IND 3103/3113

Production and Service Systems

Management I

Assist. Prof. Rahime SANCAR EDİS

[Link]@[Link]
Inventory Control Subject to
Deterministic Demand
Contents

• What is Stock? What is Inventory?

• Classification of Inventories
• Why Hold Inventory?
• Characteristics of Inventory Systems
• Relevant Costs
• The Basic EOQ model
• The EOQ with Finite Production Rate
• Quantity Discounts

3
What is Stock?
What is Inventory?
• Stock : Stock is the finished product that is sold by
the business. In some cases, stock is also raw
materials, if the business also sells those products to
its customers. For example, a car dealership's stock
includes cars, but also can include tires, engine parts
or other car accessories.
• Inventory: Inventory includes a small business's
finished products, as well as the raw materials used
to make the products, the machinery used to produce
the products and the building in which the products
are made. In other words, anything that goes into
producing the items sold by your business is part of
its inventory.
4
Differences between Stock and Inventory
• Inventory takes in account all of the assets a business uses to
produce the goods it sells and determines the sale price for the
stock. The stock determines the amount of revenue a business
generates. The more stock that is sold, the higher the revenues.
• For accounting purposes, counting inventory items is done
generally once a year, but for stock, the numbers are tracked
daily. This is mostly because inventory is replenished as needed
to ensure there is an adequate stock for the business to keep its
doors open. It is usually not necessary to count the number of
tires a car dealership has daily, but it is very important to know
how many cars are left on the lot. Also, although the sale of
assets can create in infusion of cash into the business, this
money is not considered revenue. Only the sale of the stock itself
is included in the revenue total.
5
Inventory Control

• Two main questions will be answered.

▫ When to order?
▫ How much (many) to order?

6
Inventory Control Subject to Deterministic
Demand
• The inventory related to production
systems
• Demand is known and demand variability
is assumed to be zero.
• The required products can be
▫ bought from a supplier
▫ produced in our firm

7
Classification of Inventories

Raw Materials

• These are resources required for production or processing.

Components

• These could be raw materials or subassemblies that will later be

included into a final product.

Work In Process – WIP

• These are inventories that are in the plant waiting for processing.

Finished Goods

• These are items that have completed the production process and are
waiting to be shipped out.
8
Classification According to Purpose of Usage

BUFFER INVENTORY (Safety Stock)

•Supplies of products of an organization that are kept available on hand to stabilize variations in supply, demand ,
production or lead time.

Inventory for Promotion

Seasonal Inventory
•For manufacturers, seasonal inventory allows them to build up inventory when demand is low (also keeping workers
busy during slack times) so that when demand picks up the increased inventory will be slowly depleted and the firm does
not have to react by increasing production time (along with the subsequent increase in hiring, training, and other
associated labor costs).
•This tactic is commonly used by retailers, who routinely build up inventory months before the demand for their products
will be unusually high (i.e., at Christmas, or the back-to-school season).

Stock of Spare Parts

•Maintenance, repair, and operating supplies, or MRO goods, are items that are used to support and maintain the
production process and its infrastructure. These goods are usually consumed as a result of the production process but
are not directly a part of the finished product. Examples of MRO goods include oils, lubricants, coolants, janitorial
supplies, uniforms, gloves, packing material, tools, nuts, bolts, screws, shim stock, and key stock. Even office supplies
such as staples, pens and pencils, copier paper, and toner are considered part of MRO goods inventory.

Speculative Inventory
•Speculative inventory is the purchase of inventory for the purpose of holding it for future need. Companies typically buy
speculative inventory because they are protecting against, or preparing for, some type of future event that makes buying
inventory early a necessity.

9
Why Hold Inventory?

• Demand uncertainty
• Lead time uncertainty
• Supply uncertainty
• Other Uncertainties
• Supply of labor (such as strike), the
Uncertainties price of resources, cost of capital

10
Why Hold Inventory?

• It is probably cheaper to
order or produce in large
Economies batches than in small batches.
of scale

11
Why Hold Inventory?

• Inventories may be held in anticipation of a rise

in their value or cost.
• Increase in prices
Speculation • Labor Strike

• Inventories provide a means of smoothing out an

irregular demand pattern such as seasonal effects
Smoothing

12
 Why Hold Inventory?

• Refers to pipeline inventories that are in transit from one

location to another.
Transportation • To prevent the disadvantage of producing in overseas

• System constraints that may require holding inventories.

Certain constraints can arise in the purchasing, production
and distribution of items that force the system to hold
Logistics inventory.

• Holding inventory can lower the costs necessary to monitor a

system. (For example, it may be less expensive to order
Control yearly and hold the units than to order weekly and closely
monitor orders and deliveries.)
Costs
13
 ABC Analysis
• ABC analysis is based on the Pareto Curve.

• Pareto discovered that the distribution of wealth follows an increasing exponential

curve.

• Rough guidelines are that the first 20% of the items account for 80% of the sales, the
remaining 80% of the items account for 20% of the sale.

• Since it is named as ABC classification, there should be three groups. So that, the
percentages of groups;

▫ Group A: The first 20% of the items account for 80% of the sales,

(valuable products in less quantities)

▫ Group B: The next 30% of the items account for 15% of the sales,

(moderate valuable products in moderate quantities)

▫ Group C: The last 50% of the items only account for 5% of the sales.

(less valuable products in large quantities)

14
ABC Analysis

15
ABC Analysis
Purpose

The ABC analysis provides a mechanism for identifying items that

will have a significant impact on overall inventory cost, while
also providing a mechanism for identifying different categories
of stock that will require different management and controls.

• The ABC analysis suggests that inventories of an organization

are not of equal value.

• Thus, the inventory is grouped into three categories (A, B, and

C) in order of their estimated importance.

16
ABC Analysis

17
 ABC Analysis
• 'A' items are very important for an organization. A items
should receive the most attention. because of the high value of
these ‘A’ items, frequent value analysis is required. Their
inventory levels should be reviewed often, and they should
carry a high service level. In addition to that, an organization
needs to choose an appropriate order pattern (e.g. ‘Just- in-
time’) to avoid excess capacity.

• 'B' items are important, but of course less important than ‘A’
items and more important than ‘C’ items. Therefore ‘B’ items
are intergroup items.B items do not need such close scrutiny
as A items

• 'C' items are marginally important.C items are typically

ordered infrequently in large quantities. 18
ABC Analysis
Steps
• List the all items in inventory
• Compute the annual usage value for every item in the sample by
multiplying the annual requirements by
• the cost per unit.
• Arrange the items in descending order of the usage value calculated
above.
• Make a cumulative total of the number of items and the usage value.
• Draw a graph connecting cumulative % items and cumulative % usage
value. The graph is divided approximately into three segments, where
the curve sharply changes its shape. This indicates the three segments
A, B and C.
▫ %60-%70 cumulative value - Group A
▫ % 20-%30 cumulative value - Group B
▫ The remaining cumulative value – Group C

19
 ABC Analysis Example
A washing machine producer firm has 10 different items in inventory.
The annual usage and price of of each item is given in tha table.

Birim Fiyat Yıllık Talep

No Parçalar
(TL) (x1000 adet)
1 Vidalar 0,2 20000
2 Kazan 8 1500
3 LCD Ekran 15 2500
4 Kapak 40 3800
5 Termostat 13 5000
6 Motor 60 2000
7 Hortum 4 3500
8 Menteşeler 9 6500
9 Program Kartı 80 1750
10 Sac 2 5000
20
ABC Analysis Example

Birim Fiyat Yıllık Talep Yıllık Değer

No Parçalar
(TL) (x1000 adet) (x1000 TL)
1 Vidalar 0,2 20000 4000
2 Kazan 8 1500 12000
3 LCD Ekran 15 2500 37500
4 Kapak 40 3800 152000
5 Termostat 13 5000 65000
6 Motor 60 2000 120000
7 Hortum 4 3500 14000
8 Menteşeler 9 6500 58500
9 Program Kartı 80 1750 140000
10 Sac 2 5000 10000
21
ABC Analysis Example

Birim Fiyat Yıllık Talep Yıllık Değer Kümülatif

No Parçalar Pay Grup Oran
(TL) (x1000 adet) (x1000 TL) Pay
4 Kapak 40 3800 152000 0,25 0,25 A
60%
9 Program Kartı 80 1750 140000 0,23 0,48 A
6 Motor 60 2000 120000 0,20 0,67 B
5 Termostat 13 5000 65000 0,11 0,78 B 30%
8 Menteşeler 9 6500 58500 0,10 0,87 B
3 LCD Ekran 15 2500 37500 0,06 0,93 C
7 Hortum 4 3500 14000 0,02 0,96 C
2 Kazan 8 1500 12000 0,02 0,98 C 10%
10 Sac 2 5000 10000 0,02 0,99 C
1 Vidalar 0,2 20000 4000 0,01 1,00 C
613000 1

22
ABC Analysis Example

23
Characteristics of Inventory Systems

Patterns of Demand
Constant versus Variable Known versus Random
• Constant –i.e. Economik Order • Known –Demand may be constant or
Quantity (EOQ) variable but “known” refers to that
• Variable– i.e., Aggregate Production we know the exact value of demand.
Plan, Materials Requirements • Random– It is possible for demand
Planning(MRP) to be constant in expectation but still
be random. It may refer to uncertain
or stochastic demand. Stochastic
demand models assume that the
average demand rate is constant.

24
Characteristics of Inventory Systems

Lead Time
Buy Make
• The amount of time Amount of time
that elapses from the required to produce a
instant that an order batch of items
is placed until it
arrives.

25
Characteristics of Inventory
Systems

Review Time
Periodic Review Continuous Review
• Inventory levels are only • The current inventory
known at discrete points level is known in all time.
in time. • May require systems to
• Grocery review such as scanners,
programs.
• Supermarkets

26
Characteristics of Inventory Systems

Excess Demand
Partial
Backorder,
Backorder Lost Sales
Partial
Lost Sales

27
Characteristics of Inventory Systems

Changing Inventory

Perishability Obsolescence
(Shelf life such as (Clothes, automative
foods) spare parts)

28
Relevant Inventory Costs

Objective
• Minimizing Cost or Maximizing Profit

Inventory Costs
Holding Ordering Penalty
Cost Cost Cost
29
Holding Cost

Costs proportional to the quantity of inventory held.

Holding Cost consist of;

a) Physical Cost of Space (3%)
b) Taxes and Insurance (2 %)
c) Breakage Spoilage and Deterioration (1%)
*d) Opportunity Cost of alternative investment (18%)
(Total: 24%)

h = I *c
Holding one unit in inventory in a period =
Total ratio (I) * Cost (Price) of items (c)
30
Holding Cost

Opportunity Cost of alternative investment

Suppose that the items in inventory costs 10000 TL.
If this amount is invested in an alternative investment
type, it will get an amount of profit. By stocking the
items, we could not get this profit. The Opportunity
Cost of alternative investment is the most important
part of the holding cost.

31
Holding Cost

Note: Since inventory may be changing on a continuous basis,

holding cost is proportional to the area under the inventory curve.

32
Ordering Cost
Includes both fixed and variable components.
• Fixed(K)
▫ Fixed cost of order
▫ Does not related to ordering quantity
• Varibale (c)
▫ Price or cost of each item

33
Ordering Cost

34
Penalty or Shortage Costs
• All costs that accrue when insufficient stock is
available to meet demand.

• These include:
▫ Loss of revenue for lost demand
▫ Costs of bookeeping for backordered demands
▫ Loss of goodwill for being unable to satisfy demands
when they occur.
▫ Generally assume cost is proportional to number of
units of excess demand.

35
Economic Order Quantity (EOQ) Model
• EOQ is the basic model for inventory control

• Assumptions:
1. Demand is fixed at  units per unit time.
2. Shortages are not allowed.
3. Orders are received instantaneously. (this will be
relaxed later).
4. Order quantity is fixed at Q per cycle. (can be proven
optimal.)

36
Economic Order Quantity (EOQ) Model
• Costs
K: Fixed Ordering Cost hazırlık (sipariş) maliyeti,

c: Marginal Ordering Cost or the price of the product

h: Holding cost per unit held per unit time

• Q is the quantity of the order

• Average annual inventory cost function has to be
determined depending on the ordering quantity Q.

37
Economic Order Quantity (EOQ) Model

Q
−


Q


38
Economic Order Quantity (EOQ) Model

Average
Average Average
Annual
Ordering Holding
Inventory
Cost Cost
Cost

39
Economic Order Quantity (EOQ) Model

Ordering Cost

If Q is the ordering quantity, then the cost of ordering

one order would be ;
C (Q ) = K + cQ
For a period of time, the ordering cost is;

K + cQ
C (Q) =
T
40
Economic Order Quantity (EOQ) Model

Holding Cost

• Total Holding Cost=

Holding cost of one unit * Average Inventory
Q
C (Q) = h
2 41
Economic Order Quantity (EOQ) Model

Average Annual Inventory Cost, G(Q):

Annual Annual Annual

Ordering Purchase Holding
Cost Cost Cost 42
Example

• Suppose that the annual demand of a raw material is

λ=1000 units.
• If we set the ordering quantity to Q=100, this means we
have to order 1/T=λ/Q=10 times in a year.
• The time between two orders would be 1/10=0.1 year. If 1
year=50 weeks, then it would be 0.1*50=5 weeks.
• If we purchase each raw material at a cost of c=10 TL and
the fixed cost of ordering is K=100 TL and holding cost of
a raw material for one year is h=2 TL, then the average
annual cost is

G (Q) = 100 * (1000 / 100 ) + 1000 *10 + (100 / 2) * 2 = 11100 TL 43

Economic Order Quantity (EOQ) Model

44
Economic Order Quantity (EOQ) Model

45
Example

• The annual demand of a raw material is λ=1000 units.

• Price of a raw material= 10 TL,
• Fixed cost of ordering is K=100 TL
• Holding cost of a raw material for one year is h=2 TL
• Economic Order Quantity (EOQ)

2 K 2 *100 *1000
Q* = = = 316.22  316 units
h 2
✓If we set Q*=316, this means we will order 1/T=λ/Q = 3,16 times in a
year.
✓The time between two orders would be 1/3.16=0.316 year. If 1 year=50
weeks, then it would be 0.316*50=15,82=16 weeks.
✓Average annual cost:
G (Q* = 316 ) = 100 * (1000 / 316 ) + 1000 *10 + (316 / 2) * 2 = 10632 .45TL
46
Economic Order Quantity (EOQ) Model

Annual Annual Annual

Ordering Purchase Holding
Cost Cost Cost
• If ordering quantity is set to Q=100 units;
4.2 %
improvement
G (Q) = 100 * (1000 / 100 ) + 1000 *10 + (100 / 2) * 2 = 11100 TL
G (Q) = 100 * (1000 / 100 ) + (100 / 2) * 2 = 1100 TL 42.5 %
improvement

✓If the Economic Order Quantity is used Q*=316 units;

G (Q* = 316 ) = 100 * (1000 / 316 ) + 1000 *10 + (316 / 2) * 2 = 10632 .45TL
G (Q* = 316 ) = 100 * (1000 / 316 ) + (316 / 2) * 2 = 632 .45TL 47
Economic Order Quantity (EOQ) Model
Example
• Number 2 pencils at the campus book-store are sold at a fairly
steady rate of 60 per week.
• The pencils cost to the bookstore $2 each and sell for $15 each.
• It cost the bookstore $12 to initiate an order to its supplier.
• Holding costs are based on annual interest rate of 25%.
• Determine
▫ Holding cost of one pencil
▫ The optimal number of pencils for the bookstore to purchase to minimize
total annual inventory cost,
▫ Number of orders per year,
▫ The length of each order cycle,
▫ Annual holding cost,
▫ Annual ordering cost, and
▫ Total annual inventory cost.

48
Economic Order Quantity (EOQ) Model

Example
• Number 2 pencils at the campus book-store are
sold at a fairly steady rate of 60 per week.
• Annual Demand = 60*52= 3120 pencil/year
• The pencils cost to the bookstore $2 each and sell
for $15 each.
• c= $2 /pencil
• It cost the bookstore $12 to initiate an order to its
supplier.
• K=$12 /order
• Holding costs are based on annual interest rate of
25%.
• h= $2/pencil*0,25/year=$0,5/pencil/year

49
Economic Order Quantity (EOQ) Model

Example
• The optimal number of pencils for the bookstore to purchase to
minimize total annual inventory cost,
2 K 2 * $12 / order * 3120 pencil/year
Q* = = = 387 pencil/order
h $0,5 pencil/year

• Number of orders per year,

1  3120 pencil/year
= = = 8.06order / year
T Q* 387 pencil/order
• The length of each order cycle,
Q*
387 pencil/order
T= = = 6,45week / order
 60 pencil/week

Q* 387 pencil/order
T= = = 0.124 year / order = 1.48month / order
 3120 pencil/year 50
 Economic Order Quantity (EOQ) Model

Example 12 * 3120

• Annual holding cost, K = = $96.75
Q 387

• Annual ordering cost, Q 387

h = 0.5 = $96.75
2 2
• Total annual inventory cost.
12 * 3120 387
G (Q*) = + 0.5 = 96.75 + 96.75 = $193.5
387 2
• Adding λc
12 * 3120 387
G (Q*) = + 3120 * 2 + 0.5 = $6433.5
387 2 51
 Economic Order Quantity (EOQ) Model

• Total annual inventory cost.

▫ Without λc
12 * 3120 387
G (Q*) = + 0.5 = 96.75 + 96.75 = $193.5
387 2
 In another formulation, it can be calculated as
G (Q*) = 2 Kh = 2 *12 * 3120 * 0.5 = $193 .5

▫ Adding λc
12 * 3120 387
G (Q*) = + 3120 * 2 + 0.5 = $6433.5
387 2
G (Q*) = 2 Kh + c = 2 *12 * 3120 * 0.5 + 3120 * $2 = $6433 .5
52
Economic Order Quantity (EOQ) Model

Example
Economic Order Quantity Model

450
Q* = 387 pencil/ord er
400

350
Pencils

300

250

200

150

100

50

0
0 2 3 5 6 8 9 11 12 14 15 17 18 20 21 23 24 26 27 29 30 32 33 35 36 38 39 41 42 44 45 47 48 50 51

Q* 1  3120
T= = 6,45week / order = = = 8,06order / year
 T Q * 387
53
Order Lead Time
One of the assumptions of EOQ model was, there was no lead time or it
is zero.
If the lead time (τ) is greater than zero,
When we should place the order?

54
Order Lead Time

If Order Lead Time > Cycle Time,

When the order should be placed?

55
Order Lead Time

56
Order Lead Time

If Order Lead Time > Cycle Time, then

Procedure
1. Find the ratio τ / T.
2. Consider only the fractional remainder of the ratio.
Multiply this remainder by the cycle length to
convert back to years.
3. Multiply the results of Step 2 by the demand rate
to obtain the reorder point, R.
 Sensitivity Analysis
Let G(Q) be the average annual holding and set-up
cost function given by

and let G* be the optimal average annual cost.

Then it can be shown that:

58
Sensitivity Analysis

• Suppose that pencils are not packed at quantity of

Q*=387. There are two packing and also buying
alternatives are available. Q1=100 pencils and
Q2=600 pencils.
• Which alternative costs smaller than the other one?

G(Q1 = 100) 1  387 100  G(Q2 = 600) 1  387 600 

=  + = 2,06 =  +  = 1,09
G(Q = 387) 2  100 387 
*  G(Q = 387) 2  600 387 
*

G (Q1 = 100 ) = 2,06 * G (Q = 387 )

* G (Q2 = 600 ) = 1,09 * G (Q* = 387 )

Ordering Q2=600 pencils costs smaller

comparison to Q1=100 pencils
59
Example
• Yılda 52 hafta ve haftada 5 gün çalışan bir firma
günde 30 adet fırın üretmektedir. Üretilen her bir
fırına bir valf takılmaktadır. Piyasadan satın alınan
bu valfin satın alma fiyatı 21,6 TL ve bir kere
sipariş vermenin maliyeti ise 150 TL’dir. Yıllık
envanter bulundurma maliyetinin oranı (yıllık
faiz) 0.20’dir.
• Yukarıdaki bilgiler ışığında firma kaçar adetlik
siparişler ile valf satın almalıdır? Ne kadar
aralıklarla sipariş vermelidir?

60
Example
• Q* = 736 adet/sipariş
• T=0,0944 yıl/sipariş=4,9 hafta/sipariş =
24,5 gün/sipariş
• Sipariş verildikten sonra firmamıza gelmesi
10 gün sürüyorsa;
Elimizdeki miktar = 30adet/gün*10 gün
=300 adete düştüğünde tekrar sipariş
vermeliyiz.

61
Example
• Q* = 736 adet/sipariş
• T=0,0944 yıl/sipariş=4,9 hafta/sipariş = 24,5
gün/sipariş
• Sipariş verildikten sonra firmamıza gelmesi 30
gün sürüyorsa;
Elimizdeki miktar = 30adet/gün*(30-24.5) gün
=165 adete düştüğünde sipariş vermeliyiz.
• Bu sipariş 30 gün sonra elimizde olacağından,
hemen sonraki 24.5 günlük periyotta
kullanılamaz.

62
Contents

• The EOQ with Finite Production Rate

• Quantity Discounts

63
EOQ With Finite Production Rate

• Finite production rate model is an extension of the

EOQ model
• Rather than purchasing the materials, now we are
producing the required materials. So that,
• Suppose that items are produced internally at a rate
P where P > λ.
• The finite production run model is also called the
Economic Production Quantity (EPQ) model
• Other assumptions are same as in EOQ Model.

64
Economic Production Quantity (EPQ) Model

65
Economic Production Quantity (EPQ) Model

66
Economic Production Quantity (EPQ) Model

The consumed quantity in each cycle= λT

In each cycle, The consumed quantity = The produced quantity
The produced quantity in each cycle = Q
Q= λT In other representation, T =Q / λ

The maximum inventory level = H

The production period = T1
The produced quantity in period T1 = P T1
Q= P T1 In other representation, T1 =Q / P

Also, it can be said that H/ T1 = P-λ

67
Economic Production Quantity (EPQ) Model

68
Economic Production Quantity (EPQ) Model

If the average inventory level is set to H/2, then the average annual
inventory cost G(Q) can be calculated as

By using h’, Q* can be written

Modified
Holding Cost

69
Economic Production Quantity (EPQ) Model

 = annual demand
P = the production rate in units/year
Q = size of each production run
K = cost of setting up production
h = annual holding cost per unit
h´ = modified annual holding cost per unit
h´ = h(1- /P)

Optimal solution, Q*, Economic Production Quantity (EPQ)

2 K
=
h'
70
 The Finite Production Rate Model Cost Curves

Slope = 0
Annual
cost ($) h' Q K
Total Cost= +
2 Q
Minimum
total cost
h' Q h H
Holding Cost = =
2 2
K K
Ordering Cost = =
Q T
Optimal solution, Q*, Economic Production Quantity (EPQ)

Order Quantity, Q
71
 Example
• A local company produces a programmable EPROM (erasable
programmable read-only memory) for several industrial clients.
They have experienced a relatively flat demand of 2500 units
per year for the product. The EPROM is produced at a rate of
10000 units per year. The accounting department has estimated
that it costs $50 to initiate a production run, each unit costs the
company $2 to manufacture, and the cost of holding is base on a
30% annual interest rate.

• Determine
▫ the optimal size of a production run,
▫ the length of each production run,
▫ the average annual cost of holding and setup.
▫ What is the maximum level of on-hand inventory of the EPROMs?
72
Example

▫ Demand Rate
▫ λ= 2500 unit/year
• Production Rate
▫ P= 1000 unit/year
• Setup Cost
▫ K=$50/setup
▫ Cost of producing a unit
▫ c= $2/unit
• Interest Rate
• I= 0.30/year
• The holding cost
▫ h=I*c=0.3/year*$2/unit=$0.6 unit/year
▫ Modified holding cost
▫ h´=h(1- λ/P)=0.6(1-2500/10000)=$0.45 unit/year

73
Example

• The optimal size of a production run,

▫ Q*=745 hard disks/production run

• The length of each production run,

▫ T=Q*/λ = 745/2500=0.298 years
▫ T1=Q/P=745/10000=0.0745 years T2=T-T1=0.2235 years

• The average annual cost of holding and setup.

K hQ *
▫ G(Q*)= 167.785+167.625=$335.41 G (Q*) = +
Q* 2
• What is the maximum level of on-hand inventory of the EPROMs?
 H= Q*(1- λ/P)=745(1-2500/10000)=559 hard disks
74
Example

Q=745 harddisks

λ
P

H=559

λ
P-λ

T1=0.0745 years T2=0.2235 years

T=0.298 years

75
EPQ Models for Multi Products
• This model is an extension of the EPQ model
• Consider the problem of producing many products in a
single facility. The facility may produce only one product at
a time.
• n products with known demand rates, production rates,
holding costs, and set-up costs.

• How can we compute EPQ values for each product?

• The objective is to minimize the average annual inventory

cost and to determine the optimal production quantities of
various products produced in each cycle and the optimal
length of the cycle.
EPQ Models for Multi Products

Assumptions
▫ Shortages are not allowed.
▫ In each production cycle there is only one setup for
each product, and the products are produced in the
same sequence in each production cycle. This
assumption is called the rotation cycle policy.
▫ If there are three products A, B and C, then a
production sequence under the rotation cycle policy is
A, B, C, A, B, C, ….
▫ The total capacity can not be exceeded.
▫ The objective is to produce each item once in a
production cycle.
EPQ Models for Multi Products

λj : demand rate of product j

Pj : production rate of product j •Finding optimal production quantity
hj : holding cost of product j of each product separately and using
Kj : setup cost of product j the EPQ formula may not give a good
solution because a production
quantity may not be large enough to
meet the demand between two
production runs of the product.

• T: Optimal length of the cycle.

EPQ Models for Multi Products

Average Annual Inventory Cost for product j

Average Annual Inventory Cost for all products

What is the
optimal cycle
length (T) that
optimizes G(T)?
EPQ Models for Multi Products

• Get the derivative

The required cycle
and find T* time to produce all
products

Cycle time ≥ The production time of all products+The setup times of all products

Sj : setup time of product j

EPQ Models for Multi Products

Optimal Cycle Length , T = max { T* , Tmin }

81
Example
• Bali produces several styles of men’s and women’s shoes at
a single facility near Bergamo, Italy.
• The leather for both the uppers and the soles of the shoes is
cut on a single machine, This Bergamo plant is responsible
for seven styles and several colors in each style. (The colors
are not considered different products for our purposes,
because no setup is required when switching colors.)
• Bali would like to schedule cutting for the shoes using a
rotation policy that meets all demand and minimizes setup
and holding costs.
• Setup costs are proportional to setup times. The firm
estimates that setup costs amount to an average of $110 per
hour, based on the cost of worker time and the cost of
forced machine idle time during setups.
• Holding costs are based on a 22% annual interest charge.
Example
Example
Example
 Example

• If 250 days = 1 year then,

0,1529 years= 38 days
Example
8 hours/day*250days/year = 2000 hours/year
 Example

Optimal Cycle Length , T = max { T* , Tmin }

T=max(0,1529 years, 0,04 years)

T= 0,1529 years = 38 days
Example

89
Example
Üretim Üretim Hazırlık Hazırlık
Üretim Max.
Model Süresi Süresi Süresi Süresi
Miktarı Miktar
(yıl) (gün) (saat) (gün)
1 691 603 0,0193 4,83 3,2 0,4
2 1009 902 0,0161 4,03 2,5 0,3125
3 358 337 0,0087 2,18 4,4 0,55
4 398 383 0,0056 1,40 1,8 0,225
5 1346 1092 0,0288 7,19 5,1 0,6375
6 948 865 0,0133 3,33 3,1 0,3875
7 795 721 0,0142 3,55 4,4 0,55
Toplam 0,1060 26,51 24,50 3,06

Cycle time required for production = 26,51+3,06=29,57 days

Optimal Cycle length = 38,225 days 90
Quantity Discount Models

There are two types of quantity discount models:

All Units Discounts: the discount is applied to ALL

of the units in the order.

Incremental Discounts: the discount is applied only

to the number of units above the breakpoint.

91
 All Units Discounts

Weighty Trash Bag Company’s pricing Schedule for its large

trash can liners:
• For orders of less than 500 bags, charges 30 cents per bag;
• For orders of 500 or more but fewer than 1,000 bags,
charges 29 cents per bag;
• For orders of 1,000 or more, charges 28 cents per bag

92
All Units Discounts

• Purchasing Cost in All Units Discount Model

93
 All Units Discounts
• If Weighty uses trash bags at a fairly constant
rate of 600 per year, how to place order?

• Suppose that fixed cost of placing an order is $8,

and holding costs are based on 20% annual
interest rate.

94
 All Units Discounts
c0Q 0  Q  500
2 K 
C (Q) =  c1Q 500  Q  1000
Q (0)
=
Ic0 c Q 1000  Q
 2
G(Q)
2 K
Q (1)
= G0(Q)
Ic1 G1(Q)

2 K G2(Q)
Q ( 2) =
Ic2

Q
500 1000
An EOQ value is realizable, if it falls within the interval of EOQ
that corresponds to the unit cost that has been used to compute it.
All Units Discounts

Each curve is valid only for certain values of Q, thus the average annual
cost function is given by discontinuous curves (Black curves). 96
All Units Discounts
Procedure
• Determine the largest realizable EOQ value. The
most efficient way to do this is to compute the EOQ
for the lowest price first, and continue with the next
higher price. Stop when the first EOQ is realizable
(that is, within the correct interval)
• Compare the value of the average annual cost at the
largest realizable EOQ and at all the price
breakpoints that are greater than the largest
realizable EOQ. The optimal Q is the point at which
the average annual cost is a minimum.
97
 All Units Discounts
• For all units discounts, the optimal will occur at
the bottom of one of the cost curves or at a
breakpoint. (It is generally at a breakpoint.). One
compares the cost at the largest realizable EOQ
and all of the breakpoints succeeding it.

98
Incremental Discounts

• Purchasing cost at incremental discounts

99
 Incremental Discounts
Total purchasing cost per order

 0.3Q
 , 0.3, 0  Q  500
 Q
Price (cost) per C (Q)  5 + 0.29Q 5
unit = , 0.29 + , 500  Q  1000
Q  Q Q
15 + 0.28Q , 0.28 + 15 , 1000  Q
 Q Q

100
Incremental Discounts
Total Cost Function

101
 Incremental Discounts
Procedures
• Determine an algebraic expression for C(Q)
corresponding to each price interval. Use that to
determine an algebraic expression for C(Q)/Q;
• Substitute the expressions derived for C(Q)/Q into
defining equation for G(Q). Compute the minimum value
of Q corresponding to each price interval separately.
• Determine which minima computed in (step 2) are
realizable (that is fall into the correct interval). Compare
the values of the average annual costs at the realizable
EOQ values and pick the lowest.
102
 Incremental Discounts
• For incremental discounts, the optimal will
always occur at a realizable EOQ value. Only
compare costs at all realizable EOQ’s.

103
Incremental Discounts

104
Example

• Weighty Trash Bag Company’s pricing Schedule for its

large trash can liners:
• For orders of less than 500 bags, charges 30 cents per
bag;
• For orders of 500 or more but fewer than 1,000 bags,
charges 29 cents per bag;
• For orders of 1,000 or more, charges 28 cents per bag
• Suppose that fixed cost of placing an order is $8, and
holding costs are based on 20% annual interest rate.
• If Weighty uses trash bags at a fairly constant rate of
600 per year, how to place order to minimize annual
inventory cost?
105
 Example - All Units Discounts
2 K 2 * 8 * 600
 0.3 * Q 0  Q  500 Q (0) = = = 400, in interval
 Ic0 0.2 * 0.3
C (Q) = 0.29 * Q 500  Q  1000
0.28 * Q 1000  Q 2 K 2 * 8 * 600
 Q (1) = = = 406, X
Ic1 0.2 * 0.29
2 K 2 * 8 * 600
G(Q) Q ( 2)
= = = 414, X
Ic2 0.2 * 0.28
G0(Q)
G1(Q)
G2(Q)

Q
500 1000
Example
• Q(0) = 400 bags, First alternative (From EOQ, in interval)
• Q(1) = 500 bags, Second alternative (From graph)
• Q(2) = 1000 bags, Third alternative , (From graph)
• Try all the alternative quantities and select the one with
mininum annual inventory cost.
K Q
G j (Q) = + c j + Ic j
Q 2
8 * 600 400
G0 (Q ( 0) = 400) = + 600 * 0.3 + 0.2 * 0.3 * = $204
400 2
8 * 600 500
G1 (Q (1) = 500) = + 600 * 0.29 + 0.2 * 0.29 * = $198.10
500 2
8 * 600 1000
G2 (Q ( 2) = 1000) = + 600 * 0.28 + 0.2 * 0.28 * = $200.8
1000 2 107
Example
• For the same problem suppose that the supplier offers an
alternative discount strategy.
• The trash bags cost 30 cents each for quantities of 500 or
fewer

• For quantities between 500 and 1000 the first 500 cost 30
cents each and the remaining amount cost 29 cents each

• For quantities 1000 and over, the first 500 cost 30 cents
each, the next 500 costs 29 cents each and the remaining
amount cost 28 cents each

• Determine the optimal ordering quantity that minimizes

annual inventory cost.

108
 Example

 0.3 * Q, 0.3Q, 0  Q  500


C (Q) =  500 * 0.3 + 0.29 * (Q − 500), 5 + 0.29Q, 500  Q  1000
500 * 0.3 + 500 * 0.29 + 0.28 * (Q − 1000), 15 + 0.28Q, 1000  Q


 0.3Q
 , 0.3, 0  Q  500
 Q
C (Q)  5 + 0.29Q 5
= , 0.29 + , 500  Q  1000
Q  Q Q
15 + 0.28Q , 0.28 + 15 , 1000  Q
 Q Q

Example
K c(Q) c(Q) Q
G (Q) = + +I
Q Q Q 2
2 K 2 * 8 * 600
8 * 600 Q Q (0) = = = 400
G0 (Q) = + 600 * 0.3 + 0.2 * 0.3 * Ic0 0.2 * 0.3
Q 2 in interval
8 * 600  5  5 Q
G1 (Q) = + 600 *  0.29 +  + 0.2 *  0.29 +  *
Q  Q  Q 2
7800 Q (1) = 519
G1 (Q) = + 0.29Q + 174.5 Get derivative and equalize to zero
Q in interval
8 * 600  15   15  Q
G2 (Q) = + 600 *  0.28 +  + 0.2 *  0.28 +  *
Q  Q  Q 2
13800
G2 (Q) = + 0.28Q + 169.5 Get derivative and equalize to zero Q ( 2) = 702 (X)
Q
Example
• Q(0) = 400 bags, first alternative ( From total cost function)
• Q(1) = 519 bags, second alternative (From total cost function)

8 * 600 400
G0 (Q ( 0) = 400) = + 600 * 0.3 + 0.2 * 0.3 * = $204
400 2

8 * 600  150   150  519

G1 (Q (1) ) = + 600 *  0.29 +  + 0.2 *  0.29 + *
519  519   519  2
7800
G1 (Q) = + 0.29 * 519 + 174.5 = $204.58
519

Q=400 units. Ordering 400 units in each order is going to minimize the
annual inventory cost.
Example
Total Cost Function

112