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=
Q
A
=
c =
Economic Order Quantity
( )
) ( 2
) (
0
2
) (
) cos (
2
) (
3 2
2
2
condition order Second
Q
A
dQ
Q Y d
condition order First
Q
A
D
h
dQ
Q dY
unit per t inventory Total c
Q
A
D
hQ
Q Y
=
= + =
+ + =
Economic order quantity
( )
) (
2
0
2
) (
2
quantity order economic
h
AD
Q
condition order f irst
Q
A
D
h
dQ
Q dY
=
= + =
-
Exercise
Each is invited to analyze the following insights, based on
the EOQ model (20 minutes):
1. There is a tradeoff between lot size and inventory
2. Holding and setup cost are fairly insensitive to lot size
What-if
What-if
EOQ EOQ
Annual demand 12,000 12,000
Cost per unit $6.75 $6.75
Interest rate to hold 20% 20%
Ordering cost $28.00 $28.00
Quantity each order 461 =INT(C5/C10)
Number of orders 26 26
Unit holding cost $1.35 =C6*C7
Annual holding cost $311 =C9*C11/2
Annual ordering cost $728 =C10*C8
Combined cost $1,039 =C12+C13
Annual purchase cost $81,000 =C5*C6
Total cost $82,039 =C14+C15
What-If Analysis
The minimum cost
obtained by using the
economic order
quantity is $952.50, so
increasing the order
quantity by 10% leads
a total cost increase of
only $4.30. Changing
the order quantity by a
small amount has very
little effect on the cost,
because EOQ formula
gives robust solutions.
Bina Nusantara University
Inventory Systems
Single-Period Inventory Model
One time purchasing decision (Example: vendor selling
t-shirts at a football game)
Seeks to balance the costs of inventory overstock and
under stock
Multi-Period Inventory Models
Fixed-Order Quantity Models
Event triggered (Example: running out of stock)
Fixed-Time Period Models
Time triggered (Example: Monthly sales call by sales
representative)
Bina Nusantara University
Single-Period Inventory Model
u o
u
C C
C
P
+
s
sold be unit will y that the Probabilit
estimated under demand of unit per Cost C
estimated over demand of unit per Cost C
: Where
u
o
=
=
=
P
This model states that we should
continue to increase the size of the
inventory so long as the probability
of selling the last unit added is
equal to or greater than the ratio
of: Cu/Co+Cu
Single Period Model Example
Our college basketball team is playing in a tournament
game this weekend. Based on our past experience we
sell on average 2,400 shirts with a standard deviation of
350. We make $10 on every shirt we sell at the game,
but lose $5 on every shirt not sold. How many shirts
should we make for the game?
C
u
=$10 and C
o
= $5; P $10 / ($10 + $5) = .667
Z
.667
= .432 (use NORMSDIST(.667)
therefore we need 2,400 + .432(350) = 2,551 shirts
Multi-Period Models:
Fixed-Order Quantity Model Model Assumptions (Part 1)
Demand for the product is constant and uniform
throughout the period
Lead time (time from ordering to receipt) is
constant
Price per unit of product is constant
Bina Nusantara University
Multi-Period Models:
Fixed-Order Quantity Model Model Assumptions (Part 2)
Inventory holding cost is based on average inventory
Ordering or setup costs are constant
All demands for the product will be satisfied (No back
orders are allowed)
Basic Fixed-Order Quantity Model and Reorder Point Behavior
R = Reorder point
Q = Economic order quantity
L = Lead time
L
L
Q Q Q
R
Time
Number
of units
on hand
1. You receive an order quantity Q.
2. Your start using
them up over time.
3. When you reach down to
a level of inventory of R,
you place your next Q
sized order.
4. The cycle then repeats.
Bina Nusantara University
Cost Minimization Goal
Ordering Costs
Holding
Costs
Order Quantity (Q)
C
O
S
T
Annual Cost of
Items (DC)
Total Cost
Q
OPT
By adding the item, holding, and ordering costs together, we
determine the total cost curve, which in turn is used to find the Q
opt
inventory order point that minimizes total costs
Bina Nusantara University
Basic Fixed-Order Quantity (EOQ) Model Formula
H
2
Q
+ S
Q
D
+ DC = TC
Total
Annual =
Cost
Annual
Purchase
Cost
Annual
Ordering
Cost
Annual
Holding
Cost
+ +
TC=Total annual
cost
D =Demand
C =Cost per unit
Q =Order quantity
S =Cost of placing
an order or setup
cost
R =Reorder point
L =Lead time
H=Annual holding
and storage cost
per unit of inventory
Bina Nusantara University
Deriving the EOQ
Using calculus, we take the first derivative of the total cost function with
respect to Q, and set the derivative (slope) equal to zero, solving for the
optimized (cost minimized) value of Q
opt
Q =
2DS
H
=
2(Annual Demand)(Order or Setup Cost)
Annual Holding Cost
OPT
Reorder point, R = d L
_
d = average daily demand (constant)
L = Lead time (constant)
_
We also need a
reorder point to tell us
when to place an
order
Bina Nusantara University
EOQ Example (1) Problem Data
Annual Demand = 1,000 units
Days per year considered in average
daily demand = 365
Cost to place an order = $10
Holding cost per unit per year = $2.50
Lead time = 7 days
Cost per unit = $15
Given the information below, what are the EOQ and
reorder point?
Bina Nusantara University
EOQ Example (1) Solution
Q =
2DS
H
=
2(1,000 )(10)
2.50
= 89.443 units or
OPT
90 units
d =
1,000 units / year
365 days / year
= 2.74 units / day
Reorder point, R = d L = 2.74units / day (7days) = 19.18 or
_
20 units
In summary, you place an optimal order of 90 units. In the
course of using the units to meet demand, when you only have
20 units left, place the next order of 90 units.
Bina Nusantara University
EOQ Example (2) Problem Data
Annual Demand = 10,000 units
Days per year considered in average daily
demand = 365
Cost to place an order = $10
Holding cost per unit per year = 10% of cost per
unit
Lead time = 10 days
Cost per unit = $15
Determine the economic order quantity
and the reorder point given the following
Bina Nusantara University
EOQ Example (2) Solution
Q =
2DS
H
=
2(10,000 )(10)
1.50
= 365.148 units, or
OPT
366 units
d =
10,000 units / year
365 days / year
= 27.397 units / day
R = d L = 27.397 units / day (10 days) = 273.97 or
_
274 units
Place an order for 366 units. When in the course of using the
inventory you are left with only 274 units, place the next order of 366
units.
Bina Nusantara University
Fixed-Time Period Model with Safety Stock Formula
order) on items (includes level inventory current = I
time lead and review over the demand of deviation standard =
y probabilit service specified a for deviations standard of number the = z
demand daily average forecast = d
days in time lead = L
reviews between days of number the = T
ordered be to quantitiy = q
: Where
I - Z + L) + (T d = q
L + T
L + T
o
o
q = Average demand + Safety stock Inventory currently on hand
Bina Nusantara University
Multi-Period Models: Fixed-Time Period Model:
Determining the Value of o
T+L
( )
o o
o
o o
T+L d
i 1
T+L
d
T+L d
2
=
Since each day is independent and is constant,
= (T+ L)
i
2
=