EOQ-EPQ Basics

José Antonio Larco, Ph.D.

[email protected]

5 / 5 / 2020
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Index

• Total relevant costs

• EOQ
• Sensitivity análisis
• Fundamental trade/off
• EPQ
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Final messages (previous class)

• Planning and control is important for the
finances and sales of the company.
• The strategies are disaggregated hierarchically.
• Inventory costs include more elements than the
cost of capital.
• The information is scattered in the organization.
• Only variable / marginal costs that depend on
the units in question should be considered.
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Basic Situation
• An office department consumes 1000 pencils per
week.
• Fixed ordering cost: K=$100
• Cost of holding inventory: h=$0.5/pencil
• The holding costs are realized at the end of every
week.
• How can we select Q for minimizing operational
costs?
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Characterize the situation …

• Demand demanda constante • Discounts no hay descuentos

• Constant vs Variable ▫ None

• Known vs Random ▫ All units or Incremental
• Continuos vs Discrete • Oversupply no habra escasez

• Lead time L=0 ▫ None

• Instantaneous ▫ All orders are postponed
• Constant or Variable (backorder)
(deterministic/stochastic) ▫ Lost orders
• Dependence of the ítems • Substitution el producto no se vence, es infinito

• Independent no hay dependencia entre diferentes pedidos ▫ Perishable

• Correlates ▫ No
• Perfect dependence • Planning Horizon el horizonte es infinito
• Inventory Review revision de inventario continua
▫ Single Period
• Continuous vs Periodic ▫ Finite Period
• Number of Network Levels ▫ Infinity
• One vs Many una unica ubicación • Number of Items numero de SKU , solo uno
• Capacity / Resources capacidad ilimitada = el proveedor nos da lo que quueremos ▫ One
• Unlimited vs Limited ▫ Many
 Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Symbols
Q = lot size to order
EOQ = Q* = Economic Order Quantity
D = Average Demand Rate (e.g. pencils/year)
K = Fixed Ordering Cost $ Ct

h =Carrying (inventory maintenance cost) ( $ /pencil per year) Ce

c = Procurement Cost per unit (e.g. $/unit)

T = Cycle Time (time interval between replenishments)
TC = Total Annual Costs
F = 1/T Ordering Frequency

Check consistency
in time units (e.g. year)
 Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Different strategies
 siempre se pide la


misma cantidad q
inventario de ciclo es el
1. JIT 2. Single order
inventario promedio
 Q es valor fijo
 Q/2 es inventario
promedio
 Tiempo de ciclo T

SCM 404 Demand Fulfillment Summer 2011

What
Inserta isimagen
texto de the optimum
aquí quantity and order frequency?
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Different strategies
1. JIT 2. Single order

=cilco de reabastecimiento

-->

cero
 Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Different strategies
puede ser cualquiera de las 3 formas, pero siempre hay que considerar que estrategia nos genera un menor costo.

1. JIT 2. Single order 3. Hybrid

si se hace un unico pedido de 600 unidades 1 vez si se pide 300 unidades 2 veces
si se hacen pedidos de 100 unidades 6 veces

Inserta texto de imagen aquí

Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

The average inventory Defined as the infinitisemal sum

of inventory devided by the replenishment
period

  (Q − Dtorder
T T
1.Iavg
JIT = 0 I (t )dt 2.
0 Single )dt
=
T T
Replenishment period
T
 Dt  2
2
Qt − 2 
T
QT −
 0 = 2 =Q−T D
T T 2

T Q Q Q
Iavg = Q − =Q− =
2T 2 2
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Managerial Takeaway 1
cuando determino la cantidad a pedir autometicamente estoy determinando mi tiempo de ciclo o ta mbien llamda frecuencia de reabastecimiento.
demanda y tiempo de cilo deben de estra en las mimas unidades

1. JIT 2. Single
Fixing the order order is
quantity
EQUIVALENT to fixing the period
T↔Q
between replenishments or
frequency of replinshmment.

Q=DT
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Fundamental Trade-off
F es la inversa del tiempo de ciclo = numero de pedidos en el ciclo

1. JIT 2. Single order

Avg. Inventory vs. Order frequency
1 1 D
F= = =
S/.1,600

T Q
S/.1,400
Q S/.1,200

Avg. Inventory S/.

S/.1,000

D S/.800

Q= S/.600

F S/.400

S/.200

Q D
InvAvg = =
S/.-
0 200 400 600 800
Order frequency orders/year
2 2F
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Fundamental Trade-off
Do it yourself:
1. JIT
Suppose 2. Single
that the the demand for office desks isorder
2000 units/year,
consider what would happen to average inventory (in $) if you ordered:

Consider that the product costs $300 per unit.

- Once per year

- Twice per year
- Once per trimester
- Monthly
- Once every 15 days
- Weeky
- Twice per week
- Daily
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Managerial Takeaway 3

The average inventory and order frequency are inversely

1. JIT
related: 2. Single order
• This means that for certain domains, average inventory
can be reduced drastically by a small increase in order
frequency.
• At the same time, for certain domains, average inventory is
relatively insensitive to changes in order frequency.

 el invenytario promedio y la frecuencia de pedidos son inversamente proporcionales

 que en cierto tramo el inventariop promedio se puede reducir de manera significativa cuando se
incrementa en una pequeña cantidad la frecuencia de pedidos
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Costs Analysis
Economic Order Quantity (EOQ) minimizes the relevant
costs:
1. JITcosto de mantenimeinto 2. Single order
costo de pedido costo de producto

Annual Annual
Annual
average Ordering
total = carrying + costs
+ procurement
costs costs
cost

Q =C $ e D =C t

TC(Q) = h + K + cD
2 Q
Number of Orders
Average h is given per unit and
estimated with a i% of the
Inventory procurement cost
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

The function of annual cost:

TC
Total Cost
1. JIT 2. Single order

Total Cost TC
Q
Average
h
D Q Inventory 2
K= h Carrying Cost
Q 2
Annual ordering D K
costs
Q
Annual cost of procurement

Min Order Quantity(Q)

Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

• First order conditions • Second order conditions

d1. TC(Q)
JIT =0 d
2. Single order
2 TC(Q)= 2cD >0
dQ d2Q Q3

h DK Indeed, the critical point is a minimum.

− +0=0
2 Q2
h DK
=
2 Q2
Q 2 h = 2 DK
2 DK
EOQ = Q* =
h
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Alternatively (in terms of time)…

2 DK Q
1. JIT= Q* =
EOQ T * = order
2. Single
h D
 1  2 DK 2 DK
T* =   =
D
2
Beware of units!
h D h
2k
T* =
T is in units of time
(weeks, months, years)
Dh
D demand rate in:
requested units / unit of time
(weeks, months, years)
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

The optimum total relevant cost will be….

2 DK
∗𝑄 𝐷
∗
EOQ = Q* =
𝑇𝑅𝐶 = 𝑄 ℎ
2
+𝐾 ∗
𝑄 h
2𝐷𝐾
1. JIT 2. Single order
ℎ 𝐾𝐷
∗ ℎ
𝑇𝑅𝐶 𝑄 = +
2 2𝐷𝐾
ℎ
2𝐾𝐷
2𝐾𝐷
2𝐷𝐾 2𝐷𝐾 ∗ ℎ
ℎ 𝑇𝑅𝐶 𝑄 =
∗ ℎ ℎ 𝐾𝐷 2𝐾𝐷
𝑇𝑅𝐶 𝑄 = + ℎ
2𝐷𝐾 2𝐷𝐾
2
ℎ ℎ
4𝐾𝐷 𝑇𝑅𝐶 𝑄 = 2𝐾𝐷ℎ
∗
𝑇𝑅𝐶 𝑄 =
2𝐷𝐾
2 es el TRC(Q*) el profe se olvido el * xd
ℎ
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Managerial Takeaway 3

While the holding costs increase

1. JIT 2. Single order
linearly with Q, the ordering
costs decrease in an inverse
relationship with Q.
Q is optimal when the ordering costs
are balanced with the ordering
costs.
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Managerial Takeaway 4

Changing the givens. The size of Q* will depend on K and h.

1. JIT 2. Single order
The higher the ordering cost, the larger the optimum size. The
higher h, the lower the optimum size.

For getting closer to a JIT (Just in Time) environment, it is

critical to reduce K with process improvements initiatives.
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Defining a policy: reordering points

Inventory Order
received Another
received order

1. JIT Q
2. Single order
Inventory
diminishes at a
Average constant rate
inventory
level
= Q/2

Reorder
point
R

Time
L L
s = R = DLT = L *D
Placed Received Placed Received
order Order Order Order
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Other important definitions

𝐼 𝑡 = inventory at time t (stock on hand)
= inventario disponible
1. JIT 2. Single order
𝐼𝑂 𝑡 = inventory outstanding at time t (inventory that has been
ordered but not yet received)
=inventario en transito = pipeline inventory

𝐼𝑃(𝑡) = 𝐼 𝑡 + 𝐼𝑂(𝑡) , inventory position at time t (inventory position)

= posicion de inventario = inventory position
Demand during lead time=
𝐼(𝑡 + 𝐿) = 𝐼 𝑡 + 𝐼𝑂(𝑡)- DLT D*L

𝐼(𝑡 + 𝐿) = 𝐼𝑃 𝑡 − DLT Conservation of material flow

Inventory Management: EOQ Basics José Antonio Larco, Ph.D.
Managerial Takeaway 5

For an inventory policy,

1. JIT
it is important to define the
2. Single order
inventory position (includes stock on hand and
outstanding orders). This avoids ordering more than
once and consider the in-transit inventory.
 José Antonio Larco, Ph.D.

Inventory Management: EOQ Basics

Sensitivity Analysis
A store
1. JITin PROMART has 2. forecasted a demand of 1,125
Single order
O´rings per year. Each time there is an order the central
warehouse charges a fixed tariff of $20.
The cost of the product is $1 per unit. The annual cost of
holding inventory is 25% of the product value. The Store
Manager would like to stablish an ordering policy. We know
that the Lead time is 1 week long (assume a 50 week
year). What would happen if the forecast was mistaken
and the real yearly demand was 1,445 O´ring units?

2KD
Q∗ =
h
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Solution
D = 1,125
K = $201. JIT 2. Single order
h = $0.25

2KD 2 × 20 × 1,125
Q∗= = = 424.26 units
h 0.25

Total costs:
KD hQ
C(Q) = + = $106.07
Q 2
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Sensitivity analysis

• With
1. JITa demand of 1,445 units:
2. Single order

2KD 2 × 20 × 1,445
Q∗= = = 480.83 units
h 0.25

• What is the difference in the relevant cost?

C(Q=481) = (481/2)*0.25+(1,445/481)=$120.85
C(Q=424) = (424/2)*0.25+(1,445/424)=$121.15
What if demand if the real demand is reallly x1/3, x1/2, x2, x3 than 1125?
Inventory Management: EOQ Basics
Sensitivity analysis José Antonio Larco, Ph.D.

2000

Total relevant cost ($)

Total cost: rather flat
1600
1. JIT 2. Single order
1200

Inventory
800
handling cost
400
Ordering
0 cost
0 2000 4000 6000 8000 10000

Order size Q
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Sensitivity analysis in a general form:

If demand is D instead of D´: para hallar la sensibilidad
ℎ𝑄´ 𝐾𝐷
+
1. JIT C(Q′)
=
2 𝑄´ 2. Single order
Dividing by
∗
C(Q ) 2𝐾𝐷ℎ
2 up and down

Q´ ℎ2 1 4𝐾2 𝐷2
= +
2 2𝐾𝐷ℎ 2𝑄´ 2𝐾𝐷ℎ
𝑄´ 𝑄∗
= +
2𝑄∗ 2𝑄′

Q´ ℎ 1 2𝐾𝐷
= + C(Q′) 1 𝑄´ 𝑄∗
2 2𝐾𝐷 2𝑄´ ℎ = ( + )
C(Q∗) 2 𝑄∗ 𝑄´
1/Q* Q*
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Sensitivity analysis
If demand is D instead of the estimated D´:
Q′ 𝐷´
=
1. JIT 2. Single order
Q∗ 𝐷

We will order Q´ instead of Q*, with a relevant cost:

C(Q′) 1 Q′ Q∗ 1 T′ T∗
∗ = ∗ + = ∗ +
C(Q ) 2 Q Q′ 2 T T′

If we for example are (b-1)% off:

C(bQ∗ ) 1 bQ∗ Q∗ 1 1
∗ = ∗ + ∗ = b+
C(Q ) 2 Q bQ 2 b

What if demand is twice than the optimum?

Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Sensitivity to error estimation in the demand

EOQ is robust to demand variation

1. JIT 2. Single order
𝐷 𝐴𝑐𝑡𝑢𝑎𝑙
𝐸= ′=
𝐷 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒
D E Q*/Q' TC'/TC*
200 0.10 0.32 1.74
1,000 0.50 0.71 1.06
1,500 0.75 0.87 1.01
1,800 0.90 0.95 1.00
2,000 1.00 1.00 1.00
3,000 1.50 1.22 1.02
4,000 2.00 1.41 1.06
20,000 10.00 3.16 1.74
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Sensitivity to errors in demand estimation

1. JIT 2. Single order

If demand is D´ instead of D:
Q′ 𝐷´
=
Q∗ 𝐷

In terms of the replenishment cycle time:

C(T′) 1 T′ T∗
= +
C(T∗ ) 2 T∗ T′
Inventory Management: EOQ Basics
Defining reordering points José Antonio Larco, Ph.D.

𝑰𝑷(𝒕) 𝑰𝑷(𝒕)
Inventory
I(t+L)=IP(t)-D*LT
L

1. JIT 2. Single order

I(t)
Q unidades
I(t+L)

Reordering
point R

DLT = L D L
Time
L

Policy:
Monitor constantly the inventory, whenever IP(t-) ≤ DLT trigger an order
Inventory Management: EOQ Basics
José Antonio Larco,Ph.D.

Resumen>

1. Los CEOs pueden tener un comportamiento oportunista porque los

Inversionistas observarel inventario pero no las ventas futuras ni calidad del inventario.
Presion para aumentar el invetario,.

2. Conservacion de la materia> Q=DT

3. Inv, Q/2, Frec D/Q

4. EOQ, poco sensible a los parametros, robusto

5. Frecuencia vs, Inv Promedio, relaci[on inversa

6. Cuiden siempre unidades

Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

EOQ sensitivity and Roundy´s Power of

2 policy rule (Roundy Approximation,
1. JIT 1985)
2. Single order
So to synchronize the reception of different SKU´s: Benefits:

1. Better programming of
orders / les mistakes

2. Consolidation
opportunities for cargo
and handling operations
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

EOQ sensitivity and Roundy´s Power of 2

policy rule (Roundy Approximation, 1985)
Find the optimum ordering2.quantity
1. JIT Single of a product with the
order
following characteristics:

• Demand =25,000 units/year

• Placing order cost: $750/order
• Product cost of sale: $33.50/unit
• Holding cost rate: 15% per cost unit per year

Suppose we want to apply a Policy of power of 2 policy,

what would be the new practical T and Q and the % error
of Total Cost?
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Managerial Takeaway 6
Setting T instead of Q is more
1. JIT natural for companies.
2. Single order
Setting
periods power of 2, facilitates
coordination and provides
consolidation opportunities.
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

EOQ sensitivity and Roundy´s Power of

2 policy rule (Roundy Approximation,
1. JIT 1985)
2. Single order
Finding a practical T:

1. Calculate T*
2. Find a base period (day, week, etc)
3. Find the mínimum value k, that satisfies:

𝑇∗
≥ 2𝑘 ≥ 2𝑇 ∗
2
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Production Environments
1. JIT 2. Single order
So far we have only seen inventory models suitable
for buy/sell environments. What if we are in a
production setting?
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Finite production rate

Inventory • The products are produced at a rate P (units/time).
• Q is now the production lot size.
1. JIT 2. Single order
Slope = P − D Slope = − D

Time
T1 T2
T1= simultaneous production and T=T1+ T2 total cycle time: Q/D
consumption time: Q/P

T2= consumption time: Q/D-Q/P

Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Finite production rate

Inventory:

1.A=The
JIT highest inventory will be reached
2. Single order
at the end of time T1

Q=PT1 (the lot size will be finished at the end of time T1.

Therefore:

The average inventory is given by A/2. While the number of orders

(e.g. per year) is given by D/Q.

𝑄
𝐴 = (𝑃 − 𝐷)
𝑃
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Finite production rate

𝑃−𝐷 𝑄 𝐷
𝑇𝑅𝐶 𝑄 = ℎ+ 𝐾
2𝑃 𝑄
1. JIT 2. Single order

Aqui pasamos de EOQ --> POQ Modification of EOQ formula,

Similar to the EOQ formula, the POQ formula: Think what happens when P is very
large.
cantidad optima a producir
𝑄∗ = 𝑇 ∗𝐷

2𝐾𝐷 Utilization ratio:

𝑄∗ =
ℎ(1 − 𝐷/𝑃) 𝐷
=𝜌
𝑃

What happens when P is much larger than D?

Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

¿Make or Buy?
A firm can produce and package their own guitar strings or buy pre-packed rolls of
“discount” guitar strings.
1. JIT 2. Single order
If they load their own strings, there is a production set-up cost of $20.

The finished product is valued at $1.23 a set, and the production rate is 500 sets/day.
“Discount” strings cost the firm $1.26 per set and the fixed ordering charge is $3/order.

In either case, an inventory carrying charge of 1.81% per month would be used by the firm.

Demand of this item is 10,000 sets per year.

From the standpoint of total relevant inventory policy costs, would it be better to make or
buy?
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Set-up adjustments
Consider a facility with production rate 𝑃 = 90 items per week, a demand rate of
D= 50 items per week, a set-up cost of 𝑘 = $2000 and a holding cost of ℎ = $20 per item
1.week,
per JIT and no set-up times. 2. Single order
Then, If idle time > 0 weeks there is no problem, but if there is a set-up time
then the cycle time needs to be increased to allow for this:

2(2000)(50) 𝑠
𝑄∗ = 50 = 150 𝑥∗ =
1−𝜌
20(1− )
90

150
𝑥∗ = = 3 𝑤𝑒𝑒𝑘𝑠 If there is set-up time, suppose s=2 weeks, then the original
50
Cycle is infeasible, then:
2
𝑥∗ =
1 − 50/90
The idle time is:

150/50 - 150/90 = 1.33 weeks

Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Multiple products
Cyclical Production sequence:
Inventory 1-2-3-1-2-3-1-2…
1. JIT 2. Single order Item 1
𝑃1 − 𝐷1
Item 1 Item 2 Item 3
𝑃1 − 𝐷1 𝑃2 − 𝐷2 𝑃3 − 𝐷3

𝒔𝟑 𝒔𝟏 Time
𝒔𝟏 𝒔𝟐

𝑄1 𝑄2 𝑄3 Idle
𝑃1 𝑃2 𝑃3 time
Cycle time
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Finite production rate

Total Relevant Cost: Each lot for each cycle is the cycle time multiplied
by the demand of such time.
𝑛
1
1.෍JIT 𝐷𝑗 𝑥ℎ𝑗 𝑘𝑗
𝑇𝑅𝐶(𝑥) = min 𝑃𝑗 − 𝐷𝑗 + 2. Single order
𝑥 2 𝑃𝑗 𝑥
𝑗=1
𝑄𝑗 = 𝐷𝑗 𝑥

Derivating with respect to x and equallying to zero, we can find the optimal
cycle length:

σ𝑛𝑗=1 𝑘𝑗 𝑘𝑗 : set-up cost of product j

𝑥=
𝑛 (𝑃𝑗 − 𝐷𝑗 )ℎ𝑗 𝐷𝑗 𝐷𝑗 : demand of product j
σ𝑗=1
2𝑃𝑗 𝑃𝑗 : Production rate of product j
sj: Setup time
x: Cycle time
 Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Feasibility checks & adjustments

Utilization per item:

𝐷𝑗
𝜌𝑗 = ≤ 1,1.∀𝑗JIT
∈𝐽 2. Single
Utilization order
must be less than 1 per item.
𝑃𝑗
Cummulative utilization:
𝑛
𝐷𝑗 Cummulative utilization must be less than 1
𝑁𝑜𝑛 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑣𝑒 = ෍ ≤ 1
𝑃𝑗
𝑗=1
Idleness check (we define idle as the time where is not produced)
𝑛 𝑛
𝑄𝑗 Cummulative utilization must be less than 1
𝐼𝑑𝑙𝑒 = 𝑥 − ෍ ≥ ෍ 𝑠𝑗
𝑃𝑗
𝑗=1 𝑗=1
 Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Feasibility checks & adjustments

la utilizacion
acumulativa es
la utilizacion menor a 1
acumulativa es
mayor a 1 Calculate x and
1. JIT
Cummulative 2. Single
Idle time
order
utilization<1?

el tiempo de holgura idle time el tiempo de holgura es menor a

es mayor a toda la suma de toda la suma de los set ups
los set ups
Infeasible Idle time >
sum of
Set-ups?

Set to local optimum, use Adjust cycle time

σ𝑛𝑗=1 𝑠𝑗
σ𝑛𝑗=1 𝑘𝑗 sufficiently to
𝑥=
𝑥=
(𝑃𝑗 − 𝐷𝑗 )ℎ𝑗 𝐷𝑗
accommodate for the sum 1 − σ𝑛𝑗=1 𝜌𝑗
σ𝑛𝑗=1 of set-up times
2𝑃𝑗
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Example I
A production facility assembles four type of computer servers, Type I, Type II, Type III and Type IV.
Each have a distinct, demand, production rate, ordering cost and holding cost.

The question is1.which

JIT cycle time will minimize
2. such
Single
costs:order

1 2 3 4 Units
Demand Dj 50 50 60 60 products/month
Production rate pj 400 500 500 400 products/month
Holding cost hj $ 20.00 $ 20.00 $ 30.00 $ 70.00 $/(unit-month)
Set-up cost kj 2000 2000 2000 2000 $/set-up
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Example II
A production facility assembles four type of computer servers, Type I, Type II, Type III and Type IV.
Each have a distinct, demand, production rate, ordering cost and holding cost. However, know the production
facility includes set-up times because materials need to be handed over.
1. JIT 2. Single order
The question is which cycle time will minimize such costs:

1 2 3 4 Units
Set-up sj 0.3 0.3 0.3 0.3 months
Demand Dj 50 50 60 60 units/month
Production rate pj 400 500 500 400 /month
Holding cost hj 20 20 30 70 /(unit-month)
Set-up cost kj 2000 2000 2000 2000 /cycle
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Managerial Takeaway 7

1. For
JIT production, the
2. Single order
quantity to order
is reduced dependent on the Q/P
ratio.
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.
Discount Quantity
There may be discounts depending on the volume to be acquired:

v : unit price when Q<Q0, the normal price

v´: unit price when Q≥Q0, the discount price
1. JIT 2. where
Singlev´ order
- Situations:

Purchase Cost
Total Purchase Cost

Purchase Cost
0.29 Slope = c

0.3
0.29
Slope = c
0.3
500 Quantity 500 Quantity M M
Quantity
Some units All units
Discount on last units
each M units
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Inventory with discounts: all units

𝑐𝑡 𝐷 𝑐0 ℎ𝐷
𝑐 0 ≤ 𝑄 < 𝑄1 𝐷𝑐0 + + 0 ≤ 𝑄 < 𝑄1
𝑄 2
𝐶=ቊ 0 ൞
TRC=
1. JIT
𝑐1 𝑄1 ≤ 𝑄 2. Single
𝐷𝑐1 + order
𝑄
𝑐𝑡 𝐷
+
2
𝑐1 ℎ𝐷
𝑄1 ≤ 𝑄

Purchase cost

0.3 0.29

500 Quantity

1. Find Qco*, Qc1*

2. If Qc0*>Qc1*, chose Qc1*, if not go to step
3. Find TC(Qco*), TC(Q1)
If TC(Qco*) < TC(Q1) then choose Qc0*
Opposite case Q1
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Inventory with discounts-example I

1. JIT
Consider: 2. Single order
D=2000 units/year
i=0.25
Ct=K=$500
C0=$50
Discount of 15% if Q>800
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Incremental Discounts: some units

1. JIT 2. Single order

• The discount only applies to
units from the break point.
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

• The discounts only applies to the units from the break point.
• Balance between lower purchase cost and the cost of
maintaining inventory.
• Cost of units ordered below the break point are treated as a
new fixed cost (Fi).
1. JIT 2. Single order
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Process
1. Find the fixed cost, Fi, for
each break.
1. JIT
2. Find the Q * for each range,
including Fi.
3. If Q * is not within the
allowable range, go to the
next i. Otherwise find the
TRCi.
4. Choose the Q * with the
lowest CRT.
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Managerial Takeaway 8

1. JIT 2. Single order

Discounts may radically change the
optimal inventory policies.
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Incremental Discounts for Dog World

1.
YouJIT manage the 2.department
Single order of Dog World, a
global retailer. One of its products, a set of
containers for water and food, has a demand of
2500 units per year, and the cost of each is $ 22.
The cost of maintaining inventory is 25% per year,
and the estimated cost of ordering is $ 175. The
supplier asks you to order in increments of 10.
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Incremental Discounts en Dog World

In1. addition,
JIT the supplier
2. Singleoffers
order an incremental
discount of the product. You receive 5% discount
on items ordered from 500 units and 10% discount
on items ordered from 750 units.
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Discounts - example III

Consider:
D=4000 units/year
1. JIT 2. Single order
i=0.35 (annual)
Ct=K=$800
C0=$70 for the first 600 units, then you can order up to 700
units at no additional cost.
Finally the process is repeated.
Inventory Management: EOQ Basics José Antonio Larco, Ph.D.

Mini Case Challenge

You are purchase manager in Peru and
need to buy a Cable Type C Black 3 m.

1. JIT You expect

2. Single that the monthly demand will be
order
1200 units.
You know that 40% of the firm´s financing
source is debt. There the monthly fee
interest rate is 11% in the local bank. The
60% of the firm’s financing source is equity.
The annualy expected returns of such
equity is 6%.

The non-financial related costs are in total

an extra 5% per year per value.
Ordering on the on the other hand Use websites like ali baba, ali express.
costs $40 per order, Dhgate and others to find an optimal
plus any shipping cost included. ordering policy.
Inventory Management: EOQ Basics
José Antonio Larco,Ph.D.

1. No existe necesariamente una pregunta “equivocada“, no necesariamente vamos a saber

lo que la otra persona sabe ni en qué términos maneja la información.
2. Existen estrategias favorables:
- Estructrurar lo que necesitamos y tengas objetivos concretos al preguntar
- Desagregar por componentes
- Repreguntar, reformular las preguntas
- Reconocer actitud de la otra persona e insistir
3. Preguntarse si el aumento de un costo depende (es una función) del inventario o la frecuencia de pedir
4. Resumir por % de cada rubro incidencias
5. En caso de no obtener información de una forma, probar otra
y siempre entregar lo que se tiene señalando lo que falta
6. Considerar tipos de cambio, costos laborales obsolesencia, pérdidas
7. Consignar fuentes
Thank you!

José Antonio Larco, Ph.D.

[email protected]