Inventory control models

EPL Model
Learning objective
 After this class the students should be
able to:

• calculate the order quantity that minimize the

total cost inventory, based on the EPL model
and
• analyze the implication of this model using
what-if through the Excel software.
Time management
 The expected time to deliver this module
is 50 minutes. 30 minutes are reserved
for team practices and exercises and 20
minutes for lecture.
Inventory & inventory system
 Inventory is the set of items that an
organization holds for later use by the
organization. An inventory system is a
set of policies that monitors and controls
inventory. It determines how much of
each item should be kept, when low
items should be replenished, and how
many items should be ordered or made
when replenishment is needed.
Basic types of inventory

 independent demand,

 dependent demand, and

 supplies.
Independent Demand
 Independent demand items are those items that we
sell to customers.

 Dependent demand items are those items whose

demand is determined by other items. Demand for a
car translates into demand for four tires, one engine,
one transmission, and so on. The items used in the
production of that car (the independent demand
item) are the dependent demand items.

 Supplies are items such as copier paper, cleaning

materials, and pens that are not used directly in the
production of independent demand items
Why hold Inventory

 Each team is invited to discuss for 10

minutes about what they figure out to be
the reasons that the organizations
maintain inventory. At the and, they have
to present a list of their supposed
reasons.
Five reasons
1. To decouple workcenters;
2. To meet variations in demand;
3. To allow flexible production
schedules;
4. As a safeguard against variations
in delivery time; and
5. To get a lower price.
The cost of Inventory
 Holding costs;

 Setup costs;

 Ordering costs; and

 Shortage costs .
Notation
 D = Demand rate (in units per year).
 c = Unit production cost, not counting setup or
inventory costs (in dollars per unit).
 A = Constant setup (ordering) cost to produce
(purchase) a lot (in dollars).
 h = Holding cost
 Q = Lot size (in units); this is the decision variable
Economic Lot Size Production Model

 We use the same notation and

assumptions of the EOQ model, but
now P ( that not is instantaneous)
designates the production rate, and t
designates the time needed to produce
the lot. Then, Q= P x t
The problem
 Beth Krider, Manager of Production for Zap
Electronics, is making production plans for
microphones for portable recorders. The rate of
production (P) is 4,000 microphones per month, and
the (D) demand rate is 1,000 microphones per
month. The cost of each microphone is $6.75, and
the inventory holding percent is 0.2.

 She is wondering whether this lot size gives the

lowest cost.
 Cumulative production and Demand
4,000 microphones were
made in January, and in
February, March, and April,
no microphones were
produced. 1,000
microphones were sold in
January, resulting in an
inventory of 3,000
microphones on February
1. The inventory is used up
in February, March, and
April, so that on April 30
there is no inventory. Then
the whole cycle repeats.
 Monthly inventory of microphones

The maximum
inventory is 3,000
microphones, and
the average
inventory is 3,000/2
= 1,500
microphones. Note
the similarity
between this
problem and the
EOQ problem we
have already shown
 Now A, the ordering
cost, designates the
setup cost for
producing a lot of the
microphones. Q
 P designates the Q  Pt and t
production rate, and t
P
designates the time
needed to produce the
lot.
Average Inventory Level
 The maximum inventory is

1 D 
P  t   D  t    Q
 P 
 The average inventory is
1 D  Q Q
  or F
 P  2 2

where
1 D 
F  
 P 
 The Factor F
 Demand rate (D) must be less
than or equal to the production
rate (P). If D = P, production
just meets the demand. In this
case, the factor is 0, and so is
the inventory. If the production
rate is very large compared to
the demand, D/P is very small.
In such cases, the factor is near
1 and the average inventory is
Q/2, the same as in the EOQ
problem. The straight line
shows how the factor depends
on the value of D/P.
The Costs
 Annual holding cost
1 D  Q  C i 
    C  i  F  Q 
 P  2  2 
Where C=cost of each microphone and i =interest rate

Annual setup cost = D/Q x A

D
   A
Q
The total cost
 To carry out the calculations, we need the other parameters of
the problem.

 Cost of each microphone: C = 6.75

 Percent of holding cost: i = 20%
 Setup cost: A = $28

Then,

 Annual holding cost = 4,000 x 3/4 x 6.75 x 0.2/2 = $2,025

 Annual setup cost = 12,000/4,000 x 28 = $84
 Annual total cost = $2,109
The model

dY Q  d 2Y Q 


 h   D  A
Y Q   Q 1  P    
D 2   Q  dQ
0
dQ 2
0

Appling the conditions for optimization, we find the optimal value for
order quantity and Cost

2 D  A
Q* 
 
h
1 D
P

 
Y Q*  2  D  A  h 1  D  P

Conclusion

 We calculated the optimal production lot size

and the costs and found that Q* = 814.68,
and the total cost is $824.87.
 This is $1.284.13 less than Beth's solution of
ordering 4,000 microphones three times a
year.
What-if
 Each team is invited to built a model in
the Excel software and develop what-if
analysis (10) minutes
What-if
 Open
excel file

What-if
A B C D
3 What-If Analysis for Microphones
Economic
Model Formules
4 Production
5 Demand D 12,000 12,000
6 Cost per unit C $6.75 $6.75
7 Percent to hold i 20% 20%
8 Ordering cost O 28 28
9 Production rate P 48,000 48,000
10 Lot size Q* = (2DO/Ci/(1-D/P)^0.5 815 =(2*D5*D8/D12/(1-D5/D9))^0.5
11 Number of orders D/Q 15 =D5/D10
12 Unit holding cost H=C*i $1.35 $1.35
13 Annual holding cost QH/2*(1-D/P) $412 =D10*D12/2*(1-D5/D9)
14 Annual ordering cost NO $412 =D11*D8
15 Combined cost QH/2*(1-D/P)+NO $825 =D13+D14
16 Annual purchase cost DC $81,000 =D5*D6
17 Total cost $81,825 =D15+D16
Reference
 Operations Analysis Using Excel. Weida;
Richardson and Vazsony, Duxbury,
2001,Chapter 6.