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Backorder Inventory Model

In this model, we assume that stock outs (and

backordering) are allowed.
In addition to previous assumptions, we assume that
sales will not be lost due to a stock out.
Because, we will back order any demand that can
not be fulfilled
B: Backordering cost per unit per year
b: The amount backordered at the time the next
order arrives
Q – b: Remaining units after the backorder is

Total Annual Cost = Annual Setup Cost + Annual

Holding Cost + Annual Backordering Cost
 Annual Setup (Ordering) Cost = (D/Q) . S
Annual Holding Cost = (Average Inventory Level) . H
By using the graphical ratios, we know that:

T1 / T = (Q – b) / Q Therefore, if we replace
T1/T in the above equation we get

 Average Inventory Level = (Q – b)2 / 2Q
By using the graphical ratios, we know that:
T2 / T = b / Q Therefore, if we replace T2/T in
the above equation we get
Average Backordering = b2 / 2Q and
We find optimum order quantity (Q*) and optimum
backordering quantity (b*) by taking the derivatives
of dTC/dQ = 0 and dTC / db = 0 and then putting
the values in their places.
Quantity Discount Model
A quantity discount is simply a reduced price (P) for
an item when it is purchased in LARGER quantities.
A typical quantity discount schedule is as follows:
Since the unit cost for the Third discount is the
lowest, We might be tempted to order 2000 or more
However, this quantity might not be the one that
minimizes the Total Cost.
Remember that, As the quantity goes up, the
holding cost increasesHere, there is a trade off
between reduced product price (P) and increased
holding cost (H).
Total Cost = Setup Cost + Holding Cost + Product
Price (Cost)
Total Cost = DS / Q + QH / 2 + PD where P
is the price per unit
To determine the minimum Total Cost, we perform
the following process which includes 4 steps:
Step 1: Assume that
I: is a percentage value, and
I . P represents the holding cost as a percentage of
price per unit (P).
For each discount alternative, calculate a value of
Q* = [2DS / IP]1/2
Here, instead of using a value of H, the holding cost
is equal to I . P
That is, If the item is expensive (such as a Class A
Item), Its holding cost will be higher.
Since the price of item (P) is a factor in Annual
Holding Cost, we can no longer assume that the
holding cost is constant (such as H) when price
Step 2: For any discount alternative,
If the calculated optimum order quantity (Q*) is too
low to qualify for the discount range,
Then, Adjust the order quantity upward to the
lowest quantity that will qualify for the particular
discount alternative.
Step 3: Using the total cost (TC) equation above,
compute a total cost for every order quantity (Q).
Use the adjusted Q values.
Step 4: Select the discount alternative which has the
minimum Total Cost (TC).