0:52

Compute the economic order quantity which would answer the question, how

much to order and when you are following the continuous review inventory system.

What is our total annual cost associated with ordering using the EOQ, which would

give you a comparison across our current policy and the policy using EOQ.

And then, if there's a lead time of two weeks and if there's a standard deviation

given to you, what would be the reorder point given a certain service factor

associated with a cycle service level of 90%.

That was a question for reorder point.

And then what would be the decision?

How would you go about implementing this kind of an inventory system or

how would been to go about implementing.

So what he noticed was you were also given the table of demand,

although you didn't really need it, you could infer the average demand based on

the information that you had in the text.

But you were given a table of demand.

And I put it in there from the point of view of if you were interested,

you could even calculate the standard deviation and

the average based on the demand that's in there.

So to make it real that's how you would get the average and that's how you would

get standard deviation based on data that you would have.

In this case you have the data given to you.

Anyway, so let's start with the first question of given her current

policy of ordering a certain quantity every time she places an order.

What would be her total cost of inventory management.

So she was ordering 2,600 units every time she placed an order, and

her annual demand for the four kiosks that she had at the mall were 10,400 units.

So that's the annual demand, 2,600 units being ordered every time she

placed an order, and therefore that gave you the total number of orders.

10,400 divided by 2,600 gives you a total number of orders

in a year multiply that by the cost of ordering per order is $200 and

that gives you the ordering cost over a year of $800.

So there were a total of four orders, she was only placing four orders in a year,

each cost her $200 and the ordering cost was $800.

Now for the holding cost,

there was a little bit of additional information that was given to you over and

above the traditional percentage that we associate with holding cost.

So there was a 11% holding cost up on a cost price

of 50 dollars so that was simple 11.11 times $50.

But there was also this insurance costs that was given off a one

cent per week and 52 weeks in a year, so one cent times 52 weeks.

3:44

Now, the thing that you want to keep in mind here,

based on looking at something like this.

Or the questions that you should be asking when you see a cost that's given to you

is should we include this in the holding cost, or should we not include this?

And what would be the basis for including something In the holding cost.

And for that, you should think about,

is this going to be affected by the quantity that we hold?

So, for example, if you're paying rent for your shop.

And that is not affecting, or

that is not going to be based on the quantity that you hold.

You're not going to take that rent and

try to associate it with the holding cost with the inventory that you're holding.

If you have a certain degree of theft, you're losing a phone per week.

Now that is, you're losing a phone per week based on some reason.

If you're losing a phone per week, or you're losing a phone every 10 weeks, and

it's based on either being stolen or

depreciation from it being a showpiece, a showroom piece, that people get to try.

That's not something that's going to vary based on the inventory that

you're holding, so that should not be included in holding costs.

So those are the things that you want to keep in mind from a practical perspective.

What should you include and what you should not include in your holding cost.

But here, it was clear that there was

5:27

for a single phone over a year and then you, so

it's a cost of if you were to hold a phone for a year, that would be the cost of it.

And then you multiply by the average inventory.

And in this case the average inventory would be 2600 divided by two.

The assumption that is implied in this 2600 divided by two

is that when she's buying 2,600,

there's a continuous depletion of that 2,600 over the period

that it depletes to zero and then she gets another 2,600.

So we take the average of the starting and the ending, being 2,600 and

zero, and then the average works out to 1,300.

So based on that you get total holding cost for a year of $7,826.

So total cost of $8,626.

From this you can get a sense of that this must be far off

from EOQ, the 2600 units order quantity would be far off from EOQ.

Because what should happen If she was ordering something close to an EOQ,

what would have happened is that the ordering cost over a year

would have been close to the holding cost over a year.

So here it's quite far apart, 800 versus 7,826, so

it's telling you that hot water quantity is going to be far off from the EOQ.

So lets take the next step and actually compute what the EOQ is.

So for that we have the annual demand, we have the set up cost,

the annual demand is 10,400 units, the set up cost is 200 units.

And you divide that by the holding cost.

The holding cost is calculated separately for you up there.

Although we calculated it earlier as well, on the previous slide, $6.2, so

you take that calculation and you get 831.28 units.

Since you're talking cellphones here, decimal points are not going to have

any meaning, so you are going to say, "We're going to round it to 831 units".

Now, if you remember that the EOQ is robust to the Q star

moving from Q star a little bit to the left or to the right.

So, you're going a above or below the optimal quantity,

a little bit is not going to affect total cost too much.

And if you want to see how it effects you can even make a spreadsheet and

keep calculating ordering cost and holding cost at different quantities above and

below 831.

And you'll be able to see how much difference it makes

in the total cost when you move away from that.

But that wasn't part of the question so

let's move on to what would be the total cost based on this EOQ.

What would be the total annual cost of inventory management associated with

using the EOQ as to decide how much to order.

So, if you take the ordering costs separately and the holding

cost separately, for the ordering cost you need a total number of orders.

So total number of orders would be 10,400 of annual demand,

divide by 831 units that she would order every time she would place an order.

You multiply that by the order cost of ordering every time you order, or

every time she orders and that works out to $2,503.

Holding cost would be based on $6.2 per unit.

Annual cost of holding a unit for a year is $6.2.

You multiply that by average by inventory and

once again the average inventory is going to be simply Q divided

by 2 giving the assumption that we talked about a little bit earlier.

And that cost works out to 2,501.

So 2,503, 2,501 you notice that they are close to each other, subject to rounding,

they should be close to each other to the extent of a few decimals.

So if you would have taken exactly the order quantity that we got from the EOQ,

you may have got Even closer numbers than 2501, 2503.

Nevertheless, the total cost works out to $5,004.

Now you could have used the other formula that we had talked about

associated with EOQ which is under square root of

two times the annual demand times the setup cost times the annual holding cost.

And you would have got the exact same number and you can check that,

you would get approximately 5,004 as the total cost using that formula as well.

10:04

So given that we have this decision of if binto is going

to follow the continuous review system, and she's going to use the EOQ to decide

how much to order, how would she decide when to order?

And for that, you were given some addition information to come up with her ROP,

her re-order point, so when would she place an order?

She would place an order by continuously reviewing her inventory and

whenever it reached this particular point, she would place an order.

How would you come up with the reorder point?

Well, first we need the lead time.

So, the lead time that we have here is given to us as two weeks.

We already knew the average weekly demand of 20 units.

How did we know that?

You can get to it multiple ways.

You can take the data and compute the average or

you can say there were 10,400 units and being demanded for the year.

And therefore you can come up with a weekly demand from that as well.

So the average weekly demand is 200 units and

then you take the demand during lead time for two weeks is going to be 400 units.

The safety stock that you would calculate based on the idea that

she wants to cover up to 90% of the demand during the lead time.

So we have a multiplier of 1.28

coming from a level of 90% service that she wants to maintain.

We have the standard deviation that is computed as 29 based on the data

that you have but the standard deviation is also given to you so

you could have used 29 there.

And then you take under square root of two to convert this weekly standard deviation

to standard deviation during lead times so multiply that by square root of two and

you get 52.49 for the safety stock.

So what do we have here?

We have a demand during lead time of 400 units,

we have safety stock of 52.49 units, so the reorder points works

out to demand during lead time plus safety stock works out to 452 units.