The document discusses inventory models for situations with known and uncertain demand. For known demand, it covers the economic order quantity (EOQ) model and its assumptions. The EOQ formula is presented to calculate the optimal order quantity that minimizes total inventory costs. For uncertain demand, continuous review (Q) and periodic review (P) systems are introduced to determine reorder points and order quantities when demand varies. Key factors like lead time, demand rate, holding and ordering costs are considered in the models.
The document discusses inventory models for situations with known and uncertain demand. For known demand, it covers the economic order quantity (EOQ) model and its assumptions. The EOQ formula is presented to calculate the optimal order quantity that minimizes total inventory costs. For uncertain demand, continuous review (Q) and periodic review (P) systems are introduced to determine reorder points and order quantities when demand varies. Key factors like lead time, demand rate, holding and ordering costs are considered in the models.
The document discusses inventory models for situations with known and uncertain demand. For known demand, it covers the economic order quantity (EOQ) model and its assumptions. The EOQ formula is presented to calculate the optimal order quantity that minimizes total inventory costs. For uncertain demand, continuous review (Q) and periodic review (P) systems are introduced to determine reorder points and order quantities when demand varies. Key factors like lead time, demand rate, holding and ordering costs are considered in the models.
The document discusses inventory models for situations with known and uncertain demand. For known demand, it covers the economic order quantity (EOQ) model and its assumptions. The EOQ formula is presented to calculate the optimal order quantity that minimizes total inventory costs. For uncertain demand, continuous review (Q) and periodic review (P) systems are introduced to determine reorder points and order quantities when demand varies. Key factors like lead time, demand rate, holding and ordering costs are considered in the models.
Agenda • Inventory Models with known demand: – EOQ, POQ, EOQ with discount • Inventory Models with uncertainty demand: – Q system – P System
1 Inventory Models with Known Demand
Economic Order Quantity (EOQ)
Assumptions • Demand rate is constant and known. • Lead time is constant and known. • No stock outs allowed. • Material is ordered or produced in a lot or batch and the lot is received all at once • Unit cost is constant (no quantity discounts) • Ordering cost(Ordering cost = setup cost = fixed cost) per order is fixed • The item is a single product • Note: The lead time = time from placing an order until the order is received 4
2 Notations and measurement units in EOQ D = Annual Demand (units per year) S = Cost per order placed, or setup cost, ($/order) C = Unit cost ($/unit) i = Carrying “interest” rate (%/year) Q = Order size (units) H = Holding/Carrying cost ($/Unit/year) N = Number of orders per year I = Average inventory (units)
TC = (Q/2)H + (D/Q)S + (DC) 2 SD Minimize TC Q* = EOQ = H EOQ Time between orders: TBO = D Note: you can change year to day, week, or any other time unit, as long as you are consistent
3 EOQ
TC = (Q/2)H + (D/Q)S + (DC)
2 SD Minimize TC Q* = EOQ = H EOQ Time between orders: TBO = D
Q* = EOQ = – Leads to smaller orders/batches H • Sales growth: – Suppose sales quadruple – Average inventory only doubles • Centralization of inventory: – Suppose four equal sizes hospitals “pool” their inventories – Total inventory cut in half
The Inventory Order Cycle
Lot size = Order qty = Q Inventory Level
Reorder point ROP
0 Lead Lead Time
time time Order Order Order Order Placed Received Placed Received
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5 Example 1 • The South Face store has observed a stable monthly demand for its line of Gore-Tex jackets of 100 jackets per month. The store incurs a fixed cost of $2,000 every time it places an order for additional jackets. The store pays $200 per jacket. The store’s out-of-pocket costs of storing a jacket for a year are about 20% and the opportunity cost of capital is 15%. • What order size do you recommend for the South Face store?
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? $30,000
$25,000 Total Cost $20,000
$15,000 Holding cost $10,000
$5,000 Ordering cost
$- 0 200 Q* 400 600 Order size (Q)
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6 Practice • One of the top-selling items in a shop is an ADSL modem clock. Sales are 18 units/week, and the supplier charges $60/unit. The cost of placing an order with the supplier is $45. Annual holding cost is 25% of a modem’s value and the shop operates 52 weeks/year. Management chose a 390-unit lot size so that new orders could be placed less frequently. 1. What is the annual cost of the current policy of using a 390-unit lot size? Would a lot size of 468 be better? 2. Calculate the EOQ and its total cost. How frequency will orders be placed if the EOQ is used?
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• Inventory performance: • Inventory turn over (2019) = Cost of good sold (2019)/ Avg. Inventory • Avg Inv 2019 = Inventory (1/1/2019) + Inventory (31/11/2019) • Income statement: 2019, 2020 (period) • Balance sheet/ Finance statement: 31/12/2019 ( specific time), 31/12/2020 ~ 1/1/ 2021
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7 EOQ with discount The annual demand for an item is 40,000 units. The cost to process an order is $40 and the annual inventory holding cost is $3 per item per year. What is the optimal order quantity, given the following price breaks for purchasing the item? a. What is the optimal behavior? b. Does the firm take advantage of the lowest price available? Explain.
Quantity Price 1-1,499 $2.50 per unit
1,500 - 4,999 $2.30 per unit
5,000 or more $2.25 per unit
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POQ • D: 20,000 units/year. • Number of working days: 250 days/year. • Production capacity: 100 units/ day • Production Leadtime: 4 days. • Unit production cost 50$, • Holding cost: 10$/unit/ year. • Preparation for setup: 20$. • Q*, TBP, ROP, TC?
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8 Inventory model for unconstant/ unstable demand:
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Replenishment Policies • Continuous Review: Order fixed quantity when total inventory drops below Reorder Point => fixed order quantity • Periodic Review: Order at fixed time intervals to raise total inventory to Order up to Level=> fixed interval D~ unstable demand => average demand Standard deviation of demand, Normal distribution Service level ~ prob. Of available inventory vs. ( 1- prob. ) ~ stockout/ no inventory
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9 Continuous Review (Q) System • Assumption of “constant demand” is relaxed. • Monitoring of “on hand” stock position in a continuous system • Information needed to determine: – ROP: Re-Order Point – Service-level – Safety Stock – Q*, TC*
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A Continuous Review (Q) System
R = Reorder Point (ñieåm ñaët haøng laïi)
Q = Order Quantity (löôïng ñaët haøng) L = Lead time (toång thôøi gian ñaët haøng)
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10 Determining ROP When Demand is Certain
Order qty, Q Inventory Level
Reorder point ROP = d x L
0 Lead Lead Time
time time Order Order Order Order Placed Received Placed Received
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Determining R When Demand is Certain
• Inventory position = On-hand + scheduled receipts (open orders) – Backorders IP = OH + SR - BO • When IP reach R: re-order an amount of Q • Reorder point (R) is the predetermined minimum level that an inventory position must reach before a fixed quantity Q of the item is ordered R = L* D • Determine Q: – EOQ – Price break quantity: minimum lot size that qualifies for a quantity discount – Container size, etc.
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11 Determining R • Lead time = 1.5 weeks = 1.5/50 years • Demand during lead time = D L = (1.5)[(1200 units/year)/ (50 weeks)] = 36 units ➔ Set R = 36 jackets Inventory
ROP
demand during lead time Time
lead time
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Practice • Demand for chicken soup at a supermarket is 25 cases a day and the lead time is 4 days. The selves were just restocked with chicken soup , leaving an on-hand inventory of only 10 cases. There are no backorders, but there is one open order ( scheduled receipts) for 200 cases. What is the inventory position? Should a new order be placed?
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12 Selecting the Reorder Point when Inventory Demand is Uncertain
R Demand Leadtime during leadtime Demand that was not met
Time
How Shortages Happen
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Q: What could we have done to avoid
running out of inventory?
A: If the R had been higher we would
have ordered sooner.
Reorder Point=Mean Demand over Leadtime+Safety Stock
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13 Probability Distribution of Demand over Lead Time
m = mean demand R = Reorder point s = Safety stock
Reorder Point = Mean Demand over Leadtime + Safety Stock
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Demand during Leadtime
• Suppose demand per unit time has mean D and standard deviation sr , sr2 • Lead time is L time units • Then: – Mean Demand over Leadtime = LD – Var[demand during leadtime] = L s r2 – Stdev[demand during leadtime] = L s r
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14 Safety Stocks and Service Level Service level = P(no stock out) = P(demand during lead time < R) = NORMDIST(R, L D, SQRT(L)sr) → z = NORMSINV (Service level) Safety stock: s = zs r L Safety stock decreases with a decrease in: – Demand variability or forecast error – Avg. delivery lead time – Desired level of service
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Safety Stocks
Inventory on hand
order Q order order
ROP D mean demand during supply lead time
safety stock Time t L L
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15 R=LD+s Summary Demand over lead time = L x D Safety Stock = s = zs r L Standard deviation = sqrt( sum (Dt-ave.)2/n-1) Z: look at value of Z for N(P) p: prob. Of service level. ; service level= 95%, p= 0.95, z~ 1.6 Service level = P(demand over lead time < R) Q*= sqrt(2 xD x S/ H) TC = Average inventory x H+ (DS)/Q Average inventory = Q/2 + s 32
16 Example 3 • The South Face has 4 warehouses. Each warehouse faces weekly demand with mean = 5,000 and standard deviation = 500. SF’s order leadtime is two weeks. Fixed order costs are $10,000/order and it costs $10 to hold one jacket in inventory for one year. SF wants the stockout probability to be no higher than 5% for customer satisfaction. What ordering policy do you recommend for SF – What should safety stock be to insure a desired service level ? – When should be re-order?
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Practice • Suppose that the average demand is 18 units/week with a standard deviation of 5 units. The lead time is constant at 2 weeks. Determine the safety stock and reorder point if the management wants a 90% cycle service level. What is the total cost of the Q system?
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17 Ex. • S= $4,500/ order • C= $250/ unit • H= 18%/year • L= 2 weeks • Service level = 97% • SS, ROP, Q*, TC*
Month Sept Oct Nov. Dec. Jan. Feb. Mar. Apr. May June July Aug
D 200 152 100 221 287 176 151 198 246 309 98 156
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18 Periodic Review System • All assumption of EOQ (except that demand is constant and “no stockout”) remains in effect. • Also known as “P System” or “Fixed-order- Interval System”
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Periodic review system
• Demand in leadtime r + L= (r + L) AVG • Safety stock= z STD r + L
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19 Example • There is a backorder of five 36-inch color TV sets at a distribution center. There is no on- hand inventory, and now is the time to review. How much should be reordered if T = 400 units and there is no scheduled receipts?
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Solution
IP = OH + SR – BO = 0 + 0 – 5 = -5 Q = T – IP = 405 sets
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20 Example • A gift shop has an inventory problem. One of the top-selling items is a birdfeeder. Sales are normally distributed with a mean of 18 units per week, and a standard deviation in weekly demand of 5 units. The lead time is 2 weeks, and the business operates 52 weeks/year. The EOQ is 75 units and a safety stock is 9 units for a cycle-service level of 90%. he supplier charges $60/unit. The cost of placing an order with the supplier is $45. Annual holding cost is 25% of a feeder’s value. Management chose a 390-unit lot size so that new orders could be placed less frequently. What is the annual total cost of the current policy of using a 390-unit lot size? What is the equivalent P system?
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Example • We have: D = (18 units/week)(52 weeks/year)=936 units EOQ 75 P= (52) = (52) = 4.2 (weeks) D 936 • Standard deviation of demand over the protection interval (P+L): s P + L = s t P + L = 5 6 = 12 units • For a 90% cycle-service level, z = 1.28, we have: T = d ( P + L) + zs P + L = (18 units/week)(6 weeks) + 1.28(12 units)=123 units • Total cost is: 4(18) 936 TC = ($15) + ($45) + 15($15) = $1,350 2 4(18)
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21 Practice • Suppose that a P system is used at the warehouse. The warehouse operates 5 days per week, 52 weeks/year. The following data are estimated for 3/8- inch hand drills with double insulation and variable speeds: • Average daily demand = 100 drills • Standard deviation of daily demand = 30 drills • Lead time = 3 days • Holding cost = $9.4/unit/year • Ordering cost = $35/order • Cycle service level = 92% a. Calculate P that gives approximately the same number of orders per year as the EOQ b. What is the value of T? c. It is time to review the item, If OH = 40 units, SR = 440 drills, BO = 0 , How much should be reordered?
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Using P and Q System in Practice
• Use P system when orders must be placed at
specified intervals. • Use P systems when multiple items are ordered from the same supplier (joint- replenishment). • Use P system for inexpensive items.
