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L d = ROP
_
A little bit of common sense
L
z L d = ROP
_
ROP with safety stock
TC = Total annual cost
D = Demand
C = Cost per unit
Q = Order quantity
S = Cost of placing an order or setup cost
H = Annual holding and storage cost per unit
of inventory
R or ROP = Reorder point
L = Lead time (constant)
= average (daily, weekly, etc) demand
L
= Standard deviation of demand during lead time
_
d
13
Basic EOQ & ROP Example
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, reorder point, and
total annual cost?
EOQ 89.44 89 or 90 units
ROP 2.74*7 19.18 19 or 20 units
14
Another example
Days per year considered in average daily demand = 360
Average daily demand is 3.5 units
Standard deviation of daily demand is 0.95 units
Cost to place an order = $50
Holding cost per unit per year = $7.25
Lead time = 4 days
Compute the EOQ, and ROP is the firm wants to
maintain a 97% service level (probability of not stocking out)
2
d
1
2
constant, is and t independen is day each Since
d L
L
i
d L
L
i
L
z L d = ROP
_
15
Fixed-Time Period Model with Safety Stock
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
16
Example of the Fixed-Time Period Model
Average daily demand for a product is 20 units.
The review period is 30 days, and lead time is 10 days.
Management has set a policy of satisfying 96 percent of
demand from items in stock. At the beginning of the
review period there are 200 units in inventory. The daily
demand standard deviation is 4 units.
Given the information below, how many units should be ordered?
25.298 = 4 10 + 30 = L) + (T =
2 2
d L + T
q = 20(30+10) + 1.75(25.30) 200 644.27 units
17
A special purpose model
Price-Break Model (Quantity discounts)
Based on the same assumptions as the EOQ model, the price-
break model has a similar EOQ (Q
opt
) formula:
Annual holding cost, H, is calculated using H = iC where
i = percentage of unit cost attributed to carrying inventory
C = cost per unit
Since C changes for each price-break, the formula above
must be applied to each price-break cost value.
Determine the total cost for each price break
The lowest total cost suggests the optimal order size (EOQ)
Cost Holding Annual
Cost) Setup or der Demand)(Or 2(Annual
=
iC
2DS
= Q
OPT
18
Price-Break Example
A company has a chance to reduce their inventory ordering costs by
placing larger quantity orders using the price-break order quantity
schedule below. What should their optimal order quantity be if this
company purchases this single inventory item with an e-mail ordering
cost of $4, a carrying cost rate of 2% of the inventory cost of the item,
and an annual demand of 10,000 units?
Order Quantity(units) Price/unit($)
0 to 2,499 $1.20
2,500 to 3,999 $1.00
4,000 or more $0.98
Re-do the example with an order cost of $25 and an inventory carrying cost rate of 45%.
19
0 1826 2500 4000 Order Quantity
20
ABC Classification System
Items kept in inventory are not of equal importance in terms of:
dollars invested
profit potential
sales or usage volume
stock-out penalties
So, identify inventory items based on percentage of total dollar value,
where A items are roughly top 15 %, B items as next 35 %, and the
lower 65% are the C items
0
30
60
30
60
A
B
C
% of
$ Value
% of
Use
21
Inventory Accuracy and Cycle Counting
Inventory accuracy refers to how well the inventory
records agree with physical count
Lock the storeroom
Hire the right personnel for as storeroom manager or
employees
Cycle Counting is a physical inventory-taking technique in
which inventory is counted on a frequent basis rather than
1-2 times a year
Easier to conduct when inventories are low
Randomly (minimize predictability)
Pay more attention to A items, then B, etc.
Suggested problems: 3, 6, 12, 14, 17, 18, 21, 24
Case: Hewlett-Packard