Three Inventory Model – fixed quantity | fixed period | single period
Three Inventory Model
When do you place an order for more inventory, and for how much? Running out of inventory can cost lost sales, but ordering too early or too much increases your cost to keep the extra inventory. Fortunately, there are three inventory models to help you with this decisions making. Each model has a different purpose and manages a different attribute to control inventory levels.
Let’s look at how these models are used. First, there is the fixed quantity model used by many factories to manage the arrival of materials. As the name suggests, each time you place an order it’s for the same amount. With this model, inventory is controlled by a reorder point, which is based on how much inventory you have on hand. Once your inventory reaches a specific level, you place a new order. Again, you order the same amount each time. The reorder point is set so that your factory does not run out of material and does not hold unneeded material. You must constantly monitor this system. If you use materials faster, for example, or if delivery times increase, you must raise the reorder point so that you do not run out of inventory.
The second inventory model is the fixed period model. In this case, you are ordering on a predetermined schedule. For example, grocery stores usually place orders once per week. But each time, they will order a different amount. With this model, inventory is controlled by the replenishment level. In the grocery store, for example, you determine in advance how much inventory is needed to meet expected demand. Each week, you count the current inventory and order just enough to replenish inventory back to the amount needed to meet your forecasted demand. You must also monitor this system closely. If you use inventory at a faster or slower rate, you should adjust the replenishment level up or down to better match demand. Track your on-hand inventory daily to keep from running out of inventory and to avoid unneeded inventory.
The third inventory model is called the single-period model. It is used in very special situations where you only have a specific time to sell your product. In other words, your product is perishable. Publishing a daily newspaper is a good example of this. Once the day is over, no one wants the paper, so you don’t wanna have too many extra newspapers. However, if you don’t have enough, you must turn customers away and you will lose sales. With this model, inventory is determined by balancing the cost of having too much inventory and the cost of having too little inventory. For example, it might cost 25 cents to produce a newspaper that sells for $1. For every extra newspaper you have at the end of the day, you have 25 cents in unneeded expenses. But, if you run out of newspapers today, you lose 75 cents in profit for each lost sale. You must estimate the demand that will balance these two factors.
Most companies prefer having slightly more inventory rather than less because, in our newspaper example, losing a sale costs three times more than having an extra paper. These three models are a foundation for making good inventory management decisions but they are used in different ways based on the product, material, customer, or supplier. Does your company use any of these models for inventory control?