INVENTORY MANAGEMENT:

REORDER POINT (ROP) ORDERING

Introduction
■ Two key problems in inventory management:

1) What quantity of inventory should be ordered ?

EOQ/EPQ

2) When should you place the order ?

ROP
 Reorder Point (ROP) Ordering
ROP, is the level (quantity) of inventory on hand at which next order (reorder) is triggered.

■ In EOQ model, there was an assumption that demand rate is constant, orders will arrive just
at the time inventory level falls to zero, and inventory will be replenished without any delay.

EOQ Assumptions:
• Demand is constant
• Lead time is constant

■ If we go by the above assumptions, ROP = Demand during the lead time

ROP = Demand Rate * Lead Time
= d * LT
(units must be similar)
 Determining ROP
■ What if there is a delay in arriving orders due to external circumstances (transportation
delays, etc.) ?
■ What if the demand rate during the lead time has increased ?

■ A safety stock will be required to overcome the stock-out risk.

ROP = Expected Demand during the Lead Time +

Reorder Point (ROP) Ordering
■ Stock-out reduces the service level of the firm.
■ The customer service level increases as the risk of stock-out decreases

Order Cycle Service level can be defined as the probability

that demand will not exceed supply during lead time

Service Level = 100 – Stock-out Risk

ROP based on Normal Distribution of Lead Time Demand
Service Level
(probability of Stock-out risk
no stock-out)

Quantity

Expected lead time ROP

demand (d)
Safety-Stock

Z Z-scale
0

ROP = Expected Demand during the Lead Time +

= Expected demand during the lead time + z * standard deviation of the lead time demand

Thus, ROP = d + z * σdLT

Computing ROP
■ A manager of a multinational food processing firm has determined that the average lead time
demand of one of the ingredient units is 100 tons. Let’s assume that the demand shows a
normal distribution having a standard deviation of 5 tons. Determine ROP if not more than 3%
of stock-out risk is allowed.

• Expected lead time demand = 100 tons

This is a case in which mean
• Std. Dev. Of lead time demand = 5 tons and standard deviation of the
• Service level is 97% (1 – stock out risk) = 0.9700 lead time demand are given

• Obtain the value of Z in the normal distribution table

Z = +1.88
• Safety Stock = z * σdLT = 1.88*5 = 9.40 tons
• ROP = Expected lead time demand + Safety Stock = 100+9.40 = 109.40 tones
Z +1.88

Service Level =
0.9700
 Other cases: When lead time demand data is not available

■ Case 1: When only demand is variable,

ROP = Expected Demand during the Lead Time +

■ Expected Demand during the Lead Time = Average demand * Lead time
= 𝑑ҧ * LT

= z * Standard deviation of the lead time demand

=z* 𝑑ҧ = Average demand rate
𝜎𝑑 = Standard deviation of the demand
LT = Lead time
 Other cases: When lead time demand data is not available

■ Case 2: When only lead time is variable,

ROP = Expected Demand during the Lead Time +

■ Expected Demand during the Lead Time = Average demand * Lead time
= d * 𝐿𝑇
= z * Standard deviation of the lead time demand
=z* 𝜎𝐿𝑇 = Standard deviation of the lead time
d = Demand rate
𝐿𝑇 = Average lead time
 Other cases

■ Case 3: When both demand and lead time is variable,

ROP = Expected Demand during the Lead Time +

■ Expected Demand during the Lead Time = Average demand * Lead time
= 𝑑ҧ * 𝐿𝑇
= z * Standard deviation of the lead time demand
=z*
Computing ROP:

A large hospital uses approximately 400 bottles of sanitizers per week. The actual number tends to vary with the
number of surgeries performed and beds occupied on any given week. Usage can be approximated by a normal
distribution that has a mean of 400 and a standard deviation of nine bottles per week. A supplier company
delivers hand sanitizers along with other medical supplies with a lead time of three weeks. If the hospital’s
policy is to maintain a stockout risk of 2 percent,

1) What is the minimum number of sanitizer bottles that must be on hand at reorder time?
2) What will be the stock out risk when the hospital decides to order 1245 bottles per week ?

𝑑ҧ = 400 bottles per week; LT = 3 weeks; σd = 9

Stock out risk allowed = 2 percent; Therefore, Service level = 98 percent = 0.9800
Z = +2.05

ROP = 400*3 + 2.05 * 9 * √3 = 1200 + 31.96 = 1232 (approax.)

For ROP = 1245, calculate Z; Z = (1245 -1200)/(9 * √3 ) = +2.88

The corresponding probability = .9980 = 99.8% Thus, stock-out risk = 100 - 99.8 = 1.2%