Derivation of EOQ

with Planned Backorders

Chris Caplice
 Notation
D = Average Demand (units/time)
ct = Fixed Ordering or Transaction Cost ($/order)
h = Carrying or Holding Charge (%/time)
c = Variable (Purchase) Cost ($/unit)
ce = c*h = Excess Cost per unit per period ($/unit/time)
cs = Shortage Cost per unit per period ($/unit/time)
Q = Replenishment Order Quantity (units/order)
T = Order Cycle Time (time/order)

MIT Center for Transportation & Logistics – ESD.260 2 © Chris Caplice, MIT
 EOQ with Planned Backorders
T
Inventory On Hand

We know that:

Q-b =
(
Q Q−b
=
b )
Q T2
T T1 T2
T1

b
Time
! D$ ! 1 $! T1 $ ! 1 $! T2 $
(
TRC(Q,b) = ct # & + ce # &# & Q − b + cs # &# & b
"Q% " 2 %" T % " 2 %" T %
) ()
! D$ ! 1 $! (Q − b) $ ! 1 $! b $
TRC(Q,b) = ct # & + ce # &#
"Q% " 2 %" Q %
( )
& Q − b + cs # & # & b
" 2 %" Q %
()
! 2$
! D$ (# Q−b
TRC(Q,b) = ct # & + ce #
) & ! b2 $
"Q% # 2Q && + cs # 2Q &
" %
MIT Center for Transportation & Logistics – ESD.260 3 " ©%Chris Caplice, MIT
 Finding Q* and b*
! 2 $
! D$ # Q−b
TRC(Q,b) = ct # & + ce #
( ) & ! b2 $
"Q% # 2Q && + cs # 2Q &
" %
" %

Need to find both Q* and b*, so we take partial derivatives. First, for b*:

∂TRC(Q,b) ce #c & −ce Q − b # c b & ( )

∂b
= 0+
2Q
((
2 Q − b −1 + % ( 2b =
s

$ 2Q ' Q
) ( ))
+% s ( = 0
$Q'

csb ce Q − b
=
( ) csb = ceQ − ce b ( )
csb + ce b = b cs + ce = ceQ
Q Q
Taking the second derivative shows >0,
thus it is a global minimum
ceQ
b* = ∂TRC(Q,b) −ceQ ce b csb
= + +
(c + c )
s e ∂b Q Q Q
∂2TRC '(Q,b) ce cs
= 0 + + >0
MIT Center for Transportation & Logistics – ESD.260 4
∂2 b Q Q © Chris Caplice, MIT
 Finding Q* and b*
Now we solve for Q*
! 2 $
! D$ ! b2 $ # Q−b ( ) & ! D$ ! b2 $ ! c $ 2
TRC(Q,b) = ct # & + cs # & + ce #
"Q% " 2Q % # 2Q && = ct #" Q &% + cs # 2Q & + #" 2Q &% Q − b
" %
e
( )
" %

∂TRC(Q,b) #D& # b2 & )# c & 2 # −c &,

∂Q $Q '
e

$ 2Q ' +*$ 2Q ' $ 2Q '.-

((
= −ct % 2 ( − cs % 2 ( + +% ( 2 Q − b 1 + Q − b % e2 (. = 0 ) ( )) ( )
' ! $ !c Q−b 2 $*
! D $! 2 $ ! b 2 $ )! Q $# ce 2Q − 2b
−ct # 2 &# & − cs # 2 & + )# &
( ) &−# e( ) &,
& ## 2Q 2 &&, = 0
" Q %" 2 % " 2Q % )" Q %#" 2Q % "
( %,+

! −2c D $ ! c b2 $ ! ceQ 2Q − 2b $ !c Q−b 2 $

&+#
( ) &−# e ( ) &
&& = 0
t s
# & − #
# 2& #
2
" 2Q % " 2Q % " 2Q 2 & ## 2Q 2
% " %

(
−2ct D − csb2 + 2ceQ 2 − 2ceQb − ce Q 2 − 2Qb + b2 = 0 )
MIT Center for Transportation & Logistics – ESD.260 5 © Chris Caplice, MIT
 Finding Q* and b*
Continuing to solve for Q* −2ct D − csb2 + 2ceQ 2 − 2ceQb − ce Q 2 − 2Qb + b2 = 0 ( )
−2ct D − csb2 + 2ceQ 2 − 2ceQb − ceQ 2 + 2ceQb − ce b2 = 0

−2ct D − csb2 + ceQ 2 − ce b2 = 0

ceQ 2 = 2ct D + csb2 + ce b2 = 2ct D + b2 cs + ce ( )

ceQ 2 ce2Q 2
Substituting back in the b* that we previously found . . .
b* = (b *) = 2
(c + c )
s e (c + c )
s e

2 ce2Q 2 2 ce2Q 2
ceQ = 2ct D + 2 (c + c )
s e
ceQ = 2ct D +
(c + c )
s e
(c + c )
s e

" ce2 % " "c +c % c 2 % " c c + c2 − c2 % " %

2$
Q ce − 2
' = Q $c $ s e
'− e ' = Q $ e s e e ' = Q 2 $ ce cs ' = 2c D
2
$ (
cs + ce ) ' $ e $# c + c '& c + c( ) ' $ c +c
#
'
&
$c +c '
# s e&
t
# & # s e s e & s e

MIT Center for Transportation & Logistics – ESD.260 6 © Chris Caplice, MIT
 Finding Q* and b*
Continuing to solve for Q*
! c +c
2
! cc $
Q ## e s && = 2ct D
2
Q = 2ct D #
s (
e ) $& = !# 2c D $&!# (c + c ) $&
t s e
! 2c D $
Q* = ## t &&
!c +c $
## s e &&
" cs + ce % # cc & #" c &%# cs & " ce % " cs %
" e s % e " %

Checking 2nd derivative, it is >0, therefore

a global minimum . . .

∂TRC(Q,b)
= −2ct D − csb2 + ceQ 2 − ce b2
∂Q ! 2 $
∂2TRC '(Q,b)
! D$ # Q−b
TRC(Q,b) = ct # & + ce #
( ) & ! b2 $
= 2ceQ > 0 "Q% # 2Q && + cs # 2Q &
2
∂Q " %
" %

! 2c D $ !c +c $ ceQ *
Q* = ## t && ## s e && b* =
" ce % " cs % (c + c )
s e

Order Q* when IOH = - b

MIT Center for Transportation & Logistics – ESD.260 7 © Chris Caplice, MIT
Questions, Comments,
Suggestions?

caplice@mit.edu