Chapter 11-

Independent Demand
Ordering Systems

2-Apr-01

Independent Demand Ordering

Systems

Main question now turns to when to

place an order?
Stock not ordered early enough may result
in a stockout situation
Stock ordered too soon may result in excess
inventory
How do you balance the two?

Definitions

Lead Time : The time between recognition of a

need for an order and the receipt of the goods
Order Point: A set inventory level where, if the
stock on hand plus on-order falls to or below that
point, action is taken to replenish the stock.
Safety Stock: In general, a quantity of stock
planned to be in inventory to protect against
fluctuations in demand and/or supply
Service Level: the percentage of orders
filled from stock
APICS Dictionary
7th Edition
1992

Independent Demand Ordering

Systems

Reorder Systems Include:

Order Point System
Periodic Review System
MRP

For dependent demand items

Independent Demand Ordering

Systems

Order Point Systems

A system where an order is placed whenever the onhand inventory level falls to a predetermined level
known as the order point.

Quantity ordered is usually predetermined and based

on the EOQ.

An order must be placed when there is enough stock on

hand to satisfy demand from the time the order is
placed until new stock arrives.

Independent Demand Ordering

Systems

The Order Point

The point where there exists enough inventory on
hand to equal the demand during the lead time plus
some safety stock.

OP = DDLT + SS
Note that the demand during lead time is important
as this when a stockout could occur.

Example: Order Point

Q: Demand is 100 units a week, the lead time is three
weeks, and the safety stock has been established at 300
units. Calculate the order point.
A:

OP = ?
DDLT = (100 units/week x 3 weeks)
SS = 300 units

OP = DDLT + SS = (100 x 3) + 300

= 600 units

Independent Demand Ordering

Systems

Order Point

Units in Stock

Q = Order
Quantity

Order
Point

Safety
Stock

Lead
Time

Average Inventory = Q/2 + SS

Independent Demand Ordering

Systems

Uncertainty
Quantity uncertainty

When the amount of supply or demand varies

Timing uncertainty

Time of receipt of supply or demand differs from that

expected

Two ways to protect:

Carry extra stock (safety stock)

Order early (safety lead time)

Independent Demand Ordering

Systems

Safety Stock
SS is used to protect against uncertainty in supply
and demand.
SS depends on:

Variability of demand during lead time

Frequency of reorder
Service level desired
Length of lead time

Independent Demand Ordering

Systems

Variability of Demand
Actual demand will vary from the forecast due to bias
and random fluctuations.
Usually the variation of demand will follow a normal
distribution

Average (mean)
Dispersion (range, MAD, Std. Deviation [Sigma])

Actual demand will be:

+/-1 sigma of the fcst average 68% of the time

+/-2 sigma of the fcst average 98% of the time
+/-3 sigma of the fcst average 99.88% of the time

Independent Demand Ordering

Systems

Determining Safety Stock

SS is needed only to cover those periods in which the
demand during lead time is greater than average.
Service level is a statement of the percentage of time
there is no stockout.

Is directly related to the number of standard deviations

provided as safety stock and sometimes called the
safety factor, or service factor.

Safety Stock = (Sigma x Safety Factor)

Safety Factor
Service Level Safety Stock
50.00%
0.00
55.00%
0.13
60.00%
0.25
65.00%
0.39
70.00%
0.52
75.00%
0.67
80.00%
0.84
81.00%
0.88
82.00%
0.92
83.00%
0.95
84.00%
0.99
85.00%
1.04
86.00%
1.08
87.00%
1.13
88.00%
1.17
89.00%
1.23

Service Level Safety Stock

90.00%
1.28
91.00%
1.34
92.00%
1.41
93.00%
1.48
94.00%
1.55
95.00%
1.64
96.00%
1.75
97.00%
1.88
98.00%
2.05
99.00%
2.33
99.50%
2.58
99.60%
2.65
99.70%
2.75
99.80%
2.88
99.90%
3.09
99.99%
3.72

Generated using Excel function NORMSINV

Independent Demand Ordering

Systems

Stockouts
Stockouts lead to costs such as

Back-order costs
Lost Sales
Lost Customers

Stockouts are possible only when stock is running

low, usually the time when an order is placed.

The chances of a stockout are directly proportional to

the frequency of reorder.

Independent Demand Ordering

Systems

Service Level
The service level will determine the number of
stockouts that will occur each year.
Service level decisions are the responsibility of senior
management and should reflect the companys
corporate and marketing strategy.

Independent Demand Ordering

Systems

Different Forecast & Lead-time Intervals

Usually there exists many items in inventory with
each having a different lead time.
Forecasts are usually made on a weekly or monthly
basis regardless of lead time.
As lead time increases so does the standard
deviation
But not in direct proportion to the LT

Independent Demand Ordering

Systems

Different Forecast & Lead-time Intervals

The standard deviation must be adjusted to
compensate for differences between lead time
interval (LTI) and forecast interval (FI):

Sigma for LTI = (Sigma for FI) [SQRT(LTI/FI)]

Independent Demand Ordering

Systems

Determining When the Order Point is

Reached
Two-Bin System

A quantity of an item equal to the order point is set aside

and not touched until the main stock has been used
Variations include tags and indicators

Perpetual Inventory System

A continual account of inventory transactions as they

occur
Contains permanent and variable information

Independent Demand Ordering

Systems

Periodic Review System

The quantity on hand of a particular item is
determined at specified, fixed-time intervals.
The review period is fixed and the order quantity is
allowed to vary.
The quantity on hand plus the quantity ordered must
be sufficient to last until next shipment is received.

Independent Demand Ordering

Systems

Distribution Inventory
Includes all the finished goods held anywhere in the
distribution system
Generally, utilizes distribution centers so as to improve
customer service by locating stock near the customer
Distribution Inventory Management:

Provide the required level of customer service

Minimize transportation costs
Minimize scheduling problems with the factory

Independent Demand Ordering

Systems

The Distribution System

Factory

Central
Supply

Distribution
Center A

Distribution
Center B

Distribution
Center C

Customers

Customers

Customers

Independent Demand Ordering

Systems

Distribution Inventory
Decentralized Distribution

Each center determines needs and then places orders without regard
for the other centers
Advantage- reduction in communication and coordination costs
Disadvantage - The effects on customer service and inventory levels

Centralized Distribution

All forecasting and other decisions are made centrally.

Stock is pushed in the system from central supply
Attempt to balance the available inventory with the needs of each
distribution center
Advantage: Coordination
Disadvantage: Inability to respond to local demand

Independent Demand Ordering

Systems

Distribution Inventory
Distribution Requirements Planning

A system that forecasts when the various demands will

be made on central supply.
DRP responds to customer demand and coordinate
planning and control
Translates the logic of MRP to the distribution system.

Next Week. . .

Work and Be Prepared to Discuss

11.1
11.7
11.11
11.13
11.17

Read Chapter 12 Physical Inventory and

Warehouse Management

Read Chapter 13 Physical Distribution