BA 301

Operations Management
Spring 2003
Inventory Management
Chapter 12
Continued

Calculating Order Size

When

material is ordered from a

supplier outside the firm, use the EOQ
model and extend this with quantity
discount information when appropriate.
When sub-assemblies are fabricate
within the firm, use the Production
Order Quantity (POQ) model

EOQ Model
How Much to Order?
Annual Cost
rve
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To
tC
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g
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i
Hold

Order (Setup) Cost Curve

Optimal
Order Quantity (Q*)

Order Quantity

EOQ Model
When To Order
Inventory Level
Average
Inventory
(Q*/2)

Optimal
Order
Quantity
(Q*)
Reorder
Point
(ROP)
Lead Time

Time

Production Order Quantity

Part A-60 is a sub-assembly. It is a

platform for the computer motherboard. The
company requires 3000 of these per year.
This part is fabricated in the production
facility.
The machine that fabricates the platform
(A-60) can make 30 per day.
Two hours of labor time are required to do the
set-up for the fabricating machine.
Labor time costs $100 per hour

POQ Model Inventory Levels

Inventory Level
Production portion of cycle

Demand portion of cycle with no

supply

Supply
Begins

Supply
Ends

Time

POQ continued
The

item cost of the platform (A-60) is

$20.
The holding cost is 25% of the item
cost.
What is the Order Quantity?

Inventory Costs for

Production Order Quantity
Holding costs

- associated with holding

or carrying inventory over time
Setup costs - cost to prepare a
machine or process for
manufacturing an order

Setup Costs
Clean-up

costs
Re-tooling costs
Adjustment costs
These costs are primarily determined by
the labor time necessary to perform the
tasks.

POQ continued

We need to derive a formula that minimizes the

Total Cost (Annual Holding Cost + Annual Setup Cost).
Differences between POQ situation for the A60 platform and the EOQ situation for the A-61
microprocessor:
We fabricate the item rather than purchase
it from a supplier.
We use the item while it is being made.
This results in a difference in the maximum
inventory.

POQ continued

In the EOQ model, maximum inventory was

equal to the Order Size.
In the POQ model, maximum inventory is less
than the Order Size.
Why? Because we make the item and use
it while it is being made.
Assume that the Order Size is 300.
How long would it take to make this order?
What would the inventory level be at the end of the
first day?
What would the inventory level be when we had
finished the order?
How can we use this information to derive a
general formula for Production Order Quantity?

EOQ Model
When To Order
Inventory Level
Average
Inventory
(Q*/2)

Optimal
Order
Quantity
(Q*)
Reorder
Point
(ROP)
Lead Time

Time

POQ continued

Maximum Inventory = (p-d)(# days production)

This is the inventory build-up rate (p-d) times the
number of days the fabrication machine makes the
part.

Let # days production = t (for time)

Maximum Inventory = (p-d)t = pt-dt
Order Size = Q = pt; t = Q/p
Max Inv Level = (p-d)(Q/p) = p(Q/p) d(Q/p)
= Q Q(d/p) = Q(1 - d/p)
Ave Inv Level = Q(1 d/p)/2

POQ continued
The

Production Order Quantity formula:

Q* = POQ = sq.rt.(2DS/(H(1-d/p))
See formula 12.7 on page 491
For part A-60:
POQ = sq.rt.(2x3000x200/(5(1-10/30))
POQ = 600 (rounded)
Calculate AHC, ASC, & Total Annual Cost