EOQ for constant Demand & LeadTime

IP Order received Order received IP Order received

IP
Order received

On-hand inventory

OH

OH

OH

R
Order placed L TBO TBO Order placed L TBO
12 1

Order placed L

Time

Impact of lead time and uncertainty in demand

Lead time has NO impact if the demand is deterministic and at a constant rate. Uncertainty in the demand creates the need for safety stock

Lead time under uncertain demand requires even a larger safety stock!

12 2

EOQ for Uncertain Demand and Constant Lead Time

IP Order received Q OH Order received IP Order received

On-hand inventory

Order received Q
Q

R
Order placed Order placed Order placed

L TBO1 TBO2

L TBO3

Time

12 3

Choosing an Appropriate Service-Level Policy

Service level (Cycle-service level): The desired probability of not running out of stock in any one ordering cycle, which begins at the time an order is placed and ends when it arrives. Protection interval: The period over which safety stock must protect the user from running out (in this case, it will be the leadtime period).
Reorder point (R) = DL + Safety stock (SS) Safety stock (SS) =

zsL

z=

The number of standard deviations needed for a given cycle-service level.

sL=Standard deviation of the demand during lead time

DL =The average demand during the lead time period
12 4

Finding Safety Stock

With a normal Probability Distribution for an 85% Cycle-Service Level

Cycle-service level = 85%

Average Average demand demand (D) during during lead time lead time zsL

Probability of stockout (1.0 0.85 = 0.15)

12 5

Finding Safety Stock and R

Records show that the demand for dishwasher detergent during the lead time is normally distributed, with an average of 250 boxes and sL = 22. What safety stock should be carried for a 99 percent cycle-service level? What is R?

Safety stock (SS)

= zsL = 2.33(22) = 51.3 = 51 boxes = DL + SS = 250 + 51 = 301 boxes

Reorder point

2.33 is the number of standard deviations, z, to the right of average demand during the lead time that places 99% of the area under the curve to the left of that point.

12 6

In Class Example
Suppose that the demand for an item during the lead time period is normally distributed with and an average of 85 and a standard deviation of 40. Find the safety stock and reorder point for a service level of 95% How much reduction is safety stock will result if the desired service level is reduced to 85%

12 7

Development of Demand Distributions for the Lead Time

st = 15 st = 15 st = 15

+
75 Demand for week 1 75 Demand for week 2

+
st = 26

=
75 Demand for week 3

225 Demand for 3-week lead time

12 8

Continuous Review Systems

Selecting the reorder point with variable demand and constant lead time
Reorder point = Average demand during lead time + Safety stock = dL + safety stock

Where d = average demand per week (or day or months) L = constant lead time in weeks (or days or months)

12 9

Demand During Lead Time

Specify mean and standard deviation Standard deviation of demand during lead time
dLT = d2L = d L

Safety stock and reorder point Safety stock = zdLT where z = number of standard deviations needed to achieve the cycle-service level dLT = stand deviation of demand during lead time

Reorder point R = dL + safety stock

12 10

Continuous Review Systems General Cost Equation

Calculating total systems costs Total cost = Annual cycle inventory holding cost + Annual ordering cost + Annual safety stock holding cost

Q D C= (H) + (S) + (H) (Safety stock) 2 Q

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Finding Safety Stock and R

Suppose that the average demand for bird feeders is 18 units per week with a standard deviation of 5 units. The lead time is constant at 2 weeks. Determine the safety stock and reorder point for a 90 percent cycle-service level. What is the total cost of the Q system? (t = 1 week; d = 18 units per week; L = 2 weeks) Demand distribution for lead time must be developed:

sL = st

L =5

= 7.1

Safety stock = zsL = 1.28(7.1) = 9.1 or 9 units Reorder point = dL + safety stock = 2(18) + 9 = 45 units 75 936 C= ($15) + ($45) + 9($15) 2 75 C = $562.50 + $561.60 + $135 = $1259.10
12 12

Class Example:
The following info is available for the purchase of kitty litter: Demand: 100 bags/week with a standard deviation of 10 bags/week (assume 50 weeks/year) Price: $10/bag

Ordering costs: $100/order

Annual Holding Costs: 10% of price Desired service level: 99%

Lead time: 4 weeks

What is the Order Quantity and the Reorder Point that assures this service level while minimizing inventory costs. What is the minimum inventory costs?

12 13

Reorder Point for Variable Demand and Lead Time

Often the case that both are variable The equations are more complicated
Safety stock = zdLT R = (Average weekly demand Average lead time) + Safety stock = dL + Safety stock
where dLT = Ld2 + d2LT2

12 14

Solved Problem
Grey Wolf Lodge is a popular 500-room hotel in the North Woods. Managers need to keep close tabs on all room service items, including a special pine-scented bar soap. The daily demand for the soap is 275 bars, with a standard deviation of 30 bars. Ordering cost is $10 and the inventory holding cost is $0.30/bar/year. The lead time from the supplier is 5 days, with a standard deviation of 1 day. The lodge is open 365 days a year. a. What is the economic order quantity for the bar of soap? b. What should the reorder point be for the bar of soap if management wants to have a 99 percent cycle-service level?

c. What is the total annual cost for the bar of soap, assuming a Q system will be used?

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Solved Problem
SOLUTION a. We have D = (275)(365) = 100,375 bars of soap; S = $10; and H = $0.30. The EOQ for the bar of soap is 2DS = H 2(100,375)($10) $0.30

EOQ =

6,691,666.7 = 2,586.83 or 2,587 bars

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Solved Problem
b. We have d = 275 bars/day, d = 30 bars, L = 5 days, and LT = 1 day. dLT = Ld2 + d2LT2 =

(5)(30)2 + (275)2(1)2 = 283.06 bars

Consult the body of the Normal Distribution appendix for 0.9900. The closest value is 0.9901, which corresponds to a z value of 2.33. We calculate the safety stock and reorder point as follows: Safety stock = zdLT = (2.33)(283.06) = 659.53 or 660 bars Reorder point = dL + Safety stock = (275)(5) + 660 = 2,035 bars

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Solved Problem
c. The total annual cost for the Q system is

Q D C = 2 (H) + Q (S) + (H)(Safety stock)

2,587 100,375 C= ($0.30) + ($10) + ($0.30)(660) = $974.05 2 2,587

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Periodic Review System (P)

Fixed interval reorder system or periodic reorder system

Four of the original EOQ assumptions maintained

No constraints are placed on lot size Holding and ordering costs Independent demand

Lead times are certain

Order is placed to bring the inventory position up to the target inventory level, T, when the predetermined time, P, has elapsed

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Periodic Review System (P)

T IP IP IP

On-hand inventory

Order received
Q1 OH IP1 IP3 Order placed IP2 Q2

Order received
OH

Q3

Order received

Order placed

L P Protection interval

L P

Time

Figure 12.10 P System When Demand Is Uncertain

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

How Much to Order in a P System

EXAMPLE A distribution center has a backorder (BO) for five 36-inch color TV sets. No inventory is currently on hand (OH), and now is the time to review. How many should be reordered if T = 400 and no receipts are scheduled (SR)?

SOLUTION
IP = OH + SR BO

= 0 + 0 5 = 5 sets
T IP = 400 (5) = 405 sets That is, 405 sets must be ordered to bring the inventory position up to T sets.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Periodic Review System

Selecting the period of time between reviews (P) The order-up-to level (T) when demand is variable and lead time is constant will be equal to the average demand during the protection period (P+L) + Safety Stock
T = d(P + L) + safety stock for protection interval Safety stock = zP + L , where P + L = s d P L

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Finding Safety Stock and R Continuous Review Model Example

Suppose that the average demand for bird feeders is 18 units per week with a standard deviation of 5 units. The lead time is constant at 2 weeks. Determine the safety stock and reorder point for a 90 percent cycle-service level. What is the total cost of the Q system? (t = 1 week; d = 18 units per week; L = 2 weeks) Demand distribution for lead time must be developed:

sL = st

L =5

= 7.1

Safety stock = zsL = 1.28(7.1) = 9.1 or 9 units Reorder point = dL + safety stock = 2(18) + 9 = 45 units 75 936 C= ($15) + ($45) + 9($15) 2 75 C = $562.50 + $561.60 + $135 = $1259.10

Calculating P and T

What is the equivalent P system to the bird feeder example? Recall that demand for the bird feeder is 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 per year. The Q system calls for an EOQ of 75 units and a safety stock of 9 units for a cycle-service level of 90 percent.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Calculating P and T
SOLUTION We first define D and then P. Here, P is the time between reviews, expressed in weeks because the data are expressed as demand per week:

D = (18 units/week)(52 weeks/year) = 936 units

EOQ 75 P= (52) = (52) = 4.2 or 4 weeks D 936 With d = 18 units per week, an alternative approach is to calculate P by dividing the EOQ by d to get 75/18 = 4.2 or 4 weeks. Either way, we would review the bird feeder inventory every 4 weeks.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Calculating P and T
We now find the standard deviation of demand over the protection interval (P + L) = 6:

s P L s d P L 5 6 12.25units
Before calculating T, we also need a z value. For a 90 percent cycle-service level z = 1.28. The safety stock becomes Safety stock = zP + L = 1.28(12.25) = 15.68 or 16 units We now solve for T: T = Average demand during the protection interval + Safety stock = d(P + L) + safety stock

= (18 units/week)(6 weeks) + 16 units = 124 units

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Periodic Review System

Use simulation when both demand and lead time are variable

Total costs for the P system are the sum of the same three cost elements as in the Q system
Order quantity and safety stock are calculated differently dP D C = 2 (H) + dP (S) + HzP + L

C = (18 units/week)*(4 weeks)/2*(15) + 936/(18*4)*(45) + (15)*1.28*(12.25) C = 36*15 + 13*45 + 15*16 = 540+585+240 = $1,365

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

In Class Example
Discount Appliance Store has the following information:

Demand = 10 units/wk (assume 52 weeks per year) = 520

EOQ = 62 units (with reorder point system) Lead time (L) = 3 weeks Standard deviation in weekly demand = 8 units Cycle-service level of 70% (z = 0.525 )

Choose the Reorder interval P such as this system is approximates the EOQ model.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Comparative Advantages
Primary advantages of P systems
Convenient Orders Only

can be combined

need to know IP when review is made frequency may be individualized

Primary advantages of Q systems

Review Fixed

lot sizes can result in quantity discounts

Lower

safety stocks

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Single Period Model

Assume that you want to have a certain level of confidence that you wont run out of stock and that the demand follows a normal distribution, then the inventory level you should carry will be equal to: Q = D + zs

Example
So if the demand for newspapers on Mondays is normally distributed with a mean of 90 and standard deviation of 10, and the newsboy wants to be 80% certain that he/she will not run out of papers, then the number of papers he/she should order will be equal to: Q = D + zs Q = 90 + .84 * 10 = 98.4 = 99 papers

And to make it even more interesting

If we have the following cost data: Cost per unit of overestimating demand Cost per unit of underestimating demand

Then:
Probability of stockouts <= Cu / (Cu + Co)

Example continued
If we assume that the newspaper boy pays 20 cents per paper and he sells it for 50 cents. How many newspapers should he order if the demand is normally distributed with a mean of 90 and standard deviation of 10?
Cost of underestimating (Lost sales)= .5 - .2 = .3 Cost of overestimation (stock piling) = .2
Probability of stock outs <= .3/(.2+.3) <= .6 <= 60% Z = .253 Q = 90 + .253 * 10 = 92.53 = 93 newspapers

In Class Example
Assume you are helping a Christmas tree retailer determine how many trees to order for this years season. Assuming that you know from past experience that the average demand for Christmas trees in his area is 500 but that the demand over the past 25 years has varied depending on the economy and the offers on plastic trees. The standard deviation of the demand is 100 trees. If this person can buy each tree at an average cost of $5 and sell them at $50, then how many trees would you recommend he orders?
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.