“Education in Pursuit of

Supply Chain Leadership” dp&c Chapter8

Chapter 8
Statistical Inventory
Management

8-1 dp&c Chapter8

 Learning Objectives

• Understand the demand driver

• Define the concepts of stock replenishment
• Describe the replenishment review interval
• Review the basic terms of statistical inventory
replenishment
• Review the basic inventory replenishment techniques
• Detail the basic of the reorder point
• Work with reorder point lead time and safety stock
• Explore min/max and periodic review methods
8-2 dp&c Chapter8
 Learning Objectives (cont.)

• Define order quantity techniques

• Calculate the economic order quantity (EOQ)
• Detail the assumption of the EOQ technique
• Calculate order quantity discounts
• Perform order quantity joint replenishment
• Determine the transportation EOQ
• Discuss replenishment by item class
• Discuss the application of lean to statistical order
management

8-3 dp&c Chapter8

 Chapter 8
Statistical Inventory Management

Statistical Inventory
Inventory
Replenishment
Management Basics
Concepts

8-4 dp&c Chapter8

Understanding the Demand Driver
Independent Demand
The demand for an item that is unrelated to the demand
for other items. Demand for finished goods, parts
required for destructive testing, and service parts
requirements are examples of independent demand

Dependent Demand
Demand that is directly related to or derived from the bill
of material structure for other items or end products. Such
demands are therefore calculated and need not and
should not be forecast

APICS Dictionary, 13th edition

8-5 dp&c Chapter8

Characteristics of Dependent Demand
• Demand for these items is independent of company
inventory decisions.
• Demand for these items is subject to a level of random
variation.
• These items are usually planned and managed without
reference to other items.
• Planning for these items usually involves the use of
forecasting techniques designed to foretell future demand
based on past historical usage.
• These items are best planned with some form of safety or
reserve stock to counterbalance variation in forecasting.
• The critical question for inventory availability is one of
quantity rather than timing.

8-6 dp&c Chapter8

Characteristics of Dependent Demand
• Dependent demand items are always planned and managed in
relation to other items as detailed in the bills of material (BOMs)
in which they are specified
• Replenishment quantities for production inventories can be
precisely determined by establishing the demand on “parent”
level assemblies and then using the BOM structure to calculate
exactly the “children” item requirements and due dates
• Future demand for production inventories should not be
forecasted
• Management inventory planning decisions directly impact the
demand for these items
• Dependent demand items rarely use safety or reserve stocks
• The critical question for inventory availability is one of timing
rather than quantity

8-7 dp&c Chapter8

BOM Structure Example

Independent Demand A

Dependent
B C
Independent Demand
Demand Dependent
(Service Part) D E Demand
Dependent Dependent
Demand Demand

8-8 dp&c Chapter8

Concept of Inventory Replenishment

The theory behind inventory replenishment

management is that for each item, an optimal
stocking and ordering quantity can be determined
either statistically or through some form of
experience, or even intuition. The object is to
ensure that the optimum stocking level for each
item in the inventory is maintained at the targeted
service level without creating excess stock.

8-9 dp&c Chapter8

“Saw-Tooth Chart”
Quantity

Replenishment
Order
A Trigger
Point

Inventory
C
Lead
Time Safety Stock
Time

8-10 dp&c Chapter8

Replenishment Review Interval

Continuous Review System

The inventory level on-hand and on-order for this

system is checked whenever a change in
inventory level occurs and when the reorder point
is reached a restocking order is released

Periodic Review System

In this model an order is placed every “n” time

periods. The order quantity is variable and
essentially replaces the items consumed during
the current time period

8-11 dp&c Chapter8

Continuous and Periodic Review Systems

Issue Continuous Periodic

Lower maintenance expense X
Ordering by item family X
Lower inventory investment X
Replenishment predictability X
Overall control X
Fast-moving items X
Low cost bulk items X
Higher customer service levels X
Use of computer required X
Lower purchase order costs X

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Basic Replenishment Technique Terms
Determines the rate at which an item’s
Demand inventory is consumed
Determines the average amount of
Cycle Stock inventory on hand for a product sufficient
to satisfy demand during the lead time
Determines the extra inventory a company
Safety Stock
decides to hold in addition to cycle stock

Replenishment Determines the available inventory on-

Trigger hand balance at which a replenishment
order is triggered
On-Hand Determines the current available quantity
Balance of an item

8-13 dp&c Chapter8

Basic Replenishment Technique Terms (cont.)
Determines the point in time inventory
Review Interval balance records should be reviewed for
possible replenishment
Determines the span of time from the
Lead Time moment the need for resupply is identified
until it has been received

Reorder Determines the replenishment quantity to

Quantity restore inventory above the trigger point

Determines the standard quantity in which

Lot Size items are either manufactured or
purchased

8-14 dp&c Chapter8

 Chapter 8
Statistical Inventory Management

Inventory
Inventory
Replenishment
Management Basics
Techniques

8-15 dp&c Chapter8

Replenishment Ordering Techniques
Replenishment determined by physically
Visual Review reviewing the inventory on-hand balance
Fix order system using two containers: one
Two-Bin for picking and one for reserve
A fixed review cycle is established and
Periodic Review replenishment occurs at the time of review

A targeted quantity is statistically determined

Order Point that is used as the trigger for replenishment
A computerized method that time phases
TPOP demand and replenishment activities
Replenishment is triggered using non-
Lean computer tools, such as a kanban card
8-16 dp&c Chapter8
 Chapter 8
Statistical Inventory Management

Inventory
Reorder Point
Management Basics
Systems

8-17 dp&c Chapter8

Order Point Technique

The order point calculation consists in

determining if there is enough
inventory on hand to satisfy Demand
during the Lead Time plus Safety Stock

OP = Demand x Lead Time

+ Safety Stock

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Order Point – Basic Model

Demand

Inventory Stockout point

Quantity

Time

8-19 dp&c Chapter8

Reorder Point - Exercise
Objective: Calculate a reorder point
Data: Average demand per week is 100 units, the
replenishment lead time is 2 weeks, and the safety stock
is 50 units
Formula: ROP = D x LT + SS
where:
ROP = Reorder point
D = Demand
LT = Lead time
SS = Safety stock
Solution: 100 x 2 + 50 = 250 units

8-20 dp&c Chapter8

Reorder Point Using Trend
Objective: Calculate a reorder point using trend
Data:
• Past week’s demand = 205 units
• The a factor = 0.1
• Prior period’s smoothed average = 174.46
• Prior period’s trend = 0.58
• Lead time = 2 weeks
Solution:
1. New smoothed average demand = a(Dt) + (1 – a) (Dt-1) =
0.1 x 205 + .9 x 174.46 = 177.51
2. The difference is Dt1 – Dt = 177.51 – 174.46 = 3.05
3. The trend is Trendt-1(1 – a) + a x Differencet = 0.82

8-21 dp&c Chapter8

Reorder Point Using Trend – Exercise (cont.)
Solution:
4. New expected period demand is ((Trendt(1 – a) / a) +
Smoothed averaget = 0.82 x 0.9/0.10 + 177.5 = 184.93
5. New forecast of reorder point demand is expected period
demand x LT = 184.93 x 2 = 370 units

Smoothing constant (a ) 0.1 (1-a) 0.9 Lead Time 2

Simple Smoothed Expected Actual
Date Demand Difference Trend Forecast Variance
Average Average Demand Demand
168.00 168.00 0.00
Week 1 170 338.00 168.20 0.20 0.02 168.38 337 315 22
Week 2 176 345.00 168.98 0.78 0.10 169.84 340 348 -8
Week 3 181 353.50 170.18 1.20 0.21 172.04 344 394 -50
Week 4 189 365.75 172.06 1.88 0.37 175.43 351 329 22
Week 5 196 378.88 174.46 2.39 0.58 179.64 359 352 7
Week 6 205 394.44 177.51 3.05 0.82 184.93 370 432 -62
Average -69

8-22 dp&c Chapter8

Cyclical Order Point Using Trend
Objective: Calculate a cyclical reorder point using trend
Data:
• 13 months of past data
• The a factor = 0.1
• The (1-a) / a factor = 9.0
• Current month’s demand = 145 units
• Current base series = 119.7 (calculated by using the
surrounding quarter demand from the previous year.)
Solution:
1. New demand ratio = current demand / current base series =
145 / 119.7 = 1.211.
2. New average ratio = (1-a) x Previous average ratio + (a x
Current demand ratio) = (.9 x 1.098) + (.1 x 112.11) = 1.109.

8-23 dp&c Chapter8

Cyclical Order Point Using Trend (cont.)
Solution:
3. The difference is Current demand ratio – Current average
ratio
Smoothing = 1.211
constant (a ) – 1.1090.1= .011. (1-a) 0.9 (1-a) / a 9
4. New
Month
trend Base
Demand
is (1-a) x Previous
Demand Average trend + (a x Current
Difference Trend
difference)
Expected Expected
Series Ratio Ratio Ratio Demand
=
Jan-12
(.9 x .0034)
115
+ (.1 x .011) = .0042.
1.050 0 1.050
5. New expected
Feb-13 126 120.70ratio1.044
is Current
1.049 period-0.001 average
-0.0001 ratio + (1-a)
1.049 /a
126.60
Mar-13 141 126.30 1.116 1.056 0.007 0.0006 1.062 134.08
+
Apr-13 Current
135 trend
127.30 = 1.109
1.060 + 9 +
1.057 .0042 =
0.000 1.148.
0.0006 1.062 135.18
May-13 125 128.30 0.974 1.048 -0.008 -0.0003 1.046 134.17
6. New
Jun-13
expected
149 134.70
demand1.106
is Current
1.054
expected
0.006
ratio
0.0003
x current
1.057 142.38
base series
Jul-13 170 = 1.1481.183
143.70 x 119.7 = 137.36
1.067 0.013 0.0016 1.081 155.37
Aug-13 170 144 1.181 1.078 0.011 0.0026 1.101 158.60
Sep-13 158 134.3 1.176 1.088 0.010 0.0033 1.118 150.11
Oct-13 133 119.7 1.111 1.090 0.002 0.0032 1.119 133.96
Nov-13 114 113.7 1.003 1.082 -0.009 0.0020 1.100 125.02
Dec-13 140 112.3 1.247 1.098 0.016 0.0034 1.129 126.80
Jan-14 145 119.7 1.211 1.109 0.011 0.0042 1.148 137.36

8-24 dp&c Chapter8

Defining Lead Time
The time it takes for review and selection of
Oder Review items for replenishment order action

Time to generate the order and review for

Order Prep
quantity discounts
Order Time to print, verify, and transmit order to the
Transmission supply source
Supplier Time for supplier order processing, pick and
Processing pack, and shipment to the ordering source

Time spent receiving, checking, quality

Receiving control, and staging the order

Item Time spent in item movement, put-away, and

Restocking any final information recording
8-25 dp&c Chapter8
Defining Safety Inventory
Inventory
Expected demand

A quantity of stock planned to be in

inventory to protect against
Q/2
fluctuations
Cycle in demand or supply
Inventory
S
Safety Stock
APICS Dictionary, 13th edition
T Time
Q = 250 units
Q /2 = 250 units / 2 = 125 units
S = 125 units / 2 = 63 units
Q/2 + S = 313 units

8-26 dp&c Chapter8

Normal Distribution - Diagram

1,000
1σ = 285 units 715 1,285

600 1,350

430 1,570

145 1,855
+/ -1σ
68.27%
+/ - 2σ
95.45%
+/ - 3σ
99.73%

8-27 dp&c Chapter8

Calculating the Safety Stock – Part 1

Week Sales Forecast Actual Sales Absolute Deviation Deviation²

1 1,000 550 450 202,500
2 1,000 1,350 350 122,500
3 1,000 1,175 175 30,625
4 1,000 1,125 125 15,625
5 1,000 750 250 62,500
6 1,000 1,425 425 180,625
7 1,000 675 325 105,625
8 1,000 876 124 15,376
9 1,000 1,300 300 90,000
10 1,000 875 125 15,625
Sum Absolute Deviation 2,649
Sum Squared Deviation 841,001

8-28 dp&c Chapter8

Calculating the Standard Deviation – Part 2
Two methods possible:

1. Squared Deviation:
Formula:
å (Actual Demand – Forecast)2
SD = number of periods-1
a.) Squared deviation = 841,001 / 9 = 93444.6
b.) Standard Deviation (1s) = 93,444.44 = 305.69 units

2. MAD Method
a.) Mean Absolute Deviation (MAD) = 2649 / 10 = 264.9
b.) Standard Deviation (1s) = 264.9 x 1.25 = 331.13 units

8-29 dp&c Chapter8

Reorder Point with Safety Stock Calculation
Objective: Calculate a reorder point with safety stock
Data:
• Demand per week = 1,000 units
• Lead time = 2 weeks
• Customer service level (CSL) = 98%
• Standard deviation (s) = 305.69
• Unit cost = US$235.00
Solution:
1. Demand during lead time = 1,000 x 2 weeks = 2,000 units
2. Safety stock (SS) = CSL x (s) = NORMSINV (.98) x 305.69 =
627.81 units
3. ROP = 2,000 units + 627.81 units = 2,627.81 units
4. SS cost = US$235 x 627.81 = US$147,535 (rounded)

8-30 dp&c Chapter8

Safety Stock Using Probability
Objective: Calculate safety stock using probability
Data:
• Demand per week = 1,000 units
• Lead time = 2 weeks
• Carrying cost/unit = US$30
• Cost of stock out/unit = US$100
• Optimum number of replenishment orders per year = 26
• Current reorder point = 2,000 units
• Demand above 2,000 units during reorder point period:
Number of units Probability
2,000 24%
2,100 15%
2,200 8%
2,300 2%
2,400 1%

8-31 dp&c Chapter8

Safety Stock Using Probability (cont.)
Safety Total
Solution:
Stock
Carrying Cost + Stock out Cost =
Cost

1. Calculate safety (100

stock carrying cost by multiplying the
* .15 * US$100 * 26) +
carrying cost times
(200 *the safety
.08 * US$100 * 26)stock
+
2,000 0 US$106,600
2. Calculate stock out cost: the sum of the units stocked out x
(300 * .02 * US$100 * 26) +
(400 * .01 * US$100 * 26) = US$106,600
the probability x the unit cost x the number of orders per year
(100 * .08 * US$100 * 26) +
100 * US$30 =
2,100 (200 * .02 * US$100 * 26) + US$42,000
US$3,000
(300 * .01 * US$100 * 26) = US$39,000

200 * US$30 = (100 * .02 * US$100 * 26) +

2,200 US$16,400
US$6,000 (200 * .01 * US$100 * 26) = US$10,400

300 * US$30 =
2,300 (100 * .01 * US$100 * 26) = US$2,600 US$11,600
US$9,000

400 * US$30 =
2,400 0 US$12,000
US$12,000

8-32 dp&c Chapter8

Supply Uncertainty and Safety Stock
Objective: Calculate safety stock with supply uncertainty
Data:
• Average daily demand (D) = 250 units
• Lead time (LT) = 9 days
• Standard deviation of demand (sD) = 85 units
• Customer service level (CSL) = 95%
• Standard deviation of lead time (sLT) = 5 days
Formula:

8-33 dp&c Chapter8

Supply Uncertainty and Safety Stock (cont.)
Solution:
1. Solve for standard deviation of demand during the lead time:
sL = = 1,275.74

2. Solve for safety stock (SS):

SS = sL x CSL = 1275.74 x 1.65 = 2,105 (rounded)

3. New order point calculation:

250 (D) x 9 (LT) + 2,105 (SS) = 4,355 units

8-34 dp&c Chapter8

Min/Max Order System
Definition:
Called the min/max system because the inventory position
should always be a quantity located between the minimum
and maximum stocking values

Minimum quantity calculation:

Use the standard reorder point equation
Maximum quantity calculation:
Function of the average daily demand, lad time, and the
standard deviation
Formula:
(Demand x lead time) + (customer service level x standard
deviation x square root of the lead time)

8-35 dp&c Chapter8

Min/Max Order System – Example
Objective: Calculate min/max order quantity
Data:
• Average daily demand (D) = 50 units
• Lead time (LT) = 4 days
• Standard deviation of demand (sD) = 20 units
• Customer service level (CSL) = 98%
• Min quantity = 125 units

Solution:
Max = (D x LT) + (CSL x xξ 𝐿𝑇) = (50 x 4) + (2.05 x 20 x ξ 4) =
200 + 82 = 282

8-36 dp&c Chapter8

Periodic Review – Overview
Definition:
Items are reviewed periodically and replenishment orders are
launched at each review. The order quantity contains
sufficient stock to bring the inventory position up to a target
inventory level
Uses:
1. Used when it is difficult to record withdrawals and
additions of stock on a continuous basis
2. Used when items are ordered in families
3. Used for items with a limited shelf life
4. Significant economies can be gained by ordering in bulk

8-37 dp&c Chapter8

Periodic Review System Technique
Review Cycle
Target 1 2 3
Inventory

Order
Quantity
A
Demand

Review
Point
Quantity

Replenishment
Receipt
Lead
Time Safety Stock

8-38 dp&c Chapter8

Periodic Review Calculation
Equations:
a. Order review cycle = dividing an item’s units sold annually
by the standard lot quantity
b. Target inventory level (TI) =
TI = (D(L + T)) + (SSsD L T )
where
D = the demand rate
L = item lead time
T = the review period
SS = item safety stock

8-39 dp&c Chapter8

Periodic Review Calculation – Example
Objective: Calculate a periodic review replenishment
Data:
• Average weekly demand (D) = 1,000 units
• Lead time (L) = 2 weeks
• Standard deviation of demand (sD) = 100 units
• Customer service level (CSL) = 98%
• Review cycle (T) = 4 weeks
• On-hand balance = 2,250 units
Solution:
1. Demand during lead time and review cycle: 1,000 x (2 + 4) = 6,000
units
2. Target inventory: 6,000 + (503 x 100 x 2  4) = 6,503 units
3. Reorder quantity: 6,503 – 22,50 = 2,403 units

8-40 dp&c Chapter8

 Chapter 8
Statistical Inventory Management

Inventory
Order Quantity
Management Basics
Techniques

8-41 dp&c Chapter8

Trial and Error Method
a. Order cost:
(Annual inventory usage / order quantity) x ordering cost
(24,000 units / 2,000 units) x US$20 = US$240

b.
b. Carrying
Carrying cost:
cost:
Order quantity / 2 x carrying cost % x unit cost
(2,000 / 2) units x 24% x US$0.25 = US$60
Order Quantity Order Per Year Carrying Cost Order Cost Total Cost
2,000 12 $60 $240 $300
4,000 6 $120 $120 $240
8,000 3 $240 $60 $300
12,000 2 $360 $40 $400
24,000 1 $720 $20 $740

8-42 dp&c Chapter8

EOQ Graph
Costs
800
700
Total Cost
600
500 Optimal Cost
400 Carrying
300 Cost
200 Ordering Cost
100
50

Quantities 2000 4000 8000 12000 24000

8-43 dp&c Chapter8

EOQ Calcualtion

2 x Demand x Cost of ordering

Inventory carrying cost % x Unit cost
Annual demand = 20,000 units
Cost of ordering = US$125
Unit cost = US$34
Carrying cost = 21%

2 x 20,000 x US$125
= 837 units
21% x $34

8-44 dp&c Chapter8

EOQ Assumptions
• The cost of the product does not depend on the replenishment
quantity
• There are no minimum or maximum restrictions on the
replenishment quantity
• Items are considered totally independent of each other
• Lead time is zero
• No shortages are permitted and the entire order quantity is
delivered at the same time
• The minimum purchase quantity from the supplier is not three
or four times the calculated QOQ
• Purchase order preparation and carrying costs are known and
constant
• Very high or very low item usage needs to be reviewed in
relation to unit costs before applying the EOQ technique
8-45 dp&c Chapter8
Quantity Discounts – Example
Objective: Choose from two suppliers based on quantity
discounts
Data:
• Annual demand (D) = 30,000 units
• Ordering cost (OC) = US$200
• Item unit cost (UC) = US$15
• Carrying cost (k) = 22%
Steps (base calculation):
1. Calculate EOQ = 1,907 (1,906.93)
2. Calculate number of orders per year = 30,000 / 1906.93 = 15.7
3. Calculate material cost = EOQ x orders per year x item unit cost =
1,906.93 x 15.7 x US$15 = US$450,000
4. Calculate ordering cost = order cost x orders per year = US$200 x
15.7 = US$3,146.43

8-46 dp&c Chapter8

Quantity Discounts – Example (cont.)
Steps:
5. Carrying cost = (EOQ / 2) x unit cost x carrying cost = (1906.93 / 2)
x US$15 x 22% = US$3,146.53
6. Total cost = material cost + ordering cost + carrying cost =
US$456,292.85
Steps (supplier 1):
Data:
• Discount price for minimum quantity of 5,000 units = US$14.55
• Order per year = 6
Summaries:
1. Material cost = US$436,500
2. Ordering cost = US$1,200
3. Carrying cost = US$8,002.50
4. Total cost = US$445,702.50

8-47 dp&c Chapter8

Quantity Discounts – Example (cont.)
Steps (supplier 2):
Data:
• Discount price for minimum quantity of 12,000 units = US$14.25
• Order per year = 2.5
Summaries:
1. Material cost = US$427,500
2. Ordering cost = US$500
3. Carrying cost = US$18,810
4. Total cost = US$446,810

Decision: Suppler 1 has the lowest costs

8-48 dp&c Chapter8

Joint Replenishment – Example
Objective: Calculate joint replenishment for three items
Data:
• Annual demand for item #3925 = 6,000 units
• Annual demand for item #3819 = 3,575 units
• Annual demand for item #3442 = 1,250 units
• Ordering cost (OC) = US$200
• Transportation cost (TC) = US$350
• Item unit cost (UC) = US$45
• Carrying cost (k) = 20%
Steps (base calculation):
1. Order cost = (Demand / EOQ) x (Order cost + Transportation cost)
2. Carrying cost = (EOQ / 2) x unit cost x carrying cost
3. Total cost = ordering cost + carrying cost

8-49 dp&c Chapter8

Joint Replenishment – Example (cont.)
I. The three items ordered independently
Summary:
Ordered Independently
Product EOQ # Orders / year Carrying Cost Ordering Cost Total Cost
#3925 856 7.0 $ 3,853.57 $ 3,853.57 $ 7,707.14
#3819 661 5.4 $ 2,974.58 $ 2,974.58 $ 5,949.16
#3442 391 3.2 $ 1,758.91 $ 1,758.91 $ 3,517.81
Total Cost $ 17,174.11

II. The three items ordered jointly

Summary:
Ordered Jointly
Product # Orders / year Order Lot Size Carrying Cost Ordering Cost Total Cost
#3925 7.16 837.9 $ 3,770.56 $ 3,938.41 $ 7,708.97
#3819 7.16 499.2 $ 2,246.62 $ 1,432.15 $ 3,678.77
#3442 7.16 174.6 $ 785.53 $ 1,432.15 $ 2,217.68
Total Cost $ 13,605.42

8-50 dp&c Chapter8

Joint Replenishment – Example (cont.)
III. The three items ordered jointly: selected family items
Steps:
1. Identify the most frequently order item (i)
2. Equation: Order frequency for item #3925

3. Calculate the frequency for items #3819 and #3442

4. Determine the order frequency for each item as a multiple of
the order frequency of the most ordered item (mi).
5. For item #3819, 7.01 / 7.01 = 1.
6. For item #3442, 7.01 / 5.30 = 1.32
7. Recalcuate the order frequency of items
8. For item #3819, 20% x US$45 x 1 x 6,000 = US$54,000.

8-51 dp&c Chapter8

Joint Replenishment – Example (cont.)
III. The three items ordered jointly: selected family items
Steps:
9. Sum the values for step 8
10. US$54,000 + US$32,175 + $22,500 = US$108,675
11. Divide the standard order cost by the order frequency
12. For item #3925, 200/1 = US$200
13. Sum the values for step 11
14. US$200 + US$200 + US$100 + US$350 (TC) = US$500
15. New order frequency for item #3925 =

16. New order frequency for item #3819 = 8 / 1 (original rounded

order frequency fi) = 8 orders.

8-52 dp&c Chapter8

Joint Replenishment – Example (cont.)
III. The three items ordered jointly: selected family items
Steps:
17. New order frequency for item #3442 = 8 / 2 (original rounded
order frequency fi) = 4 orders
18. Calculate order costs by using steps for ordering jointly
Ordered Selectively
Freq to most Round Order
Product Order Frequency Cost (kUCf i D i ) Order Cost / f i
ordered (f ) Frequency (fi )
#3925 7.01 1.00 1.00 $ 54,000.00 $ 200
#3819 8.97 0.78 1.00 $ 32,175.00 $ 200
#3442 5.30 1.32 2.00 $ 22,500.00 $ 100
SUM $ 108,675.00 $ 500
SUM TC+ S R/f i $ 850
Product #Orders / year Order Lot Size Carrying Cost Ordering Cost Total Cost
#3925 8.00 750.4 $ 3,376.94 $ 4,397.47 $ 7,774.41
#3819 8.00 447.1 $ 2,012.09 $ 1,599.08 $ 3,611.17
#3442 4.00 312.7 $ 1,407.06 $ 799.54 $ 2,206.60
SUM $ 6,796.09 Total Cost $ 13,592.19

8-53 dp&c Chapter8

Transportation EOQ
Objective: Calculate the EOQ with transportation cost
Data:
• Annual demand (D) = 25,000 units
• Ordering cost (OC) = US$100
• Item unit cost (UC) = US$10
• Carrying cost (k) = 22%
• Rate for small shipments = US$1.25 per unit
• Rate for large shipments = .75 per unit

Step 1: Base EOQ calculation:

Orders/
Item EOQ Year Carrying cost Ordering cost Total cost

#3925 1,507.56 17 $1,658.31 $1,658.31 $3,316.62

8-54 dp&c Chapter8

Transportation EOQ (cont.)
Step 2: Current EOQ freight cost:
1. Rate for EOQ of 1,507.56 = (Rate x order quantity) x number of
orders per year = US$1.25 x 1,507.56 x 17 = $31,250
2. Freight added EOQ =
Orders/ Carrying Shipment
Ord qty Ordering cost Total cost
Year cost cost
1,507.56 17 $1,658.31 $1,658.31 $31,250 $34,566.62

Step 3: Large shipment rate requires OQ = 5,000 units

Ord Orders/ Carrying Ordering
Shipment cost Total cost
qty Year cost cost
5,000 5 $5,500 $500 $18,750 $24,750

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Replenishment by Item Class – Steps
1. Divide the inventory into classes based on volume usage,
dollar value, or other parameters.
2. Link items to classes.
3. Assign an inventory turnover target for each class.
4. Determine the level below which only dead and obsolete
products reside. Eliminate this class from the procedure.
5. Establish the replenishment quantity for each class by
dividing the annual usage of each item by the turnover
value.
6. Recalculate the inventory classification scheme for all
items at least once a month, depending on the expected
inventory turnover.
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Replenishment by Item Class – Calculation
Objective: Replenishment using order class
Data:
ABC Class # of Total Items Expected Turns Order Interval
A 1,200 24 15 days
B 10,500 12 1 month
C 25,250 6 2 months
D 8,000 3 4 months
E 6,500 1 12 months

Calculation: Calculate a class A item order quantity with

yearly demand of 24,000 units

24,000 units / 24 turns = 1,000 units

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Investment Order Limit – Calculation
Objective: Determine investment limit for multiple items
Data:
• Annual demand for item #3925 = 14,000 units
• Annual demand for item #3819 = 9,500 units
• Annual demand for item #3442 = 7,000 units
• Unit cost #3925 (UC) = US$20.00
• Unit cost #3819 (UC) = US$10.00
• Unit cost #3442 (UC) = US$15.00
• Ordering cost (OC) = US$100
• Carrying cost (k) = 20%
• Investment limit (IL) = US$16,000

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Investment Order Limit – Calculation (cont.)
Step1: Calculate base EOQ for each item
EOQ
Product # Orders / year EOQ Carrying Cost Ordering Cost Total Cost
#3925 16.73 836.66 $ 1,673.32 $ 1,673.32 $ 3,346.64
#3819 9.75 974.68 $ 974.68 $ 974.68 $ 1,949.36
#3442 10.25 683.13 $ 1,024.70 $ 1,024.70 $ 2,049.39

Step2: Determine total inventory investment

Inventory investment = UC1(Q1/2) + UC2(Q2/2) + UC3(Q3/2)
= US$20(836.66/2) + US$10(974.68/2) +
US$15(683.13/2)
= $18,363.47
Step3: Adjust original EOQ quantities
Since inventory investment of $18,363.47 exceeds the
US$16,000 level, the original EOQs will need to be reduced by
inflating (k) and determining an adjustment factor (a)

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Investment Order Limit – Calculation (cont.)
Step3: Adjust original EOQ quantities
Since inventory investment of $18,363.47 exceeds the
US$16,000 level, the original EOQs will need to be reduced.
The formula is:

Step 4: Adjust original EOQ quantities with a factor

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 Investment Order Limit – Calculation (cont.)
Step 5: Combine new EOQ values and validate that they
match the investment limit
Min Investment EOQ
Product # Orders / year New EOQ Carrying Cost Ordering Cost Total Cost Investment Cost
#3925 19.20 728.98 $ 1,457.96 $ 1,920.50 $ 3,378.45 $ 7,289.78
#3819 11.19 849.23 $ 849.23 $ 1,118.66 $ 1,967.89 $ 4,246.17
#3442 11.76 595.21 $ 892.81 $ 1,176.06 $ 2,068.87 $ 4,464.06
Totals $ 7,415.21 $ 16,000.00

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 Chapter 8
Statistical Inventory Management

Inventory
Lean Inventory
Management Basics
Management

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Defining Lean

A management and operations philosophy based

on the planned minimization of all resources, the
continuous improvement of productivity, and a
relentless search to convert product and process
waste into customer winning value both within the
enterprise and outside in the supply chain.

APICS Dictionary, 13th edition

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Lean Philosophy
Dedication to continuous product and
Operations process improvement focused on total
Excellence customer service

Value-Added Eliminate all business functions and

activities that do not add value to the
Processes
company or the customer
All aspects of business processes must be
Continuous dedicated to incremental improvement in
Improvement ways great and small
Combination of lean techniques focused on
Lean/TQM productivity, total quality management
(TQM), and people empowerment

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Lean Tactics to Reduce Inventory
•Focus on continuous inventory reduction
•Implement an inventory pull system
•Establish lean ordering and delivery with suppliers
•Deliver inventory directly to the point of use
•Map and streamline inventory flows
•Reduce batch sizes and production queues
•Reduce setup times

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Inventory Flow Analogy
Clogged Inventory Channel

Inventory Inventory Inventory

Poor
Controls
Lack of
Unclear Training
Responsibilities
Lack of
Disciplines

Open Inventory Channel

Inventory

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Key Points of a Lean-Pull System
Produce products only to customer order
Create a level schedule so that production may
proceed according to a desired flow rate
Schedule a mix of products in varying lot sizes so
that the factory or the supplier produces and
delivers inventory close to the same mix of
products that will be sold that day
Link scheduling management to pull production
through the use of visual demand signals
Maximize process flow-through by maximizing
the flexibility of people and machinery

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The Pull System – Basic Concepts
C Operator #1
B Demand pull
A Operator #2
receives signal triggered removes
requirement and and requirement material from
makes more sent to feeding buffer inventory
inventory workstation to start work

Buffer
Process 1 Process 2
Inventory
Operator #1 Operator #2

Workstation #1 Workstation #2
D Replenishment
quantity moved to
Workstation #2
buffer inventory

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Three Types of Kanban
Specifies the quantity of product that must be
Production produced by upstream production work
centers

Specifies the quantity of product that will be

Move moved from a reserve or remote buffer
location to the requested buffer area

Is used in place of a purchase order to

Supplier replenish products from an outside supplier

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Calculating Supplier Kanbans
Objective: Calculate the number of kanbans in a system
Data:
• Daily demand (D) = 300 units
• Transit delay pick up (Td) = 2 days
• Transit delay delivery (Tp) = 2 days
• Safety stock (SS) = 50%
• Kanban container size (Q) = 50 units
• Deliveries per day (R) = 1 delivery per day

Equation:
𝐷ሺ𝑇𝑑 + 𝑇𝑝ሻ(1 + 𝑆𝑆)
# 𝑘𝑎𝑛𝑏𝑎𝑛 =
𝑄𝑅
Solution:
((300 x (2 + 2)) x (1 + .50) / (1 x 50) = 36 kanbans

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“Education in Pursuit of
Supply Chain Leadership” dp&c Chapter8

Chapter 8
End of Session

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