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Module 3: Deterministic Inventory Models

Lecture 3.6: Coordination of multiple items

IEE 534: Supply Chain Modeling & Analysis

Prof. Esma S. Gel

Objectives
• By the end of this lecture, you will be prepared to:
• Calculate ordering quantities for a number of items that may
benefit from some level of coordination in ordering and
shipments

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Recall…
• So far, we have covered several different EOQ
extensions
• Positive lead times
• Finite production rate (EPL) model
• Quantity discounts
• Planned shortages
• Constrained multi-item EOQ models

Coordination of Orders of Multiple-items

• We know that in settings with multiple items, the EOQ
values must be optimal with respect to optimizing the
holding and setup costs if “interactions” do not exist
• In the previous lecture, we covered interactions due to
a shared resource like budget or warehouse space
• Another type of interaction may be due to the costs
incurred when ordering multiple items
• Items included in the same order may share a fixed
cost of ordering
• There may be savings in transportation/shipment costs
• Etc.

Advantages and Disadvantages of

Coordination
• Advantages:
• Savings on unit purchase costs
• Savings on unit transportation costs
• Savings on fixed ordering costs
• Ease of scheduling

• Disadvantages:
• A possible increase in the average inventory level
• An increase in system control costs
• Reduced flexibility

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Coordination of Multiple Items

• In the following example, let’s compare
• Ordering independently
• Ordering in one common order
• Ordering jointly but with different frequencies
• Example:
• Note that the fixed order cost is consists of two components.

Item 1 Item 2 Item 3

Unit Purchasing Cost ($/unit) 125 200 250
Fixed Order Cost ($/order) 125
Incremental Order Cost ($/order) 75 75 75
Total Fixed Cost ($/order) 200 200 200
Annual Demand Rate (units/year) 100 1000 200
APR for Holding Cost ($/$/year) 20% 20% 20%

Example: Ordering Separately

When ordering separately, we can use the EOQ of each
product to get the following (omitting the purchase costs):

Case 1: Independent Ordering Item 1 Item 2 Item 3

Ordering Quantity, Q 40 100 40
Ordering Frequency, D/Q 2.5 10 5
Average Inventory, Q/2 20 50 20
Total Annual Cost (not including cD ) $ 1,000.00 $ 4,000.00 $ 2,000.00
TOTAL INVENTORY COSTS $ 7,000.00

Example: Joint Orders Alternative 1

If all orders are to be placed when Item 1 is normally
ordered:

Case 2: Order when Item 1 is ordered Item 1 Item 2 Item 3

Ordering Quantity, Q 40 400 80
Ordering Frequency, D/Q 2.5 2.5 2.5
Average Inventory, Q/2 20 200 40
Total Annual Cost (not including cD ) $ 1,000.00 $ 8,187.50 $ 2,187.50
TOTAL INVENTORY COSTS $ 11,375.00

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Example: Joint Orders Alternative 2

If all orders are to be placed when Item 2 is normally
ordered:

Case 3: Order when Item 2 is ordered Item 1 Item 2 Item 3

Ordering Quantity, Q 10 100 20
Ordering Frequency, D/Q 10 10 10
Average Inventory, Q/2 5 50 10
Total Annual Cost (not including cD ) $ 875.00 $ 4,000.00 $ 1,250.00
TOTAL INVENTORY COSTS $ 6,125.00

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Example: Joint Orders Alternative 3

If all orders are to be placed when Item 3 is normally
ordered:

Case 4: Order when Item 3 is ordered Item 1 Item 2 Item 3

Ordering Quantity, Q 20 200 40
Ordering Frequency, D/Q 5 5 5
Average Inventory, Q/2 10 100 20
Total Annual Cost (not including cD) $ 625.00 $ 4,375.00 $ 2,000.00
TOTAL INVENTORY COSTS $ 7,000.00

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Example: Optimal Joint Ordering of Items

What is the optimal reorder interval if we wanted to order all
three items at the same time ?
• i.e., 100% coordination of orders

Inventory
Q1

Q2

Q3

time
T 2T 3T 4T

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Example: Optimal Joint Ordering of Items

• Costs: Suppose that the same costs apply with the
exception that the fixed order cost consists of two
components

• The total annual cost can be written as

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Example: Optimal Joint Ordering of Items

• Since

we have

• Then we can write the total annual cost as a function of

only Q 1

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Example: Optimal Joint Ordering of Items

• Then, can be calculated as

• The other ordering quantities can be calculated from

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Example: Optimal Joint Ordering of Items

Case 6: Full Coordination Item 1 Item 2 Item 3

Ordering Quantity, Q 12 120 24
Ordering Frequency, D/Q 8.33 8.33 8.33
Average Inventory, Q/2 6 60 12
Total Annual Cost (not including cD) $1,816.67 $3,025.00 $1,225.00
TOTAL INVENTORY COSTS $ 6,066.67

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Joint Ordering with Power-of-Two Policy

• How about using a power-of-two policy?
• i.e., there is some coordination of replenishments, but probably
not 100%.
Inventory
Some
Q4 chosen base
period
Q1

Q2

Q3

time
B 2B 3B 4B

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EOQ Model: Power-of-Two Policies

• What if we use an order size slightly different from Q *

or a reorder interval slightly different from T * ?

• If the optimal T * is not convenient, (e.g., T *=2.37 weeks),
how much do we lose by choosing a slightly different interval
(e.g., T = 2 wks) ?
• Power-of-Two Policies restrict the reorder interval to

where is the smallest possible reorder interval, or

base period.
• For example, if is a week, the power-of-two family of
policies restricts to ordering once per week, once every two
weeks, once every four weeks, etc.

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Finding the Optimal Power-of-Two Policy

• Goal: Find the best power-of-two policy and determine
how far from optimal it is.
• The total cost per unit time for ordering interval T is equal to
(omitting purchasing costs)

• Let Then,

• The optimal reorder interval can now be written as

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Finding the Optimal Power-of-Two Policy

• Recall the Campus Bookstore
Example
• The EOQ=3870 pencils
• Time between orders,
T=64.5 weeks
• Suppose that a base period
is one week
• Then the Po2 policy
restricts order intervals to
1, 2, 4, 8, 16, 32, 64, 128, 256,
512, … weeks
• In this case, it is clear that
26=64 is the Po2 interval 64.5 wks
that is closest to optimal….
32 wks 128 wks
256 wks
64 wks

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Finding the Optimal Power-of-Two Policy

• Let denote the ordering interval of the optimal
power-of-two policy. We know that

• Since is convex, optimal k is the smallest integer

satisfying

or equivalently,

which implies that

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Finding the Optimal Power-of-Two Policy

• Since optimal k is the smallest integer that satisfies
the above equation, it should be that

• These two statements imply:

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Finding the Optimal Power-of-Two Policy

• Notice that

• Since is convex, we have:

or

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Finding the Optimal Power-of-Two Policy

• Average setup and inventory holding costs per unit time
for the best power of two policy are guaranteed to be
within 6% of total costs per unit time for the optimal
policy
• The optimal power of two ordering interval is equal to

where

• In general, break “ties” by rounding down.

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Power-of-Two Policies: Application Areas

• Power-of-two policies are particularly useful when we
have multiple products.
• Items ordered at 2 n week intervals will be placed at the
same time orders are placed for items ordered at 2 k week
intervals, for all k < n
• See Jackson, Maxwell and Muckstadt, The joint replenishment
problem with a Powers-of-two restriction, IIE Transactions, Vol.
17, No. 1, March 1985.

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Power-of-Two Policies: Application Areas

• Facilitates
• Sharing of trucks
• Consolidation of ordering efforts
• Simplification of shipping schedules
• Coordination of shipments from a single warehouse to multiple
retailers

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Example: Joint Ordering with Power-of-Two

Policy
Coming back to our example and calculating the power-
of-two ordering intervals, we get

Case 5: Power of Two Policy Item 1 Item 2 Item 3

EOQ Ordering Quantity, Q* 40 100 40

EOQ Reorder interval, T*=Q/D 0.4 0.1 0.2

Base Period, B - week (yr) 1/52

log2(T*/B ) 4.38 2.38 3.38

k * = closest integer to log2(T*/B ) 4 2 3

Po2 reorder Interval, T 2 * 0.31 0.08 0.15

Po2 Order Quantity, Q 2 * 31 77 31

Average Inventory, Q 2 */2 15.4 38.5 15.4

Setup and Holding Costs for 16 weeks $ 1,853.40

Total Annual Cost (not including cD ) $ 6,023.56

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Performance of Various Options

• Let’s compare the costs of various options
Option Annual cost
Ordering independently, with the optimal EOQ values $7000
Ordering with optimal ordering interval of item 1 $11,375

Ordering with optimal ordering interval of item 2 $6,125

Ordering with optimal ordering interval of item 3 $7,000
Power of two policy $6,023
Full coordination of items $6,067

• In this case, the optimal full coordination is more costly

than the Po2 policy. WHY?

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Time to reflect…

This Photo by Unknown Author is licensed under CC BY-SA-NC

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