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EOQ Inventory Management

EOQ Inventory Management. Why Do We Want Inventory. Improve customer service Reduce certain costs such as ordering costs Stock out costs acquisition costs start-up quality costs Contribute to the efficient and effective operation of the production system. Why We Do Not Want Inventory.

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EOQ Inventory Management

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  1. EOQ Inventory Management

  2. Why Do We Want Inventory • Improve customer service • Reduce certain costs such as • ordering costs • Stock out costs • acquisition costs • start-up quality costs • Contribute to the efficient and effective operation of the production system

  3. Why We Do Not Want Inventory • Certain costs increase such as • carrying costs • cost of customer responsiveness • cost of coordinating production • cost of diluted return on investment • reduced-capacity costs • large-lot quality cost • cost of production problems

  4. Inventory • Stock of items held to meet future demand • Inventory management answers two questions • How much to order • When to order

  5. Inventory EOQ Models • Basic EOQ • EOQ for Production Lots • EOQ with Quantity Discounts

  6. Inventory Costs • Carrying Cost • Cost of holding an item in inventory • Ordering Cost • Cost of replenishing inventory • Shortage Cost • Temporary or permanent loss of sales when demand cannot be met

  7. 2DCo Ch Q* = Basic EOQ Model Co - cost of placing order Ch - annual per-unit holding/carrying cost D - annual demand EOQ or Q*– economic order quantity

  8. EOQ Costs • Annual carrying cost = (Q/2)Ch • Annual ordering cost = (D/Q)Co • Total cost (TC) = (Q/2)Ch + (D/Q)Co

  9. 2DCo Ch Q* = Carrying Cost = ChQ 2 CoD Q Ordering Cost = EOQ Cost Model Annual cost ($) Total Cost Minimum total cost Optimal order Q* Order Quantity, Q

  10. EOQ: Economic Order Quantity • EOQ balances the cost of placing an order against the cost of storing product in inventory • The cost of storing a product in inventory can include warehouse costs, shipping costs, and cost of capital tied up in inventory • Notice that nowhere did the cost of the merchandise being sold enter into the equations • EOQ is vitally important in any retail business and most businesses where stocked items are managed

  11. Safety Stocks • Safety stock • buffer added to on hand inventory during lead time • Stockout • an inventory shortage • Service level • probability that the inventory available during lead time will meet demand

  12. Basis for setting the Reorder Point • During the lead time, customers continue to draw down the inventory • It is during this period that the inventory is vulnerable to stockout (run out of inventory) • Customer service level is the probability that a stockout will not occur during the lead time

  13. Basis for setting the Reorder Point • Thus, the order point is set based on • the demand during lead time (DDLT) and • the desired customer service level • Reorder point (ROP) = Expected demand during lead time (EDDLT) + Safety stock (SS) • The amount of safety stock needed is based on the degree of uncertainty in the DDLT and the customer service level desired

  14. Order quantity, Q Demand rate Inventory Level Reorder point, R 0 Time Lead time Lead time Order placed Order receipt Order placed Order receipt Ideal Inventory Order Cycle

  15. Q Inventory level Reorder point, R 0 LT LT Time Variable Demand with a Reorder Point stockout

  16. Q Inventory level Reorder point, R Safety Stock 0 LT LT Time Reorder Point with a Safety Stock

  17. Calculating ROP • Reorder Point (ROP) = d x L - d = daily demand - L = lead time for delivery after an order With Safety Stock (SS) we get the following: ROP = d x L + SS

  18. ROP Using Service Level • The customer service level is converted into a Z value using the normal distribution table • The safety stock is computed by multiplying the Z value by the std dev of DDLT. • The order point is set using ROP = EDDLT + SS, or by substitution • ROP = d x L + Z ( std dev D) D = demand during lead time

  19. Using Discounts in EOQ • Under this condition, material cost becomes an incremental cost and must be considered in the determination of the EOQ • The total cost (TC) = material cost + ordering cost + carrying cost • TC = DC + (D/Q) Co + (Q/2)Ch D = annual demand in units C = cost per unit

  20. 2DCs Ch(1-d/p) Qp = EOQ for production: EPQ • D = annual demand in units • Qp = quantity produced in one batch • Cs = setup cost per setup • Ch = cost of holding or carrying • p = daily production rate • d = daily demand rate

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