When to re-order with EOQ Ordering

EOQ: How much to order; ROP: When to order

Re-Order Point (ROP) in periodic inventory system is the start of the period. Where is ROP in a perpetual system? ROP in Perpetual System: Quantity on hand drops to a predetermined amount. If there were no variations in demand, and demand was really constant; ROP is when inventory on hand is equal to the [average] demand during lead time. Lead Time is the time interval from placing an order until receiving the order.

When to re-order with EOQ Ordering

The greater the variability of demand during lead time, the greater the need for additional inventory to reduce the risk of shortage (i.e., the greater the safety stock).
When variability exists in demand or lead time, actual demand during lead time may exceed average demand during lead time. If ROP is equal to average demand during lead time, there is 50% probability of satisfying all the demand. But we want this probability to be greater than 50%. We prefer 90%, 95%, or 99%. Safety Stock (SS): serves to reduce the probability of a stockout during the lead time. ROP in perpetual inventory control is the inventory level equal to the average demand during the lead time + a safety stock (to cover demand variability)

Example 1
Average demand for an inventory item is 200 units per day, lead time is three days, there is no variation in demand and lead time and therefore, safety stock is zero. What is the reorder point? In a perpetual inventory system, the ROP is the point at which inventory on hand is equal to the [average] demand in lead time plus safety stock. ROP = 3(200) Whenever inventory level drops to 600 units we place an order. We receive the order in 3 days. Because there is no variations in demand, there is no stock out.

Example 2
Average demand for an inventory item is 200 units per day, lead time is three days, and safety stock is 100 units. What is the reorder point In a perpetual inventory system, the ROP is the point at which inventory on hand is equal to the average demand in lead time plus safety stock.

ROP = 3(200)+100
Whenever inventory level drops to 700 units we place an order. Since there is variation in demand, during the next three days, we may have a demand of 500, 600, 700, or even more.

Demand During Lead Time

Inventory

Time

ROP when demand during lead time is fixed

LT

Demand During Lead Time

Inventory

Time

Demand During Lead Time is Variable

Demand During Lead Time is Variable

Inventory

Time

Safety Stock

Quantity

A large demand during lead time Average demand during lead time

ROP

Safety stock reduces risk of stockout during lead time

Safety stock
LT Time

Safety Stock

ROP

Quantity

LT

Time

When to re-order (ROP)

Demand during lead time has Normal distribution.

If we order when the inventory on hand is equal to the average demand during the lead time; then there is 50% chance that the demand during lead time is less than our inventory.

However, there is also 50% chance that the demand during lead time is greater than our inventory, and we will be out of stock for a while. We usually do not like 50% probability of stock out

We can accept some risk of being out of stock, but we usually like a risk of less than 50%.

Safety Stock and ROP

Service level Probability of no stockout Average demand 0

Risk of a stockout

Safety stock

RO P
z

Quantity

z-scale

Each Normal variable x is associated with a standard Normal Variable z x is Normal (Average x , Standard Deviation x) z is Normal (0,1) There is a table for z which tells us Given any probability of not exceeding z. What is the value of z Given any value for z. What is the probability of not exceeding z

Common z Values

Service level Probability of no stockout Average demand 0

Risk of a stockout

Safety stock

RO P
z

Quantity

z-scale

Risk
0.1 0.05 0.01

Service level
0.9 0.95 0.99

z value
1.28 1.65 2.33

Relationship between z and Normal Variable x

Service level Probability of no stockout Average demand 0

Risk of a stockout

Safety stock

RO P
z

Quantity

z-scale

z = (x-Average x)/(Standard Deviation of x) x = Average x +z (Standard Deviation of x) = Average x x = +z = Standard Deviation of x

Risk
0.1 0.05 0.01

Service z value level 0.9 1.28 0.95 1.65 0.99 2.33

Relationship between z and Normal Variable ROP

Service level Probability of no stockout Average demand 0

Risk of a stockout

Safety stock

RO P
z

Quantity

z-scale

LTD = Lead Time Demand ROP = Average LTD +z (Standard Deviation of LTD) ROP = Average LTD +ss ss = z (Standard Deviation of LTD)

Safety Stock and ROP

Service level Probability of no stockout Average demand 0

Risk of a stockout

Safety stock

RO P
z

Quantity

z-scale

Risk 0.1 0.05 0.01

Service level 0.9 0.95 0.99

z value 1.28 1.65 2.33

ss = z (standard deviation of demand during lead time)

Demand During Lead Time is Variable N(,)

Average Demand of sand during lead time is 50 tons. Standard Deviation of demand during lead time is 5 tons. Assume that management is willing to accept a risk no more that 5%. What is the service level? Service level = 1-risk of stockout = 1-.05 = 0.95 What is the z value corresponding to this service level? z = 1.65 What is safety stock (ss)? ss = z (standard deviation of demand during lead time) ss = 1.65 (5) = 8.25

 and of demand during lead time

What is ROP? ROP = Average demand during lead time + ss

ROP = 50 + 1.65(5) = 58.25

Example 2; total demand during lead time is variable

Average Demand of sand during lead time is 75 tons. Standard deviation of demand during lead time is 10 tons. Assume that the management is willing to accept a risk no more that 10%.
What is the service level? Service level = 1-risk of stockout = 1-0.1 = 0.9

Risk Service level 0.1 0.9 0.05 0.95 0.01 0.99

z value 1.28 1.65 2.33

Example 2; total demand during lead time is variable

z = 1.28 What is safety stock? ss = 1.28(10) = 12.8 ROP = Average demand during lead time + ss ROP = 75 + 12.8 = 87.8 The general relationship between service level, risk, and safety stock: Service level increases Risk decreases ss increases

 and of demand per period and fixed LT

If demand is variable and Lead time is fixed

LT : Lead time

d : Demand
d : Average Demand
Average demand during lead time : ( LT ) d

d : Standard deviation of demand

dLT : Standard deviation of demand during lead time
dLT : LT d

 and of demand per period and fixed LT

Average Demand of sand is 50 tons per week. Standard deviation of the weekly demand is 3 tons. Lead time is 2 weeks. Assume that the management is willing to accept a risk no more that 10%. z = 1.28

LT : 2 weeks

d : 50 tons

d : 3 tons

ROP d LT z LT d
ROP 50 2 1.28 2 3

ROP 100 5.43

 and of Lead Time and fixed demand

If lead time is variable and demand is fixed

d : Demand LT : Lead time LT : Average Lead time

Average demand during lead time : ( LT ) d

LT : Standard deviation of Lead Time

dLT : d LT

Lead Time Variable, Demand fixed

Demand of sand is fixed and is 50 tons per week. The average lead time is 2 weeks. Standard deviation of lead time is 0.5 week. Assuming that the management is willing to accept a risk no more that 10%. Compute ROP and SS. Acceptable risk; 10% z = 1.28

d : 50 tons

LT : 2 weeks

LT : .5 week

ROP d LT zd LT

ROP 50 2 1.28 50 .5

ROP 100 32

Assignment 12.d
(a) Average demand per day is 20 units and lead time is 10 days. Assume zero safety stock (ss=0). Compute ROP. (b) Average demand per day is 20 units and lead time is 10 days. Assume 70 units of safety stock. ss=70. Compute ROP.

(c) If average demand during the lead time is 200 and standard deviation of demand during lead time is 25. Compute ROP at 90% service level. Compute ss. (d) If average demand per day is 20 units and standard deviation of demand is 5 per day, and lead time is 16 days. Compute ROP at 90% service level. Compute ss.
(e) If demand per day is 20 units and lead time is 16 days and standard deviation of lead time is 4 days. Compute ROP at 90% service level. Compute ss.