Page 266 - DMGT501_OPERATIONS_MANAGEMENT

Operations Management

Notes 11.3.2 Model with Specified Service Levels
Look closely at the data in Table 11.2, there are several relationships that can be imputed. One
such is the service level. If we want to provide a 95 percent assurance of being able to meet

customer demand until the new shipment is received, there is a cost involved. This will reflect in
higher levels of average inventory than they otherwise would have been. This cost is critical and
is optimized with the expected stock out costs.
The expected stock out cost, a key calculation in the total inventory cost, is the expected probability
of a stock out times the stock out costs that are incurred regardless of the number of units short.
The complementary cumulative function can also be used to set buffer stocks for the allowable
number of stock outs per year. The expected number of stock outs for a demand level is found by
multiplying the number of orders in a year (D/Q) times the probability of a stock out.

Prepare a study note on the inventory model with uncertainty in demand.

11.4 Summary

It is often assumed that demand for an item is formed from a large number of smaller
demands from individual customers. As a result, the resulting demand is continuous and
follows a Normal distribution.
Inventory systems have to cope with uncertainty. You have to decide on when to order

and how much to order with a view minimization of costs, maximization of profit, or
maximization of service level i.e. the objectives stated by the organization.
The most common way to estimate demand is to collect data about past experience and
forecast future demand based on that data.
However, in re-order point models the probability distribution of demand during the lead-
time is an important characteristic in inventory management.

11.5 Keywords

Christmas Tree Problem: This type of problem occurs where demand is probabilistic. In such
cases policies are based on the probability of the occurrence of the particular event rather than
actual costs.

Price-Break Models: When item cost varies with volume ordered, the result is a modified simple

lot size situation called the quantity volume case or price break model.
11.6 Self Assessment

Fill in the blanks:

1. The ........................ occurs at the point where the expected benefits derived from carrying
the next unit are less than the expected costs for that unit.
2. ........................ seek to optimize the costs associated with investing in an idle resource.
3. ........................ models are useful for a wide variety of service and manufacturing
applications

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