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Dependent versus Independent Demand Inventory

Dependent demand = MRP system (transformation process of inputs/data into outputs/decision support

MRP system includes:

1) Master Production Schedule (MPS) – includes aggregate product plan, actual (firm) orders from
customers, and forecast of demand from other (potential) customers
2) Bill of Materials (BOM) – complete description of how a product should be made
3) Inventory Status File – provides data on how many units of items in the BOM currently exists as
cycle inventory, pipeline inventory, and safety stock inventory

Independent demand =
- fixed-order quantity model = Q system – or continuous review system or re-order point
- ”Q” stands for order size and can be selected at any quantity
- when the inventory reaches “R” (the reorder point), the system triggers an order of size
Q to be placed to vendors

- fixed-time period model = P system – or periodic review system

- “P” stands for the fixed time period between inventory counts
- “T” is the target level determined to allow for coverage of demand during P, the sum of:
o expected number of units demanded during the period P,
o expected number of units demanded during lead-time,
o expected number of units required for safety stock

Difference between two systems = lower safety stock requirements for Q System, as well as greater
monitoring efforts and costs required for Q System; P System used for C Items versus A Items

Assumptions for Q System:

- demand is constant and recurring and at a known rate
- lead time is constant and known, no stockouts are allowed
- items are ordered/produced in a lot or batch
- item is a single product
- fixed ordering or setup cost for order placed
- cost of carrying inventory is a linear function

How to compute Q for the fixed-order quantity model (Q System) =

Total Annual Cost (TC) of ordering Q units is a function of 3 components:

- Annual ordering cost
- Annual holding cost
- Annual product cost

TC = (SD/Q) + (iC Q)/2 + (CD)

D = Annual demand, expressed as a rate in units per year

S = Ordering or setup cost per order or setup, expressed in dollars per order or per setup
C = Unit Product cost, expressed in dollars per unit
H = Annual unit inventory holding cost, expressed in dollars per unit per year (H= iC)
i = Annual inventory holding “interest” rate, expressed in percent of dollar value per year
Q = Order quantity or lot size, expressed in units (the optimal order quantity or lot size is the EOQ
or ELS respectively)
TC = Total annual cost, expressed in dollars per year

EOQ (or ELS) = square root of (2DS/H) or (2DS/iC), D being the “annual demand” and S being the
“setup cost per order” and H being the “annual unit inventory holding cost”
Cycle Inventory = Q/2 = (Avg Inv/Cycle)

How to compute R in the fixed-order quantity model (Q System) =

Reorder Point = R = Dl + SS (Dl is expected demand during lead-time and SS is safety stock)

R(b) = Dl + z(ol) (Dl is expected demand during lead-time, z is # of standard deviations from the mean
needed to implement the cycle-service level, and ol is the standard deviation of Dl)

How to compute P and T in the fixed-time period model (P System) =

(don’t need to know formulas)

P = Q/Annual Demand (Q is typically EOQ or ELS)

T = D p+l + Z (o p+l)
T = D p+l + Safety Stock