Question

Operations Management: Supply and Ordering question

BACKGROUND

UPD Manufacturing produces a range of healthcare appliance for hospital as well as for home use. The company has experienced a steady demand for its products, which are highly regarded in the healthcare field. Recently the company has undertaken a review of its inventory ordering procedures as part of a larger effort to reduce costs.

One of the company’s products is a blood pressure testing kit. UPD manufactures all of the components for the kit in-house except for the digital display unit. The display units are ordered at six week intervals from the supplier. This ordering system began about five years ago, because the supplier insisted on it. However, that supplier was bought out by another supplier about a year ago, and a six week ordering requirement is no longer in place. Nonetheless, UPD has continued to use the six week ordering policy. According to the purchasing manager Tom Chambers, “unless somebody can give me a reason for changing, I am going to stick with what we have been doing. I don’t have time to reinvent the wheel.”

Further discussions with Tom reviewed a cost of $30 to order and receive a shipment of display units from the supplier. The company assembles 80 kits a week. Also, information from Sara James, in Accounting, indicated a weekly carrying cost of $0.12 for each display unit.

The supplier has been quiet reliable with deliveries; orders are received five working days (one week) after they are faxed to the supplier. Tom indicated that as far as he was concerned, lead-time variability is virtually nonexistent.

QUESTIONS:

1. Would using an order interval other than every six weeks reduce costs? If so, what order interval would be best and what order size would that involve?

2. Would you recommend changing to the optimal order interval? Explain.

MORE INFORMATION:

Please remember to provide the following in your report

(1) Compute the quantity of the two different ordering methods: Fixed order interval (FOI) and EOQ method. Please note that the FOI method here does not include the variability factor/safety stock. Then compute the total cost of ordering using each method.

(2) Make your recommendation to UPD Manufacturing based on your computation results.

Answer 1

Demand rate, d = 80 kits per week

Ordering cost, S = $ 30

Holding cost, H = $ 0.12 per unit per week

1) Fixed Order Interval method,

Using an over interval of six weeks, Q = 6d = 6*80 = 480 kits

Total Inventory related cost per week = Ordering cost + Inventory holding cost = (d/Q)*S + (Q/2)*H

= (80/480)*30 + (480/2)*0.12

= $ 33.8

Using EOQ, Q = SQRT(2dS/H) = SQRT(2*80*30/0.12) = 200

Total Inventory related cost per week = Ordering cost + Inventory holding cost = (d/Q)*S + (Q/2)*H

= (80/200)*30 + (200/2)*0.12

= $ 24

(2) Total cost of EOQ method is lesser. Therefore, it is recommended to use EOQ and order 200 kits at a time.