Economic Order Quantity
The blog on variable lead times for each part number seems to have struck a chord so with that in mind I thought it appropriate to kick over another sacred cow in parts inventory management – The Economic Order Quantity.
The EOQ has been around since 1905 when Mr. Kerr and Mr. Norton developed the formula to balance the cost of placing an order with the cost of carrying inventory. A worthwhile effort and one that worked for a long time based on the constraints of the day.
Several things have changed in the intervening 100 plus years that have rendered the traditional EOQ to be a significantly less value. Daily stock orders with turnarounds of three to five days have clearly changed things to the degree that the EOQ should be reevaluated. The dramatic reduction in the cost of computing powers, storage media and business software have also provided a reason to reexamine the logic of the cost of placing an order.
The formula for the EOQ is as follows:
EOQ = the square root of 2 times AD/LC
The variables in the formula are:-
- The A = Order Cost
- The D = Annual Demand
- The L = Product Cost
- The C = Carrying Charge
If we look more closely at the Order Cost we will see that there are several items to consider.
- a) Order Generation
- b) Order Preparation and Record Keeping
- c) Order Placement
- d) Receiving
- I) Physical
- ii) Clerical
- e) Accounts Payable
This cost is per part number so as you go through the calculations you will find the answer tends to zero. And from your earlier arithmetic experiences the square root of a division calculation that has a numerator of zero is also zero. So this pillar of the inventory control world EOQ should be revisited and a new determination made as to the variables and how to handle the determination of the Order Quantity. The time is now.