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Class 13: Managing Inventory
Learning Objectives
Be able to:
▪Calculate the economic order quantity (EOQ) and reorder point (ROP) for a Basic Continuous
Review System
▪Calculate the economic order quantity (EOQ), safety stock (SS), and reorder point (ROP) for a
Continuous Review System that includes uncertain demand and uncertain lead times.
Continuous Review Systems
▪An inventory system used to manage independent demand inventory
where the inventory level for an item is constantly monitored and when
a predetermined reorder point is reached, an order is released.
▪Key features:
▪Inventory levels are monitored constantly, and a replenishment order is issued
only when a pre-established reorder point has been reached.
▪How much to order: The size of a replenishment order (Economic Order
Quantity) is typically based on the trade-off between holding costs and ordering
costs.
▪When to order: The reorder point is based on both demand and supply
considerations, as well as on how much safety stock (corresponding to a Service
Level) managers want to hold.
Continuous Review Systems
Assumptions for Calculations
▪Assumptions for Calculations:
▪These assumptions are rarely met completely, but real business systems can
approximate these conditions:
▪The inventory item we are interested in has a constant demand per period (d). There
is no variability in demand from one period to the next. Demand for the year is D.
▪L is the lead time, or number of periods that must pass before a replenishment order
arrives. L is also constant.
▪H is the cost of holding a single unit in inventory for a year. It includes the cost of the
space needed to store the unit, the cost of potential obsolescence, and the
opportunity cost of tying up the organization’s funds in inventory. H is known and
fixed.
▪S is the cost of placing an order or the setup cost, regardless of the order quantity. S is
also known and fixed.
▪Cost of stockouts and customer perceptions is NOT included.
▪P, the price of each unit, is fixed.
Continuous Review Systems
Effect of System Changes
•Demand Rate, d or D
•When Demand INCREASES, Economic Order Quantity Increases
•When Demand DECREASES, Economic Order Quantity Decreases
•Holding Costs, H
•When Holding Costs INCREASE, Economic Order Quantity Decreases
•When Holding Costs DECREASE, Economic Order Quantity Increases
•Ordering or Setup Costs, S
•When Ordering or Setup Costs INCREASE, Economic Order Quantity
Increases
•When Ordering or Setup Costs DECREASE, Economic Order Quantity
Decreases
Continuous Review Systems - Basic
Reorder Point, ROP = dL
d = Demand Rate per Time Period
D = Demand Rate per Year
L = Lead time (time periods)
Q = Order Quantity
H = Holding Cost Per Year Per Unit
S = Ordering/Setup Cost Per Order
Average Inventory Level = Q/2
Total Annual Inventory Cost = 𝑸
𝟐𝑯 + 𝑫
𝑸𝑺
Economic Order Quantity, EOQ = 𝟐𝑫𝑺
𝑯
EOQ occurs when Holding Cost = Ordering Cost
Time Between Orders = TBO = 𝑬𝑶𝑸
𝑫[Answer is in Years]
Application: Finding the EOQ, Total Cost,
& TBO •You are reviewing the inventory policies on an item stocked at a hardware store
that sells for $80. The current policy is to replenish inventory by ordering in lots
of 360 units. Additionally:
•d = 60 units per week; 52 weeks per year
•Lead Time = 0.5 weeks
