Operations Management

Dr. Gopal Kumar

gopalkumar@iimraipur.ac.in

IIM Raipur
06 February 2020

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 1/21
Continuous Review System

Inventory is tracked continuously and an order, Q, is placed

when inventory declines below the reorder point.

Fixed order quantity

Higher value items
Inventory
Lead time
Size of inventory is lower
(Q, R) policy
QQ
Costly to maintain and review

ROP

2 Time, t Q model
0 1 3
Ordered quantity or lot size is constant EOQ model

Difficult to get quantity discount on bundled order Sawtooth model

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 2/21
Continuous Review System
Demand is variable and lead time is constant

A distribution center (DC) in Wisconsin stocks Sony plasma TV sets.

The center receives its inventory from a mega warehouse in Kansas
with a lead time (L) of 5 days. The DC uses a reorder point (R) of
300 sets and a fixed order quantity (Q) of 250 sets. Current on-
hand inventory at the end of Day 1 is 400 sets. There are no
scheduled receipts (SR) and no backorders (BO). All demands and
receipts occur at the end of the day. Given the demand schedule in
the table below, determine when to order using a Q system.

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 3/21
Continuous Review System
Demand is variable and lead time is constant
L = 5 days, Q = 250, ROP = 300
Day Demand OH SR BO IP Q

1 50 400 400 + 0 = 400

2 60 340 340 + 0 = 340

3 260 250 after ordering 260 < R before ordering 250 due
80 260 + 250 = 510 after ordering Day 8
4 40 220 250 220 + 250 = 470

5 75 145 250 145 + 250 = 395

6 55 90 250 90 + 250 = 340

7 0 + 250 – 5 = 245 < R before ordering 250 due

95 0 250+ 250 = 500 5
after ordering 0 + 500 –5= 495 after ordering Day 12

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 4/21
Continuous Review System
Demand is variable and lead time is constant
L = 5 days, Q = 250, ROP = 300
Day Demand OH SR BO IP Q

8 50 0 + 250 – 50 -5 250 195 + 250 = 445

= 195
9 45 195 – 45 = 150 250 150 + 250 = 400

10 30 120 250 120 + 250 = 370

11 50 70 250 70 + 250 = 320

12 70 – 60 + 250 250 after 260 < R before ordering 250 due

60
= 260 ordering 260 + 250 = 510 after ordering Day 17

13 40 260 – 40 = 220 250 220 + 250 = 470

14 50 170 250 170 + 250 = 420

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 5/21
Safety Stock
Q-System
.

▶Used when demand is not constant or certain

▶Use safety stock to achieve a desired service
level and avoid stockouts

Service level
❖ Desired probability of not running out of stock in any
ordering cycle.

❖ 95% service level means 95% of the time stockout can be avoided.

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 6/21
Safety Stock
Q-System

.
ROP = Demand during lead time + safety stock
= dL + ss
95%
=> ROP = dL + zσdLT
5%
σdLT = σd 𝐿 No stockout

Where, µ
zσdLT S
z = number of standard deviation
σdLT = s.dev. of demand during lead time
σd = s.dev. of demand
L = lead time
Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 7/21
Safety Stock Q-System

.
σd = 15 σd = 15 σd = 15

+ + =
75 75 75
Demand for week 1 Demand for week 2 Demand for week 3

σdlt = 15√3=25.98

225
Demand for 3-week lead
σdLT = σd 𝐿 time

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 8/21
Safety Stock Q-System
Example
Petromax Enterprises uses a continuous review inventory control
system for one of its SKUs. The following information is available on
the item. The firm operates 50 weeks in a year.
Demand = 50,000 units/year, Ordering cost = $150/order, Holding cost
= $0.50/unit/year, Average lead time = 3weeks, Standard deviation of
weekly demand = 125units
a. What is the economic order quantity for this item?
b. If Petromax wants to provide a 90 percent cycle-service level, what
should be the safety stock and the reorder point?

2𝐷𝑆 2∗50,000∗150
EOQ = = = 5,477 𝑢𝑛𝑖𝑡𝑠
𝐻 0.50
Safety stock = zσ𝑑𝐿𝑇 = 𝑧σ𝑑 𝐿 = 1.28 125 3 = 277.13 𝑜𝑟 277 𝑢𝑛𝑖𝑡𝑠
Reorder point (ROP) = Average demand during lead time + Safety stock
= 3(50000/50) + 277 = 3,277 units
Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 9/21
Periodic review policy (P-system)
P-System

Inventory is checked at a regular periodic intervals and an

order is placed to raise the inventory to a specified level.

Ordering interval is fixed

Inventory

QQ Size of inventory is higher

Fixed-time period system

Risk of running out of
stock

Time, t
0 P 1 P 2 P 3
Requires more safety stock

Items can be bundled to get quantity discount

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 10/21
Periodic review policy (P-system)
P-System
For P-system
Protection interval = P + L
= 3 + 1 = 4 weeks

Inventory
For Q-system
Protection interval = L
TQ = 1 week

Time, t
0 1 2 3 4 5

Lead time
= 1 week

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 11/21
Periodic review policy
P-System
Example
Suppose that the management want to use a Periodic
Review System for the Sony TV sets. The first review is
scheduled for the end of Day 2. All demands and receipts
occur at the end of the day. Lead time is 5 Days and
management has set T = 620 and P = 6 days.
• Determine how much to order (Q) using a P System.

L = 5 Days
T = 620 Units
Review period = 6 Days

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 12/21
Periodic review policy
P-System
Example
L = 5 Days, T = 620 Units, Review period = 6 Days
Day Demand OH SR BO IP Q

1 50 400 400

2 280 after 340 before ordering 280 (due Day 7)

60 340
ordering 340 + 280 = 620 after ordering
3 80 260 280 260 + 280 = 540

4 40 220 280 220 + 280 = 500

5 75 145 280 145 + 280 = 425

6 55 90 280 90 + 280 = 370

7 95 90 + 280 –
95 = 275 275 + 0 = 275

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 13/21
Periodic review policy P-System
Example
L = 5 Days, T = 620 Units, Review period = 6 Days
Day Demand OH SR BO IP Q

8 50 225 395 after 225 + 0 = 225 before ordering 395 (due Day
ordering 225 + 395 = 620 after ordering 13)

9 45 180 395 180 + 395 = 575

10 30 150 395 150 + 395 = 545

11 50 100 395 100 + 395 = 495

12 60 40 395 40 + 395 = 435

13 40 40 + 395 – 395 + 0 = 395

40 = 395
14 50 345 275 after 340 + 0 = 340 before ordering 275 (due Day
ordering 345 + 275 = 620 after ordering 19)
Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 14/21
Periodic review policy P-System
Example
Petromax Enterprises uses aperiodic
continuous review inventory control
system for one of its SKUs. The following information is available on
the item. The firm operates 50 weeks in a year.
Demand = 50,000 units/year, Ordering cost = $150/order, Holding cost
= $0.50/unit/year, Average lead time =3 weeks, Standard deviation of
weekly demand = 125 units
a. What should be the review period (P) and target inventory (T) to
achieve 90% cycle service level?
b. If 1,000 units were in stock during review, how many units should
be ordered?
2𝐷𝑆 2∗50,000∗150
EOQ = = = 5,477 𝑢𝑛𝑖𝑡𝑠
𝐻 0.50
𝑄 5477
Time between review (P) = = = 5.48 𝑤𝑒𝑒𝑘𝑠
𝐷 1000
Protection interval = P + L = 5.48 + 3 = 8.48 weeks
Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 15/21
Periodic review policy P-System
Example
Safety stock = z𝜎𝑃+𝐿 = 1.28 × 𝜎𝑑 𝑃 + 𝐿
= 1.28 × 125 5.48 + 3
= 466
Target inventory = Average demand during protection interval
+ Safety stock
= 8.48*(50000/50) + 466
= 8,946
The amount to order = T - IP
= 8946 - 1000
= 7,946

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 16/21
Newsvendor model (single-period model)

▶Only one order is placed for a product

▶Units have little or no value at the end of the
sales period

Cu = Cost of understocking = Sales price/unit – Cost/unit

Co = Cost of overstocking = Cost/unit – Salvage value

Cu
Service level = Critical service level (CSL)
Cu + Co Or critical fractile

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 17/21
Newsvendor model (single-period model)

▶Purchasing price = 10
▶Selling price = 22
▶Daily demand is normally distributed with average 20 and
standard deviation 30

Cu = 22 – 10 = 12
Co = 10 – 0 = 10

Cu 12 µz
Service level = = = 0.54
Cu + Co 12 + 10

=NORMSINV(0.54) = 0.10

Order quantity = µ + zσ = 20 + 0.1*30 = 23

Retailer should order 23 units/day
Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 18/21
Newsvendor model (single-period model)

▶Purchasing price = 10
▶Selling price = 22
▶Monthly demand is uniformly distributed with minimum 20 and
maximum 30 units

Cu = 22 – 10 = 12
Co = 10 – 0 = 10 A

20 30
Cu 12 x
Service level = = = 0.54
Cu + Co 12 + 10

1
0.54 = (x-20) ⇒ 𝑥 = 25.4
30−20

Retailer should order 26 units/month

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 19/21
References
Forecasting
Heizer, J., Render, B. and Munson, C. Operations
Management: Sustainability and Supply Chain
Management, Pearson, India.
OM: A South-Asian Perspective by David A.
Collier, James R. Evans, and Kunal Ganguly,
Cenage Learning, (Latest Edition), India.
Krajewski, L.J., Ritzman, L.P., Malhotra, M.K. and
Srivastava, S.K. Operations Management
Processes and Supply Chain, Latest edition,
Pearson

Dr. Gopal Kumar (IIM Raipur) Operations Management 06 February 2020 20/21
 .

Thanks!

Dr. Gopal Kumar (IIM Raipur) Operations Management II 06 February 2020 21/21