rs.)

Total Cost Formula:

$$TC=\frac{D}{Q}\cdot S+\frac{Q}{2}\cdot H$$ Where:

• $\frac{D}{Q}\cdot S$ = Total ordering cost
• $\frac{Q}{2}\cdot H$ = Average inventory holding cost

Worked Example: Ncell’s Phone Charger Stock

Given:

• Annual demand ($D$) = 50,000 chargers
• Ordering cost ($S$) = Rs. 200 per order
• Holding cost ($H$) = Rs. 5 per charger/year

Step 1: Calculate EOQ $$Q^{\ast }=\sqrt{\frac{2\times 50,000\times 200}{5}}=\sqrt{4,000,000}=2,000\text{ chargers}$$

Step 2: Calculate Reorder Point (ROP) ROP = (Daily demand × Lead time) + Safety stock Assume:

• Daily demand = 138 chargers (50,000/365)
• Lead time = 5 days
• Safety stock = 100 chargers (to cover uncertainty) $$ROP=(138\times 5)+100=790+100=890\text{ chargers}$$

Interpretation:

• Ncell should order 2,000 chargers every time stock drops to 890.
• This balances ordering costs (Rs. 200 per order) and holding costs (Rs. 5 per charger/year).

Visual: EOQ Graph | Total cost is minimized at EOQ (2,000 units).

5. ABC Analysis

Not all inventory items are equally important. ABC analysis categorizes items by annual usage value to prioritize control:

Example: eSewa’s Inventory

• A Items: Prepaid cards (high value, high demand).
• B Items: Transaction fees (moderate value).
• C Items: Old receipts (low value, minimal control).

Mermaid Diagram:

6. Safety Stock and Reorder Point

Safety stock = Buffer inventory to handle demand uncertainty or supply delays.

Reorder Point (ROP) Formula:

$$ROP=(DailyDemand\times LeadTime)+SafetyStock$$

Example: NEPSE’s Emergency Power Generators

• Annual demand: 12 generators
• Lead time: 10 days
• Daily demand: 0.033 generators/day (12/365)
• Safety stock: 2 generators (for unexpected failures) $$ROP=(0.033\times 10)+2=2.33\approx 3\text{ generators}$$ NEPSE should reorder when stock drops to 3 generators.

7. Inventory Turnover and Days of Supply

Inventory Turnover Ratio measures how quickly inventory is sold: $$\text{Turnover}=\frac{\text{Cost of Goods Sold (COGS)}}{\text{Average Inventory}}$$

Days of Supply = Average inventory / Daily demand Example: Daraz’s Inventory Turnover

• COGS = Rs. 500 million/year
• Average inventory = Rs. 100 million $$\text{Turnover}=\frac{500}{100}=5\text{ times/year}$$ Daraz sells its inventory 5 times a year, meaning it takes 73 days (365/5) to sell all stock.

8. Just-in-Time (JIT) Inventory

JIT minimizes inventory by receiving goods only as needed for production or sales. Used by:

• Pathao (spare bike parts arrive just before assembly).
• Toyota (car parts arrive at the factory minutes before use).

Advantages:

• Low holding costs.
• Reduced waste.
• Faster response to demand changes.

Disadvantages:

• High dependency on suppliers.
• Risk of stockouts if supply is disrupted.

Comparison Table: JIT vs. Traditional Inventory

9. Real-World Applications

1. Daraz’s Warehouse Management

• Uses EOQ to order popular items (e.g., smartphones) in bulk (2,000–5,000 units).
• Uses ABC analysis to prioritize high-value items (e.g., Apple products).
• Implements JIT for seasonal items (e.g., winter coats ordered only in November).

2. NTC’s Spare Parts Supply

• Safety stock ensures chargers and batteries are always available.
• ROP triggers automatic reorders when stock drops below 890 units.
• ABC classification focuses on high-value items like iPhone chargers.

3. Ncell’s Phone Inventory

• EOQ = 2,000 chargers (as calculated earlier).
• Safety stock of 100 covers unexpected demand spikes during festivals.
• Inventory turnover = 12 times/year (fast-moving items like SIM cards).

In the Real World

1. Khalti’s Payment Gateway

   • Idea: Safety stock for transaction fees
   • How: Khalti maintains a buffer of digital transaction fees (e.g., Rs. 100,000) to handle sudden spikes in payments (e.g., during Dashain/Bihu). If demand exceeds expectations, Khalti avoids stockouts by dynamically adjusting its fee processing capacity.

2. Pathao’s Bike Parts

   • Idea: Just-in-Time (JIT) for spare parts
   • How: Pathao uses a JIT system for bike tires, brakes, and batteries. Parts are delivered to depots only when needed, reducing storage costs. However, if a supplier delays (e.g., a tire shipment from China), Pathao risks stockouts, leading to delayed repairs and unhappy customers.

3. NEPSE’s Emergency Power Generators

   • Idea: Reorder Point (ROP) for critical supplies
   • How: NEPSE calculates its ROP as 3 generators (as shown earlier). If stock drops below 3, NEPSE automatically triggers an order to avoid blackouts during peak demand (e.g., summer heatwaves). This ensures 99.9% uptime for power trading.

Exam Tip

1. EOQ is the most tested concept—always memorize the formula and know how to calculate optimal order quantity and total cost.

   • Example question: "A company has annual demand of 10,000 units, ordering cost of Rs. 500, and holding cost of Rs. 20. Find EOQ and total cost if ordered in batches of 500."

2. ABC analysis is often paired with case studies—expect questions like:

   • "Classify the following items (A, B, or C) for a supermarket: milk, bread, iPhones, toilet paper."

3. Safety stock and ROP are critical for real-world scenarios—practice calculating:

   • "If daily demand is 50 units, lead time is 7 days, and safety stock is 100, what is the ROP?"

4. Compare JIT vs. traditional inventory—examiners love pro/con tables like the one above.

5. Worked examples are worth full marks—always show:

   • The EOQ formula with numbers.
   • The total cost graph (even if sketched).
   • The ROP calculation with assumptions.

6. Link theory to Nepalese companies—examiners test real-world application. For example:

   • "How would Daraz use EOQ for ordering smartphones?"
   • "Why does Ncell need safety stock for phone chargers?"

Final Advice:

• Practice EOQ calculations until you can solve them in 5 minutes.
• Draw the EOQ cost curve—it’s the most visual concept in this unit.
• Relate to local examples (NTC, Daraz, Ncell) to score higher in case studies.