What This Article Covers
- Introduction to Economic Order Quantity
- The Uses of Economic Order Quantity
- The Relationship Between the EOQ and the Forecast Error
- EOQ and Quantity Discounts
- How the Calculation Form Works
- The Economic Order Quantity Calculator
Introduction to Economic Order Quantity
Economic order quantity (EOQ) is one of the oldest formulas in inventory management. It was first developed by Ford W. Harris in 1913 (interestingly, as with the development of MRP, the originator of EOQ was not an academic). EOQ is not an adjustable formula, unlike the dynamic safety stock calculation, it has no ability to account for variability. Some have proposed that this means it cannot be used for more product location combinations (PLCs) with more variable demand history — and this is true — if the data provided to the EOQ is not periodically changed. Therefore, it must be periodically recomputed for the entire database.
This is the standard relationship between cycle stock and safety stock with a stable order quantity. The inventory is reduced by orders — hopefully only occasionally dipping into safety stock.
Economic Order Quantity and Forecast Error
The higher the forecast error the less use the EOQ value is. This is because was the forecast error increases, the likelihood that the quantity will be consumed declines. However, this is not different from any other supply planning parameter. Supply planning parameters have the highest value when the forecast is most accurate.
EOQ and Quantity Discounts
If there are quantity discounts, the calculation below will not be accurate. For instance, the formula below may propose an EOQ of 184 units. If the price per each at this level is $50 then this is a total cost of (184 * $50) + 45 or $9245.
If the quantity discount kicks it at 200 units and this discount is 15% then 16 more units could be obtained for $8538. This would be a missed opportunity. This can be easily calculated for an individual item, but this can not really be systematized because supply planning applications do not have EOQ functionality or even step function min lot sizes. Typically this is handled by procurement as they are up to date on the volume discounts and will up the orders to meet the discount.
How the Calculation Form Works
This form requires input to provide output. However, it also has default values. You can change any input value and the rest of the formula — the output will change immediately. You can continue making changes and the form will always update without having to press any button or refresh.
This calculator assumes that the location receives the entire order at one time. However, this assumption does not always hold. For the non instantaneous receipt EOQ calculator see this link: http://www.scmfocus.com/supplyplanning/2014/04/20/economic-order-quantity-calculator-noninstantaneous-receipt/
The Lost Art of Reorder Point Setting
Setting reorder points is a bit of a lost art as company after company over-rely upon advanced supply planning methods to create the supply plan, and often for their entire product database. However, there are in fact a number of situations where reorder points will actually provide a superior output.
Are Reorder Points Simplistic?
Reorder points are often considered to be simplistic, but in many cases they work quite well. There are simply a great number of misunderstandings regarding reorder points – misunderstandings that this book helps clear up. Rather than “picking a side,” this book shows the advantages and disadvantages of each.
- Understand the Lean Versus the MRP debate.
- How Lean relates to reorder points.
- Understand when to use reorder points.
- When to use reorder points versus MRP.
- The relationship between forecastabilty and reorder points.
- How to mix Lean/re-order points and MRP to more effectively perform supply planning.
- Chapter 1: Introduction
- Chapter 2: The Lean versus MRP Debate.
- Chapter 3: Where Supply Planning Fits Within The Supply Plan
- Chapter 4: Reorder Point Planning
- Chapter 5: Lean Planning.
- Chapter 6: Where Lean and Reorder Points are Applicable
- Chapter 7: Determining When to use Lean Versus MRP
- Chapter 8: Mixing Lean and Reorder Points with MRP-Type Planning
Plossl, George W. Production and Inventory Control: Principles and Techniques, Second Edition. Prentice Hall, 1985.
Plossel, George. Orlicky’s Material Requirement’s Planning. Second Edition. McGraw Hill. 1984. (first edition 1975)
Harris. Ford W. How Many Parts to Make at Once. Factory, The Magazine of Management. 1913.
Silver, Edward A. Peterson, Rein. Decision Systems for Inventory Management and Production Planning. Second Edition. John Wiley and Sons. 1985.