Session-(16-17)

Inventory Management

EOQ models considering Holding Cost, Ordering Cost &

Backorder cost

Instructor:
Dr. Anupam Keshari
Operations Management & Decision Science Area
 Question-
A museum of natural history opened a gift shop two years ago. Managing
inventories has become a problem. Low inventory turnover is squeezing
profit margins and causing cash-flow problems. One of the top-selling SKUs
in the container group at the museum’s gift shop is a bird feeder. Sales are
18 units per week, and the supplier charges $60 per unit. The cost of placing
an order with the supplier is $45. Annual holding cost is 25 percent of a
feeder’s value, and the museum operates 52 weeks per year. Management
chose a 390-unit lot size so that new orders could be placed less frequently.
What is the annual cycle-inventory cost of the current policy of using a 390-
unit lot size? Would a lot size of 468 be better?
Solution-
Total Annual
Cycle-
Inventory
Cost Function
for the Bird
Feeder
Lead time for resupply

Place
order Max stock
level

Q*=93
Quantity on hand

ROP=22
Receive
order

LT LT LT
Q= Order quantity
T=6.4 T=6.4
ROP=Reorder point
Time LT= Lead Time
Basic Pull Inventory Control Model T=Time between
orders
Non-instantaneous Resupply

Order quantity = Production run

EPQ: (Production quantity)

Qp* = 2 DS p
IC pd
*output rate p exceeds the demand rate d
Non-instantaneous Resupply
Demand during
production interval

Produced
Quantity (Q)

Max Cycle
Inventory
(Imax)

Production rate
(p)
Max Inventoy

Build rate (p-d)

Production Demand
& Demand only
Time
tpd
Economic Production Quantity Model
 Economic Production Quantity
Let time during “Production & Demand” period be tpd

If Production rate is p, during tpd , Total produced quantity will be Q

If Demand rate is d, Buidup rate will be (p-d)

With Buildup rate p-d, during tpd , Max Inventory will be Imax
Economic Production Quantity

Total cost = Annual holding cost + Annual ordering or setup cost

I max D
Total C  *H  *S
2 Q
Q pd  D
    *S
2 p  Q

Optimizing Total Cost C we get Q* also called Economic production

lot size.
2 DS p
Q* 
IC pd
 Economic Production Quantity
(Holding Cost + Ordering Cost+ Backorder cost)
Instantaneous resupply Non-instantaneous Resupply

2 𝐷 𝐶 (𝐶 + 𝐶 )
𝑄∗ =
𝐶 (𝐶 ) 2 𝐷 𝐶 (𝐶 + 𝐶 )
𝑄∗ = 𝑝
𝐶 (𝐶 ) (1 − )
( ) 𝑑
s
( )
( )( / )
s
( )
TC )+ )
( / )
TC )
( / )

+ )
( / )
 Economic Production Quantity
Instantaneous resupply : An Example
(Holding Cost + Ordering Cost) (Holding Cost + Ordering Cost+ Backorder cost)

D= 10000 𝑈𝑛𝑖𝑡/𝑌𝑒𝑎𝑟 D= 10000 𝑈𝑛𝑖𝑡/𝑌𝑒𝑎𝑟

𝐶 = 𝑅𝑠 300 /𝑜𝑟𝑑𝑒𝑟 𝐶 = 𝑅𝑠 300 /𝑜𝑟𝑑𝑒𝑟
𝐶 = 𝑅𝑠 4 /𝑢𝑛𝑖𝑡 /𝑦𝑒𝑎𝑟 𝐶 = 𝑅𝑠 4 /𝑢𝑛𝑖𝑡 /𝑦𝑒𝑎𝑟
𝐶 = 𝑅𝑠 25 /𝑢𝑛𝑖𝑡 /𝑦𝑒𝑎𝑟

𝑄 = 1224.74 𝑢𝑛𝑖𝑡 𝑄 = 1319. 09 𝑢𝑛𝑖𝑡

𝑇𝐶1 = 𝑅𝑠. 4898.98 S = 181.94 𝑢𝑛𝑖𝑡

𝑇𝐶2 = 𝑅𝑠. 4548.72

TC )+ )
TC
Example
Simple Statistics
Find distribution of Demand During the Lead Time LT=3 weeks Distribution of
Given Demand
During a week, mean demand is d=100 during 3 weeks
with standard deviation is sd=10 of LT period

Week 1 Week 2 Week 3 Also called

DDLT

+ + = S’d =17.3
Sd =10 Sd =10 Sd =10 z(s’d)

d=100 d=100 d=100 X’ = 300 ROP

Var=102 Var=102 Var=102

Mean demand during total 3 weeks time X’= d*3 = 100*3 = 300
Total varience = Sd2+ Sd2 + Sd2 = LT* Sd2
Standard Deviation of demand during 3 week time sd‘= TotalVarience

 sd * LT  10 3
 17.3
Finding ROP, with uncertain demand
We found distribution of Demand During the Lead Time LT=3
weeks

Mean demand during total 3 weeks time X’= d*3 = 100*3 = 300

Standard Deviation of demand during 3 week time sd‘= sd * LT  10 3

 17.3

What is ROP if we want to maintain instock probability of 95%

For 95% z=1.644
ROP  d  LT  z ( s ) '
d
From normal
distribution table
 100  3  1.644  17.3
 328.44 units
Where the term z is number of standard deviations from the mean of the DDLT
distribution to give us the desired probability of being in stock during the lead time period.
Thank You