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Management
Inventory Management
Chapter 12 - Part 2
12-1
Outline
Functions of Inventory.
ABC Analysis.
Inventory Costs.
Inventory Models for Independent Demand.
Economic Order Quantity (EOQ) Model.
Production Order Quantity (POQ) Model.
Quantity Discount Models.
Probabilistic Models for Varying Demand.
Fixed Period Systems.
12-2
Production Order Quantity Model
Material is not received instantaneously.
For example, it is produced in-house.
12-3
Production Order Quantity Model
Consider one product at a time.
Produce Q units in a production run; then
switch and produce other products.
Later produce Q more units in 2nd production
run (Q units of product of interest).
Later produce Q more units in 3rd production
run, etc.
12-4
POQ Model Inventory Levels
Inventory Level
Time
Production Production
Begins Run Ends
12-5
POQ Model Inventory Levels
Inventory Level Production rate = p = 20/day
Demand rate = d = 7/day
Slope = -d = -7/day
Time
Production Production Note: Not all of production goes into
Begins Run Ends inventory
12-6
POQ Model Inventory Levels
Inventory Level Production rate = p = 20/day
Demand rate = d = 7/day
Slope = p-d = 13/day
Inventory increases by 13 each day
while producing
Slope = -d = -7/day
Inventory decreases by 7/day
after producing
Time
Production Production Note: 1-(d/p) = fraction of production
Begins Run Ends that goes into inventory
12-7
POQ Model Equations
D = Annual demand (relatively constant)
S = Setup cost per setup Given
H = Holding (carrying) cost per unit per year
d = Demand rate (units per day, units per week, etc.)
p = Production rate (units per day, units per week, etc.)
Production
Portion of Cycle
Time
Demand portion of cycle
with no supply
12-9
POQ Model Equations
D = Annual demand (relatively constant)
S = Setup cost per setup Given
H = Holding (carrying) cost per unit per year
d = Demand rate (units per day, units per week, etc.)
p = Production rate (units per day, units per week, etc.)
Time
12-12
POQ Example
Demand = 1000/year (of product A) Demand rate = d = 1000/365
Setup cost = $100/setup = 2.74/day
Holding cost = $20 per year per item
Production rate = 10/day
365 working days per year
1000 117.36
Total Cost = 100 + 20 [1-(2.74/10)]
117.36 2
= 852.08 + 852.03 = $1704.11/year
12-13
POQ Example
Demand = 1000 units/year
Production rate = 10 units/day
Qp* = 117.36 units per run
42.8
11.74
12-14
Robustness of POQ
POQ is robust (like EOQ):
Can adjust production run size.
Useful even when parameters are uncertain.
A large (20%) change in parameters or operations
will cause a small (~2%) change in total costs.
12-15
POQ Robustness Example
Set production run length to 14 days (2 weeks)
rather than 11.74 days (as was optimal).
Q/p = 14 days means that: Q = 10x14 = 140 units
Q = 140 is 19% over optimal value of 117.4 units.
12-16
POQ & Multiple Products
POQ computes a production run size for a single
product.
For multiple products made on the same
equipment:
1. Compute POQ, run time, and cycle time for each product.
2. Find a common cycle time for all products.
3. Recalculate run time and cycle time, so the common cycle
time is a multiple of each product’s cycle time.
4. Fit production runs into largest cycle time.
12-17
Multiple Products Example
Example: Company makes 3 products: A, B, C
A: Optimal run time = 3 days; Optimal cycle time = 10 days
B: Optimal run time = 6 days; Optimal cycle time = 18 days
C: Optimal run time = 10 days; Optimal cycle time = 33 days
A A A
3 7 3 7 3 7
B B
6 12 6 12
C
10 23
12-18
Multiple Products Example
Optimal run time and cycle time:
A: Run time = 3 days; Cycle time = 10 days (1 run/10 days)
B: Run time = 6 days; Cycle time = 18 days (1 run/18 days)
C: Run time = 10 days; Cycle time = 33 days (1 run/33 days)
A B C A B A
3 5 9 3 5 3
12-20
Quantity Discount Model - Holding
Cost
Holding cost:
Depends on price.
Usually expressed as a % of price per unit time.
20% of price per year, 2% of price per month, etc.
12-21
Quantity Discount Equations
D = Annual demand
S = Order cost per order
H = Holding (carrying) cost = IP
I = Inventory holding cost % per year
P = Price per unit
2 ×D ×S
Order Quantity = Q* =
IP
Annual purchase cost
12-22
Quantity Discount Model
Q P IP
D = 1000/year
<500 $100 $20
S = $100/order
I = 20% per year 500-1000 $ 95 $19
1000 $ 90 $18
To solve:
1. Find EOQ amount for each discount level.
2. If EOQ is not in range for discount level, adjust to the nearest
end of range.
3. Calculate total cost for each discount level.
4. Select lowest cost and corresponding Q.
12-23
Quantity Discount Example
Q P IP
D = 1000/year
S = $100/order <500 $100 $20
I = 20% per year 500-1000 $ 95 $19
1000 $ 90 $18
1. P = $100 IP = $20
EOQ = 100 in range!
Total Cost = 1,000 + 1,000 + 100,000 = $102,000/year
2. P = $95 IP = $19
EOQ = 102.6 not in range (500-1000)!
Adjust to Q = 500
Total Cost = 200 + 4,750 + 95,000 = $99,950/year
12-24
Quantity Discount Example - cont.
Q P IP
D = 1000/year
S = $100/order <500 $100 $20
I = 20% per year 500-1000 $ 95 $19
1000 $ 90 $18
3. P = $90 IP = $18
EOQ = 105.4 not in range (>1000)!
Adjust to Q = 1000
Total Cost = 100 + 9,000 + 90,000 = $99,100/year
Q Total costs
<500 $102,100
500-1000 $ 99,950
1000 $ 99,100 Lowest cost, so order 1000
12-25
Stockouts
In basic EOQ model, demand and lead time are
known and constant, so there should never be a
stockout.
12-26
Probabilistic Models
Inventory Level
Average demand
Reorder
Point
(ROP)
Inventory Level
Reorder
Point
(ROP)
Inventory Level
Safety stock
New ROP
Old ROP
12-30
Probabilistic Models
Demand follows normal distribution.
d = Average demand rate per day.
= Standard deviation of demand.
12-31
EOQ-based Models
Order same amount every time = Q.
Time between orders varies.
ROP
12-33
Fixed Period Model
Compute optimal order interval, T (equation is
similar to EOQ).
For example, 27.35 days
Compute maximum inventory level, M (equation is
similar to ROP).
Adjust order interval to a convenient length.
For example, one month.
Then, adjust M correspondingly.
Order M - inventory on hand every T time units.
12-34
Fixed Period Models
Order at constant interval.
Order amount Q varies: M - amount on hand.
On-hand
for order 2
On-hand
for order 1