Re-Order Point Problems

Set 1: General

Notations
Lead Time Demand : LTD
Average Lead Time Demand : LTD
Std. Dev. Lead Time Demand : LTD
Safety Stock : Isafety
Reorder Point : ROP
Demand per period : R
Average Demand : R
Std. Dev. of Demand : R
L
Lead Time : L

Average Lead Time : L

Std. Dev. of Lead Time : L
Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

ROP; Fixed R, Fixed L, Zero Safety Stock

a) If average demand per day is 20 units and lead
time is 10 days. Assuming zero safety stock.
Isafety = 0, L=10, R=20
Compute ROP.
ROP = average demand during lead time + safety
stock
ROP = LTD+ Isafety
ROP = LTD + 0
LTD = L R
LTD = 20 10 = 200
ROP = 200

Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

ROP; Fixed R, Fixed L, Isafety >0

b) If average demand per day is 20 units and lead
time is 10 days. Assuming 70 units of safety
stock.
Isafety = 70, L=10, R=20
Compute ROP.
ROP = average demand during lead time +
Safety Stock
ROP = LTD + Isafety
LTD = R L = 20 10 = 200
Isafety = 70
ROP = 200 + 70 = 270
Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

ROP; total demand during lead time is variable

c) If average demand during the lead time is 200
and standard deviation of demand during lead
time is 25. Compute ROP at 90% service level.
Compute safety stock.

Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

Safety Stock and ROP

Risk of a
stockout

Service level
Probability of
no stockout

ROP

Average
demand

Quantity

Safety stock
0

z-scale

Each Normal variable x is associated with a standard Normal

Variable z
xThere
is Normal
(Average
, Standard
Deviation x) z is Normal
is a table
for z xwhich
tells us
(0,1)
a) Given any probability of not exceeding z. What is the
value of z.
b) Given any value for z. What is the probability of not

Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

Popular z Values

Risk Service level

z
value
0.1
0.9
1.28
0.05
0.95
1.65
0.01
0.99
Flow Variability; Safety Inventory
Ardavan Asef-Vaziri

Sep-2012

ROP and Isafety

z = (x-Average x)/(Standard Deviation of

x = +z
x)

x = Average x +z (Standard Deviation of

ROP = LTD +z LTD
x)
= Average x

= Standard Deviation of x
ROP = LTD +Isafe
Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

ROP and Isafety

LTD = Lead Time Demand (Demand during lead

time)
LTD = Average LTD = LR
LTD = Standard Deviation of Lead Time Demand
Isafety = zLTD
Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

ROP; total demand during lead time is variable

c) If average demand during the lead time is 200 and
standard deviation of demand during lead time is 25.
Compute ROP at 90% service level. Compute safety
stock

z = (X- )/

LTD = 200

X= +z

LTD = 25

ROP = LTD +
Isafety

ROP= 200+ 1.28 25

Isafety = z LTD

ROP = 232

ROP=LTD + zLTD

Isafety = 32

ROP = 200 + 32

SL = 90%
Flow
z
=Variability;
1.28Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

10

ROP; Variable R, Fixed L

d) If average demand per day is 20 units and
standard deviation of demand is 5 per day, and
lead time is 16 days. Compute ROP at 90%
service level. Compute safety stock.

Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

11

ROP; Variable R, Fixed L

Previous Problem: If average demand during the
lead time is 200 and standard deviation of
demand during lead time is 25. Compute ROP
at 90% service level. Compute safety stock.
This Problem: If average demand per day is 20
units and standard deviation of demand per
day is 5, and lead time is 16 days. Compute
ROP at 90% service level. Compute safety
stock.
If we can transform this problem into the previous
problem, then we are done, because we
Flowalready
Variability; Safety
Inventory how to Ardavan
Asef-Vaziri
Sep-2012
know
solve
the previous
12

ROP; Variable R, Fixed R

d) If average demand per day is 20 units and
standard deviation of demand is 5 per day, and
lead time is 16 days. Compute ROP at 90%
service level. Compute ss.
What is the average demand during the
lead time
What is standard deviation of demand
during lead time

Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

13

 and of demand per period and fixed L

If Demand is variable and Lead time is fixed
L: Lead Time
R: Demand per period (per day, week, month)
R: Average Demand per period (day, week,
month)
R: Standard deviation of demand (per period)
LTD: Average Demand During Lead Time
LTD = L R
LTD: Standard deviation
of demand during lead

=
time
Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

14

 and of demand per period and fixed L

If demand is variable and Lead time is fixed
L: Lead Time = 16 days
R: Demand per day
R: Average daily demand = 20
R: Standard deviation of daily demand = 5
LTD: Average Demand During Lead Time
LTD = L R = 16 20 = 320
LTD: Standard deviation of demand during lead
time

Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

15

Now It is Transformed
The Problem originally was: If average demand
per day is 20 units and standard deviation of
demand is 5 per day, and lead time is 16 days.
Compute ROP at 90% service level. Compute
safety stock.
We transformed it to: The average demand during
the lead time is 320 and the standard deviation
of demand during the lead time is 20. Compute
ROP at 90% service level. Compute safety
stock.
Which is the same as the previous problem: If
average demand during the lead time is 200
and standard deviation
of demand during lead 16
Flow Variability; Safety Inventory
Ardavan Asef-Vaziri Sep-2012

ROP; Variable R, Fixed L

SL = 90% z = 1.28
x=+z
ROP= LTD +z LTD
LTD = 320
LTD = 20
ROP= 320+ 1.28 20
ROP= 320 + 25.6
ROP= 320 + 26
ROP = 346
Isafety = 26

Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

17

ROP; Variable R, Fixed L

e) If demand per day is 20 units and lead time is
16 days and standard deviation of lead time is
4 days. Compute ROP at 90% service level.
Compute Isafety.
What is the average demand during the
lead time
What is standard deviation of demand
during lead time

Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

18

 and of L and Fixed R

If Lead time is variable and Demand is fixed
L: Lead Time
L: Average Lead Time
L: Standard deviation of Lead time
R: Demand per period
LTD: Average Demand during lead time
LTD = L R
LTD: Standard deviation of demand during lead

time
=R
Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

19

 and of L and Fixed R

If Lead time is variable and Demand is fixed
L: Lead Time
L: Average Lead Time = 16 days
L: Standard deviation of Lead time = 4 days
R: Demand per period = 20 per day
LTD: Average Demand During Lead Time
LTD = 16 20 = 320
LTD: Standard deviation of demand during lead

time
=R
=20(4) =80
Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

20

 and of L and Fixed R

LDT = 320
LTD = 80
SL = 90%
z =1.28
ROP = LTD +zLTD
ROP = 320 +1.28(80)
ROP = 320 + 102.4
Isafety = 102.4
Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

21

Given Safety Inventory Compute Service Level

Average lead time demand is 20,000 units. Standard
deviation of lead time demand is 5,000 units. The
warehouse currently orders a 14-day supply, 28,000
units, each time the inventory level drops to 24,000 units.
Suppose holding cost is $2 per unit per year.
LTD = 20,000, ROP = 24,000, LTD = 5,000.
a) Compute the service level.
ROP = LTD + Isafety Isafety = 24,000 20,000 =
4,000
ROP = LTD +z LTD Isafety = z LTD =4000
z(5,000) = 4,000 z = 4,000/5,000 = 0.8
z =0.8 P(z Z) = 0.7881 = 78.81%
In 78.81 % of the order cycles, the warehouse will not
have a stockout. Risk = 21.19%.
Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

22

Given Safety Inventory Compute Service Level

b) Compute the cycle inventory, and average inventory.
R = 2,000 / day, Q or EOQ = 28,000, H=$2.
At reorder point we order 28,000 units.
Icycle = Q/2 = 28,000/2 = 14,000
Isafety = 4,000
Average Inventory = I = Icycle + Isafety =14,000 + 4,000
= 18000.
c) Compute the total holding costs per year.
H(Average Inventory) = H(I) = 2 18,000 = 36,000/year
d) Compute the average flow time.
R = 2,000 / day, I = 18,000
RT = I 2000T = 18,000
T=9
Flow
Variability; Safety Inventory
Ardavan Asef-Vaziri Sep-2012
23
9 days

Problem 7.1
MassPC Inc. produces a 4-week supply of its PC Pal
model when stock on hand drops to 500 units. It takes 1
week to produce a batch. Orders average 400 units per
week, and standard deviation of forecast errors is
estimated
units.
4(40
Q
ROP =50 Lat 125
1
LTD = 400/wee =125
= table0)
Normal
k
0 = week
LTD = N(400, 125).
z
Second digit
ROP = LTD + Isafety
after
ROP = LTD +z LTD
decimal
500= 400+z(125)
100 = 125z
z = 100/125 = 0.8

Up to
the
first
digit
after
decim
al
Ardavan Asef-Vaziri Sep-2012

Probability

SL P ( LTD ROP) 0.7881

Flow Variability; Safety Inventory

24

Problem 7.1

Safety Stock

b) Compute Isafety for 80%, 90%, 95%, 99% service

levels.

Service Level

Increasing service level increases the required safety

inventory more than proportionately.
Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

25

Problem 7.1
Selecting service level and safety inventory level is an
important strategic decision.
A firm may choose high quality service in terms of product
availability. Or
The firm may choose to be a low cost supplier by holding
down inventory costs. In either case, it is positioning itself
along the quality vs. cost trade-off curve.
This graph is a perfect
example to show how a
strategic position could
be operationalized.

Cost

Quality
Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

26

Service Level, Fill Rate

Within 100 time intervals, stockouts occur in 20.
Service Level = 80/100 = 80%.
Probability of stock-out = 20%.
Risk = # of stockout intervals/ Total # of intervals
Service Level = 1- (# of stockout intervals/ Total # of
intervals)
Suppose that in each time interval in which a stockout
occurred, the number of units by which we were short.
Suppose that cumulative demand during the 100 time
intervals was 15,000 units and the total number of units
short in the 20 intervals with stockouts was 1,500 units.
Fill rate = (15,000-1,500)/15,000 = 13,500/15,000 =
90%.
Fill Rate = Expected Sales / Expected Demand
Flow Variability; Safety Inventory

Ardavan Asef-Vaziri

Sep-2012

27