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Eoq Model: Economic Order Quantity

The document discusses the economic order quantity (EOQ) model, which aims to minimize total inventory costs by balancing order processing costs and inventory holding costs. It provides the EOQ formula, assumptions of the model, cost components, and an example calculation. The optimal order quantity (Q*) is the square root of 2 times demand per year (D) times setup cost (S) divided by annual holding cost (H). The reorder point is daily demand times lead time.

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49 views

Eoq Model: Economic Order Quantity

The document discusses the economic order quantity (EOQ) model, which aims to minimize total inventory costs by balancing order processing costs and inventory holding costs. It provides the EOQ formula, assumptions of the model, cost components, and an example calculation. The optimal order quantity (Q*) is the square root of 2 times demand per year (D) times setup cost (S) divided by annual holding cost (H). The reorder point is daily demand times lead time.

Uploaded by

arunsanskriti
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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EOQ MODEL

ECONOMIC ORDER QUANTITY

EOQ ASSUMPTIONS

Known & constant demand Known & constant lead time Instantaneous receipt of material

No quantity discounts
Only order (setup) cost & holding cost No stockouts

INVENTORY HOLDING COSTS REASONABLY TYPICAL PROFILE

Category
Housing (building) cost Material handling costs Labor cost Inventory investment costs Pilferage, scrap, & obsolescence Total holding cost

% of Inventory Value
6% 3% 3% 11% 3% 26%

EOQ MODEL Annual Cost

Order Quantity

EOQ MODEL Annual Cost

Holding Cost

Order Quantity

WHY ORDER COST DECREASES


Cost is spread over more units

Example: You need 1000 microwave ovens

1 Order (Postage $ 0.35)

1000 Orders (Postage $350)

Purchase Order Description Qty. Microwave 1000

Purchase Order Purchase Order Purchase Order Description Qty. Purchase Order Description Qty. Description Qty.1 Microwave Description Qty. Microwave 11 Microwave Microwave 1

Order quantity

EOQ MODEL Annual Cost

Holding Cost Order (Setup) Cost Order Quantity

EOQ MODEL Annual Cost

Total Cost Curve


Holding Cost Order (Setup) Cost Order Quantity

EOQ MODEL Annual Cost

Total Cost Curve


Holding Cost Order (Setup) Cost Order Quantity

Optimal Order Quantity (Q*)

EOQ FORMULA DERIVATION


D= C= Q= S= I = H= Annual demand (units) Cost per unit ($) Order quantity (units) Cost per order ($) Holding cost (%) Holding cost ($) = I x C

Total cost =

(Q/2) x I x C + S x (D/Q)
inv carry cost order cost

Take the 1st derivative: d(TC)/d(Q) = (I x C) / 2 - (D x S) / Q

Number of Orders = D / Q Ordering costs = S x (D / Q) Average inventory units = Q / 2 $ = (Q / 2) x C Cost to carry average inventory = (Q / 2) x I x C = (Q /2) x H

To optimize: set d(TC)/d(Q) = 0 DS/ Q = IC / 2 Q/DS = 2 / IC Q= (DS x 2 )/ IC

Q = sqrt (2DS / IC)

ECONOMIC ORDER QUANTITY

EOQ
D= S= C= I = H=

2 D S H

Annual demand (units) Cost per order ($) Cost per unit ($) Holding cost (%) Holding cost ($) = I x C

EOQ MODEL EQUATIONS

2 D S Optimal Order Quantity Q * H D Expected Number Orders N Q*


Expected Time Between Orders T Working Days / Year

D
Working Days / Year

ROP d L

D = Demand per year S = Setup (order) cost per order H = Holding (carrying) cost d = Demand per day L = Lead time in days

EOQ EXAMPLE Youre a buyer for SaveMart.

SaveMart needs 1000 coffee makers per year. The cost of each coffee maker is $78. Ordering cost is $100 per order. Carrying cost is 40% of per unit cost. Lead time is 5 days. SaveMart is open 365 days/yr. What is the optimal order quantity & ROP?

SAVEMART EOQ

EOQ
D= S= C= I= H= H= 1000 $100 $ 78 40% CxI $31.20

2 D S H

2 1000 $100 EOQ $31.20


EOQ = 80 coffeemakers

SaveMart ROP
ROP = demand over lead time = daily demand x lead time (days) =dxl

D = annual demand = 1000 Days / year = 365 Daily demand = 1000 / 365 = 2.74 Lead time = 5 days

ROP = 2.74 x 5 = 13.7 => 14

SaveMart
Average (Cycle Stock) Inventory

Avg. CS = OQ / 2 = 80 / 2 = 40 coffeemakers = 40 x $78 = $3,120


Inv. CC = $3,120 x 40% = $1,248

Note: unrelated to reorder point

ECONOMIC ORDER QUANTITY

EOQ
D= S= C= I = H=

2 D S H

Annual demand (units) Cost per order ($) Cost per unit ($) Holding cost (%) Holding cost ($) = I x C

EOQ

2 D S H

What if
1. 2. 3. 4. 5. 6. 7. Interest rates go up ? Order processing is automated ? Warehouse costs drop ? Competitive product is introduced ? Product is cost-reduced ? Lead time gets longer ? Minimum order quantity imposed ?

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