EFFICIENCY VS.

EFFECTIVENESS
Effective (Hiệu quả) - Đủ để hoàn thành một mục đích; tạo ra kết quả dự định hoặc dự kiến.

Efficient (Hiệu suất) - Thực hiện hoặc hoạt động theo cách tốt nhất có thể với ít lãng phí thời gian và công sức nhất.

ERP applications in planning and controlling

• ERP can support planning and controlling activities including material
management, schedule physical capabilities and people, internal and
external stakeholders’ coordination. It also helps managers to design
the supply chain system, develop a plan to meet supply and demand
objective by using up-to-date and reliable data. Furthermore,
organisational performance is also measured using data from ERP to
ensure the optimization and control the expenses.

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 Common ERP problems
• Purchasing
• Production planning
• Sales – Distribution
• Inventory management
• Warehousing management
• HRM
• Finance

Common problems in SCM

• Supply chain refers to processes that move information and material
to and from the manufacturing and service processes of the firm.
These include the logistics processes that physically move product
and the warehousing and the storage processes that position
products for quick delivery to the customers.
(Jacobs & Chase, 2013).

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Transportation problems
• Transportation problems received this name because many of their
applications involve determining how to transport goods optimally
(Hillier, F., & Hillier, M., 2013).
• In mathematics and economics, transportation problems refer to the
study of optimal transportation and allocation of resources.

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 Inventory problems
• The inventory control problems are problems faced by a firm that
must decide how much to order in each time period to meet demand
for its products.
• Typical questions include:
oHow much to store/order?
oWhen to place order?
oSize of each order?
oHow to classify inventory?

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Software applications for transportation and inventory

problems in SCM
• Managers usually search best solutions to optimize the enterprise’s
resources usage by implementing software applications in order to
integrate all business activities.
• Some of used software applications for transportation and inventory
problems in SCM are Excel Solver and QM for Windows.
• QM for Windows application assist managers to make decisions on
how to use resources best.

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 Introduction to Excel Solver application
• Solver is a Microsoft Excel add-in program you can use for what-if analysis.
Use Solver to find an optimal (maximum or minimum) value for a formula
in one cell — called the objective cell — subject to constraints, or limits, on
the values of other formula cells on a worksheet. Solver works with a group
of cells, called decision variables or simply variable cells that are used in
computing the formulas in the objective and constraint cells. Solver adjusts
the values in the decision variable cells to satisfy the limits on constraint
cells and produce the result you want for the objective cell (Microsoft,
2020).
• Put simply, you can use Solver to determine the maximum or minimum
value of one cell by changing other cells. For example, you can change the
amount of your projected advertising budget and see the effect on your
projected profit amount (Microsoft, 2020).
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Introduction to QM for Windows application

• POM-QM for Windows (also known as POM for Windows and QM for
Windows) is a Decision Science software package developed by
Prentice Hall (Howard J. Weiss, 2010).
• Free download at:
• https://qm-for-windows.software.informer.com
• https://wps.prenhall.com/bp_weiss_software_1/1/358/91664.cw/ind
ex.html

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 SOFTWARE APPLICATIONS IN TRANSPORTATION
Learning Objectives:
• Understand transportation problem characteristics
• Apply Solver and QM for Windows to solve transportation problems
• Understand the variation of transportation problems

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Characteristics of Transportation Problems

• Transportation problems in general are concerned (literally or
figuratively) with distributing any commodity from any group of
supply centers, called sources, to any group of receiving centers,
called destinations, in such a way as to minimize the total distribution
cost (F. Hillier & M. Hillier, 2013).

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 Characteristics of Transportation Problems
The Requirements Assumption
Each source has a fixed supply of units, where this entire supply
must be distributed to the destinations.
Each destination has a fixed demand for units, where this entire
demand must be received from the sources.
The Feasible Solutions Property
A transportation problem will have feasible solutions if and only
if the sum of its supplies equals the sum of its demands.

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Characteristics of Transportation Problems

The Cost Assumption
• The cost of distributing units from any particular source to any
particular destination is directly proportional to the number of
units distributed.
• This cost is just the unit cost of distribution times the number of
units distributed.

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 Characteristics of Transportation Problems
Terminology for a General Model in Transportation Problem
• Units of a commodity
• Sources
• Destinations
• Supply from a source
• Demand at a destination
• Cost per unit distributed from a source to a destination

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Characteristics of Transportation Problems

Variation of transportation problems
• Supply ≥ Demand (Case Study Metro Water)
• Supply ≤ Demand (Case Study Better Products Co.)
• Combination cannot be used for distributing units (Case study
Energetic)
• Unstable Demand between Min and Max Range (Case Study
Middletown)
• The objective is to maximize profit (Case Study Nifty Co.)

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Transportation problems (P&T case study)

• The P&T Company is a small family-owned business. It receives raw
vegetables, processes and cans them at its canneries, and then
distributes the canned goods for eventual sale. One of the company’s
main products is canned peas.
• The peas are prepared at three canneries (near Bellingham,
Washington; Eugene, Oregon; and Albert Lea, Minnesota) and then
shipped by truck to four distributing warehouses in the western
United States (Sacramento, California; Salt Lake City, Utah; Rapid City,
South Dakota; and Albuquerque, New Mexico).

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Transportation problems (P&T case study)

• The company’s current approach for many years, the company has used
the following strategy for determining how much output should be
shipped from each of the canneries to meet the needs of each of the
warehouses. Current shipping strategy are:
• Since the cannery in Bellingham is furthest from the warehouses, ship its output to
its nearest warehouse, namely, the one in Sacramento, with any surplus going to the
warehouse in Salt Lake City.
• Since the warehouse in Albuquerque is furthest from the canneries, have its nearest
cannery (the one in Albert Lea) ship its output to Albuquerque, with any surplus
going to the warehouse in Rapid City.
• Use the cannery in Eugene to supply the remaining needs of the
warehouses. For the upcoming harvest season, an estimate has been made
of the output from each cannery, and each warehouse has been allocated
a certain amount from the total supply of peas. This information is given in
Table 2.1.
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P&T current approach

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P&T CURRENT APPROACH

Table 2.1 – Shipping data for the P&T Co.

Cannery Output Warehouse Allocation

Bellingham 75 truckloads Sacramento 80 truckloads

Eugene 125 truckloads Salt Lake City 65 truckloads

Albert Lea 100 truckloads Rapid City 70 truckloads

Total 300 truckloads Albuquerque 85 truckloads

Total 300 truckloads

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From \ To Warehouse

Current Cannery Sacramento Salt Lake City Rapid City Albuquerque

Shipping Bellingham 75 0 0 0

Plan Eugene 5 65 55 0

Albert Lea 0 0 15 85

From \ To Warehouse

Cannery Sacramento Salt Lake City Rapid City Albuquerque

Shipping
Bellingham $464 $513 $654 $867
Cost per
Eugene 352 416 690 791 Truckload
Albert Lea 995 682 388 685

Total shipping cost = 75($464) + 5($352) + 65($416) + 55($690) + 15($388) + 85($685)

= $165,595

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QUESTIONS
They now are reexamining the current shipping strategy to
see if P&T Co. can develop a new shipping plan that would
reduce the total shipping cost to an absolute minimum.

1. If you were the CEO of the P&T Co., what do you concern in
this case study?

2. How do you solve this problem?

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P&T case study

The Requirements Assumption
• Each source has a fixed supply of units, where this entire supply must
be distributed to the destinations. Similarly, each destination has a fixed
demand for units, where this entire demand must be received from the
sources.
• This assumption that there is no leeway in the amounts to be sent or
received means that there needs to be a balance between the total supply
from all sources and the total demand at all destinations.

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P&T case study

The Feasible Solutions Property
• A transportation problem will have feasible solutions if and only if the
sum of its supplies equals the sum of its demands.

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P&T case study

The Model
• Any problem (whether involving transportation or not) fits the model
for a transportation problem if it
(a) can be described completely in terms of a table like Table 2.4
that identifies all the sources, destinations, supplies, demands, and unit
costs, and
(b) satisfies both the requirements assumption and the cost
assumption. The objective is to minimize the total cost of distributing
the units.

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P&T case study

The Unit cost Data for the P&T Co. Problem Formulated as a
Transportation Problem

From \ To Warehouse

Cannery Sacramento Salt Lake City Rapid City Albuquerque

Bellingham $464 $513 $654 $867

Eugene 352 416 690 791

Albert Lea 995 682 388 685

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Applying Excel Solver to Formulate and Solve

Transportation Problems
• The decisions to be made are the number of truckloads of peas to
ship from each cannery to each warehouse.
• The constraints on these decisions are that the total amount shipped
from each cannery must equal its output (the supply) and the total
amount received at each warehouse must equal its allocation (the
demand).
• The overall measure of performance is the total shipping cost, so the
objective is to minimize this quantity.

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The Network Representation of a Transportation Problems

distributing a product from
several sources or origins to several destinations

Figure 2.1 – Network Representation of a P&T Problem

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P&T case study

• The Transportation Problem is a linear programming problem to
demonstrate that the P&T Co. problem (or any other transportation
problem) is, in fact, a linear programming problem, let us formulate
its mathematical model in algebraic form.
• Let xij be the number of truckloads to be shipped from Cannery i to
Warehouse j for each i = 1, 2, 3 and j = 1, 2, 3, 4.
• The objective is to choose the values of these 12 decision variables
(the xij) so as to

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Minimize cost = 464x11 + 513x12 + 654x13 + 867x14 + 352x21 + 416x22 + 690x23 + 791x24 +
995x31 + 682x32 + 388x33 + 685x34,
subject to the constraints
x11 + x12 + x13 + x14 = 75

x21 + x22 + x23 + x24 = 125

x31 + x32 + x33 + x34 = 100
x11 + x21 x31 = 80
x12 + x22 + x32 = 65
x13 + x23 + x33 = 70
x14 + x24 + x34 = 85
and xij ≥ 0 (i = 1, 2, 3; j = 1, 2, 3, 4), xij is integer number

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INTEGER SOLUTIONS PROPERTY

As long as all its supplies and demands have integer values, any
transportation problem with feasible solutions is guaranteed to have an
optimal solution with integer values for all its decision variables.
Therefore, it is not necessary to add constraints to the model that
restrict these variables to only have integer values.
Before leaving this linear programming model though, take a good look
at the left-hand side of the functional constraints. Note that every
coefficient is either 0 (so the variable is deleted) or 1. Also note the
distinctive pattern for the locations of the coefficients of 1, including the
fact that each variable has a coefficient of 1 in exactly two constraints.
These distinctive features of the coefficients play a key role in being able
to solve transportation problems extremely efficiently.
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Solving Transportation Problems

• Because transportation problems are a special type of linear
programming problem, they can be solved by the simplex method
(the procedure used by Solver to solve linear programming
problems). However, because of the very distinctive pattern of
coefficients in its functional constraints noted above, it is possible to
greatly streamline the simplex method to solve transportation
problems far more quickly.

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Solving Transportation Problems

• This streamlined version of the simplex method is called the
transportation simplex method. It sometimes can solve large
transportation problems more than 100 times faster than the regular
simplex method. However, it is only applicable to transportation
problems.

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Applying Excel Solver and QM for Windows for the P&T

Co. problem
• Applying Excel Solver

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• Figure 2.2 – Excel Solver illustration for P&T

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• Figure 2.2 – Excel Solver illustration for P&T

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Applying Excel Solver and QM for Windows for the P&T

Co. problem
Applying QM for Windows
• Practice directly in QM for Windows
Step 1: Open QM  Modules  Transportation
Step 2: Define all sources and destinations
Step 3: Input data
Step 4: Click Solve

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Figure 2.3 – Create data set for the P&T Co. Transportation problem
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Figure 2.3 – Create data set for the P&T Co. Transportation problem
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Figure 2.4 – Input data for the P&T Co. Transportation problem
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Figure 2.4 – Input data for the P&T Co. Transportation problem
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Figure 2.5 – QM for Windows solution for P&T for the P&T Co.
Transportation problem
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A LESSON FROM P&T CASE STUDY

Type of transportation problem: Supply = Demand

Directly use the transportation module to solve problem.

This method is called transportation simplex model
 Applying solver as optimal solution is not an intuitive one

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Homework
• Use Solver and QM to solve the Texago 2 case study
• Sceenshot all steps (put in 1 PDF file) and upload it to LMS
• Deadline: at 17:00 the day before the next class

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Transportation problem (Cont.)

• Solution for Texago 2
• Question: Calculate
oTotal shipping for crude oil with each potential choice off a site
and for the new refinery?
oTotal shipping cost for finished product with each potential choice
of a site for the new refinery?

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QM for Windows solution for Texago 2a

Shipping to D.C.’s when choose Los Angeles

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QM for Windows solution for Texago 2b

Shipping to D.C.’s when choose Galveston

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QM for Windows solution for Texago 2c

Shipping to D.C.’s when choose St. Louis

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VARIATION OF TRANSPORTATION PROBLEMS

Learning objectives:
• Understand variation of transportation problems
• Enable to solve the transportation problems in Solver and QM for
windows
Variation of transportation problems
• Supply ≠ Demand (Metro Water, Better Products Co.)
• Combination cannot be used for distributing units (Case study
Energetic)
• Assignment (Case Study Better Products Co.)
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VARIATION OF TRANSPORTATION PROBLEMS

Supply ≠ Demand (Metro Water, Better Products Co.)
• Metro Water District is an agency that administers water distribution
in a large geographic region. The region is fairly arid, so the district
must purchase and bring in water from outside the region.
• The sources of this imported water are the Colombo, Sacron, and
Calorie rivers. The district then resells the water to users in its region.
Its main customers are the water departments of the cities of Berdoo,
Los Devils, San Go, and Hollyglass.

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VARIATION OF TRANSPORTATION PROBLEMS

Supply ≠ Demand (Metro Water, Better Products Co.)
• It is possible to supply any of these cities with water brought in from any of
the three rivers, with the exception that no provision has been made to
supply Hollyglass with Calorie River water. However, because of the
geographic layouts of the aqueducts and the cities in the region, the cost
to the district of supplying water depends upon both the source of the
water and the city being supplied.
• The variable cost per acre foot of water for each combination of river and
city is given in Table 3.1 Using units of 1 million-acre feet, the bottom row
of the table shows the amount of water needed by each city in the coming
year (a total of 12.5). The rightmost column shows the amount available
from each river (a total of 16).

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VARIATION OF TRANSPORTATION PROBLEMS

Supply ≠ Demand (Metro Water, Better Products Co.)
• Since the total amount available exceeds the total amount needed,
management wants to determine how much water to take from each
river, and then how much to send from each river to each city. The
objective is to minimize the total cost of meeting the needs of the
four cities.

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VARIATION OF TRANSPORTATION PROBLEMS

Supply ≠ Demand (Metro Water)
• Table 3.1 – Water Resources Data for Metro Water District

Cost Per Acre Foot

To
From Berdoo Los Devils San Go Hollyglass Available

Colombo $160 $130 $220 170 5

River
Sacron River $140 $130 190 150 6
Calorie River $190 $200 230 - 5
Needed 2 5 4 1.5 (million acre feet)
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VARIATION OF TRANSPORTATION PROBLEMS

Combination cannot be used for distributing units (Case study Energetic)
• The Energetic Company needs to make plans for the energy systems for a
new building.
• The energy needs in the building fall into three categories: (1) electricity,
(2) heating water, and (3) heating space in the building. The daily
requirements for these three categories (all measured in the same units)
are 20 units, 10 units, and 30 units, respectively.
• The three possible sources of energy to meet these needs are electricity,
natural gas, and a solar heating unit that can be installed on the roof. The
size of the roof limits the largest possible solar heater to providing 30 units
per day. However, there is no limit to the amount of electricity and natural
gas available.

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VARIATION OF TRANSPORTATION PROBLEMS

Combination cannot be used for distributing units (Case study
Energetic)
• Electricity needs can be met only by purchasing electricity. Both other
energy needs (water heating and space heating) can be met by any of
the three sources of energy or a combination thereof.
• The unit costs for meeting these energy needs from these sources of
energy are shown in Table 3.2 below. The objectives of management
are to minimize the total cost of meeting all the energy needs.

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VARIATION OF TRANSPORTATION PROBLEMS

Combination cannot be used for distributing units (Case study
Energetic)
• Table 3.2 – Cost data for the Energetic Co. Problem
Unit Cost
Need
Electricity Water Heating Space heating
Source
Electricity $400 $500 $600
Natural Gas ⁃ $600 $500
Solar Heater ⁃ $300 $400
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Solution for Case Study Better Products Co.

VARIATION OF TRANSPORTATION PROBLEMS (cont.)
• Unstable Demand between Min and Max Range (Case Study
Middletown)
• The objective is to maximize profit (Case Study Nifty Co.)

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Solution for Case Study Better Products Co.

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Different variation of transportation problems

• Supply ≥ Demand (Case Study Metro Water)
• Supply ≤ Demand (Case Study Better Products Co.)
• Combination cannot be used for distributing units (Case study
Energetic)
• Unstable Demand between Min and Max Range (Case Study
Middletown)
• The objective is to maximize profit (Case Study Nifty Co.)

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VARIATION OF TRANSPORTATION PROBLEMS

Unstable Demand between Min and Max Range (Case Study
Middletown)
• The Middletown School District is opening a third high school and
thus needs to redraw the boundaries for the areas of the city that will
be assigned to the respective schools.
• For the preliminary planning, the city has been divided into nine
tracts with approximately equal populations. (Subsequent detailed
planning will divide the city further into over 100 smaller tracts.)

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VARIATION OF TRANSPORTATION PROBLEMS

Unstable Demand between Min and Max Range (Case Study
Middletown)
• The school district management has decided that the appropriate
objective in setting school attendance zone boundaries is to minimize
the average distance that students must travel to school.
• The unit costs for meeting these energy needs from these sources of
energy are shown in
Table 3.3. The objective of management is to minimize the total cost
of meeting all the energy
needs.

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VARIATION OF TRANSPORTATION PROBLEMS

Unstable Demand between Min and Max Range (Case Study
Middletown)
• Table 3.3 – Data for the Middletown school district problem
Distance (Miles) to School Number of High
Tract
1 2 3 School students
1 2.2 1.9 2.5 500
2 1.4 1.3 1.7 400
3 0.5 1.8 1.1 450
4 1.2 0.3 2.0 400
5 0.9 0.7 1.0 500
6 1.1 1.6 0.6 450
7 2.7 0.7 1.5 450
8 1.8 1.2 0.8 400
9 1.5 1.7 0.7 500
Minimum enrollment 1,200 1,100 1,000
Maximum enrollment 1,800 1,700 1,500 68

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VARIATION OF TRANSPORTATION PROBLEMS

The objective is to maximize profit (Case Study Nifty Co.)
• The Nifty Company specializes in the production of a single product,
which it produces in three plants. The product is doing very well, so
the company currently is receiving more purchase requests than it
can fill. Plans have been made to open an additional plant, but it will
not be ready until next year.
• For the coming month, four potential customers (wholesalers) in
different parts of the country would like to make major purchases.
Customer 1 is the company’s best customer, so his full order will be
met. Customers 2 and 3 also are valued customers, so the marketing
manager has decided that, at a minimum, at least a third of their
order quantities should be met. However, she does not feel that
Customer 4 warrants special consideration, and so is unwilling to
guarantee any minimum amount for this customer.
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VARIATION OF TRANSPORTATION PROBLEMS

The objective is to maximize profit (Case Study Nifty Co.)
• There will be enough units produced to go somewhat above these minimum
amounts. Due largely to substantial variations in shipping costs, the net profit
that would be earned on each unit sold varies greatly, depending on which
plant is supplying which customer. Therefore, the final decision on how much
to send to each customer (above the minimum amounts established by the
marketing manager) will be based on maximizing profit.
• The unit profit for each combination of a plant supplying a customer is shown
in Table 3.4. The rightmost column gives the number of units that each plant
will produce for the coming month (a total of 20,000). The bottom row shows
the order quantities that have been requested by the customers (a total of
30,000). The next-to-last row gives the minimum amounts that will be
provided (a total of 12,000), based on the marketing manager’s decisions
described above.
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VARIATION OF TRANSPORTATION PROBLEMS

The objective is to maximize profit (Case Study Nifty Co.)
• The marketing manager needs to determine how many units to sell to each
customer (observing these minimum amounts) and how many units to ship
from each plant to each customer to maximize profit.
• This problem is almost a transportation problem, since the plants can be
viewed as sources and the customers as destinations, where the production
quantities are the supplies from the sources.
• If this were fully a transportation problem, the purchase quantities would be
the demands for the destinations. However, this does not work here because
the requirements assumption says that the demand must be a fixed quantity
to be received from the sources.

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VARIATION OF TRANSPORTATION PROBLEMS

The objective is to maximize profit (Case Study Nifty Co.)
• Except for Customer 1, all we have here are ranges for the purchase quantities
between the minimum and the maximum given in the last two rows of Table
3.4 below. In fact, one objective is to solve for the most desirable values of
these purchase quantities.
• The marketing manager needs to determine how many units to sell to each
customer (observing these minimum amounts) and how many units to ship
from each plant to each customer to maximize profit.

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VARIATION OF TRANSPORTATION PROBLEMS

The objective is to maximize profit (Case Study Nifty Co.)
• Table 3.4 – Data for the Nifty Co. Problem
Unit profit
Customer Production
Plant 1 2 3 4
quantity
1 55 42 46 53 8,000
2 37 18 32 48 5,000
3 29 59 51 35 7,000
Minimum purchase 7,000 3,000 2,000 0

Requested purchase 7,000 9,000 6,000 8,000

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Glossary of Transportation
• Assignees: The entities (people, machines, vehicles, plants, etc.) that
are to perform the tasks when formulating a problem as an
assignment problem.
• Cost table: The table that summarizes the formulation of an
assignment problem by giving the cost for each possible assignment
of an assignee to a task.
• Demand at a destination: The number of units that need to be
received by this destination from
the sources.

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Glossary of Transportation
• Destinations: The receiving centers for a transportation problem.
• Hungarian method: An algorithm designed specifically to solve
assignment problems very
efficiently.
• Network simplex method: A streamlined version of the simplex
method for solving distribution network problems, including
transportation and assignment problems, very efficiently.
• Sources: The supply centers for a transportation problem.

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Glossary of Transportation
• Supply from a source: The number of units to be distributed from
this source to the destinations.
• Tasks: The jobs to be performed by the assignees when formulating a
problem as an assignment
problem.
• Transportation simplex method: A streamlined version of the
simplex method for solving
transportation problems very efficiently.

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SOFTWARE APPLICATIONS IN INVENTORY

MANAGEMENT
• Introduction to Inventory
• Cost Components of Inventory Models
• The Basic Economic Order Quantity (EOQ) Model
• Case study: The Atlantic coast tire corp. (ACT) problem

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SOFTWARE APPLICATIONS IN INVENTORY

MANAGEMENT
Learning Objectives:
After studying this topic, you are being able to:
• Identify the cost components of inventory models
• Describe the basic economic order quantity (EOQ) model
• Use a square root formula to obtain the optimal order quantity for
this model
• Use Excel Solver and QM for windows software to solve different
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inventory problems

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Introduction to Inventory Management

• It isn’t just retail stores that must manage inventories. In fact,
inventories pervade the business world. Maintaining inventories is
necessary for any company dealing with physical products, including
manufacturers, wholesalers, and retailers.
• For example, manufacturers need inventories of the materials
required to make their products. They also need inventories of the
finished products awaiting shipment. Similarly, both wholesalers and
retailers need to maintain inventories of goods to be available for
purchase by customers.

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Introduction to Inventory Management

• Managers use scientific inventory management comprising the
following steps:
a. Formulate a mathematical model describing the behavior of
the inventory system.
b. Seek an optimal inventory policy with respect to this model.
c. Use a computerized information processing system to maintain
a record of the current inventory levels.
d. Using this record of current inventory levels, apply the optimal
inventory policy to signal when and how much to replenish inventory.

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Cost Components of Inventory Models

• Acquisition cost: The direct cost of replenishing inventory, whether
through purchasing or manufacturing of the product.
Notation: c = unit acquisition cost.
• Setup cost: The setup cost to initiate the replenishing of inventory,
whether through purchasing or manufacturing of the product.
Notation: K = setup cost.

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Cost Components of Inventory Models

• Holding cost: The cost of holding units in inventory
Notation: h = annual holding cost per unit held = unit holding
cost.
• Shortage cost: The cost of having a shortage of units, i.e., of needing
units from inventory when there are none there.
Notation: p = annual shortage cost per unit short = unit shortage
cost.

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Cost Components of Inventory Models

• Combining of these cost components:
Annual acquisition cost = c times number of units added to inventory
per year.
Annual setup cost = K times number of setups per year.
Annual holding cost = h times average number of units in inventory
throughout a year.
Annual shortage cost = p times average number of units short
throughout a year.

costs. TC = total inventory cost per year = sum of the above four annual
TVC = total variable inventory cost per year = sum of the variable
annual costs.

83

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The Basic Economic Order Quantity (EOQ) Model

Where the Model is applicable
• A constant demand rate.
• The order quantity to replenish inventory arrives all at once just when
desired.
• Planned shortages are not allowed.
Reorder point = (daily demand) x (lead time).
𝐴𝑛𝑛𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑 𝑟𝑎𝑡𝑒
Daily demand 𝑡𝑜𝑡𝑎𝑙 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
=

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The Basic Economic Order Quantity (EOQ) Model

• Annual demand rate (denoted as D): number of units being
withdrawn from inventory per year
• Lead time: The amount of time between the placement of an order
and its receipt
• Reorder point: inventory level when placing an order

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The Basic Economic Order Quantity (EOQ) Model

• Figure 4.1 – The pattern of inventory levels over time for a product
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The Basic Economic Order Quantity (EOQ) Model

The Objective of the Model
• Since the model assumes that the order arrives at the same moment
that the inventory level drops to 0, this delivery immediately jumps
the inventory level up from 0 to Q. With the constant demand rate,
the inventory level then gradually drops down over time at this rate
until the level reaches 0 again, at which point the process is repeated.
This saw-toothed pattern is depicted in Figure 4.2. The pattern is the
same as in Figure 4.1, where Q = 1,000, but now we want to choose
the best value of Q.

87

87

The Basic Economic Order Quantity (EOQ) Model

• Figure 4.2 – The pattern of inventory levels over time assumed by the basic
EOQ model
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The Basic Economic Order Quantity (EOQ) Model

• The specific objective in choosing Q is to
Minimize TVC = total variable inventory cost per year.
• TVC excludes the cost of the product, since this is a fixed cost. TVC also does not
include any shortage costs, since the model assumes that shortages never occur.
Therefore,
TVC = annual setup cost + annual holding cost,
where
Annual setup cost = K times number of setups per year,
Annual holding cost = h times average inventory level.
As described in the preceding section,
K = setup cost each time an order occurs,
h = unit holding cost.
89

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The Basic Economic Order Quantity (EOQ) Model

• For any inventory system fitting the basic EOQ model, here are some
key formulas.
Number of setups per year 𝑎𝑛𝑛𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑 𝑟𝑎𝑡𝑒 = 𝐷.
= 𝑜𝑟𝑑𝑒𝑟 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑄

Average inventory level 𝑚𝑎𝑥𝑖𝑚𝑢𝑚 𝑙𝑒𝑣𝑒𝑙 + 𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑙𝑒𝑣𝑒𝑙

= 2
𝑄 + 0 𝑄
= =
Total variable cost (TVC) = annual setup2cost + annual holding cost =
2
𝐷 𝑄

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𝐾 +ℎ
𝑄 2

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The Basic Economic Order Quantity (EOQ) Model

• The value of Q which gives the minimum value on the TVC curve is
the optimal order quantity Q*, when annual holding cost is equal to
annual setup cost
Annual holding cost = Annual setup cost.
𝑄 𝐷
ℎ =𝐾
2 𝑄

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The Basic Economic Order Quantity (EOQ) Model

• This yields the following formula for Q* (The Square Root Formula for
the Optimal Order Quantity)
2𝐾𝐷 ℎ
𝑄 =
∗

Where
D = annual demand rate,
K = setup cost,
h = unit holding cost.

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Case study: The Atlantic coast tire corp. (ACT) problem

Figure 4.3 – The pattern of inventory levels over time for the 185/70
R13 Eversafe tire under ACT’s current inventory policy
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Case study: The Atlantic coast tire corp. (ACT) problem

Read the case study on LMS

Questions:
• When a wholesaler (like ACT) places an order for goods, what can
cause the cost to exceed the purchase price?
• What are cost components of ACT inventory model?

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The optimal inventory policy for the basic EOQ model of

ACT
The Square Root Formula for the Optimal Order Quantity
Number of setups per year = annual demand rate / order quantity = D/Q
Average inventory level = (maximum level + minimum level)/2
TVC (Total Variable Cost) = annual setup cost + annual holding cost
2𝐾𝐷 ℎ
𝑄 ∗=

Q*: the optimal order quantity

D = annual demand rate, K = setup cost,
h = unit holding cost.
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The current inventory policy of ACT

Figure 4.4 – A spreadsheet formulation of the basic EOQ model for the ACT problem when using the
current order quantity of Q = 1,000
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Applying Excel Solver to formulate and solve the basic

EOQ model

• Figure 4.5 – Excel Solver solution

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Applying QM for Windows to formulate and solve the

basic EOQ model
• Step 1: Create data set for ACT
• Step 2: Input data for ACT on QM
• Step 3: QM for Windows solution

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Applying QM for Windows to formulate and solve the

basic EOQ model

Figure 4.6 – Data settings in QM for Windows 99

99

Applying QM for Windows to formulate and solve the

basic EOQ model

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Figure 4.7 – Input data in QM for Windows

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Applying QM for Windows to formulate and solve the

basic EOQ model

101
Figure 4.7 – Input data in QM for Windows
101

Applying QM for Windows to formulate and solve the

basic EOQ model

Figure 4.8 – QM for Windows solution 102

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Applying QM for Windows to formulate and solve the

basic EOQ model

Figure 4.8 – QM for Windows

103
solution

103

VARIATION OF EOQ MODEL IN INVENTORY

MANAGEMENT
• VARIATION OF EOQ MODEL IN INVENTORY MANAGEMENT
• The EOQ model with Planned Shortages (ACT Co.)
• The EOQ Model with Quantity Discounts (ACT Co.)
• The EOQ Model with Gradual Replenishment (SOCA)

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VARIATION OF EOQ MODEL IN INVENTORY

MANAGEMENT
Learning objectives
• Understand variation of inventory problems
• Enable to solve the inventory problems in Solver and QM for windows

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Different variants of Inventory problems

The EOQ model with Planned Shortages
This model is a variation of the basic EOQ model described in the
preceding two sections. The difference arises in the third of its key
assumptions (Planned shortages are allowed):

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The EOQ model with Planned Shortages

Assumptions
• A constant demand rate.
• The order quantity to replenish inventory arrives all at once just when
desired.
• Planned shortages are allowed. When a shortage occurs, the affected
customers will wait for the product to become available again. Their
backorders are filled immediately when the order quantity arrives to
replenish inventory.

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107

The EOQ model with Planned Shortages

Assumptions
• A constant demand rate.
• The order quantity to replenish inventory arrives all at once just when
desired.
• Planned shortages are allowed. When a shortage occurs, the affected
customers will wait for the product to become available again. Their
backorders are filled immediately when the order quantity arrives to
replenish inventory.

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The EOQ model with Planned Shortages

Figure 5.1 – The pattern of inventory levels over time assumed by the EOQ model with planned
shortages, where both the order quantity Q and the maximum shortage S are the decision variables.
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109

The EOQ model with Planned Shortages

The Objective of the Model
• This model has two decision variables — the order quantity Q and the
maximum shortage S. The objective in choosing Q and S is to

Minimize TVC = total variable inventory cost per year.

• This TVC needs to include the same kinds of costs as for the basic
EOQ model plus the cost of incurring the shortages. Thus,

TVC = annual setup cost + annual holding cost + annual shortage cost.

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The EOQ model with Planned Shortages

As for the basic EOQ model,

𝐷
Annual Setup cost = 𝐾
𝑄

Annual holding cost = h times (average inventory level when positive)

times (fraction of time inventory level is positive)
2
𝑄−𝑆 𝑄−𝑆 (𝑄−𝑆)
=ℎ 2 𝑄 =ℎ 2𝑄

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The EOQ model with Planned Shortages

• To obtain a similar expression for the shortage costs, recall that

p = annual shortage cost per unit short

where the symbol p is used to indicate that this is the penalty for
incurring the shortage of a unit. Since this unit shortage cost only is
incurred during the fraction of the year when a shortage is occurring,

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The EOQ model with Planned Shortages

Since this unit shortage cost only is incurred during the fraction of the
year when a shortage is occurring,

Annual shortage cost = p times (average shortage level when a

shortage occurs) times (fraction of time shortage
is occurring)
𝑆 𝑆 𝑆2
=𝑝 =𝑝
2 𝑄 2𝑄

Combining these expressions

gives 2 2
(Q  S) S
D
TVC  K   p
Q  2Q
113
h
2Q
113

The EOQ model with Planned Shortages

The optimal inventory policy
• Calculus now can be used to find the values of Q and S that
minimize TVC. This leads to the following formulas for their optimal
values, Q* and S*.
K = setup cost,
h = unit holding cost,
where
p = unit shortage cost
D = annual demand
rate,
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h  p2KD
Q* 
ph

 h 
S*  Q*
hp 

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The EOQ model with Planned Shortages

After some algebra, these two formulas also yield
Maximum inventory level = Q* – S*
𝑝2𝐾𝐷
= ℎ + 𝑝ℎ

Since the first square root is less than 1 and the second square root is the
value of Q* when planned shortages are not allowed, the maximum
inventory level for this model always will be less than for the basic EOQ
model. This level can be considerably less if h is fairly large compared to p.
This is good, since we want the inventory levels to come down when the unit
holding cost goes up. Having shortages, a significant fraction of the time also
helps to drive down the annual holding cost.

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115

The EOQ model with Planned Shortages

Therefore, this model does a good job of reducing the annual holding
cost well below that for the basic EOQ model when h is fairly large
compared to p. When p is considerably larger than h instead, the trade-
offs between the cost factors will lead to an optimal inventory policy
that is not much different than for the basic EOQ model.

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The EOQ model with Planned Shortages

Application to the ACT Case Study

Table 5.1 –Data of the ACT problem

D= 6000 (demand/year)
K= $115 (setup cost)
h= $4.20 (unit holding cost)
p= $7.50 (unit shortage cost)

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117

The EOQ model with Planned Shortages

Applying Excel Solver to formulate and solve ACT’s planned shortage
problem.

Figure 5.2 – The results obtained for the ACT problem by applying either of the
Excel templates (Solver version or analytical version) for the EOQ model with
planned shortages 118

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The EOQ model with Planned Shortages

Applying QM for Windows to formulate and solve ACT’s planned
shortage problem.

Step 1: Data settings for ACT – EOQ model with planned shortage
(Figure 5.3)
Step 2: Input data in QM for ACT – EOQ model with planned shortage
(Figure 5.4)
Step 3: Solution for ACT –– EOQ model with planned shortage in QM
for Windows (Figure 5.5)

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The EOQ model with Planned Shortages

Figure 5.3 – Data settings in QM for ACT problem with planned shortage
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The EOQ model with Planned Shortages

Figure 5.4 – Input data in QM for Windows

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The EOQ model with Planned Shortages

Figure 5.4 – Input data in QM for Windows

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The EOQ model with Planned Shortages

Figure 5.5 – QM for Windows solution for ACT

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The EOQ model with Planned Shortages

Comparison
Quantity Basic EOQ model EOQ model with
Planned shortages
Order quantity 573 716
Maximum shortage 0 257
Maximum inventory level 573 459
Reorder point 216 -41
Annual setup cost $1,204 $964
Annual holding cost $1,204 $618
Annual shortage cost 0 $346
Total variable cost $2,407 $1,928
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The EOQ Model with Quantity Discounts

• Commonly, suppliers always wish to increase their sales by offering
quantity discounts for large orders (Refer to the Table 5.3 in ACT
discount case as an example).
• The drawback of placing larger orders is that this increases the
average inventory level and thereby increases the holding cost.
Therefore, we need to do a careful cost analysis to determine
whether it is worthwhile to take advantage of these quantity
discounts.

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The EOQ Model with Quantity Discounts

Assumptions
• Annual acquisition cost becomes a variable cost.
• Holding cost varies upon purchasing price.
• TVC = annual acquisition cost + annual setup cost + annual holding
cost.

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The EOQ Model with Quantity Discounts

The Objective of the Model
• For the basic EOQ model, the only components of the total
variable inventory cost per year (TVC) are the annual setup cost and
the annual holding cost, since the annual cost of purchasing the
product is a fixed cost. Now, with quantity discounts, this annual
acquisition cost becomes a variable cost.

TVC = annual acquisition cost + annual setup cost + annual holding cost.

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127

The EOQ Model with Quantity Discounts

TVC = annual acquisition cost + annual setup cost + annual holding cost.

where
c = unit acquisition cost (as given in Table 5.3)
D = annual demand rate
K = setup cost
Q = order quantity (the decision variable),
h = unit holding cost.
I = inventory holding cost rate
h = Ic
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The EOQ Model with Quantity Discounts

The optimal inventory policy
The decision variable of this model is the order quantity Q. The
objective in choosing a feasible Q is to get a minimum total variable
cost. This TVC needs to include the same kinds of costs as for the basic
EOQ model plus the annual acquisition cost.
Thus,
Minimize TVC = total variable inventory cost per year.
𝐷 𝑄∗
Minimize TVC = 𝑐𝐷 + 𝐾 𝑄∗ +ℎ 2

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The EOQ Model with Quantity Discounts

Application to the ACT Case Study

Discount Order quantity Discount Unit cost

quantity
1 0 – 749 0 $20.00

2 750 – 1,999 1% $19.80

3 2,000 or more 2% $19.60

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The EOQ Model with Quantity Discounts

Cost Analysis
• Even though ACT will continue to purchase a fixed total of 6,000
tires of the 185/70 R13 size per year, the annual acquisition cost now
depends on the size of the individual order quantities. Therefore, to
adapt the basic EOQ model to incorporate quantity discounts, the
total variable cost is calculated as shown in the following Figure 5.6.

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The EOQ Model with Quantity Discounts

The decision-making process for Inventory policy in Excel and in QM for
Windows.
Step 1: Data settings in QM for Windows for EOQ model with
quantity discounts (Figure 5.7)
Step 2: Input data in QM for Windows for EOQ model with
quantity discounts (Figure 5.8)
Step 3: QM for Windows solution for EOQ model with quantity
discounts (Figure 5.9)

The illustration is given below:

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Figure 5.6 – The application of the Excel template (analytical) for the EOQ
model with quantity discounts to the ACT problem 133

133

The EOQ Model with Quantity Discounts

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The EOQ Model with Quantity Discounts

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The EOQ Model with Quantity Discounts

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The EOQ Model with Gradual Replenishment

• One of the assumptions of the basic EOQ model is that the order
quantity to replenish inventory arrives all at once just when desired.
Having the order delivered all at once is common for retailers or
wholesalers (such as ACT), or even for manufacturers receiving raw
materials from their vendors. However, the situation often is different
with manufacturers when they replenish their finished-goods and
intermediate-goods inventories internally by conducting intermittent
production runs. The EOQ model with gradual replenishment is
designed to fit this situation.
• This model assumes that the pattern of inventory levels over time is
the one shown in Figure 5.10.

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137

The EOQ Model with Gradual Replenishment

Figure 5.10 – The pattern of inventory levels over time — rising during a production run and
dropping afterward — for the EOQ model with gradual replenishment

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The EOQ Model with Gradual Replenishment

Assumptions
• A constant demand rate.
• A production run is scheduled to begin each time the inventory level
drops to 0, and this production replenishes inventory at a constant
rate throughout the duration of the run.
• Planned shortages are not allowed.

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139

The EOQ Model with Gradual Replenishment

The objective of the model
• The decision variable of this model is the production lot size Q. The
objective is choosing Q to
Minimize TVC = total variable inventory cost per year.
• This TVC needs to include the same kinds of costs as for the basic EOQ
model
TVC = annual setup cost + annual holding cost
• As for the basic EOQ model,
𝐷
Annual Setup cost = 𝐾 𝑄
Annual holding cost = h (average inventory level)
1
Average inventory level = (maximum inventory level)
2
Maximum inventory level = production lot size – demand during production run

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The EOQ Model with Gradual Replenishment

The objective of the model
• The goal is to find the value of Q as the optimal production lot size that gives the
overall minimum cost. This requires the annual setup cost equals to the annual holding
cost.
Minimize TVC = annual setup cost + annual holding cost
𝐷 𝑄∗ 𝐷
= +ℎ (1 − )
𝐾 𝑄∗ 2 𝑅
• Where
D= annual demand
rate
R = annual production rate if producing continuously
K = setup cost,
h = unit holding cost.
R = (daily production rate) (number of working days per year)

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The EOQ Model with Gradual Replenishment

The optimal inventory policy
• The new square root formula is derived in the same way as
described for the basic EOQ model. The only reason the new formula
differs from the one for the basic EOQ model is that the annual
holding cost for the basic EOQ model now is being multiplied by the
factor, (1 - D/R). The reason for this factor is that the maximum
inventory level has changed from Q to

Maximum inventory level = production lot size – demand during

production run
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The EOQ Model with Gradual Replenishment

The optimal inventory policy
Maximum inventory level = production lot size – demand during
production run
= 𝑄 − 𝐷 𝑄 = (1 − 𝐷)𝑄
𝑅 𝑅
The optimal production lot size can be obtained directly from a square
root formula that is similar to the one for the basic EOQ model. The
new formula is
𝑄∗= 2𝐾𝐷
ℎ(1 − 𝐷)
𝑅
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143

The EOQ Model with Gradual Replenishment

The optimal inventory policy
• The corresponding total variable inventory cost per year is calculated
from the following formula:

TVC = annual setup cost + annual holding cost

𝐷 𝑄∗ 𝐷 1−𝑅
=𝐾 + ℎ2
𝑄∗

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The EOQ Model with Gradual Replenishment

The application to the SOCA case study
• Read the case on LMS

Applying Excel Solver and QM for Windows to formulate and solve

SOCA’s gradual replenishment problem.

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The EOQ Model with Gradual Replenishment

Figure 5.11 – The results obtained for the SOCA problem by applying the Excel

Solver for the EOQ model with gradual replenishment 146

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The EOQ Model with Gradual Replenishment

Applying QM for Windows to formulate and solve SOCA’s gradual
replenishment problem.
• Step 1: Data settings for SOCA – EOQ model with gradual
replenishment (Figure 5.12)
• Step 2: Input data for SOCA – EOQ model with gradual replenishment
(Figure 5.13)
• Step 3: Solution for SOCA - EOQ model with gradual replenishment
(Figure 5.14)
The illustration is displayed below:

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147

The EOQ Model with Gradual Replenishment

• STEP 1:

Figure 5.12 – Data settings for SOCA – EOQ model with gradual replenishment 148

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The EOQ Model with Gradual Replenishment

Figure 5.13 – Input data for SOCA – EOQ model with gradual 149
replenishment

149

The EOQ Model with Gradual Replenishment

Figure 5.13 – Input data for SOCA – EOQ model with gradual replenishment 150

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The EOQ Model with Gradual Replenishment

Figure 5.14 – Solution for SOCA - EOQ model with gradual

replenishment 151

151

The EOQ Model with Gradual Replenishment

Figure 5.14 – Solution for SOCA - EOQ model with gradual replenishment
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Glossary of Inventory management

• Acquisition cost: The direct cost of acquiring units of a product, either
through purchasing or manufacturing, to replenish inventory.
• Backorder: An order that cannot be filled currently because the inventory
is depleted, but will be filled later when the inventory is replenished.
• Constant demand rate: A fixed rate at which units need to be withdrawn
from inventory.
• Continuous-review system: An inventory system whose current inventory
level is monitored on a continuous basis.
• Cost of capital tied up in inventory: The rate of return from capital that is
foregone because that capital has been invested in the materials being
held in inventory.

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153

Glossary of Inventory management

• Demand: The number of units of a product that will need to be withdrawn
from inventory during a specific period.
• Dependent demand: Demand for a product that is dependent upon the
demand for another product, generally because the former product is a
component of the latter product.
• Fixed cost: A cost that remains the same regardless of the decisions made.
• Holding cost: The cost associated with holding units of a product in
inventory.
• Independent demand: Demand for a product that is independent of the
demand for all products.

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Glossary of Inventory management

• Inventory system: the set of policies and controls that monitor levels
of inventory.
• Inventory: Goods being stored for future use or sale.
• Inventory policy: A rule that specifies when to replenish inventory
and by how much.
• Just-in-time (JIT) inventory system: A system that places great
emphasis on reducing inventory levels to a bare minimum, as well as
eliminating other forms of waste in the production process.
• Lead time: The amount of time between the placement of an order
and the delivery of the order quantity.

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Glossary of Inventory management

• Material requirements planning (MRP): A computer-based system for planning,
scheduling, and controlling the production of all the components of a final
product.
• Manufacturing inventory: refers to items that contribute to or become part of a
firm’s product.
• Opportunity cost: When capital is used in a certain way, its opportunity cost is
the lost return
because alternate opportunities for using this capital must be foregone.
• Order quantity: The number of units of a product being acquired, either through
purchasing or
manufacturing, to replenish inventory.
• Periodic-review system: An inventory system whose inventory level is only
checked periodically.

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Glossary of Inventory management

• Production lot size: The number of units of a product being produced
during a production run.
• Quantity discounts: Reductions in the unit acquisition cost of a
product that are offered for ordering a relatively large quantity.
• Reorder point: The inventory level at which an order is placed.
• Safety stock: Extra inventory being carried to safeguard against
delivery delays.
• Scientific inventory management: A management science approach
to inventory management that involves using a mathematical model
to seek and implement an optimal inventory policy.

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Glossary of Inventory management

• Setup cost: The fixed cost associated with initiating the
replenishment of inventory, whether the administrative cost of
purchasing the product or the cost of setting up a production run to
manufacture the product.
• Shortage cost: The cost incurred when there is a need to withdraw
units from inventory and there are none available.
• Square root formula: The formula for calculating the optimal order
quantity for the basic EOQ model.
• Variable cost: A cost that is affected by the decisions made.

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