CHAPTER 4

Dynamic Inventory
Control Models
Month over month Rosetta’s uses large quantities of vegetable oil
for production of food products. Vegetable oil is one of the more
expensive ingredients in the production process. To improve
profitability, procurement personnel at Rosetta’s are always
looking at minimizing the costs of this item. If Rosetta’s procures
vegetable oil from the local supermarket on a need basis, it would
cost them an average of $20 per liter. Considering the fact that
Rosetta’s has been a high-demand loyal customer for several
years, the local supplier – Oxxa – informs Rosetta’s that if they
place an order for 500 liters or more, Oxxa would supply
vegetable oil at $19.5 per liter. Also, on certain occasions Oxxa Single Price-
runs special campaigns to clear off their current stock in
anticipation of new, fresh stock of vegetable oil. For a fixed Break Model
period, they offer a discount of 15% per liter to those buyers that
can place an order for larger than usual quantities, before the end
of the month.

What should Rosetta’s procurement strategy be?

Should they continue procuring based on their calculated

EOQ, or should they take advantage of the
discount and order more?
 Consider the first part of the running example presented in
the last slide. The question is should Rosetta’s procure 500
liters of vegetable oil because of the $0.5 per liter discount
being, or should they order based on their EOQ? This is a
single (or one) price-break problem (Vohra 2007). This
decision can be made by comparing the TIC for the two
scenarios – one without discount at $20 per liter and order
size of EOQ, and another at a discounted rate of $19.5 per
liter but with an enhanced order size of at least 500 liters.

We start by computing the EOQ, using the market price

of $20 per liter. We know the annual demand for
vegetable oil is 7200 liters, the ordering cost is $80 per
order, and the inventory holding rate is 30% per year.
Using these values, we can determine the EOQ,1 which
is

Rosetta
 The TIC2 in this case would be

The next step is to compute the TIC using a discounted rate of

$19.5 per liter. Since this price is available only if the minimum
quantity on order is 500 liters, we use this instead of the EOQ
value we computed earlier. The TIC in this case is as follows:

Since the TIC for the discounted rate is lower than that of the
regular market price, we conclude it is beneficial for Rosetta’s to
procure 500 liters of vegetable oil. Figure 4.1 illustrates the cost
curves for the two scenarios. In this case, a discount of $0.5 per
liter on an order size of 500 liters turned out to be beneficial to
Rosetta’s. However, this may not always be true as the savings
due to purchase price discount may not match the additional
carrying costs that may be incurred, in which case it is prudent
to maintain an order size that equals EOQ
Single Price-
Break Model
 A manufacturer purchases 1200 units of
an item from a supplier every year. The
ordering cost is $250 per order,
inventory rate is 15% per year, and the
cost of the item is $100. Based on this
information compute the following:.

(a) Compute the economic order quantity assuming

no shortages are allowed and no discount is being
offered by the supplier
EXAMPLE
PROBLEM 1
(b) The supplier offers a discount of 2% if the
manufacturer places an order of not less than 750
units each time they order. Should the manufacturer
accept the discounted price?

(c) What would be the minimum acceptable

discounted price if the manufacturer uses an order
size of 750 units?
 (a) The EOQ assuming no shortages are allowed and
no discount is being offered can be determined using
Eq. 3.8. Substituting the values, we get

The TIC3 in this case is

Solutions:
Or
 (b) The TIC if the supplier offers a discount of 2% (or a purchase
price or $98 per unit) for an order size not less than 750 units is

SOLUTIONS
Or

Notice that TIC98 > TIC100. Therefore, the manufacturer must not
accept the discounted price for an order size of 750 units.
(c) We assume that the minimum acceptable discount price
for order size of 750 units is k. The TIC in this case would be

Or
SOLUTIONS

Simplifying, we get

Or

or k ¼ 2.41%.

The minimum acceptable discount price for order size of 750 units is
2.41% (or purchase price must be $97.59 per unit).
 All-Units Discount:
Instantaneous
Supply Model
Consider a new business deal between Rosetta’s and Oxxa shown below:

Business Deal – Oxxa and Rosetta’s

The market price of vegetable oil is $20 per liter. If Rosetta’s procures 450
liters (or more) of vegetable oil each time they place an order, Oxxa will
offer them a discount of 10% over the prevailing market rate. The discount
rate would increase to 20% if Rosetta’s procures 500 liters or more per
order. Further, Oxxa will supply the ordered quantities immediately.
. Table 4.1
Table 4.1 shows the discount and effective price offered by Oxxa for different
ranges of quantities of vegetable oil. This is referred to as multiple price-break
(discount) schedule. It should be noted that the assumptions we used in
derivation of the Basic EOQ model in Chap. 3 will continue to apply in this
scenario as well.
 FOUR STEPS

Let us now use the information provided in Table 4.1 and determine
the optimal and feasible order quantity under discount. This can be
achieved in the following four steps:
 Compute Order Size for All Values
of Purchase Price
The first step is to compute the EOQ for each of the
price-break values of $20 , $18, and $16. We will
use the following data that have been used in
Chap. 3:
• Annual demand for vegetable oil is 7200 liters.
• Ordering cost Co is $80 per order.
• Unit cost C is $20 per liter (market price), $18 per
liter if the order size is more than 450 liters, $16 per
liter if the order size is more than 500 liters.
• Inventory holding rate i is 30%.

Using the above data, we can compute the EOQ

values for each of the price-break points, which
are as follows:

Step 1:
Or

And
 Check Feasibility of Order Quantities

Next, we analyze the order quantities we computed. We see that

EOQ16 is infeasible since it does not fall in the range of 500+
liters. In other words, a discounted rate of $16 is offered only if
the order size is more than 500 liters; however, the EOQ we
computed for purchase price of $16 is less than 500 liters, and
hence it is considered infeasible. We, therefore, adjust the
minimum value of EOQ16 to 500 liters (from 490 liters). Table 4.2
summarizes the feasibility of the order quantities for each
purchase price as well as the adjusted order quantity (adjusted
EOQ).
Step 2:
The EOQs for purchase price of $20 and $18 are in the feasible
range, and no
adjustment is required
 Determine TIC
We next compute TIC for EOQ20 , EOQ18, and EOQ16 using the
following equation:

Substituting the values in Eq. 4.1, we get

Step 3:
Similarly,

and
Fig 4.2
 Determine Optimal Order Size

Table 4.3 summarizes the results of this problem

including TIC values for each option

Notice that the TIC16 is less than both TIC20 and TIC18.
The order quantity corresponding to TIC16 is 500 liters.
Thus, we conclude that it is best to order 500 liters of
vegetable oil each time we place an order. Figure 4.2
illustrates the price curves and optimal order quantity
for this multiple price-break model. Step 4
Table 4.3
  For each unit cost value, use the basic EOQ
formula to compute the economic order
quantity

 If the EOQ value computed falls in the

feasible range, compute the TIC. If the EOQ
does not fall in the feasible range, adjust the
EOQ such that it falls in the feasible range.
Compute the TIC using this adjusted EOQ
value
Summary of All-Units
 Compare the TIC values for all such feasible
Discount EOQ values. The EOQ value which
(Instantaneous Supply) corresponds to the minimum TIC is the
optimal quality under all-unit discount.
Solution Procedure
The annual consumption of sugar used in a bakery is 10,400
kg, the carrying cost is 20% of the average inventory
valuation, and the ordering cost is $200 per order. If the
sugar supplier offers the bakery quantity discounts as shown
in Table 4.4, use the concept of optimal order quantity to
determine the EOQ strategy that best suits the needs of the
bakery.

Sample
Problem 2:

Table 4.4 Discount schedule

 Step 1: Compute Order Size for All Values of
Purchase Price

Using the EOQ formula, we first determine the order

quantities for each purchase price option. The
calculations are shown in Table 4.5.

SOLUTION:
Step 2: Check Feasibility of Order Quantities

In this step, we validate the calculated EOQs against

the quantity range. If the calculated EOQ does not fall
in the range of quantity discount, we adjust the EOQ to
the minimum in the quantity range.
Table 4.6 summarizes the feasibility of the order
quantities for each purchase price, as well as the
adjusted order quantity

Table 4.6

Solutions:
Step 3: Determine TIC Using Adjusted EOQ

TIC can be determined by using Eq. 4.1. The TIC for

the three strategies are as shown in Table 4.7.

Solutions:
 Step 4: Determine Best Strategy

Table 4.10 Summary of TIC

From Table 4.10, we notice that the minimum TIC

corresponds to CJW. The best strategy is, therefore, to Solutions:
order 4500 notebooks each time an order is placed, at a
purchase price of $0.55 per notebook.
All-Units Discount:
Gradual Supply
Model

In the previous section, we assumed a scenario that orders

would be filled instantaneously, in one lot. Let us now
consider a different scenario – that of gradual supply. The
procedure to determine the order size is similar to that in the
all-units discount (instantaneous supply) case, with the only
difference being in the formulae we use to compute the
order size and the total inventory costs (Gaither 1987).
The formulae used to compute the EOQ and TIC for the
gradual supply case are as follows:

And

The theory and concept of the all-units discount –

gradual supply model is illustrated with a numerical
example
The annual consumption of sugar used in a bakery is 10,400 kg,
the carrying cost is 20% of the average inventory valuation, and
the ordering cost is $200 per order. If the supplier offers the
bakery a quantity discount as shown in Table 4.11, use the
concept of optimal order quantity to determine the EOQ strategy
that best suits the needs of the bakery if the daily requirement is
35 kg per day while the supplier can
supply at a uniform rate of 40 kg per day.
Sample Problem 3

Table 4.11 Discount schedule

Step 1: Compute Order Size for All Options

The first step is to compute the EOQ for all price

options, using Eq. 4.2. The computations are shown
below:

Solutions:
 Step 2: Check Feasibility

The next step is to check the feasibility of the computed

EOQs. Table 4.12 summarizes the feasibility check. As can be
seen from the table, the EOQ strategy for price of $9.8 is
infeasible. We therefore adjust the EOQ upward to 5000 kg.
The EOQ strategy for $10 is not within the feasible range,
and there is no way we can adjust the EOQ for that price
strategy.

Table 4.12 Feasibility check

SOLUTIONS:
 Step 3: Determine TIC Using Adjusted EOQ

TIC can be determined by using Eq. 4.3. The TICs for the two
feasible strategies are as shown in Table 4.13.

SOLUTIONS:

Step 4: Determine Best Strategy

As can be seen from Table 4.13, the minimum TIC corresponds to

an EOQ strategy with a price of $9.8 per kg. The best strategy is,
therefore, to order 5000 kg each time an order is placed.
END
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