Lec3 - PT 3

IU ISE506IU: INVENTORY CONTROL & MANAGEMENT I S E
Lot Sizing with

Time–varying Demand
Dao Vu Truong Son
Email: dvtson@hcmiu.edu.vn
1
Contents
• Characteristics
• Wagner – Whitin algorithm.
• Heuristic method:
• Silver – Meal algorithm
• Other heuristics
2
D
Q
T
• Infinite planning horizon
• Demand D is constant
 Highly impractical, D usually changes with time
 Production quantity changes with time
 inventory problems change with time

Characteristics
 Demand varies from period to period
 The demand for each period is exactly known
 Costs may vary from period to period
 Capacity may vary from period to period
4
Big versus Small Buckets

 Big time-bucket models
 Items produced/ordered in a period can be used to satisfy
the demand for that period
 Small time-bucket models

 Production/supply leadtimes can take multiple periods
5
Some Approaches
 Basic economic quantity (EOQ):
• Useful when the variation of demand is low.
 Optimal solution given by mathematical models:
• Wagner – Whitin algorithm.
 Heuristic (rule-based) method:
• Silver – Meal algorithm
• EOQ expressed as a time supply (POQ)
• Least unit cost (LUC)
• Part-Period Balancing (PPB)
6
Assumptions for the Basic Model
Demand varies from period to period but is exactly known for

each period.
Demand in each period must be satisfied during the same
period (backordering is not allowed).
There are no limits on how much can be produced or ordered.
Itemsproduced/ordered in a period are available to satisfy
demand during the same period (big bucket model).
Setup/ordering, production/purchasing, and inventory holding
costs can vary period to period.
7
Objective
Determine the optimal order quantity (lot size) in each

period so that the demand in each period is met while
the sum of ordering, purchasing, and inventory
holding costs are minimized.
8
Notation
• t: a period (e.g., day, week, month); t = 1, … ,T, where T represents the
planning horizon
• Dt: demand in period t (number of units)
• ct: unit purchasing/production cost
• At (or Co,t): ordering/setup cost associated with placing an order (or initiating
production) in period t
• ht (or Ch,t): cost of holding one unit of inventory from period t to period t +1
• Qt: the size of the order (or lot size) in period t; a decision variable
9
Example
10
The Lot for Lot Solution
Order to satisfy exactly as demand in 1 period??
11
The Lot for Lot Solution
12
The Fixed Order Quantity Solution
Combine order to satisfy demand in a few periods

In this example,
a. use Q1 = Q4 = Q7 = 100
b. Q1 = D1 + D2; Q3 = D3+D4; …Q9 = D9+D10
13
The Fixed Order Quantity Solution
14
The Fixed Order Period Solution
15
A Mixed Integer Linear

Program (MILP) Formulation
16
Solution Approach
Solve as a standard MILP (using for example a branch and
bound algorithm); several commercial MILP solver software tools
are available
Develop a customized solution that takes advantage of structural

properties specific to the problem (e.g., the Wagner-Whitin
algorithm)
17
Property 1
A replenishment takes place when the inventory level is zero
Property II
There is an upper limit to how far a period j we would
include its requirements D(j) in a replenishment quantity.
Eventually, the carrying costs become so high that it is less
expensive to have a replenishment arrive at the start of period
j than to include its requirements in a replenishment from
many periods earlier
18
The Basic Idea of the

Wagner-Whitin Algorithm
zk* : the total costs of the best replenishment strategy that
satisfies the demand requirements in periods 1,2,…k.
Using property 1, either Qt=0 or Qt=Dt+…+Dk for some k.
If jk*
= t = last period when we have place order exactly Dt+
Dt+1 …Dk in period jk*.
19
The Basic Idea of the

Wagner-Whitin Algorithm
Construct an algorithm where the decision is whether or not
to order in a given period. If we order, then the order quantity
should be just enough to cover demand until the next period
in which we order.
Solve a series of smaller sub-problems (a one period problem,

a two period, …., N period problem), where the solution to
each sub-problem is used in solving the next subproblem.
20
Example
21
Example
 Step 1: Obviously, just satisfy D1 (note we are neglecting
production cost, since it is fixed).
 Step 2: Two choices, either j2* = 1 or j2* = 2.
22
Example (Continued…)
 Step3: Three choices, j3* = 1, 2, 3.
23
 Step 4: Four choices, j4* = 1, 2, 3, 4.
24
 Step 5: Only two choices, j5* = 4, 5.
 Step 6: Three choices, j6* = 4, 5, 6.
And so on.
25
Example Solution
26
Example Solution
 Optimal Policy:
• Order in period 8 for 8, 9, 10 (40 + 20 + 30 = 90 units)
• Order in period 4 for 4, 5, 6, 7 (50 + 50 + 10 + 20 = 130
units)
• Order in period 1 for 1, 2, 3 (20 + 50 + 10 = 80 units)
 Note: we order in 7 for an 8 period problem, but this never

comes into play in optimal solution.
27
Disadvantages
 The algorithm is too complicated.
 Need a well – defined ending point.
 The replenishment quantities should not change.
 Replenishments can be made only in discrete interval
28
Assignment 1 (optional)
 Using any software (Matlab, Excel, Cplex) to get
optimal ordering policy
Assignment 2
 Find the optimum ordering policy using the following
data using Wagner-Whitin algorithm
Month Demand Setup cost Inv. Cost

1 80 60 2
2 60 40 2
3 40 60 1
4 70 45 2
Assignment 3
 Demand for a 12-month horizon is as follows: 400; 600;
1000; 800; 1200; 900; 800; 1000; 1200; 700; 600; 800.
 Inventory holding is 20% of unit prize C = $20.
 Ordering cost is $300 per time. Calculate total cost
 a. using lot-for-lot approach.
 b. Using fixed order quantity, 4 times a year.
 c. Using fixed order quantity, 2 times a year.
 d. Using Wagner-Whitin approach.
Heuristics
Instead of solving the problem optimally, we could use a
heuristic (a rule) that leads to reasonably good solutions but not
necessarily optimal.
The advantage of heuristics is ease of implementation and lower

computational effort to reach a solution.
32
Heuristics
Example
Choose a fixed order quantity and order in multiples of this
order quantity. Order again when demand in a period cannot be
met from available inventory.
Choose a fixed order period P. Then, every P periods order all

the demand for the next P periods.
 Use a greedy heuristic such as the Silver-Meal heuristic.

33
Heuristic approach
• Practice requires fast calculation  “good enough”

solutions are preferred
• Rolling forecasts are normal  no fixed periods for

integer and dynamic programming
 Simpler approaches are required: rule-based or

heuristics.
Other heuristic approaches

 The EOQ expressed as a Time Supply (POQ)
 The EOQ is determined by using the average demand D
 Determine the time supply of EOQ (rounded to the nearest integer)
 The order are placed to cover TEOQ periods.
35
Other heuristic approaches
 The Least Unit Cost (LUC):

• The same approach of Silver – Meal except the average cost per
unit is used instead of average cost in Silver – Meal approach.
 The Part – Period Balancing (PPB):
• Select the number of periods covered by the replenishment such
that the total carrying costs are made as close as possible to the
setup cost.
36
PPB
 Initial value of the trial lot size should be the same as the
initial net requirement
 Try to use order cost/holding cost as a economic part
period (EPP)
 Select the number of periods covered by the
replenishment such that the total carrying costs are made
as close as possible to the setup cost.
 Part periods = sum of products of inv. And number of
holding periods
 Setup cost $80

 Inv. Holding cost $2/unit/week
1 2 3 4 5 6 7
Demand 20 40 0 20 15 0 20
Order
Inv.
1. L4L total cost 5* $80 = $400.

 EOQ heuristics:
 Avg Demand = 115/7 = 16.43 units
 Q = Sqrt(2*16.43*80/2) = 36.3 units  use 37
1 2 3 4 5 6 7
Demand 20 40 0 20 15 0 20
Order 37 37 37 4
Inv 17 14 14 31 16 16 0
Use EOQ formula: TC = 36.3*$2/2 + 16.43*$80/36.3 = $72.5

Weekly  $72.5 x 7 = $507.5
1 2
PPB 3 4 5 6 7
Demand 20 40 0 20 15 0 20
 Per. Lot size Part periods

 1 20 20(0) = 0
 1,2 20+40=60
 2 40 40(0)=0
 2,3 40+0=40 40(0)+0(1)=0
 2,3,4 60
 4 20 20(0)=0
 4,5 35 20(0)+15(1)=15
 4,5,6 35 20(0)+15(1)+0(2)=15
 4,5,6,7 55
 7 20 20(0)=0
1 2 3 4 5 6 7
Demand 20 40 0 20 15 0 20
Order 20 40 35 20
Inv 0 0 0 15 0 0 0
Inv cost 0 0 0 30
Setup 80 80 80 80
cost
Total cost: $320 + $30 = $350

L4L cost: $400
EOQ cost: $507.5
The Silver-Meal Heuristic

This is a forward method that requires determining the
average cost per period as a function of number of periods
the current order to span.
𝐴 + ℎ𝑑2 + 2ℎ𝑑3 + ⋯ + 𝑗 − 1 ℎ𝑑𝑗
𝐶(𝑗) =
𝑗
A: fixed cost, h: holding cost, d: demand
Starting with a period t, order for the next k periods if the
resulting average cost per period zt,t+k is smaller than the
average cost per period if we ordered only for the next (k-
1) periods. 42
The Silver-Meal Algorithm

Step 1: start the calculation from period 1 to next period
C(1)=A;
C(2)=(A+hd2)/2;
C(3)=(A+hd2+2hd3)/3
…
Step 2: Stop the calculation when C(j)>C(j-1)
Step 3: set Q1=d1+…+dj-1
Step 4: Start over at period j, repeat step 1-3.
43
The Silver-Meal Algorithm

Step 6: If zt,t’ ≤ zt,t’-1 , set t’= t’+1 and go to step 4. Otherwise
go to step 7.
Step 7: Set Qt = Dt + Dt+1 + … + Dt’-1
Step 8: Set t=t’.
Step 9: If t > T, stop. Otherwise, go to step 2.
44
1 2 3 4 5 6 7
Demand 20 40 0 20 15 0 20
• C(1) = 80
• C(2) = (80 + 40*2)/2 = 160/2 = 80
• C(3) = (80 + 40*2 + 2*2*0)/3 = 53.33
• C(4) = (80 + 40*2 + 0 + 3*2*20)/4 = 70  stop
• Q1 = 20 + 40 + 0 = 60
• Start at period 4:
• C(1) = 80
• C(2) = (80 + 15*2)/2 = 55
• C(3) = (80 + 30 + 2*0)/3 = 36.67
• C(4) = (80 + 30 + 0 + 3*2*20)/4 = 55  stop
• Q2 = 20 + 15 = 35
• Q3 = 20
1 2 3 4 5 6 7
Demand 20 40 0 20 15 0 20
Order 60 35 20
Setup 80 80 80
cost
Inv. 40 0 0 15 0 0 0
Inv. cost 80 0 0 30
• Total cost: 240 + 80 + 30 = 350 Silver-Meal
• Remember, total cost: 350 PPB; 400 L4L; 507.5 EOQ

Least unit cost
• The LUC is to select the number of periods covered by

the replenishment order such that the total relevant cost
per unit demand is minimized.
• Minimize cost per unit demand
• C(j) = (A + hd2 + 2hd3 + … +(j-1)hdj)/(d1 + d2 +…+ dj)

LUC
• Step 1: Start the calculation from period 1 to next period
• C(1) = A/d1;
• C(2) = (A + hd2) / (d1+d2)
• C(3) = (A+hd2+2hd3)/(d1+d2+d3)
• Step 2: stop the calculation when C(j)>C(j-1)
• Step 3: set Q1 = d1+d2+..dj-1
• Step 4: Start over at period j, repeat step 1 - 3

LUC
1 2 3 4 5 6 7
Demand 20 40 0 20 15 0 20
• Starting in period 1:
• C(1) = 80/20=4
• C(2) = (80+2*40)/(20+40)=2.67
• C(3) = (80+2*40+0)/(20+40+0)=2.67
• C(4) = (80+80+3*2*20)/(20+40+20)=3.5  stop
• Q1 = 20 + 40 = 60
• Starting in period 4:
• C(1) = 80/20 = 4
• C(2) = (80+2*15)/(20+15) = 3.14
• C(3) = (80+30)/(35)=3.14
• C(4) = (80+30+3*2*20)/(20+15+20)=4.18  stop
• Q2 = 20+15 = 35
• Q3 = 20
1 2 3 4 5 6 7
Demand 20 40 0 20 15 0 20
Order 60 35 20
Setup 80 80 80
cost
Inv. 40 0 0 15 0 0 0
Inv. cost 80 0 0 30
• LUC, Silver-Meal, PPB give the same result for this case:
350 (it may not be true for other cases)
• EOQ: 507.5; L4L 400

Assignment (contd)
 Demand for a 12-month horizon is as follows: 400; 600;
1000; 800; 1200; 900; 800; 1000; 1200; 700; 600; 800.
 Inventory holding is 20% of unit prize C = $20.
 Ordering cost is $300 per time. Calculate total cost
 a. Using lot-for-lot approach.
 b. Using Wagner-Whitin approach.
 c. Using Silver Meal approach
 d. Using Part Period Balancing approach
 e. Using Least Unit Cost approach
A Network Representation
The lot sizing problem can be represented as a

network, where each node t represents a period
and an arc from node t’ to node t represents the
fact that we order (or produce) in both periods t’
and t but not in periods in between.
52
The Network
Node 6 is a pseudo node representing the “end” of the problem.

53
Example Path
Interpretation: Order (or produce) in periods 1, 3, and 4

so that Q1 = D1 + D2 ; Q2 = 0; Q3 = D3; Q4 = D4 + D5 ; and Q5 = 0
54
Arc Costs
The cost ct’,t of reaching node t from t’ is the cost of

ordering in t’ but not in t’+1, t’+2, …, t-1:
55
Key Insight
Finding the minimum cost solution is equivalent to

finding the least costly path (shortest path) in the
network to go from node 1 to node T+1, where T is
number of periods.
56
A Dynamic Programming Algorithm

to Find the Least Costly Path
Step 1: t = 1, zt* = 0
Step 2: t = t+1. If t > T+1, stop. Otherwise go to step 3.
Step 3: For all t’ = 1, 2, …, t - 1,
Step 4: Compute
57
A Dynamic Programming Algorithm

to Find the Least Costly Path (cont.)
Step 5: Compute
(that is, choose the period t’ that minimizes )
Step 6: Go to to step 2.
The optimal cost is given by
The optimal set of periods in which ordering/production takes

place can be obtained by backtracking from
58
Example
1 6
2 5
3 4
59
1 6
2 5
3 4
60
1 6
2 5
3 4
61
(Continued…)
1 6
2 5
3 4
62
1 6
2 5
3 4
63
1 6
2 5
3 4
64
1 6
2 5
3 4
65
1 6
2 5
3 4
66
1 6
2 5
3 4
67
Example
t Dt At ct ht
1 10 40 2 1
2 2 40 2 1
3 12 40 2 1
4 4 40 2 1
5 14 40 2 1
68
Example
z1*= 0
c1,2 = 40 + 20 = 60
z2*= z1*+ c1,2 = 0+60=60
p2*= 1
c1,3 = 40 + 24+2 = 66
c2,3 = 40 + 4 = 44
z3* = min (z1*+ c1,3, z2*+ c2,3) = min (66, 104) = 66
p3*= 1
69
Example
c1,4 = 114, c2,4 = 80, c3,4 = 64
z4* = min (z1*+ c1,4, z2*+ c2,4, z3*+ c3,4) = min (114, 140, 130) =114
p4*= 1
c1,5 = 134, c2,5 = 96, c3,4 = 76, c4,5 = 48,

z5* = min (134, 156, 142, 162) = 134
p5*= 1
c1,6 = 218, c2,6 = 166, c3,6= 132, c4,6 = 86, c5,6 = 68

z6* = min (218, 226, 198, 200, 202) = 198
p6*= 3
70

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IU ISE506IU: INVENTORY CONTROL & MANAGEMENT I S E

Lot Sizing with

• Wagner – Whitin algorithm.

• Silver – Meal algorithm

 Highly impractical, D usually changes with time

 Production quantity changes with time

 inventory problems change with time

 The demand for each period is exactly known

 Costs may vary from period to period

 Capacity may vary from period to period

Big versus Small Buckets

 Small time-bucket models

Assumptions for the Basic Model

Demand varies from period to period but is exactly known for

Determine the optimal order quantity (lot size) in each

The Lot for Lot Solution

Order to satisfy exactly as demand in 1 period??

The Lot for Lot Solution

The Fixed Order Quantity Solution

Combine order to satisfy demand in a few periods

The Fixed Order Quantity Solution

The Fixed Order Period Solution

A Mixed Integer Linear

Develop a customized solution that takes advantage of structural

The Basic Idea of the

Using property 1, either Qt=0 or Qt=Dt+…+Dk for some k.

The Basic Idea of the

Solve a series of smaller sub-problems (a one period problem,

 Step 2: Two choices, either j2* = 1 or j2* = 2.

 Step 6: Three choices, j6* = 4, 5, 6.

 Note: we order in 7 for an 8 period problem, but this never

Month Demand Setup cost Inv. Cost

The advantage of heuristics is ease of implementation and lower

Choose a fixed order period P. Then, every P periods order all

 Use a greedy heuristic such as the Silver-Meal heuristic.

• Practice requires fast calculation  “good enough”

• Rolling forecasts are normal  no fixed periods for

 Simpler approaches are required: rule-based or

Other heuristic approaches

 Determine the time supply of EOQ (rounded to the nearest integer)

 The order are placed to cover TEOQ periods.

Other heuristic approaches

 The Least Unit Cost (LUC):

 Setup cost $80

1. L4L total cost 5* $80 = $400.

Use EOQ formula: TC = 36.3*$2/2 + 16.43*$80/36.3 = $72.5

 Per. Lot size Part periods

Total cost: $320 + $30 = $350

The Silver-Meal Heuristic

The Silver-Meal Algorithm

Step 2: Stop the calculation when C(j)>C(j-1)

Step 3: set Q1=d1+…+dj-1

Step 4: Start over at period j, repeat step 1-3.

The Silver-Meal Algorithm

Step 7: Set Qt = Dt + Dt+1 + … + Dt’-1

Step 8: Set t=t’.

Step 9: If t > T, stop. Otherwise, go to step 2.

• Total cost: 240 + 80 + 30 = 350 Silver-Meal

• Remember, total cost: 350 PPB; 400 L4L; 507.5 EOQ

Least unit cost

• The LUC is to select the number of periods covered by

• Minimize cost per unit demand

Use EOQ formula: TC = 36.3$2/2 + 16.43$80/36.3 = $72.5