EOQ for constant Demand & LeadTime

IP

On-hand inventory

IP
Order
received

Order
received

Order
received

Order
received

Q
OH

OH

IP

Q
OH

R
Order
placed

Order
placed
L

TBO

Order
placed
L

TBO

Time

TBO
12 1

Impact of lead time and uncertainty in

demand

Lead time has NO impact if the demand

is deterministic and at a constant rate.
Uncertainty in the demand creates the
need for safety stock
Lead time under uncertain demand
requires even a larger safety stock!

12 2

EOQ for Uncertain Demand and

Constant Lead Time

On-hand inventory

IP

IP

Order
received

Order
received

Order
received

Order
received
Q

Q
OH

L
TBO1

Order
placed

Order
placed

Order
placed

L
TBO2

Time

TBO3
12 3

Choosing an Appropriate Service-Level

Policy
Service level (Cycle-service level): The desired
probability of not running out of stock in any one
ordering cycle, which begins at the time an order is
placed and ends when it arrives.
Protection interval: The period over which safety
stock must protect the user from running out (in
this case, it will be the leadtime period).
Reorder point (R) = DL + Safety stock (SS)

z L

Safety stock (SS) =

z=

The number of standard deviations needed for a

given cycle-service level.

L=Standard deviation of the demand during lead time

DL =The average demand during the lead time period

12 4

Finding Safety Stock

With a normal Probability Distribution

for an 85% Cycle-Service Level

Cycle-service level = 85%

Probability of stockout
(1.0 0.85 = 0.15)

Average
Average
demand
demand
(D)
during
during
lead
lead time
time

R
z L
12 5

Finding Safety Stock and R

Records show that the demand for dishwasher
detergent during the lead time is normally
distributed, with an average of 250 boxes and L =
22. What safety stock should be carried for a 99
percent cycle-service level? What is R?
Safety stock (SS)

Reorder point

= z L
= 2.33(22) = 51.3
= 51 boxes
= DL + SS
= 250 + 51
= 301 boxes

2.33 is the number of standard

deviations, z, to the right of
average demand during the
lead time that places 99% of
the area under the curve to the
left of that point.

12 6

In Class Example
Suppose that the demand for an item
during the lead time period is normally
distributed with and an average of 85 and a
standard deviation of 40.
Find the safety stock and reorder point for
a service level of 95%
How much reduction is safety stock will
result if the desired service level is reduced
to 85%

12 7

Development of Demand
Distributions for the Lead Time
t = 15

+
75
Demand for week 1

t = 15

t = 15

+
75
Demand for week 2

75
Demand for week 3

t = 26

225
Demand for 3-week lead time

12 8

Continuous Review Systems

Selecting the reorder point with variable demand
and constant lead time
Reorder point

= Average demand during lead time

+ Safety stock
= dL + safety stock

Where
d = average demand per week (or day or months)
L = constant lead time in weeks (or days or months)

12 9

Demand During Lead Time

Specify mean and standard deviation
Standard deviation of demand during lead time
dLT =

d2L = d

Safety stock and reorder point

Safety stock = zdLT
where
z=
number of standard deviations needed to
achieve the cycle-service level
dLT = stand deviation of demand during lead time

Reorder point R = dL + safety stock

12 10

Continuous Review Systems

General Cost Equation
Calculating total systems costs
Total cost = Annual cycle inventory holding cost
+ Annual ordering cost
+ Annual safety stock holding cost
Q
D
C = 2 (H) +
(S) + (H) (Safety stock)
Q

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Finding Safety Stock and R

Suppose that the average demand for bird feeders is 18 units per
week with a standard deviation of 5 units. The lead time is
constant at 2 weeks. Determine the safety stock and reorder point
for a 90 percent cycle-service level. What is the total cost of the Q
system? (t = 1 week; d = 18 units per week; L = 2 weeks)
Demand distribution for lead time must be developed:

L = t

L =5

= 7.1

Safety stock = z L = 1.28(7.1) = 9.1 or 9 units

Reorder point = dL + safety stock = 2(18) + 9 = 45 units
75
936
C=
($15) +
($45) + 9($15)
2
75
C = $562.50 + $561.60 + $135 = $1259.10
12 12

Class Example:
The following info is available for the purchase of
kitty litter:

Demand: 100 bags/week with a standard deviation of

10 bags/week (assume 50 weeks/year)
Price: $10/bag
Ordering costs: $100/order
Annual Holding Costs: 10% of price
Desired service level: 99%
Lead time: 4 weeks
What is the Order Quantity and the Reorder Point
that assures this service level while minimizing
inventory costs. What is the minimum inventory
costs?
12 13

Reorder Point for Variable Demand and

Lead Time
Often the case that both are variable
The equations are more complicated
Safety stock = zdLT
R=
(Average weekly demand Average lead time)
+ Safety stock
= dL + Safety stock
where
dLT =

Ld2 + d2LT2

12 14

Solved Problem
Grey Wolf Lodge is a popular 500-room hotel in the North
Woods. Managers need to keep close tabs on all room service
items, including a special pine-scented bar soap. The daily
demand for the soap is 275 bars, with a standard deviation of
30 bars. Ordering cost is $10 and the inventory holding cost is
$0.30/bar/year. The lead time from the supplier is 5 days, with a
standard deviation of 1 day. The lodge is open 365 days a year.
a. What is the economic order quantity for the bar of soap?
b. What should the reorder point be for the bar of soap if
management wants to have a 99 percent cycle-service level?
c. What is the total annual cost for the bar of soap, assuming a
Q system will be used?

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Solved Problem
SOLUTION
a. We have D = (275)(365) = 100,375 bars of soap; S = $10; and
H = $0.30. The EOQ for the bar of soap is

EOQ =

2DS
=
H
=

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

2(100,375)($10)
$0.30
6,691,666.7 = 2,586.83 or 2,587 bars

Solved Problem
b. We have d = 275 bars/day, d = 30 bars, L = 5 days,
and LT = 1 day.
dLT =

Ld2 +(5)(30)
d2LT2 2 =+ (275)2(1)2 = 283.06 bars

Consult the body of the Normal Distribution appendix for

0.9900. The closest value is 0.9901, which corresponds to
a z value of 2.33. We calculate the safety stock and reorder
point as follows:
Safety stock = zdLT = (2.33)(283.06) = 659.53 or 660 bars
Reorder point = dL + Safety stock = (275)(5) + 660 = 2,035 bars

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Solved Problem
c. The total annual cost for the Q system is
Q
D
C = 2 (H) + Q (S) + (H)(Safety stock)
2,587
100,375
C=
2 ($0.30) + 2,587 ($10) + ($0.30)(660) = $974.05

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Periodic Review System (P)

Fixed interval reorder system or periodic reorder
system
Four of the original EOQ assumptions maintained

No constraints are placed on lot size

Holding and ordering costs

Independent demand

Lead times are certain

Order is placed to bring the inventory position up

to the target inventory level, T, when the
predetermined time, P, has elapsed

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Periodic Review System (P)

On-hand inventory

IP
Q1

IP

Order
received
OH

Order
received

Q2

IP
Q3

Order
received

OH

IP1
IP3

Order
placed

Order
placed

IP2

L
P
Protection interval

Figure 12.10 P System When Demand Is Uncertain

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

L
P

Time

How Much to Order in a P System

EXAMPLE
A distribution center has a backorder (BO) for five 36-inch color
TV sets. No inventory is currently on hand (OH), and now is the
time to review. How many should be reordered if T = 400 and no
receipts are scheduled (SR)?
SOLUTION

IP = OH + SR BO
= 0 + 0 5 = 5 sets
T IP = 400 (5) = 405 sets

That is, 405 sets must be ordered to bring the inventory

position up to T sets.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Periodic Review System

Selecting the period of time between
reviews (P)
The order-up-to level (T) when demand is
variable and lead time is constant will be
equal to the average demand during the
protection period (P+L) + Safety Stock
T = d(P + L) + safety stock for protection interval
Safety stock = zP + L , where P + L = d P L

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Finding Safety Stock and R

Continuous Review Model Example
Suppose that the average demand for bird feeders is 18 units per
week with a standard deviation of 5 units. The lead time is
constant at 2 weeks. Determine the safety stock and reorder point
for a 90 percent cycle-service level. What is the total cost of the Q
system? (t = 1 week; d = 18 units per week; L = 2 weeks)
Demand distribution for lead time must be developed:

L = t

L =5

= 7.1

Safety stock = z L = 1.28(7.1) = 9.1 or 9 units

Reorder point = dL + safety stock = 2(18) + 9 = 45 units
75
936
C=
($15) +
($45) + 9($15)
2
75
C = $562.50 + $561.60 + $135 = $1259.10

Calculating P and T

What is the equivalent P system to the bird feeder example?

Recall that demand for the bird feeder is normally distributed
with a mean of 18 units per week and a standard deviation in
weekly demand of 5 units. The lead time is 2 weeks, and the
business operates 52 weeks per year. The Q system calls for an
EOQ of 75 units and a safety stock of 9 units for a cycle-service
level of 90 percent.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Calculating P and T
SOLUTION
We first define D and then P. Here, P is the time between
reviews, expressed in weeks because the data are expressed
as demand per week:
D = (18 units/week)(52 weeks/year) = 936 units
EOQ
75
(52) = 4.2 or 4 weeks
P=
(52) =
D
936
With d = 18 units per week, an alternative approach is to
calculate P by dividing the EOQ by d to get 75/18 = 4.2 or 4
weeks. Either way, we would review the bird feeder inventory
every 4 weeks.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Calculating P and T
We now find the standard deviation of demand over the
protection interval (P + L) = 6:

P L d P L 5 6 12.25units
Before calculating T, we also need a z value. For a 90 percent
cycle-service level z = 1.28. The safety stock becomes
Safety stock = zP + L = 1.28(12.25) = 15.68 or 16 units
We now solve for T:
T = Average demand during the protection interval + Safety stock
= d(P + L) + safety stock
= (18 units/week)(6 weeks) + 16 units = 124 units

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Periodic Review System

Use simulation when both demand and lead time are variable
Total costs for the P system are the sum of the same three cost elements
as in the Q system
Order quantity and safety stock are calculated differently

C = (18 units/week)*(4 weeks)/2*(15) + 936/(18*4)*(45) + (15)*1.28*(12.25)

C = 36*15 + 13*45 + 15*16
= $1,365
dP = 540+585+240
D

C=

2 (H) + dP (S) + HzP + L

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

In Class Example
Discount Appliance Store has the following information:

520

Demand = 10 units/wk (assume 52 weeks per year) =

EOQ = 62 units (with reorder point system)
Lead time (L) = 3 weeks
Standard deviation in weekly demand = 8 units
Cycle-service level of 70% (z = 0.525 )

Choose the Reorder interval P such as this system is

approximates the EOQ model.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Comparative Advantages
Primary advantages of P systems
Convenient
Orders
Only

can be combined

need to know IP when review is made

Primary advantages of Q systems

Review
Fixed

frequency may be individualized

lot sizes can result in quantity discounts

Lower

safety stocks

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Single Period Model

Assume that you want to have a certain
level of confidence that you wont run out
of stock and that the demand follows a
normal distribution, then the inventory
level you should carry will be equal to:
Q = D + z

Example
So if the demand for newspapers on
Mondays is normally distributed with a
mean of 90 and standard deviation of 10,
and the newsboy wants to be 80% certain
that he/she will not run out of papers, then
the number of papers he/she should order
will be equal to:
Q = D + z
Q = 90 + .84 * 10 = 98.4 = 99 papers

And to make it even more

interesting
If we have the following cost data:
Cost per unit of overestimating demand
Cost per unit of underestimating demand
Then:
Probability of stockouts <= Cu / (Cu + Co)

Example continued
If we assume that the newspaper boy pays
20 cents per paper and he sells it for 50
cents. How many newspapers should he
order if the demand is normally distributed
with a mean of 90 and standard deviation of
10?
Cost of underestimating (Lost sales)= .5 - .2 = .3
Cost of overestimation (stock piling) = .2
Probability of stock outs <= .3/(.2+.3) <= .6 <= 60%
Z = .253
Q = 90 + .253 * 10 = 92.53 = 93 newspapers

In Class Example
Assume you are helping a Christmas tree
retailer determine how many trees to order
for this years season. Assuming that you
know from past experience that the average
demand for Christmas trees in his area is
500 but that the demand over the past 25
years has varied depending on the
economy and the offers on plastic trees.
The standard deviation of the demand is
100 trees. If this person can buy each tree
at an average cost of $5 and sell them at
$50, then how many trees would you
recommend he orders?
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.