Chapter 2: Constant and Time Varying Demand(nhu

cầu không thay đổi và nhu cầu thay đổi theo thời
gian)
¨ Costs in inventory models

¨ Economic order quantity (EOQ): Số lượng đặt hàng kinh tế

- Optimal Order Quantity, Reorder point.

- Safety stock

- Discount

¨ Planned shortage models

EOQ is the acronym for economic order quantity. The economic order quantity
is the optimum quantity of an item to be purchased at one time in order to
minimize the combined annual costs of ordering and carrying the item in
inventory. EOQ is also referred to as the optimum lot size.
Economic order quantity (EOQ): Số
lượng đặt hàng kinh tế
Economic order quantity (EOQ): Số lượng đặt
hàng kinh tế
 1. Type of Costs in
Inventory Models
¨ Inventory analyses(phân tích hàng tồn kho) can be thought
of as cost-control techniques(kỹ thuật kiểm soát chi phí)

¨ Categories of costs in inventory models:

- Holding (carrying costs)

- Order/ Setup costs

- Customer satisfaction costs

- Procurement/Manufacturing costs
 1. Type of Costs in
Inventory Models
1. Holding(carrying cost): costs that we have to pay when we keep
the items in the warehouse
+ One is the cost of holding inventory(chi phí giữ hàng tồn kho). In this case the
carrying cost is the cost of capital tied up(liên quan) in inventory, the cost of storage(chi
phí lưu kho), insurance, and obsolescence. Often this is expressed as an annual
percentage rate, such as 20% of the cost of the inventory. This is used in the formula
for determining the optimum ordering (or manufacturing) quantity of an item.

2. + Another connotation of this term is the cost at which the inventory is reported in the
company's general ledger accounts and on its balance sheet (Một ý nghĩa khác của
thuật ngữ này là chi phí mà hàng tồn kho được báo cáo trong các tài khoản sổ cái của
công ty và trên bảng cân đối kế toán của nó.)
 1. Type of Costs in
Inventory Models
1. Order cost
+ In the EOQ model, order costs are the incremental costs(chi phí gia tăng) of
processing an order of goods from a supplier. Examples of order costs include the
costs of preparing a requisition, a purchase order, and a receiving ticket, stocking the
items when they arrive, processing the supplier's invoice, and remitting the payment to
the supplier..

2. Setup cost In manufacturing, setup cost is the cost incurred to(phát sinh) get
equipment ready to process a different batch of goods. Hence, setup cost is regarded
as a batch-level cost(chi phí cấp lô) in activity based costing. Setup cost is considered
to be a non-value-added cost(chi phí gia tăng) that should be minimized.
Examples of Setup Costs. Setup costs include the following:

+ Costs of changing the tools or dies on the equipment

+ Preparing and moving materials or components to the equipment

 1. Type of Costs in
Inventory Models
1. Customer Satisfaction cost(the cost we have to pay to make customers
happy), we may keep safety stock to avoid stock out. In case, stockout
happens, we convince that customer stay with us please.... Add bonus for
customer  happy

2. Back order cost: the additional cost to order more, is kind of Customer satis
cost

3. 2 mains kind of CSC: holding cost for safety stock AND stockout cost include
back order cost and lost sell

4. Đơn hàng dự trữ là một yêu cầu của nhà bán lẻ cho một nhà cung ứng hay nhà bán
buôn về nguồn hàng bổ sung của một mặt hàng bán ra để đáp ứng đơn đặt hàng chưa
được thanh toán của khách hàng
Backorder costs include costs incurred by a business when it is unable to immediately
fill an order and promises the customer that it will be completed with a later delivery
date
 1. Type of Costs in
Inventory Models
1. Procurement cost: Phí tổn đặt hàng (actually value of
the items you have to pay for). Therefore the
procurement cost normally is not with a certain volume
doesn’t change
2. For example: you buy the raw material cost, the price of
1 unit of raw material is how much. You multiply with the
volume, it is procurement cost
 1. Type of Costs in
Inventory Models
1. If we consider production element that the cost to
create/produce product, we call thát manufacturing cost
2. But in this lesson, we focus on the procurement cost
3. Setup cost and procurement cost will study later on
 Type of Costs in
Inventory Models
Element of Holding Costs (Carrying costs): depend on the order size
¨ Cost of capital = interest rate + oppurtunities cost (5-10%)
¨ Storage space rental cost(chi phí thuê không gian lưu trữ)
¨ Costs of utilities(tiện ích)
¨ Labor(nhân công)
¨ Insurance
¨ Security
¨ Theft and breakage
¨ Deterioration or Obsolescence(suy giảm và lỗi thời)
 Type of Costs in
Inventory Models
Element of Holding Costs (Carrying costs) include: depend on the order
size
+ cost to keep stocks of items
+ It could be the cost that we have to pay to rent pallet if we rent the
warehouse
+ If we have warehouse, the cost could be cost of decitrtion(ko rõ t ừ nào)
for bulding the warehouse
+ Size of pallet: 2 main sizes length and width: 1.2*1.2 meter and 1*1
meter
Mix: 1*1.2 meter, plastic pallet (1*1), wooden pallet can be mixed
 Type of Costs in
Inventory Models
+ Element of Holding Costs (Carrying costs) include: depend on the
order size
+ Your company uses own warehouse, that case storage space rental
cost go back to the devisiation cost
+ Main Element of the holding cost is cost of capital:
Chi phí sử dụng vốn (tiếng Anh: Cost of Capital) là tỉ suất sinh lời đòi hỏi của nhà
đầu tư đối với số vốn mà doanh nghiệp huy động cho một dự án đầu tư hay kế
hoạch kinh doanh
Bản chất của chi phí sử dụng vốn là chi phí cơ hội của vốn đối với nhà đầu tư
tính trên số vốn mà họ đầu tư vào doanh nghiệp.
 Type of Costs in
Inventory Models
Order/Setup Cost: is independent of the order size(không phụ thuộc vào quy mô đơn
hàng)
¨ Order costs are incurred(phát sinh) when purchasing a good from a supplier. They
include costs such as
- Telephone
- Order checking
- Labor
- Transportation(the main element)
¨ Setup costs are incurred when producing goods for sale to others. They can include
costs of
- Cleaning machines
- Calibrating equipment(hiệu chỉnh thiết bị)
- Training staff
 Type of Costs in
Inventory Models
Customer Satisfaction Costs
¨ Measure the degree to which a customer is satisfied.
¨ Unsatisfied customers may:
- Switch to the competitors (lost sales).(chuyển sang đối thủ cách
tranh, mất donah số bán hàng)
- Wait until an order is supplied.
¨ When customers are willing to wait there are two types of costs
incurred:
 Type of Costs in
Inventory Models
Procurement/Manufacturing Cost
¨ Represents the unit purchase cost (including transportation)
in case of a purchase.
¨ Unit production cost in case of in-house manufacturing
¨ Thể hiện chi phí mua đơn vị (bao gồm cả vận chuy ển) trong
trường hợp mua.
¨ Đơn giá sản xuất trong trường hợp sản xuất trong n ước
 2. Economic Order Quantity
(EOQ) Model - Assumptions
¨ Demand occurs at a known and reasonably constant rate.
¨ The item has a sufficiently long shelf life.
(Mặt hàng có thời hạn sử dụng lâu)
¨ The item is monitored(giám sát) using a continuous review system.
¨ All the cost parameters remain((tham số chi phí)) constant forever
(over an infinite time horizon)(trong 1 khoảng thời gian vô định)
¨ A complete order is received in one batch (instantaneously).
¨ (đơn đặt hoàn chỉnh được nhận trong 1 đợt, ngay lập tức)
 The EOQ Model –
Inventory Profile
The constant environment described by the EOQ assumptions
leads to the following observation:

¨ The optimal EOQ policy consists of same-size orders.

(Chính sách EOQ tối ưu bao gồm các đơn hàng có cùng kích
thước.)

¨ This observation results in the following inventory profile :

 2.1. Cost Equation for the
EOQ Model
¨ Let is the order quantity or lot size (kich thước lô)

total annual total annual total annual total annual

inventory cost holding cost ordering cost procurement cost

EOQ =
P*D là giá trị của hàng tồn kho
P là đơn giá 1 sản phẩm còn D là nhu cầu trong năm
 Costs in the EOQ Model
cost
total cost ost
c
ld ing
ho
al
tot

at the optimal order size

total holding costs and ordering costs
are equal

total ordering cost

Order quantity
 Sensitivity Analysis in
EOQ Models

cost The curve is reasonably flat around

Deviations from the optimal order size

cause only small increase in the total cost.

Order quantity
 Cycle Time
¨ The cycle time, T, represents the time that elapses between
the placement of orders.

¨ Note, if the cycle time is greater than the shelf life, items will
go bad, and the model must be modified.
 Number of Orders per Year

¨ To find the number of orders per years, take the reciprocal(có qua có lại) of the
cycle time

Example: The demand for a product is 1000 units per year.

The order size is 250 units under an EOQ policy.

¨ How many orders are placed per year? N = 1000/250 = 4 orders.

¨ How often orders need to be placed (what is the cycle time)?
T = 250/1000 = ¼ years. {Note: the four orders are equally spaced}.
 Lead Time and Reorder Point

¨ In reality, lead time L always exists, and must be accounted

for when deciding when to place an order.
¨ The reorder point, R, is the inventory position when an order
is placed.
¨ R is calculated by:

¨ L and D must be expressed in the same time unit.

 Lead Time and Reorder Point
¨ Lead time is the time from when goods are ordered until the time
when the goods are received.
¨ The reorder point is the quantity of units in inventory that will
trigger(kích hoạt) an order to purchase additional units. Let's
assume that a company's reorder point for its Product X is 80
units. When the inventory of Product X drops to 80 units, the
company places an order for additional units of Product X.
¨ The reorder point is calculated by 1) estimating the sales in the
near future, 2) estimating the number of days between ordering
and receiving the additional units, and 3) the number of units of 
safety stock.
¨ The reorder point indicates when to place an order. The 
economic order quantity indicates the optimum number of units to
be ordered.
 Lead Time and Reorder Point –
Graphical demonstration: Short Lead Time

R = Inventory at hand at the beginning of lead time

reorder point

in
ve
nt
or
y
po
sit
io
n
place the order now
 Lead Time and Reorder Point –
Graphical demonstration: Long Lead Time

outstanding
order

place the order now

 Practice
¨ The store S has observed a stable monthly
demand for its line of mobile phone iPhone of 100
pcs per month. The store incurs a fixed cost of
$2,000 every time it places an order for additional
iPhones. The store pays $200 per iPhone. The
store’s out-of-pocket costs of storing a iPhone for
a year are about 10% and the opportunity cost of
capital is 15%.
¨ What order size do you recommend for the S
store?
¨ R=?
¨ N=?
 Solution
¨ D = 1200 pcs/ year, Co = $2,000 / order, C = $200/pcs
¨ Ch = (0.15 + 0.10)*200 = $50 /pcs/ year
 Q* = SQRT(2*1200*2000/50) = 309.8
 round to Q* = 310
¨ N = 1200/310 = 3.9 orders/year
¨ Order every 365/3.9 = 94 days
¨ Total cost:
TC(Q*) = S  (D/Q*) + H  (Q*/2)
= 2000  (1200/310) + 50  (310/2)
= $7,745 + $7,745
= $15,492 / year
 2.2. Safety Stock
¨ Safety stocks act as buffers to handle:

- Higher than average lead time demand.

- Longer than expected lead time.

¨ With the inclusion of safety stock (SS), R is calculated by

¨ The size of the safety stock is based on having a desired service level.
 Safety Stock

reorder point

place the order now

 Safety Stock

reorder point

The safety stock

place the order now prevents excessive
shortages.
 Inventory Costs
Including Safety Stock

total annual total annual total annual total annual safety stock
inventory cost holding cost ordering cost procurement holding cost
cost
 ALLEN APPLIANCE
COMPANY (AAC)
¨ AAC wholesales small appliances.
¨ AAC currently orders 600 units of the Citron brand juicer
each time inventory drops to 205 units.
¨ Management wishes to determine an optimal ordering policy
for the Citron brand juicer
 ALLEN APPLIANCE
COMPANY (AAC)
Data
¨ Co = $12 ($8 for placing an order) + (20 min. to check)($12 per hr)
¨ C = $10.
¨ H = 14% (10% ann. interest rate) + (4% miscellaneous)
¨ Ch = $1.40 [HC = (14%)($10)]
¨ D = demand information of the last 10 weeks was collected:

Sales of Juicers over the last 10 weeks

Week 1 2 3 4 5
Sales 105 115 125 120 125
Week 6 7 8 9 10
Sales 120 135 115 110 130
 ALLEN APPLIANCE
COMPANY (AAC)
Data
¨ The constant demand rate seems to be a good assumption.
¨ Annual demand = (120/week)(52weeks) = 6240 juicers.
Để ra đc con số 120, ta lấy tất cả giá sale c ộng l ại r ồi chia
cho 10 tuần
 AAC – Solution:
EOQ and Total Variable Cost
¨ Current ordering policy calls for Q = 600 juicers.

TV( 600) = (600/2)($1.40) + (6240 / 600)($12) =$544.8

TV is total variable cost

¨ The EOQ policy calls for orders of size:

TV(327) = (327 / 2)($1.40) + (6240 / 327) ( $12) = $457.89

Savings of 16% is achieved by applying the EOQ solution.

(544-457)/544
 AAC – Solution:
Reorder Point and Total Cost

¨ Under the current ordering policy AAC holds 13 units safety stock (how come?
Observe):
¨ AAC is open 5 day a week.
- The average daily demand = (120/week)/5 = 24 juicers.
- Lead time is 8 days. Lead time demand is (8)(24) = 192 juicers.
- Reorder point without Safety stock = LD = 8*24=192.
- Current policy: R = 205.
- Safety stock = 205 – 192 = 13.(R cũ-R ms)
¨ For safety stock of 13 juicers the total cost is
TC(327) = 457.89 + 6240($10) + (13)($1.40) = $62,876.09
TV(327) + procurement cost + safety stock holding cost
 AAC – Solution:
Sensitivity of the EOQ Results
Changing the order size
¨ Suppose juicers must be ordered in increments of 100 (order 300 or 400)
¨ AAC will order Q = 300 juicers in each order.
¨ There will be a total variable cost increase of $1.71.
¨ This is less than 0.5% increase in variable costs.

Changes in input parameters

¨ Suppose there is a 20% increase in demand. D=7500 juicers.
¨ The new optimal order quantity is Q* = 359.
¨ The new variable total cost = TV(359) = $502
¨ If AAC still orders Q = 327, its total variable costs becomes
TV(327) = (327/2)($1.40) + (7500/327)($12) = $504.13 → only increase 0.4%
 AAC – Solution: Cycle Time

¨ For an order size of 327 juicers we have:

T = (327/ 6240) = 0.0524 year.

= 0.0524(52)(5) = 14 days.

working days per week

¨ This is useful information because:

- Shelf life may be a problem.

- Coordinating orders with other items might be desirable.

AAC – Excel Spreadsheet
 2.3. EOQ Models with
Quantity Discounts
Quantity Discounts are Common Practice in Business
¨ By offering discounts buyers are encouraged to increase
their order sizes, thus reducing the seller’s holding costs.
¨ Quantity discounts reflect the savings inherent in large
orders.
¨ With quantity discounts sellers can reward their biggest
customers.
 EOQ Models with
Quantity Discounts
Quantity Discount Schedule

¨ This is a list of per unit discounts and their corresponding purchase

volumes(khối lượng mua hàng)

¨ Normally, the price per unit declines as the order quantity increases.

¨ The order quantity at which the unit price changes is called a break point.
(Số lượng đặt hàng mà đơn giá thay đổi được gọi là điểm phá vỡ)

¨ There are two main discount plans:

- All unit schedules - the price paid for all the units purchased is based on the
total purchase.
- Incremental schedules - The price discount is based only on the additional
units ordered beyond each break point.
 All Units Discount Schedule

¨ To determine the optimal order quantity, the total purchase

cost must be included

¨ Ci represents the unit cost at the i th pricing level.

 AAC - All Units
Quantity Discounts
¨ AAC is offering all units quantity discounts to its customers.
¨ Data
Quantity Discount Schedule
1-299 $10.00
300-599 $9.75
600-999 $9.40
1000-4999 $9.50
5000 $9.00

Should AAC increase its regular order of

327 juicers, to take advantage of the discount?
 AAC – All units
discount procedure
¨ Step 1: Find the optimal order Qi* for each discount level “i” by using the formula

¨ Step 2: For each discount level “i” modify Qi* as follows

- If Q* < qi, then Qi* = qi.

- If qi  Q* < qi+1, then Qi* = Q*

- If qi+1  Q*, eliminate this level from further consideration.

¨ Step 3: Substitute the modified Qi* value in the total cost formula TC(Qi*).

¨ Step 4: Select the Qi* that minimizes TC(Qi*)

 AAC – All units
discount procedure
¨ Step 1: Find the optimal order Q i* for each discount level “i”
by using the formula

Lowest cost order size per discount level

Discount Qualifying Price
level order per unit Q*
0 1-299 10.00 327
1 300-599 9.75 331
2 600-999 9.50 337
3 1000-4999 9.40 336
4 5000 9.00 345
 AAC – All units
discount procedure
¨ Step 2:

Lowest cost order size per discount level

Discount Qualifying Price
level order per unit Q* Qi *
0 1-299 10.00 327 ****
1 300-599 9.75 331 331
2 600-999 9.50 337 600
3 1000-4999 9.40 336 1000
4 5000 9.00 345 5000
 AAC – All units
discount procedure
¨ Step 3: Substitute the modified Q i* value in the total cost
formula TC(Qi*).

Modified Q* and total Cost

Qualified Price Modified Total

Q* Qi *
Urder per Unit Cost
1-299 10.00 300 **** ***

300-599 9.75 331 331 $61,309.88

600-999 9.50 336 600 $59,192.71
1000-4999 9.40 337 1000 $60,037.17
$59,341.36
5000 9.00 345 5000
 AAC – All units
discount procedure
¨ Step 4: AAC should order 600 juicers as it results in the
minimum total annual cost

Modified Q* and total Cost

Qualified Price Modified Total

Q*
Urder per Unit Q* Cost
1-299 10.00 300 **** ****
300-599 9.75 331 331 $61,309.88
600-999 9.50 336 600 $59,192.71
1000-4999 9.40 337 1000 $60,037.17
$59,341.36
5000 9.00 345 5000
AAC – All Units Discount Excel
Worksheet
 3. Planned Shortage Model
¨ When an item is out of stock, customers may:
- Go somewhere else (lost sales).
- Place their order and wait (backordering).
¨ In this model we consider the backordering case.
¨ All the other EOQ assumptions are in place.
 Planned Shortage Model –
the Total Variable Cost Equation

¨ The parameters of the total variable costs function are similar to those
used in the EOQ model.
¨ In addition, we need to incorporate the shortage costs in the model.
¨ Backorder cost per unit per year (loss of good will cost) - Cs.
¨ Reflects future reduction in profitability.
¨ Can be estimated from market surveys and focus groups.
¨ Backorder administrative cost per unit - Cb.
¨ Reflects additional work needed to take care of the backorder.
 Planned Shortage Model –
the Total Variable Cost Equation

¨ The Annual holding cost =

Ch[T1/T](Average inventory) = Ch[T1/T] (Q-S)/2

¨ The Annual shortage cost =

Cb(number of backorders per year) +
CS(T2/T)(Average number of backorders).

¨ To calculate the annual holding cost and

shortage cost we need to find

¨ The proportion of time inventory is carried, (T1/T)

¨ The proportion of time demand is backordered, (T2/T).

Finding T1/ T and T2/ T
average inventory (Q-S)/2

Proportion of time
inventory exists
= T1/T
= (Q - S) / Q

Proportion of time
shortage exists
= T2/T
=S/Q

Average shortage = S / 2
 Planned Shortage Model –
The Total Variable Cost Equation

¨ Annual holding cost:

Ch[T1/T](Q-S)/2 = Ch[(Q-S) /Q](Q-S)/2
= Ch(Q-S)2/2Q
¨ Annual shortage cost:
Cb(Units in short per year) +
Cs[T2/T](Average number of backorders) =
Cb(S)(D/Q) + CsS2/(2Q)
 Planned Shortage Model –
The Total Variable Cost Equation

¨ The total annual variable cost equation

Time independent Time independent

backorder costs backorder costs

¨ The optimal solution to this problem is obtained under the following

conditions
- Cs > 0 ;
- Cb < (2CoCh / D)1/2
 Planned Shortage Model –
The Optimal Inventory Policy
¨ The Optimal Order Size

¨ The Optimal Backorder level

¨ Reorder Point
 SCANLON PLUMBING
CORPORATION
¨ Scanlon distributes a portable sauna from Sweden.

¨ Data

- A sauna costs Scanlon $2400.

- Annual holding cost per unit $525.

- Fixed ordering cost $1250 (fairly high, due to costly transportation).

- Lead time is 4 weeks.

- Demand is 15 saunas per week on the average.

 SCANLON PLUMBING
CORPORATION
¨ Backorder costs(giá của đơn hàng d ự trữ)
- Scanlon estimates a $20 goodwill cost for each week a
customer who orders a sauna has to wait for delivery.
- Administrative(thuộc quản lý) backordrer cost is $10.

¨ Management wishes to know:

- The optimal order quantity.
- The optimal number of backorders.
 SCANLON PLUMBING
CORPORATION
¨ Backorder costs include costs incurred by a business
when it is unable to immediately fill an order and
promises the customer that it will be completed with
a later delivery date. Backorder costs can be direct,
indirect, or ambiguously estimated.
 SCANLON PLUMBING –
Solution
¨ Input for the total variable cost function
- D = 780 saunas [(15)(52)]
- Co = $1,250
- Ch = $525
- Cs = $1,040
- Cb = $10
SCANLON PLUMBING –
Spreadsheet Solution