BACHELOR OF BUSINESS ADMINISTRATION

MGMT35002D - Inventory and Warehouse Management

Instructor: Maryam Hafezi, Ph.D.

Professor in Supply Chain Management
Pilon School of Business
Sheridan College

Week 8 - EOQ with Safety Stock II

Agenda

EOQ with Safety Stock II

EOQ with Shortages

ROP in Fixed Order
Quantity
 Inventory Management Models

Independent Demand Dependent Demand

Multi-period model Single-period model ERP Models

Fixed Quantity System Fixed Period Systems

(FQS) (FPS)
or Fixed-order quantity model or Fixed–time period model

Basic
Production
Economic Quantity
Order Quantity
Order Quantity Discount
(POQ)
(EOQ)
Fixed-Order Quantity Models - Assumptions

Demand for the product is known, constant and uniform throughout the period
Lead time (time from ordering to receipt) is known, constant
Receipt of inventory is instantaneous and complete (i.e. The inventory from an
order arrives in one batch at one time)
Price per unit of product is constant (i.e. Quantity discounts are not possible)
The only variable costs are cost of setting up cost or placing an order and the
cost of holding or storing inventory over time.
Inventory holding cost is based on holding average inventory.
Stockout or shortages can be completely avoided if orders placed at the right
time (All demands for the product will be satisfied)
Fixed-Order Quantity Models
Release these assumptions
- Assumptions

Demand for the product is known, constant and uniform throughout the period
Lead time (time from ordering to receipt) is known, constant.
Receipt of inventory is instantaneous and complete (i.e. The inventory from an
order arrives in one batch at one time)
Price per unit of product is constant (i.e. Quantity discounts are not possible)
The only variable costs are cost of setting up cost or placing an order and the
cost of holding or storing inventory over time.
Inventory holding cost is based on holding average inventory.
Stockout or shortages can be completely avoided if orders placed at the right
time (All demands for the product will be satisfied)
Fixed Quantity System (FQS) under Stable
Demand
Reorder Point Curve
Q*
Resupply takes place as order arrives

Inventory level (units)

Slope = units/day = d

ROP
(units)

 𝑹𝑶𝑷=𝒅 ∗𝑳
Time (days)
Lead time = L

Replenishment cycle
Reorder Point Curve
Q*
Resupply takes place as order arrives

Inventory level (units)

Slope = units/day = d

ROP
(units)

Safety Stock

 𝑹𝑶𝑷=𝒅 ∗ 𝑳+𝑺𝑺 SS
(units)

Time (days)
Lead time = L
Ref. Adapted from Heizer, J., & Render, B. (2010). Operations management (10th ed.) Prentice Hall. © 2011 Pearson Education, Inc. publishing as Prentice Hall
Total cost by considering safety stock

 
When it is difficult to determine the cost of being out of stock, a manager may
decide to follow a policy of keeping enough safety stock on hand to meet a
prescribed customer service level.
Reorder point (ROP)

Case 1) Demand during lead-time and lead-time itself are constant.

Case 2) Demand during lead-time is variable and lead-time is
constant.
Case 3) Demand during lead-time is certain and lead-time is variable.
Case 4) Demand during lead-time is variable and lead-time is
variable.
ROP calculation when Demand during lead-time is constant, and lead-time is constant.

  𝑅𝑂𝑃 =𝑑 ∗ 𝐿
ROP calculation when Demand during lead-time is variable and lead-time is constant.
𝑑
  𝑁𝑜𝑟𝑚𝑎𝑙( 𝑑´ , 𝜎 𝑑 )
𝑛

 ´ ∑
𝑖=1
𝑑𝑖
𝑑=
Step1) Simple Average 𝑛

𝑛
 
Step 2) Standard deviation of the daily demand Average

  In Excel:
𝜎 𝑑=
√ ´ 2
∑ ( 𝑑 ¿ ¿𝑖 − 𝑑)
𝑖=1
𝑛− 1
¿

Step 3) Safety Stock  

  In Excel:

Step 4) ROP  

Or:  
 Q19, Page 391 The core (US)
 Part a) The annual demand for a product is 15600
Pre class Week 8 units. The average weekly demand is 300 units with a
standard deviation of 90 units. The cost to place an
order is $31.20, and the time from ordering to receipt
is 4 weeks. The annual inventory carrying cost is $0.1
per unit.
• What is the optimum order quantity?
• Find the reorder point necessary to provide a 98%
service probability.
• What is the total cost?
 Part b) Suppose the production manager is asked to
reduce the safety stock of this item by 50%. If she
does so, what will the new service probability be?
In Excel

 If you have service level and need the  If you have z value, and need the
z value, you can use following in service level you can use following in
excel: excel

𝑍  =𝑁𝑂𝑅𝑀 . 𝑆 . 𝐼𝑁𝑉 (𝑠𝑒𝑟𝑣𝑖𝑐𝑒 𝑙𝑒𝑣𝑒𝑙 𝑃𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦) 𝑆𝑆=

  𝑁𝑂𝑅𝑀 .𝑆 .𝐷𝐼𝑆𝑇 (𝑍 )
Week 8
Safety Stock II
ROP calculation when Demand during lead-time is constant and lead-time is variable.
 𝐿 ´ , 𝜎 𝐿)
𝑁𝑜𝑟𝑚𝑎𝑙 ( 𝐿
𝑛

 ´ ∑
𝑖=1
𝐿𝑖
𝐿=
Step1) Simple Average 𝑛

Step 2) Standard deviation of the Leadtime Average   In Excel:

𝑆𝑆=𝑍
  ∗𝑑 ∗ 𝜎 𝐿
Step 3) Safety Stock

  In Excel:

Step 4) ROP
 
 Days Leadtime DaysLeadtime DaysLeadtime
1 10 16 16 31 12
Activity #1 2
3
17
22
17
18
20
10
32
33
24
18
4 25 19 12 34 25
Service level= 85% 5 18 20 13 35 12
300 working days in a year 6 24 21 23
Ordering Cost = $20 per order 7 17 22 24
8 16 23 17
Holding Cost = $0.5 per unit per year
9 21 24 14
demand per day = 4000 units 10 19 25 20
Find : 11 17 26 20
Q optimal? 12 19 27 13
13 22 28 24
Safety Stock?
14 16 29 11
Reorder Point? 15 23 30 20
N ( number of time you make order)?
T( time between orders) ?
ROP calculation when Demand during lead-time is variable and lead-time is variable.
𝑑
  𝑁𝑜𝑟𝑚𝑎𝑙( 𝑑´ , 𝜎 𝑑 )  𝐿 ´ , 𝜎 𝐿)
𝑁𝑜𝑟𝑚𝑎𝑙 ( 𝐿
𝑛 𝑛

 ´ ∑
𝑖=1
𝑑𝑖  ´ ∑
𝑖=1
𝐿𝑖
𝐿=
Step1) Simple Average 𝑑=
𝑛 𝑛

Step 2) Standard deviation of the Averages   In Excel:

  In Excel:

  2 2 2
Step 3) Safety Stock ´√ ´
𝑆𝑆=𝑍 ∗ ( 𝐿 ∗ 𝜎 𝑑 ) +( 𝑑) ∗ ( 𝜎 𝐿 )
  In Excel:

Step 4) ROP  
Activity #2 The circuit town store’s most popular item is a nine-volt
batteries. About 150 packs are sold per day, following a
normal distribution with a standard deviation of 16
packs. Batteries are ordered from an out-of-town
distributor; Leadtime is normally distributed with an
average of five days and a standard deviation of one
day. To maintain a 95%service level, what ROP is
appropriate?
 

Service level: 95%

ROP?

ROP=(150*5)+(1.64)*

ROP = 750+252.9=1002.9
 Demand Demand Lead time Lead time
192 199 9 7
162 121 11 12
123 194 7 14
Activity #3 169 164 12 7
150 128 7 11
Service level= 99.99% 173 13 14
171 7 10
300 days in a year
162 7 14
Ordering Cost = $20 per order 123 11 9
Holding Cost = $0.5 per unit per year 138 12
114 10
177 14
Find :
113 9
Q optimal? 193 8
Safety Stock? 102 14
Reorder Point?
N?
T?
EOQ with Shortages
 Inventory Management Models

Independent Demand Dependent Demand

Multi-period model Single-period model ERP Models

Fixed Quantity System Fixed Period Systems

(FQS) (FPS)
or Fixed-order quantity model or Fixed–time period model

Basic Production Order

Quantity (POQ)/
Economic Quantity
Economic Shortage
Order Quantity Production Discount
(EOQ) Quantity( EPQ)
Fixed-Order Quantity Models - Assumptions

Demand for the product is known, constant and uniform throughout the period
Lead time (time from ordering to receipt) is known, constant.
Receipt of inventory is instantaneous and complete (i.e. The inventory from an
order arrives in one batch at one time)
Price per unit of product is constant (i.e. Quantity discounts are not possible)
The only variable costs are cost of setting up cost or placing an order and the
cost of holding or storing inventory over time.
Release these assumptions
Inventory holding cost is based on holding average inventory.
Stockout or shortages can be completely avoided if orders placed at the right
time (All demands for the product will be satisfied)
Inventory position for the EOQ with planned shortages model. 
  Annual   Annual   Annual 
     
TC   Holding    Ordering    Back Order 
 Cost   Cost   Cost 
        𝐻
  Q  Qb  2
 D Q 
2 𝑄 𝑏=𝑄 ∗( )
TC    H    S  
 
b
 B 𝐻+𝐵
 2Q  Q  2Q 
2 DS  H  B 
Q   OR
H  B 
B  back  order cost per unit per year
 
Qb  quantity back - ordered per order cycle 2 𝐷𝑆𝐻
H  annual holding cost per unit
D  annual demand
S  ordering (or setup) cost per order
𝑄 𝑏=
√𝐵(𝐵+𝐻)
   

=time period ( during an order interval)when

inventory level is non-negative

time period ( during an order interval)when

inventory level is negative (i.e. backorder occurs)

demand rate per day

Pre class #2- Annual demand for a refrigerator is 50 units.
Holding cost per unit per year is $200.
Week 8
Back-order cost per unit per year is estimated to be
$500.
Ordering cost from the manufacturer is $10 per order.
Determine order quantity and back-order quantity per
order cycle.
tb, t, T?
What is the total cost?
(assume we have 365 days per year)
Readings

Readings
1.a. Operations and Supply Chain Management: The Core, Jacobs and Chase (2014), Fourth
Edition, Inventory Planning and Accuracy, Chapter 11, From Page 367- 372
OR
1.b. Operations and Supply Chain Management: The Core, Jacobs et al. (2013) Second
Canadian Edition, chapter 10, from Page  307-313
AND
2.Warehouse Management, Second Edition, Richards (2014), Chapter 9 and chapter 10 from
203- 254