QAM Chapter06 Inventory Control Models

6
Inventory
Control
Models
To accompany
Quantitative Analysis for Management, Twelfth Edition,
by Render, Stair, Hanna and Hale
Power Point slides created by Jeff Heyl Copyright ©2015 Pearson Education, Inc.
LEARNING OBJECTIVES
After completing this chapter, students will be able to:
1. Understand the importance of inventory control and

ABC analysis.
2. Use the economic order quantity (EOQ) to
determine how much to order.
3. Compute the reorder point (ROP) in determining
when to order more inventory.
4. Handle inventory problems that allow quantity
discounts or noninstantaneous receipt.
Copyright ©2015 Pearson Education, Inc. 6–2

LEARNING OBJECTIVES
After completing this chapter, students will be able to:
5. Understand the use of safety stock.

6. Describe the use of material requirements planning
in solving dependent-demand inventory problems.
7. Discuss just-in-time inventory concepts to reduce
inventory levels and costs.
8. Discuss enterprise resource planning systems.

CHAPTER OUTLINE
6.1 Introduction
6.2 Importance of Inventory Control
6.3 Inventory Decisions
6.4 Economic Order Quantity: Determining How
Much to Order
6.5 Reorder Point: Determining When to Order
6.6 EOQ Without the Instantaneous Receipt
Assumption
6.7 Quantity Discount Models

CHAPTER OUTLINE
6.8 Use of Safety Stock
6.9 Single-Period Inventory Models
6.10 ABC Analysis
6.11 Dependent Demand: The Case for Material
Requirements Planning
6.12 Just-in-Time Inventory Control
6.13 Enterprise Resource Planning

Introduction
• Inventory is an expensive and important
asset
• Any stored resource used to satisfy a
current or future need
– Raw materials
– Work-in-process
– Finished goods
• Balance high and low inventory levels to
minimize costs
Introduction
• Lower inventory levels
– Can reduce costs
– May result in stockouts and dissatisfied
customers
• All organizations have some type of
inventory planning and control system
• Determine what goods/services are
produced or purchased

Introduction
FIGURE 6.1 – Planning on
Inventory Planning what to stock
and Control and how to
get it
Feedback
metrics to Forecasting
revise plans parts/product
and forecasts demand
Controlling
inventory
levels

Importance of Inventory Control
• Five uses of inventory
1. The decoupling function
2. Storing resources
3. Irregular supply and demand
4. Quantity discounts
5. Avoiding stockouts and shortages
• Decouple manufacturing processes
– A buffer between stages
– Reduces delays and improves efficiency

• Storing resources
– Seasonal products stored to satisfy off-season
demand
– Materials stored as raw materials, work-in-process,
or finished goods
– Labor can be stored as a component of partially
completed subassemblies
• Irregular supply and demand
– Not constant over time
– Inventory used to buffer the variability
Copyright ©2015 Pearson Education, Inc. 6 – 10

• Quantity discounts
– Lower prices may be available for larger orders
– Higher storage and holding costs
– More cash invested
• Avoiding stockouts and shortages
– Stockouts may result in lost sales
– Dissatisfied customers may choose to buy from
another supplier
– Loss of goodwill

Inventory Decisions
• Two fundamental decisions
1. How much to order
2. When to order
• Major objective is to minimize total inventory
costs
1. Cost of the items (purchase or material cost)
2. Cost of ordering
3. Cost of carrying, or holding, inventory
4. Cost of stockouts

Inventory Cost Factors
TABLE 6.1
ORDERING COST FACTORS CARRYING COST FACTORS

Developing and sending purchase orders Cost of capital
Processing and inspecting incoming inventory Taxes
Bill paying Insurance
Inventory inquiries Spoilage

Utilities, phone bills, and so on, for the
Theft
purchasing department
Salaries and wages for the purchasing
Obsolescence
department employees
Supplies such as forms and paper for the
Salaries and wages for warehouse employees
purchasing department
Utilities and building costs for the warehouse
Supplies such as forms and paper for the

warehouse

Inventory Cost Factors
• Ordering costs are generally independent of
order quantity
– Many involve personnel time
– The amount of work is the same no matter the size
of the order
• Holding costs generally vary with the amount
of inventory or order size
– Labor, space, and other costs increase with order
size
– Cost of items purchased can vary with quantity
discounts

Economic Order Quantity
• Economic order quantity (EOQ) model
– One of the oldest and most commonly
known inventory control techniques
– Easy to use
– A number of important assumptions
• Objective is to minimize total cost of
inventory

Economic Order Quantity
• Assumptions:
– Demand is known and constant
– Lead time is known and constant
– Receipt of inventory is instantaneous
– Purchase cost per unit is constant
– The only variable costs are ordering cost
and holding or carrying cost
• These are constant throughout the year
– Orders are placed so that stockouts or
shortages are avoided completely

Inventory Usage Over Time
FIGURE 6.2
Inventory
Level
Order Quantity = Q =
Maximum Inventory Level
Minimum
Inventory
0
Time

Inventory Costs in the
EOQ Situation
• Annual ordering cost is number of orders per year
times cost of placing each order
• Annual carrying cost is the average inventory times
carrying cost per unit per year
INVENTORY LEVEL
DAY BEGINNING ENDING AVERAGE
April 1 (order received) 10 8 9
April 2 8 6 7
April 3 6 4 5
April 4 4 2 3
April 5 2 0 1
Maximum level April 1 = 10 units
Total of daily averages = 9 + 7 + 5 + 3 + 1 = 25
Number of days = 5 TABLE 6.2
Average inventory level = 25/5 = 5 units

Q EOQ
= number Situation
of pieces to order
EOQ = Q* = optimal number of pieces to order
D = annual demand in units for the inventory
item
Co = ordering cost of each order
Ch = holding or carrying cost per unit per year
Annual Number of Ordering

ordering  orders placed  cost per
cost per year order
Annual demand Ordering

= Number of units × cost per
in each order order

Q EOQ
= number Situation
of pieces to order
EOQ = Q* = optimal number of pieces to order
D = annual demand in units for the inventory
item
Co = ordering cost of each order
Ch = holding or carrying cost per unit per year
Annual Carrying cost

Average
holding   per unit
inventory per year
cost

EOQ Situation
FIGURE 6.3 – Total Cost as a Function of Order Quantity
Cost
Curve for Total Cost
of Carrying
Minimum and Ordering
Total
Cost
Carrying Cost Curve
Ordering Cost Curve
Optimal Order Quantity

Order
Quantity
Finding the EOQ
• When the EOQ assumptions are met, total
cost is minimized when
Annual ordering cost = Annual holding cost
Thus
Solving for Q

Finding the EOQ
• Equation summary

Sumco Pump Company
• Sells pump housings to other companies
• Reduce inventory costs by finding optimal
order quantity
Annual demand = 1,000 units
Ordering cost = $10 per order
Average carrying cost per unit per year =
$0.50

Sumco Pump Company
• Total cost
Number of orders per year = (D/Q) = 5

Average inventory (Q/2) = 100

Sumco Pump Company
Cost
Curve for Total Cost
of Carrying
and Ordering
$100
Carrying Cost Curve
$50 Ordering Cost Curve
Q = 200 Order Quantity

Sumco Pump Company
PROGRAM 6.1A – Input Data and Excel QM Formulas

Sumco Pump Company
PROGRAM 6.1B – Excel QM Solution

Purchase Cost of
Inventory Items
• Total inventory cost can be written to include
the cost of purchased items
– Annual purchase cost is constant at D x C no
matter the order policy, where
C is the purchase cost per unit
D is the annual demand in units
• The average dollar level of inventory

Purchase Cost of
Inventory Items
• Carrying cost often expressed as an annual
percentage of the unit cost or price of the
inventory
• New variable
Annual inventory holding charge as a
I percentage of unit price or cost
Cost of storing inventory for one year = Ch = IC
Thus

Sensitivity Analysis with the
EOQ Model
• The EOQ model assumes all values are know
and fixed over time
• Values are estimated or may change
• Sensitivity analysis determines the effects of
these changes
• Because the EOQ is a square root, changes
in the inputs result in relatively small changes
in the order quantity

Sensitivity Analysis with the
EOQ Model
• Sumco Pump example
• Increase Co to $40
• In general, the EOQ changes by the square

root of the change to any of the inputs
Reorder Point:
Determining When To Order
• Next decision is when to order
• Time between placing an order and its receipt
is called the lead time (L) or delivery time
• Generally expressed as a reorder point
(ROP)
Demand Lead time for a new

ROP  per day  order in days
dL

Reorder Point Graphs
Inventory
FIGURE 6.4 Level
Q
ROP
0
Time
Lead time = L
ROP < Q
Inventory
Level On Order
Q
On hand
0
Time
Lead time = L
ROP > Q
Procomp’s Computer Chips
• Annual demand = 8,000
• Daily demand = 40 units
• Delivery in three working days
ROP  d  L  40 units per day  3 days

 120 units
• An order for the EOQ (400) is placed when the

inventory reaches 120 units
• The order arrives 3 days later just as the inventory is
depleted

Procomp’s Computer Chips
• Annual demand = 8,000
• Daily demand = 40 units
• Delivery in three working days Now 12 days
ROP  d  L  40 units per day  12 days

 480 units
Inventory Inventory Inventory
 +
position on hand on order
480  80 + 400
• New order placed when inventory = 80 and one order
is in transit
EOQ Without
Instantaneous Receipt
• When inventory accumulates over time, the
instantaneous receipt assumption does not
apply
– Daily demand rate must be taken into account
– Production run model
Inventory
Level Part of Inventory Cycle There is No Production
During Which Production is During This Part of the
Taking Place Inventory Cycle
Maximum
–
Inventory
t Time
FIGURE 6.5 – Inventory Control
Copyright ©2015 Pearson Education, Inc.
and the Production Process 6 – 37
Annual Carrying Cost for Production
Run Model
• Setup cost replaces ordering cost
– Model variables
Q  number of pieces per order, or

production run
Cs  setup cost
Ch  holding or carrying cost per unit per
year
p daily production rate
d daily demand rate
t length of production run in days
Run Model
• Maximum inventory level
 (Total produced during the production run)
– (Total used during the production run)
 (Daily production rate)(Number of days production)
– (Daily demand)(Number of days production)
 (pt) – (dt)
Since Total produced  Q  pt and
Maximum
inventory
level
Run Model
• Average inventory is one-half the maximum
and

Annual Setup Cost for Production
Run Model
• Setup cost replaces ordering cost
becomes

Determining the Optimal Production
Quantity
• Set setup costs equal to holding costs and
solve for the optimal order quantity
Annual holding cost  Annual setup cost
Solving for Q, we get

Production Run Model
• Equation summary

Brown Manufacturing
• Produces commercial refrigeration units in
batches
Annual demand  D  10,000 units
Setup cost  Cs  $100
Carrying cost  Ch  $0.50 per unit per year
Daily production rate  p  80 units daily
Daily demand rate  d  60 units daily
1. How many units should Brown produce

in each batch?
2. How long should the production part of
the cycle last?
Brown Manufacturing
1. 2.

Brown Manufacturing
PROGRAM 6.2A – Excel QM Formulas and Input Data

Brown Manufacturing
PROGRAM 6.2B – Excel QM Solutions

Quantity Discount Models
• Quantity discounts are commonly available
• Basic EOQ model is adjusted by adding in the
purchase or materials cost
Total cost  Material cost + Ordering cost + Holding cost
where
D  annual demand in units
Co  ordering cost of each order
C  cost per unit
Ch  holding or carrying cost per unit per year

Quantity Discount
Holding cost per Models
unit is based on cost, so
• Quantity discounts are commonly available Ch = IC
• Basic EOQ model is adjusted by adding in the
where
purchaseI =orholding
materials
cost as acost
percentage of the unit cost (C)
Total cost  Material cost + Ordering cost + Holding cost
where
D  annual demand in units
Co  ordering cost of each order
C  cost per unit
Ch  holding or carrying cost per unit per year

• Discount schedule and EOQs might not align
• Buying at the lowest unit cost may not result
in lowest total cost
TABLE 6.3 – Quantity Discount Schedule
DISCOUNT DISCOUNT DISCOUNT

NUMBER QUANTITY DISCOUNT (%) COST ($)
1 0 to 999 0 5.00
2 1,000 to 1,999 4 4.80
3 2,000 and over 5 4.75

FIGURE 6.6 – Total Cost Curve for the Quantity Discount Model
Total
TC Curve for Discount 3
Cost
$ TC Curve for
Discount 1
TC Curve for Discount 2
EOQ for Discount 2
0 1,000 2,000
Order Quantity
• Steps in the process
1. For each discount price (C), compute
2. If EOQ < Minimum for discount, adjust the quantity to

Q = Minimum for discount
3. For each EOQ or adjusted Q, compute
4. Choose the lowest-cost quantity

Brass Department Store
• Toy race cars
• Quantity discounts available
Step 1 – Compute EOQs for each discount

Step 2 – Adjust quantities below the allowable
discount range
– The EOQ for discount 1 is allowable
– The EOQs for discounts 2 and 3 are
outside the allowable range, adjust to the
possible quantity closest to the EOQ
Q1  700
Q2  1,000
Q3  2,000

Step 3 – Compute total cost for each quantity
TABLE 6.4 – Total Cost Computations for Brass Department Store
ANNUAL ANNUAL ANNUAL

UNIT ORDER MATERIAL ORDERING CARRYING
DISCOUNT PRICE QUANTITY COST ($) COST ($) COST ($)
NUMBER (C) (Q) = DC = (D/Q)Co = (Q/2)Ch TOTAL ($)
1 $5.00 700 25,000 350.00 350.00 25,700.00
2 4.80 1,000 24,000 245.00 480.00 24,725.00
3 4.75 2,000 23,750 122.50 950.00 24,822.50
Step 4 – Choose the alternative with the

lowest total cost

PROGRAM 6.3A – Excel QM Formulas and Input Data

PROGRAM 6.3B – Excel QM Solutions

Use of Safety Stock
• If demand or the lead time are uncertain, the
exact ROP will not be known with certainty
• Safety stock can help prevent stockouts
• Can be implemented by adjusting the ROP
Average demand Safety

ROP = +
during lead time stock
Average demand
ROP = + SS
during lead time
where
SS = safety stock
Use of Safety Stock
FIGURE 6.7 Inventory
on
Hand
Time
Stockout
Inventory
on
Hand
Safety
Stock, SS Stockout is avoided
0 Units
Time
Use of Safety Stock
• Objective is to choose a safety stock amount
the minimizes total holding and stockout costs
• If variation in demand and holding and
stockout costs are known, payoff/cost tables
could be used to determine safety stock
• More general approach is to choose a desired
service level based on satisfying customer
demand

Use of Safety Stock
• Set safety stock to achieve a desired service
level
Service level = 1 – Probability of a stockout

or
Probability of a stockout = 1 – Service level

Safety Stock with the
Normal Distribution
ROP = (Average demand during lead time) + ZsdLT
where
Z = number of standard deviations for a given service
level
sdLT = standard deviation of demand during the lead
time
Thus Safety stock = ZsdLT

Hinsdale Company
• Item A3378 has normally distributed demand during
lead time
Mean = 350 units, standard deviation = 10
• Stockouts should occur only 5% of the time
FIGURE 6.8
  Mean demand  350
dLT  Standard deviation  10
X  Mean demand + Safety stock
5% Area of
SS  Safety stock  X –   Z Normal Curve
SS
  350 X?

Hinsdale Company
• From Appendix A we find Z  1.65
ROP = (Average demand during lead time) + ZsdLT

= 350 + 1.65(10)
= 350 + 16.5 = 366.5 units (or about 367 units)
5% Area of
SS = Normal Curve
16.5
  350 X  366.5

Calculating Lead Time Demand and
Standard Deviation
• Three situations to consider

– Demand is variable but lead time is
constant
– Demand is constant but lead time is
variable
– Both demand and lead time are variable

Standard Deviation
1. Demand is variable but lead time is constant
where

Standard Deviation
2. Demand is constant but lead time is variable
where

Standard Deviation
3. Both demand and lead time are variable
– The most general case

– Can be simplified to the earlier equations

Hinsdale Company
• Determine safety stock for three other items
• For SKU F5402,
• Desired service level = 97%
– For a 97% service level, Z = 1.88

Hinsdale Company
• For SKU B7319,

Hinsdale Company
• For SKU F9004,

Service Levels, Safety Stock,
and Holding Costs
• As service levels increase
– Safety stock increases at an increasing
rate
• As safety stock increases
– Annual holding costs increase

Hinsdale Company
TABLE 6.5 – Safety Stock for SKU A3378 at Different Service Levels
SERVICE Z VALUE FROM SAFETY STOCK

LEVEL (%) NORMAL CURVE TABLE (UNITS)
90 1.28 12.8
91 1.34 13.4
92 1.41 14.1
93 1.48 14.8
94 1.55 15.5
95 1.65 16.5
96 1.75 17.5
97 1.88 18.8
98 2.05 20.5
99 2.33 23.3
3.72 37.2
99.99
Calculating Annual Holding Cost with
Safety Stock
• Under standard assumptions of EOQ
– Average inventory = Q/2
– Annual holding cost = (Q/2)Ch
• With safety stock
Holding cost
Total annual Holding cost of
= of regular +
holding cost safety stock
inventory
where
THC =
total annual holding
cost
Q= order quantity
Ch = holding cost
Copyright ©2015 Pearson Education, Inc.
per unit per year 6 – 74
SS = safety stock
Hinsdale Company
FIGURE 6.9 – 80 –
Service Level –
–
Versus –
–
Annual Carrying Costs 70 –
–
–
–
–
60 –
–
–
–
–
50 –
–
–
–
–
40 –
–
–
–
–
30 –
–
–
–
–
20 –
–
–
– | | | | | | | | | | |
90 91 92 93 94 95 96 97 98 9999.99(%)

Hinsdale Company
FIGURE 6.9 – 80 –
Service Level –
–
Versus –
–
Annual Carrying Costs 70 –
–
–
–
–
60 –
–
–
–
–
50 –
–
–
–
–
40 –
–
–
–
–
30 – This graph was
–
– developed for a specific
–
–
20 –
case, but the general
–
– shape of the curve is the
– | | | | | | | | |
same
| |
for all cases
90 91 92 93 94 95 96 97 98 9999.99(%)

Using Excel QM for
Safety Stock Problems
PROGRAM 6.4A – Formulas and Input Data

Using Excel QM for
Safety Stock Problems
PROGRAM 6.4B – Solutions

Single-Period Inventory Models
• Some products have no future value beyond
the current period
– News vendor problems or single-period inventory
models
• Marginal analysis uses marginal profit (MP)
and marginal loss (ML)
– With a manageable number of states of nature and
alternatives, use discrete distributions
– When there are a large number of alternatives or
states of nature, use normal distribution

Marginal Analysis with
Discrete Distributions
• Stock an additional unit only if the expected
marginal profit for that unit exceeds the
expected marginal loss
P  probability that demand will be greater than
or equal to a given supply (or the probability
of selling at least one additional unit)
1 – P  probability that demand will be less than

supply (or the probability that one additional
unit will not sell)

Marginal Analysis with
• The expected marginal profit = P(MP)
• The expected marginal loss = (1 – P)(ML)
• The optimal decision rule
Stock the additional unit if P(MP) ≥ (1 – P)ML
• With some basic manipulation
P(MP) ≥ ML – P(ML)
P(MP) + P(ML) ≥ ML or
P(MP + ML) ≥ ML

Steps of Marginal Analysis with
1. Determine the value of for the

problem
2. Construct a probability table and add a

cumulative probability column
3. Keep ordering inventory as long as the

probability (P) of selling at least one
additional unit is greater than

Café du Donut
• Café buys donuts each day for $4 per carton
of 2 dozen donuts
• Cartons not sold are thrown away at the end
of the day
• If a carton is sold, the total revenue is $6
• The marginal profit per carton is
MP = Marginal profit = $6 – $4 = $2
• Marginal loss ML = $4 since doughnuts
cannot be returned or salvaged

Café du Donut
TABLE 6.6 – Café du Donut’s Probability Distribution
DAILY SALES PROBABILITY (P) THAT DEMAND

(CARTONS OF DOUGHNUTS) WILL BE AT THIS LEVEL
4 0.05
5 0.15
6 0.15
7 0.20
8 0.25
9 0.10
10 0.10
Total 1.00

Café du Donut
Step 1. Determine the value of for the
decision rule
Step 2. Add a new column to the table to reflect the

probability that doughnut sales will be at each
level or greater

Café du Donut
TABLE 6.7 – Marginal Analysis for Café du Donut
DAILY SALES PROBABILITY (P) THAT PROBABILITY (P) THAT

(CARTONS OF DEMAND WILL BE AT DEMAND WILL BE AT THIS
DOUGHNUTS) THIS LEVEL LEVEL OR GREATER
4 0.05 1.00 ≥ 0.66
5 0.15 0.95 ≥ 0.66
6 0.15 0.80 ≥ 0.66
7 0.20 0.65
8 0.25 0.45
9 0.10 0.20
10 0.10 0.10
Total 1.00

Café du Donut
Step 3. Keep ordering additional cartons as long
as the probability of selling at least one
additional carton is greater than P, the
indifference probability
P at 6 cartons  0.80 > 0.67

Marginal Analysis with the Normal
Distribution
• Find four values

1. The average or mean sales for the product, 
2. The standard deviation of sales, 
3. The marginal profit for the product, MP
4. The marginal loss for the product, ML
X *  optimal stocking level

Steps of Marginal Analysis with the
Normal Distributions
1. Determine the value of for the

problem
2. Locate P on the normal distribution

(Appendix A) and find the associated Z-value
3. Find X * using the relationship

to solve for the resulting stocking policy

Newspaper Example
• Chicago Tribune m = 60 papers a day, s = 10
• Marginal loss ML = 20 cents
• Marginal profit MP = 30 cents
Step 1. Stock the Tribune as long as the probability of

selling the last unit is at least ML/(ML + MP)
Let P = 0.40

Newspaper Example
Step 2. Using the normal distribution in Figure 6.10 find
the appropriate Z value
Z = 0.25 standard deviations from the mean
Area under the Curve is 1 – 0.40 = 0.60

(Z = 0.25) Mean Daily Sales
Area under the Curve is 0.40
  60 X* X  Demand
FIGURE 6.10

Newspaper Example
• Chicago Tribune m = 60 papers a day, s = 10
Step 3.
or
X *  60 + 0.25(10)  62.5, or 62 newspapers
Joe should order 62 newspapers since

the probability of selling 63 newspapers
is slightly less than 0.40

Newspaper Example
Area under the Curve is 1 – 0.40 = 0.60

(Z = 0.25) Mean Daily Sales
Area under the Curve is 0.40
  60 X  Demand
FIGURE 6.10 X * = 62.5
Optimal Stocking Policy (62 Newspapers)

Newspaper Example
• The procedure is the same when P > 0.50
• Chicago Sun-Times
• ML = 40 cents, MP = 10 cents, m = 100, s = 10
Step 1.

Newspaper Example
Step 2. Using the normal distribution in Figure 6.11 find
the appropriate Z value for 0.80 and multiply by –1
Z = –0.84 standard deviations from the mean

Area under the
Curve is 0.80
(Z = – 0.84)
Figure 6.11
X *   100 X  Demand
Optimal Stocking Policy (91 Newspapers)

Newspaper Example
• Chicago Sun-Times m = 100 papers a day, s = 10
Step 3.
or
X *  100 – 0.84(10)  91.6, or 91 newspapers
Joe should order 91 copies of the

Chicago Sun-Times every day

ABC Analysis
• The purpose is to divide the inventory into
three groups based on the overall inventory
value of the items
• Group A items account for the major portion of
inventory costs
– Typically 70% of the dollar value but only 10% of
the quantity of items
– Forecasting and inventory management must be
done carefully
– Mistakes can be expensive

ABC Analysis
• Group B items are more moderately priced
– May represent 20% of the cost and 20% of the
quantity
– Moderate levels of control
• Group C items are very low cost but high
volume
– It is not cost effective to spend a lot of time
managing these items
– Simple control policies and loose control

ABC Analysis
TABLE 6.8
INVENTORY DOLLAR INVENTORY ARE QUANTITATIVE CONTROL

GROUP USAGE (%) ITEMS (%) TECHNIQUES USED?
A 70 10 Yes
B 20 20 In some cases
C 10 70 No

Dependent Demand:
The Case for Material
• Inventory models discussed so far have
assumed item demand was independent
• In many situations items demand is
dependent on demand for one or more other
items
• In these situations material requirements
planning (MRP) can be employed effectively

Dependent Demand:
The Case for Material
• Benefits of MRP
1. Increased customer service levels
2. Reduced inventory costs
3. Better inventory planning and scheduling
4. Higher total sales
5. Faster response to market changes and shifts
6. Reduced inventory levels without reduced
customer service

Material Structure Tree
• The first step is to develop a bill of materials
(BOM)
• BOM identifies components, descriptions, and
the number required for production of one unit
of the final product
• Material structure tree developed from the
BOM
– Demand for product A is 50 units
– Each A requires 2 units of B and 3 units of C
– Each B requires 2 units of D and 3 units of E
– Each C requires 1 unit of E and 2 units of F
Material Structure Tree for Item A
Level
0 A
1 B(2) C(3)
2 D(2) E(3) E(1) F(2)
FIGURE 6.12

• The demand for B, C, D, E, and F is
completely dependent on the demand for A
• The material structure tree has three levels
• Items above a level are called parents
• Items below any level are called components
• The number in parenthesis beside each item
shows how many are required for each unit of
the parent

• We can use the material structure tree and
the demand for Item A to compute demands
for the other items
Part B: 2  number of A’s  2  50  100
Part C: 3  number of A’s  3  50  150
Part D: 2  number of B’s  2  100  200
Part E: 3  number of B’s + 1  number of C’s
 3  100 + 1  150  450
Part F: 2  number of C’s  2  150  300

Gross and Net Material
Requirements Plan
• A gross material requirements plan is

constructed after the materials structure tree
is complete
– Time schedule
– Shows when an item must be ordered
– Shows when there is no inventory on hand
– Shows when the production of an item must be
started in order to satisfy the demand for the
finished product at a particular date

Requirements Plan
• Lead times are required for each item
Item A – 1 week Item D – 1 week

Item B – 2 weeks Item E – 2 weeks
Item C – 1 week Item F – 3 weeks

Gross Material Requirements Plan
FIGURE 6.13 – Gross Material Requirements Plan for 50 Units of A
Week
1 2 3 4 5 6
Required Date 50
A Lead Time = 1 Week
Order Release 50
Every part A requires 2 part B’s in week 5
Required Date 100
B Lead Time = 2 Weeks
Order Release 100
Required Date 150

C Lead Time = 1 Week
Order Release 150
Required Date 200

D Lead Time = 1 Week
Order Release 200
Required Date 300 150

E Lead Time = 2 Weeks
Order Release 300 150
Required Date 300

F Lead Time = 3 Weeks
Order Release 300
Requirements Plan
• A net material requirements plan can be
constructed from the gross materials
requirements plan and on-hand inventory
information
TABLE 6.9
ITEM ON-HAND INVENTORY
A 10
B 15
C 20
D 10
E 10
F 5
Requirements Plan
• Using this data we can construct a plan that
includes:
– Gross requirements
– On-hand inventory
– Net requirements
– Planned-order receipts
– Planned-order releases
• The net requirements plan is constructed like
the gross requirements plan

Net Material Requirements Plan
Figure 6.14(a)
Week
Lead
Item 1 2 3 4 5 6 Time
A Gross 50 1
On-Hand
10 10
Net 40
Order 40
Receipt
Order
Release 40
B Gross 80A 2
On-Hand 15
15
Net 65
Order
65
Receipt
Order
Figure 6.14(b)
Week
Lead
Item 1 2 3 4 5 6 Time
C Gross 120A 1
On-Hand 10
20
Net 100
Order
Receipt 100
Order 100
Release
D Gross 130B 1
On-Hand
10 10
Net 120
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Receipt
Figure 6.14(c)
Week
Lead
Item 1 2 3 4 5 6 Time
E Gross 195B 100C 2

On-Hand
10 10 0
Net 185 100

Order
185 100
Receipt
Order 185 100
Release
F Gross 200C 3
On-Hand
5 5
Net 195
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Receipt
Two or More End Products
• Most manufacturing companies have more
than one end item AA
• A second product AA has
this material structure tree D(3) F(2)
• If we require 10 units of AA, the gross

requirements for parts D and F are
Part D: 3 x number of AA’s = 3 x 10 = 30
Part F: 2 x number of AA’s = 2 x 10 = 20

Two or More End Products
• The lead time for AA is one week
• The gross requirement for AA is 10 units in
week 6 and there are no units on hand
• This new product can be added to the MRP
process
– The addition of AA will only change the MRP
schedules for the parts contained in AA
• MRP can also schedule spare parts and
components
– These have to be included as gross requirements

Figure 6.15(a) – Including AA
Week
Lead
Item 1 2 3 4 5 6 Time
AA Gross 10 1
On-Hand 0
0
Net 10
Order
10
Receipt
Order
10
Release
A Gross 50 1
On-Hand
10
10
Net 40
Order
Receipt 40
Order
Figure 6.15(b) – Including AA
Week
Lead
Item 1 2 3 4 5 6 Time
B Gross 80A 2
On-Hand 15
10
Net 65
Order
65
Receipt
Order
65
Release
C Gross 120A 1
On-Hand
10
20
Net 100
Order
100
Receipt
Figure 6.15(c) – Including AA
Week
Lead
Item 1 2 3 4 5 6 Time
D Gross 130B 30AA 1

On-Hand
10
10 0
Net 120 30
Order
Receipt
120 30
Order
Release
120 30
E Gross 195B 100C 2

On-Hand 10 0
10
Net 185 100
Order 185 100
Figure 6.14(d) – Including AA
Week
Lead
Item 1 2 3 4 5 6 Time
F Gross 200C 20AA 3

On-Hand
5 5 0
Net 195 20
Order
195 20
Receipt
Order 195 20
Release

Just-in-Time Inventory Control
• Organizations have tried to have less in-
process inventory on hand to achieve
greater efficiency in the production
process
• This is known as JIT inventory
– The inventory arrives just in time to be used
during the manufacturing process
• One technique of implementing JIT is a
manual procedure called kanban

Just-in-Time Inventory Control
• Kanban in Japanese means “card”
• Dual-card kanban system
– Conveyance, or C-kanban
– Production, or P-kanban
• Simple systems but require
considerable discipline
• Little inventory to cover variability
• Schedule must be followed exactly

The Kanban System
FIGURE 6.16
P-kanban C-kanban
and and
Container Container
4 1
Producer Storage User

Area Area Area
3 2

4 Steps of Kanban P-kanban
and
Container
C-kanban
and
Container
4 1
1. Full containers along with their

Area Area Area
3 2
C-kanban card are taken from

the storage area to a user area,
typically on a manufacturing line (arrow 1).
2. During the manufacturing process, parts in the
container are used up by the user. When the
container is empty, the empty container along with
the same C-kanban card is taken back to the storage
area (arrow 2). Here the user picks up a new full
container, detaches the P-kanban card from it,
attaches his or her C-kanban card to it, and returns
with it to the user area.

4 Steps of Kanban P-kanban
and
Container
C-kanban
and
Container
4 1
Area Area Area
3. The detached P-kanban card 3 2
is then attached to an empty

container in the storage area and then—and only
then—is the empty container taken back to the
upstream producer area (arrow 3).
4. This empty container is then refilled with parts and
taken with its P-kanban card back to the storage
area (arrow 4). This kanban process continuously
cycles throughout the day. Kanban is sometimes
known as a “pull” production system.

Some Kanban Rules
• Minimum of two containers are required
• No containers are filled without the
appropriate P-kanban
• Each container must hold exactly the
specified number of parts or items
• Only those parts that are needed are
produced

Enterprise Resource Planning
• MRP has evolved to include
– Labor hours
– Material cost
– Other resources related to production
– Refered to as MRP II and resource replaces the
word requirements
• Sophisticated software was developed,
systems became known as enterprise
resource planning (ERP) systems

• Objective of ERP System is to reduce costs
by integrating all of the operations of a firm
– From supplier of materials needed through the
organization to invoicing the customer
– Data entered only once
– Central database quickly and easily accessed by
anyone in the organization
• Benefits include
– Reduced transaction costs
– Increased speed and accuracy of information

• Drawbacks to ERP
– Software is expensive to buy and costly to
customize
– The implementation of an ERP system may require
a company to change its normal operations
– Employees are often resistant to change
– Training employees on the use of the new software
can be expensive

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6

1. Understand the importance of inventory control and

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5. Understand the use of safety stock.

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ORDERING COST FACTORS CARRYING COST FACTORS

Processing and inspecting incoming inventory Taxes

Bill paying Insurance

Inventory inquiries Spoilage

Utilities and building costs for the warehouse

Supplies such as forms and paper for the

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Annual Number of Ordering

Annual demand Ordering

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Annual Carrying cost

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Carrying Cost Curve

Ordering Cost Curve

Optimal Order Quantity

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Number of orders per year = (D/Q) = 5

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Carrying Cost Curve

$50 Ordering Cost Curve

Q = 200 Order Quantity

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Cost of storing inventory for one year = Ch = IC

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• In general, the EOQ changes by the square

Demand Lead time for a new

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ROP  d  L  40 units per day  3 days

• An order for the EOQ (400) is placed when the

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ROP  d  L  40 units per day  12 days

Q  number of pieces per order, or

Since Total produced  Q  pt and

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Solving for Q, we get

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1. How many units should Brown produce