Inventory Management

EOQ & POQ

1
 Production Order Quantity
Model
Part of inventory cycle during which
production (and usage) is taking place
Inventory level

Demand part of cycle with no

production
Maximum
inventory

t Time
 From EOQ model

Annual setup cost  (#. of orders per yr.)  (order cost)

 Annual demand 
 order cost 
 # of units in each order 
D
  S
Q

Annual holding cost  (Avg. inventory level)  (holding cost per unit per yr)
Q0
   (H)
 2 
Not valid
 Production Order Quantity
Model
Q  Q min
Avg. Inventory  max
2 p = Daily production rate
Q  lot produced
d = Daily demand/usage rate
Total produced during the production run  pt
Q max Total consumed during the production run  dt
Inventory level

Max. Inventory  pt - dt   p  d  t

Maximum Q  lot produced  pt  t  Q

inventory
p
Q  d
Max. Inventory   p  d    1  Q
p  p
 

t Q d Time
Avg. Inventory  1  
2 p
 For EOQ model

Annual setup cost  (#. of orders per yr.)  (order cost)

 Annual demand 
 order cost 
 # of units in each order 
D
   S
Q

Annual holding cost  (Avg. inventory level)  (holding cost per unit per yr)
Q d
 1   H
2 p
Answer to Inventory Management Questions for
EOQ Model
For Optimal :
Annual setup cost  Annual holding cost

D Q d
S  1   H
Q 2 p

2 DS
Q  2

 d
H 1  

 p

2 DS
Q
 d
H 1  
 p
Production Order Quantity
• In case the replenishment is not immediate and grows at a rate p

2 DS
Q
d
H (1  )
p

7
 Inventory Management
Quantity Discount Models

8
Quantity Discount Models
 Reduced prices are often available when larger
quantities are purchased
 Trade-off is between reduced product cost and
increased holding cost

Total cost = Setup cost + Holding cost + Product cost

D Q
TC = QS + H2+ PD
Quantity Discount Models

A typical quantity discount schedule

Discount Discount
Number Discount Quantity Discount (%) Price (P)
1 0 to 999 no discount $5.00
2 1,000 to 1,999 4 $4.80

3 2,000 and over 5 $4.75

Table 12.2
Quantity Discount Models
Steps in analyzing a quantity discount
1. For each discount, calculate Q*
2. If Q* for a discount doesn’t qualify,
choose the smallest possible order size
to get the discount
3. Compute the total cost for each Q* or
adjusted value from Step 2
4. Select the Q* that gives the lowest total
cost
Quantity Discount Models

Total cost curve for discount 2

Total cost
curve for
discount 1
Total cost $

Total cost curve for discount 3

b
a Q* for discount 2 is below the allowable range at point a and
must be adjusted upward to 1,000 units at point b

1st price 2nd price

break break

0 1,000 2,000
Order quantity
Quantity Discount Example
Calculate Q* for every discount 2DS
Q* =
IP

2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)

2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80)

2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75)
Quantity Discount Example
Calculate Q* for every discount 2DS
Q* =
IP

2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)

2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80) 1,000 — adjusted
2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75) 2,000 — adjusted
Quantity Discount Example
Annual Annual Annual
Discount Unit Order Product Ordering Holding
Number Price Quantity Cost Cost Cost Total
1 $5.00 $25,000 $350 $25,700
700 $350
2 $4.80 $24,000 $480 $24,725
1,000 $245
3 $4.75 $23.750 $950 $24,822.50
2,000 $122.50
Table 12.3
Choose the price and quantity that gives the lowest total cost
Buy 1,000 units at $4.80 per unit
Inventory Management
Robustness of EOQ
Where
Q = Lot size ordered
Q*= optimal lot size