BA3352 Inventory Management - Best PDF

3/27/2015
BA3352InventoryManagement
InventoryManagement
Introduction
Aninventoryisastockorstoreofgoods.Atypicalfirmhasabout30percentofitscurrentassetsandas
muchas90percentofitsworkingcapitalinvestedininventory.Becauseinventoriesmayrepresenta
significantportionoftotalassets,areductionofinventoriescanresultinasignificantincreaseinreturnon
investment(ROI),aratioofprofitaftertaxestototalassets.
Atypicalfirmcarriesthefollowingdifferentkindsofinventories.
Rawmaterialsandpurchasedparts.
Partiallycompletedgoods,calledworkinprocess(WIP).
Finishedgoodsinventories(manufacturingfirms)ormerchandise(retailstores).
Replacementparts,tools,andsupplies.
Goodsintransittowarehousesorcustomers(pipelineinventory).
Inventoriesservethefollowingfunctions.
Tomeetanticipateddemand.Theseinventoriesarereferredtoasanticipationstocksbecausethey
areheldtosatisfyexpecteddemand.Examplesofthistypeofdemandarestereosystems,tools,or
clothing.
Tosmoothproductionrequirements.Firmsthatexperienceseasonalpatternsindemandoften
buildupinventoriesduringoffseasonperiodstomeetoverlyhighrequirementsduringcertain
seasonalperiods.Theseinventoriesareaptlynamedseasonalinventories.Companiesthatprocess
freshfruitsandvegetablesdealwithseasonalinventories.Sodostoresthatsellgreetingcards,skis,
snowmobiles,orChristmastrees.
Todecouplecomponentsoftheproductiondistributionsystem.Theinventorybufferspermit
otheroperationstocontinuetemporarilywhilemachinebreakdownsareresolved.Similarly,buffers
ofrawmaterialsareusedtoinsulateproductionfromdisruptionsindeliveriesfromsuppliers.
Finishedgoodinventoriesareusedtobuffersalesoperationsfrommanufacturingdisruptions.By
recognizingthecostandspaceneeded,companiesstarttorealizetheeliminationofdisruptionscan
greatlydecreasetheneedfortheinventorybuffersdecouplingoperations.
Toprotectagainststockouts.Delayeddeliveriesandunexpectedincreasesindemandincreasethe
riskofshortages.Delaycanoccurbecauseofweatherconditions,supplierstockouts,deliveriesof
wrongmaterials,qualityproblems,andsoon.Theriskofshortagecanbereducedbyholdingsafety
stock,whicharestocksinexcessofaveragedemandtocompensateforvariabilityindemandand
leadtime.
Totakeadvantageofordercycles.Inventorystorageenablesafirmtobuyandproducein
economiclotsizeinordertominimizepurchasingandinventorycostswithouthavingtotryto
matchpurchaseorproductionwithdemandrequirementsintheshortrun.Thisresultsinperiodic
orders,orordercycles.Theresultingstockisknownascyclestock.Insomecases,itisalso
practicaloreconomicaltogroupordersand/ortoorderatfixedintervals.
Tohedgeagainstpriceincreasesortotakeadvantageofquantitydiscounts.
Topermitoperations.Workinprocessandpipelineinventoriesallowthesmoothoperations
throughoutaproductiondistributionsystem.
Theoverallobjectiveofinventorymanagementistoachievesatisfactorylevelsofcustomerservicewhile
keepinginventorycostswithinreasonablebounds.Regardingtheobjective,adecisionmakermustmake
twofundamentaldecisions:thetimingandsizeoforders(i.e.,whentoorderandhowmuchtoorder).
http://mcu.edu.tw/~ychen/op_mgm/notes/inventory.html
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Inventorymanagementperformancemeasures:
1. Customersatisfaction.Measuredbythenumberandquantityofbackordersand/orcustomer
complaints.
2. Inventoryturnover.Theratioofannualcostofgoodssoldtoaverageinventoryinvestment.Itisa
widelyusedmeasure.Theturnoverratioindicateshowmanytimesayeartheinventoryissold.The
highertheratio,thebetter,becausethatimpliesmoreefficientuseofinventory.Itcanbeusedto
comparecompaniesinthesameindustry.
3. Daysofinventoryonhand.Theexpectednumberofdaysofsalesthatcanbesuppliedfromexisting
inventory.Abalanceisdesirable:ahighernumberofdaysmightimplyexcessinventory,whilea
lownumbermightimplyariskofrunningoutofstock.
Backtotop.
RequirementsforEffectiveInventoryManagement
Theserequirementsare:
1. Asystemtokeeptrackoftheinventoryonhandandonorder.
2. Areliableforecastofdemandthatincludesanindicationofpossibleforecasterror.
3. Knowledgeofleadtimesandleadtimevariability.
4. Reasonableestimatesofinventoryholdingcosts,orderingcosts,andshortagecosts.
5. Aclassificationsystemforinventoryitems.
InventoryCountingSystems
Inventorycountingsystemscanbeperiodicorperpetual.Underaperiodicinventorysystem,aphysical
countofitemsininventoryismadeatperiodicintervals(e.g.,weekly,monthly)inordertodecidehow
muchtoorderforeachitem.Examplesaresmallretailers.Thissystemallowsplacingordersformany
itemsatthesametime.However,thereisalackofcontrolbetweenreviewsandthereisaneedtoprotect
againstshortagebetweenreviewperiodsbycarryingextrastock.
Aperpetualinventorysystem(alsoknownasacontinualsystem)keepstrackofremovalsfrom
inventoryonacontinuousbasis.Whentheamountonhandreachesapredefinedminimum,afixed
quantity,Q,isordered.Thesystemprovidescontinuousmonitoringofinventorywithdrawsandthe
settingofoptimalorderquantity.However,thereisaddedcostforrecordkeepingandphysicalcountis
stillneededtoverifyinventoryrecords.Discrepancycouldoccurduetoerrors,pilferage,spoilage,and
otherfactors.Examplesarebanktransactions,711stores,supermarkets,discountstores,anddepartment
stores.
PerpetualInventorySystem
Perpetualsystemsrangefromverysimpletoverysophisticated.Atwobinsystem,averyelementary
system,usestwocontainersforinventory.Itemsarewithdrawnfromthefirstbinuntilitscontentsare
exhausted.Itisthentimetoreorderbyusingtheordercardplacedatthebottomofthefirstbin.The
secondbincontainsenoughstocktosatisfyexpecteddemanduntiltheorderisfilled,plusanextra
cushionofstockthatwillreducethechanceofstockoutiftheorderislateorifusageisgreaterthan
expected.
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Theadvantageofthissystemisthatthereisnoneedtorecordeachwithdrawfrominventorythe
disadvantageisthatthereordercardmaynotbeturnedinforavarietyofreasons(e.g.,misplaced,the
personresponsibleforgetstoturnitin).
Perpetualsystemscanbeeitherbatchoronline.Inbatchsystems,inventoryrecordsarecollected
periodicallyandenteredintothesystem.Inonlinesystem,thetransactionsarerecordedimmediately.The
advantageofonlinesystemsisthattheyarealwaysuptodate.Inbatchsystems,asuddensurgein
demandcouldresultinreducingtheamountofinventorybelowthereorderpointbetweentheperiodic
readins.Frequentbatchcollectionscanreducetheproblem.
Thesedays,mostfirmsusecomputerizedcheckoutsystemsthatreadsauniversalproductcode(UPC),
orbarcode,printedonanitemtagoronpackage.
AtypicalUPSorbarcodehas11or12digits.Azeroontheleftidentifiesanitemasa
groceryitem.Thenextfivedigitsindicatethemanufacturer.Thelastfivedigitsidentitythe
item.Smallpackageditems,likecandyandgum,havesixdigitsforidentifyingtheitem.
Otherusageofbarcodeincludestheprintoutofpriceandquantity,partcountingandmonitoring,andfor
theautomationofrouting,scheduling,sorting,andpackaging.
DemandForecastsandLeadTimeInformation
Inventoriesareusedtosatisfydemandrequirements,soitisessentialtohavereliableestimatesofdemand
andtheleadtime(thetimebetweensubmittinganorderandreceivingit).Thegreaterthepotential
variability,thegreatertheneedforadditionalstocktoreducetheriskofshortagebetweendeliveries.
Knowledgeofactualsalesfrompointofsales(POS)systemscangreatlyenhanceforecastingand
inventorymanagementinrealtime.
CostInformation
Threebasiccostsareassociatedwithinventorymanagement:holding,transaction(ordering),andshortage
costs.
Holdingorcarryingcostsrelatetophysicallyhavingitemsinstorage.Costsincludeinterest,insurance,
taxes,depreciation,obsolescence,deterioration,spoilage,pilferage,breakage,andwarehousingcosts
(heat,light,rent,security).Theyalsoincludeopportunitycostsassociatedwithhavingfundswhichcould
beusedelsewheretiedupininventory.Notethatitisthevariableportionofthesecoststhatispertinent.
Thesignificanceofthevariouscomponentsofholdingcostdependsonthetypeofiteminvolved,
althoughtaxes,interest,andinsurancearegenerallybasedonthedollarvalueoftheinventory.Itemsthat
areeasilyconcealed(e.g.,pocketcameras,transistorradios,calculators)orfairlyexpensive(cars,TVs)
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arepronetotheft.Freshseafood,meatsandpoultry,produce,andbakedgoodsaresubjecttorapid
deteriorationandspoilage.Dailyproducts,saladdressings,medications,batteries,andfilmalsohave
limitedshelflives.
Holdingcostsarestatedineitheroftwoways:asapercentageofunitpriceorasadollaramountperunit.
Inanycase,typicalannualholdingcostsrangefrom20percentto40percentofthevalueofanitem.In
otherwords,toholda$100itemforoneyearcouldcostfrom$20to$40.
Orderingcostsarethecostsoforderingandreceivinginventory.Theyarethecoststhatvarywiththe
actualplacementofanorder.Theseincludedetermininghowmuchisneeded,preparinginvoices,
shippingcosts,inspectinggoodsuponarrivalforqualityandquantity,andmovingthegoodstotemporary
storage.Orderingcostsaregenerallyexpressedasafixeddollaramountperorder,regardlessoforder
size.
Whenafirmproducesitsowninventoryinsteadoforderingitfromasupplier,thecostsofmachinesetup
(e.g.,preparingequipmentforthejobbyadjustingthemachine,changingcuttingtools)areanalogousto
orderingcoststhatis,theyareexpressedasafixedchargeperproductionrun,regardlessofthesizeofthe
run.
Shortagecostsresultwhendemandexceedsthesupplyofinventoryonhand.Thesecostscanincludethe
opportunitycostofnotmakingasale,lossofcustomergoodwill,latecharges,andsimilarcosts.
Furthermore,iftheshortageoccursinanitemcarriedforinternaluse(e.g.,tosupplyanassemblyline),
thecostoflostproductionordowntimeisconsideredashortagecost.Suchcostcaneasilyruninto
hundredsofdollarsaminuteormore.Shortagecostsaresometimesdifficulttomeasure,andtheymaybe
subjectivelyestimated.
ClassificationSystem
TheABCapproachclassifiesinventoryitemsaccordingtosomemeasureofimportance,usuallyannual
dollarusage(i.e.,dollarvalueperunitmultipliedbyannualusagerate),andthenallocatescontrolefforts
accordingly.Typically,threeclassesofitemsareused:A(veryimportant),B(moderatelyimportant),and
C(leastimportant).
Theactualnumberofcategoriesvariesfromorganizationtoorganization,dependingontheextentto
whichafirmwantstodifferentiatecontrolefforts.Withthreeclassesofitems,Aitemsgenerallyaccount
forabout15to20percentofthenumberofitemsininventorybutabout60to70percentofthedollar
usage.Attheotherendofthescale,Citemsmightaccountforabout60percentofthenumberofitems
butonlyabout10percentofthedollarusageofaninventory.
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Aitemsshouldreceivecloseattentionthroughfrequentreviewsofamountsonhandandcontrolover
withdraws,wherepossible,tomakesurethatcustomerservicelevelsareattained.TheCitemsshould
receiveonlyloosecontrol(twobinsystems,bulkorders),andtheBitemsshouldhavecontrolsthatlie
betweenthetwoextremes.
NotethatCitemsarenotnecessarilyunimportantincurringastockoutofCitemssuchasthenutsand
boltsusedtoassemblemanufacturedgoodscanresultinacostlyshutdownofanassemblyline.However,
duetothelowannualdollarvolumeofCitems,theremaynotbemuchadditionalcostincurredby
orderinglargerquantitiesofsomeitems,ororderingthemabitearlier.
Example:ClassifytheinventoryitemsasA,B,orCbasedonannualdollarvalue,giventhefollowing
information:
Solution:
Annual
Annual
Dollar
Item Demand UnitCost Value
1
1,000
$4,300 $4,300,000
2
5,000
720 3,600,000
3
1,900
500
950,000
4
1,000
710
710,000
5
2,500
250
625,000
6
2,500
192
480,000
7
400
200
80,000
8
500
100
50,000
9
200
210
42,000
10
1,000
35
35,000
11
3,000
10
30,000
12
9,000
3
27,000
Thefirsttwoitemshavearelativelyhighannualdollarvalue,soitseemsreasonabletoclassifythemasA
items.ThenextfouritemsappeartohavemoderateannualdollarvalueandshouldbeclassifiedasB
items.ThereminderareCitems,basedontheirrelativelylowdollarvalue.
Althoughannualdollarvolumemaybetheprimaryfactorinclassifyinginventoryitems,otheruseful
factorsmayincludetheriskofobsolescence,theriskofastockout,thedistanceofasupplier,andsoon.
Inadditiontocustomerservice,anotherapplicationoftheABCapproachisasaguidetocycle
counting,whichisaphysicalcountofitemsininventory.Thepurposeofcyclecountingistoreduce
discrepanciesbetweentheamountsindicatedbyinventoryrecordsandtheactualquantitiesofinventory
onhand.
Keyquestionsconcerningcyclecountingare:
1. Howmuchaccuracyisneeded?
2. Whenshouldcyclecountingbeperformed?
3. Whoshoulddoit?
APICS,formerlyknownastheAmericanProductionandInventoryControlSociety,recommendsthe
followingguidelinesforinventoryrecordaccuracy:0.2percentforAitems,1percentforBitems,and
5percentforCitems.
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Somecompaniesusecertaineventstotriggercyclecounting,whereasothersdoitonperiodic(scheduled)
basis.Eventsthatcantriggeraphysicalcountofinventoryincludeaoutofstockreportwrittenonanitem
indicatedbyinventoryrecordstobeinstock,aninventoryreportthatindicatesaloworzerobalanceofan
item,andaspecifiedlevelofactivity(e.g.,every2,000unitssold).
Somecompaniesuseregularstockroompersonneltodocyclecountingduringperiodsofslowactivity
whileotherscontractwithoutsidefirmstodoitonaperiodicbasis.Useofanoutsidefirmprovidesan
independentcheckoninventoryandmayreducetheriskofproblemscreatedbydishonestemployees.
Stillotherfirmsmaintainfulltimepersonneltodocyclecounting.
Backtotop.
HowMuchToOrder:EconomicOrderQuantityModel
Economicorderquantity(EOQ)modelsidentifytheoptimalorderquantitybyminimizingthesumof
certainannualcoststhatvarywithordersize.Thesemodelsare:
1. Economicorderquantitymodel.
2. Economicproductionquantitymodel.
3. Quantitydiscountmodel.
EconomicOrderQuantity(EOQ)Model
Thebasiceconomicorderquantity(EOQ)modelidentifiestheordersizethatwillminimizethesumof
theannualcostsofholdinginventoryandorderinginventory.Theunitcostofinventoryitemsisnot
generallyincluded,becausetheunitcostisunaffectedbytheordersize.Ifholdingcostsarespecifiedasa
percentageofunitcost,thenunitcostisindirectlyincludedinthetotalcostasapartofholdingcosts.
AssumptionsofthebasicEOQmodelare:
1. Onlyoneproductisinvolved.
2. Annualdemandrequirementsareknown.
3. Demandisspreadevenlythroughouttheyearsothatthedemandrateisreasonableconstant.
4. Leadtimedoesnotvary.
5. Eachorderisreceivedinasingledelivery.
6. Therearenoquantitydiscounts.
Inventoryorderingandusageoccurincycles.AcyclebeginswithreceiptofanorderofQunits,which
arewithdrawnataconstantrateovertime.Whenthequantityonhandisjustsufficienttosatisfydemand
duringleadtime,anorderforQunitsissubmittedtothesupplier.Becauseitisassumedthatboththe
usagerateandtheleadtimedonotvary,theorderwillbereceivedatthepreciseinstantthattheinventory
onhandfallstozero.Thus,ordersaretimedtoavoidbothexcessstockandstockout(i.e.,runningoutof
stock).
Annualcarryingcostiscomputedbymultiplyingtheaverageamountofinventoryonhandbythecostto
carryoneunitforoneyear,eventhoughanygivenunitwouldnotnecessarilybeheldforayear.The
averageinventoryissimplyhalfoftheorderquantity:theamountonhanddecreasessteadilyfromQunits
to0,foranaverageof(Q+0)/2,orQ/2.UsingthesymbolHtorepresenttheaverageannualcarryingcost
perunit,thetotalannualcarryingcostis
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where
Q=orderquantityinunits
H=holding(carrying)costperunit
CarryingcostisthusalinearfunctionofQ:carryingcostsincreaseordecreaseindirectproportionto
changesintheorderquantityQ.
Ontheotherhand,annualorderingcostwilldecreaseasordersizeincreases,becauseforagivenannual
demand,thelargertheordersize,thefewerthenumberofordersneeded.Ingeneral,thenumberoforders
peryearwillbeD/Q,whereD=annualdemandandQ=ordersize.Unlikecarryingcosts,orderingcosts
arerelativelyinsensitivetoordersizeregardlessoftheamountofanorder,certainamountofactivities
mustbedone,suchasdeterminehowmuchisneeded,periodicallyevaluatesourcesofsupply,and
preparetheinvoice.Eveninspectionoftheshipmenttoverifyqualityandquantitycharacteristicsisnot
stronglyinfluencedbyordersize,sincelargeshipmentsaresampledratherthancompletelyinspected.
Hence,thereisafixedorderingcost.Annualorderingcostisafunctionofthenumberofordersperyear
andtheorderingcostperorder:
where
D=demand,usuallyinunitsperyear
S=orderingcost
Becausethenumbersofordersperyear,D/Q,decreasesasQincreases,annualorderingcostisinversely
relatedtoordersize.
ThetotalannualcostassociatedwithcarryingandorderinginventorywhenQunitsareorderedeachtime
is
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NotethatDandHmustbeinthesameunits,e.g.,months,years.Thefigurebelowrevealsthatthetotal
costcurveisUshape(i.e.,convex,withoneminimum)andthatitreachesitsminimumatthequantity
wherecarryingandorderingcostsareequal.
Anexpressionfortheoptimalorderquantity,Q0,canbeobtainedusingcalculus.Theresultofthe
formulais
Thus,givenannualdemand,theorderingcostperorder,andtheannualcarryingcostperunit,onecan
computetheoptimal(economic)orderquantity.TheminimumtotalcostisthenfoundbysubstitutingQ0
forQinthetotalcostformulaabove.
Thelengthofanordercycle(i.e.,thetimebetweenorders)is
Example:Alocaldistributorforanationaltirecompanyexpectstosellapproximately9,600steelbelted
radialtiresofacertainsizeandtreaddesignnextyear.Annualcarryingcostis$16pertire,andordering
costis$75.Thedistributoroperates288daysayear.
a. WhatistheEOQ?
b. Howmanytimesperyeardoesthestorereorder?
c. Whatisthelengthofanordercycle?
d. WhatisthetotalannualcostiftheEOQquantityisordered?
Solution:
D=9,600tiresperyear
H=$16perunitperyear
S=$75
a.
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b.
c.
d.
NotethattheorderingandcarryingcostsareequalattheEOQ,asillustratedpreviously.
Carryingcostissometimesstatedasapercentageofthepurchasepriceofanitemratherthanasadollar
amountperunit.However,aslongasthepercentageisconvertedintoadollaramount,theEOQformula
isstillappropriate.
Example:PiddlingManufacturingassemblessecuritymonitors.Itpurchases3,600blackandwhite
cathoderaytubesayearat$65each.Orderingcostsare$31,andannualcarryingcostsare20percentof
thepurchaseprice.Computetheoptimalquantityandthetotalannualcostoforderingandcarryingthe
inventory.
Solution:
Holdingandorderingcosts,andannualdemand,aretypicallyestimatedvaluesratherthanvaluesthatcan
bepreciselydetermined,say,fromaccountingrecords.Holdingcostsaresometimesdesignatedrather
thancomputedbymanagers.Consequently,theEOQshouldberegardedasanapproximatequantity
ratherthananexactquantity.Thus,roundingthecalculatedvalueisperfectlyacceptablestatingavalue
toseveraldecimalplaceswouldtendtogiveanunrealisticimpressionoftheimpressioninvolved.An
obviousquestionis:Howgoodisthis"approximate"EOQintermsofminimizingcost?Theansweris
thattheEOQisfairlyrobustthetotalcostcurveisrelativelyflatneartheEOQ,especiallytotherightof
theEOQ.Inotherwords,eveniftheresultingEOQdiffersfromtheactualEOQ,totalcostswillnot
increasemuchasall.ThisisparticularlytrueforquantitieslargerthantherealEOQ,becausethetotalcost
curverisesveryslowlytotherightoftheEOQ.
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Backtotop.
EconomicProductionQuantity(EPQ)Model
Incertaininstances,thecapacitytoproduceasinglepartexceedsthepart'susageordemandrate.Aslong
asproductioncontinues,inventorywillcontinuetogrow.Insuchinstances,itmakessensetoperiodically
producesuchitemsinbatches,orlots.
TheassumptionsoftheEPQmodelaresimilartothoseoftheEOQmodel,exceptthatinsteadoforders
receivedinasingledelivery,unitsarereceivedincrementallyduringproduction.Theassumptionsare:
1. Onlyoneitemisinvolved.
2. Annualdemandisknown.
3. Theusagerateisconstant.
4. Usageoccurscontinuously,butproductionoccursperiodically.
5. Theproductionrateisconstant.
6. Leadtimedoesnotvary.
7. Therearenoquantitydiscounts.
Duringtheproductionphaseofthecycle,inventorybuildsupatarateequaltothedifferencebetween
productionandusagerates.Aslongasproductionoccurs,theinventorywillcontinuetobuildwhen
productionceases,theinventorylevelwillbegintodecrease.Hence,theinventorylevelwillbemaximum
atthepointwhereproductionceases.Whentheamountofinventoryonhandisexhausted,productionis
resumed,andthecyclerepeatsitself.
Becausethecompanymakestheproductitself,therearenoorderingcostsassuch.Nonetheless,with
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everyproductionrun(batch),therearesetupcoststhecostsrequiredtopreparetheequipmentforthe
job,suchascleaning,adjusting,andchangingtoolsandfixtures.Setupcostsareanalogoustoordering
costsbecausetheyareindependentofthelot(run)size.Theyaretreatedintheformulainexactlythe
sameway.Thelargertherunsize,thefewerthenumberofrunsneededand,hence,thelowertheannual
setupcost.
where
Imax=maximuminventory.
Theeconomicrunquantityis
where
p=productionordeliveryrate
u=usagerate
Thecycletime(thetimebetweenordersorbetweenthebeginningofruns)fortheeconomicrunsize
modelisafunctionoftherunsizeandusage(demand)rate:
Similarly,theruntime(theproductionphaseofthecycle)isafunctionoftherunsizeandtheproduction
rate:
Themaximumandaverageinventorylevelsare
Example:Atoymanufactureruses48,000rubberwheelsperyearforitspopulardumptruckseries.The
firmmakesitsownwheels,whichitcanproduceatarateof800perday.Thetoytrucksareassembled
uniformlyovertheentireyear.Carryingcostis$1perwheelayear.Setupcostforaproductionrunof
wheelsis$45.Thefirmoperates240daysperyear.Determinethe:
a. Optimalrunsize
b. Minimumtotalannualcostforcarryingandsetup
c. Cycletimefortheoptimalrunsize
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d. Runtime
Solution:
D=48,000wheelsperyear
S=$45
H=$1perwheelperyear
p=800wheelsperday
u=48,000wheelsper240days,or200wheelsperday
a.
b.
c.
d.
Backtotop.
QuantityDiscountModel
Quantitydiscountsarepricereductionforlargeordersofferedtocustomerstoincludethemtobuyin
largequantities.
Ifquantitydiscountsareoffered,thebuyermustweightthepotentialbenefitsofreducedpurchaseprice
andfewerordersthatwillresultfrombuyinginlargequantitiesagainsttheincreaseincarryingcosts
causedbyhigheraverageinventories.Thebuyer'sgoalwithquantitydiscountsistoselecttheorder
quantitythatwillminimizetotalcost,wheretotalcostisthesumofcarryingcost,orderingcost,and
purchasingcost:
whereP=unitprice.
RecallthatinthebasicEOQmodel,determinationofordersizedoesnotinvolvethepurchasingcost.The
rationalefornotincludingunitpriceisthattheassumptionofnoquantitydiscounts,priceperunitisthe
sameforallordersizes(whenthedemand,D,isknownandaconstant).Inclusionofunitpriceinthetotal
costcomputationisthatcasewouldmerelyincreasethetotalcostbytheamountPD,PtimesD.Agraph
oftotalannualpurchasecostversusquantitywouldbeahorizontalline.Hence,includingpurchasingcosts
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wouldmerelyraisethetotalcostcurvebythesameamount(PD)ateverypoint.Thatwouldnotchange
theEOQcurve.
Whenquantitydiscountsareoffered,thereisaseparateUshapetotalcostcurveforeachunitprice.
Again,includingunitpricemerelyraiseseachcurvebyaconstantamount.However,becausetheunit
pricesarealldifferent,eachcurveisraisedbyadifferentamount:smallerunitpricewillraiseatotalcost
curvelessthanlargerunitprice.Notethatnoonecurveappliestotheentirerangeofquantitieseach
curveappliestoonlyaportionoftherange.
Hence,theapplicableorfeasibletotalcostisinitiallyonthecurvewiththehighestunitpriceandthen
dropsdown,curvebycurve,atthepricebreaks,whicharetheminimumquantitiesneededtoobtainthe
discounts.Theresultisatotalcostcurvewithstepsatpricebreaks.
Eventhougheachcurvehasaminimum,thosecurvesarenotnecessarilyfeasible(ifweconsiderthe
quantitydiscountrages).Theactualtotalcostcurveisdenotedbythesolidlinesonlythosepricequantity
combinationsarepossible.Theobjectiveofthequantitydiscountmodelistoidentifyanorderquantity
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thatwillrepresentthelowestcostfortheentiresetofcurves.
Therearetwogeneralcasesofthemodel.Inone,carryingcostsareconstantintheother,carryingcosts
arestatedasapercentageofpurchaseprice.
Whencarryingcostsareconstant,therewillbeasingleminimumpoint:allcurveswillhavetheir
minimumpointatthesamequantity.Consequently,thetotalcostcurveslineupvertically,differingonly
inthatthelowerunitpricesarereflectedbylowertotalcostcurves.
Whencarryingcostsarespecifiedasapercentageofunitprice,eachcurvewillhaveadifferentminimum
point.Becausecarryingcostsareapercentageofprice,lowerpriceswillmeanlowercarryingcostsand
largerminimumpoints.Thus,aspricedecreases,eachcurve'sminimumpointwillbetotherightofthe
nexthighercurve'sminimumpoint.
TheprocedurefordeterminingtheoverallEOQdiffersslightly,dependingonwhichofthesetwocasesis
relevant.Forcarryingcoststhatareconstant,theprocedureisasfollows:
1. Computethecommonminimumpoint.
2. Onlyoneoftheunitpriceswillhavetheminimumpointinitsfeasibleragesincetherangesdonot
overlap.Identifythatrange.
a. Ifthefeasibleminimumpointisonthelowestpricerange,thatistheoptimalorderquantity.
b. Ifthefeasibleminimumpointisinanyotherrange,computethetotalcostfortheminimum
pointandforthepricebreaksofalllowerunitcosts.Comparethetotalcoststhequantity
(minimumpointorpricebreak)thatyieldsthelowesttotalcostistheoptimalorderquantity.
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Example:Themaintenancedepartmentofalargehospitalusesabout816casesofliquidcleanser
annually.Orderingcostsare$12,carryingcostsare$4percaseperyear,andthenewpriceschedule
indicatesthatordersoflessthan50caseswillcost$20percase,50to79caseswillcost$18percase,80
to99caseswillcost$17percase,andlargerorderswillcost$16percase.Determinetheoptimalorder
quantityandthetotalcost.
Solution:D=816casesperyear,S=$12,H=$4percaseperyear.
Range
Price
1to49
$20
50to79
18
80to99
17
100ormore
16
1. ComputethecommonEOQ:
2. The70casescanbeboughtat$18percasebecause70fallsintherangeof50to79cases.Thetotal
costtopurchase816casesayear,attherateof70casesperorder,willbe
Becauselowercostrangesexist,eachmustbecheckedagainsttheminimumcostgeneratedby70
casesat$18each.Inordertobuyat$17percase,atleast80casesmustbepurchased.(Becausethe
TCcurveisrising,80caseswillhavethelowestTCforthatcurve'sfeasibleregion.)Thetotalcost
at80caseswillbe
Toobtainacostof$16percase,atleast100casesperorderarerequired,andthetotalcostwillbe
Therefore,because100casesperorderyieldsthelowesttotalcost,100casesistheoveralloptimal
orderquantity.
Whencarryingcostsareexpressedasapercentageofprice,determinethebestpurchasequantitywiththe
followingprocedure:
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1. Beginningwiththelowestunitprice,computetheminimumpointsforeachpricerangeuntilyou
findafeasibleminimumpoint(i.e.,untilaminimumpointfallsinthequantityrangeforitsprice).
2. Iftheminimumpointforthelowestunitpriceisfeasible,itistheoptimalorderquantity.Ifthe
minimumpointisnotfeasibleinthelowestpricerange,comparethetotalcostatthepricebreakfor
alllowerpriceswiththetotalcostofthelargestfeasibleminimumpoint.Thequantitythatyields
thelowesttotalcostistheoptimum.
Example:SurgeElectricuses4,000toggleswitchesayear.Switchesarepricedasfollows:1to499,90
centseach500to999,85centseachand1,000ormore,80centseachItcostsapproximately$30to
prepareanorderandreceiveit,andcarryingcostsare40percentofpurchasepriceperunitonanannual
basis.Determinetheoptimalorderquantityandthetotalannualcost.
Solution:D=4,000switchesperyear,S=$30,H=.40P.
Range UnitPrice
H
1to499
$0.90 $0.36
500to999
$0.85 $0.34
1,000ormore
$0.80 $0.32
Findtheminimumpointforeachprice,startingwiththelowestprice,untilyoulocateafeasibleminimum
point.
Becauseanordersizeof866switcheswillcost$0.85eachratherthan$0.80each,866isnotafeasible
minimumpointfor$0.80perswitch.Next,try$0.85perunit.
Thisisfeasibleitfallsinthe$0.85perswitchrangeof500to999.
Nowcomputethetotalcostfor840,andcompareittothetotalcostoftheminimumquantitynecessaryto
obtainapriceof$0.80perswitch.
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Thus,theminimumcostordersizeis1,000switches.
Backtotop.
WhentoReorderwithEOQOrdering
Thereorderpoint(ROP)occurswhenthequantityonhanddropstoapredeterminedamount.That
amountgenerallyincludesexpecteddemandduringleadtimeandperhapsanextracushionofstock,
whichservestoreducetheprobabilityofexperiencingastockoutduringleadtime.Notethatinorderto
knowwhenthereorderpointhasbeenreached,aperpetualinventoryisrequired.
Therearefourdeterminantsofthereorderpointquantity:
1. Therateofdemand(usuallybasedonaforecast).
2. Theleadtime.
3. Theextentofdemandand/orleadtimevariability.
4. Thedegreeofstockoutriskacceptabletomanager.
Ifdemandandleadtimearebothconstant,thereorderpointissimply
where
d=demandrate(unitsperdayorweek)
LT=leadtimeindaysorweeks
Note:Demandandleadtimemusthavethesametimeunits.
Example:TinglytakesTwoADayvitamins,whicharedeliveredtohishomebyaroutemansevendays
afteranorderiscalledin.AtwhatpointshouldTinglyreorder?
Solution:
Usage =
Leadtime =
ROP =
=
=
2vitaminsaday
7days
UsagexLeadtime
2vitaminsperdayx7days
14vitamins
Thus,Tinglyshouldreorderwhen14vitamintabletsareleft.
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Whenvariabilityispresentindemandorleadtime,itcreatesthepossibilitythatactualdemandwill
exceedexpecteddemand.Consequently,itbecomesnecessarytocarryadditionalinventory,calledsafety
stock,toreducetheriskofrunningoutofinventory(astockout)duringleadtime.Thereorderpointthen
increasesbytheamountofthesafetystock:
ROP=expecteddemandduringleadtime+safetystock
Thefollowingfigureillustrateshowsafetystockcanreducetheriskofastockoutduringleadtime(LT).
Notethatstockoutprotectionisneededonlyduringleadtime.Ifthereisasuddensurgeatanypoint
duringthecycle,thatwilltriggeranotherorder.Oncethatorderisreceived,thedangerofanimminent
stockoutisnegligible.
Becauseitcostsmoneytoholdsafetystock,amanagermustcarefullyweightthecostofcarryingsafety
stockagainstthereductioninstockoutriskitprovides.Thecustomerservicelevelincreasesastheriskof
stockoutdecreases.Ordercycleservicelevelcanbedefinedastheprobabilitythatdemandwillnot
exceedsupplyduringleadtime(i.e.,thattheamountofstockonhandwillbesufficienttomeetdemand).
Hence,aservicelevelof95percentimpliesaprobabilityof95percentthatdemandwillnotexceed
supplyduringleadtime.Anequivalentstatementthatdemandwillbesatisfiedin95percentofsuch
instancesdoesnotmeanthat95percentofdemandwillbesatisfied.Theriskofastockoutisthe
complementofservicelevelacustomerservicelevelof95percentimpliesastockoutriskof5percent.
Thatis,
servicelevel=100percentstockoutrisk
Theamountofsafetystockthatisappropriateforagivensituationdependsonthefollowingfactors:
1. Theaveragedemandrateandaverageleadtime.
2. Demandandleadtimevariability.
3. Thedesiredservicelevel.
Foragivenordercycleservicelevel,thegreaterthevariabilityineitherdemandrateorleadtime,the
greatertheamountofsafetystockthatwillbeneededtoachievethatservicelevel.Similarly,foragiven
amountofvariationindemandrateorleadtime,achievinganincreaseintheservicelevelwillrequire
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increasingtheamountofsafetystock.Selectionofaservicelevelmayreflectstockoutcosts(e.g.,lost
sales,customerdissatisfaction)oritmightsimplybeapolicyvariable(e.g.,themanagerwantstoachieve
aspecifiedservicelevelforacertainitem).
Thefollowingmodelcanbeusedifanestimateofexpecteddemandduringleadtimeanditsstandard
deviationareavailable.
where
z=numberofstandarddeviations
dLT=thestandarddeviationofleadtimedemand
Themodelgenerallyassumesthatanyvariabilityindemandrateorleadtimecanbeadequatelydescribed
byanormaldistribution.However,thisisnotastrictrequirementthemodelsprovideapproximate
reorderpointsevenwhereactualdistributionsdepartfromnormal.
Thevalueofzusedinaparticularinstancedependsonthestockoutriskthatthemanageriswillingto
accept.Generally,thesmallertheriskthemanageriswillingtoaccept,thegreaterthevalueofz.
Example:Supposethatthemanagerofaconstructionsupplyhousedeterminedfromhistoricalrecords
thatdemandforsandduringleadtimeaverages50tons.Inaddition,supposethemanagerdeterminedthat
demandduringleadtimecouldbedescribedbyanormaldistributionthathasameanof50tonsanda
standarddeviationof5tons.Answerthesequestions,assumingthatthemanageriswillingtoaccepta
stockoutriskofnomorethan3percent:
a. Whatvalueofzisappropriate?
b. Howmuchsafetystockshouldbeheld?
c. Whatreorderpointshouldbeused?
Solution:Expectedleadtimedemand=50tons,dLT=5tons,risk=3percent.
a. Fromtheprobabilitytableofastandardnormaldistribution,usingaservicelevelof10.03=0.97,
youobtainavalueofz=+1.88.
b. Safetystock=zdLT=1.88(5)=9.40tons.
c. ROP=expectedleadtimedemand+safetystock=50+9.40=59.40tons.
Whendataonleadtimedemandarenotreadilyavailable,thepreviousformulacannotbeused.
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Nevertheless,dataaregenerallyavailableondailyorweeklydemand,andonthelengthofleadtime.
Usingthosedata,amanagercandeterminewhetherdemandand/orleadtimeisvariable,andifvariability
existsinoneorboth,therelatedstandarddeviation(s).Forthosesituations,oneofthefollowingformulas
canbeused:
1. Ifonlydemandisvariable,then
,andthereorderpointis
where
2. Ifonlyleadtimeisvariable,then
,andthereorderpointis
where
3. Ifbothdemandandleadtimearevariable,then
andthereorderpointis
Note:Eachofthesemodelsassumesthatdemandandleadtimeareindependent.
Example:Arestaurantusesanaverageof50jarsofaspecialsauceeachweek.Weeklyusageofsaucehas
astandarddeviationof3jars.Themanageriswillingtoacceptnomorethana10percentriskofstockout
duringleadtime,whichistwoweeks.Assumethedistributionofusageisnormal.
a. Whichoftheaboveformulaisappropriateforthissituation?Why?
b. Determinethevalueofz.
c. DeterminetheROP.
Solution:
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a. Becauseonlydemandisvariable(i.e.,hasastandarddeviation),formula
is
appropriate.
b. Fromtheprobabilityofthestandardnormaldistribution,usingaservicelevelof0.90,youobtainz
=+1.28.
c.
ShortageandServiceLevels
TheROPcomputationdoesnotrevealtheexpectedamountofshortageforagivenleadtimeservicelevel.
Theexpectednumberofunitsshortcan,however,bevaryusefultoamanager:Thisquantitycaneasilybe
determinedfromthesameinformationusedtocomputetheROP,withoneadditionalpieceofinformation
(seeTable133onpage569).Useofthetableassumesthatthedistributionofleadtimedemandcanbe
adequatelyrepresentedbyanormaldistribution.Ifitcan,theexpectednumberofunitsshortineachorder
cycleisgivenbythisformula:
where
(p.569,Table133notincludedhere.)
Example:Supposethestandarddeviationofleadtimedemandisknowntobe20units.Leadtimedemand
isapproximatelynormal.
a. Foraleadtimeservicelevelof90percent,determinetheexpectednumberofunitsshortforan
ordercycle.
b. Whatleadtimeservicelevelwouldanexpectedshortageof2unitsimply?
Solution:dLT=20units.
a. Leadtime(cycle)servicelevel=0.90.FromTable133,E(z)=0.048.E(n)=0.048(20units)=0.96,or
about1unit.
b. ForE(n)=2,wehaveE(z)=E(n)/dLT=2/20=0.10.FromTable133,thisimpliesaservicelevel
ofapproximately81.5percent.
Havingdeterminedtheexpectednumberofunitsshortforanordercycle,youcandeterminetheexpected
numberofunitsshortperyear.Itissimplytheexpectednumberofunitsshortpercyclemultipliedbythe
numberofcycles(orders)peryear.Thus,
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where
E(N)=expectednumberofunitsshortperyear.
Example:Giventhefollowinginformation,determinetheexpectednumberofunitsshortperyear.
D=1,000Q=250E(n)=2.5
Solution:
Itissometimesconvenienttothinkofservicelevelinannualterms.Onedefinitionofannualservicelevel
isthepercentageofdemandfilleddirectlyfrominventory.Thisisalsoknownasthefillrate.Thus,ifD=
1,000and990unitswerefilleddirectlyfrominventory(shortagetotaling10unitsovertheyearwere
recorded),theannualservicelevel(fillrate)wouldbe990/1,000=99percent.Theannualservicelevel
andtheleadtimeservicelevelcanberelatedusingthefollowingformula:
Using
,wehave
Example:Givenaleadtimeservicelevelof90,D=1,000,Q=250,anddLT=16,determinetheannual
servicelevel,andtheamountofcyclesafetystockthatwouldprovideanannualservicelevelof0.98.
FromTable133,E(z)=0.048fora90percentleadtimeservicelevel.
Solution:
a.
b.
Notethatintheprecedingexample,aleadtimeservicelevelof90percentprovidedanannualservice
levelof99.7percent.Naturally,differentvaluesofD,Q,anddLTwilltendtoproducedifferentresults
foracycleservicelevelof90percent.Nonetheless,theannualservicelevelwillusuallybegreaterthan
thecycleservicelevel.Inaddition,sincetheannualservicelevelasdefinedrelatestothepercentageof
unitsshortperyear.Itmakessensetobasecycleservicelevelsonaspecifiedannualservicelevel.This
meanssettingannuallevelandusingthatvaluetoobtaintheservicelevelfortheordercycles.
Backtotop.
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HowMuchToOrder:FixedOrderIntervalModel
Thefixedorderinterval(FOI)modelisusedwhenordersmustbeplacedatfixedtimeintervals
(weekly,twiceamonth,etc.)Fixedintervalorderingiswidelyusedinretailbusinesses(e.g.,drugstores,
smallgrocerystores).
Reasonsofusingthemodelinclude:asupplier'spolicymightencourageordersatfixedintervals
groupingordersforitemsfromthesamesuppliercanproducesavingsinshippingcostssomesituations
donotrequirecontinuousmonitoringofinventorylevels,onlyperiodiccheckisneeded.
Inthefixedquantityarrangement,ordersaretriggeredbyaquantity(ROP),whileinthefixedinterval
arrangementordersaretriggeredbytime.Therefore,thefixedintervalsystemmusthavestockout
protectionforleadtimeplusthenextordercycle,butthefixedquantitysystemneedsprotectiononly
duringleadtime.Note,forexample,thelargerdipintosafetystockduringthesecondordercyclewiththe
fixedintervalmodelbelow.
Bothmodelsaresensitivetodemandexperiencejustprioritoordering,butinsomewhatdifferentways.In
thefixedquantitymodel,ahigherthannormaldemandcausesashortertimebetweenorders,whereasin
thefixedintervalmodel,theresultisalargerordersize.Anotherdifferenceisthatthefixedquantity
modelrequiresclosemonitoringofinventorylevelsinordertoknowwhentheamountonhandhas
reachedthereorderpoint.Thefixedintervalmodelrequiresonlyaperiodicreview(i.e.,physical
inspection)ofinventorylevelsjustprioritoplacinganordertodeterminehowmuchisneeded.
Ifboththedemandrateandleadtimeareconstant,thefixedintervalmodelandthefixedquantitymodel
functionidentically.LiketheROPmodel,thefixedintervalmodelcanhavevariationsindemandonly,in
leadtimeonly,orinbothdemandandleadtime.Forthesakeofsimplicity,onlyvariabledemandand
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constantleadtimecaseisdiscussedhere.Ordersizeofthecaseisdeterminedbythefollowingformula:
Asinpreviousmodels,weassumethatdemandduringtheintervalisnormallydistributed.
Example:Giventhefollowinginformation,determinetheamounttoorder.
Solution:z=2.33for99percentservicelevel.
Anissuerelatedtofixedintervalorderingistheriskofastockout.Fromtheperspective(i.e.,thepointin
time)ofplacinganorder,therearetwopointsintheordercycleatwhichastockoutcouldoccur.Oneis
shortlyaftertheorderisplaced,whilewaitingtoreceivethecurrentorder.Thesecondpointisnearthe
endofthecycle,whilewaitingtoreceivethenextorder.
Tofindouttheinitialriskofastockout,use
,settingROPequaltothequantityon
handwhentheorderisplaced,andsolveforz,thenobtaintheservicelevelforthatvalueofzandsubtract
itfrom1.00togettheriskofastockout.
Tofindouttheriskofastockoutattheendoftheordercycle,usetheformula
andsolveforz.Then,obtaintheservicelevelforthatvalue
ofzandsubtractitfrom1.00togettheriskofastockout.
Example:Giventhefollowinginformation:
Determinetheriskofstockoutat
a. Theendoftheinitialleadtime.
b. Theendofthesecondleadtime.
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Solution:
a. Usingformula
,weget43=10(4)+z(2)(2).z=0.75.Theservicelevelis
0.7734.Theriskis10.7734=0.2266,whichisfairlyhigh.
b. Using
,weget171=10(4+12)+z(4)(2)43.z=6.75.
Theservicelevelisvirtually100percent.Theriskisessentiallyequaltozero.
BenefitsandDisadvantages
ThefixedintervalsystemresultsinthetightcontrolneededforAitemsinanABCclassificationdueto
itsperiodicreviews.Inaddition,whentwoormoreitemscomefromthesamesupplier,groupingorders
canyieldsavingsinordering,packing,andshippingcosts.Moreover,itmaybetheonlypractical
approachifinventorywithdrawscannotbecloselymonitored.
Onthenegativeside,thefixedintervalsystemnecessitatesalargeramountofsafetystockforagivenrisk
ofstockoutbecauseoftheneedtoprotectagainstshortagesduringanentireorderintervalplusleadtime
(insteadofleadtimeonly),andthisincreasesthecarryingcost.Also,therearethecostsofperiodic
reviews.
Backtotop.
SinglePeriodModel
Thesingleperiodmodel(sometimesreferredtoasthenewsboyproblem)isusedtohandleorderingof
perishables(freshfruits,vegetables,seafood,cutflowers)anditemsthathavealimitedusefullife
(newspapers,magazines,sparepartsforspecializedequipment).Theperiodforsparepartsisthelifeof
theequipment,assumingthatthepartscannotbeusedforotherequipment.Whatsetsunsoldorunused
goodsapartisthattheyarenottypicallycarriedoverfromoneperiodtothenext,atleastnotwithout
penalty.Dayoldbakedgoods,forinstance,areoftensoldatreducedprices,leftoverseafoodmaybe
discarded,andoutofdatemagazinesmaybeofferedtousedbookstoresatbargainrates.Theremayeven
besomecostassociatedwithdisposalofleftovergoods.
Analysisofsingleperiodsituationsgenerallyfocusesontwocosts:shortageandexcess.
Shortagecostmayincludeachargeforlossofcustomergoodwillaswellastheopportunitycostoflost
sales.Generally,shortagecostissimplyunrealizedprofitperunit.Thatis,
Cshortage=Cs=revenueperunitcostperunit
Ifashortageorastockoutrelatestoanitemusedinproductionortoasparepartforamachine,then
shortagecostreferstotheactualcostoflostproduction.
Excesscostpertainstoitemsleftoverattheendoftheperiod.Ineffect,excesscostisthedifference
betweenpurchasecostandsalvagevalue.Thatis,
Cexcess=Ce=originalcostperunitsalvagevalueperunit
Ifthereiscostassociatedwithdisposingofexcessitems,thesalvagewillbenegativeandwilltherefore
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increasetheexcesscostperunit.
Thegoalofthesingleperiodmodelistoidentifytheorderquantity,orstockinglevel,thatwillminimize
thelongrunexcessandshortagecosts.
Therearetwogeneralcategoriesofproblemsthatwewillconsider:thoseforwhichdemandcanbe
approximatedusingacontinuousdistribution(perhapsatheoreticalonesuchasauniformornormal
distribution)andthoseforwhichdemandcanbeapproximatedusingadiscretedistribution(say,historical
frequenciesoratheoreticaldistributionsuchasthePoisson).Thekindofinventorycanindicatewhich
typeofmodelmightbeappropriate.Forexample,demandforpetroleum,liquids,andgasestendstovary
oversomecontinuousscale,thuslendingitselftodescriptionbyacontinuousdistribution.Demandfor
tractors,cars,andcomputersisexpressedintermsofthenumberofunitsdemandedandlendsitselfto
descriptionbyadiscretedistribution.
ContinuousStockingLevels
Whenthedemandisuniform,choosingthestockinglevelissimilartobalancingaseesaw.Wehave
excesscostperunit(Ce)ononeendofthedistributionandshortagecostperunit(Cs)ontheother.The
optimalstockinglevelisanalogoustothefulcrumoftheseesawthestockinglevelequalizesthecost
weights.
Theservicelevelistheprobabilitythatdemandwillnotexceedthestockinglevel,andcomputationofthe
servicelevelisthekeytodeterminingtheoptimalstockinglevel,So.
Example:SweetciderisdeliveredweeklytoCindy'sCiderBar.Demandvariesuniformlybetween300
litersand500litersperweek.Cindypays20centsperliterfortheciderandcharges80centsperliterfor
it.Unsoldciderhasnosalvagevalueandcannotbecarriedoverintothenextweekduetospoilage.Find
theoptimalstockinglevelanditsstockoutriskforthatquantity.
Solution:
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Asimilarapproachapplieswhendemandisnormallydistributed.
Example:Cindy'sCiderBaralsosellsablendofcherryjuiceandapplecider.Demandfortheblendis
approximatelynormal,withameanof200litersperweekandastandarddeviationof10litersperweek.
Cs=60centsperliter,andCe=20centsperliter.Findtheoptimalstockinglevelfortheapplecherry
blend.
Solution:
DiscreteStockingLevels
Whenstockinglevelsarediscreteratherthancontinuous,theservicelevelcomputedusingtheratio
Cs/(Cs+Ce)usuallydoesnotcoincidewithafeasiblestockinglevel(e.g.,theoptimalamountmaybe
betweenfiveandsixunits).Thesolutionistostockatthenexthigherlevel(e.g.,sixunits).Inother
words,choosethestockinglevelsothatthedesiredservicelevelisequaledorexceeded.
Ifthecomputedservicelevelisexactlyequaltothecumulativeprobabilityassociatedwithoneofthe
stockinglevels,therearetwoequivalentstockinglevelsintermsofminimizinglongruncosttheone
withequalprobabilityandthenexthigherone.
Example:Historicalrecordsontheuseofsparepartsforseverallargehydraulicpressesaretoserveasan
estimateofusageforsparesofanewlyinstalledpress.Stockoutcostsinvolvedowntownexpensesand
specialorderingcosts.Theseaverage$4,200perunitshort.Sparescost$800each,andunusedpartshave
zerosalvage.Determinetheoptimalstockinglevel.
Numberofsparesused
0
Relativefrequency Cumulativefrequency
0.20
0.20
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1
2
3
4ormore
0.40
0.30
0.10
0.00
1.00
0.60
0.90
1.00
Solution:
Example:Demandforlongstemmedredrosesatasmallflowershopcanbeapproximatedusinga
Poissondistributionthathasameanoffourdozenperday.Profitontherosesis$3perdozen.Leftover
flowersaremarkeddownandsoldthenextdayatalossof$2perdozen.Assumethatallmarkeddown
flowersaresold.Whatistheoptimalstockinglevel?
Solution:
Demand(dzsperday)
0
1
2
3
4
5
Cumulativefrequency
0.018
0.092
0.238
0.434
0.629
0.785
Backtotop.
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