CH 2

ENIE 351
Production Planning and

Control
2nd Session:
Chapter 2:
Inventory Control
From EOQ to
ROP
Agenda
• Chapter 2: Inventory Control From EOQ to

ROP
Inventory Control
There is a trade-off between set-ups and

inventory.
There is a trade-off between customer service

and inventory
There is a trade-off between variability and

inventory
The EOQ Model
To a pessimist, the glass is half empty.

to an optimist, it is half full.
– Anonymous
EOQ History
– Introduced in 1913 by Ford W. Harris, “How Many Parts to Make
at Once”
– Interest on capital tied up in wages, material and overhead sets

a maximum limit to the quantity of parts which can be profitably
manufactured at one time; “set-up” costs on the job fix the
minimum. Experience has shown one manager a way to
determine the economical size of lots.
– Early application of mathematical modeling to Scientific

Management
MedEquip Example
• Small manufacturer of medical diagnostic equipment.
• Purchases standard steel “racks” into which components are
mounted.
• Metal working shop can produce (and sell) racks more cheaply if
they are produced in batches due to wasted time setting up shop.
• MedEquip doesn’t want to tie up too much precious capital in
inventory.
• Question: how many racks should MedEquip order at once?

EOQ Modeling Assumptions
1. Production is instantaneous – there is no capacity constraint
and the entire lot is produced simultaneously.
2. Delivery is immediate – there is no time lag between
production and availability to satisfy demand.
3. Demand is deterministic – there is no uncertainty about the
quantity or timing of demand.
4. Demand is constant over time – in fact, it can be represented
as a straight line, so that if annual demand is 365 units this
translates into a daily demand of one unit.
5. A production run incurs a fixed setup cost – regardless of the
size of the lot or the status of the factory, the setup cost is
constant.
6. Products can be analyzed singly – either there is only a single
product or conditions exist that ensure separability of products.
Notation
D demand rate (units per year).
C unit production cost, not counting setup or inventory

costs (dollars per unit).
Co fixed or ordering cost to place an order.
Cc holding (carrying) cost (per year); if the holding cost

is consisting entirely of interest on money tied up in
inventory, then Cc = ic where i is an annual interest
rate.
Q the unknown size of the order or lot size. decision variable

Inventory vs Time in EOQ Model
Inventory
Q/D 2Q/D 3Q/D 4Q/D
Time
Costs
𝑄
• Holding Cost: average inventory =
2
𝐶𝑐 𝑄
annual holding cost =
2
𝐷
number of orders per year =
𝑄
𝐶𝑜 𝐷
• Setup (Order) Cost =
𝑄
𝐶𝑐 𝑄 𝐶𝑜 𝐷
• Cost Formulation: T(Q) = +
2 𝑄
MedEquip Example Costs
• D = 1000 racks per year

• c = $250
• Co = $500 (estimated from supplier’s
pricing)
• Ch = (0.1)($250) + $10 = $35 per unit per
year
Costs in EOQ Model
Economic Order Quantity
2Co D EOQ Square Root Formula

Q∗ =
Cc
2(500)(1000)
Q =
*
= 169 MedEquip Solution
35
Economic Production Lot (EPL)
• Harris's original formula has been extended in a
variety of ways over the years.
• One of the earliest extensions was to the case in
which replenishment is not instantaneous.
• Production rate is finite, but constant and
deterministic.
• This model is sometimes called the economic
production lot (EPL) model.
• Results in a similar square root formula to the
regular EOQ.
• Imagine we produce car’s transmissions:
• We can produce p = 50 transmissions a day
• We need to install d = 40 transmissions a day
• We would be accumulating p-d = 10
transmissions a day
• How many transmissions I would accumulate
after 30 days?
• Imagine we produce car’s transmissions:
• We can produce p = 50 transmissions a day
• We need to install d = 40 transmissions a day
• We would be accumulating p-d = 10
transmissions a day
• How many transmissions I would accumulate
after 30 days?
• (p-d)*30 = (50-40)*30 = 300 transmissions
300
• That can be consumed in = 7.5 𝑑𝑎𝑦𝑠
40
EOQ Modeling Assumptions
1. Production is instantaneous – there is no capacity constraint relax via
and the entire lot is produced simultaneously. EPL model
2. Delivery is immediate – there is no time lag between production
and availability to satisfy demand.
3. Demand is deterministic – there is no uncertainty about the
quantity or timing of demand.
4. Demand is constant over time – in fact, it can be represented as
a straight line, so that if annual demand is 365 units this
translates into a daily demand of one unit.
5. A production run incurs a fixed setup cost – regardless of the size
of the lot or the status of the factory, the setup cost is constant.
6. Products can be analyzed singly – either there is only a single
product or conditions exist that ensure separability of products.
Notation – EPL Model
D demand rate (units per year)
d daily demand rate
p daily production rate (units per day), where p>d
c unit production cost, not counting setup or inventory costs (dollars

per unit)
Co fixed or setup cost to place an order (dollars)
Cc holding (carrying) cost (per year); if the holding cost is consisting

entirely of interest on money tied up in inventory, then Cc = ic where i
is an annual interest rate.
Q the unknown size of the production lot size decision variable

Inventory vs Time in EPL Model
• We have to decide on particular production
run size.
• Do we go and produce to accumulate 300
units in 30 days?
• Should we produce for 400 days and over
that period produce 5000 transmissions and
accumulate 1000 transmissions?
The larger the The larger

The larger The grater
accumulating the
p the Cc
time inventory
The fewer the The lower the

The larger p
setup time Co
𝑄
• EOQ: average inventory =
2
𝐼 𝑚𝑎𝑥
• EPL: average inventory =
2
𝐼 𝑚𝑎𝑥 = ⧣ 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑡ℎ𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑟𝑢𝑛𝑠 ∗
•
𝑡ℎ𝑒 𝑎𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑑𝑎𝑦
𝑄
• 𝐼 𝑚𝑎𝑥 = ∗ (𝑝 − 𝑑)
𝑝
Costs
𝐼 𝑚𝑎𝑥
• Holding Cost: average inventory =
2
𝐶𝑐 ∗ 𝐼 𝑚𝑎𝑥
annual holding cost =
2
𝐷
number of production runs/year =
𝑄
𝐶𝑜 𝐷
• Setup Cost =
𝑄
𝐶𝑐 ∗ 𝐼 𝑚𝑎𝑥 𝐶𝑜 𝐷
• Total cost = +
2 𝑄
• The optimal production quantity size:
∗
2𝐷𝐶𝑜
𝑄 =
𝑑
(1 − )𝐶𝑐
𝑝
• Example: • Answer:
d = 50 units
∗ 2(12,500)(200)
p = 150 units • Q = 50
1− 10
150
Co = SR200
Cc = SR10 • Q∗ = 866 units
D = 12,500 units • The optimal production
𝑄∗ = ? ? 866
interval = = 5.7 𝑑𝑎𝑦𝑠
150
• Max. inventory= 5.7 (150-50)
= 577.3 units
The Key Insight of EOQ
There is a tradeoff between lot size and inventory
D
• Order Frequency: F=
Q
cQ cD
• Inventory Investment: I=
2
=
2F
EOQ Tradeoff Curve
50
45
Inventory Investment
40
35
30
25
20
15
10
5
0
0 20 40 60 80 100
Order/Year
EOQ Takeaways
• Batching causes inventory (i.e., larger lot sizes
translates into more stock).
• Smaller lot sizes translates into more frequent
orders (i.e., higher ordering cost)
• Under specific modeling assumptions the lot
size that optimally balances holding and setup
costs is given by the square root formula:
2Co D
Q∗ =
Cc

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ENIE 351

Production Planning and

• Chapter 2: Inventory Control From EOQ to

There is a trade-off between set-ups and

There is a trade-off between customer service

There is a trade-off between variability and

To a pessimist, the glass is half empty.

– Interest on capital tied up in wages, material and overhead sets

– Early application of mathematical modeling to Scientific

• Question: how many racks should MedEquip order at once?

C unit production cost, not counting setup or inventory

Cc holding (carrying) cost (per year); if the holding cost

Q the unknown size of the order or lot size. decision variable

Q/D 2Q/D 3Q/D 4Q/D

• D = 1000 racks per year

2Co D EOQ Square Root Formula

d daily demand rate

p daily production rate (units per day), where p>d

c unit production cost, not counting setup or inventory costs (dollars

Co fixed or setup cost to place an order (dollars)

Cc holding (carrying) cost (per year); if the holding cost is consisting

Q the unknown size of the production lot size decision variable

The larger the The larger

The fewer the The lower the

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