CASE 2 – Brushing up on Inventory Control

Abstract
This is a case about inventory management. Various situations were created which required
the use of software application. The solution and the result for each problem is explained
below.
1. Introduction
The case is about how Robert Gates - inventory control manager at Nightingale
Drugstore found out the way to control the inventory of a critical item at the drugstore.
He investigated the cost data and saw that Totalee charged $C1 per toothbrush. Robert
spent about 20 minutes to place each order with Totalee. His salary and benefits add up
to $C2 per hour. The annual holding cost for the inventory is 12 percent of the capital
tied up in the inventory of Totalee toothbrushes.
Firstly, we have to find out the optimal inventory policy: how many Totalee
toothbrushes should be ordered each time and how frequently, total variable inventory
cost per year under Robert’s assumption that there is no shortage and the delivery is
instant.
The second question is to re-calculate the optimal quantity and when should
Robert order- given that there are five days of lead time because he has to place an
order with a different warehouse.
Customers would become unhappy with the prospect of having to return to the
store again for the product so Robert decides to put on a dollar value. He estimates that
an employee would spend an average of 5 minutes with each customer who wishes to
purchase a toothbrush when none are currently available, and Nightingale employees
are currently paid $C3 per hour. Robert also believes that customers would become
upset with the inconvenience of shopping at Nightingale and would perhaps begin
looking for another store providing better service. The costs of losing customer goodwill
and future sales is $C4.We have to figure out: how many toothbrushes to order each
time, when to order, the maximum shortage under this optimal inventory policy and the
total variable inventory cost per year. Given 5 days lead time.
Robert realizes that in reality, employees could spend an average of anywhere
from 3 minutes to 10 minutes with each customer. Eventually, the costs of losing
customer goodwill and future sales could range from $0 to $20. We need to study how
changing the estimate of the unit shortage cost would affect the inventory policy and
total variable inventory cost per year found in part c?
Totalee will charge $C5 per toothbrush for any order of up to 500 toothbrushes,
$C6 per toothbrush for orders of more than 500 but less than 1,000 toothbrushes, and
$C7 per toothbrush for orders of 1,000 toothbrushes or more. Given 5 days lead time
but no shortage to occur. In this case, how many should Robert order each time, and
when should he order? What is the total inventory cost (including purchase costs) per
year?

2. Theories
We formulating the model base on variation of EOQ Model in Inventory
Management. For the first two question, the basic EOQ Model is applied (constant
 demand rate, the order quantity to replenish inventory arrives all at once just when
desired, shortage is not allowed). For the next two questions, we used The EOQ
model with Planned Shortages which is applicable when there are: constant demand
rate, the order quantity to replenish inventory arrives all at once just when desire,
planned shortages are allowed. When the shortage occurs, the affected customers
will wait for the product to become available again. Their backorders are filled
immediately when the order quantity arrives. The final problem is solved using The
EOQ Model with Quantity Discounts. For this model: annual acquisition cost
becomes a variable cost, holding cost varies upon purchasing price and the TVC =
annual acquisition cost + annual holding cost + annual setup cost.

3. Data
a) Data summary
Table 3.1 Data summary

Demand 250 toothbrushes/month

Totalee charge wholesale price $C1 per toothbrush

Robert salary and benefits $C2 per hour

Annual holding cost of inventory 12% off the capital tied up in the inventory of
Totalee toothbrushes.

Table 3.2 Data value

$C1 = 2

$C2 = 20

$C3 = 8

$C4 = 2

$C5 = 1.75

$C6 = 1.15

$C7 = 1

3.2 USE SOLVER AND QM FOR WINDOWS SOFTWARE APPLICATIONS TO SOLVE THE
PROBLEM

a. Robert decides to create an inventory policy that normally fulfills all demand since
he believes that stock-outs are just not worth the hassle of calming customers or the
risk of losing future business. He therefore does not allow any planned shortages.
Since Nightingale Drugstore receives an order several hours after it is placed, Robert
makes the simplifying assumption that delivery is instantaneous. What is the optimal
inventory policy under these conditions? How many Totalee toothbrushes should
Robert order each time and how frequently? What is the total variable inventory
cost per year with this policy?

Using Excel Solver :

Step 1: Inputting the data and formula into Excel sheet

Step 2: Using Solver to find the optimal solution

Step 3: After using solver, we have the result :

Using QM for Windows:

After inputting the relevant data into the QM spreadsheet, click “Solve” and solve
the problem.

b. Totalee has been experiencing financial problems because the company has lost
money trying to branch into producing other personal hygiene products, such as
hairbrushes and dental floss. The company has therefore decided to close the
warehouse located twenty miles from Nightingale Drugstore. The drugstore must
now place orders with a warehouse located 350 miles away and must wait five days
after it places an order to receive the shipment. Given this new lead time, how many
Totalee toothbrushes should Robert order each time, and when should he order?

Using Excel Solver :

Step 1: Inputting the data and formula into Excel sheet
Step 2: Using Solver to find the optimal solution

Step 3: After using solver, we have the result:

Using QM for Windows:

 After inputting the relevant data into the QM spreadsheet, click “Solve” and solve
the problem.

c. Robert begins to wonder whether he would save money if he allows planned

shortages to occur. Customers would wait to buy the toothbrushes from Nightingale since
they have high brand loyalty and since Nightingale sells the toothbrushes for less. Even
though customers would wait to purchase the Totalee toothbrush from Nightingale, they
would become unhappy with the prospect of having to return to the store again for the
product. Robert decides that he needs to place a dollar value on the negative ramifications
from shortages. He knows that an employee would have to calm each disgruntled customer
and track down the delivery date for a new shipment of Totalee toothbrushes. He estimates
that an employee would spend an average of 5 minutes with each customer who wishes to
purchase a toothbrush when none are currently available, and Nightingale employees are
currently paid $C3 per hour. Robert also believes that customers would become upset with
the inconvenience of shopping at Nightingale and would perhaps begin looking for another
store providing better service. He estimates the costs of losing customer goodwill and future
sales as $C4 per unit short per year. Given the five-day lead time and the shortage
allowance, how many Totalee toothbrushes should Robert order each time, and when
should he order? What is the maximum shortage under this optimal inventory policy? What
is the total variable inventory cost per year?

Using Excel Solver :

Step 1: Inputting the data and formula into Excel sheet

Step 2: Using Solver to find the optimal solution

Step 3: After using solver, we have the result:

Using QM for Windows:

 After inputting the relevant data into the QM spreadsheet, click “Solve” and solve
the problem.

d. Robert realizes that his estimate for the shortage cost is simply that — an
estimate. He realizes that employees could spend an average of anywhere from 3 minutes
to 10 minutes with each customer who wishes to purchase a toothbrush when none are
currently available. He also realizes that the cost of losing customer goodwill and future
sales could range from $0 to $20 per unit short per year. What effect would changing the
estimate of the unit shortage cost have on the inventory policy and total variable inventory
cost per year found in part c?
Scenario 1:
Using Excel Solver :
Step 1: Inputting the data and formula into Excel sheet

Step 2: Using Solver to find the optimal solution

Step 3: After using solver, we have the result:

Using QM for Windows:

 After inputting the relevant data into the QM spreadsheet, click “Solve” and solve
the problem.
Scenario 2:
Using Excel Solver :
Step 1: Inputting the data and formula into Excel sheet

Step 2: Using Solver to find the optimal solution

Step 3: After using solver, we have the result:

Using QM for Windows:
 After inputting the relevant data into the QM spreadsheet, click “Solve” and solve
the problem.

e. Closing warehouses has not improved Totalee’s bottom line significantly, so the
company has decided to institute a discount policy to encourage more sales. Totalee will
charge $C5 per toothbrush for any order of up to 500 toothbrushes, $C6 per toothbrush for
orders of more than 500 but less than 1,000 toothbrushes, and $C7 per toothbrush for
orders of 1,000 toothbrushes or more. Robert still assumes a five-day lead time, but he does
not want planned shortages to occur. Under the new discount policy, how many Totalee
toothbrushes should Robert order each time, and when should he order? What is the total
inventory cost (including purchase costs) per year?

We inputted the data and formula into Excel sheet and used Excel IF function

Using QM for Windows:

4. Discussion:
 From the case study provided, it is gathered that: D is the annual demand rate, K
is the setup cost, h is the unit holding cost, L is the lead time, Q* is the optimal
order quantity and WD is the working days.
 Since the demand is 250 toothbrushes per month.
 Then, the annual demand rate is: D = 250*12 = 3000 per year
 Setup cost: K = $20/3 = $6.666667 (because Robert spend 20 minutes to place an
order each time)
 Unit holding cost: h = 12%*2 = $0.24
 The working days: WD = 12×30 = 360 days per year

a) “Delivery is instantaneous” => Lead time in days L = 0

We apply the Basic EOQ model:

- What is the optimal inventory policy under these conditions?
Optimal quantity order = 408 toothbrushes.

- How many Totalee toothbrushes should Robert order each time and
how frequently?
Reorder Point = 0, since delivery is instantaneous
Annual order frequency = D/Q* = 3000/408 = 7.35 times
 Therefore, Robert should order 408 toothbrushes and 7 times
per year.

- What is the total variable inventory cost per year with this policy?
Total variable cost per year = Annual Setup Cost + Annual
Holding Cost = $97.98.
b) Lead time L = 5 (days)

We apply the Basic EOQ model, with lead time = 5:

- How many Totalee toothbrushes should Robert order each time,
and when should he order?
With WD = 360 days
Reorder point = D x (L/WD) = 41.67 toothbrushes (Which
approximately 42 toothbrushes.)
Annual order frequency = D/Q* = 3000/408 = 7.35 times
(which approximately equals 8 times).
Therefore, Robert should order 408 toothbrushes and 7 times per y
ear whenever inventory is dropped at 42 toothbrushes

c) The cost of paying employees = $8 per hour

The costs of losing customer goodwill and future sales as $2 per unit short
per year
Lead time = 5 days and shortage allowance
Unit shortage cost p = cost of losing customer goodwill + cost of paying
employees in 5 minutes = $2 + ($8×5)/60 = $2.666667
 We apply the EOQ model with Planned Shortage, with lead time = 5:
How many Totalee toothbrushes should Robert order each time, and
when should he order?
Unit shortage cost p = cost of losing customer goodwill + cost
of paying employees in 5 minutes = $2 + ($8×5)/60 =
$2.666667
With WD = 360 days,
Reorder point = D x (L/WD) – Maximum shortage = 6.67
toothbrushes ≈ 7 toothbrushes
Therefore, the Optimal order quantity is 426 toothbrushes and Robert
should order when inventory is dropped at 7 toothbrushes per year.
What is the maximum shortage under this optimal inventory policy?
Maximum shortage = 35 toothbrushes.
What is the total variable inventory cost per year?
Total Variable Cost = Annual Setup Cost + Annual Holding Cost + Annual
Shortage Cost = $93.85

d) Scenario 1:
The cost of paying employees = $8 per hour
The costs of losing customer goodwill and future sales as $0 per unit short
per year
Unit shortage cost p = cost of losing customer goodwill + cost of paying
employees in 3 minutes = $0 + ($8×3)/60 = $0.4

Scenario 2:
The cost of paying employees = $8 per hour
The costs of losing customer goodwill and future sales as $20 per unit short
per year
Unit shortage cost p = cost of losing customer goodwill + cost of paying
employees in 20 minutes = $20 + ($8×20)/60 = $21.33
 We apply the EOQ model with Planned Shortage,

What effect would changing the estimate of the unit shortage cost
have on the inventory policy and total variable inventory cost per year
found in part c?
We can easily find that when unit shortage cost increases, the
optimal quantity and maximum shortage decrease. Therefore,
it increases total variable cost and decreases maximum
inventory. which will lead to the increase in reorder point.
e) We draw a graph for the QM application based on that information. Total cos
t decreases gradually while the quantity of the order increases. However, tot
al cost is the same while the order for quantities ranges from 501 to 999. The
n it falls down to $3080 and if the quantity is higher or equal to 1000 toothbr
ushes keep it the same.

Under the new discount policy, how many Totalee toothbrushes should
Robert order each time, and when should he order? What is the total
inventory cost (including purchase costs) per year?

After solving, the optimal quantity order is 1000 toothbrushes with the
total variable of $3080. So, Robert should place 1000 toothbrushes each
time and 3000/1000= 3 times per year to meet the customer demand
without any planned shortage. Total variable cost including purchasing
cost is $3080.

The total inventory cost per year = times of order * variable inventory
cost per order
= 3* $3080 = $9240

5. Conclusion
1. Conclusion of some main points and results:
a. Robert should place 408 toothbrushes per order (optimal inventory
policy) and order approximately 7 times per year. The lead-time is 0
day because Nightingale Drugstore just receives an order several
 hours after it is placed and Robert makes the simplifying assumption
that delivery is instantaneous. Total variable inventory cost per year
with policy Q =408 is $97.98.

b. Robert should place 408 toothbrushes per order (optimal inventory

policy) and should order whenever inventory is dropped at 42
toothbrushes. The lead-time is 5 day because Nightingale Drugstore
now place orders with a warehouse located 350 miles away and must
wait five days after it places an order to receive the shipment. Total
variable inventory cost per year with policy Q =408 is $97.98.

c. Robert should place 426 toothbrushes and Robert should order when
inventory is dropped at 7 toothbrushes per year. The delivery then
should arrive 5 working days later when the number of toothbrushes
backordered reaches approximately 35. The total variable inventory
cost per year is $93.85

d. We can easily find that when unit shortage cost increases, the optimal
quantity and maximum shortage decrease. Therefore, it increases
total variable cost and decreases maximum inventory. which will lead
to the increase in reorder point.

e. Under the new discount policy, Robert should place 1000

toothbrushes per order (optimal quantity) with unit price is $1 and
should order whenever the inventory drop 42 toothbrushes. The
total inventory cost per year $9240

2. Limitation
Difficulties arises when solving this by meeting online, which causes
somes interruptions such as the slow network, lacking of interaction
among members, etc.
3. References:
QM for Windows
Microsoft Excel