Inventory and supply

management
Part 2
 Summary

1. Procurement policies
2. The dilemma
3. Economic order quantity (EOQ)
4. Discount and real cost
5. Exercise
6. Evaluation exercise
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2 1. Procurement policies
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4
5 Depending on their volume and their value, the different items will be handled in
6 different ways.
(Rule ABC, 80/20)

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2 1. Procurement policies
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5 Example, regular consumption:
6 Inventory
Inventory Quantity on hand, t0 Replenishment

Issue Quantity?
Issue

… Time
Time
When?
Delivery lead time

Demand increase Late delivery

/!\ Risks during the Consumption C’
Delivery
replenishment Forecast C due date
Safety
Time Time
Stock
Stock out Stock out
Time 4
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2 1. Procurement policies
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4
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2 variables: period and quantity 4 methods
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Fixed period Variable period

Fixed Automatic order system Fixed order quantity system

quantity = Order point method
Regular consumption + Cheap
Strong follow-up

Variable Periodic Review System Supply by variable dates and quantities

quantity (complement method)

Regular consumption, Strong follow-up

Expensive or perishable articles, or
grouped orders

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2 1. Procurement policies
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4 Fixed period Variable period
5Fixed Automatic order system Order point method
6quantity
T: work period
DL: delivery lead time
Order
point Q: quantity ordered
Time
Time

Need Safety stock Order point = DDLT + Safety Stock

DDLT = Demand During Lead Time = Q/T x DL
Variable Complement method Variable dates and quantities
quantity
Maximum stock limit
Mix of all methods!

In which cases ?
Time Only for items whose price varies greatly or for
not permanent needed products.
Need Safety stock
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1. Procurement policies
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5 /!\ Risks during the replenishment
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Demand increase

Order
Order point point Late delivery
Time
Time
Safety stock
Safety stock
Average consumption rate
Order point
Cover stock
safety stock
Ss = ΔC * DL + (Q / T) * ΔDL Safety stock

Ordering Delivery Time

date date

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2. The Dilemna
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5 The total cost of inventory management is :
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TC = AC + LC + CC
TC is the Total Cost
AC is Acquisition Cost (Unit Purchase Price x Quantity)
LC is Launching Cost (total of Ordering Costs)
and CC is Carrying Cost.

Carrying costs ↑ increase when we order big quantities of items

Ordering costs ↑ increase when we manage a big quantity of orders

The dilemna of the companies is :

“How to optimize Ordering and Carrying Costs at the same time ?”
Not too many items per order, not too many orders per year
How many items per order ?
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3. Economic order quantity (EOQ)
4
5 To answer this dilemma, an American production engineer has found the “EOQ”, in the
6 middle of XX’s :

• It determines the quantity of items to be purchased at one time

⇒ Store as little as possible, order as little as possible
• It works with the Order Point System (fixed quantity of items, variable period)
It’s calculated over a period, with a formula and ...
… very simplifying assumptions :
• Regular consumption over the period (No shortage possible)
• Constant carrying and ordering costs over the period
• Constant lead time
• Carrying costs proportional to the number of pieces purchased

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3. Economic order quantity (EOQ)
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5 • Total acquisition cost :
6
AC = Pu * N

Ss

• Total carrying cost ? Time

Q : Quantity supplied
CC = Average Stock * Pu * t
Ss : Safety Stock
CC Q + Ss ) x Pu x t
= ( ___
N : Total quantity consumed over the period
2
Pu : unit price
∑ stock management expenses
t : carrying rate = _________________________________
average value of period stock

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3. Economic order quantity (EOQ)
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5 • Total ordering cost ?
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Cost of launching 1 order :

∑ Purchasing and Receiving departments expenses

Co = _____________________________________________________
Total amount of ordering lines

∑ Scheduling department expenses + Set up expenses (Equipment assets, Tools, Salaries…)

Co = ___________________________________________________________________________________________
Total amount of work orders launched

=> Annual cost LC = Co x Total amount of ordering lines or work orders

= Co x ____ N Q: Quantity supplied

Co: ordering cost (cost of launching an order)
Q
N: Total quantity consumed over the period

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3. Economic order quantity (EOQ)
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Ss : Safety stock
5 Costs
6 CT : Total costs of Q: Quantity supplied
management
EOQ: economic order
(cumulated costs)
quantity
Pu: unit price
Lc: ordering cost or
launching cost per order
OC : Total t: carrying rate
Ordering cost Carrying cost
N: Total quantity consumed
over the period

Replenishment
EOQ quantity

Total cost of management

TC = OC + CC + AC = Lc * (N / Q) + (Ss + Q / 2) * t * Pu + Pu * N
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3. Economic order quantity (EOQ)
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5
Costs CT : Total costs of
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management
(cumulated costs)

OC : Total
Ordering cost Carrying cost

Replenishment
EOQ quantity

∂CT = 0
_____ => EOQ =
Lc WILSON FORMULA
∂Q
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4. Discount and real cost
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5
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Real unit cost = Total cost of management / N
= Pu + Lc / Q + (Ss + Q / 2). t. Pu / N

Discount: Deduction granted by the seller to the buyer. If Q increases, Pu

decreases.

⇒ What does the real cost of the product become ?

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5. Exercise
4
5 Example : • EOQ ?
6 • N = 200 000 units per year • Delivery Lead Time DL ?
• Pu = 10 €
• Total Cost of Management ?
• Lc = 150 €
• Real Unit Cost Ru ?
• t = 20%
• Ss = 0
Co
EOQ = = 5477 units
Pu
EOQ x 365 days
⇒ DL= _________________ = 10 => Order placed every 10 days
N

N EOQ
⇒ Total Cost = AC + OC + CC = N x Pu + _______ x Lc + _______ x Pu x t = 2 010 954 €
EOQ 2

⇒ Real Unit Cost Ru = Total Cost / N = 10,05 €

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5. Exercise
4 Discount Example
5 • N = 20 000 units per year
6 • Pu1 = 0,85 € if Q ≥ 4000 units Discount Qtity DQ = 4000 units
• Pu2 = 1 € if Q < 4000 units
• Lc = 50 €
• t = 20%
• Ss = 0
Lc
Q1 = Pu = 3430 units < 4000 : impossible => in this case Q = DQ
1

Lc
Q2 = Pu = 3162 units < 4000 : coherent => In this case EOQ = Q2
2

N Q2
Total Cost for EOQ: C2 = N x Pu2 + ____ x Lc + ____ x Pu2 x t = 20 632 € => Ru = 1,03 €
Q2 2
N DQ
Total Cost for DQ: DC = N x Pu1 + ___ x Lc + ____ x Pu1 x t = 17 590 € => Ru = 0,88 € 16
DQ 2
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5. Exercise
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6 Annual cost

Total cost

C2 >Cr
Discount cost Carrying cost

Replenishment quantity
Q2 = DQ with Pu = 0,85€
= EOQ with Pu = 1€

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6. Evaluation exercise
4
5 In the FROG company, we buy three similar parts:
6

Reference Annual consumption Unit price

4804 30375 10€

5203 9375 10€

2520 4050 12€

The ordering cost in the company is Co = 30 € per order

and the carrying rate t = 20%.

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6. Evaluation exercise
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1) Calculate the economic order quantities for each parts.
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2) After a standardization study, the 3 variants are reduced to a single reference,
consumption is unchanged. The unit price goes uniformly to 10 €.

What becomes the economic order quantity?

What is the gain made?
What is the real cost of the product:
- without safety stock?
- with a safety stock of 500 pieces?

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6. Evaluation exercise
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6 3) The supplier offers a 2% discount for purchases of 2,500 pieces. Is it interesting? (case
treated with safety stock of 500 pieces).

4) Bonus Question: Still in the case of a safety stock of 500 pieces and this 2% discount,
knowing that the year includes 219 working days, and that the delivery lead time is on
average 4 days, what is the maximum level of stock possible?
Specify the conditions for the occurrence of this maximum (demand, delivery lead
time…). Draw a chart to illustrate your hypothesis.

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