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Methods For Independent Demand
Methods For Independent Demand
Part II
Methods for
Independent Demand
Chapter 3
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Introduction
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Stock
level
Stock
out
Place Place
order order
Time
Replenishment Replenishment
Replenishment
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Implicit Assumptions:
• We can consider a single item in isolation, so we cannot
save money by substituting other items or grouping several
items into a single order;
• Purchase price and reorder costs do not vary with the
quantity ordered;
• A single delivery is made for each order;
• Replenishment is instantaneous, so that all of an order
arrives in stock at the same time and can be used
immediately.
Demand
Time
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Stock
level
Time
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• Unit cost (UC) is the price charged by the suppliers for one unit of the
item, or the total cost to the organization of acquiring one unit.
• Reorder cost (RC) is the cost of placing a routine order for the item and
might include allowances for drawing-up an order, correspondence,
telephone costs, receiving, use of equipment, expediting, delivery,
quality checks, and so on. If the item is made internally, this might be a
set-up cost.
• Holding cost (HC) is the cost of holding one unit of the item in stock for
one period of time. The usual period for calculating stock costs is a
year.
• Shortage cost (SC) is the cost of having a shortage and not being able
to meet demand from stock. In this analysis we have said that no
shortages are allowed, so SC does not appear (it is effectively so large
that any shortage would be prohibitively expensive).
Decision Variables
Other Variables
• Demand (D) which sets the number of units to be
supplied from stock in a given time period.
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Standard approach
1. Find the total cost of one stock cycle.
2. Divide this total cost by the cycle length to get a
cost per unit time.
3. Minimize this cost per unit time.
D
Average
stock
level
Time
𝑄 =𝐷×𝑇 Place order & T Place order &
receive delivery receive delivery
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𝑆𝑖𝑛𝑐𝑒 𝑄 = 𝐷 × 𝑇
𝑅𝐶 × 𝐷 HC × Q
𝑇𝐶 = 𝑈𝐶 × 𝐷 + +
𝑄 2
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𝑑(𝑇𝐶) 𝑅𝐶 × 𝐷 HC
=− + =0
𝑑(𝑄) 𝑄2 2
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Worked Example 1:
EOQ
Jaydeep Company buys 6,000 units of an item every year with a unit
cost of $30. It costs $125 to process an order and arrange delivery,
while interest and storage costs amount to $6 a year for each unit
held. What is the best ordering policy for the item?
𝐷 = 6000 units/yr 𝑅𝐶= $125 an order
𝑈𝐶= $30 a unit 𝐻𝐶= $6/yr for a unit
2 × 𝑅𝐶 × 𝐷 2 × 125 × 6000
𝑄𝑜 = = = 500
𝐻𝐶 6
𝑄𝑜 500 1
𝑇𝑜 = = = 𝑦𝑒𝑎𝑟 = 1 𝑚𝑜.
𝐷 6000 12
𝑇𝐶𝑜 = 𝑈𝐶 × 𝐷 + 𝐻𝐶 × 𝑄𝑜 = 30 × 6000 + 6 × 500
= $183000
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Worked Example 2:
EOQ
Sarah Brown works for a manufacturer that makes parts for marine
engines. The parts are made in batches, and every time a new
batch is started it costs £1,640 for disruption and lost production and
£280 in wages for the fitters. One item has an annual demand of
1,250 units with a selling price of £300, 60% of which is direct
material and production costs. If the company looks for a return of
20 per cent a year on capital, what is the optimal batch size for
the item and the associated costs?
𝐷 = 1250 units/yr
𝑈𝐶= (£300)(60%) = £180 a unit
𝐻𝐶= (£180)(20%) = £36/yr for a unit
𝑅𝐶= £1640 + 280 = £1920 per setup
Worked Example 2:
EOQ
𝐷 = 1250 units/yr
𝑈𝐶= (£300)(60%) = £180 a unit
𝐻𝐶= (£180)(20%) = £36/yr for a unit
𝑅𝐶= £1640 + 280 = £1920 per setup
2 × 𝑅𝐶 × 𝐷 2 × 1920 × 1250
𝑄𝑜 = = = 365
𝐻𝐶 36
𝑄𝑜 365
𝑇𝑜 = = = 0.29 𝑦𝑒𝑎𝑟 = 15 𝑤𝑒𝑒𝑘𝑠
𝐷 1250
𝑇𝐶𝑜 = 𝑈𝐶 × 𝐷 + 𝐻𝐶 × 𝑄𝑜 = 180 × 1250 + 36 × 365
= £238140
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𝑅𝐶×𝐷 HC× Q
𝑆𝑖𝑛𝑐𝑒 𝑉𝐶𝑜 = 𝐻𝐶 × 𝑄𝑜 and 𝑉𝐶 = 𝑄 + 2
𝑉𝐶 𝑅𝐶 × 𝐷 𝐻𝐶 × 𝑄
= +
𝑉𝐶𝑜 𝑄 × 𝐻𝐶 × 𝑄𝑜 2 × 𝐻𝐶 × 𝑄𝑜
2×𝑅𝐶×𝐷
Substituting 𝑄𝑜 = 𝐻𝐶
𝑉𝐶 1 𝑄0 𝑄 1 1 𝑘 𝑄
= + = + where k =
𝑉𝐶𝑜 2 𝑄 𝑄𝑜 2 𝑘 1 𝑄0
−𝑏± 𝑏 2 −4𝑎𝑐
Quadratic formula 𝑥 = 2𝑎
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Worked Example 3:
Adjusting EOQ
Each unit of an item costs a company £40 with annual holding costs
of 18% of unit cost for interest charges, 1% for insurance, 2% per
cent allowance for obsolescence, £2 for building overheads, £1.50
for damage and loss and £4 miscellaneous costs. If the annual
demand for the item is constant at 1,000 units and each order costs
£100 to place, calculate the economic order quantity and the total
cost of stocking the item. If the supplier will only deliver batches of
250 units, how does this affect the costs?
𝐷 = 1000 units/yr
𝑈𝐶= £40
𝐻𝐶= (£40 )(21%)+ £7.50 = £15.90 /yr for a unit
𝑅𝐶= £100 per order
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Worked Example 3:
Adjusting EOQ
𝐷 = 1000 units/yr
𝑈𝐶= £40
𝐻𝐶= (£40 )(21%)+ £7.50 = £15.90 /yr for a unit
𝑅𝐶= £100 per order
2 × 𝑅𝐶 × 𝐷 2 × 100 × 1000
𝑄𝑜 = = = 112.15
𝐻𝐶 15.90
𝑉𝐶𝑜 = 𝐻𝐶 × 𝑄𝑜 = 15.90 × 112.15 = £1783
𝑉𝐶 1 𝑄0 𝑄
= +
𝑉𝐶𝑜 2 𝑄 𝑄𝑜
𝑉𝐶𝑜 𝑄0 𝑄 1783 112.15 250
𝑉𝐶 = + = + = £2388 a year
2 𝑄 𝑄𝑜 2 250 112.15
Worked Example 4:
Adjusting EOQ
Jessica Choi works in her bakery for 6 days a week for 49 weeks a
year. Flour is delivered directly with a charge of £7.50 for each
delivery. Jessica uses an average of 10 sacks of whole-grain flour a
day, for which she pays £12 a sack. She has an overdraft at the
bank which costs 12% a year, with spillage, storage, loss and
insurance costing 6.75% a year.
a) What size of delivery should Jessica use and what are the
resulting costs?
b) How much should she order if the flour has a shelf-life of 2
weeks?
c) How much should she order if the bank imposes a maximum
order value of £1,500?
d) If the mill only delivers on Mondays, how much Jessica order
and how often?
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Worked Example 4:
Adjusting EOQ
𝐷 = 10(6)(49) = 2940 sacks/yr
𝑈𝐶= £12
𝐻𝐶= (£12 )(12%+6.75%) = £2.25 /yr for a sack
𝑅𝐶= £7.50 per order
2×𝑅𝐶×𝐷 2×7.50×2940
a) 𝑄𝑜 = = = 140
𝐻𝐶 2.25
𝑉𝐶𝑜 = 𝐻𝐶 × 𝑄𝑜 = 2.25 × 140 = £315
Worked Example 4:
Adjusting EOQ
c) Max. order = £ 1500; Q 125
𝑉𝐶𝑜 𝑄0 𝑄 315 140 125
𝑉𝐶 = + = + = £317.03 a year
2 𝑄 𝑄𝑜 2 125 140
d) Weekly delivery; T = 1, 2, 3,… weeks
𝑉𝐶𝑜 𝑄0 𝑄 315 140 120
𝑇 = 2; 𝑉𝐶 = + = + = £318.75 a year
2 𝑄 𝑄𝑜 2 120 140
𝑉𝐶𝑜 𝑄0 𝑄 315 140 180
𝑇 = 3; 𝑉𝐶 = + = + = £325.00 a year
2 𝑄 𝑄𝑜 2 180 140
e) Consider all conditions simultaneously
Shelf-life = 2 weeks; Q 10(6)(2) = 120
Max. order = £ 1500; Q 125
Weekly delivery; Q = 60, 120, 180, …
Q = 120
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Worked Example 5:
Orders for Discrete Items
Schlessinger Aeronautic work a 50-week year and stock an electric
motor with the following characteristics:
D = 20 a week
UC = £2,500 a unit
RC = £50
HC = £660 a unit a year
What is the optimal order quantity? Would it make much difference
if this number were rounded up or down to the nearest integer?
Worked Example 5:
Orders for Discrete Items
D = 20 a week
UC = £2,500 a unit
RC = £50
HC = £660 a unit a year
2×𝑅𝐶×𝐷 2×50×(20×50)
a) 𝑄𝑜 = = = 12.31
𝐻𝐶 660
Check if (𝑄′ )(𝑄′ − 1) ≤ 𝑄𝑜 2
12 13 > 12.312 ∴ 𝑄 = 12
𝑅𝐶×𝐷 HC× Q 50×(20×50) 660×12
b) VC 12 = 𝑄
+ 2
= 12
+ 2 = £8126.67
𝑅𝐶 × 𝐷 HC × Q′ 50 × (20 × 50) 660 × 13
VC 13 = + = + = £8136.15
𝑄 2 13 2
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140.00%
120.00%
100.00%
80.00%
60.00%
40.00%
20.00%
0.00%
-150% -100% -50% 0% 50% 100% 150%
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Reverse Calculation:
Estimating Implied Costs
2×𝑅𝐶×𝐷 𝑄0 2 ×𝐻𝐶
𝑄0 = , 𝑅𝐶 =
𝐻𝐶 2×𝐷
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Worked Example 6:
Estimating implied costs
A company has a standing order of 40 units of an item every
month. What can you infer about the costs? If the reorder cost
is actually €160, what is the implied holding cost?
D = 40 a month
RC = €160
2 × 𝑅𝐶 × 𝐷 2 × €160 × 40/𝑚𝑜
𝐻𝐶 = = = €8.00/mo
𝑄0 2 402
2 × 𝑅𝐶 × 𝐷
𝑄=𝑘×
𝐻𝐶
2 × 𝑅𝐶 × 𝐷
𝑄=
𝐻𝐶 × 𝑘
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Reorder
level
LT Time
𝑅𝑂𝐿 = 𝐷 × 𝐿𝑇 Place Receive
order delivery
Worked Example 7:
Reorder Level w/Finite Lead Time
Carl Smith uses radiators at the rate of 100 a week, and he
has calculated an EOQ of 250 units. What is his best ordering
policy if lead time is: (a) one week? or (b) two weeks?
D = 100 a week
EOQ = 250
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Stock
level
Time
Place Place Receive Receive
order B order C delivery B delivery C
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Worked Example 8:
Longer Lead Time
Demand for an item is steady at 1,200 units a year with an ordering
cost of £16 and holding cost of £0.24 a unit a year. Describe an
appropriate ordering policy if the lead time is constant at (a) 3
months; (b) 9 months; or (c) 18 months.
𝐷 = 1200 units/yr; 𝐻𝐶= £0.24 /yr for a unit; 𝑅𝐶= £16 per order
2 × 𝑅𝐶 × 𝐷 2 × 16 × 1200
𝑄𝑜 = = = 400
𝐻𝐶 0.24
𝑄𝑜 400
𝑇𝑜 = = = 0.3333 𝑦𝑟. = 4 𝑚𝑜.
𝐷 1200
𝐿𝑇
a) LT = 3 mo.; 𝑛 = 𝑟𝑜𝑢𝑛𝑑𝑑𝑜𝑤𝑛 = 0; 𝑅𝑂𝐿 = 𝐿𝑇 × 𝐷 − 𝑛 × 𝑄0 = 300
𝑇𝑜
𝐿𝑇
b) LT = 9 mo.; 𝑛 = 𝑟𝑜𝑢𝑛𝑑𝑑𝑜𝑤𝑛 = 2; 𝑅𝑂𝐿 = 𝐿𝑇 × 𝐷 − 𝑛 × 𝑄0 = 100
𝑇𝑜
𝐿𝑇
c) LT = 18 mo.; 𝑛 = 𝑟𝑜𝑢𝑛𝑑𝑑𝑜𝑤𝑛 = 4; 𝑅𝑂𝐿 = 𝐿𝑇 × 𝐷 − 𝑛 × 𝑄0 = 200
𝑇𝑜
Practical Points
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