MGT7101

Managing Operations in Business

Supply Chain Management

Chapters 12, 14 and 15

1
What is Supply Chain Design?
Supply Chain Design
Designing a firm’s
supply chain to
meet the
competitive
priorities of the
firm’s operations
strategy.
Creating An Effective Supply Chain
• Identifying external and internal pressures
– Dynamic sales volumes

– Customer service and quality expectations

– Service/product proliferation

– Emerging markets
Creating an Effective Supply Chain
Link Services/Products Link Services/Products
with Internal Processes with External Supply Chain

Service/Product

Processes Supply Chain

Link Services/Products with Customers,

Suppliers, and Supply Chain Processes
Figure 12.1
 Supply Chain Efficiency Curve
Inefficient
supply chain
Area of
operations improved
operations
Total costs

Reduce costs
New supply chain
efficiency curve with
changes in design
Improve and execution
perform-
ance

Figure 12.2 Supply chain performance

 Service Supply Chain
Flowers: Arrangement
Packaging
Local/International materials

Maintenance FedEx delivery Local delivery Internet

services service service service

Flowers-on-Demand florist

Home Commercial
customers customers
Figure 12.3
 Manufacturing Supply Chain
Tier 3 Poland USA Canada Australia Malaysia Raw
materials

Tier 2 Germany Mexico USA China Components

Major
Tier 1 Germany Mexico USA subassemblies

Manufacturer
USA Assembly

USA Ireland Distribution

centers

East Coast West Coast East Europe West Europe Retail

Figure 12.4
Measuring Supply Chain Performance

• Financial measures
– Total revenue
– Cost of goods sold
– Operating expenses
– Cash flow
– Working capital
– Return on assets (ROA)
 SCM Decisions Affecting ROA
Total revenue
Increase sales through
better customer service
Net income
Cost of goods sold
Improve profits
Reduce costs of with greater
transportation and revenue and lower
purchased materials costs
Operating expenses
Reduce fixed expenses by Return on assets
reducing overhead (ROA)
associated with supply
Working capital Increase ROA with
chain operations
Reduce working higher net income and
capital by reducing fewer total assets
Net cash flows inventory investment,
Improve positive cash flows lead times, and Total assets
by reducing lead times and backlogs
Achieve the same
backlogs or better
Fixed assets performance with
Inventory Reduce the number fewer assets
of warehouses
Increase inventory turnover through improved
supply chain design
Figure 12.6
 Strategic Options for
Supply Chain Design
• Efficient supply chains
– Make-to-stock (MTS)

• Responsive supply chains

– Assemble-to-order (ATO)
– Make-to-order (MTO)
– Design-to-order (DTO)
 Environments
Responsive Supply
Factor Efficient Supply Chains
Chains
Demand Predictable, low forecast Unpredictable, high
errors forecast errors
Competitive Low cost, consistent Development speed, fast
priorities quality, on-time delivery delivery times,
customization, volume
flexibility, variety, top
quality
New- Infrequent Frequent
service/product
introduction
Contribution Low High
margins
Product variety Low High
Table 12.1
 Supply Chain Designs
Make-to-Stock Strategy

Order based on forecast Order based on forecast Customer order

Finished
Component
Manufacturer Goods Customer
Supplier
Inventory
Supply to Supply to Ship to
forecasted forecast order
demand

Figure 12.7
 Supply Chain Designs
Assemble-to-Order Strategy
Customer order

Order based on forecast Supply

as
needed

Component Standardized Customer

Component Fabrication Assembly
Supplier
Inventory
Supply to
Forecasted
Demand

Supply as
needed

Figure 12.8
 Design Features
Responsive Supply
Factor Efficient Supply Chains
Chains
Operation strategy Make-to-stock or Assemble-to-order, make-
standardized services or to-order, or customized
products; emphasize high service or products;
volumes emphasize variety
Capacity cushion Low High
Inventory Low; enable high inventory As needed to enable fast
investment turns delivery time
Lead time Shorten, but do not Shorten aggressively
increase costs
Supplier selection Emphasize low prices, Emphasize fast delivery
consistent quality, on-time time, customization,
delivery variety, volume flexibility,
top quality
Table 12.2
What is Supply Chain Integration?
Supply Chain
Integration

The effective coordination

of supply chain processes
though the seamless flow
of information up and
down the supply chain.
 Supply Chain Integration
Upstream Downstream

Tier 3 Tier 2 Tier 1

Tomato Tomato Tomato Ketchup Retail Consumers
suppliers grading paste factory sales
stations factories

Information flows
Cash flows

Figure 14.1
 Supply Chain Disruptions
• External Causes
– Environmental Disruptions
– Supply Chain Complexity
– Loss of Major Accounts
– Loss of Supply
– Customer-Induced Volume Changes
– Service and Product Mix Changes
– Late Deliveries
– Underfilled Shipments
 Supply Chain Disruptions
• Internal Causes
– Internally Generated Shortages
– Quality Failures
– Poor Supply Chain Visibility
– Engineering Changes
– Order Batching
– New Service or Production Introductions
– Service or Product Promotions
– Information Errors
 Supply Chain Dynamics
• Bullwhip Effect
– The phenomenon in supply chains whereby
ordering patterns experience increasing variance
as you proceed upstream in the chain.
 Supply Chain Dynamics
Package
Retailers’ Manufacturer’s supplier’s weekly
Consumers’ daily orders weekly orders orders to
daily to to package cardboard
demands manufacturer supplier supplier
9,000
Order quantity

7,000

5,000

3,000

Day 1 Day 30 Day 1 Day 30 Day 1 Day 30 Day 1 Day 30

0
Month of April

Figure 14.2 The Bullwhip Effect

 Integrated Supply Chains
• External Supply Chain Linkages
First-Tier Supplier Service/Product Provider
Support Processes Support Processes

New service/ Business- New service/ Business-to-

Business-
to-business consumer

External Consumers
product to-business product to-business
External Suppliers

development (B2B)
(B2B) development (B2C)
(B2B)
process customer process customer
customer
relationship relationship
relationship
process
process process
process

Supplier Order Supplier Order

relationship fulfillment relationship fulfillment
process process process process

Figure 14.3
New Service/Product Development
Design
 Service or
product not
profitable
 Need to rethink
Analysis the new offering
or production
process

Development  Post-launch
review

Figure 14.5 Full Launch

 Green Purchasing
• Green purchasing – The process of identifying,
assessing, and managing the flow of
environmental waste and finding ways to
reduce it and minimize its impact on the
environment.
– Choose environmentally conscious suppliers.
– Use and substantiate claims such as green,
biodegradable, natural, and recycled.
– Use sustainability as criteria for certification.
 Supplier Relationship Process
• Design collaboration
– Early supplier involvement
– Presourcing
– Value analysis

• Negotiation
– Competitive orientation
– Cooperative orientation
 Supplier Relationship Process
• Buying
– Electronic Data Interchange (EDI)

– Catalog Hubs

– Exchanges

– Auctions

– Locus of Control
 Supplier Relationship Process

• Information Exchange

– Radio Frequency Identification (RFID)

– Vendor-Managed Inventories (VMI)

 Order Fulfillment Process
• Customer Demand Planning
• Supply Planning
• Production
• Logistics
– Ownership
– Facility location
– Mode selection
– Capacity level
– Cross-docking
 The Customer Relationship Process
• Marketing
– Business-to-Consumer Systems
– Business-to-Business Systems
• Order Placement
– Cost Reduction
– Revenue Flow Increase
– Global Access
– Pricing Flexibility
• Customer Service
 Supply Chain Risk Management
• Supply Chain Risk Management
– The practice of managing the risk of any factor or
event that can materially disrupt a supply chain,
whether within a single firm or across multiple
firms.
 Supply Chain Risk Management
• Operational Risks – Threats to the effective flow of
materials, services, and products in a supply chain
– Strategic Alignment
– Upstream/Downstream Supply Chain Integration
– Visibility
– Flexibility and Redundancy
– Short Replenishment Lead Times
– Small Order Lot Sizes
– Rationing Short Supplies
– Everyday low pricing (EDLP)
– Cooperation and Trustworthiness
 Supply Chain Risk Management
• Financial Risks – Threats to the financial flows in
a supply chain, such as prices, costs, and profits.

– Low Cost Hopping

– Hedging
• Production Shifting
• Futures Contract
 Supply Chain Risk Management
• Security Risks - Threats to a supply chain that could
potentially damage stakeholders, facilities, or
operations.
– Access Control
– Physical Security
– Shipping and Receiving
– Transportation Service Provider
– ISO 28000
 Performance Measures
Customer Relationship Order Fulfillment
 Percent of orders taken  Percent of incomplete
accurately orders shipped
 Time to complete the  Percent of orders shipped
order placement process on-time
 Customer satisfaction  Time to fulfill the order
with the order  Percent of botched services
placement process or returned items
 Customer’s evaluation of  Cost to produce the service
firm’s environmental or item
stewardship
 Customer satisfaction with
 Percent of business lost the order fulfillment process  Evaluation of suppliers’
because of supply chain
disruptions  Inventory levels of work-in-
process and finished goods
 Amount of greenhouse
gasses emitted into the air
 Number of security
breaches
Supplier Relationship
 Percent of suppliers’
deliveries on-time
 Suppliers’ lead times
 Percent defects in services
and purchased materials
 Cost of services and
purchased materials
 Inventory levels of
supplies and purchased
components
collaboration on
streamlining and waste
conversion
 Amount of transfer of
environmental
technologies to suppliers
What is Sustainability?

Sustainability

A characteristic of
processes that are
meeting humanity’s
needs without
harming future
generations.
 Sustainability

• Sustainability Challenges:

– Environmental protection

– Productivity improvement

– Risk minimization

– Innovation
 Supply Chains and Sustainability

Supply Chains
Social
Responsibility and
Sustainability

Financial Environmental
Responsibility Responsibility

Figure 15.1
 The Three Elements of
Supply Chain Sustainability
• Financial Responsibility

• Environmental Responsibility
- Reverse Logistics
- Efficiency

• Social Responsibility
- Disaster Relief Supply Chains
- Ethics
Humanitarian Logistics
Humanitarian Logistics
The process of planning,
implementing and controlling
the efficient, cost-effective
flow and storage of goods and
materials, as well as related
information, from the point of
origin to the point of
consumption for the purpose
of alleviating the suffering of
vulnerable people.
Reverse Logistics
Reverse Logistics

The process of planning,

implementing and
controlling the efficient,
cost-effective flow of
products, materials, and
information from the point
of consumption back to the
point of origin for returns,
repair, remanufacture, or
recycling.
Closed-Loop Supply Chain
Closed-Loop Supply
Chain

A supply chain that

integrates forward logistics
with reverse logistics,
thereby focusing on the
complete chain of
operations from the birth
to the death of a product.
 Flows in a Closed-Loop Supply Chain

Production Distribution/
Customers
process Retailers

New
service/product Repair
Direct
development reuse
process Recycle
parts and Returns
materials processor
Waste
Remanufacture disposal
Product
information Forward flow
Figure 15.2 Reverse flow
 Reverse Logistics
• Financial Implications
– Fee
– Deposit fee
– Take back
– Trade-in
– Community programs
 Energy Efficiency
• Carbon footprint

– The total amount of greenhouse gasses

produced to support operations, usually
expressed in equivalent tons of carbon
dioxide (CO2)
 Transportation Distance
• Route Planning
– Shortest route problem
• Find the shortest distance between two
cities in a network or map.

– Traveling salesman problem

• Find the shortest possible route that visits
each city exactly once and returns to the
starting city.
 Nearest Neighbor Heuristic
• Steps
1. Start with the city that is designated as the central
location. Call this city the start city. Place all other cites
in an unvisited set.
2. Choose the city in the unvisited set that is closest to
the start city. Remove that city from the unvisited set.
3. Repeat the procedure with the latest visited city as the
start city.
4. Conclude when all cities have been visited, and return
back to the central location.
5. Compute the total distance traveled along the selected
route.
Four-City Traveling Salesman Problem

90

100
Central 130
Hub
85
80

B C
120
Figure 15.3
 Freight Density
• Freight rates are based on the following
factors:
1. The freight density
2. The shipment’s weight
3. The distance the shipment is moving
4. The commodity’s susceptibility to damage
5. The value of the commodity
6. The commodity’s loadability and handling
characteristics.
 Transportation Mode

• Major Modes of Transportation

1. Air freight
2. Trucking
3. Shipping by Water
4. Rail
 Supply Chain Strategies
 Negotiating with many suppliers
 Long-term partnering with few
suppliers
 Vertical integration
 Joint ventures
 Keiretsu
 Virtual companies that use
suppliers on an as needed basis
49
 Supply Chain Ethics
• Buyer-Supplier Relationships
– Identifying ethical and unethical work
practices

• Facility Location

• Inventory Management
 Managing Sustainable Supply Chains

1. Develop a sustainable supply chain framework.

2. Gather data on current supplier performance
and use that information to screen new
suppliers.
3. Require compliance across all business units.
4. Engage in active supplier management utilizing
ethical means.
5. Provide periodic reports on the impact of supply
chains on sustainability.
 MGT7101
Managing Operations in Business

Designing Lean Systems

Chapter 6

52
What is a Lean System?
Lean Systems

Operations systems that

maximize the value
added by each of a
company’s activities by
removing waste and
delays from them.
Continuous Improvement Using a Lean
Systems Approach
• Just-in-time (JIT) philosophy
– The belief that waste can be eliminated by cutting
unnecessary capacity or inventory and removing
non-value-added activities in operations.
 Eight Types of Waste or Muda

1. Overproduction 5. Motion
2. Inappropriate
Processing 6. Inventory

3. Waiting 7. Defects

4. Transportation 8. Underutilization of
Employees

Table 6.1
 Continuous Improvement
with Lean Systems

Figure 6.1
 Supply Chain Considerations
in Lean Systems

• Close Supplier Ties

• Small Lot Sizes

– Single-digit setup
 Process Considerations
in Lean Systems
Pull Method of Workflow (LEAN)

A method in which customer demand activates the

production of the service or item.

Push Method of Workflow (NOT LEAN)

A method in which production of the item begins in

advance of customer needs.
 Process Considerations
in Lean Systems
• Quality at the Source
– Jidoka
• Automatically stopping the process when something is
wrong and then fixing the problems on the line itself as
they occur.

– Poka-Yoke
• Mistake-proofing methods aimed at designing fail-safe
systems that minimize human error.
 Process Considerations
in Lean Systems
• Uniform Workstation Loads
– Takt time
– Heijunka
– Mixed-model assembly

• Standardized Components and Work Methods

 Process Considerations
in Lean Systems
• Flexible Workforce

• Automation

• 5S

• Total Preventative
Maintenance
 5S

Table 6.2
 Toyota Production System

• All work must be completely specified as to

content, sequence, timing, and outcome.
• All customer-supplier connections should be
direct and unambiguous.
• All pathways should be simple and direct.
• All improvements should be made under the
guidance of a teacher using the scientific
method.
 House of Toyota

Figure 6.3
 One-Worker, Multiple Machines

Figure 6.4
 Group Technology
Jumbled Flows
without GT

Lines Flows with 3

GT cells
Figure 6.5
What is a Value Stream Mapping?
Value Stream Mapping

A widely used
qualitative lean tool
aimed at eliminating
waste or muda.

Figure 6.6
What is a Kanban?
Kanban

A Japanese word
meaning “card” or
“visible record” that
refers to cards used to
control the flow of
production through a
factory
 The Kanban System
Receiving post Storage
Kanban card for
product 1 area
Kanban card for
product 2

Empty containers

Assembly line 1
O2

Fabrication
cell
O1 O3
Assembly line 2
Full containers
O2
Figure 6.9
 The Kanban System
Receiving post Storage
Kanban card for
product 1 area
Kanban card for
product 2

Empty containers

Assembly line 1
O2

Fabrication
cell
O1 O3
Assembly line 2
Full containers
O2
Figure 6.9
 The Kanban System
Receiving post Kanban card for Storage
product 1 area
Kanban card for
product 2

Empty containers

Assembly line 1
O2

Fabrication
cell
O1 O3
Assembly line 2
Full containers
O2
Figure 6.9
 The Kanban System
Receiving post Kanban card for Storage
product 1 area
Kanban card for
product 2

Empty containers

Assembly line 1
O2

Fabrication
cell
O1 O3
Assembly line 2
Full containers
O2
Figure 6.9
 The Kanban System
Receiving post Kanban card for Storage
product 1 area
Kanban card for
product 2

Empty containers

Assembly line 1
O2

Fabrication
cell
O1 O3
Assembly line 2
Full containers
O2
Figure 6.9
 The Kanban System
Receiving post Kanban card for Storage
product 1 area
Kanban card for
product 2

Empty containers

Assembly line 1
O2

Fabrication
cell
O1 O3
Assembly line 2
Full containers
O2
Figure 6.9
 The Kanban System
Receiving post
Kanban card for Storage
product 1 area
Kanban card for
product 2

Empty containers

Assembly line 1
O2

Fabrication
cell
O1 O3
Assembly line 2
Full containers
O2
Figure 6.9
 General Operating Rules
1. Each container must have a card.
2. Assembly always withdraws from fabrication
(pull system).
3. Containers cannot be moved without a kanban.
4. Containers should contain the same number of
parts.
5. Only good parts are passed along.
6. Production should not exceed authorization.
 Summary Goals and Building Blocks
Ultimate A
Goal balanced
rapid flow

Supporting
Goals Eliminate disruptions
Make the system flexible Eliminate waste

Product Process Personnel Manufactur-

Design Design Elements ing Planning

Building Blocks

77
 MGT7101
Managing Operations in Business

Managing Inventories

Chapter 9

78
What is a Inventory Management?
Inventory
Management

The planning and

controlling of
inventories to meet the
competitive priorities
of the organization.
What is Inventory?

Inventory

A stock of materials
used to satisfy
customer demand or
to support the
production of services
or goods.
 Inventory Trade-Offs

Input flow of materials

Inventory level

Scrap flow
Figure 9.1 Output flow of materials
 Pressures for Small Inventories
• Inventory holding cost
• Cost of capital
• Storage and handling costs
• Taxes
• Insurance
 Pressures for Large Inventories
• Customer service
• Ordering cost
• Setup cost
• Labor and equipment utilization
• Transportation cost
• Payments to suppliers
 Types of Inventory

• Accounting Inventories

– Raw materials

– Work-in-process

– Finished goods
 Types of Inventory

Figure 9.2
 Types of Inventory
• Operational Inventories

– Cycle Inventory

– Safety Stock Inventory

– Anticipation Inventory

– Pipeline Inventory
 Cycle Inventory
Lot sizing principles
1. The lot size, Q, varies directly with the elapsed
time (or cycle) between orders.
2. The longer the time between orders for a given
item, the greater the cycle inventory must be.

Q+0 Q
Average cycle inventory = =
2 2
 Pipeline Inventory

Average demand during lead time = DL

Average demand per period = d
Number of periods in the item’s lead time = L

Pipeline inventory = DL = d L
 Example 9.1
A plant makes monthly shipments of electric drills to a
wholesaler in average lot sizes of 280 drills. The
wholesaler’s average demand is 70 drills a week, and
the lead time from the plant is 3 weeks. The wholesaler
must pay for the inventory from the moment the plant
makes a shipment. If the wholesaler is willing to
increase its purchase quantity to 350 units, the plant
will give priority to the wholesaler and guarantee a lead
time of only 2 weeks. What is the effect on the
wholesaler’s cycle and pipeline inventories?
 Example 9.1

The wholesaler’s current cycle and pipeline

inventories are
Q
Cycle inventory = 2 = 140 drills

Pipeline inventory = DL = d L = (70 drills/week)(3 weeks)

= 210 drills
 Example 9.1

The wholesaler’s cycle and pipeline inventories if

they accept the new proposal
Q
Cycle inventory = 2 = 175 drills

Pipeline inventory = DL = d L = (70 drills/week)(2 weeks)

= 140 drills
 Inventory Reduction Tactics
• Cycle inventory
– Reduce the lot size
• Reduce ordering and setup costs and allow Q to be reduced
• Increase repeatability to eliminate the need for changeovers

• Safety stock inventory

– Place orders closer to the time when they must be
received
• Improve demand forecasts
• Cut lead times
• Reduce supply uncertainties
• Rely more on equipment and labor buffers
 Inventory Reduction Tactics
• Anticipation inventory
– Match demand rate with production rates
• Add new products with different demand cycles
• Provide off-season promotional campaigns
• Offer seasonal pricing plans

• Pipeline inventory
– Reduce lead times
• Find more responsive suppliers and select new carriers
• Change Q in those cases where the lead time depends on the
lot size
 Economic Order Quantity
• The lot size, Q, that minimizes total annual
inventory holding and ordering costs

• Five assumptions
1. Demand rate is constant and known with certainty.
2. No constraints are placed on the size of each lot.
3. The only two relevant costs are the inventory holding
cost and the fixed cost per lot for ordering or setup.
4. Decisions for one item can be made independently of
decisions for other items.
5. The lead time is constant and known with certainty.
 Economic Order Quantity
• Don’t use the EOQ
– Make-to-order strategy
– Order size is constrained
• Modify the EOQ
– Quantity discounts
– Replenishment not instantaneous
• Use the EOQ
– Make-to-stock strategy with relatively stable
demand.
– Carrying and setup costs are known and relatively
stable
 Calculating EOQ
Receive Inventory depletion
order (demand rate)

Q
On-hand inventory (units)

Q Average
cycle
2 inventory

1 cycle
Time
Figure 9.5
 Calculating EOQ
• Annual holding cost
Annual holding cost = (Average cycle inventory)
 (Unit holding cost)

• Annual ordering cost

Annual ordering cost = (Number of orders/Year)
 (Ordering or setup costs)

• Total annual cycle inventory cost

Total costs = Annual holding cost

+ Annual ordering or setup cost
 Calculating EOQ

Total cost
Annual cost (dollars)

Holding cost

Ordering cost

Figure 9.6
Lot Size (Q)
 Calculating EOQ

• Total annual cycle-inventory cost

Q D
C= (H) + (S)
2 Q

where
C = total annual cycle-inventory cost
Q = lot size (in units)
H = holding cost per unit per year
D = annual demand (in units)
S = ordering or setup costs per lot
 Example 9.2
• A museum of natural history opened a gift shop which
operates 52 weeks per year.
• Top-selling SKU is a bird feeder.
• Sales are 18 units per week, the supplier charges $60 per
unit.
• Ordering cost is $45.
• Annual holding cost is 25 percent of a feeder’s value.
• Management chose a 390-unit lot size.
• What is the annual cycle-inventory cost of the current
policy of using a 390-unit lot size?
• Would a lot size of 468 be better?
 Example 9.2
We begin by computing the annual demand and holding cost as
D = (18 units/week)(52 weeks/year) = 936 units
H = 0.25($60/unit) = $15
The total annual cycle-inventory cost for the current policy is
Q D 390 936
C = 2 (H) + Q (S) = ($15) + ($45)
2 390
= $2,925 + $108 = $3,033
The total annual cycle-inventory cost for the alternative lot size is
468 936
C= ($15) + 468 ($45) = $3,510 + $90 = $3,600
2
 Example 9.2
Current
cost

3000 –
Total Q D
= (H) + (S)
Annual cost (dollars)

cost 2 Q

2000 –
Q
Holding cost = (H)
2

1000 –
D
Ordering cost = (S)
Lowest Q
cost
0– | | | | | | | |
50 100 150 200 250 300 350 400
Lot Size (Q)
Best Q Current
Figure 9.7 (EOQ) Q
 Calculating EOQ
• The EOQ formula:
2DS
EOQ =
H

• Time Between Orders (TBO):

EOQ
TBOEOQ = (12 months/year)
D
 Example 9.3
For the bird feeders in Example 9.2, calculate the
EOQ and its total annual cycle-inventory cost. How
frequently will orders be placed if the EOQ is used?

Using the formulas for EOQ and annual cost, we get

2DS 2(936)(45)
EOQ = = = 74.94 or 75 units
H 15
 Example 9.3
Below shows that the total annual cost is much less than the $3,033 cost
of the current policy of placing 390-unit orders.

Figure 9.8
 Example 9.3
When the EOQ is used, the TBO can be expressed in various
ways for the same time period.
EOQ 75
TBOEOQ = = = 0.080 year
D 936

EOQ 75
TBOEOQ = (12 months/year) = (12) = 0.96 month
D 936

EOQ 75
TBOEOQ = D
(52 weeks/year) = (52) = 4.17 weeks
936

EOQ 75
TBOEOQ = (365 days/year) = (365) = 29.25 days
D 936
 Application 9.1
Suppose that you are reviewing the inventory policies on an
$80 item stocked at a hardware store. The current policy is to
replenish inventory by ordering in lots of 360 units. Additional
information is:
D = 60 units per week, or 3,120 units per year
S = $30 per order
H = 25% of selling price, or $20 per unit per year
What is the EOQ?

2DS 2(3,120)(30)
EOQ = = = 97 units
H 20
 Application 9.1
What is the total annual cost of the current policy (Q = 360),
and how does it compare with the cost with using the EOQ?

Current Policy EOQ Policy

Q = 360 units Q = 97 units

C = (360/2)(20) + C = (97/2)(20) +
(3,120/360)(30) (3,120/97)(30)
C = 3,600 + 260 C = 970 + 965
C = $3,860 C = $1,935
 Application 9.1
What is the time between orders (TBO) for the current
policy and the EOQ policy, expressed in weeks?

360
TBO360 = (52 weeks per year) = 6 weeks
3,120

97
TBOEOQ = (52 weeks per year) = 1.6 weeks
3,120
 Managerial Insights from the EOQ
SENSITIVITY ANALYSIS OF THE EOQ
Parameter EOQ Parameter EOQ Comments
Change Change

Demand 2DS ↑ ↑
Increase in lot size is in proportion
to the square root of D.
H

Order/ 2DS Weeks of supply decreases and

↓ ↓ inventory turnover increases
Setup Costs H because the lot size decreases.

Holding 2DS Larger lots are justified when

↓ ↑
Costs H holding costs decrease.
Table 9.1
 Periodic Review System (P)

• Fixed interval reorder system or periodic reorder

system

• Four of the original EOQ assumptions maintained

1. No constraints are placed on lot size
2. Holding and ordering costs
3. Independent demand
4. Lead times are certain and supply is known