College of Business Administration

Cal State San Marcos

Production & Operations Management

HTM 305
Dr. M. Oskoorouchi
Summer 2006

CHAPTER

11

Inventory
Management

Types of Inventories

Raw materials & purchased parts

Partially completed goods called
work in progress

Finished-goods inventories

(manufacturing firms)
or merchandise
(retail stores)

Functions of Inventory

To meet anticipated demand

To smooth production requirements

To protect against stock-outs

To take advantage of order cycles

To hedge against price increases

To take advantage of quantity discounts

Effective Inventory Management

A system to keep track of inventory

A reliable forecast of demand

Knowledge of lead times

Reasonable estimates of

Holding costs

Ordering costs

Shortage costs

Key Inventory Terms

Lead time: time interval between ordering

and receiving the order
Holding (carrying) costs: cost to carry an
item in inventory for a length of time
Ordering costs: costs of ordering and
receiving inventory
Shortage costs: costs when demand exceeds
supply

Inventory Counting Systems

Periodic System
Physical count of items made at periodic
intervals

Perpetual Inventory System

System that keeps track
of removals from inventory
continuously, thus
monitoring
current levels of
each item

Inventory Counting Systems

Two-Bin System - Two containers of

inventory; reorder when the first is empty
Universal Bar Code - Bar code
printed on a label that has
information about the item
to which it is attached
0

214800 232087768

ABC Classification System

Classifying inventory according to some
measure of importance and allocating control
efforts accordingly.

A - very important
B - mod. important
C - least important

High

Annual
$ value
of items

B
C

Low
Few

Many

Number of Items

Economic Order Quantity Models

Economic order quantity model

Economic production quantity model

Quantity discount model

Assumptions of EOQ Model

Only one product is involved

Annual demand requirements known

Demand is even throughout the year

Lead time does not vary

Each order is received in a single delivery

There are no quantity discounts

The Inventory Cycle

Profile of Inventory Level Over Time

Q
Quantity
on hand

Usage
rate

Reorder
point

Receive
order

Place Receive
order order

Lead time

Place Receive
order order

Time

Order frequency

Annual carrying cost

Annual carrying cost =
(average number of inventory)*(holding cost/unit/year)
Average number of inventory = (Q+0)/2 = Q/2

Annual carrying cost = (Q/2)H,

Where
Q = Order quantity in units
H = Holding cost /unit/year

Total Cost
Annual
Annual
Total cost = carrying + ordering
cost
cost
TC =

Q
H
2

DS
Q

Cost Minimization Goal

Annual Cost

The Total-Cost Curve is U-Shaped

Q
D
TC H S
2
Q

Ordering Costs
QO (optimal order quantity)

Order Quantity
(Q)

Deriving the EOQ

Using calculus, we take the derivative of the
total cost function and set the derivative
(slope) equal to zero and solve for Q.

Q OPT =

2DS
=
H

2( Annual Demand )(Order or Setup Cost )

Annual Holding Cost

Example

A toy manufacturer uses approximately 32,000

silicon chips annually. The chips are used at a
steady rate during the 240 days a year that the
plant operates. Annual holding cost is $3 per chip,
and ordering cost is $120. Determine

The optimal order quantity.

Holding cost, ordering cost, and the total cost.
The number of workdays in an order cycle.

Problem

PM assembles security monitors. It purchases

3,600 black-and-white cathode ray tubes a year
at $65 each. Ordering costs are $31, and annual
carrying costs are 20% of the purchase price.
Compute

The optimal quantity

the total annual cost of ordering and carrying the
inventory.

Problem

A large bakery buys flour in 25-pound bags. The bakery uses an

average of 4,860 bags a year. Preparing an order and receiving a
shipment of flour involves a cost of $10 per order. Annual carrying
costs are $75 per bag

Determine the economic order quantity.

What is the average number of bags on hand.

How many orders per year will there be?

Compute the total cost of ordering and carrying flour.

If ordering costs were to increase in $1 per order, how much would that
affect the minimum total annual cost?

Economic Production Quantity (EPQ)

Production done in batches or lots

Capacity to produce a part exceeds the parts
usage or demand rate
Assumptions of EPQ are similar to EOQ
except orders are received incrementally
during production

Economic Production Quantity Assumptions

Only one item is involved

Annual demand is known
Usage rate is constant
Usage occurs continually
Production rate is constant
Lead time does not vary
No quantity discounts

EPQ Model

Economic Run Size

Q0

2DS
p
H p u

Example

A toy manufacturer uses 48,000 rubber wheels per year

for its popular dump truck series. The firm makes its
own wheels, which it can produce at a rate of 800 per
day. The toy trucks are assembled uniformly over the
entire year. Carrying cost is $1 per wheel a year. Setup
cost for a production run of wheels is $45. the firm
operates 240 day per year. Determine the

Optimal run size

Minimum total annual cost for carrying and setup
Cycle time for the optimal run
Run time.

Problem

The Dine Corporation is both a producer and a user of

brass couplings. The firm operates 220 days a year and
uses the couplings at a steady rate of 50 per day.
Couplings can be produced at a rate of 200 per day.
Annual storage cost is $2 per coupling, and machine
setup cost is $70 per run.

Determine the economic run quantity

Approximately how many runs per year will there be?
Compute the maximum inventory level.
Determine the length of the pure consumption portion of
the cycle.

Problem

The Friendly Sausage Factory (FSF) can produce hot dogs

at a rate of 5,000 per day. FSF supplies hot dogs to local
restaurants at a steady rate of 250 per day. The cost to
prepare the equipment for producing hot dogs is $66.
annual holding costs are 45 cents per hot dog. The factory
operates 300 days a year. Find

The optimal run size.

The number of runs per year.
The maximum inventory level.
The length of run.

Review: EOQ Model

Cost Minimization Goal

Annual Cost

The Total-Cost Curve is U-Shaped

Q
D
TC H S
2
Q

Holding Costs

Ordering Costs
QO (optimal order quantity)

Order Quantity
(Q)

Deriving the EOQ

Using calculus, we take the derivative of the
total cost function and set the derivative
(slope) equal to zero and solve for Q.

Q OPT =

2DS
=
H

2( Annual Demand )(Order or Setup Cost )

Annual Holding Cost

Total Cost
Annual
Annual
Total cost = carrying + ordering
cost
cost
TC =

Q
H
2

DS
Q

Total Costs with Purchasing Cost

EOQ models with constant purchase price:

Annual
Annual
Purchasing
+
TC = carrying + ordering cost
cost
cost
Q
H
TC =
2

DS
Q

PD

Cost

Total Costs with PD

Adding Purchasing cost TC with PD

doesnt change EOQ

TC without PD

PD

EOQ

Quantity

Total Costs with quantity discount

Order
quantity

Unit Price

1 to 44

$2.00

45 to 69

1.70

70 or more

1.40

Example: Constant Carrying Costs

A mail-order house uses 18,000 boxes a year. Carrying costs

are 60 cents per box a year, and ordering costs are $96. The
following price schedule applies:
Number of boxes

Price per box

1,000 to 1,999

$1.25

2,000 to 4,999

1.20

5,000 to 9,999

1.15

10,000 or more

1.10

Determine the optimal order quantity.

Determine the number of orders per year.

Total Costs with Purchase discount

TC

Lowest TC

2,400

5,000

10,000

Quantity

Steps for total Cost with Constant Carrying Costs

Compute the common minimum point.

Only one of the unit prices will have the minimum point in its
feasible range since the ranges do not overlap. Identify that
range.

If the feasible minimum point is on the lowest price range,

that is the optimal order quantity.

Otherwise, compute the total cost for the minimum point and
for the price breaks of all lower unit costs. Compare the total
costs; the quantity (minimum point or price break) that yields
the lowest total cost is the optimal order quantity.

Problem: Constant Carrying Costs

The maintenance department of a large hospital

uses about 816 cases of liquid cleanser annually.
Ordering costs are $12, carrying costs are $4 per
case a year, and the new price schedule indicates
that orders of less than 50 cases will cost $20
per case, 50 to 79 cases will cost $18 per case,
80 to 99 cases will cost $17 per case, and larger
orders will cost $16 per case.

Determine the optimal order quantity and the

total cost.

Problem: Constant Carrying Costs

A jewelry firm buys semiprecious stone to make bracelets

and rings. The supplier quotes a price of $8 per stone for
quantities of 600 stones or more, $9 per stone for orders
of 400 to 599 stones, and $10 per stone for lesser
quantities. The jewelry firm operates 200 days per year.
Usage rate is 25 stones per day, and ordering costs are
$48.

If carrying costs are $2 per day for each stone, find the
order quantity that will minimize total annual cost.

Total Costs with quantity discount

There are two general cases of the model:

Carrying costs are constant (for example, $2 per

unit)
Carrying costs are stated as a percentage of
purchase price (for example, 20% of purchase
price)

Problem: variable Carrying Costs

A jewelry firm buys semiprecious stone to make

bracelets and rings. The supplier quotes a price of
$8 per stone for quantities of 600 stones or more,
$9 per stone for orders of 400 to 599 stones, and
$10 per stone for lesser quantities. The jewelry
firm operates 200 days per year. Usage rate is 25
stones per day, and ordering costs are $48.

If annual carrying costs are 30% of unit cost, what

is the optimal order size?

Steps for total Cost with variable Carrying Costs

Beginning with the lowest unit price, compute the minimum

points for each price range until you find a feasible minimum
point (i.e., until a minimum point falls in the quantity range for
its price).

If the minimum point for the lowest unit price is feasible, it is the
optimal order quantity. If the minimum point is not feasible in
the lowest price range, compare the total cost at the price break
for all lower prices with the total cost of the feasible minimum
point. The quantity which yields the lowest total cost is the
optimum.

Problem: variable Carrying Costs

A manufacturer of exercise equipments purchases the pulley

section of the equipment from a supplier who lists these prices:
less than 1,000, $5 each; 1,000 to 3,999, $4.95 each; 4,000 to
5,999, $4.90 each; and 6,000 or more, $4.85 each. Ordering
costs are $50, annual carrying costs per unit are 40% of
purchase cost, and annual usage is 4,900 pulleys.

Determine an order quantity that will minimize total cost.

Problem: variable Carrying Costs

TC

495

497

500

503

1,000

4,000
Quantity

6,000

When to Reorder with EOQ Ordering

A simple case:

Demand is constant

Lead time is constant

ROP = d * LT

Example: Demand is 20 items per day and lead

time is one week. What is the reorder point (ROP)?

When to Reorder with EOQ Ordering

Reorder Point - When the quantity on hand

of an item drops to this amount, the item is
reordered

Safety Stock - Stock that is held in excess of

expected demand due to variable demand
rate and/or lead time.

Service Level - Probability that demand will

not exceed supply during lead time.

Determinants of the Reorder Point

The rate of demand (based on a forecast)

The lead time
Demand and/or lead time variability
Stockout risk (safety stock)
ROP = Expected demand during lead time +
safety stocks

Quantity

Safety Stock

Maximum probable demand

during lead time
Expected demand
during lead time

ROP

Safety stock reduces risk of

stockout during lead time

Safety stock
LT

Time

Reorder Point
The ROP based on a normal
Distribution of lead time demand
Service level
Risk of
a stockout
Probability of
no stockout
Expected
demand
0

ROP

Quantity

Safety
stock
z

z-scale

Reorder Point
ROP = Expected demand during lead time + safety stocks

We discuss several models:

An estimate of expected demand during lead time and its

standard deviation are available.

Data on lead time demand is not available: we consider

three cases:

Demand is variable, lead time is constant

Lead time is variable, demand is constant
Both demand and lead time are variable

ROP for model 1

An estimate of expected demand during lead

time and its standard deviation are available

Expected demand
ROP
during lead time

z dLT

Example

Given this information:

Expected demand during lead time = 300 units

Standard deviation of demand during lead time = 30 units

Determine each of the following, assuming that lead time demand

is distributed normally:

The ROP that will provide a 5% risk of stockout during lead time.

The ROP that will provide a 1% risk of stockout during lead time.

The safety stock needed to attain a 1% risk of stockout during lead time.

Cumulative Distribution Function of the Standard Normal Distribution

Example:
z
-3.0
-2.9
-2.8
-2.7
-2.6
-2.5
-2.4
-2.3
-2.2
-2.1
-2.0
-1.9
-1.8
-1.7
-1.6
-1.5
-1.4
-1.3
-1.2
-1.1
-1.0
-0.9
-0.8
-0.7
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0.0

0.00
0.0013
0.0019
0.0026
0.0035
0.0047
0.0062
0.0082
0.0107
0.0139
0.0179
0.0228
0.0287
0.0359
0.0446
0.0548
0.0668
0.0808
0.0968
0.1151
0.1357
0.1587
0.1841
0.2119
0.2420
0.2743
0.3085
0.3446
0.3821
0.4207
0.4602
0.5000

If Z is standard Normal random variable, then F(1.00) = P(Z 1.00) = .8413

0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.0013
0.0013
0.0012
0.0012
0.0011
0.0011
0.0011
0.0018
0.0018
0.0017
0.0016
0.0016
0.0015
0.0015
0.0025
0.0024
0.0023
0.0023
0.0022
0.0021
0.0021
0.0034
0.0033
0.0032
0.0031
0.0030
0.0029
0.0028
0.0045
0.0044
0.0043
0.0041
0.0040
0.0039
0.0038
0.0060
0.0059
0.0057
0.0055
0.0054
0.0052
0.0051
0.0080
0.0078
0.0075
0.0073
0.0071
0.0069
0.0068
0.0104
0.0102
0.0099
0.0096
0.0094
0.0091
0.0089
0.0136
0.0132
0.0129
0.0125
0.0122
0.0119
0.0116
0.0174
0.0170
0.0166
0.0162
0.0158
0.0154
0.0150
0.0222
0.0217
0.0212
0.0207
0.0202
0.0197
0.0192
0.0281
0.0274
0.0268
0.0262
0.0256
0.0250
0.0244
0.0351
0.0344
0.0336
0.0329
0.0322
0.0314
0.0307
0.0436
0.0427
0.0418
0.0409
0.0401
0.0392
0.0384
0.0537
0.0526
0.0516
0.0505
0.0495
0.0485
0.0475
0.0655
0.0643
0.0630
0.0618
0.0606
0.0594
0.0582
0.0793
0.0778
0.0764
0.0749
0.0735
0.0721
0.0708
0.0951
0.0934
0.0918
0.0901
0.0885
0.0869
0.0853
0.1131
0.1112
0.1093
0.1075
0.1056
0.1038
0.1020
0.1335
0.1314
0.1292
0.1271
0.1251
0.1230
0.1210
0.1562
0.1539
0.1515
0.1492
0.1469
0.1446
0.1423
0.1814
0.1788
0.1762
0.1736
0.1711
0.1685
0.1660
0.2090
0.2061
0.2033
0.2005
0.1977
0.1949
0.1922
0.2389
0.2358
0.2327
0.2296
0.2266
0.2236
0.2206
0.2709
0.2676
0.2643
0.2611
0.2578
0.2546
0.2514
0.3050
0.3015
0.2981
0.2946
0.2912
0.2877
0.2843
0.3409
0.3372
0.3336
0.3300
0.3264
0.3228
0.3192
0.3783
0.3745
0.3707
0.3669
0.3632
0.3594
0.3557
0.4168
0.4129
0.4090
0.4052
0.4013
0.3974
0.3936
0.4562
0.4522
0.4483
0.4443
0.4404
0.4364
0.4325
0.4960
0.4920
0.4880
0.4840
0.4801
0.4761
0.4721

0.08
0.0010
0.0014
0.0020
0.0027
0.0037
0.0049
0.0066
0.0087
0.0113
0.0146
0.0188
0.0239
0.0301
0.0375
0.0465
0.0571
0.0694
0.0838
0.1003
0.1190
0.1401
0.1635
0.1894
0.2177
0.2483
0.2810
0.3156
0.3520
0.3897
0.4286
0.4681

0.09
0.0010
0.0014
0.0019
0.0026
0.0036
0.0048
0.0064
0.0084
0.0110
0.0143
0.0183
0.0233
0.0294
0.0367
0.0455
0.0559
0.0681
0.0823
0.0985
0.1170
0.1379
0.1611
0.1867
0.2148
0.2451
0.2776
0.3121
0.3483
0.3859
0.4247
0.4641

z
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
2.0
2.1
2.2
2.3
2.4
2.5
2.6
2.7
2.8
2.9
3.0

0.00
0.5000
0.5398
0.5793
0.6179
0.6554
0.6915
0.7257
0.7580
0.7881
0.8159
0.8413
0.8643
0.8849
0.9032
0.9192
0.9332
0.9452
0.9554
0.9641
0.9713
0.9772
0.9821
0.9861
0.9893
0.9918
0.9938
0.9953
0.9965
0.9974
0.9981
0.9987

0.01
0.5040
0.5438
0.5832
0.6217
0.6591
0.6950
0.7291
0.7611
0.7910
0.8186
0.8438
0.8665
0.8869
0.9049
0.9207
0.9345
0.9463
0.9564
0.9649
0.9719
0.9778
0.9826
0.9864
0.9896
0.9920
0.9940
0.9955
0.9966
0.9975
0.9982
0.9987

0.02
0.5080
0.5478
0.5871
0.6255
0.6628
0.6985
0.7324
0.7642
0.7939
0.8212
0.8461
0.8686
0.8888
0.9066
0.9222
0.9357
0.9474
0.9573
0.9656
0.9726
0.9783
0.9830
0.9868
0.9898
0.9922
0.9941
0.9956
0.9967
0.9976
0.9982
0.9987

0.03
0.5120
0.5517
0.5910
0.6293
0.6664
0.7019
0.7357
0.7673
0.7967
0.8238
0.8485
0.8708
0.8907
0.9082
0.9236
0.9370
0.9484
0.9582
0.9664
0.9732
0.9788
0.9834
0.9871
0.9901
0.9925
0.9943
0.9957
0.9968
0.9977
0.9983
0.9988

0.04
0.5160
0.5557
0.5948
0.6331
0.6700
0.7054
0.7389
0.7704
0.7995
0.8264
0.8508
0.8729
0.8925
0.9099
0.9251
0.9382
0.9495
0.9591
0.9671
0.9738
0.9793
0.9838
0.9875
0.9904
0.9927
0.9945
0.9959
0.9969
0.9977
0.9984
0.9988

0.05
0.5199
0.5596
0.5987
0.6368
0.6736
0.7088
0.7422
0.7734
0.8023
0.8289
0.8531
0.8749
0.8944
0.9115
0.9265
0.9394
0.9505
0.9599
0.9678
0.9744
0.9798
0.9842
0.9878
0.9906
0.9929
0.9946
0.9960
0.9970
0.9978
0.9984
0.9989

0.06
0.5239
0.5636
0.6026
0.6406
0.6772
0.7123
0.7454
0.7764
0.8051
0.8315
0.8554
0.8770
0.8962
0.9131
0.9279
0.9406
0.9515
0.9608
0.9686
0.9750
0.9803
0.9846
0.9881
0.9909
0.9931
0.9948
0.9961
0.9971
0.9979
0.9985
0.9989

0.07
0.5279
0.5675
0.6064
0.6443
0.6808
0.7157
0.7486
0.7794
0.8078
0.8340
0.8577
0.8790
0.8980
0.9147
0.9292
0.9418
0.9525
0.9616
0.9693
0.9756
0.9808
0.9850
0.9884
0.9911
0.9932
0.9949
0.9962
0.9972
0.9979
0.9985
0.9989

0.08
0.5319
0.5714
0.6103
0.6480
0.6844
0.7190
0.7517
0.7823
0.8106
0.8365
0.8599
0.8810
0.8997
0.9162
0.9306
0.9429
0.9535
0.9625
0.9699
0.9761
0.9812
0.9854
0.9887
0.9913
0.9934
0.9951
0.9963
0.9973
0.9980
0.9986
0.9990

0.09
0.5359
0.5753
0.6141
0.6517
0.6879
0.7224
0.7549
0.7852
0.8133
0.8389
0.8621
0.8830
0.9015
0.9177
0.9319
0.9441
0.9545
0.9633
0.9706
0.9767
0.9817
0.9857
0.9890
0.9916
0.9936
0.9952
0.9964
0.9974
0.9981
0.9986
0.9990

Problem

Suppose that the manager of a construction supply

house determine from historical records that demand
for sand during lead time obeys a normal distribution
with mean 35 tons and standard deviation of 2.5 tons.

What value of z is appropriate if the manager is willing

to accept a stockout risk of no more than 4%.

How much safety stock should be held?

What reorder point should be used?

ROP for variable demand and constant lead time

Only demand is variable

ROP d LT z LT d

where
d Average daily or weekly demand
d Standard deviation of demand per day or week
LT Lead time in days or weeks

Example

A restaurant uses an average of 50 jar of a special sauce each

week. Weekly usage of sauce has a standard deviation of 3 jars.
The manager is willing to accept no more than a 10% risk of
stockout during lead time, which is two weeks. Assume the
distribution of usage is normal.

Determine the value of z

Determine the ROP

ROP for variable lead time and constant demand

Only lead time is variable

ROP d LT zd LT

where
d Daily or weekly demand

LT Standard deviation of lead time per day or week

LT Average lead time in days or weeks

Problem

The housekeeping department of a motel uses approximately 600

bars of soap per day, and this tends to be fairly constant. Lead
time for soap delivery is normally distributed with a mean of six
days and standard deviation of two days. A service lead of 98% is
desired. Find the ROP.

ROP for variable demand and variable lead time

Both demand and lead time are variable

2
ROP d LT z LT d2 d 2 LT

Problem

The motel replaces broken glasses at a rate of 25 per day. In the

past, this quantity has tend to vary normally and have a standard
deviation of 3 glasses per day. Glasses are ordered from a
Cleveland supplier. Lead time is normally distributed with an
average of 10 days and a standard deviation of 2 days. What
ROP should be used to achieve a service level of 95%?

Problem

The manager of FSF has determined that demand

for hot dogs obeys a normal distribution with an
average of 5000 per week and standard deviation
of 150 per week.

The manager is willing to accept 3% stockout

risk during lead time which is one week.

Determine the reorder point

Problem

The manager of FSF has determined that demand

for hot dogs is approximately 5000 per week and
it is fairly constant.

The lead time obeys a normal distribution with

an average of one week and standard deviation
of 0.5 weeks.

Determine the reorder point if the manager is

willing to accept 8% stockout risk.

Problem

The manager of FSF has determined that demand for

hot dogs obeys a normal distribution with an average of
5000 per week and standard deviation of 150 per week.

In the past the lead time had a normal distribution with

mean of one week and standard deviation of 0.5 weeks

The manager is willing to accept 3% stockout risk

during lead time.

Determine the reorder point

Shortages per cycle

The expected number of units short can be very useful

to management.
This quantity can easily be determined using the
information for ROP and Table 11.3 in your textbook.
E(n), expected number of units short per order cycle:

E (n) E ( z ) dLT
E ( z ) Standardized number of units short from Table 11.3
dLT standard deviation of demand during lead time

Example

Suppose the standard deviation of demand during

lead time is known to be 50 units. Lead time
demand is approximately normal.

For the lead time service level of 95%, determine

the expected number of units short for any order
cycle.
What lead time service level would an expected
shortage of 3 units imply?

Shortages per year

Expected number of units short per year =
(Expected number of units short per cycle) *( Number of cycles)

D
E ( N ) E ( n)
Q

Example

Given the following information, determine the expected

number of units short per year.

Demand = 48,000 units per year

Order quantity (Q) = 1,200 units
Service level for the lead time = 90%
Std. of demand during lead time = 150 units

How the expected number of units short would change, if

the service level is increases from 90% to 99%?

Annual service level (fill rate)

Annual service level (fill rate) is the percentage of demand

filled directly from inventory.

Example
Demand = 100 units/year,
Annual shortage = 10 units
Annual service level = 90/100 = 90%

General formula:

SLannual

E( N )
1
D

Example

Given

A lead time service level of 85%

D = 48,000
Q = 1,200
Std. of demand during lead time = 150

Determine the annual service level

Problem

The manager of a store that sells office supplies has decided to

set an annual service level of 96% for a certain model of
answering machine. The store sells approximately 300 of this
model a year. Holding cost is $5 per unit annually. Ordering cost
is $25, and the standard deviation of demand during lead time is
7.

What average number of units short per year will be consistent with the
specified annual service level?

What average number of units short per cycle will provide the desired
annual service level?

What lead time service level is necessary for the 96% annual service
level?

Fixed-Order-Interval (FOI) Model

In EOQ/ROP, order size is fixed and time to

reorder varies.

In FOI model, orders are placed at fixed time

intervals (weekly, monthly, etc.)

Order quantity for next interval?

If demand is variable, order size may vary from

cycle to cycle

Reasons for using FOI model

Suppliers might encourage fixed intervals

May require only periodic checks of inventory

levels

Risk of stockout

FOI must have stockout protection for lead time

plus the next order cycle

Fixed-Order-Interval Model

Expected demand
Amount
Safety
Amount on hand
= during protection +

to order
stock
at reorder time
interval

= d (OI LT ) + z d OI LT

Where

OI = Order interval (length of time between orders)

A = Amount on hand at reorder time

Example

A lab orders a number of chemicals from the same supplier

every 30 days. Lead time is 5 days. The assistant manager of the
lab must determine how much of one of these chemicals to
order. A check of stock revealed that eleven 25-ml jars are on
hand. Daily usage of the chemicals is approximately normal
with a mean of 15.2 ml per day and a standard deviation of 1.6
ml per day. The desired service level for this chemical is 95%.

How many jars of the chemical should be ordered?

What is the average amount of safety stock of the chemicals?

Single Period Model

Single period model: model for ordering of

perishables (vegetables, milk, ) and other
items with limited useful lives

Shortage cost: generally the unrealized

profits per unit

Excess cost: difference between purchase

cost and salvage value of items left over at
the end of a period

Example: Uniform distribution

Sweet potatoes are delivered weekly to Caspian restaurant.

Demand varies uniformly between 30 to 50 pounds per week.
Caspian pay 25 cents per pound for potatoes and charges 75
cent per pound for it as a side dish. Unsold potatoes have no
salvage value can cannot be carried over into the next week.
Find

The optimal stocking level.

Its stockout risk.

Example: Normal distribution

Caspian restaurant also serves apple juice. Demand for the juice
is approximately normal with a mean of 35 liters per week and
std of 6 liters per week. If shortage cost is 50 cents and excess
cost is 25 cents per liter, find

The optimal stocking level.

Its stockout risk.

Example: Discrete distribution

A newsboy can buy the Wall Street Journal newspaper for 20
cents and sell them for 75 cents.

If he buys more paper he can sell, he disposes of the excess

at no additional cost.
If he does not buy enough paper, he loses potential sales

For simplicity, we assume that the demand distribution is

P{demand = 0} = 0.1

P{demand = 1} = 0.3

P{demand = 2} = 0.4

P{demand = 3} = 0.2

Problem

Skinners Fish Market buys fresh Boston blue fish daily for
$4.20 per pound and sells it for $5.70 per pound. At the end of
each business day, any remaining blue fish is sold to a producer
of cat food for $2.40 per pound. Daily demand can be
approximated by a normal distribution with a mean of 80
pounds and a standard deviation of 10 pounds. What is the
optimal stocking level?

Problem

Burger Prince buys top-grade ground beef for $1.00 per pound.
A large sign over the entrance guarantees that the meat is fresh
daily. Any leftover meat is sold to the local high school
cafeteria for 80 cents per pound. Four hamburgers can be
prepared from each pound of meat. Burgers sell for 60 cents
each. Labor, overhead, meat, buns, and condiments cost 50
cents per burger. Demand is normally distributed with a mean
of 400 pounds per day and a standard deviation of 50 pounds
per day.

What daily order quantity is optimal?

Single Period Model

Continuous stocking levels

Identifies optimal stocking levels

Optimal stocking level balances unit shortage

and excess cost

Discrete stocking levels

Service levels are discrete rather than

continuous

Desired service level is equaled or exceeded