Inventory Management

Extensions to EOQ
Chris Caplice
ESD.260/15.770/1.260 Logistics Systems
Oct 2006

Agenda
Review of Basic EOQ
Non-instantaneous Leadtime
Finite Replenishment (EPQ)
Multiple Locations
Discounting

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Chris Caplice, MIT

Economic Order Quantity (EOQ)

Finding the order quantity Q (and frequency T) that
minimizes the total relevant cost.

AD vrQ
TRC[Q] =
+
Q
2
2 AD
Q* =
vr

T* =

2A
Dvr

TRC* = 2 ADvr
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Chris Caplice, MIT

Assumptions: Basic EOQ Model

Demand

Discounts

Constant vs Variable
Known vs Random
Continuous vs Discrete
Instantaneous
Constant or Variable
(deterministic/stochastic)

Dependence of items

Independent
Correlated
Indentured
Continuous
Periodic
One
Multi (>1)

None
Uniform with time

Single Period
Finite Period
Infinite

One
Many

Single Stage
Multi-Stage

Form of Product

Unlimited
Limited / Constrained

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Number of Items

Capacity / Resources

None
All orders are backordered
Lost orders
Substitution

Planning Horizon

Number of Echelons

Perishability

Review Time

None
All Units or Incremental

Excess Demand (Shortages)

Lead time

Chris Caplice, MIT

Extensions: Leadtime
Order Leadtime

Demand

Positive (nonzero)
Deterministic

Impact

Order

Receive

Does this change Q*?

What is my new policy?
What is my new avg
IOH?

L = Order Leadtime
Inventory On Order

Inventory
On
Hand
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EOQ Inventory Policy:

Order Q* units when IOH = DL
5

Chris Caplice, MIT

Extensions: Finite Replenishment

Inventory becomes available at a rate of m units/time
rather than all at one time

Does this change Q*?

What is my new policy?
What is my new avg IOH?

Q(1-D/m)

Inventory
On
Hand

Slope = m-D

D
Q 1 vr
AD
m
+
TRC[Q] =
2
Q

Slope = -D

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D
2 AD
EPQ =
= EOQ 1
m
D

vr 1
m
6

Chris Caplice, MIT

Extensions: Multiple Locations

Suppose that instead of one location satisfying all demand, there
are n locations.

Each location serves di = D/n units of demand

Identical (uniform) demand at each location

What is my new inventory policy?

What is my new average Inventory on Hand?
How much is this better or worse than a single location?

Questions

Q*

2 AD
Q* =
vr
Q*
IOH =
TRC* = 2 DAvr
2
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q1*

qi* =

versus

2 Adi
2 AD
=
vr
vrn

n q
IOH = i =1
2

*
i

q2*
q3*

TRC* = 2nDAvr

Q*
=
n

Chris Caplice, MIT

Extensions: Multiple Locations

What if I reduce number of stocking locations from M to N?

M
TRC*[M ]
2MDAvr
=
=
N
TRC*[ N ]
2 NDAvr
What if my sub-regions do not have uniform demand?
Is this a reduction in safety stock, cycle stock, or both?
How dependent is this effect on inventory policy at each site?

EOQ Policy (order qEOQ* when IOHi=0)

Fixed Order Size (Always order a full truckload at a time)
Days of Supply (Always order a months supply)

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Chris Caplice, MIT

Extensions: Multiple Locations

Fixed Order Size, e.g. only order full truckloads
Days of Supply, e.g. order at start of each month

For a Single Location

Policy

EOQ

FOS

DOS

Q*

QFOS

QDOS

Order Size
Average IOH

Q*/2

QFOS/2

QDOS/2

Order Cost

OEOQ

OFOS

ODOS

Holding Cost

HEOQ

HFOS

HDOS

OEOQ + HEOQ

OFOS + HFOS

ODOS + HDOS

Total Cost

For N Locations
Policy

EOQ

FOS

DOS

q*

QFOS

qDOS

Average IOH

N(Q*/2)

N(QFOS/2)

QDOS/2

Order Cost

N( OEOQ)

OFOS

N(ODOS)

Holding Cost

N (HEOQ)

N(HFOS)

HDOS

N (OEOQ+HEOQ)

OFOS+NHFOS

NODOS+HDOS

Order Size

Total Cost

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Example
DATA
A=
500
D = 2000
r=
0.25
v=
50
N=
4
Trk Cap =
500
DOS = 0.083
30

$/order
Units/year
$/$/year
$/unit
locations
units/shipment
years
days

Single Location
Policy
Order Size
Average IOH
Order Cost
Holding Cost
Total Cost

EOQ
FOS
400
500
200
250
$ 2,500 $ 2,000 $
$ 2,500 $ 3,125 $
$ 5,000 $ 5,125 $

DOS

4 Locations
Policy
Order Size
Average IOH
Order Cost
Holding Cost
Total Cost

EOQ
FOS
200
500
400
1000
$ 5,000 $ 2,000 $
$ 5,000 $ 12,500 $
$ 10,000 $ 14,500 $

DOS

167
83
6,000
1,042
7,042

42
21
24,000
1,042
25,042

Chris Caplice, MIT

Extensions: Discounts
All Units Discount

Discount applies to all units purchased if total amount exceeds

the break point quantity
Examples?

Incremental Discount

Discount applies only to the quantity purchased that exceeds

the break point quantity
Examples?

One Time Only Discount

Less common but not unheard of!

A one time only discount applies to all units you order right now
(no quantity minimum or limit)

How will different discounting strategies impact your lot sizing

decision?
What cost elements are relevant?

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10

Chris Caplice, MIT

Extensions: All Units Discounts

Two Cases to Examine . . .

v0
v=
v0 (1 d )

0 Q Qb
Qb Q

AD v0 rQ

Dv
+
+
0 Q Qb
0

Q
2

TRC =
Dv (1 d ) + AD + v0 (1 d ) rQ
Qb Q
0
Q
2

Qb

$112,000
$110,000

Where
d = Discount
v0 = Base unit price
Qb = Break quantity

Total Cost

$108,000
$106,000
$104,000
$102,000

Typically, Q* < Qb but

what if Q* > Qb?

$100,000
$98,000
100

200

300

400

500

600

700

800

900 1000

Order Quantity (Lot Size)

TC2

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TC1

11

Chris Caplice, MIT

Extensions: All Units Discounts

Simple efficient algorithm
1.
2.
3.

Find EOQ with discount (EOQd)

If EOQdQb then pick EOQd
Otherwise, go to 3
Solve for TRC(Q*) and TRC(Qb)
If TRC(Q*) < TRC(Qb) then pick Q*
Otherwise, pick Qb

Can be extended to more than one break point

Example:
D=2000 Units/yr
r=.25
A=$500
v0 = $50
Discount of 2% off if Q500

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12

Chris Caplice, MIT

Extensions: Incremental Discounts

Total
Purchase
Cost

Discount only applies to quantity above breakpoint

Trade-off between lower purchase cost and higher carrying costs
Cost of units ordered below each breakpoint are essentially fixed

v1
v2

v0

v1Q1
v0Q1

(v0-v1)Q1

Q1

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Q2
13

Units
Chris Caplice, MIT

Extensions: Incremental Discounts

Efficient algorithm
1.
2.
3.
4.

Find Fixed Cost per breakpoint, Fi, for each break

Find EOQi for each range including the Fi
If EOQi is not within allowable range, go to next I
Otherwise, find TRCi using effective cost per unit, vei
Pick EOQi with lowest TRC

Can be extended to more than one break point

Fi = Fi 1 + ( vi 1 vi ) Qi

F0 = 0

2 D ( A + Fi )
EOQi =
rvi
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vi EOQi + Fi
v =
EOQi
e
i

14

Chris Caplice, MIT

Example: Incremental Discounts

Price Breaks:
10% off for 500 to <1000 units
20% off for 1000 or more units

i=2

i=1

i=0

vi

$40

$45

$50

Qbi

1,000

500

Fi

7,500

2,500

EOQi

1,789
OK

1,033
X

400
OK

vei

$44.19
Purch
Order
Hold

TRCi

D=2000 Units/yr
r=.25
A=$500
v0 = $50

$50

$ 88,384
$
559
$ 9,882
$ 98,825

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$100,000
$ 2,500
$ 2,500
$ 105,000
15

Chris Caplice, MIT

Extensions: One Time Discount

Suppose you are offered a One Time deal!
Should you take it?
vg = One time good deal purchase price ($/unit)
Qg = One time good deal order quantity (units)
TCsp=TC over time covered by special purchase ($)

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16

Chris Caplice, MIT

Extensions: One Time Discount

Compare Options: Not Special Price vs. Special Price

Find TC for normal price

TC = (CycleTime)(TC * + PurchaseCost )
Qg
Qg
TC =
2 ArvD +
D
D

vD

Find the Savings (TC-TCSP)

Savings = TC TCSP
Qg
Qg
=
2 ArvD +
D
D
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Qg Qg
vD vg Qg + rvg

+ A

2 D

17

Chris Caplice, MIT

Extensions: One Time Discount

Finding 1st and 2nd order conditions (Maximize Savings)

2rvg Qg
dS
1
= 0 = 2 AvrD + ( v vg )

d (Qg )
D
2
D

2rvg
d 2S
=
2
d (Qg )
2D

So that the Optimal Quantity to buy is

D
Q =
Drv
g

*
g

<0

Cleaning this up gives:

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D ( v vg )

2 ArvD +
rvg

v
Q =Q
v
g
*
g

18

D ( v vg )
+
rvg

Chris Caplice, MIT

Take-Aways
EOQ is a good place to start for most analysis
EOQ can be extended to cover

Non-zero leadtimes
Finite replenishment systems
Multiple locations

Square Root law rests on implicit assumptions

Distribution of demand and inventory policy will impact
results

Discounts

Purchase price (v) becomes relevant

Common in practice (economies of scale)

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19

Chris Caplice, MIT

Questions?
Comments?
Suggestions?