Inventory Control Models: EOQ Model

Inventory control models
EOQ Model
Learning objective
 After this class the students should be
able to:
• calculate the order quantity that minimize the

total cost inventory, based on the EOQ model
and
• analyze the implication of this model.
Time management
 The expected time to deliver this module
is 50 minutes. 30 minutes are reserved
for team practices and exercises and 20
minutes for lecture.
Inventory & inventory system
 Inventory is the set of items that an
organization holds for later use by the
organization. An inventory system is a
set of policies that monitors and controls
inventory. It determines how much of
each item should be kept, when low
items should be replenished, and how
many items should be ordered or made
when replenishment is needed.
Basic types of inventory
 independent demand,
 dependent demand, and
 supplies.
Independent Demand
 Independent demand items are those items that we
sell to customers.
 Dependent demand items are those items whose

demand is determined by other items. Demand for a
car translates into demand for four tires, one engine,
one transmission, and so on. The items used in the
production of that car (the independent demand
item) are the dependent demand items.
 Supplies are items such as copier paper, cleaning

materials, and pens that are not used directly in the
production of independent demand items
Why hold Inventory
 Each team is invited to discuss for 10
minutes about what they figure out to be
the reasons that the organizations
maintain inventory. At the and, they have
to present a list of their supposed
reasons.
Five reasons
1. To decouple workcenters;
2. To meet variations in demand;
3. To allow flexible production
schedules;
4. As a safeguard against variations
in delivery time; and
5. To get a lower price.
The cost of Inventory
 Holding costs;
 Setup costs;
 Ordering costs; and

Shortage costs .
The Economic Order Quantity Model
 Assumptions:
• 1. Production is instantaneous. There is no capacity constraint and the
entire lot is produced simultaneously.
• 2. Delivery is immediate. There is no time lag between production and

availability to satisfy demand.
• 3. Demand is deterministic. There is no uncertainty about the quantity or

timing of demand.
• 4. Demand is constant over time. In fact, it can be represented as a

straight line, so that if annual demand is 365 units this translates into a daily
demand of one unit.
• 5 A production run incurs a constant setup cost. Regardless of the size

of the lot or the status of the factory, the setup cost is the same.
• 6. Products can be analyzed singly. Either there is only a single product

or conditions exist that ensure reparability of products.
Notation
 D = Demand rate (in units per year).
 c = Unit production cost, not counting setup or
inventory costs (in dollars per unit).
 A = Constant setup (ordering) cost to produce
(purchase) a lot (in dollars).
 h = Holding cost
 Q = Lot size (in units); this is the decision variable
The model
Inventory versus time in the EOQ model
The model
Q

 average inventory level: 2
Q
h
2 hQ
 The holding cost per unit:
 
D 2D
A
 The setup cost per unit: 
Q
 The production cost per unit:

c
Economic order quantity
hQ A
Y (Q)    c (total inventory cos t per unit )
2D Q
dY (Q) h A
  2 0  first order condition
dQ 2D Q
d 2Y (Q) A
2
2 3 (sec ond order condition)
dQ Q
Economic order quantity
dY (Q) h A
  2 0  first order condition
dQ 2D Q
 2 AD
Q  (economic order quantity)
h
Exercise
Each is invited to analyze the following
insights, based on the EOQ model (20
minutes):
1. “There is a tradeoff between lot size

and inventory
2. “Holding and setup cost are fairly
insensitive to lot size”
What-if
Open
excel file
What-if
The minimum cost What-If Analysis
obtained by using the EOQ EOQ
economic order Annual demand 12,000 12,000
quantity is $952.50, so Cost per unit $6.75 $6.75
increasing the order Interest rate to hold 20% 20%
quantity by 10% leads Ordering cost $28.00 $28.00
a total cost increase of Quantity each order 461 =INT(C5/C10)
only $4.30. Changing Number of orders 26 26
Unit holding cost $1.35 =C6*C7
the order quantity by a
Annual holding cost $311 =C9*C11/2
small amount has very
Annual ordering cost $728 =C10*C8
little effect on the cost, Combined cost $1,039 =C12+C13
because EOQ formula Annual purchase cost $81,000 =C5*C6
gives robust solutions. Total cost $82,039 =C14+C15
Reference
 Factory Physics. Hopp & Spearman,
Irvin, 1996, Chapter 2

Inventory Control Models: EOQ Model

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Inventory control models

• calculate the order quantity that minimize the

 dependent demand, and

 Dependent demand items are those items whose

 Supplies are items such as copier paper, cleaning

 Ordering costs; and

• 2. Delivery is immediate. There is no time lag between production and

• 3. Demand is deterministic. There is no uncertainty about the quantity or

• 4. Demand is constant over time. In fact, it can be represented as a

• 5 A production run incurs a constant setup cost. Regardless of the size

• 6. Products can be analyzed singly. Either there is only a single product

 The production cost per unit:

1. “There is a tradeoff between lot size

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