Strategic Operations

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Identify the two basic decisions addressed by inventory management and discuss why the responses to these decisions differ for continuous and periodic inventory systems.

An inventory system controls the level of inventory by determining how much to order (the level of replenishment), and when to order. There are two basic types of inventory systems: a continuous (or fixed-order-quantity) system and a periodic (or fixed-time-period) system. In a continuous system, an order is placed for the same constant amount whenever the inventory on hand decreases to a certain level, whereas in a periodic system, an order is placed for a variable amount after specific regular intervals.

In a continuous inventory system (also referred to as a perpetual system and a fixed-order-quantity system), a continual record of the inventory level for every item is maintained. Whenever the inventory on hand decreases to a predetermined level, referred to as the reorder point, a new order is placed to replenish the stock of inventory. The order that is placed is for a fixed amount that minimizes the total inventory costs. This amount, called the economic order quantity, is discussed in greater detail later.

In a periodic inventory system (also referred to as a fixed-time-period system or a periodic review system), the inventory on hand is counted at specific time intervals; for example, every week or at the end of each month. After the inventory in stock is determined, an order is placed for an amount that will bring inventory back up to a desired level. In this system the inventory level is not monitored at all during the time interval between orders, so it has the advantage of little or no required record keeping. The disadvantage is less direct control. This typically results in larger inventory levels for a periodic inventory system than in a continuous system to guard against unexpected stock outs early in the fixed period. Such a system also requires that a new order quantity be...