IE 375 — Production Planning Instructor Emre Nadar Unit 4 Notes 1. Unit 4 Goals Explore the methods for inventory control subject to known demand: — The basic economic order quantity (EOQ) model. — EOQ models with finite production rate. — Quantity discount models. 2. Inventory Management Types of inventories: Raw materials. These are the resources required for production Components/subassemblies. These correspond to items that have not yet reached completion in the production process. Work-in-process (WIP). This corresponds to inventory either waiting in the system for processing or being processed. WIP inventories include compo- nent inventories and may include some raw materials inventories as well # Finished goods/end items. These are the final products of the production process Motivation for holding inventories: # Economies of scale. « Uncertainties. # Speculation. Transportation Smoothing. Logistics. Control costs.Characteristics of inventory systems: Demand — Constant versus variable. — Deterministic versus stochastic. Lead time. Review time. — Continuous review versus periodic review. Excess demand. — Backordering, — Lost sales, — Partial backordering. Perishability /obsolescence. Relevant costs: © Holding cost. — Cost of providing the physical space to store the items. — Taxes and insurance. — Breakage, spoilage, deterioration, and obsolescence — Opportunity cost of alternative investment. © Order cost. — Fixed cost/setup cost. This is incurred independent of the size of the order. = Variable cost/proportional order cost. This is incurred on a per-unit basis. e Penalty cost (also known as shortage cost or stock-out cost)3. The EOQ Model The EOQ model is the simplest and most fundamental of all inventory models. It describes the important trade-off between fixed order costs and holding costs, and is the basis for the analysis of more complex systems. Assumptions: The demand rate is known and is a constant \ units per unit time. (We assume that the unit of time is a year.) # Shortages are not allowed. # There is no order lead time. (We will relax this assumption later.) # The costs include: — Setup cost at K per positive order placed — Proportional order cost at c per unit ordered. — Holding cost at h per unit held per unit time # Let Q be the size of the order. The objective is to choose to minimize the average cost per unit time. We will formulate the average annual cost G((Q) as a function of Q: ORDER COST PER UNIT TIME = KrsQ HOLDING COST PER UNIT TIME = 48 _~k+eQ,hQ _ K+ hQ _ KA hQ 6@ = AS + = a +t = Dire + oy 70, for Q>0. heb, Gla) =CYCLE LENGTH = T = Investory (it) —e- Slope = -A SS |-_—_— ; —+| Time t —> Figure 1: Inventory levels for the EOQ mode. | 600 = 500 g oS 400 300 GQ) ha 200 2 100 KA 0 Q 5 10 15 20 25 30 @ a— Figure 2: The average annual cost functionEXAMPLE: Pencils at the campus bookstore are sold at a constant rate of 60 per week. The pencils cost the bookstore 2 cents each and sell for 15 cents each. It costs the bookstore $12 to initiate an order and holding costs are based on an annual interest rate of 25 percent. Determine the optimal number of pencils for the bookstore to purchase and the time between placement of orders. What are the yearly holding and setup costs for this item? K=12, A=60x52 = 3120, h=Te = (025X002) = 0.005 3870 = Fao = LA geass We now relax the assumption of zero lead time. Suppose that the pencils must be ordered four months in advance. Ly evonhs = 0.3333 year => RK = (03333) = (3120) (03333) = 1OL0 1.24 years ——e Order placed f Order arrivesEXAMPLE: Consider an item with an EOQ of 25, a demand rate of 500 units per year, and a lead time of six weeks. = BE = 005 yor = 26 wwels > f-u3 > 03) axle in advance fo COB I005) + 0.0195 year = 31 => R = (0.0155)(500) w Order placed — Order arrives t 2.31 eycles = .1154 year t We next examine how sensitive the annual cost function is to errors in the calcu- lation of Q: KA, b@ 7 GQ) . “a7 2 1 f20', @fe*_- W, a Cc fkyh = 2Q Vb © 2 V2KX 2Q ° 2G"4. EOQ Models with Finite Production Rate We now assume that items are procured at a rate P during a production run. We require that P > 2 for feasibility. NOTE : “TOTAL PRODUCTION/ CYCLE “TOTAL CONSUMPTION / CYCLE Q = PT, AT " Note: H ~ p_y5. Quantity Discount Models EXAMPLE: A trash bag company has the following price schedule for its large trash can liners: 0.30Q if 0< Q < 500, C(Q) = § 0.29Q if 500< Q < 1000, 0.28Q if 1000< Q. The discount schedule is|all-units| because the discount is applied to all of the units in the order. Assume that \ = 600, K = 8, and h = Ic; where I = 20%. GQ = As rege te@ pe jeoia, Q= J2KA" _ |.2.(8)(600) = 400 Tey (0.20.30) Q = [2X = [21800 _ 1 Te (0.10.29 = [2 - [2 taleoo! _ 1, 2 VIg 0.20.29) 8GIs || | = 230 zg g 220 GolQ) | Gy) | 210 GQ) 200 190 180, 100 200 300 400 ae 600 700 800 900 1,000 1,100 1,200 e— GQ) ={ GQ) if 500¢Q< 4000 Gia if 4000 a= 702 10Ga) — SLSERRLS: SBgo—NoaaoNeos 300, [ot eye Seeger eee sen quemery ery oer | ree [oem 100 200 300 400 500 600 700 800 900 1,000 1,100 1,200 | o— Q, AND Q, ARE REALIZABLE: COMPARE GQ) £ GQ) G,(400) = 4204.00 Q*=400. Summary of the solution technique for 1. Determine an algebraic expression for C'((Q) corresponding to each price 6519) = $204.58 incremental} discounts: interval. Use it to determine an algebraic expression for C(Q)/Q. 2. Substitute the expressions derived for C'(Q), for G(Q). Compute the minimum value of @ corresponding to each price interval separately. 3. Determine which minima computed in (2) are realizable. Compare the values of the average annual costs at the realizable EOQ values and pick the lowest. u /Q into the defining equation