IE 457 Management of Business Logistics

Prepared by
Dr. Siraj Zahran
Inventory • Inventory is one of the most expensive assets of
many companies.

• A “typical” firm has roughly 30% of its current

assets and as much as 90% of its working
capital invested in inventory.
Inventory
• A firm can reduce costs by
reducing inventory.

• On the other hand, production

may stop and customers
become dissatisfied when an
item is out of stock.
Inventory

Inventories are a vital part

of business:

➢necessary for operations

➢contribute to customer
satisfaction
 Refers to the raw materials used in
Inventory in production, and the semi-finished goods in
Manufacturing the warehouse or on the factory floor as
well as the goods produced that are
available for sale.
Inventory in Service
Industry
Includes the steps involved
before completing a sale.
Example:
• For a research consultancy firm, inventory consists of all
the information collected for a project.
• In the hotel industry, a vacant room is inventory for the
owner.
Inventory
Independent demand
items

• Items that are ready to be sold or

used.
• They are those whose demand is
ultimately determined by the
market.

Dependent demand
items

• Items whose demand depends on

the demand for other items.
Stock
In practice, there are
always and when
materials stop moving,
they form .
Examples of Stocks 9

A shop that stocks goods for customers to look at.

A chef with stocks of ingredients in the pantry.

A market research company with stocks of

information in a database.
Definitions 10

• are supplies of goods and materials

that are held by an organization.
STOCKS • They are formed whenever the organization's inputs or
outputs are not used at the time they become
available.

INVENTORY • is a list of things held in stock.

 11
Reasons for Holding Stocks

• The main purpose of is to act as

a buffer between supply and demand.

• They allow to continue

smoothly and avoid disruptions.
Reasons for Holding Stocks

✓Act as a buffer between different parts

of the supply chain.

✓Allow for demands that are larger than

expected, or at unexpected times.

✓Allow for deliveries that are delayed or

too small.
Reasons for Holding Stocks

✓Take advantage of price discounts on

large orders.

✓Give cover for emergencies.

✓Allow for seasonal operations.

✓Make full loads and reduce transport

costs.
Reasons for Holding Stocks

✓Allow the purchase of items that are

going out of production or are difficult
to find.

✓Allow the purchase of items when the

price is low and expected to rise.

✓Can be profitable when inflation is high.

 Inventory Management Definition

Inventory management refers to the process of ordering, storing,

using, and selling a company's inventory. This includes the
management of raw materials, components, and finished products,
as well as warehousing and processing of such items.
Investopedia
Inventory 16
Management
Inventory management is
a step in the supply chain
where inventory and stock
quantities are tracked in
and out of your
warehouse.
 Inventory Management Objective

The of inventory You can never

management is to strike a achieve a low-cost

balance between inventory strategy without

good inventory
investment and customer
management.
service.
Types of Inventory
Raw materials

•the materials, parts and components that have been

delivered to an organisation, but are not yet being used.

Work in process

•materials that have started, but not yet finished their

journey through the production process.

Finished goods

•goods that have finished the process and are waiting to

be shipped out to customers.

Spare parts

•for machinery, equipment, and so on

Consumables

•such as oil, fuel, paper, and so on.

Types of Inventory
Key Benefits of Effective
Inventory Management
Inventory tracking
• Know exactly where inventory is across the
supply chain.

Order management
• Customize pricing, send quotes, track orders and
manage returns.

Transfer management
• Move product to where it's most valuable.
Key Benefits of Effective
Inventory Management
Reporting and analytics
• Evaluate patterns in processes to forecast future
demand and sales.

Purchasing
• Create and manage purchase orders.

Shipping capabilities
• Automate shipping to reduce errors such as late
deliveries or delivering incorrect packages.
Managing Inventory

Management has two basic functions

concerning inventory:

Establish a system for tracking items in

inventory.

Make decisions about When to order,

and How much to order.
Effective Inventory Management 23

Requires:

A system keep track of A reliable forecast of

inventory demand

Reasonable estimates of
Knowledge of lead time • Holding costs
and lead time variability • Ordering costs
• Shortage costs

A classification system
for inventory items
Inventory Costs
Purchase (unit)
cost

Holding
(carrying) costs

Ordering costs

Setup costs

Shortage costs
 Purchase (Unit) Cost

The price for an item charged by the

supplier, or the cost to the organization
of acquiring one unit of the item.

The cost of production/product if a

company makes the item itself.
 Holding (Carrying) Cost
The cost of holding one unit of an item in stock for a
unit period of time.

The obvious cost is tied-up money.

• This is either borrowed (in which case there are interest payments) or it is cash that
could be put to other uses (in which case there are opportunity costs).

Other holding costs are

• storage space, loss, handling, special treatment (such as refrigeration and insurance),
obsolescence (which refers to stock that has been kept in storage so long that it has little
or no value).
Holding (Carrying) Cost
 Ordering/Setup Cost
The cost of placing a repeat order for an item
or setting up a machine.

This might include

• allowances for preparing an order, receiving, unloading, checking, testing, use of
equipment and follow-up, quality control, transport, sorting and movement of received
goods.

In practice, the best estimate for a order cost often comes from
dividing the total annual cost of the purchasing department by
the number of orders it sends out.
 Shortage Cost
It occurs when an item is needed but it
cannot be supplied from stock.

In the simplest case a retailer loses direct

profit from a sale.

The effects of shortages include

• lost goodwill, loss of reputation, loss of potential future sales, and
payments for positive action to remedy the shortage (such as
expediting orders, sending out emergency orders, paying for
special deliveries, or using more expensive suppliers).
Calculating Reorder and Holding Costs 30
Example
Janet Long is a purchasing clerk at Overton Travel Group. She
earns £16,000 a year, with other employment costs of £3,000, and
has a budget of £6,200 for telephone, communications, stationery
and postage. In a typical month Janet places 100 orders. When
goods arrive there is an inspection that costs about £15 an order.
The cost of borrowing money is 9%, the obsolescence rate is 5%
and insurance and other costs average 4%. How can Overton
estimate their reorder and holding costs?
Calculating Reorder and Holding Costs 31
Example
1. The total number of orders a year is 12 × 100 = 1,200 orders.

2. The reorder cost includes all costs that occur for an order. These
are:
a) salary = £16,000/1,200 = £13.33 an order
b) employment costs = £3,000/1,200 = £2.50 an order
c) expenses = £6200/1,200 = £5.17 an order
d) inspection = £15 an order

So, the reorder cost is 13.33 + 2.50 + 5.17 + 15 = £36 an order.

Calculating Reorder and Holding Costs 32
Example
1. Holding costs include all costs that occur for holding
stock. These are:
a) borrowing = 9%

b) obsolescence = 5%

c) insurance and taxes = 4%

So, the holding cost is 9 + 5 + 4 = 18% of inventory value a year.

 How inventory items can be
1
classified (called ABC analysis )
Systems for
Managing
Inventory
How accurate inventory records
2 can be maintained.
Inventory Counting
Systems
Periodic System

• Physical count of items in inventory made at

periodic intervals.

Perpetual Inventory System

• System that keeps track of removals from

inventory continuously, thus monitoring current
levels of each item.

• An order is placed when inventory drops to a

predetermined minimum level.
Demand Forecasts and Lead Time 35

Forecasts: Inventories are necessary to satisfy customer

demands, so it is important to have a reliable estimates of the
amount and timing of demand.

• Point-of-sale (POS) systems: A system that electronically

records actual sales.
• Such demand information is very useful for enhancing
forecasting and inventory management.

Lead time: Time interval between ordering and receiving the

order.
 ABC Analysis 36

A-B-C approach: Classifying

inventory according to some
measure of importance, and
allocating control efforts
accordingly.
 ABC Analysis 3

A items (very important)

• 10 to 20 percent of the number of items in

inventory and about 70 to 80 percent of the
annual dollar value.

B items (moderately important)

• 30 percent of the number of items in inventory and about

15 to 25 percent of the annual dollar value.

C items (least important)

• 50 to 60 percent of the number of items in

inventory but only about 5 to 15 percent of the
annual dollar value.
Policies that may be based
on ABC analysis include the
following:
Purchasing resources expended on supplier
development should be much higher for individual A items
than for C items.

A items, as opposed to B and C items, should have tighter

physical inventory control; perhaps they belong in a more
secure area, and perhaps the accuracy of inventory records
for A items should be verified more frequently.

Forecasting A items may warrant more care than

forecasting other items.
 Silicon Chips, Inc., maker of superfast DRAM
ABC chips, wants to categorize its 10 major inventory

Classification items using ABC analysis. The table in the next

example slide represents the item stock number, annual

volume, and unit cost for the items.
ABC Classification
example
Item stock Annual volume Unit cost
number (Units) ($)

10286 1,000 90.00

12572 600 14.17
14075 2,000 0.60
01307 1,200 0.42
01036 100 8.50
11526 500 154.00
12760 1,550 17.00
10867 350 42.86
10500 1,000 12.50
10572 250 0.60
 Step 1: Annual Volume × Unit Cost
Item Stock Annual Unit Cost Annual Dollar
Number Volume ($) Volume
(Units) ($)

10286 1,000 90.00 90,000

ABC 12572 600 14.17 8,502

ABC 14075 2,000 0.60 1,200
Classification
CLASSIFICATION 01307 1,200 0.42 504
example - 01036 100 8.50 850
EXAMPLE -
Solution 11526 500 154.00 77,000
SOLUTION 12760 1,550 17.00 26,350
10867 350 42.86 15,001
10500 1,000 12.50 12,500
10572 250 0.60 150

41
Step 2: Sort the data (largest to smallest) based on
Item Stock Annual Unit Cost Annual Dollar
Number Volume ($) Volume
(Units) ($)

10286 1,000 90.00 90,000

ABC 11526 500 154.00 77,000

ABC 12760 1,550 17.00 26,350
Classification
CLASSIFICATION 10867 350 42.86 15,001
example - 10500 1,000 12.50 12,500
EXAMPLE -
Solution 12572 600 14.17 8,502
SOLUTION 14075 2,000 0.60 1,200
01036 100 8.50 850
01307 1,200 0.42 504
10572 250 0.60 150

42
 Item Stock Annual Unit Cost Annual Dollar
Number Volume ($) Volume
(Units) ($)

10286 1,000 90.00 90,000

ABC 11526 500 154.00 77,000

ABC 12760 1,550 17.00 26,350
Classification
CLASSIFICATION 10867 350 42.86 15,001
example - 10500 1,000 12.50 12,500
EXAMPLE -
Solution 12572 600 14.17 8,502
SOLUTION 14075 2,000 0.60 1,200
01036 100 8.50 850
01307 1,200 0.42 504
10572 250 0.60 150
Total 232,057
Step 3: Calculate the Total Annual Dollar Volume 43
 Item Stock Annual Unit Cost Annual Dollar Percentage of
Number Volume ($) Volume Annual Dollar
(Units) ($) Volume (%)

10286 1,000 90.00 90,000 38.8

ABC 11526 500 154.00 77,000 33.2

ABC 12760 1,550 17.00 26,350 11.3
Classification
CLASSIFICATION 10867 350 42.86 15,001 6.4
example - 10500 1,000 12.50 12,500 5.4
EXAMPLE -
Solution 12572 600 14.17 8,502 3.7
SOLUTION 14075 2,000 0.60 1,200 0.5
01036 100 8.50 850 0.4
01307 1,200 0.42 504 0.2
10572 250 0.60 150 0.1

Total 232,057 100

Step 4: Calculate the percentage of the 44
Annual Dollar Volume
 Item Stock Annual Unit Cost Annual Dollar Percentage of
Number Volume ($) Volume Annual Dollar
(Units) ($) Volume (%)

10286 1,000 90.00 90,000 38.8 A

ABC 11526 500 154.00 77,000 33.2 72%
ABC 12760 1,550 17.00 26,350 11.3
Classification B
CLASSIFICATION 10867 350 42.86 15,001 6.4
23%
example - 10500 1,000 12.50 12,500 5.4
EXAMPLE -
Solution 12572 600 14.17 8,502 3.7
SOLUTION 14075 2,000 0.60 1,200 0.5
01036 100 8.50 850 0.4 C
5%
01307 1,200 0.42 504 0.2
10572 250 0.60 150 0.1

Total 232,057 100

Step 5: Categorize the items based on 45

the (%)
 Cycle Counting 46
Cycle counting (sampling
technique): A physical count of
(sample) items and verifying
the inventory records to ensure
the integrity of the system.

➢ Cycle counting management

➢ How much accuracy is needed?

A items: ± 0.2
B items: ± 1 percent
percent (frequently
(once a quarter)
once a month)

C items: ± 5 percent
(every 6 months)
 Cycle Counting 47

Cycle counting also has the

following advantages

Eliminates the shutdown and interruption of

production necessary for annual physical
inventories.

Eliminates annual inventory adjustments.

Allows the cause of the errors to be

identified and remedial action to be taken.

Maintains accurate inventory records.

 Cycle Counting 48

Steps
1.Classify the items to A, B and C
(Using ABC Analysis).

2.Identify the number of working

day per month.

3.Identify the number of items

that should be counted each
day.
 49

Cycle Counting example

Cole’s Trucks, Inc., a builder of high-quality

refuse trucks, has about 5,000 items in its
inventory. It wants to determine how many
items to cycle count each day.
 50

Cycle Counting example - solution

Step 1: Classify the items to A, B and C.

The firm determined that it has 500 A items,

1,750 B items, and 2,750 C items.
 51

Cycle Counting example - solution

Step 2: Identify the number of working day

A items B items C items

per month, and remember that •once a month •once a quarter • every 6 months

Company policy is to count all A items every month (every 20 working

days), all B items every quarter (every 60 working days), and all C
items every 6 months (every 120 working days)
 52

Cycle Counting example - solution

Step 3: Identify the number of items that

should be counted each day.
Item Number of Items The number of items that should be
Quantity Cycle Counting Policy
Class Counted Per Day
counted each day is equal to the
A 500 Each month (20 working days) 500/20 = 25/day
sum of items that should be counted
B 1,750 Each quarter (60 working days) 1,750/60 = 29/day per day from all categories.
Every 6 months (120 working
C 2,750 2,750/120 = 23/day
days)
* This daily audit of 77 items is much more
efficient and accurate than conducting a
Total 77/day massive inventory count once a year.
Economic order quantity models The basic economic order quantity model (EOQ)

identify the optimal order quantity by The economic production quantity model (EPQ)

minimizing the sum of annual costs The quantity discount model

that vary with order size and

When to order, and How much
frequency. to order

How Much to Order: EOQ Models

The basic EOQ model is used to find a fixed order quantity
that will minimize total annual inventory costs.

• Only one product is involved

• Annual demand requirements are known
• Demand is even throughout the year (constant)
Assumptions
• Lead time does not vary
• Each order is received in a single delivery
• There are no quantity discounts

Basic EOQ Model

 55

Basic EOQ
Model
Basic EOQ Model 56

Total Cost = Annual Holding Cost + Annual Ordering Cost

Q D
= H + S
2 Q
where
Q = Order quantity in units
H = Holding (carrying) cost per unit, usually per year
D = Demand, usually in units per year
S = Ordering cost per order
Annual Cost Basic EOQ Model 57

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)

 Basic EOQ Model 58

The total cost curve reaches its minimum where the carrying and
ordering costs are equal.

2𝐷𝑆
• 𝑬𝑶𝑸 =
𝐻

𝐷𝑒𝑚𝑎𝑛𝑑 𝐷
• 𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑶𝒓𝒅𝒆𝒓𝒔 = 𝑵 = =
𝑂𝑟𝑑𝑒𝑟 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑄∗

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

• 𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑻𝒊𝒎𝒆 𝒃𝒆𝒕𝒘𝒆𝒆𝒏 𝑶𝒓𝒅𝒆𝒓𝒔 = 𝑇 = 𝑁
 EOQ Example

Sharp, Inc., a company that markets painless hypodermic needles to hospitals,

would like to reduce its inventory cost by determining the optimal number of
hypodermic needles to obtain per order. The annual demand is 1,000 units; the
setup or ordering cost is $10 per order; and the holding cost per unit per year is
$0.50. If Sharp, Inc. has a 250-day working year, find the number of orders (N)
and the expected time between orders (T).
EOQ Example - solution
2𝐷𝑆 2 1,000 10
• 𝑬𝑶𝑸 = = = 200 𝑝𝑐
𝐻 0.5

𝑫𝒆𝒎𝒂𝒏𝒅 𝟏,𝟎𝟎𝟎
•𝑵= 𝑶𝒓𝒅𝒆𝒓 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚
= 𝟐𝟎𝟎
= 𝟓 𝒐𝒓𝒅𝒆𝒓𝒔/𝒚𝒆𝒂𝒓

𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝒘𝒐𝒓𝒌𝒊𝒏𝒈 𝒅𝒂𝒚𝒔 𝒑𝒆𝒓 𝒚𝒆𝒂𝒓 𝟐𝟓𝟎

•𝑻= = =
𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝒏𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝒐𝒓𝒅𝒆𝒓𝒔 𝟓

𝟓𝟎 𝒅𝒂𝒚𝒔 𝒃𝒆𝒕𝒘𝒆𝒆𝒏 𝒐𝒓𝒅𝒆𝒓𝒔

EOQ Example - solution
 EOQ Example

The annual demand for a certain item is 22,500. One unit of the product
costs $35.00, and the holding cost rate is 15% per year. Setup time to
produce a batch is 3.25 hours. The cost of equipment downtime during
setup plus associated labor is $200 per hour. Determine
A. the economic order quantity.
B. the total inventory cost for this case.
EOQ Example - solution

A. 𝑆 = 200 3.25 = $650, 𝐻 = 𝑖𝑐 = 0.15(35) = $5.25

2𝐷𝑆 2 22,500 650

𝑬𝑶𝑸 = = = 2,360 𝑝𝑐
𝐻 5.25

𝑄 𝐷 2,360 22,500
B. 𝑻𝑰𝑪 = 𝐻 2 + 𝑆 𝑄 = (5.25) 2
+ (650)
2,360
=

6,195 + 6,197 = $12,392

EOQ Example - solution
Economic Production Quantity (EPQ) is the

quantity of a product that should be manufactured in a

single batch so as to minimize the total cost that

includes setup costs for the machines and inventory

holding costs.

Economic Production Quantity (EPQ)

Assumptions

• Only one item is involved

• Annual demand requirements are known
• Usage rate is constant
• Usage occurs continually, but production occurs periodically
• The production rate is constant
• Lead time does not vary
• There are no quantity discounts

Economic Production Quantity (EPQ)

Economic Production Quantity (EPQ)
Economic Production Quantity (QP)

𝑸𝑷 =
𝟐𝑫𝑺 EPQ
𝑫
𝑯 𝟏−
𝑷

Cycle Length (T)

𝑸
𝑻=
𝑫
Production Run Length (Tp)

𝑸
𝑻𝑷 =
𝑷 EPQ
Demand Period Length (Td)

𝑸 𝑸
𝑻𝒅 = −
𝑫 𝑷
𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 Production Runs
(N)

𝑵=
𝑫𝒆𝒎𝒂𝒏𝒅
𝑬𝑷𝑸
=
𝑫
𝑸𝑷
EPQ
Maximum Inventory (Imax)

𝑫
𝑰𝒎𝒂𝒙 =𝑸 𝟏−
𝑷
EPQ Total Annual Cost

𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒔𝒕 = 𝑨𝒏𝒏𝒖𝒂𝒍 𝑷𝒓𝒐𝒅𝒖𝒄𝒕𝒊𝒐𝒏 𝑪𝒐𝒔𝒕 + 𝑨𝒏𝒏𝒖𝒂𝒍 𝑯𝒐𝒍𝒅𝒊𝒏𝒈 𝑪𝒐𝒔𝒕

𝑫 𝑸 𝑸𝑫
𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒔𝒕 = 𝑺 + 𝑯 −
𝑸 𝟐 𝟐𝑷
 EPQ Example

Nathan Manufacturing, Inc., makes and sells specialty hubcaps for the retail automobile
aftermarket. Nathan’s forecast for its wire-wheel hubcap is 1,000 units next year, with
an average daily demand of 4 units. However, the production process is most efficient at
8 units per day. So, the company produces 8 per day but uses only 4 per day. The setup
cost is equal to $10, and the holding cost is equal to $0.50 per unit per year. The
company wants to solve for the optimum number of units per order. (Note: This plant
schedules production of this hubcap only as needed, during the 250 days per year the
shop operates.)
EPQ Example - solution
𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑 = 𝐷 = 1,000 𝑢𝑛𝑖𝑡𝑠
𝑆𝑒𝑡𝑢𝑝 𝐶𝑜𝑠𝑡 = 𝑆 = $10
𝐻𝑜𝑙𝑑𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 = 𝐻 = $0.50
𝐷𝑎𝑖𝑙𝑦 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 = 𝑃 = 8 𝑢𝑛𝑖𝑡𝑠 𝑑𝑎𝑖𝑙𝑦 = 8 ∗ 250 = 2,000 𝑢𝑛𝑖𝑡𝑠/𝑦𝑒𝑎𝑟
𝐷𝑎𝑖𝑙𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 𝑟𝑎𝑡𝑒 = 𝐷 = 4 𝑢𝑛𝑖𝑡𝑠 𝑑𝑎𝑖𝑙𝑦 = 4 ∗ 250 = 1,000 𝑢𝑛𝑖𝑡𝑠/𝑦𝑒𝑎𝑟

𝟐𝑫𝑺 2(1,000)(10) 20,000

𝑸𝑷 = = =
𝑫 1,000 0.5 1/2
𝑯 𝟏−𝑷 0.5 1 − 2,000

= 282.8 𝑜𝑟 283 ℎ𝑢𝑏𝑐𝑎𝑝𝑠

Quantity Discount
Model
Quantity discount: price

reduction for larger orders

offered to customers to induce

them to buy in large quantities.

 Quantity Discount
Model
𝑻𝒐𝒕𝒂𝒍 𝒂𝒏𝒏𝒖𝒂𝒍 𝒄𝒐𝒔𝒕
= 𝑨𝒏𝒏𝒖𝒂𝒍 𝒔𝒆𝒕𝒖𝒑 𝒐𝒓𝒅𝒆𝒓𝒊𝒏𝒈 𝒄𝒐𝒔𝒕 + 𝑨𝒏𝒏𝒖𝒂𝒍 𝒉𝒐𝒍𝒅𝒊𝒏𝒈 𝒄𝒐𝒔𝒕 + 𝑨𝒏𝒏𝒖𝒂𝒍 𝒑𝒓𝒐𝒅𝒖𝒄𝒕 𝒄𝒐𝒔𝒕

𝑫 𝑸
𝑻𝑪 = 𝑺 + 𝑰𝑷 + 𝑷𝑫
𝑸 𝟐

IP = H
Where
Q = Quantity ordered
D = Annual demand in units
S = Setup or ordering cost per order
P = Price per unit
I = Holding cost per unit per year expressed as a percent of price P
 Quantity Discount
Model

The EOQ formula is modified for the

quantity discount problem as follows:

∗
𝟐𝑫𝑺
𝑬𝑶𝑸 = 𝑸 =
𝑰𝑷
To determine the quantity that
will minimize the total annual
inventory cost Quantity
• Step 1: identify all possible order quantities Discount
that could be the best solution. Model
• Step 2: calculate the total cost of all possible
best order quantities, and the least expensive
order quantity is selected.
 Quantity Discount Example

Chris Beehner Electronics stocks toy remote control flying drones.

Recently, the store has been offered a quantity discount schedule for
these drones. This quantity schedule was shown in the Table next slide.
Furthermore, setup cost is $200 per order, annual demand is 5,200 units,
and annual inventory carrying charge as a percent of cost, I , is 28%.
What order quantity will minimize the total inventory cost?
Quantity Discount Example

Quantity Price Per Unit

Price Range
Ordered (P)
Initial price 1 – 119 $ 100
Discount price 1 120 – 1,499 $ 98
Discount Price 2 1,500 and over $ 96
Quantity Discount
Example - solution
Quantity Price Per Unit
Price Range
Ordered (P)
Initial price 1 – 119 $ 100
Discount price 1 120 – 1,499 $ 98
Discount Price 2 1,500 and over $ 96

Step 1: Calculate Q* and check the feasibility

You need to start from the lowest price

𝟐𝑫𝑺 𝟐(𝟓, 𝟐𝟎𝟎)(𝟐𝟎𝟎)

𝑸∗$𝟗𝟔 = = = 𝟐𝟕𝟖 𝒇𝒍𝒚𝒊𝒏𝒈 𝒅𝒓𝒐𝒏𝒆𝒔 𝒑𝒆𝒓 𝒐𝒓𝒅𝒆𝒓
𝑰𝑷 𝟎. 𝟐𝟖(𝟗𝟔)

⇒ 𝟐𝟕𝟖 < 𝟏, 𝟓𝟎𝟎

⇒ 𝑻𝒉𝒊𝒔 𝑬𝑶𝑸 𝒊𝒔 𝒊𝒏𝒇𝒆𝒂𝒔𝒊𝒃𝒍𝒆 𝒇𝒐𝒓 $𝟗𝟔 𝒑𝒓𝒊𝒄𝒆.
Quantity Discount
Example - solution
Quantity Price Per Unit
Price Range
Ordered (P)
Initial price 1 – 119 $ 100
Discount price 1 120 – 1,499 $ 98
Discount Price 2 1,500 and over $ 96

Step 1: Calculate Q* and check the feasibility

You need to start from the lowest price

𝟐𝑫𝑺 𝟐(𝟓, 𝟐𝟎𝟎)(𝟐𝟎𝟎)

𝑸∗$𝟗𝟖 = = = 𝟐𝟕𝟓 𝒇𝒍𝒚𝒊𝒏𝒈 𝒅𝒓𝒐𝒏𝒆𝒔 𝒑𝒆𝒓 𝒐𝒓𝒅𝒆𝒓
𝑰𝑷 𝟎. 𝟐𝟖(𝟗𝟖)

⇒ 𝟏𝟐𝟎 < 𝟐𝟕𝟓 < 𝟏, 𝟒𝟗𝟗

⇒ 𝑻𝒉𝒊𝒔 𝑬𝑶𝑸 𝒊𝒔 𝒇𝒆𝒂𝒔𝒊𝒃𝒍𝒆 𝒇𝒐𝒓 $𝟗𝟖 𝒑𝒓𝒊𝒄𝒆.
Quantity Discount
Example - solution
Quantity Price Per Unit
Price Range
Ordered (P)
Initial price 1 – 119 $ 100
Discount price 1 120 – 1,499 $ 98
Discount Price 2 1,500 and over $ 96

Step 1: Calculate Q* and check the feasibility

You need to start from the lowest price

➔ Thus, the possible best order quantities are 275 (the first
feasible EOQ) and 1,500 (the price-break quantity for the
lower price of $96).
➔ We need not bother to compute Q* for the initial price of
$100 because we found a feasible EOQ for a lower price.
 Quantity Discount
Example - solution
Quantity Price Per Unit
Price Range
Ordered (P)
Initial price 1 – 119 $ 100
Discount price 1 120 – 1,499 $ 98
Discount Price 2 1,500 and over $ 96
Step 2: Compute the total cost for each of the
possible best order quantities using the TC
Equation.
𝑫 𝑸
𝑻𝑪 = 𝑺 + 𝑰𝑷 + 𝑷𝑫
𝑸 𝟐
Annual Annual Annual Total
Order Unit
Ordering Holding Product Annual
Quantity Price
Cost Cost Cost Cost
Because the total annual cost for 275 275 $ 98 $ 3,782 $ 3,773 $ 509,600 $ 517,155
units is lower, 275 units should be
ordered. 1,500 $ 96 $ 693 $ 20,160 $ 499,200 $ 520,053
 Simple inventory models assume that
receipt of an order is
instantaneous. In other words, they
assume

(1) A firm will place an

order when the (2) It will receive the
inventory level for that ordered items
particular item reaches immediately.
zero.

Reorder Point
 Reorder point (ROP): the
Reorder Point inventory level (point) at which
action is taken to replenish the
stocked item.
Lead Time

Lead time (LT) or delivery

time: the time between
placement and receipt of an
order.
• It can be as short as a few hours or as long as
months.
 87
Safety Stock
Safety stock: stock
that is held in excess
of expected demand
due to variable
demand and/or lead
time.
Reorder Point: Under lead time Certainty

𝑹𝑶𝑷 = 𝒅 × 𝑳𝑻
Where,
𝑑 = 𝐷𝑒𝑚𝑎𝑛𝑑 𝑝𝑒𝑟 𝑑𝑎𝑦
𝐿𝑇 = 𝐿𝑒𝑎𝑑 𝑡𝑖𝑚𝑒 𝑓𝑜𝑟 𝑎 𝑛𝑒𝑤 𝑜𝑟𝑑𝑒𝑟 𝑖𝑛 𝑑𝑎𝑦𝑠

This equation for ROP assumes that demand

during lead time and lead time itself are
constant.
Reorder Point: Under lead time
Uncertainty
𝑫
𝑫𝒆𝒎𝒂𝒏𝒅 𝒑𝒆𝒓 𝒅𝒂𝒚 = 𝒅 =
𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝒘𝒐𝒓𝒌𝒊𝒏𝒈 𝒅𝒂𝒚𝒔 𝒊𝒏 𝒂 𝒚𝒆𝒂𝒓

If lead time is uncertain, the equation for

ROP will be

𝑹𝑶𝑷 = 𝒅 × 𝑳𝑻 + 𝑺𝒂𝒇𝒆𝒕𝒚 𝑺𝒕𝒐𝒄𝒌

𝑺𝒂𝒇𝒆𝒕𝒚 𝑺𝒕𝒐𝒄𝒌 = 𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝒅𝒂𝒚𝒔 × 𝒅𝒂𝒊𝒍𝒚 𝒅𝒆𝒎𝒂𝒏𝒅
 Reorder Point Example

An Apple store has a demand (D) for 8,000 iPhones per year. The firm
operates a 250-day working year. On average, delivery of an order
takes 3 working days, but has been known to take as long as 4 days.
The store wants to calculate the reorder point without a safety stock
and then with a one-day safety stock.
Reorder Point Example -
solution

𝑫 𝟖, 𝟎𝟎𝟎
𝒅= =
𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝒘𝒐𝒓𝒌𝒊𝒏𝒈 𝒅𝒂𝒚𝒔 𝒊𝒏 𝒂 𝒚𝒆𝒂𝒓 𝟐𝟓𝟎
= 𝟑𝟐 𝒖𝒏𝒊𝒕𝒔

𝑹𝑶𝑷 = 𝒅 × 𝑳𝑻 = 𝟑𝟐 𝒖𝒏𝒊𝒕 𝒑𝒆𝒓 𝒅𝒂𝒚 × 𝟑 𝒅𝒂𝒚𝒔

= 𝟗𝟔 𝒖𝒏𝒊𝒕𝒔

𝑹𝑶𝑷 𝒘𝒊𝒕𝒉 𝑺𝑺 = 𝒅 × 𝑳𝑻 + 𝑺𝑺 = 𝟑𝟐 × 𝟑 + 𝟑𝟐
= 𝟏𝟐𝟖 𝒖𝒏𝒊𝒕𝒔
92