OPERATIONS MANAGEMENT

Topic: Inventory Models for Independent Demand (Inventory Management)

Sub-topics:

1. Basic economic order quantity (EOQ) model

2. Minimizing costs
3. Robust Model
4. Reorder Points
5. Production order quantity model
6. Quantity Discount Models
INVENTORY MODEL
Terminologies:
Independent vs. dependent demand
Holding or Carrying Cost
Ordering Cost or Set up Cost
Set up Time
Quantity Discount
Lead Time
Stock-outs
Inventory Model - Independent Demand
General objective is to minimize total inventory cost
(Carrying and Ordering Cost).

1. Economic Order Quantity (Basic)

2. Production Order Quantity model
3. Quantity Discount Model
ECONOMIC ORDER QUANTITY (EOQ)
-one of the most commonly used inventory-control techniques

Assumptions:
1. Demand for an item is known, reasonably constant, and independent of decisions for
other items.
2. Lead-time is the time between placement and receipt of the order is known and
consistent.
3. Receipt of inventory is instantaneous and complete. The inventory from an order
arrives in one batch at one time.
4. Quantity discounts are not possible.
5. The only variable costs are the cost of setting up or placing an order (setup or
ordering cost) and the cost of holding or storing inventory over time(holding or
carrying cost).
6. Stockouts (shortages) can be completely avoided if orders are placed at the right
time
 Minimizing Costs

(a)Quantity order Thus, (b) Quantity order (c) A reduction in either holding or setup
Quantity order
cost will reduce the total cost curve.
A reduction in the setup curve also
reduces the optimal order quantity(
lot size). Smaller lot sizes have a
total number of Annual setup or Holding cost will
positive impact on quality and
orders placed per ordering cost increase due to the
larger inventories that production flexibility.
year
are maintained
The necessary steps are:
1. Develop an expression for setup or ordering cost.
2. Develop an expression for holding cost.
3. Set setup (order) cost equal to holding cost.
4. Solve the equation for the optimal order quantity.

We can determine setup and holding costs and solve for Q*:

Q= number of units per order

Q*= optimum number of units per order (EOQ)
D= annual demand in units for the inventory item
S= setup or ordering cost for each other
H= holding /carrying cost per unit per year
ECONOMIC ORDER QUANTITY (EOQ)
Let:
Q = Order Quantity
S = Order cost
D = Annual Demand
H = Carrying cost

Formula:
Q = the square root of (2DS/H)
Purpose: To arrive at the optimal order quantity that will provide the least cost.
Sample Problem
Assume that a business is able to sell 1,000 units of product X
per year and usually pays $10 per order and the carrying cost is $0.50
per unit per year. Compute for the optimal order size (lot):
D = 1,000 units
S = Order Cost
H = carrying cost
Solution:
Q = [2(1,000x$10)/$0.5)
= 40,000
= 200 units
The expected number of orders placed during the year (N) and the expected
time between orders (T)

Demand D
Expected number of orders= N = order quantity = Q*

number of working days per year

Expected time between orders = T = N
SAMPLE PROBLEM- COMPUTING NUMBER OF
ORDERS AND TIME BETWEEN ORDERS
Sharp, Inc. has a 250-day working year and wants to find the number
of order (N) and the expected time between orders (T).
The total annual variable inventory cost is the sum of
setup and holding costs:

Total annual cost = Setup (order) cost + Holding cost

In terms of the variable in the model, we can express the total cost TC as:
D Q
TC = Q
+
s
2
H
 SAMPLE PROBLEM-COMPUTING COMBINED
COST OF ORDERING AND HOLDING
Sharp, Inc. wants to determine the combined annual
ordering and holding costs.
At EOQ the total order cost equals the total
carrying cost..
Compute for the number of orders per unit by dividing the
annual demand by the EOQ.
No. of orders is 1,000 divided by 200 units or 5 orders per year.
At 5 orders per year the order cost will be 5 times $10 or $50
dollars
The annual carrying cost for 200 units divided by 2 times
carrying cost per unit of $0.5 or $50 dollars.
Thus in EOQ the total order cost ($50) is equal to carrying cost
($50)
ROBUST MODEL
-giving satisfactory answers even with substantial variation in the
parameters
Reorder Point
When to order? In EOQ the timing of order ill depend on the
Lead Time. Take for example if it will take 2 days for an order to arrive
there should be a buffer stocks equivalent for the 2 day demand until
such time that the inventory ordered will arrived. If per day the
demand is 10 units, therefore, if the stock level goes below 20 units
(10x2 days) then thats the time an order is placed.
Formula is
ROP = Demand per day X Lead time
ROP = 10 units x 2 days
ROP = 20 units
SAMPLE PROBLEM- COMPUTING POINTS (ROP) FOR
IPHONES WITH AND WITHOUT SAFETY STOCK
I leave you with this quote

Learning is a never ending process, as we

live we always learn

-The END-