Inventory 02

Inventory Management
Production & Operations Management
INVENTORY MANAGEMENT
Economic Order Quantity
Prof. Ajith Kumar, XLRI Jamshedpur
XLRI, Jamshedpur Prof. Ajith Kumar

MANAGING INVENTORY
Objective: manage the level of inventory such that we
neither have too much to handle, nor too less to satisfy

demand.
HOW INVENTORY BEHAVES

• Rice in the kitchen
• Iron-ore in a steel plant
Inventory • Inputs to an assembly line
Level
• Items on shelves in a retail store
• Samosas in a canteen
• Newspapers at a roadside tall
Time
❖ CONSUMPTION
INVENTORY LEVEL
❖ REPLENISHMENT
XLRI, Jamshedpur Prof. Ajith Kumar 2
INVENTORY REPLENISHMENT
Two ways in which replenishment can happen

▪ Procure the item from an external supplier.
▪ Produce the item internally.
Two key decision points for replenishment

1. How much should be ordered (produced)?
2. When should it be ordered (produced)?

Two key decision points for replenishment

1. How much should be ordered (produced)?

Economic Order Quantity (EOQ) &
related models
2. When should it be ordered (produced)?
Demand During Lead Time (DDLT) &
related models

ECONOMIC ORDER QUANTITY (EOQ)

To estimate the optimal order quantity
1. Basic EOQ model.
2. EOQ with gradual replenishment.
3. EOQ with backordering.
❖ The “EOQ” computed using these models is a conceptual

value representing the optimal quantity to order.
❖ It is used for guiding decisions in real-life inventory control

applications.

1 BASIC EOQ MODEL

Assumptions
▪ Demand rate is a constant over time & known with certainty.
▪ Stock-out and back-ordering are not permitted. There are
no quantity discounts. Only holding and order (or set-up)
costs are relevant and both are known with certainty
(constants).
▪ Costs pertaining to a given SKU are independent of those of
other SKUs.
▪ Replenishment happens instantaneously (the entire order
quantity is added to the inventory at the same instant of
time).
▪ There is no constraint on the order quantity (lot size).
1 BASIC EOQ MODEL

Order Order Order Order

received received received received
On-hand inventory (OH) Q
Q/2
r
placed placed placed placed
Time (t)
L L L L
❖ Inventory decreases at a uniform rate (D) with time.

❖ A new order is placed when the inventory level falls to r. It takes time L to
arrive.
❖ When inventory reaches 0 it is instantly replenished with order quantity Q.
1 BASIC EOQ MODEL


received received received received
On-hand inventory (OH) Q
Q/2
r
Time (t)
L L L L
Maximum inventory level Qmax = Q.

Average inventory level Qavg = Q/2.

1 BASIC EOQ MODEL

Inventory Cost (C) as function of order quantity (Q)
TOTAL
HOLDING ORDER INVENTORY
Cost per unit time
Cost per unit time
Cost per unit time

COST COST COST
Lot Size (Q) Lot Size (Q) Q* Lot Size (Q)
𝑄 𝐷 𝐶=
𝑄
𝑐 +
𝐷
𝑐
𝐶𝐻 = 𝑐ℎ 𝐶𝑂 = 𝑐𝑜 2 ℎ 𝑄 𝑜
2 𝑄
co = order (or set-up) cost
ch = holding cost per unit
per order (or set-up).
per unit of time.
D = demand rate.

1 BASIC EOQ MODEL

𝑄 𝐷
Total inventory cost per unit time, 𝐶 = 𝑐 + 𝑐
2 ℎ 𝑄 𝑜
Which order quantity will minimize total inventory cost?
𝑑𝐶 𝑐ℎ 𝐷𝑐𝑜
Set =0 − 2 =0
𝑑𝑄 2 𝑄
𝟐𝑫𝒄𝒐
𝑸∗ =
𝒄𝒉
𝑸∗ is known as economic order quantity (EOQ).

1 BASIC EOQ MODEL

Optimal holding cost per unit time, 𝐷𝑐𝑜 𝑐ℎ

𝑄∗
𝐶𝐻∗ = 𝑐ℎ = 2
2
Optimal order cost per unit time, 𝐷𝑐𝑜 𝑐ℎ

𝐷
𝐶𝑂∗ = ∗ 𝑐𝑜 = 2
𝑄
Optimal total inventory cost per 2𝐷𝑐𝑜 𝑐ℎ

unit time, 𝐶 ∗ = 𝐶𝐻∗ + 𝐶𝑂∗ =
Time between consecutive orders,

𝑄∗ 2𝑐𝑜
𝑇∗ = =
𝐷 𝐷𝑐ℎ
also known as cycle time

1 Example 1
A retail store stocks and sells an SKU of soap that has a demand of
1225 units per month. The store values the soap at Rs. 9.6 per unit
and sells it for Rs. 12 per unit. The annual holding cost for a unit of
is taken to be 20% of its unit value. The cost of placing a new
order from an external supplier is Rs. 128. Assume that the SKUs
are independent of each other. The store currently orders 600
units every 15 days or so. If the store orders this SKU optimally,
by how much will it reduce its inventory costs?

1 Example 1
𝐷 = 1225 𝑢𝑛𝑖𝑡𝑠/𝑚𝑜𝑛𝑡ℎ
𝑅𝑠. 9.6 ∗ 0.2
𝑐ℎ = = 𝑅𝑠. 0.16 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑝𝑒𝑟 𝑚𝑜𝑛𝑡ℎ
12
Instead of acquiring from an external supplier, if
𝑐𝑜 = 𝑅𝑠. 128 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑜𝑟𝑑𝑒𝑟 we produced the item internally, 𝑐𝑜 can be taken
as the set-up cost.
2𝐷𝑐𝑜 2 ∗ 1225 ∗ 128 The retailer should order

𝑄∗ = = = 1400 this quantity each time.
𝑐ℎ 0.16
How frequently must the retailer place an order?

1400
Time between consecutive orders, = = 1.143 𝑚𝑜𝑛𝑡ℎ𝑠
1225
~ 34 days (5 weeks)
1 Example 1
𝐷𝑐𝑜 𝑐ℎ
Holding cost per month, 𝐶𝐻∗ = = Rs. 112
2
𝐷𝑐𝑜 𝑐ℎ
Order cost per month, 𝐶𝑂∗ = = Rs. 112
2
Total inventory cost per month, 𝐶 ∗ = 𝐶𝐻∗ + 𝐶𝑂∗ = 𝑹𝒔. 𝟐𝟐𝟒

1 Example 1
Currently, the retailer orders about 600 units each time.

What is its current total inventory cost per month?
𝑄
Holding cost per month, 𝐶𝐻 = 𝑐 = 𝑅𝑠. 48
2 ℎ
𝐷
Ordering cost per month, 𝐶𝑂 = 𝑐𝑜 = 𝑅𝑠. 261.33
𝑄
Total inventory cost per month, 𝐶 = 𝐶𝑂 + 𝐶𝐻 = 𝑹𝒔. 𝟑𝟎𝟗. 𝟑𝟑
Switching to the EOQ reduces total inventory cost from Rs.

309.33 to Rs. 224, a reduction of about 28.6%.

1 Reflections on the EOQ

𝟐𝑫𝒄𝒐
𝑸∗ =
𝒄𝒉
❖ When D ↑ or 𝑐𝑜 ↑, Q also ↑, implying that larger lots and

less frequent ordering (more stocking) is better.
❖ Low priced products, FMCG goods.
❖ When 𝑐ℎ ↑, Q ↓, implying that smaller lots and more

frequent ordering is better.
❖ Expensive products, consumer durables, jewellery.

1
30
CHANGE IN TOTAL INVENTORY COST AS A % OF THE OPTIMAL COST

250
Total inventory cost per month
25
200
20
150 Holding cost per

month
15
INVENTORY COSTS
100
Order cost per month 10
50
5
Sensitivity of change in C as
% of C*
C to changes 0 0
in Q
700 840 980 1120 1260 1400 1540 1680 1820 1960 2100
ORDER QUANTITY, Q

2 EOQ WITH GRADUAL REPLENISHMENT

Assumptions
▪ Stock-out and back-ordering are not permitted. There are
no quantity discounts. Only holding and ordering (or set-
up) costs are relevant and both are known with certainty
(constants).
other SKUs.
▪ Replenishment happens
Replenishment instantaneously
happens (the order
gradually (the entirequantity
order
quantity is added
is added to the
to the inventory
inventory at athe
over same
time instant
period andofnot
time). instantly).

inventory (OH)
Q
On-hand inventory (OH)
Qmax
Q max
QQmax /2
max/2
On-hand
R r
Time (t)
Time (t)
L L L L
❖ D = rate of demand (ongoing consumption).

❖ P = rate of replenishment (whenever it happens) , P > D.
❖ P – D = net rate of increase in inventory.
❖ (Q/P) = time over which the replenishment lasts.

inventory (OH)
Q
Qmax
Q max
QQmax /2
max/2
On-hand
R r
Time (t)
Time (t)
L L L L
𝑄
❖ Maximum inventory level = 𝑄𝑚𝑎𝑥 = ∗ 𝑃 − 𝐷 = 𝑄(𝑃 − 𝐷)/𝑃
𝑃
𝑄𝑚𝑎𝑥
❖ Average inventory level = 𝑄𝑎𝑣𝑔 = = 𝑄(𝑃 − 𝐷)Τ2𝑃
2


𝑄(𝑃−𝐷)
❖ Holding cost per unit time, 𝐶𝐻 = 𝑐ℎ
2𝑃
𝐷
❖ Order cost per unit time, 𝐶𝑂 = 𝑐
𝑄 𝑜
𝑄(𝑃−𝐷) 𝐷
❖ Total inventory cost per unit time, 𝐶 = 𝑐ℎ + 𝑐𝑜
2𝑃 𝑄
𝑑𝐶
To find the optimal order quantity, set =0
𝑑𝑄


∗
𝟐𝑫𝒄𝒐 𝑷
𝑸 = .
𝒄𝒉 𝑷−𝑫
Since P > D, the optimal
order quantity Q* is
greater than that of the
basic EOQ model with the
same D, 𝑐𝑜 and 𝑐ℎ .
In other words, gradual

replenishment means
larger order size &
hence, fewer orders.
𝟐𝑫𝒄𝒐 𝑷 − 𝑫
𝑸∗𝒎𝒂𝒙 ∗
= 𝑄 (𝑃 − 𝐷)Τ𝑃 = .
𝒄𝒉 𝑷
The maximum & average on-hand inventory levels reached are

less than their counterparts in the basic EOQ model.
In other words, gradual replenishment brings inventory

levels down.

∗
Q𝑄
inventory (OH)
𝑄 ∗ 𝑜𝑓 𝑡ℎ𝑒 𝑏𝑎𝑠𝑖𝑐 𝐸𝑂𝑄
Qmax
∗
𝑄𝑚𝑎𝑥
Qmax∗/2
𝑄𝑎𝑣𝑔
On-hand
R
r
Time (t)
Time (t)
L L L L
when P >> D, this model approaches the basic EOQ model.
when P → D, 𝑄 ∗ → ∞ but 𝑄𝑚𝑎𝑥

∗
→ 0 and the model approaches that of continuous flow with
zero waiting and no reordering. It becomes as if one large long-term order is placed.


𝑫𝒄𝒐 𝒄𝒉 𝑷−𝑫
Optimal holding cost per unit time, 𝐶𝐻∗ = 𝑄𝑎𝑣𝑔 𝑐ℎ = .
𝟐 𝑷
𝐷 𝐃𝐜𝐨 𝐜𝐡 𝐏−𝐃
Optimal order cost per unit time, 𝐶𝑂∗ = 𝑐 = .
𝑄∗ 𝑜 𝟐 𝐏
𝑷−𝑫
Optimal total inventory cost per unit time, 𝐶 ∗ = 𝟐𝑫𝒄𝒐 𝒄𝒉 .
𝑷
All the costs are lower than those in the basic EOQ model. When P >> D, the costs tend towards
those in the basic EOQ model but when P → D, they tend towards 0 as in a continuous flow
situation.
𝑄∗ 𝟐𝒄𝒐 𝑷
Time between consecutive orders, 𝑇 ∗ = = .
𝐷 𝑫𝒄𝒉 𝑷−𝑫
The optimal cycle time is more than that in the basic EOQ model. When P >> D, the cycle time
approaches that in the basic EOQ model but when P → D, it approaches ∞. It is as if one large
permanent order is placed.

2 Example 2
SKU 89-3 is produced at a steady rate of 180 units a month on

an ongoing basis by a vendor for a washing machine
manufacturer. Part Y, a component of SKU 89-3, is produced
internally by the vendor. Each unit of the SKU requires two
units of Y. The unit value of Y is an estimated Rs. 720.
After the order is received, Y is produced at a rate of 60 units a
day at a different work center from that of SKU 89-3. Producing
Y each time involves a changeover cost of Rs. 676. Currently, the
manager computes the EOQ of Y, produces that quantity and
then transfers the entire lot to the input buffer of SKU 89-3, for
the latter’s production. The vendor works 30 days a month,
and the annual holding cost is taken as 15% of the unit value.

2 Example 2
a) How many units of Part Y are currently produced?

b) How many times a year is Y produced?
c) What are the average and maximum inventory levels of
Y at SKU’s input buffer?
d) What are the inventory related costs?
There is a proposal to switch to a practice of transferring
the units of Y as and when they are produced, to SKU 89-
3’s input buffer, for consumption. How will that change
the values in a) – d) ?

2 Example 2
❖ D = 360 units/month
❖ co = Rs. 676 per unit order

Rs.720 ∗0.15
❖ ch = = Rs. 9 per unit per month
12
❖ P = 60 units/day = 1800 units/month

NOTE: This is the rate at which the quantity ordered
will be produced, whenever (and only whenever) it is
ordered for replenishment. This should not be taken to
mean that a production of 60 units takes place on an
ongoing basis, unlike the demand, which happens at the
given rate, D, on an ongoing basis.

2 Example 2
INVENTORY CURRENT PROPOSED

Change %
MEASURES (Basic EOQ) (EOQ- Gradual)
EOQ 232.55 260 11.80
N* (/ month) 1.55 1.38 –10.56
T* (months) 0.65 0.72 11.80
Max inventory 232.55 208 –10.56
Avg inventory 116.28 104 –10.56
Holding cost (/month) 1046.48 936 –10.56
Order cost (/month) 1046.48 936 –10.56
Total Inv cost (/month) 2092.96 1872 –10.56

3 EOQ WITH BACKORDERING

Assumptions
▪ There are no quantity discounts but back-ordering is
permitted. Holding, order (or set-up) and backordering
costs are involved and are known with certainty (constants).
other SKUs.
▪ Replenishment happens instantaneously (the entire order
quantity is added to the inventory at the same instant of
time).

Qmax
0 1–p p 1–p p 1–p p 1–p p

Backorders
r
Bmax
Time (t)
L L L L
❖ Order quantity = 𝑄 = 𝑄𝑚𝑎𝑥 + 𝐵𝑚𝑎𝑥

❖ p = proportion of time on-hand inventory = 0 and 1 – p, when it is > 0.

❖ p = proportion of time on-hand inventory = 0 (backorders exist)
❖ 1 – p, when on-hand inventory > 0.
❖ Maximum inventory level = 𝑄𝑚𝑎𝑥 = 𝑄(1 − 𝑝)

𝑄𝑚𝑎𝑥 𝑄
❖ Average inventory level = 𝑄𝑎𝑣𝑔 = . 1 − 𝑝 + 0. 𝑝 = (1 − 𝑝)2
2 2
❖ Maximum backorder level = 𝐵𝑚𝑎𝑥 = 𝑄𝑝

𝐵𝑚𝑎𝑥 𝑄
❖ Average backorder level = 𝐵𝑎𝑣𝑔 = .𝑝 + 0. 1 − 𝑝 = 𝑝2
2 2
𝑄 𝑄 2 𝐷
𝐶𝐻 = (1 − 𝑝)2 𝑐ℎ 𝐶𝐵 = 𝑝 𝑐𝑏 𝐶𝑂 = 𝑐𝑜
2 2 𝑄
𝑸 𝟐
𝑸 𝟐 𝑫
𝑪 = (𝟏 − 𝒑) 𝒄𝒉 + 𝒑 𝒄𝒃 + 𝒄𝒐
𝟐 𝟐 𝑸


To find the optimal order quantity and proportion p.

𝜕𝐶 𝜕𝐶
setting = 0 and = 0 gives two equations in Q and p:
𝜕𝑝 𝜕𝑄
𝑐ℎ Proportion of time that
− 1 − 𝑝 𝑐ℎ 𝑄 + 𝑝𝑐𝑏 𝑄 = 0 𝑝∗ = backordering happens
𝑐ℎ + 𝑐𝑏
1−𝑝 2 𝑝2 𝐷 2𝐷𝑐𝑜
𝑐ℎ + 𝑐𝑏 − 2 𝑐𝑜 = 0 𝑄∗ =
2 2 𝑄 (1 − 𝑝∗ )2 𝑐ℎ + 𝑝∗ 2 𝑐𝑏
Substituting p* in the formula for Q gives
∗
1 1 The holding cost and the
𝑄 = 2𝐷𝑐𝑜 . + backordering cost complement
𝑐ℎ 𝑐𝑏 each other


1 1
𝑄∗ = 2𝐷𝑐𝑜 . +
𝑐ℎ 𝑐𝑏
𝑸∗
2𝐷𝑐𝑜 𝑐ℎ 2𝐷𝑐𝑜 𝑐𝑏
𝑄∗ = . 1+ 𝑄∗ = . 1+
𝑐ℎ 𝑐𝑏 𝑐𝑏 𝑐ℎ


∗ ∗ ∗ 2𝐷𝑐𝑜 𝑐𝑏
𝑄𝑚𝑎𝑥 =𝑄 1−𝑝 = .
𝑐ℎ +𝑐𝑏 𝑐ℎ
∗ 2𝐷𝑐𝑜 𝑐ℎ
𝐵𝑚𝑎𝑥 = 𝑄 ∗ 𝑝∗ = .
𝑐ℎ +𝑐𝑏 𝑐𝑏
LOW HOLDING, HIGH BACKORDERING COSTS HIGH HOLDING, LOW BACKORDERING COSTS
❖ 𝑐𝑏 ≫ 𝑐ℎ . ❖ 𝑐ℎ ≫ 𝑐𝑏 .
∗
∗
❖ 𝑄𝑚𝑎𝑥 → 𝑄∗ → 2𝐷𝑐𝑜 Τ𝑐ℎ . ❖ 𝑄𝑚𝑎𝑥 → 0.
∗
❖ 𝐵𝑚𝑎𝑥 → 0.
∗
❖ 𝐵𝑚𝑎𝑥 → 𝑄∗ → 2𝐷𝑐𝑜 Τ𝑐𝑏 .
❖ …tends towards basic EOQ model ❖ …tends towards pure
having only holding and no backordering with no holding, but
backordering. analogous to basic EOQ model.
goods are low-valued and fast moving, goods are high-valued, slow moving,
FMCG, inexpensive electronic items and and/or highly customized or those that
so on. customers are willing to wait for.

❖ Optimal holding cost = 𝐶𝐻∗ =
𝐷𝑐𝑜 𝑐ℎ 𝑐𝑏 𝑐
𝑄∗
(1 ∗ 2
− 𝑝 ) 𝑐ℎ 𝐶𝐻∗ = . . 𝑏
2 2 (𝑐ℎ +𝑐𝑏 ) 𝑐ℎ +𝑐𝑏
❖ By similar substitution, the

𝐷𝑐𝑜 𝑐ℎ 𝑐𝑏 𝑐
optimal backordering cost, 𝐶𝐵∗ 𝐶𝐵∗ = . . ℎ
2 (𝑐ℎ +𝑐𝑏 ) 𝑐ℎ +𝑐𝑏
NOTE: 𝐶𝐻∗ + 𝐶𝐵∗ = 𝐶𝑂∗
𝐷𝑐𝑜 𝑐ℎ 𝑐𝑏
❖ And, the optimal order cost, 𝐶𝑂∗ 𝐶𝑂∗ = .
2 (𝑐ℎ +𝑐𝑏 )
❖ The optimal total inventory cost, 𝑐ℎ 𝑐𝑏

𝐶 ∗ = 𝐶𝐻∗ + 𝐶𝐵∗ + 𝐶𝑂∗
𝐶∗ = 2𝐷𝑐𝑜 .
(𝑐ℎ +𝑐𝑏 )
At the optimal solution, the order cost 𝐶𝑂∗ accounts for half of the total
inventory cost, 𝐶 ∗ . The other half is split between the holding cost, 𝐶𝐻∗ ,
and the backordering cost, 𝐶𝐵∗ in the ratio of 𝑐𝑏 : 𝑐ℎ .


❖ Optimal time between orders (cycle time) 2𝑐𝑜 1 1

= 𝑇∗ =
𝑄∗ 𝑇∗ = +
𝐷
𝐷 𝑐ℎ 𝑐𝑏
❖ 𝑇𝐵∗ = duration of time backordering happens

within an order cycle
𝑇 ∗ . 𝑝∗
Or, the maximum time that a customer needs to wait
after ordering, to receive the good.
❖ 𝑇𝐼∗ = duration of time inventory is on-hand

within an order cycle
𝑇 ∗ . (1 − 𝑝∗ )
Or, the maximum continuous time that the store can
fulfill an order when it arises, without asking the
customer to wait.

3 Example 3
In a remotely located small town, Mehta Electronics sells large
screen high definition TV sets. Apart from this shop, there is

only one shop that sometimes stocks the same items.
The TV sets valued at Rs. 1,20,000 each and sold at Rs. 1,56,000.
The annual holding cost is taken as 30% of the unit value.
The order cost is Rs. Rs. 7500 and the annual demand for the
item is estimated at 60 units.
Mehta electronics decides to follow the EOQ model. How much
should it order in a given replenishment cycle, and how many
times a year should it order? What are its total inventory costs?

3 Example 3
Since the town is remotely located, customers are accustomed to
wait for a while to get a product they want. Hence, Mehta is

exploring whether it can switch to a backordering model to
reduce its inventory costs.
Taking into account various options that customers have and the
maximum they might be willing to wait for this TV set, Mehta
assesses the backordering cost to be Rs. 12000 /unit / year.
If Mehta implements this idea, what will its optimal
backordering time proportion be? What will the maximum
backorder level be? By how much will the maximum on-hand
inventory reduce and what will the optimal inventory costs now
become? Finally, what is the maximum time that a customer
has to wait for the TV set?

3 Example 3
D 60 Basic with BO Change %
ch 36000 EOQ 5 10 100

co 7500 Qmax 5 2.5 –50
cb 12000 Bmax 0 7.5
p* 0.75 Qavg 2.5 0.3125 –87.5
1 - p* 0.25 Bavg 0 2.8125
1/(1-p*) 4 CH* 90000 11250 –87.5
CB* 0 33750
CO* 90000 45000 –50
C* 180000 90000 –50
T* (months) 1 2 100
T*i (months) 1 0.5 –50
T*b (months) 0 1.5

3 Example 3
D 60 Basic with BO Change %
Order quantity
doubles
ch 36000 EOQ 5 10 100
co 7500 Qmax 5 2.5 –50
cb 12000 Bmax 0 7.5
p* 0.75 Qavg 2.5 0.3125 –87.5
1 - p* 0.25 Bavg 0 2.8125
1/(1-p*) 4 CH* 90000 11250 –87.5
CB* 0 33750 C * = C * + C *
o H B
CO* 90000 45000 –50
Inventory
cost halves C* 180000 90000 –50
T* (months) 1 2 100
Maxm wait
time for T*i (months) 1 0.5 –50
customer
after ordering T*b (months) 0 1.5

Thank you

Inventory 02

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Inventory 02

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Inventory Management

Production & Operations Management

Prof. Ajith Kumar, XLRI Jamshedpur

XLRI, Jamshedpur Prof. Ajith Kumar

neither have too much to handle, nor too less to satisfy

HOW INVENTORY BEHAVES

Two ways in which replenishment can happen

Two key decision points for replenishment

XLRI, Jamshedpur Prof. Ajith Kumar 3

Two key decision points for replenishment

1. How much should be ordered (produced)?

XLRI, Jamshedpur Prof. Ajith Kumar 4

ECONOMIC ORDER QUANTITY (EOQ)

1. Basic EOQ model.

2. EOQ with gradual replenishment.

3. EOQ with backordering.

❖ The “EOQ” computed using these models is a conceptual

❖ It is used for guiding decisions in real-life inventory control

XLRI, Jamshedpur Prof. Ajith Kumar 5

1 BASIC EOQ MODEL

1 BASIC EOQ MODEL

Order Order Order Order

On-hand inventory (OH) Q

❖ Inventory decreases at a uniform rate (D) with time.

1 BASIC EOQ MODEL

Order Order Order Order

On-hand inventory (OH) Q

Maximum inventory level Qmax = Q.

XLRI, Jamshedpur Prof. Ajith Kumar 8

1 BASIC EOQ MODEL

Inventory Cost (C) as function of order quantity (Q)

Cost per unit time

Cost per unit time

Lot Size (Q) Lot Size (Q) Q* Lot Size (Q)

XLRI, Jamshedpur Prof. Ajith Kumar 9

1 BASIC EOQ MODEL

Which order quantity will minimize total inventory cost?

𝑸∗ is known as economic order quantity (EOQ).

XLRI, Jamshedpur Prof. Ajith Kumar 10

1 BASIC EOQ MODEL

Optimal holding cost per unit time, 𝐷𝑐𝑜 𝑐ℎ

Optimal order cost per unit time, 𝐷𝑐𝑜 𝑐ℎ

Optimal total inventory cost per 2𝐷𝑐𝑜 𝑐ℎ

Time between consecutive orders,

XLRI, Jamshedpur Prof. Ajith Kumar 11

XLRI, Jamshedpur Prof. Ajith Kumar 12

2𝐷𝑐𝑜 2 ∗ 1225 ∗ 128 The retailer should order

How frequently must the retailer place an order?

Total inventory cost per month, 𝐶 ∗ = 𝐶𝐻∗ + 𝐶𝑂∗ = 𝑹𝒔. 𝟐𝟐𝟒

XLRI, Jamshedpur Prof. Ajith Kumar 14

Currently, the retailer orders about 600 units each time.

Total inventory cost per month, 𝐶 = 𝐶𝑂 + 𝐶𝐻 = 𝑹𝒔. 𝟑𝟎𝟗. 𝟑𝟑

Switching to the EOQ reduces total inventory cost from Rs.

XLRI, Jamshedpur Prof. Ajith Kumar 15

1 Reflections on the EOQ

❖ When D ↑ or 𝑐𝑜 ↑, Q also ↑, implying that larger lots and

❖ When 𝑐ℎ ↑, Q ↓, implying that smaller lots and more

XLRI, Jamshedpur Prof. Ajith Kumar 16

CHANGE IN TOTAL INVENTORY COST AS A % OF THE OPTIMAL COST

150 Holding cost per

XLRI, Jamshedpur Prof. Ajith Kumar 17

2 EOQ WITH GRADUAL REPLENISHMENT

2 EOQ WITH GRADUAL REPLENISHMENT