Re-Order Point Problems

Set 1: General
Notations
Lead Time Demand : LTD
Average Lead Time Demand : LTD
Std. Dev. Lead Time Demand :  LTD
Safety Stock : Isafety
Reorder Point : ROP
Demand per period : R
Average Demand : R
Std. Dev. of Demand :  R
Lead Time : L
L
Average Lead Time : L
Std. Dev. of Lead Time :  L
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 2
ROP Problems
a) If average demand per day is 20 units and lead time is 10 days.
Assuming zero safety stock. Isafety=0, compute ROP.
b) If average demand per day is 20 units and lead time is 10 days.
Assuming 70 units of safety stock. Isafety=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 safety stock.
d) If average demand per day is 20 units and standard deviation
of daily demand is 5, and lead time is 16 days. Compute ROP at
90% service level. Compute safety stock.
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 safety stock.

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 3

ROP; Fixed R, Fixed L, Zero Safety Stock
a) If average demand per day is 20 units and lead time
is 10 days. Assuming zero safety stock.
Isafety = 0, L=10, R=20
Compute ROP.

ROP = average demand during lead time + safety stock

ROP = LTD+ Isafety
ROP = LTD + 0
LTD = L × R
LTD = 20 × 10 = 200
ROP = 200
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 4
ROP; Fixed R, Fixed L, Isafety >0
b) If average demand per day is 20 units and lead time
is 10 days. Assuming 70 units of safety stock.
Isafety = 70, L=10, R=20
Compute ROP.

ROP = average demand during lead time + Safety Stock

ROP = LTD + Isafety
LTD = R × L = 20 × 10 = 200
Isafety = 70
ROP = 200 + 70 = 270

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 5

ROP; total demand during lead time is variable
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
safety stock.

Service level Risk of a

stockout
Probability of
no stockout

Average
ROP Quantity
demand
Safety stock

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 6

Safety Stock and ROP
Subtract the random variable from its mean.
Positive or Negative
Divide it by Standard Deviation. How many standard deviations to the
right or left.

There is a table for z which tells us

a) Given any probability of not exceeding z. What is the value of z.
b) Given any value for z. What is the probability of not exceeding z.

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 7

Popular z Values

=NORM.S.INV(0.9)
= 1.28155

1.28155 StdDev to Right

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 8

ROP; total demand during lead time is variable
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 safety stock

LTD = 200, σLTD = 25, SL=90%, z(90%)=?

=NORM.S.INV(0.9) = 1.28155
Order 1.28155 standard deviation as safety stock to reduce
probability of stockout from 50% to 10%. That is Safety Stock.
Isafety = z σLTD
Isafety = 1.28 × 25 = 32
ROP=LTD + zσLTD
ROP = ROP = 200 + 32 =232
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 9
ROP; Variable R, Fixed L

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 safety stock.

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 10

ROP; Variable R, Fixed L
Previous Problem: 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 safety stock.

This Problem: If average demand per day is 20 units and

standard deviation of demand per day is 5, and lead
time is 16 days. Compute ROP at 90% service level.
Compute safety stock.

If we can transform this problem into the previous

problem, then we are done, because we already know
how to solve the previous problem.
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 11
ROP; Variable R, Fixed R
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.
What is the average demand during the lead time
What is standard deviation of demand during lead
time

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 12

μ and σ of demand per period and fixed L
If Demand is variable and Lead time is fixed

L: Lead Time
R: Demand per period (per day, week, month)
R: Average Demand per period (day, week, month)
R: Standard deviation of demand (per period)
LTD: Average Demand During Lead Time
LTD = L × R
LTD: Standard deviation of demand during lead time
 
=
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 13
μ and σ of demand per period and fixed L
If demand is variable and Lead time is fixed

L: Lead Time = 16 days

R: Demand per day
R: Average daily demand =20
R: Standard deviation of daily demand =5
LTD: Average Demand During Lead Time
LTD = L × R = 16 × 20 = 320
LTD: Standard deviation of demand during lead time
 
=  
=
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 14
Now It is Transformed
The Problem originally was: 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 safety stock.
We transformed it to: The average demand during the
lead time is 320 and the standard deviation of
demand during the lead time is 20. Compute ROP at
90% service level. Compute safety stock.
Which is the same as the previous problem: 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 safety stock.
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 15
ROP; Variable R, Fixed L
LTD = 320, σLTD = 20
SL = 90%  z = 1.28
Move 1.28 StdDev to right
Isafety = z σLTD = 1.28× 20 =25.6 ≈ 26
ROP= LTD +Isafety
ROP= 320 + 26
ROP = 346

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 16

ROP; Variable R, Fixed L
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
Isafety.
What is the average demand during the lead time
What is standard deviation of demand during lead
time

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 17

μ and σ of L and Fixed R
If Lead time is variable and Demand is fixed

L: Lead Time
L: Average Lead Time
L: Standard deviation of Lead time
R: Demand per period
LTD: Average Demand during lead time
LTD = L × R
LTD: Standard deviation of demand during lead time
 
=R
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 18
μ and σ of L and Fixed R

If Lead time is variable and Demand is fixed

L: Lead Time
L: Average Lead Time = 16 days
L: Standard deviation of Lead time = 4 days
R: Demand per period = 20 per day
LTD: Average Demand During Lead Time
LTD = 16 × 20 = 320
LTD: Standard deviation of demand during lead time
 
=R  
=20(4) =80
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 19
μ and σ of L and Fixed R

LDT = 320, LTD = 80, SL = 90%, z(90%) =1.28

Isafety = 1.28(80) = 102.4 = ≈ 103

ROP = LTD +Isafety
ROP = 320 +103=423

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 20

Comparing the two problems
I. Average demand per day is 10 units and standard
deviation of demand per day is 3 units. The lead
time is 5 days
II. Demand per day is 10 units. The average lead time is
3 days and standard deviation of lead time is 1 days.

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 21

Given Safety Inventory Compute Service Level
Average lead time demand is 20,000 units. Standard deviation of
lead time demand is 5,000 units. Each time the inventory level
drops to 24,000 units, we order a 14-day supply of 28,000 units.
Suppose holding cost is $2 per unit per year.
LTD = 20,000, LTD = 5,000, ROP = 24,000, H=$2, R = 2,000 / day,
Q or EOQ = 28,000.
a) Compute the service level.
ROP = LTD + Isafety  Isafety = 24,000 – 20,000 = 4,000
Isafety = 4000 = z LTD
z LTD = z(5,000) = 4,000
z = 4,000/5,000 = 0.8
z =0.8  P(z ≤ Z) = =NORM.S.DIST(0.8,1) = 0.78814
In 78.81 % of the order cycles, the warehouse will not have a
stockout. Risk = 21.19%.
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 22
Given Safety Inventory Compute Service Level
b) Compute the cycle inventory, and average inventory.
At reorder point we order 28,000 units.
Icycle = Q/2 = 28,000/2 = 14,000
Isafety = 4,000
Average Inventory = I = Icycle + Isafety =14,000 + 4,000 = 18000.
c) Compute the total holding costs per year.
H(Average Inventory) = H(I) = 2  18,000 = 36,000/year
d) Compute the average flow time.
R = 2,000 / day, I = 18,000
RT = I 2000T = 18,000
T=9
9 days

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 23

Problem 7.1
MassPC Inc. produces a 4-week supply of its PC Pal model when
stock on hand drops to 525 units. It takes 1 week to produce a
batch. Orders average 400 units per week, and standard deviation
of forecast errors is estimated at 125 units.
ROP = 525 L = 1 week LTD = 400/week  =125 Q = 4(400)
LTD = N(400, 125).
ROP = LTD + Isafety
ROP = LTD +z LTD
525= 400+z(125)
125 = 125z
z = 125/125 = 1

SL  P( LTD  ROP) = NORM.S.DIST(1,1)  0.84134

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 24
Problem 7.1
b) Compute Isafety for 80%, 90%, 95%, 99% service levels.
Safety Stock

Service Level
Increasing service level increases the required safety inventory
more than proportionately.
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 25
Problem 7.1
Selecting service level and safety inventory level is an important
strategic decision.
A firm may choose high quality service in terms of product
availability. Or
The firm may choose to be a low cost supplier by holding down
inventory costs. In either case, it is positioning itself along the
quality vs. cost trade-off curve.

This graph is a perfect

example to show how a
Cost
strategic position could be
operationalized.
Quality

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 26

More Practice on the Same Concepts
Average demand of a product 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
L= 2 weeks, R= 50 tons per week, R = 3 tons per week

LTD = LR LTD = 2(50) = 100

LTD =(L) R  LTD =(2) 3 = 4.24

ROP = LTD + Isafety = LTD + zLTD

ROP = 100 + 1.28 × 4.24  ROP = 105.43

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 27

More Practice on the Same Concepts
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.
Under a risk of no more that 10%, compute ROP and Isafety.
Acceptable risk; 10%  z = 1.28
R: 50 tons, L = 2 weeks, L = 0.5 week

R: 50 tons, L = 2 weeks, L = 0.5 week

R: 50 tons, L = 2 weeks, L = 0.5 week

LTD = LR  LTD = 2(50) = 100

LTD = R L  LTD = 50 ×0.5 = 25

ROP = LTD + Isafety = LTD + zLTD

ROP = 100 + 1.28 × 25  ROP =Ardavan

Flow Variability; Safety Inventory
100+Asef-Vaziri
32 Sep-2012 28
Service Level, Fill Rate
Within 100 time intervals, stockouts occur in 20.
Service Level = 80/100 = 80%.
Probability of stock-out = 20%.
Risk = # of stockout intervals/ Total # of intervals
Service Level = 1- (# of stockout intervals/ Total # of intervals)
Suppose that in each time interval in which a stockout occurred,
the number of units by which we were short.
Suppose that cumulative demand during the 100 time intervals
was 15,000 units and the total number of units short in the 20
intervals with stockouts was 1,500 units.
Fill rate = (15,000-1,500)/15,000 = 13,500/15,000 = 90%.
Fill Rate = Expected Sales / Expected Demand
Fill Rate = (1- Expected Stockout )/ Expected Demand
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 29
One Additional Formula- Not Needed
R: demand rate per period
R: Average demand rate
σR: Standard deviation of demand

L: lead time
L: Average lead time
σL: Standard deviation of the lead time

LTD: demand during the lead time (a random variable)

LTD: Average demand during the lead time
σLTD: Standard deviation of the demand during lead time

 
  =

Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 30

One Additional Formula- Not Needed
 Lead time has mean of 10 days and a stddev of 2 days. Demand
per day has a mean of 2000 and stddev of 1581. How much safety
inventory is needed in order to provide a 95% service level?
R: Average demand rate= 2000 units
σR: Standard deviation of demand = 1581
L: Average lead time = 10 days
σL: Standard deviation of the lead time = 2 days

= 10(2000) = 20000

=6402.78  =1.65

=1.65(6402.78) = 10565
Flow Variability; Safety Inventory Ardavan Asef-Vaziri Sep-2012 31