Chapter 11 Independent Demand Ordering Systems

Introduction

If stock is not reordered soon enough, there will be a stockout and a potential loss in customer
service. Stock ordered earlier than needed will create extra inventory. The problem then is how to
balance the costs of carrying extra inventory against the costs of a stockout.

Three basic reorder systems used to determine when to order are (first two are for independent
demand and the third is for dependent demand items):
1.

Order point system When the quantity of an item on hand in inventory falls to a
predetermined level, called an order point, an order is placed for a precalculated quantity
based on economic-order-quantity concepts. Using this system, an order must be placed
when there is enough stock on hand to satisfy demand from the time the order is placed until
the new stock arrives. If it is necessary to provide some protection against stockout, safety
stock can be added. The item is ordered when the quantity on hand falls to a level equal to
the demand during the lead-time plus the safety stock. Note that the demand during the leadtime is important.

2.

OP = DDLT + SS

Periodic review system Using the periodic review system, the quantity on hand of a
particular item is determined at specified, fixed-time intervals, and an order is placed. The
quantity on hand plus the quantity ordered must equal the sum of the demand during the leadtime plus the demand during the review period plus the safety stock (target level or
maximum-level inventory).
T = D(R+L) + SS

3.

Material requirements planning

Determining Safety Stock

Safety stock is intended to protect against uncertainty in supply and demand. Uncertainty may occur
in two ways: quantity uncertainty and timing uncertainty. Quantity uncertainty occurs when the
National Institute of Industrial engineering | Chap 11 Independent Demand
Ordering Systems

amount of supply or demand varies. Timing uncertainty occurs when the time of receipt of supply or
demand differs from that expected.

There are two ways to protect against uncertainty: safety stock or safety lead time.

The pattern of demand distribution about the average will differ for different products and

markets. Some method is needed to describe the distribution its shape, center, and spread. A
smooth natural curve shows predictability.

The most common predictable pattern is a normal curve. The normal distribution has most of

the values clustered near a central point with progressively fewer results occurring away from the
center. It is symmetrical about this central point in that it spreads out evenly on both sides.

The average or mean value is at the high point of the curve. It is the central tendency of the

distribution.

The variation, or dispersion, of actual demands about the average refers to how closely the

individual values cluster around the mean or average.

The standard deviation is a statistical value that measures how closely the individual values

cluster about the average.

The actual demand will be within +/- 1, 2 & 3 sigma of the forecast average approximately 68%,

98% & 99.88% of the time respectively.

One property of the normal curve is that it is symmetrical about the average. This means that

half the time the actual demand is less than the average and half the time it is greater. Safety stocks
are needed to cover only those periods in which the demand during the lead-time is greater that the
average.

Service level is a statement of the percentage of time there is no stockout.

Determining Service Levels

Theoretically, we want to carry enough safety stock on hand so the cost of carrying the extra
inventory plus the cost of stockouts is a minimum. Stockouts cost money for the following reasons:
back-order costs, lost sales, and lost customers.

Determining When the Order Point is Reached

In the two-bin system, a quantity of an item equal to the order point quantity is set aside and not
touched until all the main stock is used up. When this stock needs to be used, the production control
National Institute of Industrial engineering | Chap 11 Independent Demand
Ordering Systems

or purchasing department is notified and a replenishment order is placed. The two-bin system is a
simple way of keeping control of C items. Because they are of low value, it is best to spend the
minimum amount of time and money controlling them. When it is out of stock, a C item becomes
an A item.

A perpetual inventory record is a continual account of inventory transactions as they occur. At any
instant, it holds an up-to-date record of transactions. At a minimum, it contains the balance on hand,
but it may also contain the quantity on order but not received, the quantity allocated but not issued,
and the available balance.

The difference between permanent and variable information in the inventory record.

Permanent Information

Variable Information

Part no, name, description, Storage Location,

Quantity Ordered: dates, order no, quantities

Order point, Order quantity, lead time, safety

Quantity Received: dates, order no, quantities

stock, suppliers

Quantity issued: dates orders no, quantities

Balance on hand. Available balance
Allocated: dates order no, quantities

Distribution Inventory

Distribution inventory includes all the finished goods held anywhere in the distribution system. The
objectives of distribution inventory management are to provide the required level of customer service,
to minimize the costs of transportation and handling, and to be able to interact with the factory to
minimize scheduling problems. The distribution system is the factorys customer, and the way the
distribution system interfaces with the factory has a significant effect on the efficiency of factory
operations. Although the demand from customers may be relatively uniform, the demand on central
supply is not, because it is dependent on when the distribution centers place replenishment orders. In
turn, the demand on the factory depends on when central supply places orders.

Distribution inventory management systems can be classified into decentralized, centralized, and
distribution requirements planning

National Institute of Industrial engineering | Chap 11 Independent Demand

Ordering Systems

1.

In a decentralized system, each distribution center first determines what it needs and when,
and then places orders on central supply. The advantage of the decentralized system is that
each center can operate on its own and thus reduce communication and coordination
expense. The disadvantage is the lack of coordination and the effect this may have on
inventories, customer service, and factory schedules.

2.

In a centralized system, all forecasting and order decisions are made centrally. Stock is
pushed out into the system from central supply. Distribution centers have no say about what
they receive. Different ordering systems can be used, but generally an attempt is made to
replace the stock that has been sold and to provide for special situations such as seasonality or
sales promotions. These systems attempt to balance the available inventory with the needs of
each distribution center. The advantage of these systems is the coordination between factory,
central supply, and distribution center needs. The disadvantage is the inability to react to
local demand, thus lowering the level of service.

3.

Distribution requirements planning is a system that forecasts when the various demands
will be made by the system on central supply. This gives central supply and the factory the
opportunity to plan for the goods that will actually be needed and when. It is able both to
respond to customer demand and coordinate planning and control. The system translates the
logic of material requirements planning to the distribution system. Planned order releases
from the various distribution centers become the input to the material plan of central supply.
The planned order releases from central supply become the forecast of demand for the factory
master production schedule.

Reference

1. Introduction to Material management: Fifth Edition J. R. Tony Arnold, Stephen N.

Chapman, R.V. Ramakrishnan

National Institute of Industrial engineering | Chap 11 Independent Demand

Ordering Systems