1. 1

2. 2 Dependent VS Independent E(1) Independent Demand (Demand not related to other items) Dependent Demand (Derived)

3. 3 Dependent VS Independent Independent Demand Dependent Demand

4. 4 Independent Demand Ordering Systems Main question now turns to when to place an order?Main question now turns to when to place an order? –Stock not ordered early enough may result in a stockout situation –Stock ordered too soon may result in excess inventory –How do you balance the two?

5. 5 Definitions Lead Time : “The time between recognition of a need for an order and the receipt of the goods”Lead Time : “The time between recognition of a need for an order and the receipt of the goods” Order Point: “A set inventory level where, if the stock on hand plus on-order falls to or below that point, action is taken to replenish the stock.”Order Point: “A set inventory level where, if the stock on hand plus on-order falls to or below that point, action is taken to replenish the stock.” Safety Stock: “In general, a quantity of stock planned to be in inventory to protect against fluctuations in demand and/or supplySafety Stock: “In general, a quantity of stock planned to be in inventory to protect against fluctuations in demand and/or supply Service Level: “… the percentage of orders filled from stock…”Service Level: “… the percentage of orders filled from stock…” APICS Dictionary 7th Edition ©1992

6. 6 Independent Demand Ordering Systems Reorder Systems Include:Reorder Systems Include: –Order Point System –Periodic Review System –MRP For dependent demand itemsFor dependent demand items

7. 7 Independent Demand Ordering Systems Order Point SystemsOrder Point Systems –A system where an order is placed whenever the on- hand inventory level falls to a predetermined level known as the order point Quantity ordered is usually predetermined and based on the EOQQuantity ordered is usually predetermined and based on the EOQ An order must be placed when there is enough stock on hand to satisfy demand from the time the order is placed until new stock arrivesAn order must be placed when there is enough stock on hand to satisfy demand from the time the order is placed until new stock arrives

8. 8 Independent Demand Ordering Systems The Order PointThe Order Point –The point where there exists enough inventory on hand to equal the demand during the lead time plus some safety stock. Order Point = Demand During Lead Time + Safety Stock OP = DDLT + SS –Note that the demand during lead time is important as this when a stockout could occur.

9. 9 Example: Order Point Q: Demand is 100 units a week, the lead time is three weeks, and the safety stock has been established at 300 units. Calculate the order point. A:Order Point = ? DDLT = (100 units per week x 3 weeks) SS = 300 units OP = DDLT + SS = (100 x 3) + 300 = 600 units

10. 10 Independent Demand Ordering Systems Order PointOrder Point Average Inventory = Q/2 + SS Lead Time Q = Order Quantity Order Point Safety Stock Units in Stock

11. 11 Example: Average inventory Q: Order quantity is 7000 units and safety stock is 900 units. What is the average annual inventory? A: Average inventory = Q/2 + SS = 7000 + 900 = 4400 units = 7000 + 900 = 4400 units 2

12. 12 Independent Demand Ordering Systems UncertaintyUncertainty –Quantity uncertainty When the amount of supply or demand variesWhen the amount of supply or demand varies –Timing uncertainty Time of receipt of supply or demand differs from that expectedTime of receipt of supply or demand differs from that expected –Two ways to protect: Carry extra stock (safety stock)Carry extra stock (safety stock) Order early (safety lead time)Order early (safety lead time)

13. 13 Independent Demand Ordering Systems Safety StockSafety Stock –SS is used to protect against uncertainty in supply and demand. –SS depends on: Variability of demand during lead timeVariability of demand during lead time Frequency of reorderFrequency of reorder Service level desiredService level desired Length of lead timeLength of lead time

14. 14 Independent Demand Ordering Systems Variability of DemandVariability of Demand –Actual demand will vary from the forecast due to bias and random fluctuations. –Usually the variation of demand will follow a normal distribution (bell curve)

15. 15 Independent Demand Ordering Systems Variability of DemandVariability of Demand –Actual demand will be +1 Sigma Sigma -2 Sigma +2 Sigma -3 Sigma +3 Sigma

16. 16 Average & Dispersion

17. 17 Mean Absolute Deviation Forecast Forecast D Actual D Deviation 1006634 10011010 10013131 1001033 100964 10011919 100928 1001000 1008020

18. 18 Standard Deviation (Sigma)  Forecast Demand Actual Demand Deviation Dev Squared 10066341156 10011010100 10013131961 10010339 10096416 10011919361 10092864 10010000 1008020400 Total3067

19. 19 Independent Demand Ordering Systems Determining Safety StockDetermining Safety Stock –SS is needed only to cover those periods in which the demand during lead time is greater than average. –Service level is a statement of the percentage of time there is no stockout –Safety Factor is derived from the service level

20. 20 Independent Demand Ordering Systems Safety Stock EquationSafety Stock Equation Safety Stock = (Sigma x Safety Factor)Safety Stock = (Sigma x Safety Factor)

21. 21 Example: Safety Stock & Order Point Using the figures in the last example problem in which the sigma was calculated as 18.5 unitsSafety Stock = (Sigma x Safety Factor) Q: a) Calculate the safety stock and order point for an 84% service level. A: Safety stock = Sigma x safety Factor = 18.5 x 1.00 = 18.5 units = 18.5 x 1.00 = 18.5 units Order point = DDLT + SS = 100 + 18.5 = 118.5 units = 100 + 18.5 = 118.5 units From safety factor on page 291

22. 22 Example: Safety Stock & Order Point Using the figures in the last example problem in which the sigma was calculated as 18.5 unitsSafety Stock = (Sigma x Safety Factor) Q: b) If a safety stock equal to 95.5% is carried, calculate the safety stock and the order point. Q: b) If a safety stock equal to 95.5% is carried, calculate the safety stock and the order point. A: Safety stock = Sigma x safety Factor = 18.5 x 1.65 = 30.525 or 31 units = 18.5 x 1.65 = 30.525 or 31 units Order point = DDLT + SS = 100 + 31 = 131 units = 100 + 31 = 131 units

23. 23 Safety Factor Generated using Excel function NORMSINV

24. 24 Example: Safety Stock & Order Point Q: If the standard deviation is 18.5 units, what safety stock should be carried to provide a service level of 90%? If the expected demand during the lead-time is 500 units, what is the order point? A: The safety factor for a service level of 90% is 1.28 Safety stock = sigma x safety factor Safety stock = sigma x safety factor = 18.5 x 1.28 = 23.68 or 24 units = 18.5 x 1.28 = 23.68 or 24 units Order point = DDLT + SS Order point = DDLT + SS = 500 + 24 = 524 units = 500 + 24 = 524 units

25. 25 Independent Demand Ordering Systems Service LevelService Level –Stockouts lead to costs such as Back-order costsBack-order costs Lost SalesLost Sales Lost CustomersLost Customers Possible only when stock is running low, usually the time when an order is placedPossible only when stock is running low, usually the time when an order is placed Chances of a stockout are directly proportional to frequency of reorderChances of a stockout are directly proportional to frequency of reorder

26. 26 Independent Demand Ordering Systems Service LevelService Level –The service level will determine the number of stockouts that will occur each year. –Service level decisions are the responsibility of senior management and should reflect the company’s corporate and marketing strategy.

27. 27 Independent Demand Ordering Systems Determining When the Order Point is ReachedDetermining When the Order Point is Reached –Two-Bin System A quantity of an item equal to the order point is set aside and not touched until the main stock has been usedA quantity of an item equal to the order point is set aside and not touched until the main stock has been used Variations include tags and indicatorsVariations include tags and indicators FullEmpty Order One Bin of Inventory

28. 28 Independent Demand Ordering Systems Determining When the Order Point is ReachedDetermining When the Order Point is Reached –Perpetual Inventory System A continual account of inventory transactions as they occurA continual account of inventory transactions as they occur Contains “permanent” and “variable” informationContains “permanent” and “variable” information –Barcoding

29. 29 Independent Demand Ordering Systems Periodic Review SystemPeriodic Review System –The quantity on hand of a particular item is determined at specified, fixed-time intervals. –The review period is fixed and the order quantity is allowed to vary. –The quantity on hand plus the quantity ordered must be sufficient to last until next shipment is received.