Dynamic Lot Size Models

A Production Engineering Special

presented by the ENM Faculty

Fine print: This is section 7.2 and Appendix 7-A in the text. You
will want to read it! 1
 Why would demands fluctuate?

• Material Requirements Planning (MRP) methodology

(planned order releases)
• optimal production lot sizes
• produce to meet contract orders by specified dates
• seasonal demands
• replacement parts
• trends in demands
• shifts in market place (competitor, advertising,
discounts, etc.
• change in sales force
2
 The Problem
• A known set of time-varying demands
• Setup or order costs independent of order or lot
size (Q)
• Holding costs proportional to the number of time
periods item is maintained in inventory
• What order quantities or production lot sizes will
minimize order + holding cost over the planning
horizon?

3
 Methods for dealing with “lumpy” demands
A set of lumpy demands (D1, D2, …,Dn)
• Production Smoothing
• Use EOQ (assumes constant demand)
• Simple rules
– fixed period demand
– period order quantity
– lot for lot reordering
• Heuristic rules
– Silver-Meal method
– least unit cost
– part period balancing (PPB)
• Wagner-Whitin algorithm
• Transportation Problem
4
 Some Assumptions
• Demands, Dj, are known for periods j =1, …n
• Demand Dj must be satisfied in period j and available
at the start of the period
• Replenishments arrive at the beginning of a period
• No quantity discounts
• Unit costs do not change over planning horizon
• no shortages permitted
• lead-times are known and constant
• entire order quantity arrives at the same time
• items are independent of one another
• carrying costs applies only to inventory carried over
from one time period to another 5
 Using EOQ
Wk1 Wk2 Wk3 Wk4 Wk5 Wk6 Wk7 Wk8 Wk9 Wk10

42 42 32 12 26 112 45 14 76 38

• Setup cost is $132

• Holding costs are $.60 per item per week

Total demand  439

D  43.9, K  132 / h  .6
(2)(132)(43.9)
Q  139
.6
6
 Using EOQ
Wk1 Wk2 Wk3 Wk4 Wk5 Wk6 Wk7 Wk8 Wk9 Wk10

42 42 32 12 26 112 45 14 76 38
Q 139 0 0 0 139 0 139 0 0 139
End 97 55 23 11 124 12 106 92 16 117 Sum =
Inv 653

• Total Setup cost is $132 x 4 = $528

• Total Holding costs are $.60 x (653-117) = $321.60
• Total cost = $849.60

7
Fixed Period Demand
(D1, D2, …,Dn)

Rule: Order m months worth of demands.

Example: m = 3

1st order quantity: D1 + D2 + D3

2nd order quantity: D4 + D5 + D6

8
 Fixed Period Demand
Wk1 Wk2 Wk3 Wk4 Wk5 Wk6 Wk7 Wk8 Wk9 Wk10

42 42 32 12 26 112 45 14 76 38
Q 84 44 138 59 114
End Inv 42 12 112 14 38

• M = 2; cost = 5 x 132 + 218 x .60 = $790.80

Wk1 Wk2 Wk3 Wk4 Wk5 Wk6 Wk7 Wk8 Wk9 Wk10

42 42 32 12 26 112 45 14 76 38
154 285
Q
End Inv 112 70 38 26 0 173 128 114 38 0

• M = 5; cost = 2 x 132 + 699 x .60 = $683.40

9
 Period Order Quantity (POQ)
(D1, D2, …,Dn)
1. Establish an average lot size - L.
2. Determine the average demand - Davg
3. Set m = L / Davg
4. Order in period j, Dj+1 , Dj+2 , …,Dj+m
Example: week
1 2 3 4 5 6
demands 19 14 21 25 18 23

Davg = 120 / 6 = 20 If L = 40 then m = 40 / 20 = 2

order: D1 + D2 , D3+ D4 , D5 + D6
10
Period Order Quantity (POQ) (D1, D2, …,Dn)
1 L = 150 (perhaps breakpoint for quantity discounting)
2. Davg = 43.9  44
3. Set m = L / Davg = 150 / 44 = 3.4  3

Wk1 Wk2 Wk3 Wk4 Wk5 Wk6 Wk7 Wk8 Wk9 Wk10

42 42 32 12 26 112 45 14 76 38
116 150 135 38
Q
End Inv 74 32 0 138 112 0 90 14 0 0

cost =4 x 132 + 460 x .60 = $804.00

11
 Lot for Lot (L4L)
(D1, D2, …,Dn)
Set order quantity equal to Dj

That is, order for each period , the expected demands.

Wk1 Wk2 Wk3 Wk4 Wk5 Wk6 Wk7 Wk8 Wk9 Wk10
42 42 32 12 26 112 45 14 76 38
Q 42 42 32 12 26 112 45 14 76 38
End Inv 0 0 0 0 0 0 0 0 0 0

cost = 10 x 132 = $1,320

Note that holding costs are zero!

12
 Silver-Meal Heuristic

• Try to minimize average cost per period

• costs includes ordering (set-up) (K) and holding
cost (h).
• Assume K and h are constant over the planning
horizon.
• assume holding costs occur at the end of the
period
• assume quantity needed in a period is used at the
beginning of the period
13
 Silver-Meal Heuristic (D1, D2, …,Dn) Continue until
cost / period
Order quantity is then D1 + D2 + … + Dm starts increasing

Order period Ordering cost Holding cost Cost / period

One period K 0 K/1

Two periods K hD2 (K+hD2) / 2

Three periods K hD2 + 2hD3 (K+ hD2 +

2hD3) / 3

Four periods K hD2 + 2hD3 + (K+ hD2 +

3hD4 2hD3 + 3hD4)
/4 m
14
 Silver-Meal Heuristic
Example: K = $90 ; h = 1.20 per unit per month

Month 1 2 3 4 5 6
Demands 20 30 23 19 32 28

Order Period Ordering cost Holding Cost Avg cost / period

one month 90 90
two months 90 1.2(30) = 36 126 / 2 = 63
three months 90 1.2(30)
+2.4(23)=91.2 181.2 / 3 = 60.4
M=3
Four months 90 91.2 + 3.6 (19)
= 159.6 249.6 / 4 = 62.4
Order quantity = 20 + 30 + 23 = 73 15
 Repeat for next order
Example: K = $90 ; h = 1.20 per unit per month

Month 1 2 3 4 5 6
Demands 20 30 23 19 32 28
Order Period Ordering cost Holding Cost Avg cost / period

one month 90 90

two months 90 1.2(32) = 38.4 128.4 / 2 = 64.2

three months 90 1.2(32) M=2
+2.4(28)=105.6 195.6 / 3 = 65.2

Order quantity = 19 + 32 = 51

16
 Least Unit Cost Heuristic
Compute average cost per unit demanded rather
average cost per period.
Order period Ordering cost Holding cost Cost / unit

One period K 0 K / D1

Two periods K hD2 (K+hD2) / (D1

+ D2)

Three periods K hD2 + 2hD3 (K+ hD2 +

2hD3) / (D1 +
D2 + D3)
Four periods K hD2 + 2hD3 + (K+ hD2 +
3hD4 2hD3 + 3hD4) /
(D1+D2+D3+D)
17
 Example: K = $90 ; h = 1.20 per unit per month

Month 1 2 3 4 5 6
Demands 20 30 23 19 32 28

Order Period Ordering cost Holding Cost Avg cost / unit

one month 90 90/20 = 4.50

two months 90 1.2(30) = 36 126/ 50 = 2.52

three months 90 1.2(30)

+2.4(23)=91.2 181.2 / 73 = 2.48
M=3
Four months 90 91.2 + 3.6 (19)
= 159.6 249.6 / 92 = 2.71
Order quantity = 20 + 30 + 23 = 73

18
 Part Period Balancing (PPB)

Attempts to minimize the sum of the variable cost for all lots.
Definition:
Part period = one unit held in inventory for one period
PPm = part period for m periods
PP1 = 0
PP2 = D2
PP3 = D2 + 2D3
PPm = D2 + 2D3 + … + (m-1) Dm

19
Continued Part Period Balancing (PPB)

Inventory holding cost = h (PPm)

Find m so that K h(PPm) or PPm K/h

Order quantity = Q = D1 + D2 + … + Dm

20
 Example problem continued
Example: K = $90 ; h = 1.20 per unit per month

Month 1 2 3 4 5 6
Demands 20 30 23 19 32 28
K / h = 90 / 1.2 = 75

PP1 = 0 Starting month 4:

PP2 = 30 PP1 = 0
PP3 = (30) +2(23)= 76 stop! PP2 = (32)
Q1 = 20 + 30 + 23 = 73 PP3 =32 + 2 (28) = 88 stop
Q2 = 19 + 32 + 28 = 79

21
 An Old Favorite
Wk1 Wk2 Wk3 Wk4 Wk5 Wk6 Wk7 Wk8 Wk9 Wk10
42 42 32 12 26 112 45 14 76 38

PPm  K/h = 132 / .6 = 220 pp1 = 0

pp2 = 45
pp1 = 0 pp3 = 45 + (2) 14 = 73
pp2 = 42 pp4 = 73 + 3(76) = 301
Pp3 = 42 + (2) 32 = 106 Q6 = 112 + 45 + 14 + 76 = 247
pp4 = pp3 + 3(12) = 142
pp5 = pp4 + 4(26) = 246 Q10 = 38
Q1 = 42 + 42 + 32 + 12 + 26 = 154
Wk1 Wk2 Wk3 Wk4 Wk5 Wk6 Wk7 Wk8 Wk9 Wk10
42 42 32 12 26 112 45 14 76 38
154 247 38
112 70 38 26 0 135 90 76 0 0
22
cost =3 x 132 + 328 x .60 = $724.20
Our Feature Presentation

The Wagner-Whitin Algorithm

The Whole Thing!

The Big Enchilada

23
 The General Problem
n
Min  C (Q )  h  I 
t 1
t t t t

subject to :
I t  I t 1  Qt  Dt 
 t  1, 2,..., n
Qt , I t  0,1, 2,3,...

Qt = production or order quantity in period t

It = inventory at the end of period t
Ct(Qt) = cost of production in period t
ht(It) = holding cost from period t to t+1
24
 The Linear Problem
n
Min K
t 1
t  ct Qt  ht I t

subject to :
I t  I t 1  Qt  Dt 
 t  1, 2,..., n
Qt , I t  0,1, 2,3,...

Qt = production or order quantity in period t

It = inventory at the end of period t
Kt = fixed cost of production in period t
Ct = cost of production in period t
ht = holding cost per unit carried from period t to t+1
25
A Simpler Problem?
n
Min K
t 1
t  cQt  h I t 

subject to :
I t  I t 1  Qt  Dt 
 t  1, 2,..., n
Qt , I t  0,1, 2,3,...

n
Min K
t 1
t  h It 
n n n
since  cQ
t 1
t  c Qt  c Dt
t 1 t 1 26
 n
Min K
t 1
t  h It

subject to :
I t  I t 1  Qt  Dt 
 t  1, 2,..., n
Qt , I t  0,1, 2,3,...

Property 1: A replenishment only takes place when

the inventory level is zero. Therefore It-1 Qt = 0
Qk = 0, or Dk or Dk + Dk+1 or … or Dk + Dk+1 + … + Dn

Property 2: There is an upper limit to how far before a

period j we would include its requirements, Dj in a
replenishment quantity. That is, the carrying costs
become so high that it is less expensive to have a second
replenishment occur.
27
 A Wagner-Whitin Example
The Maka Parte Company makes parts for General Motors
automobiles. One part they make is a vulcanized tri-solenoid
distributor. A primary component used in the manufacture of
this distributor is a silicon computer chip. This chip is purchased
from a vendor - Outspeak Corp. Ordering costs are $70 and holding
costs are $ .5 per item per month. Demands for the next six months
based upon an exponential smoothing model with seasonal effects are:

Nov Dec Jan Feb Mar Apr

120 80 94 78 86 110

28
 A Wagner-Whitin Example
n = 6 (Apr) Order Cost = $70
Q6 = 110; f = $70 Holding cost = .5
Nov Dec Jan Feb Mar Apr
n = 5 (Mar/Apr) 120 80 94 78 86 110
Q5 = 86, 196
f5(86) = 70 + 70 =140
f5(196) = 70 + .5 (110) = 125

n = 4 (Feb/Mar/Apr)
Q4 = 78, 164, 274
f4(78) = 70 + 125 = 195
f4(164) = 70 + .5 (86) + 70 = 183
f4(274) = 70 + .5(86) + 1.00 (110) = 223 29
 A Wagner-Whitin Example
Order Cost = $70
Holding cost = .5
Nov Dec Jan Feb Mar Apr
120 80 94 78 86 110

n = 3 (Jan/Feb/Mar/Apr)
Q3 = 94, 172, 258, 368
f3(94) = 70 + 183 = 253
f3(172) = 70 + .5 (78) + 125 = 234
f3(258) = 70 + .5(78) + 1.00 (86) + 70 = 265
f3(368) = 70 + .5(78) + 1.00 (86) + 1.5(110) = 360

30
 A Wagner-Whitin Example
Order Cost = $70
Holding cost = .5
Nov Dec Jan Feb Mar Apr
120 80 94 78 86 110

n = 2 (Dec/Jan/Feb/Mar/Apr)
Q2 = 80, 174, 252, 338, 448
f2(80) = 70 + 234 = 304
f2(174) = 70 + .5 (94) + 183 = 300
f2(252) = 70 + .5(94) + 1.00 (78) + 125 = 320
f2(338) = 70 + .5(94) + 1.00 (78) + 1.5(86) + 70 = 394
f2(448) = 70 + .5(94) + 1.00 (78) + 1.5(86) + 2(110) = 544

31
 A Wagner-Whitin Example
Order Cost = $70 Holding cost = .5
Nov Dec Jan Feb Mar Apr
n = 1 (Nov/Dec/Jan/Feb/Mar/Apr) 120 80 94 78 86 110
Q1 = 120, 200, 294, 372, 458, 568
f1(120) = 70 + 300 = 370
f1(200) = 70 + .5 (80) + 234 = 344
f1(294) = 70 + .5(80) + 1.00 (94) + 183 = 387
f1(372) = 70 + .5(80) + 1.00 (94) + 1.5(78) + 125 = 446
f1(458) = 70 + .5(80) + 1.00 (94) + 1.5(78) + 2(86)+70= 563
f1(568) = 70 + .5(80) + 1.00 (94)
+ 1.5(78) + 2(86) + 2.5(110) = 768

Q1 = 200; Q3 = 172; Q5 = 196 ; Cost = $344

32
 Capacity Constraints
n
Min  C (Q )  h  I 
t 1
t t t t

subject to :
Qt  Pt 

I t  I t 1  Qt  Dt  t  1, 2,..., n
Qt , I t  0,1, 2,3,...

33
Why isn’t Wagner-Whitin used more frequently?

• relatively complex
• needs a well-defined ending point
• all information out to end point needed even to
compute initial quantity
• within MRP systems using rolling schedules, the
solution will keep changing
• the assumption that replenishments can be made
only at discrete intervals
• computational requirements
34
 No Fixed Cost

n
Min c Q  h I
t 1
t t t t

subject to :
Qt  Pt 
 t  1, 2,..., n
I t  I t 1  Qt  Dt 

35
 The Transportation Problem
n n
Min z   ctj xtj
t 1 j t

where ctj  ct  ht 1  ht  2  ...  h j 1

subject to:
n

x
j t
tj  Pt t  1, 2,..., n

x
t 1
ij  Dj j  1, 2,..., n

xtj = number of units produced in month t

to satisfy month j demands 36
 The Example
Month Shift March April May June July August Dum supply prod
cost
March R 10 12 14 16 18 20 0 16 10
O 12 14 16 18 20 22 0 6 12
April R M 11 13 15 17 19 0 15 11
O M 13 15 17 19 21 0 5 13
May R M M 12 14 16 18 0 17 12
O M M 14 16 18 20 0 6 14
June R M M M 13 15 17 0 16 13
O M M M 15 17 19 0 6 15
July R M M M M 14 16 0 18 14
O M M M M 16 18 0 8 16
August R M M M M M 15 0 12 15
O M M M M M 17 0 5 17
Demands 16 24 16 24 16 24 10 130

h = $2 per unit per month

37
 What can we conclude from all of this?

• Most heuristics outperform EOQ

• the Silver-Meal heuristic incurs an average cost
penalty relative to Wagner-Whitin of less than 1
percent.
• Significant costs penalties using Silver-Meal will
incur if
– demand pattern drops rapidly over several periods
– when there are a large number of periods having no
demand
38
Can we have some
really neat
homework
problems? Huh?

Text: Chapter 7: problems 13, 14, 17, 18, 19, 22

39
 Safety Stock

When demand or lead-time is random (or both), then safety stock

may be established as a “hedge” against uncertain demands.

For the deterministic case: R = D L

For the stochastic case: R = LTDavg + s where

LTD = a random variable, the lead-time demand,

LTDavg = average lead-time demand and s is the safety stock.

40
 Safety Stock based on Fill Rate
Shortage probability
Pr{LTD > R) = p

LTD
LTDavg R
s

Fill rate criterion: set s = z STD

where STD = standard deviation of the lead-time demand distribution
then
R = LTDavg + z STD 41
But I need to know when
demands are lumpy, don’t I?

Compute the variability coefficient,

v= variance of demand per period

square of average demand per period
n
n Dt2
V t 1
1 If V < .25 , use EOQ with Davg
F
G

I
n
DJ
2

else use a DLS method

H K
t 1
t

42