The Definition of EOQ Economic Order Quantity EOQ, or Economic Order Quantity, is defined as the optimal quantity of orders that minimizes total variable costs required to order and hold inventory. The basic model makes the following assumptions: How to use EOQ in your organization Demand is uniform, constant and continuous over time; The leadtime is zero; There is no limit on order size due either to stores capacity; The cost of placing an order is independent of size of order; Exactly the same quantity is ordered each time that a purchase is made. How much inventory should we order each month? The EOQ tool can be used to model the amount of inventory that we should order. 1
Costs EOQ accounts for 3 types of costs: Unit Cost: the cost of the units themselves, assumed to be fixed, regardless of the number of units ordered Inventory-Holding Cost: the cost of holding units in inventory Fixed order cost: represents all the costs associated with placing an order excluding the cost of the units themselves (any administrative costs of placing and/or receiving an order) Inventory Holding Costs Reasonably Typical Profile Category % of Inventory Value Housing (building) cost 6% Material handling costs 3% Labor cost 3% Inventory investment costs 11% Pilferage, scrap, & obsolescence 3% Total holding cost 26% 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 Order quantity Purchase Order Description Purchase Purchase Order Order Description Purchase Order Qty. Qty. Description Description Microwave Microwave Qty. Qty. 1 1 Microwave Microwave 1 1 2
EOQ Model EOQ Model Annual Cost Holding Cost Annual Cost Total Cost Curve Order Cost Holding Cost Order Cost Order Quantity Optimal Order Quantity (Q*) Order Quantity How EOQ Works How EOQ Works Expected Number Orders = N = R/Q* Expected time between orders: P = Purchase cost per unit R = Annual usage in units C = Cost per order event (not per unit) F = Holding cost factor T = Working days / Year N 3
How EOQ Works Real Life Example: The graphic representation of the EOQ equation Real Life Example: Real Life Example: First, Recall the EOQ Equation: P = Purchase cost per unit R = Annual usage in units C = Cost per order event F = Holding cost factor 4
Real Life Example: Real Life Example: Next let s identify the correct variables R = 5200 C = $10 per order P = $2 F = 20% of value of inventory per year Real Life Example: Wrapping It Up EOQ, or Economic Order Quantity, is defined as the optimal quantity of orders that minimizes total variable costs required to order and hold inventory. EOQ = 2 (10) (5200) (2 )(.20) 5
EOQ Example SaveMart EOQ You re 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. Holding cost is 40% of per unit cost. Lead time is 5 days. SaveMart is open 365 days/yr. What is the optimal order quantity? R = 1000 C = $100 P = $ 78 F = 40% H = P x F H = $31.20 EOQ 2 1000 $100 $31.20 EOQ = 80 coffeemakers SaveMart EOQ Example R = 1000 C = $100 P = $ 78 F = 40% H = P x F H = $31.20 Expected Number of Orders: N = R/Q* = 1000/80 = 12 to 13 times Calculate the EOQ of A materials if: The quartal demand for material "A" is 1.500 pieces The purchase price per unit is $80 The holding cost is 20% of the purchase price per unit Fixed costs are $50 per order How many times should we order to meet the annual demand for material "A"? 6
Vendor managed inventory VENDOR MANAGED INVENTORY (VMI) VMI represents a business model in which the buyer of goods provides certain information to a supplier of that product (the quantity of goods sold, liquid stocks) Based on information obtained supplier takes full responsibility for maintaining agreed inventory of the material, where buyer only informs about the increase or decrease of desired inventories Stages of the simple VMI system Stages of the simple VMI system Stage 1 Buyer sends an information about the number of goods sold to the supplier; information can be collected by bar code and sent via EDI (Electronic Data Interchange) or Internet; Stage 2 Supplier is forwarding information about product description and about the amount of the products that are going to be deliverd, date of the delivery and the place of delivery; Supplier is sending all the datas connected with the need of the buyer to the producer via EDI or Internet 7
Stages of the simple VMI system Vendor Managed Inventory: three steps in making it work Stage 3 Producer is restocking the supplies to the wholesalers (suppliers); Stage 4 Supplier is sending products and invoice to the buyer who is paying for the goods. What are the benefits and disadvantages of VMI for the costumers? What are the benefits and disadvantages of VMI for suppliers? Benefits of VMI for the supplier Supplier disadvantages Demand smoothing and forecasting (VMI information improves forecast of customer requirements, thereby enabling producers to plan production to meet costumer demand); Long-term customer relationship (due to high cost to the customer of switching to an alternative supplier); Improved operational flexibility (enabling production times and quantities to be adjusted to suit the supplier). Transfer of costumer costs to the supplier (these costs include handling costs and increased inventory to meet customer needs); Reduced working capital (due to the increase in inventories and operating expenses). 8
Customer advantages include Customer disadvantages Reduced handling and administrative costs (due to the elimination of the need to monitor inventory levels) Increase of working capital (reducing inventory increases inventory turnover ratio) Reduced lead time (from order to delivery) with improved sales. Increased risk (resulting from the dependence on a single supplier) Disclosure of potentially sensitive information to the supplier (the possession of such information will put the supplier in a strong position when a contract is renegotiated) Customers may be better positioned then suppliers to make replenishment decision. Walmart & P&G Walmart & P&G Walmart is ordering Pampers nappies from P&G company Considering that P&G knows more about nappies turnover than Walmart (has information about demand and orders from retailers from across the country), Walmart proposes P&G to keep him informed about the needs of ordering nappies Since the agreement worked well, after some period, P&G takes full responsibility for ordering nappies to all Walmart stores (Walmart switches restocking function to its supplier) Benefits of cooperation: Walmart has eliminated the cost of maintaining Pampers inventory nappies ordering was more efficient (no shortages of products situations) lower level of inventories in the Walmart distribution centers frees up space and reduces his working capital need implementation of this concept requires a high level of trust and cooperation between partners 9
Vendor Managed Inventorythere is more to it than just selling products What Smokey did wrong in presented cases and what they needed to do? 10