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Chapter 4 Single Item Probabilistic Demand
Chapter 4 Single Item Probabilistic Demand
Probabilistic Demand
¨ Characteristics
Routine Leverage
$
Types of Stochastic Models
¨ Single period models
¨ Fashion goods, perishable goods, goods with short lifecycles, seasonal goods
¨ One time decision (how much to order).
¨ Multiple period models
Periodic models
¨ Goods with recurring demand but whose demand varies from period to period
¨ Inventory systems with periodic review
¨ Periodic decisions (how much to order in each period)
Continuous time models
¨ Goods with recurring demand but with variable inter-arrival times between customer
orders
¨ Inventory system with continuous review
=E(D)L
r
2. The Base Stock Model
5
Example
¨ Consider the situation facing an appliance store sells a
particular model of TV. Because space is limited and
because the manufacturer makes frequent deliveries of
other appliances, the store finds it practical to order
replacement TVs each time one is sold. In fact, they
have a system that places purchase orders (POs)
automatically whenever a sale is made. But, because
the manufacturer is slow to fill replenishment orders,
the store must carry some stock in order to meet
customer demands promptly. Under these conditions,
the key question is how much stock to carry?
The Base-Stock Policy
¨In the base stock model, inventory is refilled one unit at a time and demand
is random (arrivals).
¨Start with an initial amount of inventory R. Each time a new demand arrives, place a
replenishment order with the supplier.
¨An order placed with the supplier is delivered L units of time after it is placed.
¨Because demand is stochastic, we can have multiple orders (inventory on-order) that have
been placed but not delivered yet.
¨The amount of demand that arrives during the replenishment leadtime L is called the
Q=1
leadtime demand (inventory on order).
R=r+1
r
t
t1
t2 Assumptions
1. Demands occur one at a time.
2. Any demand not filled from stock is backordered.
3. Replenishment lead times are fixed and known;
4. Times between consecutive orders are stochastic but
independent and identically distributed (i.i.d.)
5. Inventory is reviewed continuously
6. There is no fixed cost associated with placing an order; and
7. There is no constraint on the number of orders that can be
placed per year.
¨ On-hand and backorders are never positive at the same time, so if X=x,
then:
¨ Expected backorder level:
¨ Expected inventory level: I(R) = R - + B(R)
Where: = E(D)l
¨ G(R) (z) R r B(R) I(R)
Base Stock Example: Discrete Case
l = one month
¨ Backorder Level:
B(r) = 0.187
¨ Inventory Level:
¨ Calculations:
since , z =0.32 and hence
R* = + z = 10 + 0.32(3.16) = 11.01 ~ 11 r = 10
¨ Observation: from previous table fill rate is G(10) = 0.583, so
maybe backorder cost is too low.
Base Stock Insights
1. Reorder points control the probability of stockouts by
establishing safety stock = r-
2. The “optimal” fill rate is an increasing function of the backorder
cost (b) and a decreasing function of the holding cost (h). We
can use either a service constraint or a backorder cost to
determine the appropriate base stock level.
bG zR
h keep more stock G zR
3. Base stock levels in multi-stage production systems are very
similar to kanban systems and therefore the above insights apply
to those systems as well. (production card= order, withdrawal
card = demand)
3. The (Q,r) or (Q,s) Model
Assumptions
¨Demand occurs continuously over time
¨Times between consecutive orders are stochastic but independent and identically
distributed (i.i.d.)
¨Inventory is reviewed continuously
¨Supply leadtime is a fixed constant L
¨ Orders that cannot be fulfilled immediately from on-hand inventory are
backordered
¨Fixed cost associated with replenishment orders and cost per backorder.
¨Constraint on number of replenishment orders per year and service constraint
18
The (Q, r) Policy
¨Start with an initial amount of inventory R. When inventory level reaches
level r, place an order in the amount Q = R-r to bring inventory position
back up to level R. Thereafter whenever inventory position drops to r,
place an order of size Q.
¨The base-stock policy is the special case of the (Q, r) policy where Q =
1.
¨Objective:
or lost sale cost
(lost sale)
(Q,r) Notation (cont.)
¨ Decision Variables:
¨ Performance Measures:
Inventory versus Time
N=D/Q = 1/T
Demand during Leadtime
2
Demand during Leadtime
r r)
2
Costs in (Q,r) Model
¨ Result:
r Q
¨ Type II:
Note: neglects B(r,Q)
term, underestimates S(Q,r)
Backorder Costs in (Q,r) Model
¨ Result:
Notes:
1. B(Q,r)» B(r) is a base stock approximation for backorder level.
¨ Objective Function:
¨ Results:
¨ Conclusion: this has higher service and lower inventory than the
original policy (Q=4, r=2). But the cost of achieving this is an
extra 3.5 replenishment orders per year.
3.2. (Q,r) Model with Stockout Cost
¨ Objective Function:
¨ Assumptions:
¨ Q,r can be treated as continuous variables
¨ G(x) is a continuous cdf
¨ Results:
E(X)=E(L)E(D)
Var(X)=E(L)Var(D) + E(D)2Var(L)
Including Lead Time Variability in Formulas
45
Expected Leadtime Demand
46
Variance of Leadtime Demand
47
Variance of Leadtime Demand
48
3.4. Uncertain Demand with Safety Stock
IP
IP
Order
Order
Order received
Order received
received
On-hand inventory
received
Q
Q Q
On
Hand
r
Order Order Order
placed placed placed
L1 L2 L3 Time
TBO1 TBO2 TBO3
49
Expected Inventory (Assumptions)
I(t)
Q Slope
-D
Q
SS T=
D
Time
50
Expected cost function
¨ Include expected: holding (h), setup (A), penalty (p – e.g.
backorder) and ordering (per unit) costs (c)
¨ Average Holding Cost:
𝑄
¨ Average Set-up Cost:
(
h + 𝑆𝑆
2 )
A AD
=
T Q
51
Expected cost function
Expected Shortage per Cycle:
¥
E(max(X - r, 0)) = ò(x - r) g(x) dx =n(r)
r
¶Y h D pDn(r) 2D [ A + p n(r)]
= - A 2- 2
=0 => Q =
¶Q 2 Q Q h
(2) This is the first equation
¶Y pD we will use to determine
=h + n¢(r) optimal values Q and r
¶r Q
Cost Minimization
Partial Derivatives:
(2)
¶Y pD
=h + n¢(r) =0
¶r Q
¥
Note: n(r) = ò(x - r)g(x)dx
r
Find (Q,r)
Solution
2 éë + ( )ùû 2(800)(10 +5 ( ))
= =
2
= 8000 + 4000 ( )
2
1- ( )= = =
5(800) 2000
58
Solution
From Uniform U(0,200) distribution:
1 1
U(0,200): g(x) = =
b-a 200
200
¥
1
n(r) = ò(x - r)g(x)dx = ò(x - r) dx
r r 200
æ 2 x=200 ö
æ200 2 2 ö
1 çx 1 r 2
=
ç
- rx ÷=
÷ ç - 200r - + r ÷
200 è 2 x=r ø
200 è 2 2 ø
r2
=100 + -r
400
59
r2
Solution n(r) =
400
- r +100
Qi = 8000 + 4000n(r)
Q
Iteration 1: 1- G(r) =
2000
2AD 2(10)(800)
EOQ = = = 8000 =89.44 =Qo
h 2
G(r)
Qo h 89
1- G(ro ) = = =.04
pD 2000
G(ro ) =.96
ro =(.96)(200 - 0) =192 0 200
G(r)/100% = (r-0)/(200-0) r0
r2
Solution n(r) =
400
- r +100
Qi = 8000 + 4000n(r)
Q
Iteration 2: 1- G(r) =
2000
2
(192)
n(r0 ) = - 192 +100 =.198
400
Q1 = 8000 + 4000(.198) =93.76
94
1- G(r1 ) = =.05
2000
Þ r1 =(.95)(200) =190
61
r2
Solution n(r) =
400
- r +100
Qi = 8000 + 4000n(r)
Q
Iteration 3: 1- G(r) =
2000
190 2
n(r1 ) = - 190 +100 =.2197
400
Q2 = 8000 + 4000(.2197) =94.228
94
(1- G(r2 )) = =.05
2000
r2 =190
62
Solution
r didn’t change => CONVERGENCE
(Q*,r*) = (94,190)
I(t)
253
Slope
190
-800
Find (Q,r)
66
Solution
¥
( 0 ) = ò( - ) ( )
2
1æ - m ö
¥
1 - ç ÷
( 0 ) = ò( - ) 2è s ø
2p s
æ - mö æ86.68 - 80 ö
=s ç ÷=4 ç ÷=4 (1.67)
è s ø è 4 ø
=4(.0197) =.0788
69
Solution
Iteration 2:
n(r0 ) =.0788
2D ( A + pn(r)) 2(40) ( 50 + 5(.0788))
Q1 = = =423.3
h .0225
Q1h 423.3(.0225)
1- G(r1 ) = = =.0476
pD 5(40)
G(r1 ) =.9523
r1 =86.68
Convergence!
70
Practice
74
3.5.2. (Q,r) Systems with Type 2 Service Constraint
75
Type 2 Service Constraint
¨ May specify fill rate b, and use EOQ for Q to compute r
¨ Or, solve for p (penalty caused by shortage) : 1- ( ) =
and substitute into the equation: æ Qhn(r) ö
2D çA + ÷
2D ( A + pn(r)) è (1- G(r))D ø
Q= =
h h
hQ 2 hn(r)
=A + Q
2D (1- G(r))D
hQ 2 hn(r)
- Q - A =0
2D (1- G(r))D
¨ Result: 2
n(r) 2AD æ n(r) ö
Q= + +ç ÷
1- G(r) h è1- G(r) ø
n(r) =(1- b )Q
4. The (R, r) Model
¨This is usually called the (s, S) model
¨Each demand order can be for multiple units
¨Demand orders are stochastic
¨A replenishment order is placed to bring inventory position back to
R
¨Decision variables are R (instead of Q) and r
77
4.1. Order-Up-To-Level (s, S) vs (Q, r) System
SS • If all demand
transactions are
unit-sized, two
systems are the
ss same S= r+Q
• (s,S)~ “min-max”
(s,S) (s,
system
S) system rR+Q
+Q
rR
(Q,,R)
(Q,r) system
system
78
Alternative (s, S) Policy
79
4.2. Periodic Review (S, T) System
T T
80
Periodic Review Systems
Continuous Review Systems
Always knew level of on-hand inventory
Could place an order at any time
81
Periodic Review Systems
If demand were known and constant, we would just resort
to our EOQ solution, possibly modifying it to meet
shipping date
Now: demand is random variable
Setting:
Place an order every T periods
Policy: Order up to S
The value of Q (order quantity) will now change periodically
Previous concern: demand exceeding supply during the
lead time
Now: demand exceeding supply during the period and lead
time, or T + l
82
Periodic Review Systems
Order up to S
every T periods of
time.
I(t) Order arrives.
S Cycle continues.
Demand
Q
l l
Time
T
83
Expected Cost Function
Include expected holding, setup, penalty
and ordering (per unit) costs
Average Inventory Level:
S
At level r*,on average,
order Q = S-r* units.
r* l periods later, units arrive.
Inventory level?
l
T
84
Expected Cost Function
Include expected: holding, setup, penalty
and ordering (per unit) costs
Average Inventory Level:
S
S-Dl units present when
Q arrive (expected) as
Dl units consumed over
leading time.
85
Expected Cost Function
Include expected: holding, setup, penalty
and ordering (per unit) costs
Average Inventory Level:
S S - Dl
D*T units
removed
(expected) from
inventory over
time T.
T
86
Expected Cost Function
Include expected: holding, setup, penalty
and ordering (per unit) costs
Average Inventory Level:
S S-Dl
D*T/2 D*T
S-Dl-D*T
T
DT DT
Average Inventory Level = ( S - Dℓ- DT ) + =S - Dℓ-
87
2 2
Expected Cost Function
Include expected:
holding, setup, penalty and ordering (per unit) costs
(max( ( + ℓ) - ,0))
¥
= ò( - ) ( ) = ( )
n(S)
p
T
89
Cost Minimization
Expected Cost Function:
DT A pn(S)
Y (S, T ) =h(S - Dℓ- )+ + + Dc
2 T T
Derivative:
Recall that T and l are given:
dY p
=h + n¢(S)
dS T
90
Cost Minimization
Derivative:
dY p
=h + n¢(S) =0
dS T
¥
Note: n(S) = ò(x - S)g(x)dx
S
92
Solution
Holding cost is:
h = Ic = .30 (122.50) = 36.75 / 52 = $.7067 per week
Compute:
p - hT 100 - (.7067)1
G(S) = = =0.993
p 100
Demand Distribution is Normal
mean = 125 variance = 104.17
Z = 2.455 from Normal table
S = 125+(2.455)(104.17)1/2 = 150.06
S z
93
Solution
94