UME 515: INDUSTRIAL ENGINEERING

PROJECT REPORT

Topic: Lot Sizing Rule For Material Requirement

Planning

Submitted By:

Gautam Kamra 101688006

Gursagar Virdi 101688007

Gurnoor Singh 101508037

Harmanpreet Singh 101508039

Himanshu Mishra 101508043

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 INDEX

Sr. no. Topic Page no.

1. Literature Review 2

2. Introduction 4

3. Lot Sizing 5

4. Fixed Order Quantity 8

5. Economic Order Quantity Model 9

6. Lot for Lot Size 12

7. Period Order Quantity 13

8. References 14

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 LITERATURE REVIEW

Most practical scheduling problems involve setup times (costs). In general, setup
includes work required to prepare a machine (or process) to produce parts of a given
type, including setting jigs and fixtures, adjusting tools, and acquiring material.
Because of their prevalence in, and importance to, industry and because of the
challenges they present to solution methodologies, scheduling problems that involve a
Sequence-Dependent Setup (SDS) have attracted attention from many researchers.
Lot sizing is intimately related to scheduling and a significant body of literature deals
with integrating these issues (Potts and Van Wassenhove,; Hasse, 1994; Drexl and
Kimms, 1997; Karimi et al., 2003. Typical studies seek to prescribe the schedule as
well as lot sizes to minimize the average setup cost over all jobs and holding cost over
the entire schedule.

The purpose of this is to review the body of work related to the class of scheduling
problems that involve SDS as a guide for future research. Specific objectives of this
paper are: (i) an overview with emphasis on recent results; (ii) an integrated view of
lot sizing and SDS scheduling; (iii) a perspective of this line of research; and (iv)
fertile opportunities for future research.

The problem of prescribing a sequence, even for a single machine with SDS with
makespan as the objective, is equivalent to the Traveling Salesman Problem (TSP)
and is therefore NP-hard (Pinedo, 2002). This difficulty has motivated a number of
solution methods, including optimizing methods (Branch and Bound (B&B), branch
and cut (B&C), Dynamic Programming (DP), and Mixed-Integer Programming (MIP)
solvers), hybrids (methods that combine B&B, DP, or MIP solvers with a heuristic),
and heuristics (metaheuristics such as genetic algorithms (GAs), simulated annealing
(SA), tabu search (TS), and greedy randomized adaptive search procedure (GRASP);
methods based on TSP algorithms, greedy algorithm; decomposition; dispatching
rules; simulation; list scheduling). Each approach has unique characteristics that make
it suitable for application to specific problems.

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Several earlier papers have reviewed research related to setup times
(e.g., Allahverdi et al. (1999) & Yang and Liao (1999). In particular, Allahverdi et al.
(1999) cited nearly 200 references that deal with setup issues, but most were
published before the 1990s. They categorized setup as sequence independent or
sequence dependent as well as batch and non-batch. Batch setups involve times (or
costs) that are typically much larger between batches (i.e., “major”) than those
between jobs within a batch (i.e., “minor”). Batches are also called families. They
addressed traditional configurations (single machine, parallel machines, flow shops,
and job shops) and emphasized that future research should focus on objectives related
to due dates.
Other review papers have focused on specific machine configurations. Cheng et al.
(2000) reviewed research on flow shop scheduling problems with setup times.

Yet other papers have focused on combined lot sizing and scheduling. Potts and Van
Wassenhove (1992) reviewed work that combined batching, lot sizing and scheduling,
stressing that, up to 1992, few studies had considered this important set of interrelated
decisions. Drexl and Kimms (1997) summarized more recent work by presenting MIP
formulations for different single-and multi-level lot sizing and scheduling problems.
However, these formulations do not incorporate SDS.

Lot sizing models determine the optimal timing and level of production. They can be
classified according to their time scale, the demand distribution and the time horizon.
The famous Economic Order Quantity model (EOQ) assumes a continuous time scale,
constant demand rate and infinite time horizon. The extension to multiple items and
constant production rates is known as the Economic Lot Scheduling Problem (ELSP)
(Elmaghraby 1978, Zipkin 1991). The subject of this review is the dynamic lot sizing
problem with a discrete time scale, deterministic dynamic demand and finite time
horizon. We will see that lot sizing models will incorporate more and more scheduling
aspects. These scheduling models essentially determine the start and finish times of
jobs (scheduling), the order in which jobs are processed (sequencing) and the
assignment of jobs to machines (loading). Lawler et al. (1993 Lawler, give an
extensive overview of models and algorithms for these problems.

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 INTRODUCTION
Manufacturing businesses need to balance the necessity of having stock to fill orders
with the cost of storing too much inventory. How do they know how many units
create that balance? In this report, we'll explore lot sizing in MRP systems.

Material requirements planning (MRP) is a production planning, scheduling, and

inventory control system used to manage manufacturing processes. Most MRP
systems are software-based, but it is possible to conduct MRP by hand as well.

An MRP system is intended to simultaneously meet three objectives:

• Ensure materials are available for production and products are available for
delivery to customers.
• Maintain the lowest possible material and product levels in store
• Plan manufacturing activities, delivery schedules and purchasing activities.

As part of the MRP system, businesses have to calculate how much product they
should manufacture. This guides their material purchasing decisions and also impacts
how efficiently their business runs. To help figure out how many products to
manufacture, let's take a closer look at the lot sizing aspect of MRP.

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 LOT SIZING
Material requirements planning implement in the business so that it will run
efficiently. But for an MRP program to work: how can be make sure that
manufactures just enough and not too many?

Lot sizing involves determining the amount of an

item that needs to be manufactured. lot sizing will
help determine the perfect lot size, or number of
units. So, how to approach lot sizing?

There are two basic approaches: static and dynamic:

STATIC LOT SIZING

It involves manufacturing the same quantity of items regularly. For example, if Adam
decides that he needs to make 100 glucose monitors per week on average, a static lot
sizing approach will allow him to make 100 monitors every single week. But what
happens if the amount he needs varies from week to week? He ends up with leftover
inventory (sometimes called safety stock) in the weeks where he sells less than he
makes, and the safety stock can then be used in those weeks where he sells more than
he makes.

All that sounds okay, but what if Adam doesn't want a large safety stock and doesn't
want to store the extra monitors in his warehouse? What if, instead, he wants to
produce just the right number of monitors each week to keep up with demand?

DYNAMIC LOT SIZING

Dynamic lot sizing involves manufacturing different quantities of items based on
what orders have been placed. For example, if Adam has a big order from a hospital
one week and needs 150 monitors, then dynamic lot sizing will allow him to make
150 monitors that week. Then, the following week, if he only needs 50 monitors,
that's how many he'll produce. Dynamic lot sizing does away with having a large
safety stock (though Adam still might have some inventory set aside in his
warehouse). It allows him to respond to the demand he's seeing at the moment.

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Of course, there's a problem with this approach, too: Adam could run into trouble if
he gets a big order and doesn't have enough time to manufacture enough monitors.
For example, if a client wants to order 300 monitors, but his factory can only make
150 monitors by the time the client needs them, then he's out of luck. On the other
hand, if he has a large safety stock (as he likely will with static lot sizing), he can
make up the rest of the order from the inventory in his warehouse.
The dynamic models consider the problem of determining production lot sizes when
demand is deterministic but varies with the time.

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METHODS:
The benefits and drawbacks of both static and dynamic lot sizing are known now, but
still doesn't know exactly how to figure out how many to produce. Just to take a shot
in the dark? How to calculate lot size?
There are several methods for lot sizing. Some of the most popular are:

1. Lot for Lot (LFL): Order the exact amount of the net requirement each
period.
2. Single Lot: Order quantity is equal to the total requirement and only one
order is to be placed.
3. Economic Order Quantity (EOQ): Order an EOQ or ERL amount.
4. Least Unit Cost (LUC): Order the net requirement for the current period
or current plus next or current plus next two and so on, depending upon
which gives the lowest unit cost.
5. Minimum Cost Period (MCP): Order quantity is selected in such a way
the cost period must be minimum.
6. Part-Period Algorithm (PPA): Use the ratio of ordering and carrying
costs to derive a part-period number and use the number as a criterion for
cumulating requirements.
7. Period Order Quantity (POQ): Divide the Economic Order Quantity
(EOQ) into the annual demand and order that many times per year.

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 FIXED ORDER QUANTITY

The Fixed Order Quantity is the inventory control system, wherein the maximum and
minimum inventory levels are fixed, and maximum and fixed amount of inventory
can be replenished at a time when the inventory level reaches the auto set reorder
point or the minimum stock level.

In other words, an auto-reorders point is linked with the pre-fixed amount of

inventory in the system, which automatically places an order with the supplier for the
maximum stock capacity, as soon as the inventory level reaches its minimum set-
point. The firm is required to set the maximum and minimum stock capacity based on
its storage space and the sales trend.

The Fixed Order Quantity system is followed by many firms since it helps to reduce
the reorder mistakes, manage the storage capacity efficiently and prevent the
unnecessary blockage of funds, which can be used elsewhere. Also, this method
ensures the regular replenishment of inventory items, which are currently being used
in the production process.

The Fixed Order Quantity method assumes that all the variables are known with
certainty and remains constant. Such variables could be the sales, unit cost, holding
cost, Lead time, stock out cost, etc. But, however, this assumption could not be true in
the real life situations and despite this, the method is frequently applied by the firms
and yields excellent results.

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 THE ECONOMIC ORDER QUANTITY (EOQ) MODEL

One of the earliest application of mathematics to factory management was the work of
Ford W. Harris on the problem of setting manufacturing lot sizes.

The problem is originated from fact that of a factory producing various products
where switching between products entails a costly set-up, machines had to be
adjusted, clerical work had to be done, and material might be wasted. Set-up cost is
defined as the sum of total of the labour and material cost to ready the shop to
produce a product. If we make changeovers on the line infrequently, we will keep set-
up cost low. However, infrequent set-ups also imply that we will produce huge lots of
a given type of components before switching to a different one. If demand for
components is relatively steady, then a substantial portion of each lot will be held in
inventory before being sold. Money tied up in this inventory is unavailable for use
elsewhere. To reduce this cost we could reduce inventory by producing in smaller
lots. This is the basic dilemma behind the EOQ model.

In order to derive a lot size formula the following assumptions about the
manufacturing system are made:

• Production is instantaneous: There is no capacity constraint and the entire lot is

produced simultaneously.

• Delivery is immediate: There is no time lag between production and availability

to satisfy demand.

• Demand is deterministic: There is no uncertainty about the quantity or timing of

demand.

• Demand is constant over time.

• A production run incurs a constant set-up cost.

• Products can be analysed separately.

With these assumptions, we can develop the EOQ model for computing optimal
production lot sizes. The notation we will use is as follows:

D = Demand rate (in units per year)

c = unit production cost, not running set-up or inventory cost

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A = constant set - up to produce (purchase) a lot

h = holding cost; if the holding cost consists entirely of interest on money tied up in
inventory, then h = ic, where i is an annual interest rate

Q = lot size (in units).

hQ A
Y (Q )   c
2D Q
The total (inventory, set-up, and production) cost per unit of product can be
expressed as:

dY (Q) h A
  2 0
dQ 2D Q
Taking the derivative of Y (Q) and setting the result equal to zero, yields

2 AD
Q* 
h
The lot size Q* that minimises Y (Q) is:

This square root formula is the well-known economic order quantity (EOQ) (also
referred as the economic lot size). The obvious implication of the above result is that
the optimal order quantity increases with the square root of the set-up cost or demand
rate and decreases with the square root of the holding cost. Increasing the lot size
increases the average amount of inventory on hand, but reduces the frequency of
ordering.

To examine the sensitivity of the cost to lot size, we begin by substituting Q* for Q
into equation for Y (but omitting the c term, since this is not affected by lot size) and

find that the minimum holding plus set-up cost per unit is given by

hQ* A 2 Ah
Y  Y (Q ) 
* *
 * 
2D Q D
To convert this into an annual cost, we multiply by D, which yields

AnnualCost  2 ADh

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Now, suppose that instead of using Q*, we use some other arbitrary lot size, Q´ =
(1+α)Q*. Here, α represent the fractional error, which could be positive or negative.

Hence, the ratio of the annual cost using lot size Q` to that using lot size Q* is given
by

hQ ' AD
 '
2 Q 1 Q ' Q*
 (  )
2 ADh 2 Q* Q '

Suppose that Q` = 2Q* then ratio of the resulting holding plus set-up cost to the
optimum is 1.25. That is, a 100 per sent error in lot size results in a 25 per sent error.
This is useful in multi-product settings, where it is desirable to order such that
different products are frequently replenished at the same time (e.g. to facilitate sharing
of delivery trucks).

Harris's original formula has been extended in variety of ways over years. One of the
earliest extensions was to the case where replenishment is not instantaneous, but,
instead, there is a finite but constant and deterministic production rate P. This model
is sometimes called the economic production lot (EPL) model. Using the same
notation as that used for the EOQ model we can analogically find the cost minimising

2 AD
Q* 
h(1  D )
P
value of Q which is identical to the EOQ formula.

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 LOT FOR LOT (LFL)
It is called DOQ (Discrete Order Quantity), and is a method for lot sizing, where the
net requirements occurring for each period are the quantity of order. This method is
often used mainly for expensive items and the items whose demand occurs
intermittently. In this case the quantity is the same as that of the case in which one
period is specified in the fixed period requirements.

Table X.X. Data for Lot-sizing example

t 1 2 3 4 5 6 7 8 9 10
Dt 20 50 10 50 50 10 20 40 20 30
Ct 10 10 10 10 10 10 10 10 10 10
At 100 100 100 100 100 100 100 100 100 100
Ht 1 1 1 1 1 1 1 1 1 1

The simplest dynamic lot-sizing rule is, known as lot-for-lot, states that the amount to
be produced in a period id equal to that period's requirements. Table X.X shows the
production schedule and resulting costs for this policy. Since we never carry
inventory, the total cost is just that of the 10 set-ups, or 1000 kroons.
Table X.X. Lot-for-Lot solution to example
t 1 2 3 4 5 6 7 8 9 10 Total
Dt 20 50 10 50 50 10 20 40 20 30 300
Qt 20 50 10 50 50 10 20 40 20 30 300
It 0 0 0 0 0 0 0 0 0 0 0
Set-up cost 100 100 100 100 100 100 100 100 100 100 1000
Holding 0 0 0 0 0 0 0 0 0 0 0
cost
Total cost 100 100 100 100 100 100 100 100 100 100 1000

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 PERIOD ORDER QUATITY (POQ)
Uses EOQ to calculate a fixed umber of period requirements to include in each order.
POQ= EOQ / Avg. Period Usage
In case of fraction round to the nearest number.

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