Chapter 4 PMOR

4: Lot Sizing
4.1. The Economic Order Quantity (EOQ)

4.1.1 The EOQ-Formula
4.1.2 Example
4.1.3 Properties
4.1.4 Sensitivity Analysis
4.1.5 Further Remarks
4.2. The Economic Batch Quantity (EBQ)
4.3. Dynamic Lot Sizing
4.3.1. The Wagner-Whitin-Problem
4.3.2. Heuristics for dynamic lot-sizing
4.3.3. An exact approach to the dynamic lot-sizing problem
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SS 2015
Production Management & Operations Research
4-1
4: Lot Sizing
Literature
Nahmias, S. (2005), 183-202; 346-366
Krajewski, L. J.; Ritzman, L. P. (2002), 593-607; 731-796
Heizer, J.; Render, B. (2006), 473-513; 549-586

SS 2015
4-2
Exercise 4.1
An enterprise consumes 15,000 kilograms of a certain material per month (30 days),
which is demanded by the production department at a constant rate per day (also on
Saturdays, Sundays and public holidays). The (variable) cost per order are 600
(order cost rate), the (variable) cost of storing one kilogram for one day have been
calculated at 0.15 (holding cost rate).
1.
Determine an optimal lot size under the assumption that the enterprise would
like to minimize the sum of its monthly holding and ordering cost!
2.
What are the total cost per month? What are the contributions of the holding
cost and of the ordering cost? Also determine the corresponding cost per
material unit!
3.
How long will this lot last? How many orders will have to be placed per month?

SS 2015
4-3
The classic EOQ model

constants
T
: length of planning period (in time units);
cH
: holding cost rate: cost of keeping one unit in stock for one time unit;
cO
: ordering cost rate: cost per order;
: demand rate: number of units required per time unit;
variables
(a)
expectation variables
: total cost per planning period;
CH
: total holding cost per planning period;
CO
: total ordering cost per planning period;
(b)
decision variable
: order lot-size, Economic Order Quantity (EOQ).

SS 2015
4-4
The classic EOQ model

(1) development of inventory over time
inventory
x (1)
( 2) 1 (1)
x = 3 x
(2) relationship between total, holding and ordering cost

C
C H = c HT
1
x
2
CH
CO
nT
CO = c O
x
x
optimal lot-size,
Economic Order Quantity (EOQ)

SS 2015
4-5
SS 2015
13,500
14,250
14,850
15,000
15,150
15,750
16,500
22,500
0.95
0.99
1.00
1.01
1.05
1.10
1.50
7,500
0.50
0.90
actual
demand
demand
deviation
factor
(expected) demand rate (n):

ordering cost rate (cO):
holding cost rate (cH):
optimal lot-size (x*):
2,449.5
2,097.6
2,049.4
2,010.0
2,000.0
1,990.0
1,949.4
1,897.4
1,414.2
optimal
lot-size
500
600
0.15
2,000
11,022.7
9,439.3
9,222.3
9,044.9
9,000.0
8,954.9
8,772.1
8,538.1
6,364.0
total cost for

optimal
lot-size
11,250.0
9,450.0
9,225.0
9,045.0
9,000.0
8,955.0
8,775.0
8,550.0
6,750.0
2.062
0.114
0.030
0.001
0.000
0.001
0.033
0.139
6.066
total cost for

increase of
non-optimal
total cost (%)
lot-size
The classic EOQ model: sensitivity analysis
4-6
Exercise 4.2
Customers demand 15,000 kilograms per month (30 days) of a certain final product
from a manufacturing company. The demand is coming in at a more or less
constant rate. The company produces at a constant rate of 1,500 kilograms per day
(also on Saturdays, Sundays and public holidays). The holding cost rate per product
unit (one kilogram) is 0.15 , the (variable) set-up cost rate has been determined at
600 per set up.
1.
Determine the lot-size, which minimizes the sum of the monthly holding and setup costs!
2.
How long is the cycle time? How many lots have to be produced in one month?
3.
What are the total costs per month? What are the contributions of the holding
cost and of the set-up cost?

SS 2015
4-7
The Economic Batch Quantity (EBQ) Model

constants
T
: length of planning period (in time units);
cH
: holding cost rate: cost of keeping one unit in stock for one time unit;
cS
: set-up cost rate: cost per set-up;
: production rate: number of units produced per time unit;
: demand rate: number of units required (by customers) per time unit.
variables
(a)
expectation variables
CH
: total holding cost per planning period;
CS
: total set-up cost per planning period;
t1
: length of stock-accumulation period;
t2
: length of stock-reduction period;
Tc
: cycle time; Tc = t1 + t2;
: maximal number of product units in stock.
(b)
decision variable
: production lot-size, batch size.

SS 2015
4-8
Development of inventory over time
inventory
x
y
t
t1
t2

SS 2015
4-9
Results from EOQ and EBQ Models

a
a = 1,500
optimal lot size

x*
optimal maximal stock
size
y*
number of lots per
month
length of stockaccumulation period t1
length of stockreduction period
t2
cycle time
Tc
total cost per month C
total holding cost per
month
CH
total ordering / set-up
cost per month CO /
CS
per unit cost
c

SS 2015
4 - 10
Limits of the EBQ-Model, multiple product case
inventory
product type I
t
inventory
product type II

SS 2015
4 - 11
Exercise 4.3
Besides other components, a car-manufacturing company buys batteries from a
supplier. On the basis of its planned product-mix, the production planning
department is able to give a precise forecast of its demand for (12-volt-) batteries for
the following six weeks (which is identical with the planning period; see Table 1).
week
number of batteries
nt
8,000
4,000
6,000
2,000
3,000
7,000
Table 1: Demand forecast for batteries
The (decision-relevant) cost of placing an order has been calculated at 600 each.
Batteries which have to be stocked until they are needed in manufacturing cause
(decision-relevant) holding cost (interest on included capital, in particular) of 0.10
per unit and week.
The buying centre of the company would like to determine a purchasing policy which
minimizes the sum of ordering and holding cost.
With respect to storage the following assumptions can be made:
Ordered batteries are received once a week, shortly before production starts
on Monday morning. The time which is needed to unload the transportation
vehicles and to transfer the batteries to their respective storage locations can
be neglected.

SS 2015
4 - 12
Exercise 4.3 (cont.)
Likewise, withdrawals from stock only take place once a week directly before
the start of production on Monday morning.
There will be no batteries available for manufacturing on Monday morning of the

first week unless an order is placed. In other words: Inventory of batteries on
hand is zero.
The planned inventory for the end of the last week is zero.
Assignments
1.
Formulate a mathematical model (Wagner-Whitin-Model) from which an optimal

ordering policy can be determined!
2.
By means of standard LP-software, determine an optimal solution of the

described problem and give an interpretation of the results!
3.
Elaborate some of the assumptions of the Wagner-Whitin-Model which have not

been mentioned explicitly!
4.
Determine an ordering policy by means of the following heuristics:
Least-Unit-Cost Method
Silver-Meal-Heuristic
Part-Period-Method.

SS 2015
4 - 13
Wagner-Whitin-Model: Symbols
(1) identification of variables and constants
x1
y0
x2
x3
x4
t=1
t=2
t=3
n1
n2
n3
y1
y2
y3
xT-1
n4
y4
xT
t=T-1
t=T
nT-1
nT
yT-1
yT
(2) constants
T
: length of planning period, number of (sub-)periods into which the

planning period is divided;
cH
: holding cost rate: cost of keeping one unit in stock over one sub-period;
cO
: ordering cost rate: cost per order;
nt
: demand: number of units required during sub-period t (t = 1,,T).
(3) variables
(3.1) expectation variables
C
yt
: inventory of sub-period t, after reception of shipment and withdrawals for

production (t = 0, , T);
yt = yt-1 + xt nt
for t = 1,,T.
or
yt-1 yt + xt = nt
y0 = 0 (inventory on hand at the beginning of sub-period t = 1)

yT = 0 (planned inventory at the end of the last sub-period)
SS 2015
4 - 14
Wagner-Whitin-Model: Symbols (cont.)

(3.2) decision variables
xt
: order quantity which is received at the beginning of sub-period t

(t = 1,,T);
: binary variable
t =
1, if xt > 0
0, if xt = 0
for t = 1,,T.

SS 2015
4 - 15
Wagner-Whitin-Model: General formulation

T
(4.1)
C=
(cHyt + cOt) Min!

t=1
(4.2)
yt-1
yt
(4.3)
xt
(4.4)
y0,
(4.5)
yt
(4.6)
(4.7)
+ xt
Mt
= nt
for t = 1,,T;
for t = 1,,T;
= 0
yT
xt
t
for t = 0,,T;
for t = 1,,T;
0,1
for t = 1,,T.

SS 2015
4 - 16
Wagner-Whitin-Model: Exercise 4.3 Formulation of the problem

SS 2015
4 - 17
Wagner-Whitin-Model: Exercise 4.3 Excel input

SS 2015
4 - 18
Wagner-Whitin-Model: Exercise 4.3 Excel results
Microsoft Excel 9.0 Antwortbericht

Tabelle: [wagner_whitin.xls]model
Bericht erstellt am: 12.11.2002 11:37:28
Zielzelle (Min)
Zelle
Name
Ausgangswert Lsungswert
$D$16 Total_Cost
0
3000
Vernderbare Zellen
Zelle
Name
Ausgangswert Lsungswert
$D$9 OrderQ_1
0
12000
$E$9 OrderQ_2
0
0
$F$9 OrderQ_3
0
8000
$G$9 OrderQ_4
0
0
$H$9 OrderQ_5
0
3000
$I$9
OrderQ_6
0
7000
$D$10 Inventory_1
0
4000
$E$10 Inventory_2
0
0
$F$10 Inventory_3
0
2000
$G$10 Inventory_4
0
0
$H$10 Inventory_5
0
0
$I$10 Inventory_6
0
0
$D$11 BinaryV_1
0
1
$E$11 BinaryV_2
0
0
$F$11 BinaryV_3
0
1
$G$11 BinaryV_4
0
0
$H$11 BinaryV_5
0
1
$I$11 BinaryV_6
0
1

SS 2015
4 - 19
Wagner-Whitin-Model: Exercise 4.3 optimal ordering policy

total cost
t
order
quantity
xt
demand
nt
8,000
4,000
6,000
2,000
3,000
7,000
inventory
yt
holding cost
cHyt
ordering cost
cOt

SS 2015
4 - 20
Wagner-Whitin-Model: Properties
There exists always an optimal ordering policy
(x1, x2, ,xT)
for which the following two conditions hold:
(1) xt yt-1 = 0,
t = 1, ,T;
0
or
(2) xt =
t = 1, ,T.
t+i1
nj,
1iTt+1
j=t

SS 2015
4 - 21
Wagner-Whitin-Model: Properties (Exercise 4.3)

demand
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
t
t=1
t=2
t=3
t=4
t=5
t=6
inventory
11,000
10,000
9,000
x1 = 19,000 ( = n1 n2 n3 1000)
8,000
x1 = 18,000 ( = n1 n2 n3 )
7,000
6,000
5,000
4,000
3,000
2,000
1,000
t
t=1
t=2
t=3
t=4
t=5
t=6

SS 2015
4 - 22
Data of reasonable ordering policies of Exercise 4.3

(1) Matrix of order quantities (for reasonable policies)
j
t
1
1
8,000
12,000
18,000
20,000
23,000
30,000
4,000
10,000
12,000
15,000
22,000
6,000
8,000
11,000
18,000
2,000
5,000
12,000
3,000
10,000
3
4
5
6
7,000
(2) Cost matrix (for reasonable policies)

j
t
1
2
3
4
1
600
1,000
2,200
2,800
4,000
7,500
600
1,200
1,600
2,500
5,300
600
800
1,400
3,500
600
900
2,300
600
1,300
5
6
600
t:
period, in which an order can be placed;
j:
last period, in which the demand can be satisfied from the

order placed at the beginning of period t.

SS 2015
4 - 23
Wagner-Whitin-Model: Reasonable Ordering Policies
(t, i)
: partial (ordering) policy in which at the beginning of subperiod t the demand of (the following) i sub-periods is
ordered.
x(t, i)
: order quantity of partial (ordering) policy (t, i)

t+i1
x(t, i)
nj
j=t
= x(t, i 1) + nt+i-1
C(t, i)
with x(t, 0) = 0
: cost of partial (ordering) policy (t, i)

t+i1
C(t, i)
= cO +
cH (j t) nj
j=1
= C(t, i 1) + cH (i 1) nt+i1
with C(t, 0) = cO

SS 2015
4 - 24
Wagner-Whitin-Model: Pseudocode of Heuristics

Algorithm
Given:
T, nt, t = 1, ...,T;
t := 1;
i := 1;
Iteration:
while t T do
i := 1;
xt := nt;
while t + i 1 T and cut of criterion for ordering policy (t, i)
is not satisfied do
i := i + 1;
xt := xt + nt+i-1;
xt+i-1 = 0;
endwhile
t := t + i - 1;
endwhile
Result:
(x1, x2, ,xT) contains a feasible ordering policy

SS 2015
4 - 25
Wagner-Whitin-Model: Cut-Off Criteria of Heuristics

Least-Unit-Cost Heuristic (LUC Heuristic)
C(t, i + 1) C(t,i)
>
=: cu(t,i)
x(t, i + 1)
x(t,i)
SILVER-MEAL-Heuristic (SM Heuristic)
C(t, i + 1) C(t,i)
>
=: ct(t,i)
i+1
i
Part-Period Heuristic (PP Heuristic)
cO CH (t,i + 1)>cO CH(t,i)

SS 2015
4 - 26
Wagner-Whitin-Model: Least-Unit-Cost Heuristic (Exercise 4.3)
sub-period
demand
(in no. of units)
nt
8,000
4,000
6,000
2,000
3,000
7,000
order quantity
xt

SS 2015
4 - 27
Wagner-Whitin-Model: SILVER-MEAL-Heuristic (Exercise 4.3)
sub-period
demand
(in no. of units)
nt
8,000
4,000
6,000
2,000
3,000
7,000
order quantity
xt

SS 2015
4 - 28
Wagner-Whitin-Model: Part-Period-Heuristic (Exercise 4.3)
sub-period
demand
(in no. of units)
nt
8,000
4,000
6,000
2,000
3,000
7,000
order quantity
xt

SS 2015
4 - 29
x4
x3
part-period-method
SILVER-MEAL-heuristic
least-unit-cost-method
optimization model
x1
x2
ordering policy
x5
x6
holding ordering
cost
cost
total
cost
Wagner-Whitin-Model: Exercise 4.3 ordering policies

SS 2015
4 - 30

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4: Lot Sizing

4.1. The Economic Order Quantity (EOQ)

Lehrstuhl fr Management Science

Production Management & Operations Research

Lehrstuhl fr Management Science

Production Management & Operations Research

Lehrstuhl fr Management Science

Production Management & Operations Research

The classic EOQ model

: length of planning period (in time units);

: ordering cost rate: cost per order;

: demand rate: number of units required per time unit;

: total cost per planning period;

: total holding cost per planning period;

: total ordering cost per planning period;

: order lot-size, Economic Order Quantity (EOQ).

Lehrstuhl fr Management Science

Production Management & Operations Research

The classic EOQ model

(2) relationship between total, holding and ordering cost

Lehrstuhl fr Management Science

Production Management & Operations Research

(expected) demand rate (n):

total cost for

total cost for

The classic EOQ model: sensitivity analysis

Lehrstuhl fr Management Science

Production Management & Operations Research

Lehrstuhl fr Management Science

Production Management & Operations Research

The Economic Batch Quantity (EBQ) Model

: length of planning period (in time units);

: set-up cost rate: cost per set-up;

: production rate: number of units produced per time unit;

: total cost per planning period;

: total holding cost per planning period;

: total set-up cost per planning period;

: length of stock-accumulation period;

: length of stock-reduction period;

: cycle time; Tc = t1 + t2;

: maximal number of product units in stock.

: production lot-size, batch size.

Lehrstuhl fr Management Science

Production Management & Operations Research

Development of inventory over time

Lehrstuhl fr Management Science

Production Management & Operations Research

Results from EOQ and EBQ Models

optimal lot size

Lehrstuhl fr Management Science

Production Management & Operations Research

Limits of the EBQ-Model, multiple product case

Lehrstuhl fr Management Science

Production Management & Operations Research

Table 1: Demand forecast for batteries

With respect to storage the following assumptions can be made:

Lehrstuhl fr Management Science

Production Management & Operations Research

Exercise 4.3 (cont.)

There will be no batteries available for manufacturing on Monday morning of the

Formulate a mathematical model (Wagner-Whitin-Model) from which an optimal

By means of standard LP-software, determine an optimal solution of the

Elaborate some of the assumptions of the Wagner-Whitin-Model which have not

Determine an ordering policy by means of the following heuristics: