CTL.

SC1x -Supply Chain & Logistics Fundamentals

Extensions to EOQ Model

MIT Center for

Transportation & Logistics
 Model Assumptions: EOQ
• Demand • Discounts
n Constant vs Variable n None
n Known vs Random n All Units vs Incremental vs One Time
n Continuous vs Discrete • Excess Demand
• Lead Time n None
n Instantaneous n All orders are backordered
n Constant vs Variable n Lost orders
n Deterministic vs Stochastic n Substitution
n Internally Replenished • Perishability
• Dependence of Items n None
n Independent n Uniform with time
n Correlated n Non-linear with time
n Indentured • Planning Horizon
• Review Time n Single Period
n Continuous vs Periodic n Finite Period
• Number of Locations n Infinite
n One vs Multi vs Multi-Echelon • Number of Items
• Capacity / Resources n One vs Many
n Unlimited • Form of Product
n Limited / Constrained n Single Stage
n Multi-Stage
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 2
 Non-Instantaneous Lead Time

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 3
 Model Assumptions: EOQ w/ Lead Time
• Demand • Discounts
n Constant vs Variable n None
n Known vs Random n All Units vs Incremental vs One Time
n Continuous vs Discrete • Excess Demand
• Lead Time n None
n Instantaneous n All orders are backordered
n Constant vs Variable n Lost orders
n Deterministic vs Stochastic n Substitution
n Internally Replenished • Perishability
• Dependence of Items n None
n Independent n Uniform with time
n Correlated n Non-linear with time
n Indentured • Planning Horizon
• Review Time n Single Period
n Continuous vs Periodic n Finite Period
• Number of Locations n Infinite
n One vs Multi vs Multi-Echelon • Number of Items
• Capacity / Resources n One vs Many
n Unlimited • Form of Product
n Limited / Constrained n Single Stage
n Multi-Stage
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 4
 Extensions: Leadtime > 0

Demand

• Order Leadtime
n Positive (nonzero)
n Deterministic
Order

L = Order Leadtime
Receive

Inventory On Order
or Pipeline Inventory

Inventory
On Inventory On Hand
Hand

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 5
 Extensions: Leadtime > 0
Inventory
Inventory Position
On
Hand

• What is the average amount of pipeline inventory?

n Cycle length = T* = Q*/D
n Pipeline inventory level changes over the replenishment cycle
w In transit: Pipeline Inventory = Q* which happens (L/T*) of the cycle
w Not in transit: Pipeline Inventory = 0 which happens (1- L/T*) of the cycle
w Average Pipeline Inventory
= Q*(L/T*) + 0(1 – L/T*) = Q*(L/T*) = Q*(DL/Q*) = DL

• What is the average inventory in the system?

n Cycle Stock + Pipeline = Q/2 + DL
n Need to consider who owns it and when (on-hand vs. system)
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 6
 Extensions: Leadtime > 0
• What is my new TC function?
! D$ !Q $
TC(Q) = cD + ct # & + ce # + DL & + cs E '(Units Short )*
"Q% "2 %

• What is my new Q*? 2ct D

Q* =
ce

inventory
IP
• What is my new optimal policy? IOH

Inventory Policy: DL
• Order Q* units when IP=DL
• Order Q* units every T* time periods
L time

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 7
 Quantity Discounts

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 8
 Model Assumptions: EOQ w/ Discounts
• Demand • Discounts
n Constant vs Variable n None
n Known vs Random n All Units vs Incremental vs One Time
n Continuous vs Discrete • Excess Demand
• Lead Time n None
n Instantaneous n All orders are backordered
n Constant vs Variable n Lost orders
n Deterministic vs Stochastic n Substitution
n Internally Replenished • Perishability
• Dependence of Items n None
n Independent n Uniform with time
n Correlated n Non-linear with time
n Indentured • Planning Horizon
• Review Time n Single Period
n Continuous vs Periodic n Finite Period
• Number of Locations n Infinite
n One vs Multi vs Multi-Echelon • Number of Items
• Capacity / Resources n One vs Many
n Unlimited • Form of Product
n Limited / Constrained n Single Stage
n Multi-Stage
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 9
 Extensions: Discounts
• All Units Discount
cD
n Discount applies to all units purchased if
total amount exceeds the break point
quantity

Q1 Q2 Q

• Incremental Discount cD
n Discount applies only to the quantity
purchased that exceeds the break point
quantity

Q1 Q2 Q

IOH
• One Time Only Discount
n A one time only discount applies to all
units you order right now (no quantity
minimum or limit)
t
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 10
 Quantity Discounts:
All Units

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 11
 Extensions: All Units Discounts
Two Cases to Examine . . .
" c D c hQ
$ Dc0 + t + 0 0 ≤ Q ≤ Q1
" c 0 ≤ Q ≤ Q1 $ Q 2
$ 0 TRC = #
c=# $ ct D c1hQ
Dc + + Q1 ≤ Q
$% c1 Q1 ≤ Q $
%
1
Q 2

$112,000 Qb

$110,000
Where
$108,000 c0 = Base unit price
Total Cost

$106,000 Qi = Volume break quantity i

$104,000 di = Percent discount (0 to 1)
in break i
$102,000
ci = Unit price under discount i
$100,000
= c0(1-di)
$98,000
100 200 300 400 500 600 700 800 900 1000
Order Quantity (Lot Size) Typically, Q* < Q1
TC2 TC1
but what if Q* > Q1?
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 12
 Extensions: All Units Discounts
Procedure: Example:
D=2000 Units/yr
1. Find Qc0* and Qc1*
h=.25
2. If Qc1*≥Q1 then pick Qc1* ct=$500
Otherwise, go to 3 c0 = $50
3. Solve for TRC(Qc0*) and TRC(Q1) Discount of 15% off if Q≥800
If TRC(Qc0*) < TRC(Q1) then pick Qc0*
Otherwise, pick Q1

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 13
 Quantity Discounts:
Incremental

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 14
 Extensions: Incremental Discounts
• Discount i only applies to quantity purchased above breakpoint i
• Trade-off between lower purchase cost and higher carrying costs
• Cost of units ordered below breakpoint i are treated as new Fixed Cost (Fi)
Purchase
Total

Cost

c0 c1
c2

F0 = 0
c1Q1
( )
Fi = Fi−1 + ci−1 − ci Qi
c0Q1
2D ( c + F )
t i
Q *i =
hci

(c0-c1)Q1 Q1 Q2 Units

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 15
 Extensions: Incremental Discounts
• Procedure
1. Find Fixed Cost per breakpoint, Fi, for each break
2. Find Qi* for each range – including the Fi
3. If Qi* is not within allowable range, go to next i
Otherwise, find TRCi using effective cost per unit, cie
4. Pick Qi* with lowest TRC

F0 = 0 (
2D ct + Fi ) e Fi
*
Q = c = ci +
i
(
Fi = Fi−1 + ci−1 − ci Qi ) i
hci Qi

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 16
 Quantity Discounts:
One Time Buy

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 17
 Extensions: One Time Discount
Suppose you are offered a One Time deal!
Should you take it?
vg = One time good deal purchase price ($/unit)
Qg = One time good deal order quantity (units)
TCsp=TC over time covered by special purchase ($)

IOH

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 18
 Extensions: One Time Discount
• Compare Options: Normal Price (c) vs. Special Price (cg)
n Find TC for normal price

TC = (CycleTime)(TC * + PurchaseCost)
!Q $ !Q $
TC = ## g && 2ct hcD + ## g && cD
"D% "D%
n Find the Savings (TC-TCSP)

Savings = TC − TCSP
"" Q % "Q % % " " Q %" Q % %
= $$$ g '' 2ct hcD + $$ g '' cD ' − $ cg Qg + hcg $$ g ''$$ g '' + ct '
$ D D ' $ 2 D '
## & # & & # # &# & &

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 19
 Extensions: One Time Discount
n Finding 1st and 2nd order conditions (Maximize Savings)
dS !1$ ! 2hc Q $
g g

d(Qg )
= 0 = # & 2ct hcD + c − cg − ##
" D%
( && )
" 2D %
d 2S ! 2hc $
g
2
= − #
# && < 0
d (Qg ) " 2D %
n So that the Optimal Quantity to buy is

*
! D $
Qg = ## & 2ct hcD +
D c − cg ( )
Dhc & hcg
" g %

n Cleaning this up gives: *

Q *ch + D c − cg
( )
Q =g
hcg
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 20
 Finite Replenishment:
Economic Production Quantity (EPQ)

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 21
 Model Assumptions: EPQ
• Demand • Discounts
n Constant vs Variable n None
n Known vs Random n All Units vs Incremental vs One Time
n Continuous vs Discrete • Excess Demand
• Lead Time n None
n Instantaneous n All orders are backordered
n Constant vs Variable n Lost orders
n Deterministic vs Stochastic n Substitution
n Internally Replenished • Perishability
• Dependence of Items n None
n Independent n Uniform with time
n Correlated n Non-linear with time
n Indentured • Planning Horizon
• Review Time n Single Period
n Continuous vs Periodic n Finite Period
• Number of Locations n Infinite
n One vs Multi vs Multi-Echelon • Number of Items
• Capacity / Resources n One vs Many
n Unlimited • Form of Product
n Limited / Constrained n Single Stage
n Multi-Stage
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 22
 Extensions: Finite Replenishment
• What if inventory becomes available at a rate
of P units/time rather than all at one time?
1. How long does it take to produce Q units?
2. During that time, what is the accumulation rate?
3. What is the most inventory I will have on hand?
4. What is my average IOH?
5. How does Q* change?
Production Slope = P

Q
Demand Slope = -D Maximum
Level of
Inventory
Q(1-D/P)
Accumulation
Slope = P-D

Avg. IOH
= (1-D/P)Q/2
Q/P
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 23
 Extensions: Finite Replenishment
• The IOH is reduced which leads to a higher order quantity.

" D%
Q $1− ' hc
• EPQ can be related to EOQ ct D # P&
TRC[Q] = +
n If Pèinfinity then EPQ≈EOQ Q 2
n If P=2D then EPQ = √2(EOQ)
2ct D EOQ
n If P=1.5D then EPQ = √3(EOQ) EPQ = =
" D% " D%
hc $1− ' $1− '
# P & # P&

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 24
 Allowing for Stockouts:
EOQ with Planned Backorders

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 25
 Assumptions: EOQ with Planned Backorders
• Demand • Discounts
n Constant vs Variable n None
n Known vs Random n All Units vs Incremental vs One Time
n Continuous vs Discrete • Excess Demand
• Lead Time n None
n Instantaneous n All orders are backordered
n Constant vs Variable n Lost orders
n Deterministic vs Stochastic n Substitution
n Internally Replenished • Perishability
• Dependence of Items n None
n Independent n Uniform with time
n Correlated n Non-linear with time
n Indentured • Planning Horizon
• Review Time n Single Period
n Continuous vs Periodic n Finite Period
• Number of Locations n Infinite
n One vs Multi vs Multi-Echelon • Number of Items
• Capacity / Resources n One vs Many
n Unlimited • Form of Product
n Limited / Constrained n Single Stage
n Multi-Stage
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 26
 EOQ with Planned Backorders
T*
Inventory On Hand

Q*

Time

What will happen to Q* and T* if we allow

for planned backorders at some cost (cs)?
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 27
 EOQ with Planned Back Orders

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 28
 Notation
D = Average Demand (units/time)
c = Variable (Purchase) Cost ($/unit)
ct = Fixed Ordering Cost ($/order)
h = Carrying or Holding Charge ($/inventory $/time)
ce = c*h = Excess Holding Cost ($/unit/time)
cs = Shortage Cost ($/unit/time)
Q = Replenishment Order Quantity (units/order)
T = Order Cycle Time (time/order)
N = 1/T = Orders per Time (order/time)

TRC(Q) = Total Relevant Cost ($/time)

TC(Q) = Total Cost ($/time)
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 29
 EOQ with Planned Backorders
T From similar triangles:
Inventory On Hand

Q Q−b
=
(
=
b )
Q-b
T T1 T2
Q T1 T2 (
T1 Q − b ) T2 b
= =
T Q T Q
b
Time
! D$ ! 1 $! T1 $ ! 1 $! T2 $
(
TRC(Q,b) = ct # & + ce # &# & Q − b + cs # &# & b
"Q% " 2 %" T % " 2 %" T %
) ()
! D$ ! 1 $! (Q − b) $ ! 1 $! b $
TRC(Q,b) = ct # & + ce # &#
"Q% " 2 %" Q %
( )
& Q − b + cs # & # & b
" 2 %" Q %
()
! 2 $
! D$
TRC(Q,b) = ct # & + ce #
(# Q−b ) & ! b2 $
"Q% # 2Q && + cs # 2Q &
" %
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model " %
 Planned Backorders - Solution

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 31
 EOQ with Planned Backorders
! 2 $
! D$ # Q−b
TRC(Q,b) = ct # & + ce #
( ) & ! b2 $
"Q% # 2Q && + cs # 2Q &
" %
" %

Q *
=
2ct D (c s
+ ce ) = Q (c
* s
+ ce )
PBO
ce cs cs

*
ceQPBO " cs %
b* = $
= 1− ' Q*
(c + ce ) $ (
cs + ce ) ' PBO
s # &

Inventory Policy Critical Ratio

Order Q*PBO when IOH = - b* cs
CR =
Order Q*PBO every T*PBO time periods (c s
+ ce )
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model
 EOQ with Planned Backorders
1000%
Critical Ratio
Q*(PBO) as percent of Q* (w/o backorders)

900%

If cs is very small, cs
800% CR =
then Q*PBO>>Q* (c s
+ ce )
700%

600%

500%

400%
If cs is very big,
300% then Q*PBO=Q*
200%

100%

0%
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
Critical Ratio Cs/(Cs+Ce)

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model
 Key Take Aways

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 34
 Take-Aways
• EOQ is a good place to start for most analysis and can
be extended to cover many variations:
n Non-zero lead times
w No effect on Q*
w Monitor Inventory Position vs Inventory on Hand
w Changes timing of replenishment (IP≤DL)
n Discounts (All Units, Incremental, One Time Buy)
w Common in practice (economies of scale)
w Purchase price (c) becomes relevant
w Need to estimate costs at breakpoints & compare
n Finite replenishment systems
w Items become available incrementally over time
w Lowers holding costs and leads to higher EPQ

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Extensions to EOQ Model 35
 CTL.SC1x -Supply Chain & Logistics Fundamentals

Questions, Comments, Suggestions?

MIT Center for

Transportation & Logistics caplice@mit.edu