Inventory Management

Rafia Islam
Lecturer,IPE, AUST
Introduction
What is Inventory??
Inventory is stock or store of goods

3 types of Inventory
• Raw material
• Work-in-process
• Finished goods
MROs (Maintenance, Repair, and Operating Materials)
2
Independent Versus Dependent Demand
▪ Independent demand - the demand for item is independent of the
demand for any other item in inventory
▪ Dependent demand - the demand for item is dependent upon the
demand for some other item in the inventory

Dependent demand Independent demand 3

Functions of Inventory
• To meet anticipated demand

• To smooth production requirements – seasonal

• To protect against stock outs

• To take advantages of quantity discounts

4
Objectives of Inventory Control
Inadequate control of inventories can result in both
under and overstocking of items

The overall objective of inventory management is to achieve

satisfactory levels of customer service while keeping inventory
costs within reasonable bounds.

The timing Size of orders

5
 Inventory Counting Systems
Periodic system

Perpetual inventory or Continual system

Two-bin system

Universal product code (UPC)

Point-of-sale (POS) systems

6
For details, please read this topic from the referred book (pdf page 595)
Universal product code (UPC)

- The zero on the left of the bar code identifies this as a grocery item,
the first five numbers (14800) indicate the manufacturer, and the last five
numbers (23208) indicate the specific item.
- Items in small packages, such as candy and gum, use a six-digit
number.

7
Inventory Costs
▪ Holding (carrying) cost
Cost to carry an item in inventory for a length of time, usually a year.
▪ Ordering costs
Costs of ordering and receiving inventory.
▪ Setup costs
The costs involved in preparing equipment for a job.
▪ Shortage costs
Costs resulting when demand exceeds the supply of inventory.

**Lead time: Time interval between ordering and receiving the order.
8
 Classification System
ABC Analysis

▪ Classifies inventory items according to some measure of importance and then

allocates control efforts accordingly.

▪ The origin of ABC analysis is “The Pareto Principle” which is named after an

Italian economist Vilfredo Pareto, also called as 80/20 rule.

9
 ABC Analysis
▪ Typically, three classes of items:

➢ A (very important)
➢ B (moderately important)
➢ C (least important)

10
ABC Analysis

A Class A: 10-15% contributes 60-70% value

Cost

B Class B: 20-30% contributes 20-30% value

C Class C: 60-70% contributes 5-10% value

Quantity

11
ABC Analysis Example-1
A manager has obtained a list of unit costs and estimated annual demands
for 10 inventory items and now wants to categorize the items on an A-B-C
basis.
Item Number Annual Demand Unit Cost Annual Dollar Value
1 2500 360 900000
2 1000 70 70000
3 2400 500 1200000
4 1500 100 150000
5 700 70 49000
6 1000 1000 1000000
7 200 210 42000
8 1000 4000 4000000
9 8000 10 80000
10 500 200 100000 12
ABC Analysis Example-1
Item Annual Unit Annual
Number Demand Cost Dollar Value
8 1000 4000 4000000
3 2400 500 1200000
6 1000 1000 1000000
1 2500 360 900000
4 1500 100 150000
10 500 200 100000
9 8000 10 80000
2 1000 70 70000
5 700 70 49000
7 200 210 42000
Total 7591000

13
ABC Analysis Example-1
Percentage
of
Item Annual Unit Annual Annual
Number Demand Cost Dollar Value Dollar Value
8 1000 4000 4000000 53%
3 2400 500 1200000 16%
6 1000 1000 1000000 13%
1 2500 360 900000 12%
4 1500 100 150000 2%
10 500 200 100000 1%
9 8000 10 80000 1%
2 1000 70 70000 1%
5 700 70 49000 1%
7 200 210 42000 1%
Total 7591000 14
ABC Analysis Example-1
Item Annual Unit Annual Percentage of
Number Demand Cost Dollar Value Annual Dollar Value
8 1000 4000 4000000 53% 53%
3 2400 500 1200000 16%
6 1000 1000 1000000 13% 41%
1 2500 360 900000 12%
4 1500 100 150000 2%
10 500 200 100000 1%
9 8000 10 80000 1% 6%
2 1000 70 70000 1%
5 700 70 49000 1%
7 200 210 42000 1%
Total 7591000 100%

15
ABC Analysis Example-1
Item Annual Unit Annual Percentage of Percentage
Number Demand Cost Dollar Annual Dollar of Items Classification
Value Value
8 1000 4000 4000000 53% 53% 10% A
3 2400 500 1200000 16%
6 1000 1000 1000000 13% 41% 30% B
1 2500 360 900000 12%
4 1500 100 150000 2%
10 500 200 100000 1%
9 8000 10 80000 1% 6% 60% C
2 1000 70 70000 1%
5 700 70 49000 1%
7 200 210 42000 1%
Total 7591000 100% 100%
16
ABC Analysis Example-1

Cost
Class A

50 Class B

Class C

10% 30% 60% Quantity

17
Inventory Models for Independent Demand

Need to determine when and how much to order

• The basic economic order quantity model

• The economic production quantity model
• The quantity discount model

18
Inventory Ordering & Usage Cycle
Maximum
Quantity inventory Usage rate
level Average
inventory
𝐐
level, 𝟐

ROP

Time
Minimum LT Place
inventory order Receive
level order
19
Economic Order Quantity (EOQ)
EOQ is the order quantity that minimizes total cost

Assumptions
• Only one product is involved
• Annual demand requirements are known
• Demand is spread evenly
• Lead time does not vary
• No quantity discount

20
Cost Calculations
𝑄 Average inventory level × Holding
Annual Holding Cost, HC = 𝐻 cost per unit per year
2
𝐷 Number of orders placed annually ×
Annual Ordering Cost, OC = 𝑆 Order cost per order
𝑄
𝑄 𝐷
Total Cost, TC = 𝐻 + 𝑆
2 𝑄 Material
Cost
𝑄 𝐷
Total Cost (including Material), TC = 𝐻 + 𝑆 + 𝐷 × 𝑃
2 𝑄

2𝐷𝑆
𝑓𝑜𝑟 𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝐶𝑜𝑠𝑡, 𝑄 =
𝐻 21
Cost Calculations
𝑑
𝑓𝑜𝑟 𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝐶𝑜𝑠𝑡, 𝑇𝐶 = 0
𝑑𝑄
𝑑 𝑄 𝐷
≫ 𝐻+ 𝑆 =0
𝑑𝑄 2 𝑄
𝑑 𝑄 𝑑 𝐷
≫ 𝐻 + 𝑆 =0
𝑑𝑄 2 𝑑𝑄 𝑄
𝐻 𝐷𝑆 𝐷𝑆 𝐻 1 𝐻
≫ − 2=0 ≫ 2= ≫ 2=
2 𝑄 𝑄 2 𝑄 2𝐷𝑆

2𝐷𝑆
⸫𝑄 =±
𝐻 22
Cost Calculations
𝑓𝑜𝑟 2𝑛𝑑 𝑑𝑒𝑟𝑖𝑣𝑎𝑡𝑖𝑣𝑒,

𝑑 𝐻 𝐷𝑆
= −
𝑑𝑄 2 𝑄 2
𝑑 𝐻 𝑑 𝐷𝑆
= −
𝑑𝑄 2 𝑑𝑄 𝑄2
𝐷𝑆
=0+2 3
𝑄
𝐷𝑆
=2 3 𝑝𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝑣𝑎𝑙𝑢𝑒
𝑄
23
Cost Curves
Annual

Total cost
Cost

Holding cost

Material cost
Ordering cost
EOQ Order Quantity
24
EOQ Example – 1 (LT = 0)

A local distributor for a national tire company expects to sell

approximately 9,600 steel-belted radial tires of a certain size and tread
design next year. Annual carrying cost is $16 per tire, and ordering cost
is $75. The distributor operates 288 days a year.
a. Determine the optimal number of tires to order.

2𝐷𝑆 2 × 9600 × 75
𝑊𝑒 𝑘𝑛𝑜𝑤, 𝑄 = = = 300 tires per order
𝐻 16

25
EOQ Example – 1
A local distributor for a national tire company expects to sell
approximately 9,600 steel-belted radial tires of a certain size and tread
design next year. Annual carrying cost is $16 per tire, and ordering cost
is $75. The distributor operates 288 days a year.
b. How many times per year does the store reorder?

We know,
𝐷 9600 𝑡𝑖𝑟𝑒𝑠/𝑦𝑟
Number of orders per year, N = =
𝑄 300 𝑡𝑖𝑟𝑒𝑠/𝑜𝑟𝑑𝑒𝑟

= 32 orders per year

26
EOQ Example – 1
A local distributor for a national tire company expects to sell
approximately 9,600 steel-belted radial tires of a certain size and tread
design next year. Annual carrying cost is $16 per tire, and ordering cost
is $75. The distributor operates 288 days a year.
c. Determine the length of an order cycle or expected time
between orders.

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

Length of an order cycle =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑟𝑑𝑒𝑟𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟, 𝑁
288
= = 9 days
32
27
EOQ Example – 1
A local distributor for a national tire company expects to sell
approximately 9,600 steel-belted radial tires of a certain size and tread
design next year. Annual carrying cost is $16 per tire, and ordering cost
is $75. The distributor operates 288 days a year.
d. Determine the annual Total cost.

We know,
𝑄 𝐷 300 9600
Total Cost, TC = 𝐻 + 𝑆 = × 16 + × 75
2 𝑄 2 300

= 2400 + 2400 = $4800

28
EOQ Example – 2 (LT = 0)

Piddling Manufacturing assembles security monitors. It purchases 3,600

black-and-white cathode ray tubes a year at $65 each. Ordering costs
are $31, and annual carrying costs are 20 percent of the purchase
price.
a. Compute the optimal quantity and the total annual cost of
ordering and carrying the inventory.

2𝐷𝑆 2 × 3600 × 31 2 × 3600 × 31

𝑊𝑒 𝑘𝑛𝑜𝑤, 𝑄 = = =
𝐻 65 × 0.2 13

≈ 131 cathode ray tubes

29
EOQ Example – 2
Piddling Manufacturing assembles security monitors. It purchases 3,600
black-and-white cathode ray tubes a year at $65 each. Ordering costs
are $31, and annual carrying costs are 20 percent of the purchase
price.
a. Compute the optimal quantity and the total annual cost of
ordering and carrying the inventory.
We know,
𝑄 𝐷 131 3600
Total Cost, TC = 𝐻 + 𝑆 = × 13 + × 31
2 𝑄 2 131

≈ 852 + 852 = $1704

30
Sudden Test!!!
A large bakery buys flour in 25-pound bags. The bakery uses an average of
1,215 bags a year. Preparing an order and receiving a shipment of flour
involves a cost of $10 per order. Annual carrying costs are $75 per bag.
a. Determine the economic order quantity.
b. What is the average number of bags on hand?
c. How many orders per year will there be?
d. Compute the total cost of ordering and carrying flour.
e. If holding costs were to increase by $9 per year, how much would that
affect the minimum total annual cost?

31
Solution

a. Economic Order Quantity:

2𝐷𝑆 2 × 1215 × 10
𝑊𝑒 𝑘𝑛𝑜𝑤, 𝑄 = = = 18 bags per order
𝐻 75

𝑄 18
b. Average number of bags on hand: = = 𝟗 𝒃𝒂𝒈𝒔
2 2

32
Solution
c. Number of orders per year:

𝐷 1215
= = 𝟔𝟕. 𝟓
𝑄 18
d. Total cost:
𝑄 𝐷 18 1215
TC = 𝐻 + 𝑆 = × 75 + × 10
2 𝑄 2 18

= 675 + 675 = $1350

33
Solution
e. By increasing holding costs by $9 per year:

2𝐷𝑆 2 × 1215 × 10 24300

𝑄= = = = 17 bags per order
𝐻 75 + 9 84

𝑄 𝐷 17 1215
⸫ Total Cost, TC = 𝐻 + 𝑆 = × 84 + × 10
2 𝑄 2 17

= 714 + 715 = $1429

Thus, total annual cost increases by $79
34
Economic Production Quantity (EPQ)
Production quantity that minimizes total cost
Production and Usage occur simultaneously
Assumptions
• Only one product is involved
• Annual demand requirements are known
• Demand is spread evenly
• Production as well as usage rate is constant
• Usage occur continually but Production occur periodically
• Lead time does not vary
• No quantity discount
35
Production & Usage cycle

Quantity
Production Production
Usage only Usage only
& Usage & Usage

Run size Q0

Imax

 u
Time
I max = Q0 
 1 − 

 p  36
Average Inventory Level
𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑙𝑒𝑣𝑒𝑙 𝐼𝑚𝑎𝑥
Annual inventory level = =
2 2

𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑙𝑒𝑣𝑒𝑙 = Total produced during certain time period –

Total used during certain time period

𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑙𝑒𝑣𝑒𝑙, 𝐼𝑚𝑎𝑥 = (p × 𝑡) − (𝑢 × 𝑡)

Q𝟎
𝑨𝒈𝒂𝒊𝒏, Q𝟎 = (p × 𝒕) ≫ 𝒕 =
𝒑
Q0 Q0 𝑢
𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑙𝑒𝑣𝑒𝑙, 𝐼𝑚𝑎𝑥 = p × − 𝑢× =Q0 − Q0 ×
𝑝 𝑝 𝑝
𝐮
⸫ 𝐈𝐦𝐚𝐱 =Q𝟎 × 𝟏 −
𝐩 37
Cost Calculations
𝐼𝑚𝑎𝑥
Annual Holding Cost, HC = 𝐻
2
𝐷
Annual Setup Cost, SC = 𝑆
𝑄0

𝐼𝑚𝑎𝑥 𝐷 𝑄0 𝑢 𝐷
Total Cost, TC = 𝐻+ 𝑆 = 1− 𝐻+ 𝑆
2 𝑄0 2 𝑝 𝑄0

2𝐷𝑆 𝑝
𝑓𝑜𝑟 𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝐶𝑜𝑠𝑡, 𝑄0 =
𝐻 𝑝−𝑢
38
Cycle Time or Length of the Cycle
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
Cycle time =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑟𝑑𝑒𝑟𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟, 𝑁

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

=
𝐷𝑒𝑚𝑎𝑛𝑑ൗ
𝑅𝑢𝑛 𝑠𝑖𝑧𝑒

𝑅𝑢𝑛 𝑠𝑖𝑧𝑒 × 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

=
𝐷𝑒𝑚𝑎𝑛𝑑
𝑅𝑢𝑛 𝑠𝑖𝑧𝑒
=
𝐷𝑒𝑚𝑎𝑛𝑑ൗ
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
𝑅𝑢𝑛 𝑠𝑖𝑧𝑒 𝑄0
= =
𝑈𝑠𝑎𝑔𝑒 𝑟𝑎𝑡𝑒 𝑢 39
EPQ Example – 1 (LT = 0)

A toy manufacturer uses 48,000 rubber wheels per year for its popular
dump truck series. The firm makes its own wheels, which it can produce
at a rate of 800 per day. The toy trucks are assembled uniformly over
the entire year. Carrying cost is $1 per wheel a year. Setup cost for a
production run of wheels is $45. The firm operates 240 days per year.
Determine the followings.
a. Optimal run size.

2𝐷𝑆 𝑝 2 × 48,000 × 45 800

𝑊𝑒 𝑘𝑛𝑜𝑤, 𝑄0 = =
𝐻 𝑝−𝑢 1 800 − 200

= 2,078.46 × 1.1547 ≈ 2400 wheels

40
EPQ Example – 1
A toy manufacturer uses 48,000 rubber wheels per year for its popular
dump truck series. The firm makes its own wheels, which it can produce
at a rate of 800 per day. The toy trucks are assembled uniformly over
the entire year. Carrying cost is $1 per wheel a year. Setup cost for a
production run of wheels is $45. The firm operates 240 days per year.
Determine the followings.
b. Minimum total annual cost for carrying and setup.
We know,
𝑄0 𝑢 𝐷 2400 200 48000
Total Cost, TC = 1− 𝐻+ 𝑆 = 1− ×1+ × 45
2 𝑝 𝑄0 2 800 2400

= $1800
41
EPQ Example – 1
A toy manufacturer uses 48,000 rubber wheels per year for its popular
dump truck series. The firm makes its own wheels, which it can produce
at a rate of 800 per day. The toy trucks are assembled uniformly over
the entire year. Carrying cost is $1 per wheel a year. Setup cost for a
production run of wheels is $45. The firm operates 240 days per year.
Determine the followings.
c. Cycle time for the optimal run size.

𝑄0 2400
Cycle time = = = 12 days
𝑢 200

42
EPQ Example – 1
A toy manufacturer uses 48,000 rubber wheels per year for its popular
dump truck series. The firm makes its own wheels, which it can produce
at a rate of 800 per day. The toy trucks are assembled uniformly over
the entire year. Carrying cost is $1 per wheel a year. Setup cost for a
production run of wheels is $45. The firm operates 240 days per year.
Determine the followings.
d. Run time.

𝑄0 2400
𝑅𝑢𝑛 𝑡𝑖𝑚𝑒 𝑜𝑟 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑡𝑖𝑚𝑒 = = = 3 days
𝑝 800

43
Quantity Discount
TC is affected by the price
discount on order size

Total cost
Annual
Cost

Holding cost

Material cost
Ordering cost
EOQ Order Quantity
44
Quantity Discount Example – 1
Here,
Demand = 816 units
H = $4 per unit
S = $12 per order
Price for the products are stated below:

Quantity Price
1 - 49 pcs $20/pc
50 - 79 pcs $18/pc
80 – 99 pcs $17/pc
100 pcs & above $16/pc
45
Quantity Discount Example – 1
2𝐷𝑆 2 × 816 × 12
𝑊𝑒 𝑘𝑛𝑜𝑤, 𝑄 = = ≈ 70 units
𝐻 4

Quantity Price
1 - 49 pcs $20/pc
50 - 79 pcs $18/pc
80 – 99 pcs $17/pc
100 pcs & above $16/pc

46
 Quantity Discount Example – 1
For Q = 70 units
𝑄 𝐷 70 816
Total Cost, TC70 = 𝐻 + 𝑆 + (𝐷 × 𝑃) = ×4 + × 12 + (816 × 18)
2 𝑄 2 70

= 140 + 11.657 × 12 + 14688

= 140 + 144 + 14688

= $14,972

47
 Quantity Discount Example – 1
For Q = 80 units
𝑄 𝐷 80 816
Total Cost, TC80 = 𝐻 + 𝑆 + (𝐷 × 𝑃) = ×4 + × 12 + (816 × 17)
2 𝑄 2 80

= 160 + 10.2 × 12 + 13872

= 160 + 132 + 13872

= $14,164

48
 Quantity Discount Example – 1
For Q = 100 units
𝑄 𝐷 100 816
Total Cost, TC100 = 𝐻 + 𝑆 + (𝐷 × 𝑃)= ×4 + × 12 + (816 × 16)
2 𝑄 2 100

= 200 + 8.16 × 12 + 13056

= 200 + 108 + 13056

= $13,364

49
Quantity Discount Example – 1

Quantity Total Cost EOQ

1 - 49 pcs -
50 - 79 pcs $14,972
80 – 99 pcs $14,164
100 pcs & $13,364 100 pcs
above

Thus, Minimum cost is obtained for purchasing 100 units

50
Reorder Point (ROP)
If demand and lead time are both constant, the reorder
point is easy to calculate.

𝑅𝑂𝑃 = 𝑑 × 𝐿𝑇
Where,
d = Demand rate (units per day or week)
LT = Lead time in days or weeks

When variability is present in demand or lead time, it creates the

possibility that actual demand will exceed expected demand.

51
Reorder Point (ROP) Example – 1 (LT ≠ 0)

Kevin takes Two-a-Day vitamins, which are delivered to his home by a

routeman three days after an order is called in. At what point should
Kevin reorder?

Usage rate = 2 vitamins per day

Lead time = 3 days
ROP = Usage rate × Lead time
= 2 vitamins per day × 3 days
= 6 vitamins

52
Cycle Time when LT ≠ 0
Considering from the first day of consumption or use,

7
LT = 3

4 3

Cycle time
between placing Cycle time between
order = 4 receiving order = 7 53
Safety Stock
Stock that is held in excess of expected demand due to
variable demand and/or lead time.

𝑅𝑂𝑃 = 𝑑 × 𝐿𝑇 + 𝑠𝑠

Where,
d = Demand rate (units per day or week)
LT = Lead time in days or weeks
ss = Safety Stock

54
Probabilistic Demand
If an estimate of expected demand during lead time and its standard
deviation are available. Safety
Stock
𝑅𝑂𝑃 = (𝑑 × 𝐿𝑇) + 𝑧𝜎𝑑𝐿𝑇
Where,
d = Demand rate (units per day or week)
LT = Lead time in days or weeks
z = Number of standard deviations (z-value from Normal Distribution curve)
σdLT = The standard deviation of lead time demand

The models generally assume that any variability in demand rate or lead time
can be adequately described by a normal distribution.
55
 Probabilistic Demand
Generally, the smaller the risk
the manager is willing to accept,
Service Level the greater the value of z.
The probability
that demand will
Probability of Risk of a
not exceed supply no stockout
during lead time stockout

Mean ROP Quantity

demand
Safety
stock
Number of
0 z standard deviations 56
Normal Table: Appendix B, Table B – pdf page 916
Probabilistic Demand
When demand is variable:
𝑅𝑂𝑃 = (𝑑ҧ × 𝐿𝑇) + 𝑧𝜎𝑑 𝐿𝑇
Where,
𝑑ҧ = Average demand

When lead time is variable:

𝑅𝑂𝑃 = (𝑑 × 𝐿𝑇) + 𝑧𝑑𝜎𝐿𝑇

Where,
𝐿𝑇 = Average lead time

57
Reorder Point (ROP) Example – 2
Suppose that the manager of a construction supply house determined
from historical records that demand for sand during lead time averages
50 tons. In addition, suppose the manager determined that demand
during lead time could be described by a normal distribution that has a
mean of 50 tons and a standard deviation of 5 tons. Answer the following
questions, assuming that the manager is willing to accept a stockout risk
of no more than 3 percent.
Here,
Expected Demand during lead time, d = 50 tons
Lead time, LT = 1 day
Standard deviation, 𝝈𝒅𝑳𝑻 = 5 tons
Risk = 3%
58
Reorder Point (ROP) Example – 2
Suppose that the manager of a construction supply house determined
from historical records that demand for sand during lead time averages
50 tons. In addition, suppose the manager determined that demand
during lead time could be described by a normal distribution that has a
mean of 50 tons and a standard deviation of 5 tons. Answer the following
questions, assuming that the manager is willing to accept a stockout risk
of no more than 3 percent.
a. What value of z is appropriate?

Area of risk = 3% or 0.03

⸫ Area of Service Level = 1- 0.03 = 0.97
Thus z = +1.88 (from Normal Table)
59
Normal Table

60
Reorder Point (ROP) Example – 2
Suppose that the manager of a construction supply house determined
from historical records that demand for sand during lead time averages
50 tons. In addition, suppose the manager determined that demand
during lead time could be described by a normal distribution that has a
mean of 50 tons and a standard deviation of 5 tons. Answer the following
questions, assuming that the manager is willing to accept a stockout risk
of no more than 3 percent.
b. How much safety stock should be held?

𝑠𝑠 = 𝑧𝜎𝑑𝐿𝑇 = 1.88 × 5 = 𝟗. 𝟒 𝒕𝒐𝒏𝒔

61
Reorder Point (ROP) Example – 2
Suppose that the manager of a construction supply house determined
from historical records that demand for sand during lead time averages
50 tons. In addition, suppose the manager determined that demand
during lead time could be described by a normal distribution that has a
mean of 50 tons and a standard deviation of 5 tons. Answer the following
questions, assuming that the manager is willing to accept a stockout risk
of no more than 3 percent.
c. What reorder point should be used?

𝑅𝑂𝑃 = (𝑑 × 𝐿𝑇) + 𝑧𝜎𝑑𝐿𝑇 = (50 × 1) + 9.4 = 𝟓𝟗. 𝟒 𝒕𝒐𝒏𝒔

62
Reorder Point (ROP) Example – 3
A restaurant uses an average of 50 jars of a special sauce each week.
Weekly usage of sauce has a standard deviation of 3 jars. The manager is
willing to accept no more than a 10 percent risk of stockout during lead
time, which is two weeks. Assume the distribution of usage is normal.

Here,
Mean Demand, 𝒅 ഥ = 50 jars
Lead time, LT = 2 weeks
Standard deviation, 𝝈𝒅 = 3 jars
Risk = 10%

63
Reorder Point (ROP) Example – 3
A restaurant uses an average of 50 jars of a special sauce each week.
Weekly usage of sauce has a standard deviation of 3 jars. The manager is
willing to accept no more than a 10 percent risk of stockout during lead
time, which is two weeks. Assume the distribution of usage is normal.

a. Determine the value of z?

Area of risk = 10% or 0.10

⸫ Area of Service Level = 1- 0.10 = 0.9
Thus z = +1.28 (from Normal Table)

64
Normal Table

65
Reorder Point (ROP) Example – 3
A restaurant uses an average of 50 jars of a special sauce each week.
Weekly usage of sauce has a standard deviation of 3 jars. The manager is
willing to accept no more than a 10 percent risk of stockout during lead
time, which is two weeks. Assume the distribution of usage is normal.

b. What reorder point should be used?

Here, only demand is variable (i.e., has a standard deviation).

ROP = (dത × LT) + 𝑧𝜎𝑑 𝐿𝑇 = (50 × 2) + (1.28 × 3 × 2)

= 105.43 𝑗𝑎𝑟𝑠

≈ 𝟏𝟎𝟔 𝒋𝒂𝒓𝒔
66
Reference: Operations Management (11th edition) By William Stevenson (Chapter 13) 67