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Supply Chain Management: Traditional Inventory Models For Independent Demand
Supply Chain Management: Traditional Inventory Models For Independent Demand
Supply Chain Management: Traditional Inventory Models For Independent Demand
Independent Demand
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Cost of holding inventory
Capital cost (Interest)
Storage cost
Obsolescence cost
Consist of about 20% of total cost in the
United States
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Inventory issues
Demand
Constant vs. variable
deterministic vs. stochastic
Lead time Inventory
Review time
Continuous vs. periodic Decisions:
Excess demand
Backorders, lost sales
When, What,
Inventory change and how many
Perish, obsolescence
to order
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Two basic types of Inventory Systems
1) continuous (fixed-order quantity)
an order is placed for the same constant amount
when inventory decreases to a specified level, ie.
Re-order point
2) periodic (fixed-time)
an order is placed for a variable amount after a
specified period of time
used in smaller retail stores, drugstores, grocery
stores and offices
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basic inventory elements
1. Carrying cost, Cc
• Include facility operating costs, record
keeping, interest, etc.
2. Ordering cost, Co
• Include purchase orders, shipping, handling,
inspection, etc.
3. Shortage (stock out) cost, Cs
• Sometimes penalties involved; if customer is
internal, work delays could result
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Carrying Costs
Cost (and Range) as a
Percent of Inventory
Category Value
Housing costs (including rent or depreciation, 6% (3 - 10%)
operating costs, taxes, insurance)
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Inventory models
Here, we only study the following three different
models:
1. Basic model
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1. Basic model
The basic model is known as:
“Economic Order Quantity” (EOQ) Models
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Profile of Inventory Level Over
Time
Q Usage
rate
Quantity
on hand
Reorder
point
Lead time
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Profile of … Frequent Orders
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Basic EOQ models
Three models to be discussed:
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Basic Fixed-Order Quantity Model
This model attempts to estimate the order size (Q) and
determine the point (R) at which an order should be
placed.
Model assumptions:
1. Annual demand (D) for the product is known, constant
and uniform throughout the period,
2. Lead time (L) is known and constant,
3. Product unit price (C) is known and constant,
4. Per unit holding or carrying cost (Cc) is known and
constant,
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1 Economic Order Quantity (EOQ) Model
Q
Order Size
Q/2
R
L L Time
d
Daily Usage Rate
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The Basic EOQ Model
• The optimal order size, Q, is to minimize the sum of carrying costs and ordering costs.
• Assumptions and Restrictions:
- Demand is known with certainty and is relatively constant over time.
- No shortages are allowed.
- Lead time for the receipt of orders is constant. (will consider later)
- The order quantity is received all at once and instantaniously.
How to determine
the optimal value
Q*?
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Determine of Q
We try to
Find the total cost that need to spend for keeping
inventory on hands
= total ordering + stock on hands
Determine its optimal solution by finding its first
derivative with respect to Q
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The Basic EOQ Model
We assumed that, we will only keep half the inventory over a year then
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The Basic EOQ Model
• EOQ occurs where total cost curve is at minimum value and carrying cost equals
ordering cost:
TC C D C Q
min
min
oo
cc
Q 2
Then, Q * 2C D
**
oo
(How to obtain this?)
C cc
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EOQ Derivation
Min. The Total Cost Function by finding first derivative and equating it to zero:
TC = DCo/Q + QCc/2
dTC 2
= (- DCo/Q ) + Cc/2 = 0
dQ
2DCo
Solving for Q: EOQ =
Cc
To keep inventory
• Total annual inventory cost is sum of ordering and carrying cost:
TC C D C Q
o c
Q 2
Qopt (2,000)
Total annual inventory cost : TC min Co D Cc (150) 10,000 (0.75) $1,500
Q* 2 2,000 2
Model parameters : Cc $0.0625 per yd per month, Co $150 per order, D 833.3 yd per month
2(150)(833.3)
Optimal order size : Q* 2CoD 2,000 yd
Cc (0.0625)
Q* (833.3) (2,000)
Total monthly inventory cost : TC min Co D Cc (150) (0.0625) $125 per month
Q* 2 2,000 2
12 months a
year
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Robust Model
Max.
Build up No production
Q
Usage Rate usage only
(p-d)
Usage Rate, d
(p - d).Q.H
TC = DC + DS/Q + 2p 26
The EOQ Model with Noninstantaneous Receipt
The order quantity is received gradually over time and inventory is drawn on
at the same time it is being replenished.
Example: Let p = production, d = demand,
p daily rate at which the order is received over time ( or production rate)
d daily rate at which inventory is demanded
Q
Total annual inventory cost :TC Co D Cc 1 d
Q 2 p
Assuming placing an order/yr
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The EOQ Model with finite-replenishment rate
Let,
Co $150, Cc $0.75 per unit,
D 10,000 yd per year, 10,000/311 32.2 yd per day, p 150 yd per day
2CoD 2(150)(10,000)
Optimal order size : Q* 2,256.8 yd
d 32.2
Cc1 0.751
p 150
Q * 2,256.8
Production run length 15.05 days
p 150
D 10,000
Number of orders per year (production runs) 4.43 runs
Q * 2,256.8
d 32.2
Maximum inventorylevel Q * 1 2,256.81 1,772 yd
p 150
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The EOQ Model with Shortages
• In the EOQ model wth shortages, the assumption that shortages cannot exist is relaxed.
• Assumed that unmet demand can be backordered with all demand eventually satisfied.
Shortage = S/Q
Shortage
• In the EOQ model wth shortages, the assumption that shortages cannot exist is relaxed.
• Assumed that unmet demand can be backordered with all demand eventually satisfied.
Shortage = S/Q
Shortage
What we needed
Total cost Total shortage costs total carryingcosts total ordering cost
S2 (Q S ) 2 D
Total inventorycost : TC Cs Cc Co
2Q 2Q Q
2CoD Cs Cc
Optimal order quantity: Q*
Cc Cs
Cc
Shortage level: S * Q *
Cc Cs
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The EOQ Model with Shortages
Example
Let,
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The EOQ Model with Shortages
Q S 2,345.2 - 639.6
Time during which inventory is on hand t1 0.171 or 53.2 days
D 10,000
Time during which there is a shortage t2 S 639.6 0.064 year or 19.9 days
D 10,000
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4. Model with “discount rate”
Price discounts are often offered if a
predetermined number of units is ordered or
when ordering materials in high volume.
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All-Unit Quantity Discounts
Pricing schedule has specified quantity break points
q0, q1, …, qr, where q0 = 0
If an order is placed that is at least as large as qi but
smaller than qi+1, then each unit has an average unit
cost of Ci
The unit cost generally decreases as the quantity
increases, i.e., C0>C1>…>Cr
The objective for the company (a retailer for
example) is to decide on a lot size that will minimize
the sum of material, order, and holding costs
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All-Unit Quantity Discount Procedure
Step 1: Calculate the EOQ for the lowest price. If it is feasible
(i.e., this order quantity is in the range for that price), then
stop. This is the optimal lot size. Calculate TC for this lot
size.
Step 2: If the EOQ is not feasible, calculate the TC for this price
and the smallest quantity for that price.
Step 3: Calculate the EOQ for the next lowest price. If it is
feasible, stop and calculate the TC for that quantity and price.
Step 4: Compare the TC for Steps 2 and 3. Choose the
quantity corresponding to the lowest TC.
Step 5: If the EOQ in Step 3 is not feasible, repeat Steps 2, 3,
and 4 until a feasible EOQ is found.
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All-Unit Quantity Discounts:
Example
Cost/Unit Total Material Cost
$3
$2.96
$2.92
q0 = 0, q1 = 5000, q2 = 10000
C0 = $3.00, C1 = $2.96, C2 = $2.92
D = 120000 units/year, Co = $100/lot,
Cc = 0.2
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All-Unit Quantity Discount:
Example
Step 1: Calculate Q2* = Sqrt[(2DCo)/CcC2]
= Sqrt[(2)(120000)(100)/(0.2)(2.92)] = 6410
Not feasible (6410 < 10001)
Calculate TC2 using C2 = $2.92 and q2 = 10001
TC2 = (120000/10001)(100)+(10001/2)(0.2)(2.92)+ (120000)(2.92) =
$354,520
Step 2: Calculate Q1* = Sqrt[(2DCo)/CcC1]
=Sqrt[(2)(120000)(100)/(0.2)(2.96)] = 6367
Feasible (5000<6367<10000) Stop
TC1 = (120000/6367)(100)+(6367/2)(0.2)(2.96)+ (120000)(2.96) =
$358,969
TC2 < TC1 The optimal order quantity Q* is q2 = 10001
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All-Unit Quantity Discounts
What is the effect of such a discount schedule?
Retailers are encouraged to increase the size of
their orders
Average inventory (cycle inventory) in the supply
chain is increased
Average flow time is increased
Is an all-unit quantity discount an advantage in the
supply chain?
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5. Model with “re-order points”
• The reorder point is the inventory level at which a new order is placed.
• Order must be made while there is enough stock in place to cover demand during lead time.
• Formulation: R = dL, where d = demand rate per time period, L = lead time
Then R = dL = (10,000/311)(10) = 321.54
Working days/yr
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Reorder Point
• Inventory level might be depleted at slower or faster rate during lead time.
• When demand is uncertain, safety stock is added as a hedge against stockout.
No Safety
stocks!
Safety stock!
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Determining Safety Stocks Using Service Levels
R d L (Zd L )
Safety stock
Reorder point
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Reorder Point with Variable Demand
Example
Example: determine reorder point and safety stock for service level of 95%.
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