Anderson Sweeney Williams Camm Cochran Fry Ohlmann

An Introduction to
Management Science, 15e
Quantitative Approaches to Decision Making

© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 10 - Inventory Models

10.1 - Economic Order Quantity (EOQ) Model

10.2 - Economic Production Lot Size Model
10.3 - Inventory Model with Planned Shortages
10.4 - Quantity Discounts for the EOQ Model
10.5 – Single-Period Inventory Model with Probabilistic Demand
10.6 – Order-Quantity, Reorder Point Model with Probabilistic
Demand
10.7 – Periodic Review Model with Probabilistic Demand

2
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Inventory Models

• Inventory refers to idle goods or materials held by an

organization for use sometime in the future.

• The study of inventory models is concerned with two basic

questions:
• How much should be ordered when the inventory is
replenished?
• When should the inventory be replenished?

3
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Order Quantity (EOQ) Model

The economic order quantity (EOQ) model is applicable when

the demand for an item shows a constant, or nearly constant,
rate and when the entire quantity ordered arrives in inventory at
one point in time.

The constant demand rate assumption means that the same

number of units is taken from inventory each period of time
such as 5 units every day, 25 units every week, 100 units every
four-week period, and so on.

4
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (1 of 21)

R&B Beverage is a distributor of beer, wine, and soft drink

products.
• From a main warehouse located in Columbus, Ohio, R&B
supplies nearly 1000 retail stores with beverage products.
• The beer inventory, which constitutes about 40% of the
company’s total inventory, averages approximately 50,000
cases.
• With an average cost per case of approximately $8, R&B
estimates the value of its beer inventory to be $400,000.

5
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (2 of 21)

The warehouse manager decided to conduct a detailed study of

the inventory costs associated with Bub Beer, the number-one-
selling R&B beer.

The purpose of the study is to establish the how-much-to-order

and the when-to-order decisions for Bub Beer that will result in
the lowest possible total cost.

6
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (3 of 21)

As the first step in the study, the warehouse manager obtained

the following demand data for the past 10 weeks:
Week Demand (cases)
Strictly speaking, these 1 2000
weekly demand figures do 2 2025

not show a constant demand 3 1950

4 2000
rate. However, given the
5 2100
relatively low variability 6 2050
exhibited by the weekly 7 2000
demand, inventory planning 8 1975

with a constant demand rate 9 1900

10 2000
of 2000 cases per week
Total cases 20,000
appears acceptable. Average cases per week 2000

7
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (4 of 21)

The how-much-to-order decision involves selecting an order

quantity that draws a compromise between (1) keeping small
inventories and ordering frequently, and (2) keeping large
inventories and ordering infrequently.

• The first alternative can result in undesirably high ordering

costs, while the second alternative can result in undesirably
high inventory holding costs.

• To find an optimal compromise between these conflicting

alternatives, let us consider a mathematical model that shows
the total cost as the sum of the holding cost and the ordering
cost.

8
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (5 of 21)

Holding costs are the costs associated with maintaining or

carrying a given level of inventory; these costs depend on the
size of the inventory.
• The first holding cost to consider is the cost of financing the
inventory investment.
• When a firm borrows money, it incurs an interest charge. If the
firm uses its own money, it experiences an opportunity cost
associated with not being able to use the money for other
investments.
• In either case, an interest cost exists for the capital tied up in
inventory. This cost of capital is usually expressed as a
percentage of the amount invested. R&B estimates its cost of
capital at an annual rate of 18%.

9
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (6 of 21)

A number of other holding costs, such as insurance, taxes,

breakage, pilferage, and warehouse overhead, also depend on
the value of the inventory.
• R&B estimates these other costs at an annual rate of
approximately 7% of the value of its inventory.
• Thus, the total holding cost for the R&B beer inventory is 18%
+ 7% = 25% of the value of the inventory.
• The cost of one case of Bub Beer is $8.
• With an annual holding cost rate of 25%, the cost of holding
one case of Bub Beer in inventory for 1 year is 0.25($8) =
$2.00.

10
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (7 of 21)

The next step in the inventory analysis is to determine the

ordering cost.

This cost, which is considered fixed regardless of the order

quantity, covers the preparation of the voucher; and the
processing of the order, including payment, postage, telephone,
transportation, invoice verification, receiving, and so on.

11
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (8 of 21)

For R&B Beverage, the largest portion of the ordering cost

involves the salaries of the purchasers. An analysis of the
purchasing process showed that a purchaser spends
approximately 45 minutes preparing and processing an order for
Bub Beer.

With a wage rate and fringe benefit cost for purchasers of $20
per hour, the labor portion of the ordering cost is $15. Making
allowances for paper, postage, telephone, transportation, and
receiving costs at $17 per order, the manager estimates that the
ordering cost is $32 per order. That is, R&B is paying $32 per
order regardless of the quantity requested in the order.

12
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (9 of 21)

The holding cost, ordering cost, and demand information are the
three data items that must be known prior to the use of the EOQ
model.

After developing these data for the R&B problem, we can look at
how they are used to develop a total cost model. We begin by
defining Q as the order quantity.

Thus, the how-much-to-order decision involves finding the value

of Q that will minimize the sum of holding and ordering costs.

13
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (10 of 21)

The inventory for Bub Beer will have a maximum value of Q units
when an order of size Q is received from the supplier. R&B will
then satisfy customer demand from inventory until the inventory
is depleted, at which time another shipment of Q units will be
received.

14
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (11 of 21)

The complete inventory pattern is shown here. If the average

inventory during each cycle is 1/2Q, the average inventory over
any number of cycles is also 1/2Q.

15
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (12 of 21)

The holding cost can be calculated using the average inventory.

That is, we can calculate the holding cost by multiplying the
average inventory by the cost of carrying one unit in inventory for
the stated period.

The period selected for the model is up to you; it could be one

week, one month, one year, or more. However, because the
holding cost for many industries and businesses is expressed as
an annual percentage, most inventory models are developed on
an annual cost basis.

16
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (13 of 21)

Let
I = annual holding cost rate
C = unit cost of the inventory item
Ch = annual cost of holding one unit in inventory

The annual cost of holding one unit in inventory is Ch = IC.

The general equation for the annual holding cost for the average
inventory of 1/2Q units is as follows:

17
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (14 of 21)
To complete the total cost model, we must include the annual ordering
cost. The goal is to express the annual ordering cost in terms of the
order quantity Q. How many orders will be placed during the year?
Let D denote the annual demand for the product.
For R&B Beverage, D = (52 weeks)(2000 cases per week) = 104,000
cases per year.
We know that by ordering Q units every time we order, we will have to
place D/Q orders per year. If Co is the cost of placing one order, the
general equation for the annual ordering cost is as follows:

18
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (15 of 21)

Thus, the total annual cost, denoted TC, can be expressed

as follows:

1 D
TC  QCh  Co
2 Q
Using the Bub Beer data [Ch = IC = (0.25)($8) = $2, Co = $32,
and D = 104,000], the total annual cost model is

1 104, 000 3,328, 000

TC  Q($2)  ($32)  Q 
2 Q Q

19
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (16 of 21)

The next step is to find the order quantity Q that will minimize the
total annual cost for Bub Beer. Using a trial-and-error approach,
we can compute the total annual cost for several possible order
quantities.
Annual Cost
Order Quantity Holding Ordering Total
5000 $5000 $666 $5666
4000 $4000 $832 $4832
3000 $3000 $1109 $4109
2000 $2000 $1664 $3664
1000 $1000 $3328 $4328

The disadvantage of this approach, however, is that it does not

provide the exact minimum cost order quantity.

20
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (17 of 21)

A graphical/analytical approach can also be taken. The minimum

total cost order quantity is denoted by an order size of Q*.

The minimum total

annual cost order
quantity for Bub
beer is 1824 cases
and the minimum
cost inventory
policy for Bub beer
has a total annual
cost of $3649.

21
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (18 of 21)

Now that we know how much to order, we want to address the

question of when to order. To answer this question, we need to
introduce the concept of inventory position.

The inventory position is defined as the amount of inventory on

hand plus the amount of inventory on order.

The when-to-order decision is expressed in terms of a reorder

point—the inventory position at which a new order should be
placed.

22
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (19 of 21)

• The manufacturer of Bub Beer guarantees a two-day delivery

on any order placed by R&B Beverage.
• Hence, assuming R&B Beverage operates 250 days per year,
the annual demand of 104,000 cases implies a daily demand
of 104,000 / 250 = 416 cases.
• Thus, we expect (2 days)(416 cases per day) = 832 cases of
Bub to be sold during the two days it takes a new order to
reach the R&B warehouse.

In inventory terminology, the two-day delivery period is referred

to as the lead time for a new order, and the 832-case demand
anticipated during this period is referred to as the lead-time
demand.

23
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (20 of 21)

R&B should order a new shipment of Bub Beer from the

manufacturer when the inventory reaches 832 cases.

For inventory systems using the constant demand rate

assumption and a fixed lead time, the reorder point is the
same as the lead-time demand. For these systems, the
general expression for the reorder point is as follows:

r = dm
Where
r = reorder point
d = demand per day
m = lead time for a new order in days

24
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example: Economic Order Quantity (EOQ) Model (21 of 21)

The question of how frequently the order will be placed can

now be answered. The period between orders is referred to as
the cycle time.

Recall that D/Q = the number of orders that will be placed in a

year. Thus, D/Q* = 104,000 / 1824 = 57 is the number of orders
R&B Beverage will place for Bub Beer each year.

If R&B places 57 orders over 250 working days, it will order

approximately every 250 / 57 = 4.39 working days.

Thus, the cycle time is 4.39 working days.

25
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (1 of 13)

The inventory model presented in this section is similar to the

EOQ model in that we are attempting to determine how much
we should order and when the order should be placed.

We again assume a constant demand rate. However, instead of

assuming that the order arrives in a shipment of size Q*, as in
the EOQ model, we assume that units are supplied to inventory
at a constant rate over several days or several weeks.

26
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (2 of 13)

The constant supply rate assumption implies that the same

number of units is supplied to inventory each period of time
(e.g., 10 units every day or 50 units every week).

This model is designed for production situations for which, once

an order is placed, production begins and a constant number of
units is added to inventory each day until the production run has
been completed.

27
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (3 of 13)

The lot size is the number of units in an order.

• If we have a production system that produces 50 units per day

and we decide to schedule 10 days of production, we have a
50(10) = 500-unit production lot size.

• If we let Q = the production lot size, the approach to the

inventory decisions is similar to the EOQ model; that is, we
build a holding and ordering cost model that expresses the
total cost as a function of the production lot size.

• We want to find the production lot size that minimizes the total
cost.

28
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (4 of 13)

The model only applies to situations where the production rate is

greater than the demand rate; the production system must be
able to satisfy demand.

For instance, if the constant demand rate is 400 units per day,
the production rate must be at least 400 units per day to satisfy
demand.

During the production run, demand reduces the inventory while

production adds to inventory.

29
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (5 of 13)

Because we assume that the production rate exceeds the

demand rate, each day during a production run we produce more
units than are demanded. Thus, the excess production causes a
gradual inventory buildup during the production period. When the
production run is completed, the continuing demand causes the
inventory to gradually decline until a new production run is
started.

30
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (6 of 13)

As in the EOQ model, we are now dealing with two costs, the
holding cost and the ordering cost.
• The holding cost is identical to the definition in the EOQ
model, but the interpretation of the ordering cost is slightly
different.
• In fact, in a production situation the ordering cost is more
correctly referred to as the production setup cost.
• This cost, which includes labor, material, and lost production
costs incurred while preparing the production system for
operation, is a fixed cost that occurs for every production run
regardless of the production lot size.

31
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (7 of 13)

Let us build the production lot size model by writing the holding
cost in terms of the production lot size Q. We will develop an
expression for average inventory and then establish the holding
costs associated with the average inventory. We use
a one-year time period and an annual cost for the model.

In the EOQ model the average inventory is one-half the

maximum inventory, or 1/2Q. For a production lot size model, a
constant inventory buildup rate occurs during the production run,
and a constant inventory depletion rate occurs during the
nonproduction period; thus, the average inventory will be one-
half the maximum inventory. However, in this inventory system
the production lot size Q does not go into inventory at one point
in time, and thus the inventory never reaches a level of Q units.

32
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (8 of 13)

To show how we can compute the maximum inventory, let

d = daily demand rate
p = daily production rate
t = number of days for a production run

Maximum inventory = (p – d)t

The length of the production run is t = Q / p days

Q  d 
Maximum inventory  ( p  d )t  ( p  d )    1   Q
P  p

33
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (9 of 13)

The average inventory, which is one-half the maximum inventory,

is given by
1 d 
Average inventory =  1   Q
2 p

With an annual per-unit holding cost of Ch, the general equation

for annual holding cost is as follows:

1 d 
= 1   QCh
2 p

34
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (10 of 13)

If D is the annual demand for the product and Co is the setup

cost for a production run, then the annual setup cost, which
takes the place of the annual ordering cost in the EOQ model, is
as follows:

Thus, the total annual cost (TC) model is

1 d  D
TC = 1   QCh  Co
2 p Q

35
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (11 of 13)

Given estimates of the holding cost (Ch), setup cost (Co), annual
demand rate (D), and annual production rate (P), we could use a
trial-and-error approach to compute the total annual cost for
various production lot sizes (Q). However, trial and error is not
necessary; we can use the minimum cost formula for Q* that has
been developed using differential calculus.

2 DCo
Q* 
 1  D P  Ch

36
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (12 of 13)

What is the recommended production lot size?

• Beauty Bar Soap is produced on a production line that has an

annual capacity of 60,000 cases.
• The annual demand is estimated at 26,000 cases, with the
demand rate essentially constant throughout the year.
• The cleaning, preparation, and setup of the production line
cost approximately $135.
• The manufacturing cost per case is $4.50, and the annual
holding cost is figured at a 24% rate.
• Thus, Ch = IC = 0.24($4.50) = $1.08.

37
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Economic Production Lot Size Model (13 of 13)

Other relevant data include a five-day lead time to schedule and

set up a production run and 250 working days per year.

Thus, the lead-time demand of (26,000 / 250)(5) = 520 cases is

the reorder point.

The cycle time is the time between production runs. The cycle
time is T = 250Q* / D = [(250)(3387)] / 26,000 = 33 working days.

Thus, we should plan a production run of 3387 units every 33

working days.

38
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Inventory Model with Planned Shortages (1 of 2)

A shortage or stock-out occurs when demand exceeds the

amount of inventory on hand. In many situations, shortages are
undesirable and should be avoided if at all possible. However,
in other cases it may be desirable—from an economic point of
view—to plan for and allow shortages.

In practice, these types of situations are most commonly found

where the value of the inventory per unit is high and hence the
holding cost is high. An example of this type of situation is a
new car dealer’s inventory. Often a specific car that a customer
wants is not in stock. However, if the customer is willing to wait
a few weeks, the dealer is usually able to order the car.

39
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Inventory Model with Planned Shortages (2 of 2)

The model developed in this section takes into account a

type of shortage known as a backorder.
In a backorder situation, we assume that when a customer
places an order and discovers that the supplier is out of
stock, the customer waits until the new shipment arrives, and
then the order is filled.

Frequently, the waiting period in backorder situations is

relatively short. Thus, by promising the customer top priority
and immediate delivery when the goods become available,
companies may be able to convince the customer to wait
until the order arrives. In these cases, the backorder
assumption is valid.

40
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Quantity Discounts for the EOQ Model

Quantity discounts occur in numerous situations for which

suppliers provide an incentive for large order quantities by
offering a lower purchase cost when items are ordered in larger
quantities.

In this section we show how the EOQ model can be used when
quantity discounts are available.

41
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Order-Quantity, Reorder Point Model with Probabilistic
Demand
In the previous section we considered a single-period inventory
model with probabilistic demand. In this section we extend our
discussion to a multiperiod order-quantity, reorder point inventory
model with probabilistic demand.

In the multiperiod model, the inventory system operates

continuously with many repeating periods or cycles; inventory
can be carried from one period to the next. Whenever the
inventory position reaches the reorder point, an order for Q units
is placed. Because demand is probabilistic, the time the reorder
point will be reached, the time between orders, and the time the
order of Q units will arrive in inventory cannot be determined in
advance.

42
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Periodic Review Model with Probabilistic Demand

The order-quantity, reorder point inventory models previously

discussed require a continuous review inventory system.

In a continuous review inventory system, the inventory position is

monitored continuously so that an order can be placed whenever
the reorder point is reached. Computerized inventory systems
can easily provide the continuous review required by the order-
quantity, reorder point models.

An alternative to the continuous review system is the periodic

review inventory system. With a periodic review system, the
inventory is checked and reordering is done only at specified
points in time.

43
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 End of Presentation: Chapter 10

44
© 2019 Cengage. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.