Which of the following lot sizing techniques requires you to purchase exactly what is needed?

Base on the requirements of product, MRP refers to the net requirements of parts or materials. But these requirements without any change may be unsuitable for placing an order or manufacturing. Lot sizing is to unify the calculated net requirements by a certain unit considering cost reduction and work efficiency.

There are two main types of lot sizing: a method to unify in terms of the period and another method to unify in terms of the quantity. The former includes "Fixed Period Requirements", which, generally speaking, is suitable for the relatively expensive items whose demand occurs irregularly. The latter includes "Fixed Period Requirements" or "Economic Lot Sizing", which is suitable for items whose demand is relatively stable. In addition to these types, there are any other types of lot sizing as shown in the figure.

Manufacturing companies purchase large quantities of inbound materials and base components to produce finished goods, most of which are bought from external suppliers. As of today, manufacturing companies use a process named “Material Requirements Planning” to estimate the quantity of each material needed for production and when it is required.

The material planner (who is the person in charge of placing the order) must decide how large the order should be, as placing numerous orders each month could be very costly as well as inventory holding costs. Their decision should be made to find an appropriate trade-off between the costs to find a viable financial solution.

This optimization problem is called “lot sizing”. As more and more constraints are added to the equation such as quality control or perishability, it becomes quite thorny. In this article, we will present how lot sizing is done as of today and review the lot sizing techniques available to industrial companies to plan their purchases of raw materials and components.

1. Material Requirements Planning: the first step before computing lot sizes

Determining adequate lot sizes is needed to maintain acceptable inventory and service levels. Minimum order quantities demanded by suppliers often blow up inventory levels especially for items with long inventory turn cycles. To determine the lot size that will minimize the costs, industrial companies use Materials Requirements Planning (MRP). 

Materials Requirements Planning (MRP) is a software-based solution used by every Entreprise Ressource Planned (ERP) system whose purpose is to:

1. Ensure the availability of materials, components, and products for planned production and for customer delivery,
2. Maintain the lowest possible levels of inventory,
3. Plan production, delivery schedules, and purchasing activities.

MRP is especially suited for manufacturing environments where the demand of many materials and components depend on products with external requirements. 

• Demand for end products is independent. 
• Demand for components depends on end products, which is why we call it dependent demand

The three major inputs of an MRP system are: 

1. the master production schedule, which expresses how much of each material is required and when it is required
2. the product structure records, also known as the Bill of Material Records (BOM), contains information on every item or assembly required to produce the end products
3. the inventory status records which contains the status of all materials in inventory

After running the Material Requirements Planning, industrial companies know the following:

• What items are required for the production
• How many of them are required
• When are they required (i.e. when they will be consumed in production)

However, they must now decide when to order what quantity of the desired material in order to minimize costs, which is when lot sizing comes into the equation. 

2. What are the different methods applied to determine optimal lot size?

The different lot sizing techniques implemented across industrial companies can be categorized into static, periodic, or dynamic. Static lot sizing consists of placing a fixed order quantity or ordering exactly the amount that is needed to cover forecasted demand. Periodic lot sizing groups together the requirements that lie in a determined period. For dynamic lot sizing, the cumulative forecasted demand throughout the entire time horizon is taken into account to determine the optimal order quantities. As time progresses and the production requirements for the new time horizon adjusts, the previously developed planned orders might be adapted.

Static lot sizing procedures

Static lot sizing methods consist of ordering a fixed quantity or the exact amount of requirements for the date needed. 

1. Fixed Order Quantity: This method involves ordering a fixed quantity when the reorder point is reached. The quantity often depends on the supplier-specific constraints.
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2. Economic Order Quantity: This formula was developed in 1913 by Ford W. Harris which results in an order quantity that minimizes the total holding costs and ordering costs.
The formula is the following:  Q= (2DS/H)0,5
where:
Q = Quantity to be ordered
D = Demand in units (typically on an annual basis)
S = Order cost (per purchase order)
H = Holding costs (per unit, per year)
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3. Lot for Lot (L4L): It consists of ordering the exact amount that matches the net requirement for each period.
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4. Single Lot: It entails ordering the total requirement for the defined period in one go.
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Static lot sizing procedures are easy to automate but do not provide much flexibility as a high demand variability could result in high inventory holding costs. The Lot for Lot procedure stands out as an exception as inventory is minimized which on the other hand results in extremely high ordering costs.

Periodic Lot sizing procedures

Periodic lot sizing groups several requirements within a time interval together to form a lot. Periodic lot sizing procedures are effective when used with cheap items when inventory cost is low. 

5. Period Of Supply (POS): A period of supply such as 3 weeks is specified, for which the net requirements across that period are ordered together each time.
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6. Period Order Quantity: It consists of applying the EOQ model to a subset of the entire period under consideration at a time, where the demand is translated into the average requirement of each subset period.
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Dynamic lot sizing procedures

Dynamic lot sizing considers the effect of cumulative needs across time to determine the best order quantities. As time advances and new production requirements for inbound materials are known, previously developed planned orders may end up changing. This could also be the result of forecast variability. 

In the examples for each technique provided at the end of this article, we oversimplify the situation for ease of comprehension, by assuming perfectly forecasted requirements which in reality is often not the case.

7. Least Unit Cost (LUC): An order size is determined such that the demand for the next “n” periods will be met, where “n” minimizes the average cost per unit.
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8. Least Total Cost (LTC): In this heuristic technique the optimal solution corresponds to the order plan where the order costs approximate the carrying costs.
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9. Part Period Balancing (PPB): This method represents a variation of the LTC approach. It converts the ordering cost to its equivalent in part periods, “the economic part period (EPP)”, by dividing the ordering cost by the cost of carrying one unit for one period. When “the cumulative parts period” which corresponds to the excess inventory x the number of weeks that it is carried, exceeds the EPP, we take it as the optimal lot size.
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10. Silver Meal (SM): Silver and Meal developed this heuristic in 1973, which determines the average cost per period. It first considers a lot that covers the demand for a period and calculates the costs. It then increases the lot size to cover the requirements for another period and calculates the average cost for that period. One period is added at a time until the average cost per period increases, after which the process stops.
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11. Uncapacitated Multi-Supplier Order Quantity Problem with Time-Varying All-units Discounts (UMSOQPVAD): Developed by Horst Tempelmeier in 2002, it is the model implemented by SAP APO (Advanced Planner and Optimizer) the software of SAP AG. The heuristic starts with a LUC solution and iterates on improvement steps. The iteration stops when the solution cannot be improved given the input parameters. 

What is the lot sizing technique that generates exactly what was required to meet the plan?

Which of the following are reasons why a lot for lot L4L method of lot sizing can be used in an MRP application?

What is a schedule that shows when an item must be ordered from suppliers or when the production?

What is the difference between the gross and net material requirements plan?