Independent Demand Ordering Systems Chapter 11 1 Dependent

Independent Demand Ordering Systems Chapter 11 1

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

Dependent VS Independent Demand Dependent Demand 3

Independent Demand Ordering Systems • 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? 4

Definitions • 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. ” • Safety 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…” APICS Dictionary 7 th Edition 5 © 1992

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

Independent Demand Ordering Systems • Order Point Systems – A system where an order is placed whenever the onhand inventory level falls to a predetermined level known as the order point • Quantity 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 arrives 7

Independent Demand Ordering Systems • The 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. 8

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 9

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

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 2 11

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

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

Independent Demand Ordering Systems • Variability 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) 14

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

Average & Dispersion 16

Mean Absolute Deviation Forecast D Actual D Deviation 100 66 34 100 110 10 100 131 31 100 103 3 100 96 4 100 119 19 100 92 8 100 0 100 80 20 17

Standard Deviation (Sigma) Forecast Demand Actual Demand Deviation Dev Squared 100 66 34 1156 100 110 10 100 131 31 961 100 103 3 9 100 96 4 16 100 119 19 361 100 92 8 64 100 0 0 100 80 20 400 Total 3067 18

Independent Demand Ordering Systems • Determining 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 19

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

Example: Safety Stock & Order Point Using the figures in the last example problem in which the sigma was calculated as 18. 5 units Safety 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 Order point = DDLT + SS = 100 + 18. 5 = 118. 5 units From safety factor on page 291 21

Example: Safety Stock & Order Point Using the figures in the last example problem in which the sigma was calculated as 18. 5 units Safety 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. A: Safety stock = Sigma x safety Factor = 18. 5 x 1. 65 = 30. 525 or 31 units Order point = DDLT + SS = 100 + 31 = 131 units 22

Safety Factor Generated using Excel function NORMSINV 23

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 = 18. 5 x 1. 28 = 23. 68 or 24 units Order point = DDLT + SS 24

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

Independent Demand Ordering Systems • Service 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. 26

Independent Demand Ordering Systems • Determining 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 used • Variations include tags and indicators Order One Bin of Inventory Full Empty 27

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

Independent Demand Ordering Systems • Periodic 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. 29