[MUSIC] Welcome back to our lesson on replenishment planning.

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Upon completion of this lesson, learners should be able to describe the difference between independent and dependent demand, and discuss the purpose and calculation of economic order quantities.

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To replenish products and materials in the supply chain, operations must plan for two types of demand. Independent and dependent demand. Independent demand is demand for finished goods that are produced and delivered or stocked to meet external customer demand.

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Examples of finished products for external customers include a computer, bicycle, or pizza.

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Dependent demand is the demand for materials, components, parts, or subassemblies needed to create a finished product. For example, the sale of computer represents independent demand, and requires the production of a computer. The production of a computer creates dependent demand for components such as screens, keyboards, and processors. Other examples of dependent demand include the wheels and handlebars on a bicycle, or the cheese and dough for a pizza.

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Now, we have a question for your consideration.

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In order to replenish goods, techniques need to be used to determine when and how much to reorder. Two common reorder point management techniques are Fixed Order Quantity, where the same amount of product is reordered each time, but the timing of order placement varies. Inventory for items is monitored regularly. And when the amount on hand reaches the pre-determined reorder point, the same quantity is ordered each time for replenishment.

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The reorder point quantity is the amount of inventory needed to cover demand over the lead time. Therefore, if the daily demand was ten units, and the lead time was five days. Then the reorder point would be for 50 units.

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Conversely, the Fixed Order in the Interval approach occurs when the amount ordered varies, but the time between orders remains the same.

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For particular products, the inventory level would be observed for that item when the reorder time comes. The on hand inventories would not be continuously reviewed, instead they would be reviewed to place an order that would make the inventory reach the desired level. For example, the inventory level might be checked every two weeks and have a predetermined maximum amount of inventory such as 50 units. If the item is reviewed and there are only 30 units on hand, the difference between the maximum value and what’s currently on hand would be ordered. That will be in this brief example, 20 units.

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Let’s turn our attention now to approach for determining economic order quantities to support replenishment. To convey the concept, let’s start with an environment that has a constant annual demand of D.

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Delivery time is negligible. Replenishment lots are always received in full requested quantities. All costs remain constant. And no quantity discounts are available.

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The goal in determining the Economic Order Quantity is to minimize the total annual cost of replenishment, which consists of procurement costs, inventory costs and ordering costs. The graph depicts the simplified environment where demand is constant over time, and replenishment orders arrive as expected. The average inventory level is equal to the area under the inventory curve and the number of orders over the course of the year equals demand divided by the calculated economic order quantity.

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The formula for calculating the economic order quantity and number of orders is shown in the box on the right. It takes into account, demand, inventory holding cost, average inventory, and procurement cost. Let’s take a look at an applied example of the EOQ model with the company being a gym equipment dealer and a product being gym mats. Let’s assume that annual demand

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is 3,600 gym mats per year with each mat costing $100 per unit. And an annual holding cost of 25% per unit. And the cost to place an order for gym mats being $200. The EOQ in this case would be the square root of 1,440,000 which comes from multiplying 2 x 3,600 x 200 / 25, to come up with 240 gym mats as the EOQ. So this suggests that the Economic Order Quantity would be for 240 gym mats, in the Fixed Quantity Model.

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In this lesson we have described the difference between the Independent and Dependent demand, and discussed the purpose and calculation of Economic Order Quantity Models. Thank you for joining us and we’ll see you on the next lesson. [MUSIC]

# 13. Replenishment Planning

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