Definition
Economic Order Quantity (EOQ) is a decision model used in inventory management to determine the ideal order size that minimizes the total cost of inventory. The EOQ model calculates the optimal quantity of stock that should be purchased or produced to minimize the combined total cost of ordering and holding inventory. The classic EOQ formula is:
\[ EOQ = \sqrt{\frac{2cd}{h}} \]
where:
- Q is the quantity to be purchased or manufactured.
- c is the cost of processing an order for delivery.
- d is the demand in the period for that stock item.
- h is the cost of holding a unit of stock per period.
Examples
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Manufacturing Scenario: A manufacturing company requires raw materials to produce its goods. The company has calculated that the cost of placing an order (c) is $50, the annual demand (d) is 10,000 units, and the holding cost per unit per year (h) is $2. Using the EOQ formula:
\[ EOQ = \sqrt{\frac{2 \times 50 \times 10,000}{2}} = \sqrt{500,000} = 707 \text{ units (rounded)} \]
Thus, the company should order 707 units each time to minimize costs.
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Retail Scenario: A retail store sells electronic gadgets. The store knows that the ordering cost is $100 per order, the annual demand is 3,600 units, and the holding cost per unit per year is $5. Using the EOQ formula:
\[ EOQ = \sqrt{\frac{2 \times 100 \times 3,600}{5}} = \sqrt{144,000} = 379 \text{ units (rounded)} \]
To minimize costs, the store should order 379 units each time.
Frequently Asked Questions (FAQs)
Q: What are the primary assumptions of the EOQ model? A: The EOQ model assumes that the demand rate is constant, the order lead time is fixed, the replenishment is instantaneous, and the holding and ordering costs are constant.
Q: How is EOQ different from Economic Batch Quantity (EBQ)? A: EOQ typically refers to the optimum order size for purchasing items, while EBQ (Economic Manufacturing Quantity) or EBQ (Economic Batch Quantity) refers to the optimal production batch size for manufacturing.
Q: Can EOQ be used for perishable goods? A: EOQ is not typically used for perishable goods due to their shelf-life constraints. Models like the Perishable Inventory Management (PIM) are more appropriate for such items.
Q: What is the impact of discount policies on EOQ? A: Quantity discounts can influence the EOQ calculation by reducing the cost per unit, which might lead to adjustments in the order size to take advantage of the lower price.
Related Terms
- Economic Batch Quantity (EBQ): Similar to EOQ, but used for determining the optimal batch size for manufacturing, considering setup costs and holding costs.
- Reorder Point: The inventory level at which a new order should be placed to avoid stockouts.
- Holding Costs: Costs associated with storing inventory, including warehousing, insurance, and spoilage.
- Ordering Costs: Costs related to placing and receiving orders, including administrative and shipping expenses.
- Safety Stock: Additional inventory held to protect against uncertainties in demand or supply.
Online References
Suggested Books for Further Studies
- “Production and Operations Analysis” by Steven Nahmias: Discusses production analysis techniques including EOQ and its variations.
- “Inventory Management and Production Planning and Scheduling” by Edward Silver, David Pyke, and Rein Peterson: Comprehensive coverage of inventory management, including EOQ models.
- “Principles of Operations Management: Sustainability and Supply Chain Management” by Jay Heizer and Barry Render: Offers insights on EOQ within the context of broader operations management.
